Fundamental Ethical and Professional Principles (A) : Acca Strategic Business Reporting (SBR)

ACCA STRATEGIC BUSINESS REPORTING (SBR)
SUMMARY OF TECHNICAL ARTICLES

Objective
This summary of SBR technical articles is drafted to help students to grasp the insights into the course
within the shortest possible time.
Fundamental ethical and professional principles (A)

Accounting Ethics in the Digital Age
In the face of new digital technologies, accountants require more than professional competence to keep
the moral and ethical culture of organizations.
The digital age has increased ethical threats such as follows:

Ethical Threats Explanation
A financial or other interest (personal/organisational) which inappropriately
1. Self-interest threat
influences a professional accountant‟s judgement or behaviour.
A professional accountant will not evaluate appropriately the results of a
2. Self-review threat previous judgement, made earlier in the course of providing a current
service.
A professional accountant will promote a client‟s or employer‟s position to
3. Advocacy
the point that the professional accountant‟s objectivity is compromised.
Owing to an established or close relationship with a client or employer, a
4. Familiarity threat professional accountant will be too sympathetic to that party‟s interests or
too accepting of their work.
A professional accountant will be deterred from acting objectively because
5. Intimidation threat of actual or perceived pressures, including attempts to exercise undue
influence over the professional accountant.
Note:
 A contemporary accountant needs to be aware of new digital scenarios such as cybersecurity,
platform-based business models, big data and analytics, cryptocurrencies, distributed ledgers and
artificial intelligence (AI).
 Stakeholders are much more likely to continue investing their trust in the accountant if there is
belief that the accountant will always act ethically.
The ethical principles which are most likely to be compromised by digital developments are as follows:
Ethical principles Explanation
 A lack of knowledge and expertise will create the risk of compromising
1. Professional professional competence and due care.
competence and due  Professional accountants will need to learn new information relatively
care quickly, and to apply their judgement to this information, often in
situations they may not have seen before.
 The risk that objectivity may be compromised arises from intimidation
2. Objectivity
from a hacker‟s threats that data will be misused or destroyed.
 A lack of confidentiality could get customers or employees data to be
compromised.
3. Confidentiality  Professional accountants need to know where there is information of
value to external parties and should ensure that there are controls to
secure it.
4. Integrity  Professional accountants must be honest about whether they are
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comfortable with their knowledge of digital technologies and may need
to consider the public interest when they are dealing with large volumes
of sensitive information.
Big Data and Artificial Intelligence (AI)

 The use of big data and AI can enable quicker, more consistent, evidence-based and accurate
decisions.
 AI should be lawful, ethical and robust.
 The accountant should review the governance and assurance needed around AI, so that all
stakeholders can have confidence in its appropriate use.
How ethical issues may arise for the accountant:

a) Artificial intelligence, like human intelligence, may be used maliciously.
b) There are risks of bias in the system in unexpected and potentially detrimental ways.
c) AI will be a threat to certain categories of employment.
d) There is the question of technical safety and failure.
Ways of addressing an ethical issue:

a) The accountant must determine the nature of the decision that has to be made by determining the
context of the ethical dilemma.
b) The accountant must determine whose rights and interests are affected by the decision.
c) The accountant must determine the rules of professional practice, internal and external
governance codes and relevant laws.
d) The accountant needs to set out the arguments in for and against taking a particular course of
action.
e) The accountant needs to formulate a solution that does justice to the arguments for and against the
action to be taken.
f) The accountant needs to take into account any negative consequences of taking or not taking the
action.
Summary
Although the environment in which an accountant operates may become more digitalised, the basic
ethical considerations remain the same. However, there may be some additional things that the accountant
may need to think about if s/he finds herself/himself in an ethical dilemma that is set in a digital context.
These considerations are summarised above and SBR candidates should have an awareness of these
whilst preparing themselves for their forthcoming SBR exam and professional career.
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The Financial Reporting Framework (B)
This article explains the current rules and the conceptual debate as to where profits and losses should be
recognised in the statement of profit or loss and other comprehensive income– ie when should they be
recognised in profit or loss and when in the other comprehensive income. Further, it explores the debate
as to whether it is appropriate to recognise profits or losses twice!
 The performance of a company is reported in the statement of profit or loss and other
comprehensive income.
a) IAS® 1, Presentation of Financial Statements, defines profit or loss as ‘the total of
income less expenses, excluding the components of other comprehensive income’.
b) Other comprehensive income (OCI) is defined as comprising ‘items of income and
expense (including reclassification adjustments) that are not recognised in profit or loss
as required or permitted by other International Financial Reporting Standards (IFRS®).
c) Total comprehensive income is defined as „the change in equity during a period resulting
from transactions and other events, other than those changes resulting from transactions
with owners in their capacity as owners‟.
 It is a myth, and incorrect, to state that only realised gains are included in the statement of profit
or loss (SOPL) and that only unrealised gains and losses are included in the OCI. For example,
gains on the revaluation of land and buildings accounted for in accordance with IAS 16, Property
Plant and Equipment (IAS 16 PPE), are recognised in OCI and accumulate in equity in Other
Components of Equity (OCE). On the other hand, gains on the revaluation of land and buildings
accounted for in accordance with IAS 40, Investment Properties, are recognised in SOPL and are
part of the Retained Earnings (RE). Both such gains are unrealised.
 The same point could be made with regard to the gains and losses on the financial asset of equity
investments. If such financial assets are designated in accordance with IFRS 9, Financial
Instruments (IFRS 9), at inception as Fair Value Through Other Comprehensive Income
(FVTOCI) then the gains and losses are recognised in OCI and accumulated in OCE. Whereas if
management decides not to make this election, then the investment will by default be designated
and accounted for as Fair Value Through Profit or Loss (FVTP&L) and the gains and losses are
recognised in SOPL and become part of RE.
 There is at present no overarching accounting theory that justifies or explains in which part of the
statement gains and losses should be reported. So rather than have a clear principles based
approach what we currently have is a rules based approach to this issue. It is down to individual
accounting standards to direct when gains and losses are to be reported in OCI. This is clearly an
unsatisfactory approach. It is confusing for users.
 In March 2018, the Board published its Conceptual Framework for Financial Reporting. It
suggests that the SOPL should provide the primary source of information about the entity’s
financial performance for the reporting period. Accordingly, the SOPL should recognise all
income and expense. However, the Board also provide exceptional circumstances where income
or expenses arising from the change in the carrying amount of an asset or liability should be
included in OCI. This will usually occur to allow the SOPL to provide more relevant information
or provide a more faithful representation of an entity’s performance. Whilst this may be an
improvement on the absence of general principles, it might be argued that it does not provide the
clarity and certainty users crave.
Recycling (The Reclassification from Equity to P&L)

 Recycling is the process where gains or losses are reclassified from equity to SOPL as an
accounting adjustment.
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 The gains or losses are first recognised in the OCI and then later in the SOPL. In this way the
gain or loss is reported in the total comprehensive income of two accounting periods and in
colloquial terms is said to be recycled as it is recognised twice.
 At present it is down to individual accounting standards to direct when gains and losses are to be
reclassified from equity to SOPL as a reclassification adjustment. So rather than have a clear
principles based approach on recycling what we currently have is a rules based approach to this
issue.
 For example, IAS 21 The Effects of Changes in Foreign Exchange Rates (IAS 21), is one
example of a standard that requires gains and losses to be reclassified from equity to SOPL as a
reclassification adjustment. When a group has an overseas subsidiary a group exchange
difference will arise on the re-translation of the subsidiary‟s goodwill and net assets. In
accordance with IAS 21 such exchange differences are recognised in OCI and so accumulate in
OCE. On the disposal of the subsidiary, IAS 21 requires that the net cumulative balance of group
exchange differences be reclassified from equity to P&L as a reclassification adjustment – ie the
balance of the group exchange differences in OCE is transferred to SOPL to form part of the
profit on disposal.
 Alternatively, IAS 16 PPE is an example of a standard that prohibits gains and losses to be
reclassified from equity to SOPL. If we consider land that cost $10m which is treated in
accordance with IAS 16 PPE. If the land is subsequently revalued to $12m, then the gain of $2m
is recognised in a revaluation reserve and will be taken to OCE. When in a later period the asset is
sold for $13m, IAS 16 PPE specifically requires that the profit on disposal recognised in the
SOPL is $1m – ie the difference between the sale proceeds of $13m and the carrying amount of
$12m. The previously recognised gain of $2m is not recycled/reclassified back to SOPL as part of
the gain on disposal. However the $2m balance in the revaluation surplus is now redundant as the
asset has been sold and the profit is realised. Accordingly, there will be a transfer in the Statement
of Changes in Equity, from the OCE of $2m into RE.
Double Entry
The purchase, the revaluation, the disposal and the transfer to RE is accounted for in this way.
On purchase $m $m
Dr Land PPE 10
Cr Cash 10
On revaluation
Dr Land PPE 2
Cr Revaluation surplus and recognised in OCI 2
On disposal
Dr Cash 13
Cr Land PPE 12
Cr SOPL 1
On transfer
Dr Revaluation surplus/OCE 2
Cr Retained earnings 2
If IAS 16 PPE allowed the reclassification from equity to SOPL as a reclassification adjustment, the profit
on disposal recognised in SOPL would be $3m including the $2m reclassified from equity to SOPL and
the last two double entries above replaced with the following.
On reclassification from equity to SOPL $m $m

Dr Cash 13
Cr Land PPE 12
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Cr SOPL 3
Dr Revaluation surplus/OCE 2
 IFRS 9 also prohibits the recycling of the gains and losses on FVTOCI investments to SOPL on
disposal. The no reclassification rule in both IAS 16 PPE and IFRS 9 means that such gains on
those assets are only ever reported once in the statement of profit or loss and other comprehensive
income – ie are only included once in total comprehensive income.
 However many users, it appears, rather ignore the total comprehensive income and the OCI and
just base their evaluation of a company‟s performance on the SOPL.
 These users then find it strange that gains that have become realised from transactions in the
accounting period are not fully reported in the SOPL of the accounting period. As such we can
see the argument in favour of reclassification. With no reclassification the earnings per share will
never fully include the gains on the sale of PPE and FVTOCI investments.
 The following extract from the statement of comprehensive income summarises the current
accounting treatment for which gains and losses are required to be included in OCI and, as
required, discloses which gains and losses can and cannot be reclassified back to profit and loss.
Extract from the statement of profit or loss and other comprehensive income
$m
Profit for the year XX
Other comprehensive income
Gains and losses that cannot be reclassified back to profit or loss
Changes in revaluation surplus where the revaluation method is used in accordance XX / (XX)
with IAS 16
Remeasurements of a net defined benefit liability or asset recognised in accordance XX / (XX)
with IAS 19
Gains and losses on remeasuring FVTOCI financial assets in accordance with IFRS 9 XX / (XX)
Gains and losses that can be reclassified back to profit or loss
Group exchange differences from translating functional currencies into presentation XX / (XX)
currency in accordance with IAS 21
The effective portion of gains and losses on hedging instruments in a cash flow XX / (XX)
hedge under IFRS 9
Total comprehensive income XX / (XX)
Different Approaches to Reclassification

1. Ignore all possible reclassifications;
2. Permit only a few reclassifications (narrow approach); or
3. Permit all reclassifications if they provide useful information (broad approach).
No OCI and No Reclassification

It can be argued that reclassification should simply be prohibited. This would free the statement of profit
or loss and other comprehensive income from the need to formally to classify gains and losses between
SOPL and OCI.
Advantages of No OCI and No Reclassification

1. This would reduce complexity
2. The gains and losses could only ever be recognised once.
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Disadvantages of No OCI and No Reclassification
There would still remain the issue of how to define the earnings in earnings per share, as clearly total
comprehensive income would contain too many gains and losses that were non-operational, unrealised,
outside the control of management and not relating to the accounting period.
Narrow Approach to the OCI

 Only bridging and mismatch gains and losses should be included in OCI and be reclassified from
equity to SOPL.
 A revaluation surplus on a financial asset classified as FVTOCI is a good example of a bridging
gain. The asset is accounted for at fair value on the statement of financial position but effectively
at cost in SOPL. As such, by recognising the revaluation surplus in OCI, the OCI is acting as a
bridge between the statement of financial position and the SOPL. On disposal, reclassification
ensures that the amount recognised in SOPL will be consistent with the amounts that would be
recognised in SOPL if the financial asset had been measured at amortised cost.
 The effective gain or loss on a cash flow hedge of a future transaction is an example of a
mismatch gain or loss as it relates to a transaction in a future accounting period so needs to be
carried forward so that it can be matched in the SOPL of a future accounting period. Only by
recognising the effective gain or loss in OCI and allowing it to be reclassified from equity to
SOPL can users to see the results of the hedging relationship.
Broad Approach to The OCI

Include transitory gains and losses. The Board would decide on each IFRS whether a transitory
remeasurement should be subsequently recycled. Examples of transitory gains and losses are those that
arise on the remeasurement of defined benefit pension funds and revaluation surpluses on PPE.
Conclusion
 The Board has adopted the latter approach in its March 2018 Conceptual Framework stating that
reclassifications from OCI to SOPL are permitted '…in a future period when doing so results in
the [SOPL] providing more relevant information, or providing a more faithful representation of
the entity‟s financial performance for that future period'.
 However, if there is no clear basis to identify the period or the amount that should be reclassified,
the Board, when developing IFRS standards, may decide that no classification should occur.
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Profit, Loss and Other Comprehensive Income

This article looks at what differentiates profit or loss from other comprehensive income and where items
should be presented.
1. The purpose of the statement of profit or loss and other comprehensive income (OCI) is to show an
entity‟s financial performance in a way that is useful to a wide range of users so that they may attempt
to assess the future net cash inflows of an entity. The statement should be classified and aggregated in
a manner that makes it understandable and comparable.
2. IFRS currently require the statement to be presented as either one statement, being a combined
statement of profit or loss and other comprehensive income or two statements, being the statement
of profit or loss and the statement of profit or loss and other comprehensive income. An entity has
to show separately in OCI, those items which would be reclassified (recycled) to profit or loss and
those items which would never be reclassified (recycled) to profit or loss. The related tax effects have
to be allocated to these sections.
3. Profit or loss includes all items of income or expense (including reclassification adjustments) except
those items of income or expense that are recognised in OCI as required or permitted by IFRS
standards. Reclassification adjustments are amounts recycled to profit or loss in the current period
that were recognised in OCI in the current or previous periods.
4. An example of items recognised in OCI that may be reclassified to profit or loss are foreign currency
gains on the disposal of a foreign operation and realised gains or losses on cash flow hedges. Those
items that may not be reclassified are changes in a revaluation surplus under IAS ® 16, Property, Plant
and Equipment, and actuarial gains and losses on a defined benefit plan under IAS 19, Employee
Benefits.
5. However, there is a general lack of agreement about which items should be presented in profit or loss
and in OCI. The interaction between profit or loss and OCI is unclear, especially the notion of
reclassification and when or which OCI items should be reclassified. A common misunderstanding is
that the distinction is based upon realised versus unrealised gains. This lack of a consistent basis for
determining how items should be presented has led to an inconsistent use of OCI in IFRS standards. It
may be difficult to deal with OCI on a conceptual level since the International Accounting Standards
Board (the Board) is finding it difficult to find a sound conceptual basis. However, there is urgent
need for some guidance around this issue.
6. Opinions vary but there is a feeling that OCI has become a ‘dumping ground’ for anything
controversial because of a lack of clear definition of what should be included in the statement. Many
users are thought to ignore OCI as the changes reported are not caused by the operating flows used
for predictive purposes. Financial performance is not defined in the Conceptual Framework for
Financial Reporting® but could be viewed as reflecting the value the entity has generated in the period
and this can be assessed from other elements of the financial statements and not just the statement of
profit or loss and other comprehensive income. Examples would be the statement of cash flows and
disclosures relating to operating segments. The presentation in profit or loss and OCI should allow a
user to depict financial performance including the amount, timing and uncertainty of the entity‟s
future net cash inflows and how efficiently and effectively the entity‟s management has discharged
their duties regarding the resources of the entity.
Reclassification: For and Against

For
1. If reclassification ceased, then there would be no need to define profit or loss, or any other total or
subtotal in profit or loss, and any presentation decisions can be left to specific IFRS standards. It
is argued that reclassification protects the integrity of profit or loss and provides users with
relevant information about a transaction that occurred in the period.
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2. Additionally, it can improve comparability where IFRS standards permit similar items to be
recognised in either profit or loss or OCI.
Against
1. The recycled amounts add to the complexity of financial reporting, which may lead to earnings
management and the reclassification adjustments may not meet the definitions of income or
expense in the period as the change in the asset or liability may have occurred in a previous
period.
2. The original logic for OCI was that it kept income-relevant items that possessed low reliability
from contaminating the earnings number. Markets rely on profit or loss and it is widely used. The
OCI figure is crucial because it can distort common valuation techniques used by investors, such
as the price/earnings ratio. Thus, profit or loss needs to contain all information relevant to
investors. Misuse of OCI would undermine the credibility of net income.
3. The use of OCI as a temporary holding for cash flow hedging instruments and foreign currency
translation is non-controversial. However, other treatments such the policy of IFRS 9 to allow
value changes in equity investments to go through OCI, are not accepted universally.
4. US GAAP will require value changes in all equity investments to go through profit or loss.
Accounting for actuarial gains and losses on defined benefit schemes are presented through OCI
and certain large US corporations have been hit hard with the losses incurred on these schemes.
The presentation of these items in OCI would have made no difference to the ultimate settled
liability but if they had been presented in profit or loss, the problem may have been dealt with
earlier. An assumption that an unrealised loss has little effect on the business is an incorrect one.
5. The Board‟s preliminary view is that any requirement to present a profit or loss total or subtotal
could also result in some items being reclassified. The commonly suggested attributes for
differentiation between profit or loss and OCI (realised/unrealised, frequency of occurrence,
operating/non-operating, measurement certainty/uncertainty, realisation in the short/long-term or
outside management control) are difficult to distil into a set of principles.
Therefore, the Board is suggesting two broad principles, namely:

a) Profit or loss provides the primary source of information about the return an entity has made on
its economic resources in a period.
b) To support profit or loss, OCI should only be used if it makes profit or loss more relevant.
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The Conceptual Framework

In March 2018, the International Accounting Standards Board (the Board) finished its revision of The
Framework for Financial Reporting (the Framework).
The Primary Purpose of Financial Information

To provide useful information to existing and potential investors, lenders and other creditors (users) when
making decisions about the financing of the entity and exercising rights to vote on, or otherwise influence,
management‟s actions that affect the use of the entity‟s economic resources.
Chapter 1 – The Objective of General-Purpose Financial Reporting

The purpose of the Framework is to:
1. assist the IASB to develop and revise its standards
2. assist entities to develop consistent accounting policies when no standard applies to a particular
transaction or other event, or when a standard allows a choice of accounting policy, and
3. assist all stakeholders to understand and interpret the standards
Note
IFRSs take precedence over the Framework. However, should new IFRSs depart from the Framework, the
IASB will explain the reasons in the Basis for Conclusions on that standard.
Users base their expectations of returns on their assessment of:

1. the amount, timing and uncertainty of future net cash inflows to the entity, and
2. management‟s stewardship of the entity‟s resources.
Chapter 2 – Qualitative Characteristics of Useful Financial Information

The characteristics are subject to cost constraints, and it is therefore important to determine whether the
benefits to users of the information justify the cost incurred by the entity providing it.
Fundamental qualitative characteristics of useful financial information

1. Relevance
2. Faithful representation
Enhancing qualitative characteristics of useful financial information

1. Timeliness
2. Understandability
3. Verifiability
4. Comparability.
Note
Whilst the qualitative characteristics remain unchanged, the Board decided to reinstate explicit references
to prudence and substance over form.
Prudence
1. The exercise of caution when making judgements under conditions of uncertainty
2. Support of the principle of neutrality for the purposes of faithful representation
Substance over form

1. Not a separate component of faithful representation
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2. If financial statements represented a legal form that differed from the economic substance, then
they could not result in a faithful representation.
For example
 Many standards, such as IAS 37 Provisions, Contingent Liabilities and Contingent Assets, apply a
system of asymmetric prudence.
 In IAS 37, a probable outflow of economic benefits would be recognised as a provision, whereas a
probable inflow would only be shown as a contingent asset and merely disclosed in the financial
statements.
 Therefore, two sides in the same court case could have differing accounting treatments despite the
likelihood of the pay-out being identical for either party.
Measurement Reliability Versus Measurement Uncertainties

 Many users would prefer the concept of measurement reliability, but the Framework provides
clarification concerning measurement uncertainties which are defined in terms of faithful
representation.
 Faithful representation of information does not mean that that information must be accurate in all
respects.
 As the use of estimates are an essential part of the preparation of financial information and this does
not necessarily weaken the usefulness of the information.
Chapter 3 – Financial Statements And The Reporting Entity

Reporting Entity
An entity that chooses or is required to prepare general purpose financial statements.
The Basic Assumption

 The general purpose financial statements are prepared on the assumption that the reporting entity
is a going concern.
 If this assumption is not appropriate, they are prepared in accordance with a basis other than
IFRSs.
 The Framework explains that this assumption means that the entity has neither the intention nor
the need to enter liquidation or cease trading in the foreseeable future.
Chapter 4 – The Elements of Financial Statements

Note
The Board has changed the definitions of assets and liabilities. The changes to the definitions of assets
and liabilities can be seen below.
2010 2018
Term Supporting Concept
Definition Definition
A resource controlled by the
A present economic
entity as a result of past events
Asset (of resource controlled by the
and from which future economic
an entity) entity as a result of past
benefits are expected to flow to
events.
the entity.
A right that has
Economic the potential to
resource produce economic
benefits
Liability A present obligation of the A present obligation of An entity‟s obligation to
(of an entity arising from past events, the entity to transfer an transfer and economic resource
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entity) the settlement of which economic resource as a must have the potential to
is expected to result in an result of past events. require the entity to transfer an
outflow from the entity of economic resource to another
resources embodying economic party.
benefits.
A duty of responsibility
Obligation that an entity has no
practical ability to avoid.
Note
 Whilst the concept of „control’ remains for assets and ‘present obligation’ for liabilities, the key
change is that the term „expected’ has been replaced.
 For assets, ‘expected economic benefits’ has been replaced with ‘the potential to produce
economic benefits’.
 For liabilities, the ‘expected outflow of economic benefits’ has been replaced with the ‘potential
to require the entity to transfer economic resources’.
 The reason for this change is that some people interpret the term „expected‟ to mean that an item
can only be an asset or liability if some minimum threshold were exceeded.
 As no such interpretation has been applied by the Board in setting recent IFRS Standards, this
definition has been altered in an attempt to bring clarity.
Chapter 5 – Recognition and Derecognition

New Approach to Recognition
1. The decision should be made by reference to the qualitative characteristics of financial
information.
2. An entity should recognise an asset or a liability (and any related income, expense or changes in
equity) if such recognition provides users of financial statements with:
 relevant information about the asset or the liability and about any income, expense or changes
in equity
 a faithful representation of the asset or liability and of any income, expenses or changes in
equity, and
 information that results in benefits exceeding the cost of providing that information.
3. A key change to this is the removal of a „probability criterion‟. This also means that it will not
specifically prohibit the recognition of assets or liabilities with a low probability of an inflow or
outflow of economic resources.
4. The chapter 5; paragraph 15 of the Framework states that „an asset or liability can exist even if
the probability of an inflow or outflow of economic benefits is low‟.
New Approach to Derecognition

The Framework states that derecognition should aim to represent faithfully both:
a) the assets and liabilities retained after the transaction or other event that led to the derecognition
(including any asset or liability acquired, incurred or created as part of the transaction or other
event), and
b) the change in the entity‟s assets and liabilities as a result of that transaction or other event.
Chapter 6 – Measurement
The selection of a measurement basis must take into account:
 Relevance and faithful representation)
 The characteristics of the element,
 The contribution to cash flows due to economic activities, and
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 Measurement uncertainty and the cost constraint.
But Note
 Entity-specific information is more useful than standardised descriptions
 Duplication of information in different parts of the financial statements is unnecessary and can
make financial statements less understandable.
Historical Cost
 This accounting treatment is unchanged, but the Framework now explains that the carrying
amount of non-financial items held at historical cost should be adjusted over time to reflect the
usage (in the form of depreciation or amortisation).
 Alternatively, the carrying amount can be adjusted to reflect that the historical cost is no longer
recoverable (impairment).
 Financial items held at historical cost should reflect subsequent changes such as interest and
payments, following the principle often referred to as amortised cost.
Measurements of Current Value

 Fair value
The price in an orderly transaction between market participants (exit value).
 Value in use (or fulfilment value for liabilities):
An entity-specific value (i.e., the present value of the cash flows that an entity expects to derive
from the continuing use of an asset and its ultimate disposal) (exit values).
 Current cost
An entry value (i.e., the value in which the entity would acquire the asset or incur the liability) at
current market prices.
Note
 The Framework says that historical cost may not provide relevant information about assets held
for a long period of time, and are certainly unlikely to provide relevant information about
derivatives. In both cases, it is likely that some variation of current value will be used to provide
more predictive information to users.
 Conversely, the Framework suggests that fair value may not be relevant if items are held solely
for use or to collect contractual cash flows. Alongside this, the Framework specifically mentions
items used in a combination to generate cash flows by producing goods or services to customers.
As these items are unlikely to be able to be sold separately without penalising the activities, a
cost-based measure is likely to provide more relevant information, as the cost is compared to the
margin made on sales.
Chapter 7 – Presentation And Disclosure

1. Income and expenses should be included in the SOPL unless relevance or faithful representation
would be enhanced by including a change in the current value of an asset or a liability in OCI.
2. IAS 1 Presentation of Financial Statements suggests the recycling of items in OCI into P/L
should be disclosed as items to be reclassified into profit or loss, or not reclassified.
3. Some commenters argue that all OCI items should be recycled.
4. Others argue that OCI items should never be recycled, whilst some argue that only some items
should be recycled.
5. Income and expenses included in OCI should be recycled when doing so would enhance the
relevance or faithful representation of the information.
6. OCI may not be recycled if there is no clear basis for identifying the period in which recycling
should occur.
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Reporting the Financial Performance of a Range of Entities
(C)
IFRS for SMEs
The Principal Aim
To provide a framework that generates relevant, reliable and useful information which should provide a
high quality and understandable set of accounting standards suitable for SMEs that can be applied by
eligible entities in place of the full set of International Financial Reporting Standards (IFRS® standards).
Details
1. In July 2009, the IASB issued the IFRS for SMEs Standard (the SMEs Standard) and amended in
2015. There are a number of accounting standards and disclosures that may not be relevant for the
users of SME financial statements.
2. As a result, the standard does not address the following topics:
 Earnings per share
 Interim financial reporting
 Segment reporting
 Insurance (entities that issue insurance contracts are not eligible to use the standard),
 Assets held for sale.
3. In addition, there are certain accounting treatments that are not allowable under the SMEs
Standard. An example of these disallowable treatments is the capitalisation of borrowing and
development costs – under IFRS for SME‟s they would be expensed to profit or loss.
4. Additionally, the SMEs Standard requires that all basic financial instruments are measured at
amortised cost using the effective interest method except for investments in non-convertible and
non-puttable ordinary and preference shares that are publicly traded or whose fair value can
otherwise be measured reliably are measured at fair value through profit or loss. All amortised
cost instruments must be tested for impairment.
5. At the same time the standard simplifies the derecognition and disclosure requirements. The SME
Standard separates basic and other financial instruments e.g. hedging instruments, swaps, options.
However, the SME Standard still offers significant simplifications even for more complex
financial instruments. SMEs can choose to apply the recognition and measurement requirements
of IAS 39 if they so wish.
6. The standard also contains a section on transition, which allows all of the exemptions in IFRS
1, First-time Adoption of International Financial Reporting Standards. It also contains
'impracticability' exemptions for comparative information and the restatement of the opening
statement of financial position although these must be disclosed.
7. As a result of the above, the SMEs Standard requires SMEs to comply with less than 10% of the
volume of disclosure requirements applicable to listed companies complying with the full set of
IFRS Standards.
8. The SMEs Standard is intended for use by entities that have no public accountability (ie its debt
or equity instruments are not publicly traded or holds assets in a fiduciary capacity eg most banks
and financial institutions).
9. Ultimately, the decision regarding which entities should use the SMEs Standard stays with
national regulatory authorities and standard setters. If an entity opts to use the SMEs Standard, it
must follow the standard in its entirety - it cannot cherry pick between the requirements of the
SMEs Standard and those of full IFRS Standards.
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10. The Board makes it clear that the prime users of IFRS Standards are the capital markets. This
means that IFRS Standards are primarily designed for quoted companies and not SMEs. The vast
majority of the world's companies are small and privately owned, and it could be argued that
IFRS Standards are not relevant to their needs or to the needs of their users. It is often thought
that small business managers perceive the cost of compliance with accounting standards to be
greater than their benefit.
11. To this end, the SMEs Standard makes numerous simplifications to the recognition, measurement
and disclosure requirements in full IFRS Standards.
Examples of these simplifications are:
 Goodwill and other indefinite-life intangibles are amortised over their useful lives, but if
useful life cannot be reliably estimated, then 10 years
 A simplified calculation is allowed if measurement of defined benefit pension plan
obligations (under the projected unit credit method) involves undue cost or effort
 The cost model is permitted for investments in associates and joint ventures.
Arguments for IFRS for SMEs

1. Undue cost burden of reporting, which is proportionately heavier for smaller firms. The cost
burden of applying the full set of IFRS Standards may not be justified on the basis of user needs.
2. Much of the current reporting framework is based on the needs of large business, so SMEs
perceive that the full statutory financial statements are less relevant to the users of SME accounts.
3. SMEs also use financial statements for a narrower range of decisions, as they have less complex
transactions and therefore less need for a sophisticated analysis of financial statements. Thus, the
disclosure requirements in the SMEs Standard are also substantially reduced when compared with
those in full IFRS Standards partly because they are not considered appropriate for users' needs
and for cost-benefit considerations.
4. Many disclosures in full IFRS Standards are more relevant to investment decisions in capital
markets than to the transactions undertaken by SMEs.
Arguments for IFRS for SMEs

1. It may lead to a two-tier system of reporting. Entities should not be subject to different rules,
which could give rise to different 'true and fair views'.
Note
 Entities that are eligible to apply the SMEs Standard, and that choose to do so, must apply that
standard in full and cannot chose the most suitable accounting policy from full IFRS Standards or
the SMEs Standard.
 The Board are expected to limit revisions to the SME Standard to once every three years although
the process means in reality the time frames are longer. The IASB are currently (2021) in the
process of consulting on whether and how to align the IFRS for SME standard with the full IFRS
standards to better serve the users and preparers of financial statements without causing undue
cost and effort to SMEs.
 Where financial statements are prepared using the SMEs Standard, the basis of presentation note
and the auditor's report will refer to compliance with the SMEs Standard. This reference may
improve access to capital.
 In the absence of specific guidance on a particular subject. An SME may, but is not required to,
consider the requirements and guidance in full IFRS Standards dealing with similar issues. The
Board has produced full implementation guidance for SMEs.
 There may be some important tax issues arising for SMEs that adopt the SMEs Standard and this
has been cited as one of the main reasons why some SMEs have not adopted the SME Standard.
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Deferred Tax – IAS 12

Deferred tax is a topic that is consistently tested in Financial Reporting (FR) and is often tested in
further detail in Strategic Business Reporting (SBR). This article will start by considering aspects of
deferred tax that are relevant to FR before moving on to the more complicated situations that may be
tested in SBR.
The Basics
1. In FR, deferred tax normally results in a liability being recognised within the SFP.
2. IAS 12 defines a deferred tax liability as being the amount of income tax payable in future
periods in respect of taxable temporary differences.
3. So, in simple terms, deferred tax is tax that is payable in the future.
4. Temporary differences are defined as being differences between the carrying amount of an asset
(or liability) within the Statement of Financial Position and its tax base, i.e. the amount at which
the asset (or liability) is valued for tax purposes by the relevant tax authority.
5. IAS 12 requires that a deferred tax liability is recorded in respect of all taxable temporary
differences that exist at the year-end – this is sometimes known as the full provision method.
6. All of this terminology can be rather overwhelming and difficult to understand, so consider it
alongside an example. Depreciable non-current assets are the typical deferred tax example used in
FR.
 Within financial statements, non-current assets with a limited useful life are subject to
depreciation.
 However, within tax computations, non-current assets are subject to capital allowances
(also known as tax depreciation) at rates set within the relevant tax legislation.
 Where at the year-end the cumulative depreciation charged and the cumulative capital
allowances claimed are different, the carrying amount of the asset (cost less accumulated
depreciation) will then be different to its tax base (cost less accumulated capital
allowances) and hence a taxable temporary difference arises.
EXAMPLE 1
A non-current asset costing $2,000 was acquired at the start of year 1. It is being depreciated straight line
over four years, resulting in annual depreciation charges of $500. Thus a total of $2,000 of depreciation is
being charged. The capital allowances granted on this asset are:
$
Year 1 800
Year 2 600
Year 3 360
Year 4 240
Total capital allowances 2,000
Table 1 shows the carrying amount of the asset, the tax base of the asset and therefore the temporary
difference at the end of each year. So, how does the above example result in tax being payable in the
future?
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 In the above example, when the capital allowances are greater than the depreciation expense in
years 1 and 2, the entity has received tax relief early. This is good for cash flow in that it delays
(ie defers) the payment of tax. However, the difference is only a temporary difference and so the
tax will have to be paid in the future. In years 3 and 4, when the capital allowances for the year
are less than the depreciation charged, the entity is being charged additional tax and the
temporary difference is reversing. Hence the temporary differences can be said to be taxable
temporary differences.
 Notice that overall, the accumulated depreciation and accumulated capital allowances both equal
$2,000 – the cost of the asset – so over the four-year period, there is no difference between the
taxable profits and the profits per the financial statements.
 At the end of year 1, the entity has a temporary difference of $300, which will result in tax being
payable in the future (in years 3 and 4). In accordance with the concept of prudence, a liability is
therefore recorded equal to the expected tax payable.
 Assuming that the tax rate applicable to the company is 25%, the deferred tax liability that will be
recognised at the end of year 1 is 25% x $300 = $75. This will be recorded by crediting
(increasing) a deferred tax liability in the Statement of Financial Position and debiting
(increasing) the tax expense in the Statement of Profit or Loss.
 By the end of year 2, the entity has a taxable temporary difference of $400, ie the $300 bought
forward from year 1, plus the additional difference of $100 arising in year 2. A liability is
therefore now recorded equal to 25% x $400 = $100. Since there was a liability of $75 recorded
at the end of year 1, the double entry that is recorded in year 2 is to credit (increase) the liability
and debit (increase) the tax expense by $25.
 At the end of year 3, the entity‟s taxable temporary differences have decreased to $260 (since the
company has now been charged tax on the difference of $140). Therefore, in the future, the tax
payable will be 25% x $260 = $65. The deferred tax liability now needs reducing from $100 to
$65 and so is debited (a decrease) by $35. Consequently, there is now a credit (a decrease) to the
tax expense of $35.
 At the end of year 4, there are no taxable temporary differences since now the carrying amount of
the asset is equal to its tax base. Therefore, the opening liability of $65 needs to be removed by a
debit entry (a decrease) and hence there is a credit entry (a decrease) of $65 to the tax expense.
This can all be summarised in the following working.
The movements in the liability are recorded in the SOPL as part of the taxation charge
Year 1 2 3 4
$ $ $ $
Opening deferred tax liability 0 75 100 65
Increase/(decrease) in the year 75 25 (35) (65)
Closing deferred tax liability 75 100 65 0
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Note
1. The closing figures are reported in the Statement of Financial Position as part of the deferred
tax liability.
2. The movement in the deferred tax liability in the year is recorded in the Statement of Profit or
Loss where:
 an increase in the liability, increases the tax expense
 a decrease in the liability, decreases the tax expense.
The Statement of Profit or Loss

Continuing with the previous example, suppose that the profit before tax of the entity for each of years 1
to 4 is $10,000 (after charging depreciation). Since the tax rate is 25%, it would then be logical to expect
the tax expense for each year to be $2,500. However, income tax is based on taxable profits not on the
accounting profits.
The FR exam
Here are some hints on how to deal with the Deferred tax information in the question.
1. The deferred tax liability given within the trial balance or draft financial statements will be the
opening liability balance.
2. In the notes to the question there will be information to enable you to calculate the closing
liability for the SFP or the increase/decrease in the liability.
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3. It is important that you read the information carefully. You will need to ascertain exactly what
you are being told within the notes to the question and therefore how this relates to the working
that you can use to calculate the figures for the answer.
Revaluations of non-current assets (NCA)

1. When an NCA is revalued to its current value within the financial statements, the revaluation
surplus is recorded in equity (in a revaluation reserve) and reported as other comprehensive
income.
2. While the carrying amount of the asset has increased, the tax base of the asset remains the same
and so a temporary difference arises.
3. Tax will become payable on the surplus when the asset is sold and so the temporary difference is
taxable.
4. Since the revaluation surplus has been recognised within equity, to comply with matching, the tax
charge on the surplus is also charged to equity.
Suppose that in Example 1, the asset is revalued to $2,500 at the end of year 2, as shown in Table 5.
5. The carrying amount will now be $2,500 while the tax base remains at $600. There is, therefore, a
temporary difference of $1,900, of which $1,500 relates to the revaluation surplus. This gives rise
to a deferred tax liability of 25% x $1,900 = $475 at the year-end to report in the Statement of
Financial Position. The liability was $75 at the start of the year (Example 1) and thus there is an
increase of $400 to record.
6. However, the increase in relation to the revaluation surplus of 25% x $1,500 = $375 will be
charged to the revaluation reserve and reported within other comprehensive income. The
remaining increase of $25 will be charged to the Statement of Profit or Loss as before.
The overall double entry is:

Dr Tax expense in Statement of Profit or Loss $25
Dr Revaluation reserve in equity $375
Cr Deferred tax liability in SFP $400
The SBR Exam

 Deferred tax can arise in respect of many different types of asset or liability and not just non-
current assets as discussed above.
 Therefore, for SBR it is more important that candidates understand the principles behind deferred
tax so that they can be applied to any given situation. Some of the situations that may be seen are
discussed below.
Note
In all of the following situations, assume that the applicable tax rate is 25%.
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Deferred Tax Assets
1. It is important to be aware that temporary differences can result in needing to record a deferred
tax asset instead of a liability.
2. Temporary differences affect the timing of when tax is paid or when tax relief is received.
3. While normally they result in the payment being deferred until the future or relief being received
in advance (and hence a deferred tax liability) they can result in the payment being accelerated or
relief being due in the future.
4. In these latter situations the temporary differences result in a deferred tax asset arising (or where
the entity has other larger temporary differences that create deferred tax liabilities, a reduced
deferred tax liability).
5. Whether an individual temporary difference gives rise to a deferred tax asset or liability can be
ascertained by applying the following rule:
Carrying amount of asset / Tax base of asset /

- = Temporary difference
(Liability) (Liability)
Note
 If the temporary difference is positive, a deferred tax liability will arise.
 If the temporary difference is negative, a deferred tax asset will arise.
EXAMPLE 3
1. Suppose that at the reporting date the carrying amount of a non-current asset is $2,800 while its
tax base is $3,500, as shown in Table 6 above.
2. In this scenario, the carrying amount of the asset has been written down to below the tax base.
This might be because an impairment loss has been recorded on the asset which is not allowable
for tax purposes until the asset is sold. The entity will therefore receive tax relief on the
impairment loss in the future when the asset is sold.
3. The deferred tax asset at the reporting date will be 25% x $700 = $175.
4. It is worth noting here that revaluation gains, which increase the carrying amount of the asset and
leave the tax base unchanged, result in a deferred tax liability.
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5. Conversely, impairment losses, which decrease the carrying amount of the asset and leave the tax
base unchanged, result in a deferred tax asset.
EXAMPLE 4
 At the reporting date, inventory which cost $10,000 has been written down to its net realisable
value of $9,000. The write down is ignored for tax purposes until the goods are sold.
 The write off of inventory will generate tax relief, but only in the future when the goods are sold.
Hence the tax base of the inventory is not reduced by the write off.
 Consequently, a deferred tax asset of 25% x $1,000 = $250 as shown in Table 8 should be
recorded at the reporting date.
EXAMPLE 5
 At the reporting date, an entity has recorded a liability of $25,000 in respect of pension
contributions due. Tax relief is available on pension contributions only when they are paid.
 The contributions will only be recognised for tax purposes when they are paid in the future.
 Hence the pension expense is currently ignored within the tax computations and so the liability
has a nil tax base, as shown in Table 8.
 The entity will receive tax relief in the future and so a deferred tax asset of 25% x $25,000 =
$6,250 should be recorded at the reporting date.
Group Financial Statements

 When dealing with deferred tax in group financial statements, it is important to remember that a
group does not legally exist and so is not subject to tax.
 Instead, tax is levied on the individual legal entities within the group and their individual tax
assets and liabilities are cross-cast in the consolidation process.
 To calculate the deferred tax implications on consolidation adjustments when preparing the group
financial statements, the carrying amount refers to the carrying amount within the group financial
statements while the tax base will be the tax base in the entities‟ individual financial statements.
Fair value adjustments

 At the date of acquisition, a subsidiary‟s net assets are measured at fair value.
 The fair value adjustments may not alter the tax base of the net assets and hence a temporary
difference may arise.
 Any deferred tax asset/liability arising as a result is included within the fair value of the
subsidiary‟s net assets at acquisition for the purposes of calculating goodwill.
Goodwill
 Goodwill only arises on consolidation – it is not recognised as an asset within the individual
financial statements.
 Theoretically, goodwill gives rise to a temporary difference that would result in a deferred tax
liability as it is an asset with a carrying amount within the group financial statements but will
have a nil tax base.
 However, IAS 12 specifically excludes a deferred tax liability being recognised in respect of
goodwill.
Provisions for unrealised profits (PUPs)

 When goods are sold between group companies and remain in the inventory of the buying
company at the year-end, an adjustment is made to remove the unrealised profit from the
consolidated financial statements.
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 This adjustment also reduces the inventory to the original cost when a group company first
purchased it.
 However, the tax base of the inventory will be based on individual financial statements and so
will be at the higher transfer price.
 Consequently, a deferred tax asset will arise.
 Recognition of the asset and the consequent decrease in the tax expense will ensure that the tax
already charged to the individual selling company is not reflected in the current year‟s
consolidated Statement of Profit or Loss but will be matched against the future period when the
profit is recognised by the group.
EXAMPLE 6
P Owns 100% of the Equity Share Capital of S. P Sold Goods to S for $1,000 Recording A Profit of $200.
All of The Goods Remain in The Inventory of S at The Year-End. Table 9 Shows That A Deferred Tax
Asset Of 25% X $200 = $50 Should Be Recorded Within The Group Financial Statements.
Measurement Of Deferred Tax
 IAS 12 states that deferred tax assets and liabilities should be measured based on the tax rates that
are expected to apply when the asset/liability will be realised/settled.
 Normally, current tax rates are used to calculate deferred tax on the basis that they are a
reasonable approximation of future tax rates and that it would be too unreliable to estimate future
tax rates.
Deferred tax assets and liabilities represent future taxes that will be recovered or that will be
payable.
 It may therefore be expected that they should be discounted to reflect the time value of money,
which would be consistent with the way in which other liabilities are measured.
 IAS 12, however, does not permit or allow the discounting of deferred tax assets or liabilities on
practical grounds.
 The primary reason behind this is that it would be necessary for entities to determine when the
future tax would be recovered or paid.
 In practice this is highly complex and subjective. Therefore, to require discounting of deferred tax
liabilities would result in a high degree of unreliability.
 Furthermore, to allow but not require discounting would result in inconsistency and so a lack of
comparability between entities.
Deferred Tax and The Framework

 As we have seen, IAS 12 considers deferred tax by taking a “balance sheet” approach to the
accounting problem by considering temporary differences in terms of the difference between the
carrying amounts and the tax values of assets and liabilities – also known as the valuation
approach.
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 This can be said to be consistent with the approach taken to recognition in the IASB‟s Conceptual
Framework for Financial Reporting® (the Conceptual Framework).
 However, the valuation approach is applied regardless of whether the resulting deferred tax will
meet the definition of an asset or liability in its own right.
 Thus, IAS 12 considers the overriding accounting issue behind deferred tax to be the application
of matching – ensuring that the tax consequences of an item reported within the financial
statements are reported in the same accounting period as the item itself.
 For example, in the case of a revaluation surplus, since the gain has been recognised in the
financial statements, the tax consequences of this gain should also be recognised – that is to say, a
tax charge. In order to recognise a tax charge, it is necessary to complete the double entry by also
recording a corresponding deferred tax liability.
 However, part of the Conceptual Framework‟s definition of a liability is that there is a „present
obligation‟. Therefore, the deferred tax liability arising on the revaluation gain should represent
the current obligation to pay tax in the future when the asset is sold. However, since there is no
present obligation to sell the asset, there is no present obligation to pay the tax.
 Therefore, it is also acknowledged that IAS 12 is inconsistent with the Conceptual Framework to
the extent that a deferred tax asset or liability does not necessarily meet the definition of an asset
or liability.
IFRS 2 Share-based Payment

 International Financial Reporting Standard (IFRS®) 2, Share-based Payment, applies when a
company acquires or receives goods and services for equity-based payment.
 These goods can include inventories, property, plant and equipment, intangible assets, and other
non-financial assets.
 There are two notable exceptions: shares issued in a business combination, which are dealt with
under IFRS 3, Business Combinations; and contracts for the purchase of goods that are within the
scope of International Accounting Standard (IAS®) 32 and IAS 39.
 In addition, a purchase of treasury shares would not fall within the scope of IFRS 2, nor would a
rights issue where some of the employees are shareholders.
 Examples of some of the arrangements that would be accounted for under IFRS 2 include call
options, share appreciation rights, share ownership schemes, and payments for services made to
external consultants based on the company‟s equity capital.
Recognition of Share-based Payment

 IFRS 2 requires an expense to be recognised for the goods or services received by a company.
 The corresponding entry in the accounting records will either be a liability or an increase in the
equity of the company, depending on whether the transaction is to be settled in cash or in equity
shares.
 Goods or services acquired in a share-based payment transaction should be recognised when they
are received.
 In the case of goods, this is obviously the date when this occurs. However, it is often more
difficult to determine when services are received.
 If shares are issued that vest immediately, then it can be assumed that these are in consideration
of past services. As a result, the expense should be recognised immediately.
 Alternatively, if the share options vest in the future, then it is assumed that the equity instruments
relate to future services and recognition is therefore spread over that period.
Equity Settled Transactions

 Equity-settled transactions with employees and directors would normally be expensed and would
be based on their fair value at the grant date.
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 Fair value should be based on market price wherever this is possible.
 Many shares and share options will not be traded on an active market. If this is the case then
valuation techniques, such as the option pricing model, would be used.
 IFRS 2 does not set out which pricing model should be used, but describes the factors that should
be taken into account.
 It says that „intrinsic value‟ should only be used where the fair value cannot be reliably estimated.
Intrinsic value is the difference between the fair value of the shares and the price that is to be paid
for the shares by the counterparty.
 The objective of IFRS 2 is to determine and recognise the compensation costs over the period in
which the services are rendered.
 For example, if a company grants share options to employees that vest in the future only if they
are still employed, then the accounting process is as follows:
i. The fair value of the options will be calculated at the date the options are granted.
ii. This fair value will be charged to profit or loss equally over the vesting period, with
adjustments made at each accounting date to reflect the best estimate of the number of
options that will eventually vest.
iii. Shareholders‟ equity will be increased by an amount equal to the charge in profit or loss.
The charge in the income statement reflects the number of options vested. If employees
decide not to exercise their options, because the share price is lower than the exercise
price, then no adjustment is made to profit or loss. On early settlement of an award
without replacement, a company should charge the balance that would have been charged
over the remaining period.
EXAMPLE 1
A company issued share options on 1 June 20X6 to pay for the purchase of inventory. The inventory is
eventually sold on 31 December 20X8. The value of the inventory on 1 June 20X6 was $6m and this
value was unchanged up to the date of sale. The sale proceeds were $8m. The shares issued have a market
value of $6.3m.
How will this transaction be dealt with in the financial statements?
ANSWER
IFRS 2 states that the fair value of the goods and services received should be used to value the share
options unless the fair value of the goods cannot be measured reliably. Thus equity would be increased by
$6m and inventory increased by $6m. The inventory value will be expensed on sale.
Performance Conditions
 Schemes often contain conditions which must be met before there is entitlement to the shares.
These are called vesting conditions.
 If the conditions are specifically related to the market price of the company‟s shares, then such
conditions are ignored for the purposes of estimating the number of equity shares that will vest.
 The thinking behind this is that these conditions have already been taken into account when fair
valuing the shares.
 If the vesting or performance conditions are based on, for example, the growth in profit or
earnings per share, then it will have to be taken into account in estimating the fair value of the
option at the grant date.
EXAMPLE 2
A company grants 2,000 share options to each of its three directors on 1 January 20X6, subject to the
directors being employed on 31 December 20X8. The options vest on 31 December 20X8. The fair value
of each option on 1 January 20X6 is $10, and it is anticipated that on 1 January 20X6 all of the share
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options will vest on 30 December 20X8. The options will only vest if the company‟s share price reaches
$14 per share.
The share price at 31 December 20X6 is $8 and it is not anticipated that it will rise over the next two
years. It is anticipated that on 31 December 20X6 only two directors will be employed on 31 December
20X8.
How will the share options be treated in the financial statements for the year ended 31 December 20X6?
ANSWER
The market-based condition (ie the increase in the share price) can be ignored for the purpose of the
calculation. However, the employment condition must be taken into account. The options will be treated
as follows:
2,000 options x 2 directors x $10 x 1 year / 3 years = $13,333
Equity will be increased by this amount and an expense shown in profit or loss for the year ended 31
December 20X6.
Cash Settled Transactions

 Cash settled share-based payment transactions occur where goods or services are paid for at
amounts that are based on the price of the company‟s equity instruments.
 The expense for cash settled transactions is the cash paid by the company.
 As an example, share appreciation rights (SARs) entitle employees to cash payments equal to the
increase in the share price of a given number of the company‟s shares over a given period.
 This creates a liability, and the recognised cost is based on the fair value of the instrument at the
reporting date.
 The fair value of the liability is re-measured at each reporting date until settlement.
EXAMPLE 3
Jay, a public limited company, has granted 300 share appreciation rights to each of its 500 employees on
1 July 20X5. The management feel that as at 31 July 20X6, the year end of Jay, 80% of the awards will
vest on 31 July 20X7. The fair value of each share appreciation right on 31 July 20X6 is $15.
What is the fair value of the liability to be recorded in the financial statements for the year ended 31 July
20X6?
ANSWER
300 rights x 500 employees x 80% x $15 x 1 year / 2 years = $900,000
Deferred Tax Implications

 In some jurisdictions, a tax allowance is often available for share-based transactions.
 It is unlikely that the amount of tax deducted will equal the amount charged to profit or loss under
the standard.
 Often, the tax deduction is based on the option‟s intrinsic value, which is the difference between
the fair value and exercise price of the share.
 A deferred tax asset will therefore arise which represents the difference between a tax base of the
employee‟s services received to date and the carrying amount, which will effectively normally be
zero.
 A deferred tax asset will be recognised if the company has sufficient future taxable profits against
which it can be offset.
 For cash settled share-based payment transactions, the standard requires the estimated tax
deduction to be based on the current share price. As a result, all tax benefits received (or expected
to be received) are recognised in the profit or loss.
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EXAMPLE 4
A company operates in a country where it receives a tax deduction equal to the intrinsic value of the share
options at the exercise date. The company grants share options to its employees with a fair value of $4.8m
at the grant date. The company receives a tax allowance based on the intrinsic value of the options which
is $4.2m. The tax rate applicable to the company is 30% and the share options vest in three-years‟ time.
ANSWER
A deferred tax asset would be recognised of:
$4.2m @ 30% tax rate x 1 year / 3 years = $420,000
The deferred tax will only be recognised if there are sufficient future taxable profits available.
Disclosure
IFRS 2 requires extensive disclosures under three main headings:
 Information that enables users to understand the nature and extent of the share-based payment
transactions that existed during the period.
 Information that allows users to understand how the fair value of the goods or services received,
or the fair value of the equity instruments which have been granted during the period, was
determined.
 Information that allows users to understand the effect of expenses, which have arisen from share-
based payment transactions, on the entity‟s profit or loss in the period.
Note
 The standard is applicable to equity instruments granted after 7 November 2002 but not yet
vested on the effective date of the standard, which is 1 January 2005. IFRS 2 applies to liabilities
arising from cash-settled transactions that existed at 1 January 2005.
 SBR candidates need to be comfortable with the above accounting principles and be able to
explain them in the context of some accounting numbers.
IFRS 9 Financial Instruments

 IFRS® 9, Financial Instruments, is the result of work undertaken by the International Accounting
Standards Board (the Board) in conjunction with the Financial Accounting Standards Board
(FASB) in the US.
 It was last revised in October 2017. This article focuses on the accounting requirements relating
to financial assets and financial liabilities only.
 Arguably, IFRS 9 has simplified and improved accounting for financial assets in comparison with
its predecessor, IAS® 39.
 IFRS 9 has also reduced the degree of discretion for classification and accounting treatment of
financial assets, which should support consistent reporting of financial information relating to
financial assets and enhance understanding and comparability of that information.
 If we begin with the classification of financial assets, IFRS 9 now classifies financial assets under
three headings as follows:
Classification Of Financial Assets

(1) Financial assets at fair value through profit or loss (FVTPL)
 This apply to all financial assets unless they are designated to be measured and accounted for in
any other way.
 This classification includes any financial assets held for trading purposes and also derivatives,
unless they are part of a properly designated hedging arrangement.
 Debt instruments will be classified to be measured and accounted for at FVTPL unless they have
been correctly designated to be measured at amortised cost (see later).
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 Initial recognition at fair value is normally cost incurred and this will exclude transactions costs,
which are charged to profit or loss as incurred.
 Remeasurement to fair value takes place at each reporting date, with any movement in fair value
taken to profit or loss for the year, which effectively incorporates an annual impairment review.
(2) Financial assets at fair value through other comprehensive income (FVTOCI)
 This classification applies to equity instruments and simple debt instruments and must be
designated upon initial recognition.
 It will be applicable to financial assets that an entity holds within a business model whose
objective is achieved by both collecting the contractual cash flows and selling the financial assets.
 The contractual cash flows will usually be collected on a specific date will consist of payments of
principle and interest.
 Initial recognition at fair value would normally include the associated transaction costs of
purchase.
 The accounting treatment automatically incorporates an impairment review, with any change in
fair value taken to other comprehensive income in the year.
 Upon derecognition, any gain or loss is based upon the carrying amount at the date of disposal.
 There is no recycling of any amounts previously taken to equity in earlier accounting periods.
 Instead, at derecognition, an entity may choose to make an equity transfer from other components
of equity to retained earnings as any amounts previously taken to equity can now be regarded as
having been realised.
(3) Financial assets measured at amortised cost

 This classification can apply only to debt instruments and must be designated upon initial
recognition.
 For the designation to be effective, the financial asset must pass two tests as follows:
 The business model test –
 To pass this test, the entity must be holding the financial asset to collect in the
contractual cash flows associated with that financial asset.
 If this is not the case, then the financial asset reverts to the default classification
to be measured at FVTPL.
 The cash flow characteristics test –
 The contractual cash flows collected must consist solely of payment of interest
and capital.
 If this is not the case, the financial asset reverts to the default classification to be
measured at FVTPL.
 One problem that may arise in relation to financial assets measured at fair value is whether a
reliable fair value can be determined at the reporting date. For exchange-traded financial assets,
such as equity shares in a listed entity, this may be a relatively straightforward process. If,
however, the financial assets in question are not traded on an exchange, there may be no
definitive method to determine fair value at a particular date. This could result in the exercise of
judgment or discretion, which could undermine the reliability or relevance of any amounts
accounted for as a fair value.
Illustration 1 – Classification and Measurement of Financial Assets

An entity, Suarez, purchased a five-year bond on 1 January 2010 at a cost of $5m with annual
interest of 5%, which is also the effective rate, payable on 31 December annually. At the
reporting date of 31 December 2010 interest has been received as expected and the market rate of
interest is now 6%.
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Required:
Account for the financial asset at 31 December 2010 on the basis that:
i. it is classified as FVTPL, and
ii. it is classified to be measured at amortised cost, on the assumption it passes the
necessary tests and has been properly designated at initial recognition.
Answer:
i. If classified as FVTPL
This requires that the fair value of the bond is measured based upon expected future cash flows
discounted at the current market rate of interest of 6% as follows:
Year Expected cash flows 6% discount factor Present value $m
31 December 2011 $5m x 5% = $0.25m 0.9434 0.2358
31 December 2012 $0.25m 0.8900 0.2225
31 December 2013 $0.25m 0.8396 0.2099
31 December 2014 $0.25m + $5m 0.7921 4.1585
4.8267
Therefore, at the reporting date of 31 December 2010, the financial asset will be stated at a fair value of
$4.8267m, with the fall in fair value amounting to $0.1733m taken to profit or loss in the year. Interest
received will be taken to profit or loss for the year amounting to $0.25m.
ii. If classified to be measured at amortised cost

This requires that the fair value of the bond is measured based upon expected future cash flows
discounted at the original effective rate of 5%. This will continue to be at $5m as the following
calculation confirms:

31 December 2011 $5m x 5% = $0.25m 0.9524 0.2381
31 December 2012 $0.25m 0.9070 0.2267
31 December 2013 $0.25m 0.8638 0.2160
31 December 2014 $0.25m + $5m 0.8227 4.3192
5,0000
In addition, interest received during the year of $0.25m will be taken to profit or loss for the year.
Impairment Of Financial Assets

 IFRS 9 requires an entity to account for expected credit losses – ie a credit event does not need to
have occurred for a credit loss to be recognised.
 An impairment review is required for financial assets that are measured at fair value and any fall
in fair value is taken to profit or loss or other comprehensive income for the year, depending upon
the classification of the financial asset (see earlier).
 For financial assets designated to be measured at amortised cost, an entity must make an
assessment at each reporting date whether there is evidence of possible impairment; if there is,
then an impairment review should be performed.
 If impairment is identified, it is charged to profit or loss immediately. Quantification of the
recoverable amount would normally be based upon the present value of the expected future cash
flows estimated at the date of the impairment review and discounted to their present value based
on the original effective rate of return at the date the financial asset was issued.
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Illustration 2 – impairment of financial assets measured at amortised cost
Using the information contained within Illustration 1, where the carrying amount of the financial asset at
31 December 2010 was $5m. If, in early 2011, it was identified the bond issuer was beginning to
experience financial difficulties, and there was doubt regarding full recovery of the amounts due to
Suarez, an impairment review would be required. The expected future cash flows now expected by Suarez
from the bond issuer are as follows:
Year Expected cash flows
31 December 2011 $0.20m
31 December 2012 $0.20m
31 December 2013 $0.20m
31 December 2014 $0.20m + $4.4m
Required:
Calculate the extent of impairment of the financial asset to be included in the financial statements of
Suarez for the year ending 31 December 2011.
Answer:
The future cash flows now expected are discounted to present value based on the original effective rate
associated with the financial asset of 5% as follows:
31 December 2011 $0.20m 0.9524 0.1905
31 December 2012 $0.20m 0.9070 0.1814
31 December 2013 $0.20m 0.8638 0.1727
31 December 2014 $0.20m + $4.4m 0.8227 3,7844
4,3290
 Therefore, impairment amounting to the change in carrying value of ($5.0m – $4.329m) $0.671m
will be recognised as an impairment charge in the year to 31 December 2011.
 Additionally, there will also be recognition of interest receivable in the statement of
comprehensive income for the year amounting to (4.329m x 5%) $0.2165m.
Classification Of Financial Liabilities

Financial liabilities should be accounted for as follows:
 Financial liabilities at fair value through profit or loss (FVTPL):
This will include financial liabilities incurred for trading purposes and also derivatives that are
not part of a hedging arrangement.
 Other financial liabilities measured at amortised cost:
If financial liabilities are not measured at FVTPL, they are measured at amortised cost.
Note
 IFRS 9 also retains the option for some liabilities, which would normally be measured at
amortised cost to be measured at FVTPL if, in doing so, it eliminates or reduces an accounting
mismatch, sometimes referred to as „the fair value option‟.
 Where this is the case, to the extent that part of the change in fair value of the financial liability is
due to a change in the entity‟s own credit risk, this should be taken to other comprehensive
income in the year, with the balance of any change in fair value taken to profit or loss.
 If this accounting treatment for the credit risk creates or enlarges an accounting mismatch in
profit or loss then the gain or loss relating to credit risk should also be taken to profit or loss.
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Summary
 The overall impact of IFRS 9 is that there is likely to be increased emphasis on fair value
accounting for financial assets, rather than the use of other forms of measurement such as
amortised cost or historical cost.
 In addition, accounting for impairment of financial assets has become less complex.
 There have been no significant changes to accounting for financial liabilities.
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IFRS 13 Fair Value Measurement

IFRS 13 has required a significant amount of work by entities to simply understand the nature of the
principles and concepts involved.
1. IFRS® 13, Fair Value Measurement was issued in May 2011 and defines fair value, establishes a
framework for measuring fair value and requires significant disclosures relating to fair value
measurement.
2. The guidance in IFRS 13 does not apply to transactions dealt with by certain standards. For
example,
(i) Share based payment transactions in IFRS 2, Share-based Payment
(ii) Leasing transactions in IFRS 16, Leases
(iii) Net realisable value calculations in IAS® 2, Inventories
(iv) Value in use calculations in IAS 36, Impairment of Assets
Fair Value
 Fair value is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date. Basically it is an exit
price.
 Fair value is focused on the assumptions of the market place, is not entity specific and so takes
into account any assumptions about risk.
 The prices to be used are those in „an orderly transaction‟.
Orderly Transaction
An orderly transaction is one that assumes exposure to the market for a period before the date of
measurement to allow for normal marketing activities to take place and to ensure that it is not a forced
transaction.
Note
Fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place in
the principal market for the asset or liability or, in the absence of a principal market, in the most
advantageous market for the asset or liability.
Principal Market
The market with the greatest volume and level of activity for the asset or liability that can be accessed by
the entity.
Most Advantageous Market

The market which maximises the amount that would be received for the asset or paid to extinguish the
liability after transport and transaction costs. Often these markets would be the same.
Note
 Although transaction costs are taken into account when identifying the most advantageous
market, the fair value is calculated before adjustment for transaction costs because these costs are
characteristics of the transaction and not the asset or liability.
 Market participants must be independent of each other and knowledgeable, and able and willing
to enter into transactions.
 IFRS 13 sets out a valuation approach based on the market, income and cost. The entity is
required to maximise the use of observable inputs and minimise the use of unobservable inputs.
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Fair Value Hierarchy
Fair value measurements are based on the type of inputs to the valuation techniques used, as follows:
1. Level 1 inputs
 Unadjusted quoted prices in active markets for items identical to the asset or liability
being measured. An example of this would be prices quoted on a stock exchange.
2. Level 2 inputs
 Inputs other than the quoted prices in determined in level 1 that are directly or indirectly
observable for that asset or liability.
 They are likely to be quoted assets or liabilities for similar items in active markets or
supported by market data. For example, interest rates, credit spreads or yields curves.
3. Level 3 inputs
 Unobservable inputs.
 These inputs should be used only when it is not possible to use Level 1 or 2 inputs.
 IFRS 13 does not preclude an entity from using its own data. For example, cash flow
forecasts may be used to value an entity that is not listed.
Fair Value Non-Financial Assets

 Fair value is determined based on the highest and best use of the asset as determined by a
market participant.
 Highest and best use considers how market participants would use a non-financial asset to
maximise its benefit or value.
 The maximum value of a non-financial asset to market participants may come from its use in
combination with other assets and liabilities or on a standalone basis.
 In determining the highest and best use of a non-financial asset, IFRS 13 indicates that all uses
that are physically possible, legally permissible and financially feasible should be considered.
Note
 For fair value measurement of a liability, or the entity‟s own equity, where there is no observable
market to provide pricing information and the highest and best use is not applicable, the fair value
is based on the perspective of a market participant who holds the identical instrument as an asset.
 If there is no corresponding asset, then a corresponding valuation technique may be used. This
would be the case with a decommissioning activity. The fair value of a liability reflects the non-
performance risk based on the entity‟s own credit standing plus any compensation for risk and
profit margin that a market participant might require to undertake the activity.
 Transaction price is not always the best indicator of fair value at recognition because entry and
exit prices are conceptually different.
IFRS 13 Disclosure Requirements

1. Information about the hierarchy level into which fair value measurements fall
2. Transfers between levels 1 and 2
3. Methods and inputs to the fair value measurements and changes in valuation techniques, and
4. Additional disclosures for level 3 measurements that include a reconciliation of opening and
closing balances, and quantitative information about unobservable inputs and assumptions used.
Impairment of Financial Assets

 Whilst IFRS 9 replaced IAS 39® Financial Instruments: Recognition and Measurement, IAS
32 Financial Instruments: Presentation is still applicable.
 The objective of IFRS 9 is to „…establish principles for the financial reporting of financial assets
and financial liabilities that will present relevant and useful information to users of financial
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statements for their assessment of the amounts, timing and uncertainty of an entity‟s future cash
flows.‟
 If a financial asset is deemed to be impaired, then this will impact on its carrying amount and
future cash flows and so this article considers the principles on which the impairment of financial
assets is considered.
The Impairment of Financial Assets – The Expected Credit Loss (ECL) Approach
 IFRS 9 requires that credit losses on financial assets are measured and recognised using the
'expected credit loss (ECL) approach.
 Credit losses are the difference between the present value (PV) of all contractual cash flows and
the PV of expected future cash flows, often referred to as the „cash shortfall‟.
 The present values are discounted at the original effective interest rate.
 ECLs are then calculated using the weighted average of credit losses with the respective risks of a
default occurring as the weights.
 The ECL approach results in the early recognition of credit losses because it includes, not only
losses that have already been incurred, but also expected future credit losses – it is a forward
looking model.
 Arguably, this method is prudent as both financial assets and profits will be reduced.
 It is however open to the criticism that, by requiring the estimation of future credit losses, which
will necessarily involve judgment, it will allow some companies to engage in profit smoothing.
 Consequently, IFRS 9 has included definitions to provide clarity as to what (and what is not)
permitted.
 The ECL approach also impacts on the calculation of interest revenue recognised from the
financial asset (see below).
Classification of Expected Credit Losses (ECLs)

 Lifetime ECLS
They result from all possible default events over the expected life of a financial instrument.
 12-month ECL
They result from default events that are possible within 12 months after the reporting date.
Note
 An entity is required to account for ECLs on initial recognition of the financial asset (the ECL could
be nil) and then separately account for changes in the ECL at each reporting date.
 Therefore, the impairment of financial assets is recognised in stages:
1. Stage 1
 As soon as a financial instrument is originated or purchased, a 12-month ECL is
recognised in profit or loss and a loss allowance is established (may be nil).
 For financial assets, interest revenue is calculated on the gross carrying amount (ie
without deduction for ECLs).
2. Stage 2
 At each reporting date, the ECL is remeasured:
a. if the credit risk has not increased significantly, continue to recognise a 12 month
ECL. The calculation of interest revenue is the same as for Stage 1.
b. if the credit risk increases significantly and is not considered low, full lifetime ECLs
are recognised in profit or loss. The calculation of interest revenue is the same as for
Stage 1.
c. if the credit risk of a financial asset increases to the point that it is considered credit-
impaired, interest revenue is calculated based on the amortised cost (ie the gross
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carrying amount less the loss allowance). Financial assets in this stage will generally
be assessed individually. Lifetime ECLs are recognised on these financial assets.
Example of the Expected Credit Loss Approach

Bale Co has a portfolio of $50,000 financial assets (debt instruments) that have two years to maturity and
are correctly accounted for at amortised cost. Each asset has a coupon rate of 10% as well as an effective
rate of 10%.
No previous loss allowance has been recognised as the 12 month ECL was assessed to be nil and there
had been no significant change in the credit risk since the portfolio had been acquired (this is Stage 1).
At the year-end (this is Stage 2), information has emerged that the sector in which the borrowers operate
is experiencing tough economic conditions. It is now felt that a proportion of loans will default over the
remaining loan period and therefore the credit risk has increased significantly. After considering a range
of possible outcomes, the overall rate of return from the portfolio is expected to be approximately 6% per
annum for each of the next two years. The debt instruments are not, however, considered credit impaired.
Required:
Calculate the lifetime expected credit losses and the loss allowance required.
Answer
The lender was expecting an annual return of $5,000 a year ($50,000 × 10%) but is now only expecting
an annual return of $3,000 a year ($50,000 × 6%). There is therefore a cash shortfall – ie an ECL of
$2,000 per year. A loss allowance should be calculated at the present value of the shortfalls over the
remaining life of the asset.
The discount rate used should be the effective discount rate ie 10%.
Contractual cash flow shortfall Discount Present value
$ rate $
$
Year 1 2,000 0.9091 1,818
Year 2 2,000 0.8264 1,653
3,471
 Thus, the ECL is $3,471.
 This is recognised as a loss allowance creating an expense to be charged to profit or loss
and offset against the carrying amount of the financial asset on the statement of financial
position.
 You should note IFRS 9 is not prescriptive about the presentation in the statement of
financial position and the loss allowance may be presented as a liability instead of offset
against the asset.
Financial Assets Subject to Impairment

 If deemed necessary, a loss allowance for ECLs should be recognised for the following financial
assets:
i. those measured at amortised cost and at fair value through other comprehensive income
(OCI)
ii. lease receivables
iii. contract assets
iv. irrevocable loan commitments, and
v. financial guarantee contracts that are not accounted for at fair value through profit or loss
under IFRS 9.
 Therefore, this includes debt instruments such as loans, debt securities and trade receivables (but
see later for simplified approach).
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 The recognition of ECLs is required for these financial assets by creating a loss
allowance/provision based on either 12-month or lifetime ECLs.
 Some entities would recognise a loss allowance whilst others may choose to present ECLs as a
liability.
 Financial assets with a low credit risk would not meet the lifetime ECL criterion. An entity does
not recognise lifetime ECL for financial assets that are equivalent to 'investment grade', which
means that the asset has a low risk of default. There is a rebuttable presumption that lifetime
expected losses should be provided for if contractual cash flows are more than 30 days overdue
(„backstop indicator‟). If the credit quality subsequently improves and the lifetime ECL criterion
is no longer met, the credit loss reverts back to a 12-month ECL basis. Therefore, a financial asset
can move from 12 month ECL to lifetime ECL and back again if there is evidence that there is no
longer a significant increase in credit risk and there should not be an assumption that a financial
asset with a lifetime ECL will default. The assessment of significant increases in credit risk can
be performed on a collective basis, rather than on an individual basis, if the financial instruments
share the same risk characteristics. However, if any assets are deemed credit impaired they will
generally be assessed on an individual basis.
Summary of The Two-Stage Approach:

1. Stage 1 - on initial recognition
An entity would recognise a loss allowance based on the 12-months' ECL. This may be assessed as
nil.
2. Stage 2 - each reporting date
Where there is no evidence that the credit quality of a financial asset has deteriorated significantly
since initial recognition, then the loss allowance continues to be based on the 12 months ECL (which
could continue to be nil).
Simplified Approach for Trade Receivables

 No credit loss allowance is recognised on initial recognition.
 Any loss allowance will be the present value of the expected cash flow shortfalls over the
remaining life of the receivables.
 This approach uses the conventional matrix method (aged receivables list) of considering
historically observed default rates and adjusted for forward-looking estimates.
Conclusion
 The ECL model will require judgment carrying amount of financial assets and assessment of
impairment is dependent on forward-looking information which can be subjective.
 IFRS 9 has attempted to limit this subjectivity by providing detailed definitions.
 IFRS 9 addressed the criticism that losses were recognised too late, only after a credit event, and
by requiring a considered forward looking approach to impairment assessment it will make the
financial reporting of financial assets more relevant and useful to users of financial statements.
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Measurement
This article considers the relevance of information provided by different measurement methods and
explains the effect that they may have on the financial statements.
 The relevance of information provided by a particular measurement method depends on how it

affects the financial statements. The cost should be justified by the benefits of reporting that
information to existing and potential users.
 The different measures used should be the minimum necessary to provide relevant information
and there should be infrequent changes with any necessary changes clearly explained.
 Further it makes sense for comparability and consistency purposes, to use the same method for
initial and subsequent measurement unless there is a good reason from not doing so.
 A single measurement basis may not provide the most relevant information to users and therefore
IFRS® standards adopt a mixed measurement basis, which includes fair value, historical cost,
and net realisable value.
 A particular measurement bases may be easier to understand, more verifiable and less costly to
implement. However, if different measurement bases are used, it can be argued that the totals in
financial statements have little meaning. Those that prefer a single measurement method favour
the use of current values to provide the most relevant information.
 It makes sense that current values should play a key role in measurement. Current market value
would appear to be the most relevant measure of assets and liabilities for financial reporting
purposes.
 The IASB favour a mixed measurement approach whereby the most relevant measurement
method is selected. In recent standards, it seems that the Board felt that fair value would not
provide the most relevant information in all circumstances. For example, IFRS 9 requires the use
of cost in some cases and fair value in other cases, while IFRS 15 essentially applies cost
allocation.
 A factor to be considered when selecting a measurement basis is the degree of measurement
uncertainty. The Exposure Draft on the Conceptual Framework states that for some estimates, a
high level of measurement uncertainty may outweigh other factors to such an extent that the
resulting information may have little relevance. Most measurement is uncertain and requires
estimation. For example, recoverable value for impairment, depreciation estimates and fair value
measures at level 2 and 3 under IFRS 13. Consequently, the Board believes that the level of
uncertainty associated with the measurement of an item should be considered when assessing
whether a particular measurement basis provides relevant information.
 Measurement uncertainty could be considered too great with the result that the entity may not
recognise the asset or liability. An example of this would be research activities. However,
sometimes a measure with a high degree of uncertainty provides the most relevant information
about an item. For example, financial instruments for which prices are not observable. The Board
thinks that the level of measurement uncertainty that makes information lack relevance depends
on the circumstances and can only be decided when developing particular standards.
 It would be easier if measurement bases were categorised as either historical cost or current value.
The Exposure Draft on the Conceptual Framework describes these two categories but also states
that cash-flow-based measurement techniques are generally used to estimate the measure of an
asset or a liability as part of a prescribed measurement basis. Cash-flow-based measurement can
be used to customise measurement bases, which can result in more relevant information but it
may also be more difficult for users to understand. As a result, the Exposure Draft does not
identify those techniques as a separate category.
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 There are several areas of debate about measurement. For example, should any discussion of
measurement bases include the use of entry and exit values, entity-specific values and the role of
deprival value. Again should an entity‟s business model affect the measurement of its assets and
liabilities. Many would advocate that different measurement methods should be applied that are
dependent both on the nature of assets and liabilities and also, importantly, on how these are used
in the business. For example, property can be measured at historical cost or fair value depending
upon the business model.
 In order to meet the objective of financial reporting, information provided by a particular
measurement basis must be useful to users of financial statements. In addition, the measurement
basis needs to provide information that is comparable, verifiable, timely and understandable.
 There are many different ways in which an asset or liability can be measured. Historical cost
seems to be the easiest of these measures but even here, complexity can arise where there is a
deferred payment or a payment, which involves an asset exchange. Subsequent accounting after
initial recognition is not necessarily straightforward with historical cost as such matters as
impairment of assets have to be taken into account and the latter is dependent upon rules, which
can be sometimes subjective.
 Current values have a variety of alternative valuation methods. These include market value,
value-in-use and fulfilment value. Of these various methods, there is less ambiguity around
current market prices as with any other measure of current value, there is likely to be specific
rules in place to avoid inconsistency. In the main, the details of how these different measurement
methods are applied, are set out in each accounting standard.
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Revenue Revisited
This two-part article considers the application of IFRS 15, Revenue from Contracts with Customers using
the five-step model.
 On 28 May 2014, the International Accounting Standards Board (the Board), as a result of the
joint project with the US Financial Accounting Standards Board (FASB), issued
IFRS® 15, Revenue from Contracts with Customers. Application of the standard is mandatory for
annual reporting periods starting from 1 January 2017 onward (though there is currently a
proposal to defer this date to 1 January 2018) and earlier application is permitted.
 Historically, there has been a significant divergence in practice over the recognition of revenue,
mainly because IFRS standards have contained limited guidance in certain areas. The original
standard, IAS® 18, Revenue, was issued in 1982 with a significant revision in 1993, however, IAS
18 was not fit for purpose in today‟s corporate world as the guidance available was difficult to
apply to many transactions. The result was that some companies applied US GAAP when it suited
their needs.
IFRS 15 replaces the following standards and interpretations:

 IAS 11, Construction Contracts
 IAS 18, Revenue
 IFRIC 13, Customer Loyalty Programmes
 IFRIC 15, Agreements for the Construction of Real Estate
 IFRIC 18, Transfer of Assets from Customers
 SIC-31, Revenue – Barter Transactions Involving Advertising Services
Core Principle of IFRS 15

That an entity shall recognise revenue from the transfer of promised good or services to
customers at an amount that reflects the consideration to which the entity expects to be entitled in
exchange for those goods and services.
Using the five-step model for Revenue Recognition

Step one: Identification of The Contract with the Customer
 Contracts may be in different forms (written, verbal or implied), but must be enforceable, have
commercial substance and be approved by the parties to the contract.
 The model applies once the payment terms for the goods or services are identified and it is
probable that the entity will collect the consideration.
 Each party‟s rights in relation to the goods or services have to be capable of identification.
 If a contract with a customer does not meet these criteria, the entity can continually reassess the
contract to determine whether it subsequently meets the criteria.
 Two or more contracts that are entered into around the same time with the same customer may be
combined and accounted for as a single contract, if they meet the specified criteria.
 The standard provides detailed requirements for contract modifications. A modification may be
accounted for as a separate contract or as a modification of the original contract, depending upon
the circumstances of the case.
Step two: Identification of the Separate Performance Obligations in the Contract

 This is often referred to as „unbundling‟, and is done at the beginning of a contract.
 The key factor in identifying a separate performance obligation is the distinctiveness of the good
or service, or a bundle of goods or services.
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 A good or service is distinct if the customer can benefit from the good or service on its own or
together with other readily available resources and it is separately identifiable from other
elements of the contract.
 IFRS 15 requires that a series of distinct goods or services that are substantially the same with the
same pattern of transfer, to be regarded as a single performance obligation.
 A good or service which has been delivered may not be distinct if it cannot be used without
another good or service that has not yet been delivered.
 Similarly, goods or services that are not distinct should be combined with other goods or services
until the entity identifies a bundle of goods or services that is distinct.
 IFRS 15 provides indicators rather than criteria to determine when a good or service is distinct
within the context of the contract. This allows management to apply judgment to determine the
separate performance obligations that best reflect the economic substance of a transaction.
Step three: Determine the Transaction Price

 The amount of consideration that an entity expects to be entitled to in exchange for the promised
goods or services.
 This excludes amounts collected on behalf of a third party – for example, government taxes.
 An entity must determine the amount of consideration to which it expects to be entitled in order
to recognise revenue.
 The transaction price might include variable or contingent consideration. Variable consideration
should be estimated as either the expected value or the most likely amount. The expected value
approach represents the sum of probability-weighted amounts for various possible outcomes. The
most likely amount represents the most likely amount in a range of possible amounts.
 An entity can only include variable consideration in the transaction price to the extent that it is
highly probable that a subsequent change in the estimated variable consideration will not result in
a significant revenue reversal. If it is not appropriate to include all of the variable consideration in
the transaction price, the entity should assess whether it should include part of the variable
consideration. However, this latter amount still has to pass the „revenue reversal‟ test.
 Variable consideration is wider than simply contingent consideration as it includes any amount
that is variable under a contract, such as performance bonuses or penalties.
 Additionally, an entity should estimate the transaction price, taking into account non-cash
consideration, consideration payable to the customer and the time value of money if a significant
financing component is present.
 The latter is not required if the time period between the transfer of goods or services and payment
is less than one year. In some cases, it will be clear that a significant financing component exists
due to the terms of the arrangement.
 In other cases, it could be difficult to determine whether a significant financing component exists.
This is likely to be the case where there are long-term arrangements with multiple performance
obligations such that goods or services are delivered and cash payments received throughout the
arrangement. For example, if an advance payment is required for business purposes to obtain a
longer-term contract, then the entity may conclude that a significant financing obligation does not
exist.
 If an entity anticipates that it may ultimately accept an amount lower than that initially promised
in the contract due to, for example, past experience of discounts given, then revenue would be
estimated at the lower amount with the collectability of that lower amount being assessed.
Subsequently, if revenue already recognised is not collectable, impairment losses should be taken
to profit or loss.
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Step four: Allocation of the Transaction Price to the Separate Performance Obligations
 The allocation is based on the relative standalone selling prices of the goods or services promised
and is made at the inception of the contract.
 It is not adjusted to reflect subsequent changes in the standalone selling prices of those goods or
services.
 The best evidence of standalone selling price is the observable price of a good or service when
the entity sells that good or service separately.
 If that is not available, an estimate is made by using an approach that maximises the use of
observable inputs – for example, expected cost plus an appropriate margin or the assessment of
market prices for similar goods or services adjusted for entity-specific costs and margins or in
limited circumstances a residual approach.
 The residual approach is different from the residual method that is used currently by some
entities, such as software companies.
 When a contract contains more than one distinct performance obligation, an entity should allocate
the transaction price to each distinct performance obligation on the basis of the standalone selling
price.
 Where the transaction price includes a variable amount and discounts, it is necessary to establish
whether these amounts relate to all or only some of the performance obligations in the contract.
 Discounts and variable consideration will typically be allocated proportionately to all of the
performance obligations in the contract. However, if certain conditions are met, they can be
allocated to one or more separate performance obligations.
 This will be a major practical issue as it may require a separate calculation and allocation exercise
to be performed for each contract. For example, a mobile telephone contract typically bundles
together the handset and network connection and IFRS 15 will require their separation.
Step five: Revenue to be Recognised as each Performance Obligation is Satisfied

 An entity satisfies a performance obligation by transferring control of a promised good or service
to the customer, which could occur over time or at a point in time.
 The definition of control includes the ability to prevent others from directing the use of and
obtaining the benefits from the asset.
 A performance obligation is satisfied at a point in time unless it meets one of the following
criteria, in which case, it is deemed to be satisfied over time:
 The customer simultaneously receives and consumes the benefits provided by the entity‟s
performance as the entity performs.
 The entity‟s performance creates or enhances an asset that the customer controls as the asset is
created or enhanced.
 The entity‟s performance does not create an asset with an alternative use to the entity and the
entity has an enforceable right to payment for performance completed to date.
 Revenue is recognised in line with the pattern of transfer. Whether an entity recognises revenue
over the period during which it manufactures a product or on delivery to the customer will depend
on the specific terms of the contract.
 If an entity does not satisfy its performance obligation over time, it satisfies it at a point in time
and revenue will be recognised when control is passed at that point in time.
 Factors that may indicate the passing of control include the present right to payment for the asset
or the customer has legal title to the asset or the entity has transferred physical possession of the
asset.
 As a consequence of the above, the timing of revenue recognition may change for some point-in-
time transactions when the new standard is adopted.
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Note
 In addition to the five-step model, IFRS 15 sets out how to account for the incremental costs of
obtaining a contract and the costs directly related to fulfilling a contract and provides guidance to
assist entities in applying the model to licences, warranties, rights of return, principal-versus-
agent considerations, options for additional goods or services and breakage.
 For exam purposes, you should focus on understanding the principles of the five-step model so
that you can apply them to practical questions.
Definition and Nature of a Contract

 A contract exists when an agreement between two or more parties creates enforceable rights and
obligations between those parties.
 The agreement does not need to be in writing to be a contract, but the decision as to whether a
contractual right or obligation is enforceable is considered within the context of the relevant legal
framework of a jurisdiction.
 Thus, whether a contract is enforceable will vary across jurisdictions. Indeed, the performance
obligation could include promises that result in a valid expectation that the entity will transfer
goods or services to the customer even though those promises are not legally enforceable.
Criteria for Identifying a Contract

1) The parties should have approved the contract and are committed to perform their
respective obligations.
 In the case of oral or implied contracts, this may be difficult, but all relevant facts and
circumstances should be considered in assessing the parties‟ commitment. The parties
need not always be committed to fulfilling all of the obligations under a contract.
2) That each party’s rights and the payment terms can be identified regarding the goods or
services to be transferred.
 This is the key to determining the transaction price.
3) The contract must have commercial substance
 Without this requirement, entities might artificially inflate their revenue and it would be
questionable whether the transaction has economic consequences.
4) It should be probable that the entity will collect the consideration due under the contract.
 An assessment of a customer‟s credit risk is an important element in deciding whether a
contract has validity, but customer credit risk does not affect the measurement or
presentation of revenue.
 The consideration may be different to the contract price because of discounts and bonus
offerings.
Note
IAS 18 did not provide specific guidance for variable consideration in these circumstances, but IFRS 15
does.
Scope, Exclusions and Interactions with Other Standards

 IFRS 15 excludes transactions involving non-monetary exchanges between entities in the same
industry to facilitate sales to customers or to potential customers.
 It is common in the oil industry to swap inventory with another oil supplier to reduce transport
costs and facilitate the sale of oil to the end customer. The party exchanging inventory with the
entity meets the definition of a customer, because of the contractual obligation which results in
the party obtaining output of the entity‟s ordinary activities. In this situation, the recognition of
revenue would not be appropriate as there would be an overstatement of revenue and costs.
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 Leases, insurance contracts, and financial instruments and other contractual rights or obligations
within the scope of IFRS 9, Financial Instruments, IFRS 10, Consolidated Financial Statements,
IFRS 11, Joint Arrangements, IAS 27, Separate Financial Statements, and IAS 28, Investments in
Associates and Joint Ventures, are also scoped out in the standard.
 Some contracts with customers will fall partially under IFRS 15 and partially under other
standards.
 An example of this would be a lease arrangement with a service contract. If other IFRSs specify
how to account for the contract, then the entity should first apply those IFRSs. The specific
subject standard would take precedence in accounting for a part of a contract and any residual
consideration should be accounted for under IFRS 15. Essentially, the transaction price will be
reduced by the amounts that have been measured by the other standard.
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When Does Debt Seem To Be Equity?

The classification of debt and equity in an entity’s statement of financial position is not always easy for
preparers of financial statements. Many financial instruments have both features with the result that this
can lead to inconsistency of reporting.
 IAS® 32 clarifies the definition of financial assets, financial liabilities and equity.
 The objective of IAS® 32, Presentation is to establish principles for presenting financial
instruments as liabilities or equity and for offsetting financial assets and liabilities.
 The classification of a financial instrument by the issuer as either debt or equity can have a
significant impact on the entity‟s gearing ratio, reported earnings, and debt covenants.
 Equity classification can avoid such impact but may be perceived negatively if it is seen as
diluting existing equity interests.
 The distinction between debt and equity is also relevant where an entity issues financial
instruments to raise funds to settle a business combination using cash or as part consideration in a
business combination.
Debt versus Equity

 Liability classification normally results in any payments being treated as interest and charged to
earnings, which may affect the entity's ability to pay dividends on its equity shares.
 The key feature of debt is that the issuer is obliged to deliver either cash or another financial asset
to the holder. The contractual obligation may arise from a requirement to repay principal or
interest or dividends. Such a contractual obligation may be established explicitly or indirectly but
through the terms of the agreement. For example, a bond that requires the issuer to make interest
payments and redeem the bond for cash is classified as debt.
 In contrast, equity is any contract that evidences a residual interest in the entity‟s assets after
deducting all of its liabilities. A financial instrument is an equity instrument only if the instrument
includes no contractual obligation to deliver cash or another financial asset to another entity, and
if the instrument will or may be settled in the issuer's own equity instruments.
For instance, ordinary shares, where all the payments are at the discretion of the issuer, are
classified as equity of the issuer. The classification is not quite as simple as it seems. For
example, preference shares required to be converted into a fixed number of ordinary shares on a
fixed date, or on the occurrence of an event that is certain to occur, should be classified as equity.
 A contract is not an equity instrument solely because it may result in the receipt or delivery of the
entity‟s own equity instruments. The classification of this type of contract is dependent on
whether there is variability in either the number of equity shares delivered or variability in the
amount of cash or financial assets received. A contract that will be settled by the entity receiving
or delivering a fixed number of its own equity instruments in exchange for a fixed amount of
cash, or another financial asset, is an equity instrument. This has been called the „fixed for fixed‟
requirement. However, if there is any variability in the amount of cash or own equity instruments
that will be delivered or received, then such a contract is a financial asset or liability as
applicable.
 For example, where a contract requires the entity to deliver as many of the entity‟s own equity
instruments as are equal in value to a certain amount, the holder of the contract would be
indifferent whether it received cash or shares to the value of that amount. Thus, this contract
would be treated as debt.
Other factors that may result in an instrument being classified as debt are:
a) is redemption at the option of the instrument holder?
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b) is there a limited life to the instrument?
c) is redemption triggered by a future uncertain event that is beyond the control of both the
holder and issuer of the instrument?
d) are dividends non-discretionary?
Other factors that may result in an instrument being classified as equity are:
a) whether the shares are non-redeemable
b) whether there is no liquidation date
c) where the dividends are discretionary.
Note
 The classification of the financial instrument as either a liability or as equity is based on the
principle of substance over form.
 Two exceptions from this principle are certain puttable instruments meeting specific criteria and
certain obligations arising on liquidation.
 Some instruments have been structured with the intention of achieving particular tax, accounting
or regulatory outcomes, with the effect that their substance can be difficult to evaluate.
 The entity must make the decision as to the classification of the instrument at the time that the
instrument is initially recognised.
 The classification is not subsequently changed based on changed circumstances. For example,
this means that a redeemable preference share, where the holder can request redemption, is
accounted for as debt even though legally it may be a share of the issuer.
 In determining whether a mandatorily redeemable preference share is a financial liability or an
equity instrument, it is necessary to examine the particular contractual rights attached to the
instrument's principal and return elements.
 The critical feature that distinguishes a liability from an equity instrument is the fact that the
issuer does not have an unconditional right to avoid delivering cash or another financial asset to
settle a contractual obligation. Such a contractual obligation could be established explicitly or
indirectly. However, the obligation must be established through the terms and conditions of the
financial instrument.
Compound Financial Instruments

 Some instruments are structured to contain elements of both a liability and equity in a single
instrument.
 Such instruments – for example, bonds that are convertible into a fixed number of equity shares
and carry interest – are accounted for as separate liability and equity components.
 'Split accounting' is used to measure the liability and the equity components upon initial
recognition of the instrument.
 This method allocates the fair value of the consideration for the compound instrument into its
liability and equity components.
 The fair value of the consideration in respect of the liability component is measured at the fair
value of a similar liability that does not have any associated equity conversion option.
 The equity component is assigned the residual amount.
Offsetting Requirements of Financial Instruments

 IAS 32 requires an entity to offset a financial asset and financial liability in the statement of
financial position only when the entity currently has a legally enforceable right of set-off and
intends either to settle the asset and liability on a net basis or to realise the asset and settle the
liability simultaneously.
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 An amendment to IAS 32 has clarified that the right of set-off must not be contingent on a future
event and must be immediately available.
 It also must be legally enforceable for all the parties in the normal course of business, as well as
in the event of default, insolvency or bankruptcy.
 Netting agreements, where the legal right of offset is only enforceable on the occurrence of some
future event – such as default of a party – do not meet the offsetting requirements.
Rights Issues
 Rights issues can still be classified as equity when the price is denominated in a currency other
than the entity‟s functional currency.
 The price of the right is denominated in currencies other than the issuer‟s functional currency,
when the entity is listed in more than one jurisdiction or is required to do so by law or regulation.
 A fixed price in a non-functional currency would normally fail the fixed number of shares for a
fixed amount of cash requirement in IAS 32 to be treated as an equity instrument.
 As a result, it is treated as an exception in IAS 32 and therefore treated as equity.
Measurement of Financial Liabilities

1. Fair value through profit or loss (FVTPL)
Financial liabilities held for trading
2. Amortised cost
All other financial liabilities unless the fair value option is applied
Note
 In June 2018, the Board issued a Discussion Paper DP/2018/1 Financial Instruments with
Characteristics of Equity.
 This was issued to allow the Board to investigate challenges that have been encountered when
IAS 32 has been applied in practice.
 Specifically, it addresses issues relating to the classification of both simple bonds and ordinary
shares and the limited disclosures that users are faced with when such financial instruments are
used.
 It is anticipated that the direction of this research project will be concluded during 2020.
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Accounting for Cryptocurrencies

There are many issues that accountants may encounter in practice for which no accounting standard
currently exists; one example is cryptocurrencies. For example, as no accounting standard currently
exists to explain how cryptocurrency should be accounted for, accountants have no alternative but to
refer to existing accounting standards. This article demonstrates to Strategic Business Reporting (SBR)
candidates how this can be done using cryptocurrencies as an example.
Note
SBR candidates should note that it is perfectly acceptable to suggest a reasonable accounting standard and
then explain why that standard is not applicable; indeed, this article adopts a similar approach with
International Accounting Standard (IAS®) 7 Statement of Cash Flows, IAS 32, Financial Instruments:
Presentation and International Financial Reporting Standard (IFRS®) 9 Financial Instruments
What Is Cryptocurrency?
 Cryptocurrency is an intangible digital token that is recorded using a distributed ledger
infrastructure, often referred to as a blockchain.
 These tokens provide various rights of use. For example, cryptocurrency is designed as a medium
of exchange.
 Other digital tokens provide rights to the use other assets or services, or can represent ownership
interests.
 These tokens are owned by an entity that owns the key that lets it create a new entry in the ledger.
 Access to the ledger allows the re-assignment of the ownership of the token.
 These tokens are not stored on an entity‟s IT system as the entity only stores the keys to the
Blockchain (as opposed to the token itself).
 They represent specific amounts of digital resources which the entity has the right to control, and
whose control can be reassigned to third parties.
What accounting standards might be used to account for cryptocurrency?

 Cryptocurrencies cannot be considered equivalent to cash (currency) as defined in IAS 7 and IAS
32 because they cannot readily be exchanged for any good or service.
 Digital currencies are not yet widely accepted as a medium of exchange and do not represent
legal tender.
 Entities may choose to accept digital currencies as a form of payment, but there is no requirement
to do so.
 IAS 7 defines cash equivalents as „short-term, highly liquid investments that are readily
convertible to known amounts of cash and which are subject to an insignificant risk of changes in
value‟.
 Thus, cryptocurrencies cannot be classified as cash equivalents because they are subject to
significant price volatility.
 Therefore, it does not appear that digital currencies represent cash or cash equivalents that can be
accounted for in accordance with IAS 7.
Accounting for Cryptocurrencies

IFRS 9 Perspective
 Intuitively, it might appear that cryptocurrency should be accounted for as a financial asset at fair
value through profit or loss (FVTPL) in accordance with IFRS 9.
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 However, it does not seem to meet the definition of a financial instrument either because it does
not represent cash, an equity interest in an entity, or a contract establishing a right or obligation to
deliver or receive cash or another financial instrument.
 Cryptocurrency is not a debt security, nor an equity security (although a digital asset could be in
the form of an equity security) because it does not represent an ownership interest in an entity.
 Therefore, it appears cryptocurrency should not be accounted for as a financial asset.
IAS 38 Perspective
 However, digital currencies do appear to meet the definition of an intangible asset in accordance
with IAS 38, Intangible Assets.
 This standard defines an intangible asset as an identifiable non-monetary asset without physical
substance.
 IAS 38 states that an asset is identifiable if it is separable or arises from contractual or other legal
rights.
 An asset is separable if it is capable of being separated or divided from the entity and sold,
transferred, licensed, rented or exchanged, either individually or together with a related contract,
identifiable asset or liability.
IAS 21 Perspective
 IAS 21 The Effects of Changes in Foreign Exchange Rates, states that an essential feature of a
non-monetary asset is the absence of a right to receive (or an obligation to deliver) a fixed or
determinable number of units of currency.
 Thus, it appears that cryptocurrency meets the definition of an intangible asset in IAS 38 as it is
capable of being separated from the holder and sold or transferred individually and, in accordance
with IAS 21, it does not give the holder a right to receive a fixed or determinable number of units
of currency.
Note
 Cryptocurrency holdings can be traded on an exchange and therefore, there is an expectation that
the entity will receive an inflow of economic benefits.
 However, cryptocurrency is subject to major variations in value and therefore it is non-monetary
in nature.
 Cryptocurrencies are a form of digital money and do not have physical substance.
 Therefore, the most appropriate classification is as an intangible asset.
Measurement of Cryptocurrencies – IAS/IFRS Approaches

IAS 38 and IFRS 13 Approach
 IAS 38 allows intangible assets to be measured at cost or revaluation.
 Using the cost model, intangible assets are measured at cost on initial recognition and are
subsequently measured at cost less accumulated amortisation and impairment losses.
 Using the revaluation model, intangible assets can be carried at a revalued amount if there is an
active market for them; however, this may not be the case for all cryptocurrencies.
 The same measurement model should be used for all assets in a particular asset class.
 If there are assets for which there is not an active market in a class of assets measured using the
revaluation model, then these assets should be measured using the cost model.
 IAS 38 states that a revaluation increase should be recognised in OCI and OCE. However, a
revaluation increase should be recognised in profit or loss to the extent that it reverses a
revaluation decrease of the same asset that was previously recognised in P/L.
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 A revaluation loss should be recognised in P/L. However, the decrease shall be recognised in OCI
to the extent of any credit balance in the revaluation surplus in respect of that asset.
 It is unusual for intangible assets to have active markets. However, cryptocurrencies are often
traded on an exchange and therefore it may be possible to apply the revaluation model.
 Where the revaluation model can be applied, IFRS 13, Fair Value Measurement, should be used
to determine the fair value of the cryptocurrency.
 IFRS 13 defines an active market, and judgement should be applied to determine whether an
active market exists for particular cryptocurrencies.
 As there is daily trading of Bitcoin, it is easy to demonstrate that such a market exists.
 A quoted market price in an active market provides the most reliable evidence of fair value and is
used without adjustment to measure fair value whenever available.
 In addition, the entity should determine the principal or most advantageous market for the
cryptocurrencies.
 An entity will also need to assess whether the cryptocurrency‟s useful life is finite or indefinite.
 An indefinite useful life is where there is no foreseeable limit to the period over which the asset is
expected to generate net cash inflows for the entity.
 It appears that cryptocurrencies should be considered as having an indefinite life for the purposes
of IAS 38.
 An intangible asset with an indefinite useful life is not amortised but must be tested annually for
impairment.
IAS 2 Approach
 In certain circumstances, and depending on an entity‟s business model, it might be appropriate to
account for cryptocurrencies in accordance with IAS 2, Inventories, because IAS 2 applies to
inventories of intangible assets.
 IAS 2 defines inventories as assets:
 held for sale in the ordinary course of business
 in the process of production for such sale, or
 in the form of materials or supplies to be consumed in the production process or in the rendering
of services.
 For example, an entity may hold cryptocurrencies for sale in the ordinary course of business and,
if that is the case, then cryptocurrency could be treated as inventory. Normally, this would mean
the recognition of inventories at the lower of cost and net realisable value.
 However, if the entity acts as a broker-trader of cryptocurrencies, then IAS 2 states that their
inventories should be valued at fair value less costs to sell.
 This type of inventory is principally acquired with the purpose of selling in the near future and
generating a profit from fluctuations in price or broker-traders‟ margin.
 Thus, this measurement method could only be applied in very narrow circumstances where the
business model is to sell cryptocurrency in the near future with the purpose of generating a profit
from fluctuations in price.
Disclosure Requirements
 As there is so much judgement and uncertainty involved in the recognition and measurement of
crypotocurrencies, a certain amount of disclosure is required to inform users in their economic
decision-making.
 IAS 1, Presentation of Financial Statements, requires an entity to disclose judgements that its
management has made regarding its accounting for holdings of assets, in this case
cryptocurrencies, if those are part of the judgements that had the most significant effect on the
amounts recognised in the financial statements.
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 Also IAS 10, Events after the Reporting Period requires an entity to disclose any material non-
adjusting events. This would include whether changes in the fair value of cryptocurrency after the
reporting period are of such significance that non-disclosure could influence the economic
decisions that users of financial statements make on the basis of the financial statements.
Note
 Accounting for cryptocurrencies is not as simple as it might first appear.
 As no IFRS standard currently exists, reference must be made to existing accounting standards
(and perhaps even the Conceptual Framework of Financial Reporting).
 SBR candidates should be prepared to adopt this approach in an exam situation because it allows
them to substantiate their conclusion which is an approach that will be expected by employers in
practice.
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Financial Statements of Groups of Entities (D)

Business Combinations – IFRS 3 (Revised)
This article provides an introduction to IFRS® 3, Business Combinations and IFRS, 10 Consolidated
Financial Statements, including piecemeal acquisitions and disposals.
Purchase Consideration
 This includes the fair value of all interests that the acquirer may have held previously in the
acquired business.
 This includes any interest in an associate or joint venture, or other equity interests of the acquired
business.
 Any previous stake is seen as being „given up‟ to acquire the entity, and a gain or loss is recorded
on its disposal.
 If the acquirer already held an interest in the acquired entity before acquisition, the standard
requires the existing stake to be re-measured to fair value at the date of acquisition, taking into
account any movement to the P/L together with any gains previously recorded in equity that
relate to the existing holding.
 If the value of the stake has increased, there will be a gain recognised in the OCI of the acquirer
at the date of the business combination.
 A loss would only occur if the existing interest has a carrying amount in excess of the proportion
of the fair value of the business obtained and no impairment had been recorded previously.
 Contingent consideration is also recognised at fair value even if payment is not deemed to be
probable at the date of the acquisition.
EXAMPLE 1
Josey acquires 100% of the equity of Burton on 31 December 2008. There are three elements to the
purchase consideration: an immediate payment of $5m, and two further payments of $1m if the return on
capital employed (ROCE) exceeds 10% in each of the subsequent financial years ending 31 December.
All indicators have suggested that this target will be met. Josey uses a discount rate of 7% in any present
value calculations.
Requirement:
Determine the value of the investment.
SOLUTION
The two payments that are conditional upon reaching the target ROCE are contingent consideration and
the fair value of $(1m/1.07 + 1m/1.072) ie $1.81m will be added to the immediate cash payment of $5m
to give a total consideration of $6.81m.
Note
Changes in Consideration
 All subsequent changes in debt-contingent consideration are recognised in the statement of profit
or loss, rather than against goodwill, as they are deemed to be a liability recognised in accordance
with IFRS 9, Financial Instruments.
 An increase in the liability for good performance by the subsidiary results in an expense in the
statement of profit or loss, and under-performance against targets will result in a reduction in the
expected payment and will be recorded as a gain in the statement of profit or loss.
 These changes were previously recorded against goodwill.
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 The nature of the contingent consideration is important as it may meet the definition of a liability
or equity.
 If it meets the definition of equity, then there will be no re-measurement.
 The new requirement is that contingent consideration is fair valued at acquisition and, unless it is
equity, is subsequently re-measured through earnings rather than the historic practice of re-
measuring through goodwill.
 This change is likely to increase the focus and attention on the opening fair value calculation and
subsequent re-measurements.
Bargain Purchase (Negative Goodwill)

 The standard also requires any gain on a „bargain purchase‟ (negative goodwill) to be recorded in
the statement of profit or loss, as in the previous standard.
Transaction Costs
 Transaction costs no longer form a part of the acquisition price; they are expensed as incurred.
 Transaction costs are not deemed to be part of what is paid to the seller of a business.
 They are also not deemed to be assets of the purchased business that should be recognised on
acquisition.
 The standard requires entities to disclose the amount of transaction costs that have been incurred.
Employee Share-Based Payments

 The standard provides additional guidance on valuation, as well as on how to decide whether
share awards are part of the consideration for the business combination or are compensation for
future services.
Goodwill and Non-Controlling Interests (NCI)

Goodwill
 Goodwill is 'an asset representing the future economic benefits arising from other assets acquired
in a business combination that are not individually identified and separately recognised' (IFRS 3
Appendix A).
 In simple terms, goodwill is measured as the difference between:
a) the consideration paid plus any NCI, and
b) the acquisition–date fair value of identifiable net assets acquired
Non-Controlling Interests (NCI)

 The measurement of NCI impacts on the calculation of goodwill.
 IFRS 3 gives entities the option, to measure NCIs at:
a) the fair value of their proportion of identifiable assets and liabilities (partial method), or
b) full fair value (full method)
EXAMPLE 2
Missile acquires a subsidiary on 1 January 2008. The fair value of the identifiable net assets of the
subsidiary was $2,170m. Missile acquired 70% of the shares of the subsidiary for $2.145m. The NCI was
fair valued at $683m.
Requirement:
Compare the value of goodwill under the partial and full methods.
SOLUTION
Goodwill based on the partial and full goodwill methods under IFRS 3 (Revised) would be:
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Partial Goodwill Method $m
Purchase consideration 2,145
Fair value of identifiable net assets (2,170)
NCI (30% x 2,170) 651
Goodwill 626
Full Goodwill Method $m

Purchase consideration 2,145
NCI 683
2,828
Fair value of identifiable net assets (2,170)
Goodwill 658
Fair Valuing Assets and Liabilities

 IFRS 3 (Revised) requires all of the identifiable assets and liabilities of the acquiree to be
included in the consolidated statement of financial position.
 Most assets are recognised at fair value, with exceptions for certain items such as deferred tax and
pension obligations.
 The IASB provided additional clarity that has resulted in more intangible assets being recognised
than previously.
 Acquirers are required to recognise brands, licences and customer relationships, and other
intangible assets.
Contingent Assets and Liabilities

 Contingent assets are not recognised, and contingent liabilities are measured at fair value.
 After the date of the business combination, contingent liabilities are re-measured at the higher of
the original amount and the amount in accordance with the relevant standard.
 The ability of an acquirer to recognise a liability for terminating or reducing the activities of the
acquiree is severely restricted.
Restructuring Provision
 A restructuring provision can be recognised in a business combination only when the acquiree
has, at the acquisition date, an existing liability for which there are detailed conditions in IAS 37,
but these conditions are unlikely to exist at the acquisition date in most business combinations.
Note
 An acquirer has a maximum period of 12 months from the date of acquisition to finalise the
acquisition accounting.
 The adjustment period ends when the acquirer has gathered all the necessary information, subject
to the 12-month maximum.
 There is no exemption from the 12-month rule for deferred tax assets or changes in the amount of
contingent consideration.
 The revised standard will only allow adjustments against goodwill within this one-year period.
 Where NCI is measured at fair value, the valuation methods used for determining that value
require to be disclosed; and, in a step acquisition, disclosure is required of the fair value of any
previously held equity interest in the acquiree, and the amount of gain or loss recognised in the
statement of profit or loss resulting from re-measurement.
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IFRS 10 Consolidated Financial Statements
 The objective of IFRS 10 is to establish principles for the presentation and preparation of
consolidated financial statements.
 These are the financial statements of a group where the parent and its subsidiaries are presented
as those of a single economic entity.
 The economic entity approach treats all providers of equity capital as shareholders of the entity,
even when they are not shareholders in the parent company.
 For example, disposal of a partial interest in a subsidiary in which the parent company retains
control, does not result in a gain or loss but in an increase or decrease in equity under the
economic entity approach.
 Purchase of some or all of the NCI is treated as a treasury transaction and accounted for in equity.
 A partial disposal of an interest in a subsidiary in which the parent company loses control but
retains an interest as an associate, creates the recognition of gain or loss on the entire interest.
 A gain or loss is recognised on the part that has been disposed of, and a further holding gain is
recognised on the interest retained, being the difference between the fair value of the interest and
the carrying amount of the interest.
 The gains are recognised in the statement of comprehensive income.
 Amendments to IAS 28, Investments in Associates, extend this treatment to associates and joint
ventures.
EXAMPLE 3
Step Acquisition
On 1 January 2008, A acquired a 50% interest in B for $60m. A already held a 20% interest which had
been acquired for $20m but which was valued at $24m at 1 January 2008. The fair value of the NCI at 1
January 2008 was $40m, and the fair value of the identifiable net assets of B was $110m. The goodwill
calculation would be as follows, using the full goodwill method:
$m
1 January 2008 consideration 60
Fair value of interest held 24
84
NCI 40
124
Fair value of identifiable net assets (110)
Goodwill 14
Note
A gain of $4m would be recorded on the increase in the value of the previous holding in B.
EXAMPLE 4
Acquisition of Part of an NCI
On 1 January 2008, Rage acquired 70% of the equity interests of Pin, a public limited company. The
purchase consideration comprised cash of $360m. The fair value of the identifiable net assets was $480m.
The fair value of the NCI in Pin was $210m on 1 January 2008. Rage wishes to use the full goodwill
method for all acquisitions. Rage acquired a further 10% interest from the NCIs in Pin on 31 December
2008 for a cash consideration of $85m. The carrying amount of the net assets of Pin was $535m at 31
December 2008.
$m
Fair value of consideration for 70% interest 360
Fair value of NCI 210
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570
Fair value of identifiable net assets (480)
Goodwill 90
Acquisition of further interest

The net assets of Pin have increased by $(535 – 480)m – ie $55m and therefore the NCI has increased by
30% of $55m – ie $16.5m. However, Rage has purchased an additional 10% of the shares and this is
treated as a treasury transaction. There is no adjustment to goodwill on the further acquisition.
$m
Pin NCI, 1 January 2008 210
Share of increase in net assets in post-acquisition period 16.5
Net assets, 31 December 2008 226.5
Transfer to equity of Rage (10/30 x 226.5) (75.5)
Balance at 31 December 2008 – NCI 151
Fair value of consideration 85
Charge to NCI (75.5)
Negative movement in equity 9.5
Note
Rage has effectively purchased a further share of the NCI, with the premium paid for that share naturally
being charged to equity. The situation is comparable when a parent company sells part of its holding but
retains control.
EXAMPLE 5
Disposal of part of holding to NCI
Using Example 4, instead of acquiring a further 10%, Rage disposes of a 10% interest to the NCIs in Pin
on 31 December 2008 for a cash consideration of $65m. The carrying amount of the net assets of Pin is
$535m at 31 December 2008.
$m
Pin net assets at 1 January 2008 480
Increase in net assets 55
Net assets at 31 December 2008 535
Transfer to NCI (10% x (535 net assets + 90 goodwill)) (62.5)
Positive movement in equity 2.5
Note
The parent has effectively sold 10% of the carrying amount of the net assets (including goodwill) of the
subsidiary ($62.5m) at 31 December 2008 for a consideration of $65m, giving a profit of $2.5m, which is
taken to equity.
Disposal of Controlling Interest While Retaining Associate Holding

IFRS 10 sets out the adjustments to be made when a parent loses control of a subsidiary:
 Derecognise the carrying amount of assets (including goodwill), liabilities and NCIs
 Recognise the fair value of consideration received
 Recognise any distribution of shares to owners
 Recognise the fair value of any residual interest
 Reclassify to profit or loss any amounts (the entire amount, not a proportion) relating to the
subsidiary‟s assets and liabilities previously recognised in other comprehensive income, as if the
assets and liabilities had been disposed of directly
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 Recognise the fair value of any residual interest.
EXAMPLE 6
Disposal of controlling interest
On 1 January 2008, Rage acquired a 90% interest in Machine, a public limited company, for a cash
consideration of $80m. Machine‟s identifiable net assets had a fair value of $74m and the NCI had a fair
value of $6m. Rage uses the full goodwill method. On 31 December 2008, Rage disposed of 65% of the
equity of Machine (no other investor obtained control as a result of the disposal) when its identifiable net
assets were $83m. Of the increase in net assets, $6m had been reported in profit or loss, and $3m had
been reported in comprehensive income. The sale proceeds were $65m, and the remaining equity interest
was fair valued at $25m. After the disposal, Machine is classified as an associate in accordance with IAS
28, Investments in Associates. The gain recognised in profit or loss would be as follows:
$m
NCI 6.9
(6+(10%x(83-74)))
Fair value of residual interest to be recognised as an associate 25
Gain reported in comprehensive income 3
99.9
Less net assets and goodwill derecognised:
net assets (83)
goodwill (80 + 6 – 74) (12)
Gain on disposal to profit or loss 4.9
Note
 After the sale of the interest, the holding in the associate will be fair valued at $25m.
 Issues associated with both IFRS 3 and IFRS 10 will be tested regularly in SBR and candidates
should be comfortable with the numerical examples provided above.
 Candidates should also be able to provide an explanation of the principles that support these
calculations.
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Impairment of Goodwill
According to IFRS® 3, Business Combinations, there are two ways to measure the goodwill that arises on
the acquisition of a subsidiary and each has a slightly different impairment process.
Note
This article discusses and shows both ways of measuring goodwill following the acquisition of a
subsidiary, and how each measurement of goodwill is subject to an impairment review.
How to Calculate Goodwill

1. The Proportionate Method
 It determines only the goodwill that is attributable to the parent company.
2.
The Gross or Full Goodwill Method
 Compare the fair value of the whole of the subsidiary (as represented by the fair value of the
consideration given by the parent and the fair value of the non-controlling interest) with all of the
fair value of the net assets of the subsidiary acquired.
 It determines the goodwill that relates to the whole of the subsidiary, ie goodwill that is both
attributable to the parent‟s interest and the non-controlling interest (NCI).
Consider Calculating Goodwill

Borough acquires an 80% interest in the equity shares of High for consideration of $500. The fair value of
the net assets of High at that date is $400. The fair value of the NCI at that date (ie the fair value of
High‟s shares not acquired by Borough) is $100.
Required
1. Calculate the goodwill arising on the acquisition of High on a proportionate basis.
2. Calculate the gross goodwill arising on the acquisition of High, ie using the fair value of the NCI.
Solution
1. The proportionate goodwill arising is calculated by matching the consideration that the parent has
given, with the interest that the parent acquires in the net assets of the subsidiary, to give the
goodwill of the subsidiary that is attributable to the parent.
Parent‟s cost of investment at the $500

fair value of consideration given
Less the parent‟s share of the fair
value of the net assets of the subsidiary acquired
(80% x $400) ($320)
Goodwill attributable to the parent $180
2. The gross goodwill arising is calculated by matching the fair value of the whole business with the
whole fair value of the net assets of the subsidiary to give the whole goodwill of the subsidiary,
attributable to both the parent and to the NCI.
Parent‟s cost of investment at the $500

fair value of consideration given
Fair value of the NCI $100
Less the fair value of the net
assets of the subsidiary acquired (100% x $400) ($400)
Gross Goodwill $200
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Note
 Given a gross goodwill of $200 and a goodwill attributable to the parent of $180, the goodwill
attributable to the NCI is the difference of $20.
 In these examples, goodwill is said to be a premium arising on acquisition. Such goodwill is
positive goodwill and accounted for as an intangible asset in the group financial statements, and
as we shall see be subject to an annual impairment review.
 In the event that there is a bargain purchase, ie negative goodwill arises, then this is regarded as a
profit and immediately recognised in income.
Basic Principles of Impairment

 An asset is impaired when its carrying amount exceeds the recoverable amount.
 The recoverable amount is the higher of the fair value less cost to sell and the value in use; where
the value in use is the present value of the future cash flows.
 An impairment review calculation looks like this.
Consider an Impairment Review

A company has an asset that has a carrying amount of $800. The asset has not been revalued. The asset is
subject to an impairment review. If the asset was sold, then it would sell for $610 and there would be
associated selling costs of $10. (The fair value less costs to sell of the asset is therefore $600.) The
estimate of the present value of the future cash flows to be generated by the asset if it were kept is $750.
(This is the value in use of the asset.)
Required
Determine the outcome of the impairment review.
Solution
An asset is impaired when its carrying amount exceeds the recoverable amount, where the recoverable
amount is the higher of the fair value less costs to sell and the value in use. In this case, with a fair value
less cost to sell of only $600 and a value in use of $750 it both follows the rules, and makes common
sense to minimise losses, that the recoverable amount will be the higher of the two, ie $750.
Impairment Review
Carrying amount of the asset $800
Recoverable amount ($750)
Impairment loss $50
Note
 The impairment loss must be recorded so that the asset is written down.
 There is no accounting policy or choice about this.
 In the event that the recoverable amount had exceeded the carrying amount then there would be
no impairment loss to recognise and as there is no such thing as an impairment gain, no
accounting entry would arise.
 As the asset has never been revalued, the loss has to be charged to income. Impairment losses are
non-cash expenses, like depreciation, so in the cash flow statement they will be added back when
reconciling operating profit to cash generated from operating activities, just like depreciation
again.
 Assets are generally subject to an impairment review only if there are indicators of impairment.
Circumstances That Would Trigger an Impairment Review - IAS® 36, Impairment of Assets
1. External sources
 market value declines
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 negative changes in technology, markets, economy, or laws
 increases in market interest rates
 company share price is below the carrying amount
2. Internal sources
 obsolescence or physical damage
 asset is part of a restructuring or held for disposal
 worse economic performance than expected
Goodwill and Impairment

 Goodwill arises in the group financial statements because it is not separable from the net assets of
the subsidiary that have just been acquired.
 The impairment review of goodwill therefore takes place at the level of a cash-generating unit (a
group of assets that together create an independent stream of cash).
 The CGU will normally be assumed to be the subsidiary. In this way, when conducting the
impairment review, the carrying amount will be that of the net assets and the goodwill of the
subsidiary compared with the recoverable amount of the subsidiary.
 When looking to assign the impairment loss to particular assets within the cash generating unit,
unless there is an asset that is specifically impaired, it is goodwill that is written off first, with any
further balance being assigned on a pro rata basis.
 The goodwill arising on the acquisition of a subsidiary is subject to an annual impairment review.
 Goodwill cannot be revalued so any impairment loss will automatically be charged against
income.
 Goodwill is not deemed to be systematically consumed or worn out thus there is no requirement
for a systematic amortisation.
Proportionate Goodwill and the Impairment Review

 When goodwill has been calculated on a proportionate basis then gross up goodwill so that in the
impairment review goodwill will include an unrecognised notional goodwill attributable to the
NCI.
 Any impairment loss that arises is first allocated against the total of recognised and unrecognised
goodwill in the normal proportions that the parent and NCI share profits and losses.
 Any amounts written off against the notional goodwill will not affect the consolidated financial
statements and NCI.
 Any amounts written off against the recognised goodwill will be attributable to the parent only,
without affecting the NCI.
 If the total amount of impairment loss exceeds the amount allocated against recognised and
notional goodwill, the excess will be allocated against the other assets on a pro rata basis.
 This further loss will be shared between the parent and the NCI in the normal proportion that they
share profits and losses.
Consider an impairment review of proportionate goodwill

At the year-end, an impairment review is being conducted on a 60%-owned subsidiary. At the date of the
impairment review the carrying amount of the subsidiary‟s net assets were $250 and the goodwill
attributable to the parent $300 and the recoverable amount of the subsidiary $700.
Required
Solution
In conducting the impairment review of proportionate goodwill, it is first necessary to gross it up.
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Proportionate goodwill Grossed up Goodwill including the
notional unrecognised NCI
$300 x 100/60 = $500
Note
Now, for the purposes of the impairment review, the goodwill of $500 together with the net assets of
$250 form the carrying amount of the cash-generating unit.
Impairment review
Carrying amount
Net assets $250
Goodwill $500
$750
Recoverable amount ($700)
Impairment loss $50
Note
 The impairment loss does not exceed the total of the recognised and unrecognised goodwill so
therefore it is only goodwill that has been impaired. The other assets are not impaired. As
proportionate goodwill is only attributable to the parent, the impairment loss will not impact NCI.
 Only the parent‟s share of the goodwill impairment loss will actually be recorded, ie 60% x $50 =
$30.
 The impairment loss will be applied to write down the goodwill, so that the intangible asset of
goodwill that will appear on the group statement of financial position will be $270 ($300 – $30).
 In the group statement of financial position, the accumulated profits will be reduced $30. There is
no impact on the NCI.
 In the group statement of profit or loss, the impairment loss of $30 will be charged as an extra
operating expense. There is no impact on the NCI.
Gross/Full Goodwill and the Impairment Review

 Where goodwill has been calculated gross, then all the ingredients in the impairment review
process are already consistently recorded in full.
 Any impairment loss (whether it relates to the gross goodwill or the other assets) will be allocated
between the parent and the NCI in the normal proportion that they share profits and losses.
Consider an impairment review of gross goodwill

At the year-end, an impairment review is being conducted on an 80%-owned subsidiary. At the date of
the impairment review the carrying amount of the net assets were $400 and the gross goodwill $300 (of
which $40 is attributable to the NCI) and the recoverable amount of the subsidiary $500.
Required
Solution
The impairment review of goodwill is really the impairment review of the net asset‟s subsidiary and its
goodwill, as together they form a cash generating unit for which it is possible to ascertain a recoverable
amount.
Carrying amount
Net assets $400
Goodwill $300
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$700
Recoverable amount $500
Impairment loss $200
Note
 The impairment loss will be applied to write down the goodwill, so that the intangible asset of
goodwill that will appear on the group statement of financial position, will be $100 ($300 –
$200).
 In the equity of the group statement of financial position, the accumulated profits will be reduced
by the parent‟s share of the impairment loss on the gross goodwill, ie $160 (80% x $200) and the
NCI reduced by the NCI‟s share, ie $40 (20% x $200).
 In the statement of profit or loss, the impairment loss of $200 will be charged as an extra
operating expense. As the impairment loss relates to the gross goodwill of the subsidiary, so it
will reduce the NCI in the subsidiary‟s profit for the year by $40 (20% x $200).
Observation
 In passing, you may wish to note an apparent anomaly with regards to the accounting treatment of
gross goodwill and the impairment losses attributable to the NCI. The goodwill attributable to the
NCI in this example is stated as $40. This means that goodwill is $40 greater than it would have
been if it had been measured on a proportionate basis; likewise, the NCI is also $40 greater for
having been measured at fair value at acquisition.
 The split of the gross goodwill between what is attributable to the parent and what is attributable
to the NCI is determined by the relative values of the NCI at acquisition to the parent‟s cost of
investment. However, when it comes to the allocation of impairment losses attributable to the
write off of goodwill then these losses are shared in the normal proportions that the parent and the
NCI share profits and losses, ie in this case 80%/20%.
 This explains the strange phenomena that while the NCI are attributed with only $40 out of the
$300 of the gross goodwill, when the gross goodwill was impaired by $200 (ie two thirds of its
value), the NCI are charged $40 of that loss, representing all of the goodwill attributable to the
NCI.
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Interpret Financial Statements for Different Stakeholders

(E)
Sustainability Reporting
 In April 2021, the IFRS Foundation published two documents in relation to their project
on sustainability reporting.
 The first summarises the significant matters raised by respondents to their Consultation
Paper on Sustainability Reporting.
 The second document was an Exposure Draft with proposed targeted amendments to the
IFRS Foundation Constitution to accommodate an International Sustainability Standards
Board (ISSB).
 This would allow the ISSB to set IFRS sustainability standards.
 The IFRS Foundation reached the following conclusions:
a) the new board would focus on information that is material to the decisions of investors
and other participants in the world‟s capital markets
b) the new board would initially focus on climate-related reporting while also moving
quickly to work towards meeting the information needs of investors on other
environmental, social and governance (ESG) matters
c) the new board would build on the well-established work of the Financial Stability
Board‟s Task Force on Climate-related Financial Disclosures (TCFD), as well as work by
the alliance of leading standard-setters in sustainability and integrated reporting focused
on enterprise value
d) by working with standard-setters from key jurisdictions, standards issued by the new
board would provide a globally consistent and comparable sustainability reporting
framework.
 There is broad stakeholder support for globally recognised sustainability reporting standards.
Currently it can be argued that there are diverse approaches to and objectives for sustainability
standard-setting which could result in increasing global fragmentation. This demonstrates the
need to promote comparable reporting and reduce the complexity in approaches and objectives.
 The objective of the ISSB would be to develop and maintain a global set of sustainability
reporting standards. Such standard setting could make use of existing sustainability frameworks
and standards.
 The development of a framework for sustainability reporting could be coherent with IFRS
standards and the IASB‟s mission to serve investors and primary users of financial statements.
The ISSB could adapt the existing standard setting process and use the experience of the IASB in
promoting the consistent use and application of sustainability standards.
 The IFRS Foundation has established expertise in standard-setting which would benefit both the
new ISSB and investors. This would help investors to use sustainability reporting to inform their
decisions by giving them comparable and verifiable information.
 The standards would benefit from the interconnectedness between financial reporting and
sustainability reporting. In addition, investors would benefit if a single organisation developed
requirements in financial reporting and sustainability reporting.
 The IFRS Foundation is well positioned to develop an appropriate institutional and governance
framework. However, there is a risk of reducing the current momentum created by other
frameworks and standard setting bodies.
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 As an alternative, the IFRS Foundation could encourage regulators to mandate the use of
sustainability reporting standards globally. In addition, it could be argued that the GRI standards
already have created global sustainability reporting standards that regulatory authorities could
mandate.
 Also, as the EU is already taking the lead in developing sustainability standards and has a very
ambitious timescale to develop and issue them, the IASB could contribute its expertise in
financial reporting to find consistency between financial and sustainability reporting.
 There is demand from investors for international coordination of an agreed set of sustainability
reporting standards. Currently, investors are often struggling with incomplete and inconsistent
data on companies. The ISSB would assist in providing a level playing field for companies that
prepare reports and also international comparability for investors.
Note
SBR candidates need to be aware of progress in this area of business reporting as it is a dynamic, fast-
paced and developing subject area.
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Additional Performance Measures

Introduction
 Many jurisdictions have enforced a standard format for performance reporting, with no additional
analysis permitted on the face of the Statement of Profit or Loss.
 Others have allowed entities to adopt various methods of conveying the nature of „underlying‟ or
„sustainable‟ earnings.
 Although financial statements are prepared in accordance with applicable financial reporting
standards, users are demanding more information and issuers seem willing to give users their
understanding of the financial information.
 This information varies from the disclosure of additional key performance indicators of the
business to providing more information on individual items within the financial statements.
 These additional performance measures (APMs) can assist users in making investment
decisions, but they do have limitations.
Common Practice
 It is common practice for entities to present APMs, such as normalised profit, earnings before
interest and tax (EBIT) and earnings before interest, tax, depreciation and amortisation
(EBITDA).
 These alternative profit figures can appear in various communications, including company media
releases and analyst briefings.
 Alternative profit calculations normally exclude particular income and expense items from the
profit figure reported in the financial statements.
 Also, there could be the exclusion of income or expenses that are considered irrelevant from the
viewpoint of the impact on this year‟s performance or when considering the expected impact on
future performance.
 An example of the latter has been gains or losses from changes in the fair value of financial
instruments. The exclusion of interest and tax helps to distinguish between the results of the
entity‟s operations and the impact of financing and taxation.
Advantages of APMs
1. Enhance users‟ understanding of the company‟s results and can be important in assisting users in
making investment decisions, as they allow them to gain a better understanding of an entity‟s
financial statements and evaluate the entity through the eyes of the management.
2. They can also be an important instrument for easier comparison of entities in the same sector,
market or economic area.
Disadvantages of APMs
1. They can be misleading due to bias in calculation, inconsistency in the basis of calculation from
year to year, inaccurate classification of items and, as a result, a lack of transparency.
2. Often there is little information provided on how the alternative profit figure has been calculated
or how it reconciles with the profit reported in the financial statements.
3. The APMs are also often described in terms which are neither defined by issuers nor included in
professional literature and thus cannot be easily recognised by users.
APMs include:
1. all measures of financial performance not specifically defined by the applicable financial
reporting framework
2. all measures designed to illustrate the physical performance of the activity of an issuer‟s business
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3. all measures disclosed to fulfil other disclosure requirements included in public documents
containing regulated information.
For example
Demonstrating the use of APMs is the financial statements of Telecom Italia Group for the year ended 31
December 2011. These contained a variety of APMs as well as the conventional financial performance
measures laid down by IFRS® Standards. The non-IFRS APMs used in the Telecom Italia statements
were:
 EBITDA. Used by Telecom Italia as the financial target in its internal presentations (business
plans) and in its external presentations (to analysts and investors). The entity regarded EBITDA
as a useful unit of measurement for evaluating the operating performance of the group and the
parent.
 Organic change in revenues, EBITDA and EBIT. These measures express changes in
revenues, EBITDA and EBIT, excluding the effects of the change in the scope of consolidation,
exchange differences and non-organic components constituted by non-recurring items and other
non-organic income and expenses. The organic change in revenues, EBITDA and EBIT is also
used in presentations to analysts and investors.
 Net financial debt. Telecom Italia saw net financial debt as an accurate indicator of its ability to
meet its financial obligations. It is represented by gross financial debt less cash and cash
equivalents and other financial assets. The report on operations includes two tables showing the
amounts taken from the statement of financial position and used to calculate the net financial debt
of the group and parent.
 Adjusted net financial debt. A new measure introduced by Telecom Italia to exclude effects that
are purely accounting in nature resulting from the fair value measurement of derivatives and
related financial assets and liabilities.
Evaluating The Aims

1. The IASB is undertaking an initiative to explore how disclosures in IFRS financial reporting can
be improved.
 The project has started to look at possible ways to address the issues arising from the use
of APMs. This initiative is made up of a number of projects.
 It will consider such things as adding an explanation in IAS® 1 that too much detail can
obscure useful information and adding more explanations, with examples, of how IAS 1
requirements are designed to shape financial statements instead of specifying precise
terms that must be used.
 This includes whether subtotals of IFRS numbers such as EBIT and EBITDA should be
acknowledged in IAS 1.
2. In the UK, the Financial Reporting Council supports the inclusion of APMs when users are
provided with additional useful, relevant information.
In contrast, the Australian Financial Reporting Council feels that such measures are outside the
scope of the financial statements.
In 2012, the Financial Markets Authority (FMA) in the UK issued a guidance note on disclosing
APMs and other types of non-GAAP financial information, such as underlying profits, EBIT and
EBITDA.
3. APMs appear to be used by some issuers to present a confusing or optimistic picture of their
performance by removing negative aspects.
There seems to be a strong demand for guidance in this area, but there needs to be a balance
between providing enough flexibility, while ensuring users have the necessary information to
judge the usefulness of the APMs.
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4. To this end, the European Securities and Markets Authority (ESMA) has launched a consultation
on APMs.
The aim is to improve the transparency and comparability of financial information while reducing
information asymmetry among the users of financial statements.
ESMA also wishes to improve coherency in APM use and presentation and restore confidence in
the accuracy and usefulness of financial information.
5. ESMA has therefore developed draft guidelines that address the concept and description of
APMs, guidance for the presentation of APMs and consistency in using APMs. The main
requirements are:
 Issuers should define the APM used, the basis of calculation and give it a meaningful
label and context.
 APMs should be reconciled to the financial statements.
 APMs that are presented outside financial statements should be displayed with less
prominence.
 An issuer should provide comparatives for APMs and the definition and calculation of
the APM should be consistent over time.
 If an APM ceases to be used, the issuer should explain its removal and the reasons for the
newly defined APM.
6. However, these guidelines may not be practicable when the cost of providing this information
outweighs the benefit obtained or the information provided may not be useful to users.
7. Application of the guidelines will enable users to understand the adjustments made by
management to figures presented in the financial statements.
 ESMA believes that this information will help users to make better-grounded projections
and estimates of future cashflows and assist in equity analysis and valuations.
 The information provided by issuers in complying with these guidelines will increase the
level of disclosures, but should lead issuers to provide more qualitative information.
 The national competent authorities will have to implement these guidelines as part of
their supervisory activities and provide a framework against which they can require
issuers to provide information about APMs.
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Giving Investors What They Need

This article looks at how reporting capital structure is challenging, but markets are keen for the
information.
Introduction
 Often the advice to investors is to focus upon cash and cash flow when analysing corporate
reports.
 However, insufficient financial capital can cause liquidity problems and sufficiency of financial
capital is essential for growth.
 Discussion of the management of financial capital is normally linked with entities that are subject
to external capital requirements but it is equally important to those entities which do not have
regulatory obligations.
Financial Capital - What is it?

 The term has no accepted definition having been interpreted as equity held by shareholders or
equity plus debt capital including finance leases.
 This can obviously affect the way in which „capital‟ is measured which has an impact on return
on capital employed (ROCE).
 Some focus on historical invested capital, others on accounting capital and others on market
capitalisation.
Investor Needs
 Investors need depend upon their approach to the valuation of a business.
 If the valuation approach is based upon a dividend model, then shortage of capital may have an
impact upon future dividends.
 If ROCE is used for comparing the performance of entities, then investors need to know the
nature and quantity of the historical capital employed in the business.
 There are various requirements for entities to disclose information about „capital‟. In drafting
IFRS® 7, Financial Instruments: Disclosures, the IASB Board considered whether it should
require disclosures about capital.
 In assessing the risk profile of an entity, the management and level of an entity‟s capital is an
important consideration.
 The Board believes that disclosures about capital are useful for all entities, but they are not
intended to replace disclosures required by regulators as their reasons for disclosure may differ
from those of the Board.
 As an entity‟s capital does not relate solely to financial instruments, the Board has included these
disclosures in IAS® 1, Presentation of Financial Statements rather than IFRS 7.
 IFRS 7 requires some specific disclosures about financial liabilities, it does not have similar
requirements for equity instruments.
 The Board considered whether the definition of „capital‟ is different from the definition of equity
in IAS 32, Financial Instruments; Presentation.
 In most cases disclosure of capital would be the same as equity but it might also include or
exclude some elements.
 The disclosure of capital is intended to give entities the ability to describe their view of the
elements of capital if this is different from equity.
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IAS 1 Disclosures
 IAS 1 requires an entity to disclose information that enables users to evaluate the entity‟s
objectives, policies and processes for managing capital.
 This objective is obtained by disclosing qualitative and quantitative data. The former should
include narrative information such as what the company manages as capital, whether there are
any external capital requirements and how those requirements are incorporated into the
management of capital.
 Some entities regard some financial liabilities as part of capital whilst other entities regard capital
as excluding some components of equity, for example, those arising from cash flow hedges.
 The Board decided not to require quantitative disclosure of externally imposed capital
requirements but rather decided that there should be disclosure of whether the entity has complied
with any external capital requirements and, if not, the consequences of non-compliance.
 Further there is no requirement to disclose the capital targets set by management and whether the
entity has complied with those targets, or the consequences of any non-compliance.
Examples
 Examples of some of the disclosures made by entities include information as to how gearing is
managed, how capital is managed to sustain future product development and how ratios are used
to evaluate the appropriateness of its capital structure.
 An entity bases these disclosures on the information provided internally to key management
personnel.
 If the entity operates in several jurisdictions with different external capital requirements such that
an aggregate disclosure of capital would not provide useful information, the entity may disclose
separate information for each separate capital requirement.
 Besides the requirements of IAS 1, the IFRS Practice Statement Management Commentary
suggests that management should include forward-looking information in the commentary when
it is aware of trends, uncertainties or other factors that could affect the entity‟s capital resources.
Companies Act
 In the UK, Section 414 of the Companies Act 2006 deals with the contents of the Strategic Report
and requires a „balanced and comprehensive analysis‟ of the development and performance of the
business during the period and the position of the company at the end of the period.
 The section further requires that to the extent necessary for an understanding of the development,
performance or position of the business, the strategic report should include an analysis using key
performance indicators.
 It makes sense that any analysis of a company‟s financial position should include consideration of
how much capital it has and its sufficiency for the company‟s needs.
 The Financial Reporting Council Guidance on the Strategic Report suggests that comments
should appear in the report on the entity‟s financing arrangements such as changes in net debt or
the financing of long-term liabilities.
Capitalisation Table
 In addition to the annual report, an investor may find details of the entity‟s capital structure where
the entity is involved in a transaction, such as a sale of bonds or equities.
 It is normal for an entity to produce a capitalisation table in a prospectus showing the effects of
the transactions on the capital structure. The table shows the ownership and debt interests in the
entity but may show potential funding sources, and the effect of any public offerings.
 The capitalisation table may present the pro forma impact of events that will occur as a result of
an offering such as the automatic conversion of preferred stock, the issuance of common stock, or
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the use of the offering proceeds for the repayment of debt or other purposes. The Board does not
require such a table to be disclosed but it is often required by securities regulators.
 For example, in the US, the table is used to calculate key operational metrics. Amedica
Corporation announced in February 2016 that it had „made significant advancements in its
ongoing initiative toward improving its capitalisation table, capitalisation, and operational
structure‟.
 It can be seen that information regarding an entity‟s capital structure is spread across several
documents including the management commentary, the notes to financial statements, interim
accounts and any document required by securities regulators.
Classes of Capital - Debt and Equity

 Debt and equity instruments can have different levels of benefits and risks.
 When an entity issues a financial instrument, it has to determine its classification either as debt or
as equity.
 The result of the classification can have a significant effect on the entity‟s reported results and
financial position.
 Liability classification impacts upon an entity‟s gearing ratios and results in any payments being
treated as interest and charged to earnings.
 Equity classification may be seen as diluting existing equity interests.
 IAS 32 sets out the nature of the classification process but the standard is principle based and
sometimes the outcomes are surprising to users.
 IAS 32 does not look to the legal form of an instrument but focuses on the contractual obligations
of the instrument.
 IAS 32 considers the substance of the financial instrument, applying the definitions to the
instrument‟s contractual rights and obligations.
 The variety of instruments issued by entities makes this classification difficult with the
application of the principles occasionally resulting in instruments that seem like equity being
accounted for as liabilities.
 Recent developments in the types of financial instruments issued have added more complexity to
capital structures with the resultant difficulties in interpretation and understanding.
 The Board has undertaken a research project with the aim of improving accounting for financial
instruments that have characteristics of both liabilities and equity.
 The Board has a major challenge in determining the best way to report the effects of recent
innovations in capital structure.
Diversity and Difficulty

 There is a diversity of thinking about capital, which is not surprising given the issues with
defining equity, the difficulty in locating sources of information about capital and the diversity of
business models in an economy.
 Capital needs are very specific to the business and are influenced by many factors such as debt
covenants, and preservation of debt ratings.
 The variety and inconsistency of capital disclosures does not help the decision making process of
investors.
 Therefore, the details underlying a company‟s capital structure are essential to the assessment of
any potential change in an entity‟s financial flexibility and value.
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The Integrated Report Framework

In 2013, the International Integrated Reporting Council (IIRC) released a framework for integrated
reporting. The framework establishes principles and concepts that govern the overall content of an
integrated report.
Introduction
 An integrated report sets out how the organisation‟s strategy, governance, performance and
prospects, which lead to the creation of value.
 The report is aimed primarily at the private sector but it could be adapted for public sector and
not-for-profit organisations.
 The primary purpose of an integrated report is to explain to providers of financial capital how an
organisation creates value over time.
 An integrated report benefits all stakeholders interested in a company‟s ability to create value,
including employees, customers, suppliers, business partners, local communities, legislators,
regulators and policymakers, although it is not directly aimed at all stakeholders.
 Providers of financial capital can have a significant effect on the capital allocation and attempting
to aim the report at all stakeholders would be an impossible task and would reduce the focus and
increase the length of the report. This would be contrary to the objectives of the report, which is
value creation.
 Historical financial statements are essential in corporate reporting, particularly for compliance
purposes, but do not provide meaningful information regarding business value.
 Users need a more forward-looking focus without the necessity of companies providing their own
forecasts and projections.
 The IIR Framework will encourage the preparation of a report that shows their performance
against strategy, explains the various capitals used and affected, and gives a longer-term view of
the organisation.
 The integrated report is creating the next generation of the annual report as it enables stakeholders
to make a more informed assessment of the organisation and its prospects.
Principle-based Framework
 The IIRC has set out a principle-based framework rather than specifying a detailed disclosure and
measurement standard. T
 his enables each company to set out its own report rather than adopting a checklist approach.
 The culture change should enable companies to communicate their value creation better than the
often boilerplate disclosures under IFRSs.
 The report acts as a platform to explain what creates the underlying value in the business and how
management protects this value.
 This gives the report more business relevance rather than the compliance led approach currently
used.
Note
 Integrated reporting will not replace other forms of reporting but the vision is that preparers will
pull together relevant information already produced to explain the key drivers of their business‟s
value.
 Information will only be included in the report where it is material to the stakeholder‟s
assessment of the business.
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 There were concerns that the term „materiality‟ had a certain legal connotation, with the result
that some entities may feel that they should include regulatory information in the integrated
report.
 However, the IIRC concluded that the term should continue to be used in this context as it is well
understood.
Aim of Integrated Reporting

 To provide an insight into the company‟s resources and relationships that are known as the
capitals and how the company interacts with the external environment and the capitals to create
value.
The Capitals
1. Financial
2. Manufactured
3. Intellectual
4. Human
5. Social and relationship
6. Natural capital
Note
The report should be concise, reliable and complete, including all material matters, both positive and
negative in a balanced way and without material error.
Key Components of IR
Integrated reporting is built around the following key components:
 Organisational overview and the external environment under which it operates
 Governance structure and how this supports its ability to create value
 Business model
 Risks and opportunities and how they are dealing with them and how they affect the company‟s
ability to create value
 Strategy and resource allocation
 Performance and achievement of strategic objectives for the period and outcomes
 Outlook and challenges facing the company and their implications
 The basis of presentation needs to be determined, including what matters are to be included in the
integrated report and how the elements are quantified or evaluated.
Relationship with stakeholders

 An integrated report should provide insight into the nature and quality of the organisation‟s
relationships with its key stakeholders, including how and to what extent the organisation
understands, takes into account and responds to their needs and interests.
 Further, the report should be consistent over time to enable comparison with other entities.
 An integrated report may be prepared in response to existing compliance requirements – for
example, a management commentary. Where that report is also prepared according to the
framework, or even beyond the framework, it can be considered an integrated report.
 An integrated report may be either a standalone report or be included as a distinguishable part of
another report or communication. For example, it can be included in the company‟s financial
statements.
 The IIRC considered the nature of value and value creation. These terms can include the total of
all the capitals, the benefit captured by the company, the market value or cash flows of the
organisation and the successful achievement of the company‟s objectives.
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 However, the conclusion reached was that the framework should not define value from any one
particular perspective because value depends upon the individual company‟s own perspective.
 It can be shown through movement of capital and can be defined as value created for the
company or for others.
 An integrated report should not attempt to quantify value as assessments of value are left to those
using the report.
Concerns
 Many respondents felt that there should be a requirement for a statement from those „charged
with governance‟ acknowledging their responsibility for the integrated report in order to ensure
the reliability and credibility of the integrated report.
 Additionally, it would increase the accountability for the content of the report.
 The IIRC feels the inclusion of such a statement may result in additional liability concerns, such
as inconsistency with regulatory requirements in certain jurisdictions, and could lead to a higher
level of legal liability.
 The IIRC also felt that the above issues might result in a slower take-up of the report and decided
that those „charged with governance‟ should, in time, be required to acknowledge their
responsibility for the integrated report while, at the same time, recognising that reports in which
they were not involved would lack credibility.
 There has been discussion about whether the framework constitutes suitable criteria for report
preparation and for assurance.
 The questions asked concerned measurement standards to be used for the information reported
and how a preparer can ascertain the completeness of the report.
 There were concerns over the ability to assess future disclosures, and recommendations were
made that specific criteria should be used for measurement, the range of outcomes and the need
for any confidence intervals be disclosed.
 The preparation of an integrated report requires judgment but there is a requirement for the report
to describe its basis of preparation and presentation, including the significant frameworks and
methods used to quantify or evaluate material matters.
 Also included is the disclosure of a summary of how the company determined the materiality
limits and a description of the reporting boundaries.
Note
 The IIRC has stated that the prescription of specific KPIs and measurement methods is beyond
the scope of a principles-based framework.
 The framework contains information on the principle-based approach and indicates that there is a
need to include quantitative indicators whenever practicable and possible.
 Additionally, consistency of measurement methods across different reports is of paramount
importance.
 There is outline guidance on the selection of suitable quantitative indicators.
 A company should consider how to describe the disclosures without causing a significant loss of
competitive advantage.
 The entity will consider what advantage a competitor could actually gain from information in the
integrated report, and will balance this against the need for disclosure.
 Companies struggle to communicate value through traditional reporting.
 The framework can prove an effective tool for businesses looking to shift their reporting focus
from annual financial performance to long-term shareholder value creation.
 The framework will be attractive to companies who wish to develop their narrative reporting
around the business model to explain how the business has been developed.
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Using the Business Model of a Company to Help Analyse

Its Performance
Understanding the business model of an entity is helpful in analysing and communicating the essence of a
business and for predicting the implications of a change in circumstance on a business. Strategic
Business Reporting (SBR) candidates should use this technique to improve their answers to SBR
questions and this article should help them to do this.
 The business model in the context of Integrated Reporting is a company‟s system of
„transforming inputs, through its business activities, into outputs and outcomes that aim to fulfil
the organization‟s strategic purposes and create value over the short, medium and long term‟.
 The definition may seem quite theoretical but there are a number of entities who use this
definition to disclose the resources (also known as capital) that the organisation draws on as
inputs to its business activities, and how these are converted to outputs (products, services, by-
products, and waste), which then have a further impact on the various capitals and stakeholders.
 The business model describes the entity‟s activities, asset configuration, and the way in which the
business adds value including the generation of its cash flows and its customers, products and
services.
 The aim is to provide users with insight on the ability of the business to adapt to changes, for
example, in the availability, quality, and affordability of inputs, and how these changes can affect
the organisation‟s longer-term viability.
 Business model information can be fundamental to investor analysis. It provides context and
understanding to the other information in the annual report.
 The provision of business model information can demonstrate an entity‟s understanding of its
business and key drivers which can create investor trust and reduce risk.
 Additionally, investors need to understand the business, how the business has performed, and
how this performance has been affected by various factors.
 There is an argument that the information regarding the business model should be presented
outside the financial statements, such as in the management commentary.
 Investors will need to know how the business model is responding to market trends and how the
strategy supports the key components of the business model. They will wish to know how
management considers the risks and opportunities across the business model and how money is
made and value generated and re-distributed.
 Investors will look at the Key Performance Indicators (KPIs) and how they reflect the key
components of the business model. Having the business model play a role in financial reporting
presumes that investors have a good understanding of it prior to assessing the entity‟s financial
position and performance.
 There has been discussion as to whether the business model should be considered in standard
setting and in particular whether the term should be defined in the Conceptual Framework for
Financial Reporting (the Conceptual Framework).
 The International Accounting Standards Board (the Board) has decided not to define the business
model in the Conceptual Framework even though there was reference to the business model in an
early Exposure Draft.
 However, the term has been implicit in International Financial Reporting Standards (IFRS®) for a
while. For example, International Accounting Standard (IAS®) 2 Inventories generally requires
inventories to be measured at the lower of cost and net realisable value. However, IAS 2 includes
an exception that allows commodity traders to measure their inventories at fair value less cost of
sale with changes in fair value less cost to sell recognised in profit or loss.
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 The justification for this different treatment is that the inventory of commodity traders is
principally acquired with the purpose of selling in the near future and generating a profit from
the fluctuation in prices.
 IFRS 9 requires classification and measurement of financial assets based on an entity‟s business
model. Although IFRS 9 does not contain a definition of the term „business model‟, it does
include some implicit assumptions about its meaning. IFRS 9 views the business as based upon
how the entity‟s assets and liabilities are managed.
 It states that an entity should classify financial assets as subsequently measured at either
amortised cost or fair value on the basis of both:
a. The entity‟s business model for managing the financial assets and
b. The contractual cash flow characteristics of the financial asset.
 To qualify for an amortised cost classification, the financial asset must be held to collect
contractual cash flows rather than be held with a view to selling the asset to realise a profit or
loss. For example, trade receivables held by a manufacturing entity are likely to fall within the
'hold to collect' business model if the trade receivables do not contain a significant financing
component in accordance with IFRS 15 Revenue from Contracts with Customers.
 A debt instrument is classified as subsequently measured at fair value through other
comprehensive income (FVOCI) under IFRS 9 if it meets the 'hold to collect' and the 'sell'
business model test. The asset is held within a business model whose objective is achieved by
both holding the financial asset in order to collect contractual cash flows and selling the financial
asset.
 Fair value through profit or loss (FVTPL) is the residual category in IFRS 9. If the business
model is to hold the financial asset for trading, then it is classified and measured at FVTPL. Some
stakeholders have suggested that the requirements for equity investments in IFRS 9 could
discourage long-term investment. Their view is that the default requirement to measure those
investments at fair value with value changes recognised in profit or loss may not reflect the
business model of long-term investors.
 The term „business model‟ has also been used in other standards. IFRS 8 Operating Segments
defines an operating segment as a „component of an entity that engages in business activities from
which it can earn revenue and incur expenses‟. An entity with more than one business model is
likely to also have different segments. If an entity has a business model, it would have internal
reporting information which measure the performance of the business model which may in fact be
the business segments.
 IAS 40 Investment property distinguishes a property that is held by entities for investment
purposes from the one that is intended to be occupied by the owner. An investment property
differs from an owner-occupied property because the investment property generates cash flows
largely independently of the other assets.
 IAS 40 sets out the two main uses of property (owner occupied and investment) which implicitly
correspond to different business models. An owner-occupied property should be measured at
depreciated cost less any impairment loss, which is an appropriate way of reflecting the use of the
property. Whereas, investment property is measured at either fair value with fair value changes
recognised in the statement of profit or loss, or on the same cost basis as for an owner-occupied
property. These different accounting treatments reflect the different uses of these assets.
 If the business model continues to play a significant role in standard-setting, it could give insight
into how the entity‟s business activities are managed and help users assess the resources and
liabilities of the entity.
 Alternatively, it can be argued that this approach may reduce comparability as it could result in
different classification, measurement or disclosure of the same transaction. This may introduce
bias in the way the financial statements of an entity are reported, and therefore make comparisons
between entities difficult. It could encourage less neutral reporting as preparers may present the
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most favourable outcome which creates a conflict with faithful representation. This approach can
make financial statements of entities with similar business models and in the same industry, more
comparable. Thus, the difficulties with the definition of the business model and its consistent
application should not constitute a reason for excluding it because it has relevance in terms of the
financial decision-making needs of the users of the accounting information. It has always been
the case that different businesses will account for the same asset in different ways depending on
what its role is within the firm‟s business model. A change in the entity‟s business model is a
significant event, because it implies a change in how assets and liabilities are used in the cash -
flow generation process, that is when and how gains and losses are recognised
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The Impact of Changes and Potential Changes in

Accounting Regulation (F)
Climate-Related Disclosures and Investor Focus
 Investors need to know how a company is considering the impact of climate change on its
business model, risk strategy, and also the effect on its financial statements.
 Investors want to understand the future challenges that the company faces, and what the
company‟s plans are to deal with these challenges.
 The Paris Agreement (United Nations) is a legally binding international treaty on climate change
which will require a significant reallocation of company resources if the agreed goals are to be
met. Therefore, companies could be exposed to a wide range of risks and opportunities as they
aim to meet these goals. Companies will need to disclose the financial implications of climate-
related challenges that face them.
 An increasing number of companies are providing narrative reporting on climate-related issues.
Where minimum legal requirements are being met, investors are calling for additional disclosure
to inform their decision making. Some companies have set strategic goals such as „net zero‟ (or
carbon neutral), but it is often unclear from their reporting how progress towards these goals will
be achieved, monitored or assured. Climate-related narrative reporting requirements and
expectations cover both the potential impact on the future of a business and the company‟s impact
on the environment.
 As the demand for climate-related disclosure by investors and other stakeholders‟ increases,
many companies are developing their climate governance in line with reporting frameworks,
principally „The Task Force on Climate-related Financial Disclosures‟ (TFCD).
 Some of the information that investors may require is set out below:
a) the arrangements in place and strategy for assessing and considering climate-related
issues
b) the metrics used to monitor climate-related goals and targets
c) the opportunities and risks concerning climate-related issues which are most relevant and
material to the company‟s business model and strategy
d) the potential effects on the company‟s profitability, net assets, products, customers,
suppliers etc of different climate scenarios
e) are the risks and opportunities reflected in the financial statements, for example the effect
of assumptions used in impairment testing, depreciation rates, decommissioning etc
f) the assessment of the company‟s viability over the longer-term taking into account
climate-related issues
g) the viability of the company‟s business and business model.
®
Climate change and International Financial Reporting Standards (IFRS standards)
 There is no single IFRS standard which addresses climate change.
 However, IFRS standards provide a framework for incorporating the risks of climate change into
companies‟ financial reporting.
 Companies must consider climate-related matters when the effect is material on the financial
statements.
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®
IAS 1, Presentation of Financial Statements
 IAS 1 requires disclosure of information not specifically required by IFRS standards and not
presented elsewhere in the financial statements, but that is relevant to an understanding of the
 In addition, IAS 1 requires a company to consider whether any material information is missing
from its financial statements such as the impact of climate-related matters on the company‟s
financial position and performance.
 Disclosure of assumptions about climate-related matters may be required, where assumptions
have been affected by climate change. For example, estimates of future cash flows for impairment
testing purposes or the calculation of decommissioning obligations.
 The disclosure may include the nature of the assumptions or the sensitivity of the calculations.
 In addition, IAS 1 requires disclosure of the judgements that have a significant effect on the
amounts recognised in the financial statements.
 IAS 1 requires management to assess a company‟s ability to continue as a going concern.
Climate-related matters may create material uncertainties that cast significant doubt upon a
company‟s ability to continue as a going concern. IAS 1 requires disclosure of those
uncertainties.
IAS 2 Inventory
 Climate-related matters may cause a company‟s inventories to become obsolete, or the value to
decline or costs of completion to increase.
 IAS 2 requires inventories to be valued at the lower of cost and net realisable value (NRV).
 NRV is the estimated selling price in the ordinary course of business, less the estimated cost of
completion and the estimated costs necessary to make the sale.
 Estimates of NRV will be based on the most reliable evidence available of the amount which the
inventories are expected to realise.
IAS 12 Income Taxes

 IAS 12 requires companies to recognise deferred tax assets for deductible temporary differences
and unused tax losses and credits, to the extent it is probable that future taxable profit will be
available against which those amounts can be utilised.
 Climate-related matters may affect a company‟s estimate of future taxable profits which may
result in potential deferred tax assets not being recognised or the derecognition of already
recognised deferred tax assets.
IAS 16 Property, Plant and Equipment

 IAS 16 requires companies to review the residual value and the useful life of an asset at least at
each financial year end and, if expectations differ from previous estimates, any change should be
accounted for prospectively as a change in estimate.
 Climate-related matters may affect the estimated residual value and expected useful lives of
assets because of obsolescence or legal restrictions on their use.
IAS 36 Impairment of Assets

 Climate-related matters may give rise to an indication that assets are impaired.
 A decline in demand for products that are not environmentally friendly could indicate impairment
of that product or the manufacturing unit making the product.
 An adverse change in the business environment of a company is an indication of impairment.
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 In assessing value in use, a company is required to calculate cash flow projections based upon
reasonable and supportable assumptions that are the best estimate of the future economic
conditions.
 Thus, companies will need to consider whether climate-related matters affect those assumptions.
 Companies are required to disclosure the events, circumstances and assumptions that led to the
recognition of an impairment loss, which could include climate-related events.
IAS 37 Provisions, Contingent Liabilities and Contingent Assets

 Climate-related matters may affect the recognition, measurement and disclosure of liabilities
related to such things as penalties imposed by governments for not meeting climate-related
targets or causing environmental damage.
 In addition, contracts may become onerous due to a change in inventory purchasing strategy or
redesign of products.
 Companies should disclose major assumptions about any future events that have affected a
provision or contingent liability.
IFRS 9 Financial Instruments

 Climate-related matters may affect a lender‟s exposure to credit losses, caused by environmental
disasters or regulatory change, and also a borrower‟s ability to meet its debt obligations to the
lender.
 Climate-related matters may, therefore, affect the calculation of expected credit losses if there is
an impact on the different potential future economic scenarios or the assessment of a significant
increase in credit risk.
 The classification and measurement of loans may be affected as lenders may include terms
linking contractual cash flows to an entity‟s achievement of climate-related targets.
 The lender would need to assess whether the contractual terms of the financial asset give rise to
cash flows that are solely payments of principal and interest on the principal amount outstanding.
 Additionally, climate-related targets may create an embedded derivative that needs to be
separated from the host contract.
 Climate change may reduce the probability of a hedged forecast transaction occurring or affect its
timing. In this case, the hedge accounting relationship may need to be terminated or there may be
hedge ineffectiveness.
 Similarly, a reduction in the volume of highly probable forecast transactions may lead to partial
termination under IFRS 9.
IFRS 13 Fair Value Measurement (FVM)

 When making the critical assessments and judgements for measuring fair value, the entity should
consider what conditions and the corresponding assumptions were known or knowable to market
participants.
 The impact of climate change on FVM would depend on the evaluation of whether the climate
change would have impacted market participants‟ valuation assumptions at the reporting date.
 The information such as climate-related legislation available to the market at the reporting date
may be relevant in making this evaluation.
 This would include any corroborative or contrary evidence such as the timing and trajectory of
observable market price movements of related assets in the relevant markets, as well as
information from other sources of market data up to the reporting date.
 Depending on the facts and circumstances of each case, disclosure may be needed to enable users
to understand whether or not climate change has been considered for the purpose of FVM.
 Users should understand the basis for selecting the assumptions and inputs that were used in the
FVM and the related sensitivities.
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 The above examples from IFRS standards are not exclusive but are indicative of the far-reaching
impact climate change will have on business reporting.
 This area of business reporting is evolving as the investor, and wider stakeholder, demand for
both financial and non-financial disclosures increases generally.
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Bin the Clutter

The effects of clutter have typically come in for little consideration by the preparers of annual reports.
However, the phenomenon is increasingly under discussion, with initiatives recently launched to combat
it.
 It is unusual to think about the effects of „clutter‟ but, increasingly, this phenomenon is being
discussed. One prominent website describes clutter as follows: „Clutter invades your space and
takes over your life. Clutter makes you disorganised, stressed, out of control. Clutter distracts you
from your priorities. Clutter can stop you achieving your goals.‟ This definition of clutter may not
be completely applicable to annual reports, but it is possible to see certain aspects, which are
applicable.
 The UK‟s Financial Reporting Council (FRC), among other organizations, has called for reduced
‟clutter‟ in annual reports. Additionally, the Institute of Chartered Accountants in Scotland
(ICAS) and the New Zealand Institute of Chartered Accountants (NZICA) were commissioned by
the International Accounting Standards Board (the Board) to make cuts to the disclosures within a
certain group of International Financial Reporting Standards (IFRS®), and produce a report.
 Clutter in annual reports is a problem, obscuring relevant information and making it more
difficult for users to find the key points about the performance of the business and its prospects
for long-term success. The main observations of the discussion paper published by the FRC were:
a) there is substantial scope for segregating standing data, either to a separate section of the
annual report (an appendix) or to the company‟s website
b) immaterial disclosures are unhelpful and should not be provided
c) the barriers to reducing clutter are mainly behavioural
d) there should be continued debate about what materiality means from a disclosure
perspective.
 It is important for the efficient operation of the capital markets that annual reports do not contain
unnecessary information. However, it is equally important that useful information is presented in
a coherent way so that users can find what they are looking for and gain an understanding of the
company‟s business and the opportunities, risks and constraints that it faces. A company,
however, must treat all of its shareholders equally in the provision of information. It is for each
shareholder to decide whether they wish to make use of that information. It is not for a company
to pre-empt a shareholder's rights in this regard by withholding the information.
 A significant cause of clutter in annual reports is the vast array of requirements imposed by laws,
regulations and financial reporting standards. Regulators and standard setters have a key role to
play in cutting clutter both by cutting the requirements that they themselves already impose and
by guarding against the imposition of unnecessary new disclosures. A listed company may have
to comply with listing rules, company law, international financial reporting standards, the
corporate governance codes, and if it has an overseas listing, any local requirements, such as
those of the Securities and Exchange Commission (SEC) in the US. Thus, a major source of
clutter is the fact that different parties require differing disclosures for the same matter. For
example, an international bank in the UK may have to disclose credit risk under IFRS
7, Financial Instruments: Disclosures, the Companies Acts and the Disclosure and Transparency
Rules, the SEC rules and Industry Guide 3, as well as the requirements of Basel II Pillar 3. A
problem is that different regulators have different audiences in mind for the requirements they
impose on annual reports. Regulators attempt to reach wider ranges of actual or potential users
and this can lead to a loss of focus and structure in reports.
 There may a need for a proportionate approach to the disclosure requirements for small and mid-
cap quoted companies that take account of the needs of their investors, as distinct from those of
larger companies. This may be achieved by different means. For example, a principles-based
approach to disclosures in IFRS standards, specific derogations from requirements in individual
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IFRS standards or the creation of an appropriately adapted local version of the IFRS for
SMEs standard. Pressures of time and cost can understandably lead to defensive reporting by
smaller entities and to choosing easy options, such as repeating material from a previous year,
cutting and pasting from the reports of other companies and including disclosures of marginal
importance.
 There are behavioural barriers to reducing clutter. It may be that the threat of criticism or
litigation could be a considerable limitation on the ability to cut clutter. The threat of future
litigation may outweigh any benefits to be obtained from eliminating „catch-all‟ disclosures.
Preparers of annual reports are likely to err on the side of caution and include more detailed
disclosures than are strictly necessary to avoid challenge from auditors and regulators. Removing
disclosures is perceived as creating a risk of adverse comment and regulatory challenge.
Disclosure is the safest option and is therefore often the default position. Preparers and auditors
may be reluctant to change from the current position unless the risk of regulatory challenge is
reduced. Companies have a tendency to repeat disclosures because they were there last year.
 Explanatory information may not change from year to year but it nonetheless remains necessary
to an understanding of aspects of the report. There is merit in a reader of an annual report being
able to find all of this information in one place. If the reader of a hard copy report has to switch to
look at a website to gain a full understanding of a point in the report, there is a risk that the report
thereby becomes less accessible rather than more. Even if the standing information is kept in the
same document but relegated to an appendix, that may not be the best place to facilitate a quick
understanding of a point. A new reader may be disadvantaged by having to hunt in the small print
for what remains key to a full understanding of the report.
 Preparers wish to present balanced and sufficiently informative disclosures and may be unwilling
to separate out relevant information in an arbitrary manner. The suggestion of relegating all
information to a website assumes that all users of annual reports have access to the internet,
which may not be the case. A single report may best serve the investor, by having one reference
document rather than having the information scattered across a number of delivery points.
 Shareholders are increasingly unhappy with the substantial increase in the length of reports that
has occurred in recent years. This has not resulted in more or better information, but more
confusion as to the reason for the disclosure. A review of companies‟ published accounts will
show that large sections such as „Statement of Directors Responsibilities‟ and „Audit Committee
report‟ are almost identical.
 Materiality should be seen as the driving force of disclosure, as its very definition is based on
whether an omission or misstatement could influence the decisions made by users of the financial
statements. The assessment of what is material can be highly judgmental and can vary from user
to user. A problem that seems to exist is that disclosures are being made because a disclosure
checklist suggests it may need to be made, without assessing whether the disclosure is necessary
in a company‟s particular circumstances. However, it is inherent in these checklists that they
include all possible disclosures that could be material. Most users of these tools will be aware that
the disclosure requirements apply only to material items, but often this is not stated explicitly for
users.
 One of the most important challenges is in the changing audiences. From its origins in reporting
to shareholders, preparers now have to consider many other stakeholders including employees,
unions, environmentalists, suppliers, customers, etc. The disclosures required to meet the needs of
this wider audience have contributed to the increased volume of disclosure. The growth of
previous initiatives on going concern, sustainability, risk, the business model and others that have
been identified by regulators as „key‟ has also expanded the annual report size.
 The length of the annual report is not necessarily the problem but the way in which it is
organised. The inclusion of „immaterial‟ disclosures will usually make this problem worse but, in
a well organised annual report, users will often be able to bypass much of the information they
consider unimportant, especially if the report is on line. It is not the length of the accounting
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policies disclosure that is itself problematic, but the fact that new or amended policies can be
obscured in a long note running over several pages. A further problem is that accounting policy
disclosure is often „boilerplate‟, providing little specific detail of how companies apply their
general policies to particular transactions.
 IFRS standards require disclosure of „significant accounting policies‟. In other words, IFRS
standards do not require disclosure of insignificant or immaterial accounting policies. Omissions
in financial statements are material only if they could, individually or collectively, influence the
economic decisions that users make. In many cases, it would not. Of far greater importance is the
disclosure of the judgments made in selecting the accounting policies, especially where a choice
is available.
 A reassessment of the whole model will take time and may necessitate changes to law and other
requirements. For example, unnecessary clutter could be removed by not requiring the disclosure
of IFRS standards in issue but not yet effective. The disclosure seems to involve listing each new
standard in existence and each amendment to a standard, including separately all those included
in the annual improvements project, regardless of whether there is any impact on the entity. The
note becomes a list without any apparent relevance.
 The Board has recently issued a request for views regarding its forward agenda in which it
acknowledges that stakeholders have said that disclosure requirements are too voluminous and
not always focused in the right areas. The drive by the Board has very much been to increase the
use of disclosure to address comparability between companies and, in the short to medium term, a
reduction in the volume of accounting disclosures does not look feasible although this is an area
to be considered by the Board for its post 2012 agenda.
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IAS 21 – Does It Need Amending?

This article examines the issues raised by IASB research that referred to a KASB study into whether IAS
21 needs amending.
The International Accounting Standards Board (IASB) initiated a research project that examined the
previous research conducted by the Korean Accounting Standards Board (KASB). This research
considered whether any work on IAS 21, The Effects of Changes in Foreign Exchange Rates, was
appropriate. This article looks at some of the issues raised by the project in the context of IAS 21®.
 The foreign exchange market is affected by many factors, and in countries with a floating
exchange rate, their foreign exchange rates are inevitably exposed to volatility due to the effects
of the different factors influencing the market. For example, the ongoing problem of Greece
repaying its enormous debts has significantly affected the value of the euro.
 As the barriers to international flows of capital are further relaxed, the volatility of the foreign
exchange market is likely to continue. This volatility affects entities that engage in foreign
currency transactions and there has been a resultant call in some quarters to amend IAS 21.
 IFRS® 7, Financial Instruments: Disclosure requires disclosure of market risk, which is the risk
that the fair value or cashflows of a financial instrument will fluctuate due to changes in market
prices. Market risk reflects, in part, currency risk. In IFRS 7, the definition of foreign currency
risk relates only to financial instruments. IFRS 7 and IAS 21 have a different conceptual basis.
IFRS 7 is based upon the distinction between financial/non-financial elements, whereas IAS 21
utilises the monetary/non-monetary distinction.
 The financial/non-financial distinction determines whether an item is subject to foreign currency
risk under IFRS 7, whereas translation in IAS 21 uses monetary/non-monetary distinction,
thereby possibly causing potential conceptual confusion. Foreign currency risk is little mentioned
in IAS 21 and on applying the definition in IFRS 7 to IAS 21, non-financial instruments could be
interpreted as carrying no foreign currency risk. Under IAS 21, certain monetary items include
executory contracts, which do not meet the definition of a financial instrument. These items
would be translated at the closing rate, but as such items are not financial instruments, they could
be deemed not to carry foreign currency risk under IFRS 7.
 Foreign currency translation should be conceptually consistent with the conceptual framework.
IAS 21 was issued in 1983 with the objective of prescribing how to include foreign currency
transactions and foreign operations in the financial statements of an entity and how to translate
financial statements into a presentation currency.
 There is little conceptual clarification of the translation requirements in IAS 21. The requirements
of IAS 21 can be divided into two main areas: the reporting of foreign currency transactions in
the functional currency; and the translation to the presentation currency. Exchange differences
arising from monetary items are reported in profit or loss in the period, with one exception which
is that exchange differences arising on monetary items that form part of the reporting entity‟s net
investment in a foreign operation are recognised initially in other comprehensive income, and in
profit or loss on disposal of the net investment.
 However, it would be useful to re-examine whether it is more appropriate to recognise a gain or
loss on a monetary item in other comprehensive income instead of profit or loss in the period and
to define the objective of translation. Due to the apparent lack of principles in IAS 21, difficulty
could arise in determining the nature of the information to be provided on translation.
 There is an argument that the current accounting standards might not reflect the true economic
substance of long-term monetary assets and liabilities denominated in foreign currency because
foreign exchange rates at the end of the reporting period are used to translate amounts that are to
be repaid in the future. IAS 21 states that foreign currency monetary amounts should be reported
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using the closing rate with gains or losses recognised in profit or loss in the period in which they
arise, even when the rate is abnormally high or low.
 There are cases where an exchange rate change is likely to be reversed, and thus it may not be
appropriate to recognise foreign exchange gains or losses of all monetary items as realised gains
or losses. Thus there is an argument that consideration should be given as to whether foreign
exchange gains or losses should be recognised in profit or loss or in other comprehensive income
(OCI) based on the distinction between current items and non-current items.
 Any potential fluctuation in profit or loss account would be reduced by recognising in OCI those
foreign exchange gains or losses of non-current items with a high possibility of reversal.
Furthermore, the question would arise as to whether these items recognised in OCI could be
reclassified.
 However, the IASB is currently determining via its conceptual framework project the purpose and
nature of OCI, as there is no obvious principle that drives gains and losses out of profit or loss
and into OCI, and there is no shared view among the IASB‟s constituents about what should be in
profit or loss and what should be in OCI.
 IAS 21 does provide some guidance on non-monetary items by stating that when a gain or loss on
a non-monetary item is recognised in OCI, any exchange component of that gain or loss shall be
recognised in OCI.
 Conversely, when a gain or loss on a non-monetary item is recognised in profit or loss, any
exchange component of that gain or loss shall be recognised in profit or loss.
Long-Term Liabilities
 In the case of long-term liabilities, although any translation gains must be recognised in profit or
loss, and treated as part of reported profit, in some jurisdictions, these gains are treated as
unrealised for the purpose of computing distributable profit.
 The reasoning is that there is a greater likelihood in the case of long-term liabilities that the
favourable fluctuation in the exchange rate will reverse before repayment of the liability falls due.
 As stated already, IAS 21 requires all foreign currency monetary amounts to be reported using the
closing rate; non-monetary items carried at historical cost are reported using the exchange rate at
the date of the transaction and non-monetary items carried at fair value are reported at the rate
that existed when the fair values were determined. As monetary items are translated at the closing
rate, although the items are not stated at fair value, the use of the closing rate does provide some
fair value information. However, this principle is not applied to non-monetary items as, unless an
item is measured at fair value, the recognition of a change in the exchange rate appears not to
provide useful information.
 A foreign operation is defined in IAS 21 as a subsidiary, associate, joint venture, or branch whose
activities are based in a country or currency other than that of the reporting entity. Thus the
definition of a foreign operation is quite restrictive. It is possible to conduct operations in other
ways; for example, using a foreign broker. Therefore, the definition of a foreign operation needs
to be based upon the substance of the relationship and not the legal form.
 Although the exchange rate at the transaction date is required to be used for foreign currency
transactions at initial recognition, an average exchange rate may also be used. The date of a
transaction is the date on which the transaction first qualifies for recognition in accordance with
IFRS. For practical reasons, a rate that approximates to the actual rate at the date of the
transaction is often used. For example, an average rate for a week or a month might be used for
all transactions in each foreign currency occurring during that period. However, if exchange rates
fluctuate significantly, the use of the average rate for a period is inappropriate.
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Average Exchange Rate

 A question arises as to which exchange rate to use and therefore it would be useful to have more
specific guidance on the use of the average exchange rate.
 IAS 21 allows a certain amount of flexibility in calculating the average rate.
 The determination of the average rate depends upon factors such as the frequency and value of
transactions, the period over which the rate will apply and the nature of the entity‟s systems.
 There are a large number of methods that can be used to calculate the average rate, but no
guidance is given in IAS 21 as to how such a rate is determined.
 The IASB has completed its initial assessments on this project and decided that narrow scope
amendments were unnecessary.
 In May 2015, it had no plans to undertake any additional work and is to remove this project from
the research programme, subject to feedback in the next agenda consultation.
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The Definition and Disclosure of Capital

This article is structured in two parts – first, it considers what might be included as the capital of a
company and, second, why this distinction is important for the analysis of financial information.
 Essentially, there are two classes of capital reported in financial statements: debt and equity.
 However, debt and equity instruments can have different levels of right, benefit and risks.
 When an entity issues a financial instrument, it has to determine its classification either as debt or
as equity.
 The result of the classification can have a significant effect on the entity‟s reported results and
financial position.
 Liability classification impacts upon an entity‟s gearing ratios and results in any payments being
treated as interest and charged to earnings.
 Equity classification may be seen as diluting existing equity interests.
 IAS® 32, Financial Instruments: Presentation sets out the nature of the classification process but
the standard is principle-based and sometimes the outcomes that result from its application are
surprising to users.
 IAS 32 does not look to the legal form of an instrument but focuses on the contractual obligations
of the instrument.
 IAS 32 considers the substance of the financial instrument, applying the definitions to the
instrument‟s contractual rights and obligations.
More Complexity
 The variety of instruments issued by entities makes this classification difficult with the
application of the principles occasionally resulting in instruments that seem like equity being
accounted for as liabilities.
 Recent developments in the types of financial instruments issued have added more complexity to
capital structures with the resultant difficulties in interpretation and understanding.
 Consequently, the classification of capital is subjective which has implications for the analysis of
 To avoid this subjectivity, investors are often advised to focus upon cash and cash flow when
analysing corporate reports. However, insufficient financial capital can cause liquidity problems
and sufficiency of financial capital is essential for growth.
 Discussion of the management of financial capital is normally linked with entities that are subject
to external capital requirements, but it is equally important to those entities that do not have
regulatory obligations.
 Financial capital is defined in various ways but has no widely accepted definition having been
interpreted as equity held by shareholders or equity plus debt capital including finance leases.
This can obviously affect the way in which capital is measured, which has an impact on return on
capital employed (ROCE). An understanding of what an entity views as capital and its strategy
for capital management is important to all companies and not just banks and insurance
companies. Users have diverse views of what is important in their analysis of capital. Some focus
on historical invested capital, others on accounting capital and others on market capitalisation.
 Investors have specific but different needs for information about capital depending upon their
approach to the valuation of a business. If the valuation approach is based upon a dividend model,
then shortage of capital may have an impact upon future dividends. If ROCE is used for
comparing the performance of entities, then investors need to know the nature and quantity of the
historical capital employed in the business. There is diversity in practice as to what different
companies see as capital and how it is managed.
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 There are various requirements for entities to disclose information about „capital‟. In drafting
IFRS® 7, Financial Instruments: Disclosures, the IASB (the Board) considered whether it should
require disclosures about capital. In assessing the risk profile of an entity, the management and
level of an entity‟s capital is an important consideration. The Board believes that disclosures
about capital are useful for all entities, but they are not intended to replace disclosures required by
regulators as their reasons for disclosure may differ from those of the Board. As an entity‟s
capital does not relate solely to financial instruments, the Board has included these disclosures in
IAS 1, Presentation of Financial Statements rather than IFRS 7. IFRS 7 requires some specific
disclosures about financial liabilities; it does not have similar requirements for equity
instruments.
 The Board considered whether the definition of capital is different from the definition of equity in
IAS 32. In most cases, capital would be the same as equity but it might also include or exclude
some other elements. The disclosure of capital is intended to give entities the ability to describe
their view of the elements of capital if this is different from equity.
 As a result, IAS 1 requires an entity to disclose information that enables users to evaluate the
entity‟s objectives, policies and processes for managing capital. This objective is obtained by
disclosing qualitative and quantitative data. The former should include narrative information such
as what the company manages as capital, whether there are any external capital requirements and
how those requirements are incorporated into the management of capital. Some entities regard
some financial liabilities as part of capital, while other entities regard capital as excluding some
components of equity – for example, those arising from cash flow hedges.
 The Board decided not to require quantitative disclosure of externally imposed capital
requirements but rather decided that there should be disclosure of whether the entity has complied
with any external capital requirements and, if not, the consequences of non-compliance. Further,
there is no requirement to disclose the capital targets set by management and whether the entity
has complied with those targets, or the consequences of any non-compliance.
 Examples of some of the disclosures made by entities include information as to how gearing is
managed, how capital is managed to sustain future product development and how ratios are used
to evaluate the appropriateness of its capital structure. An entity bases these disclosures on the
information provided internally to key management personnel. If the entity operates in several
jurisdictions with different external capital requirements, such that an aggregate disclosure of
capital would not provide useful information, the entity may disclose separate information for
each separate capital requirement.
Trends
 Besides the requirements of IAS 1, the IFRS Practice Statement Management Commentary
suggests that management should include forward-looking information in the commentary when
it is aware of trends, uncertainties or other factors that could affect the entity‟s capital resources.
 Additionally, some jurisdictions refer to capital disclosures as part of their legal requirements.
 In the UK, Section 414 of the Companies Act 2006 deals with the contents of the Strategic Report
and requires a „balanced and comprehensive analysis‟ of the development and performance of the
business during the period and the position of the company at the end of the period. The section
further requires that to the extent necessary for an understanding of the development,
performance or position of the business, the strategic report should include an analysis using key
performance indicators. It makes sense that any analysis of a company‟s financial position should
include consideration of how much capital it has and its sufficiency for the company‟s needs. The
Financial Reporting Council Guidance on the Strategic Report suggests that comments should
appear in the report on the entity‟s financing arrangements such as changes in net debt or the
financing of long-term liabilities.
 In addition to the annual report, an investor may find details of the entity‟s capital structure where
the entity is involved in a transaction, such as a sale of bonds or equities. It is normal for an entity
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to produce a capitalisation table in a prospectus showing the effects of the transactions on the
capital structure. The table shows the ownership and debt interests in the entity but may show
potential funding sources and the effect of any public offerings. The capitalisation table may
present the pro forma impact of events that will occur as a result of an offering such as the
automatic conversion of preferred stock, the issuance of common stock, or the use of the offering
proceeds for the repayment of debt or other purposes.
 The Board does not require such a table to be disclosed but it is often required by securities
regulators. For example, in the USA, the table is used to calculate key operational metrics.
America Corporation announced in February 2016 that it had „made significant advancements in
its ongoing initiative toward improving its capitalization table, capitalization, and operational
structure‟.
 It can be seen that information regarding an entity‟s capital structure is spread across several
documents including the management commentary, the notes to financial statements, interim
accounts and any document required by securities regulators.
 The Board has undertaken a research project with the aim of improving the accounting for
financial instruments that have characteristics of both liabilities and equity. This is likely to be a
major challenge in determining the best way to report the effects of recent innovations in capital
structure.
 There is a diversity of thinking about capital that is not surprising given the issues with defining
equity, the difficulty in locating sources of information about capital and the diversity of business
models in an economy. Capital needs are very specific to the business and are influenced by
many factors, such as debt covenants and preservation of debt ratings. The variety and
inconsistency of capital disclosures does not help the decision making process of investors.
 Therefore, the details underlying a company‟s capital structure are essential to the assessment of
any potential change in an entity‟s financial flexibility and value. An appreciation of these issues
and their significance is important to candidates studying for Strategic Business Reporting.
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The Sustainable Development Goals

The Sustainable Development Goals (SDGs) are 17 goals tackling major world issues agreed by 193 UN
member states to be achieved by 2030. These goals include zero hunger, decent work and economic
growth, and reduced inequalities.
 The SDGs apply to all countries and set the priorities for governments. Demographic and social
change, shifts in global economic power, urbanisation, climate change, resource scarcity,
inequality and technological breakthroughs demand a corporate response.
 The SDGs can provide insights for companies on how they can create economic, social and
environmental value for their investors and other stakeholders. The goals will allow business to
understand and better respond to the risks and opportunities created by rapid change across the
various sectors.
 There is increasing interest by the investors in understanding how businesses are developing
SDGs. Investors seek information on the relevance of the SDGs to overall strategies, and thus
entities providing relevant SDG data will help investors make informed decisions which can lead
to capital being channelled to responsible businesses. Companies are developing business
strategies that embrace the growth potential of responsible environmental and societal policies.
 There are several reasons why companies should focus on sustainable business practices, and
they include:
a) the increased future government focus on sustainable business
b) such business practices often improve performance as they lower operational,
reputational and regulatory risk
c) there are significant business growth opportunities in products and services that address
the SDG challenges
d) the fact that short term, profit based models are reducing in relevance. Companies and
their stakeholders are changing how they measure success and this is becoming more
than just about profit.
 Investors realise that the SDGs will not all be equally relevant to all companies, with boilerplate
disclosures having little relevance at all. Good disclosure will qualitatively show how the
company‟s SDG related activities affect the primary value drivers of the business. It would be
natural to assume that SDG reporting should be based around the disclosure of information to
mitigate business risk and the drive for improved predictability of investment decisions.
However, if there is to be fair presentation, then there should also be disclosure of any negative
and positive impacts on society and the environment.
 Investors‟ expectations will still be focused on companies realising their core business activities
with financial sustainability as a prerequisite for attracting investment. However, institutional
investors have a fiduciary duty to act in the best interests of their beneficiaries, and thus have to
take into account environmental, social and governance (ESG) factors, which can be financially
significant. Companies utilising more sustainable business practices provide new investment
opportunities.
 Investors screen companies as regards their ESG policies and integrate these factors into their
valuation models. Additionally, there is an increased practice of themed investing, whereby
investors select a company for investment based upon specific ESG policy criteria such as clean
technology, green real estate, education and health. Investors are increasingly factoring impact
goals into their decision making whereby they evaluate how successful the company has been in a
particular area for example, the reduction of educational inequality. This approach can help
optimise financial returns and demonstrate their contribution to the SDGs through their portfolios.
Investors are increasingly incentivised to promote sustainable economies and markets to improve
their long-term financial performance.
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 Institutional investors realise that environmental events can create costs for their portfolio in the
form of insurance premiums, taxes, and the physical cost related with disasters. Social issues can
lead to unrest and instability, which carries business risks which may reduce future cash flows
and financial returns.
 Investors seek SDG information produced in line with widely-accepted recommendations. The
Global Reporting Initiative (GRI) and the UN Global Compact amongst others, have developed
guidance documents that mutually complement each other and create a reference point for
companies.
 Companies should disclose to investors how they have decided on their SDG strategy, philosophy
and approach. The approach should be capable of measurable impacts and have a clear
description of the material issues and a narrative that links the sustainability issues back to the
business model and future outlook of the entity.
 For investors, it is important that SDG-related reporting is presented in the context of the strategy,
governance, performance and prospects of the entity. Stakeholders should be engaged from the
beginning in order to identify any potential impact with some investors expecting companies to
have a stakeholder dialogue that goes beyond financial matters. Investors often require an
understanding of how the entity feels about the relevance of the SGDs to the overall corporate
strategy, and this will include a discussion of any risks and opportunities identified and changes
that have occurred in the business model as a result.
 The SDGs and targets are likely to present some of the greatest business risks and opportunities
for companies who should publish material SDG contributions, both positive and negative, as part
of their report. For example, an inability to address negative social and environmental impacts
may also be directly detrimental to short-term financial value for a business. Investors are
increasingly seeking investment opportunities that can make a credible contribution to the
realisation of the SDGs.
 However, if an investor wants to have a positive impact on working conditions for example, they
cannot assume that any investment in this area is relevant. The investor would need to be
provided with additional information such as data on the lowest income workers, any potential
income increase and how confident the company is that an increase in income will occur.
 Investors can choose not to invest in, or to favour, certain investments. Alternatively, they can
actively engage in new or previously overlooked opportunities that offer an attractive impact and
financial opportunity, even though these may involve additional risk.
 There is an assumption that the disclosure of ESG factors will ultimately affect the cost of capital;
lowering it for sustainable businesses and increasing it for non-sustainable ones. It may also
affect cash flow forecasts, business valuations and growth rates. Investors employ screening
strategies, which may involve eliminating companies that have specific features, for example, low
pay rates for employees and eliminating them on a ranking basis. They may also be eliminated on
the basis of companies who are contributing or not, to a range of SDGs and targets. Investors will
use SDG-related disclosures to identify risks and opportunities on which they will, or will not,
engage with companies. Investors will see potential business opportunities in those companies
that address the risks to people and the environment and those companies that develop new
beneficial products, services and investments that may mitigate the business risks related to the
SDGs.
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Technical Articles On Multiple Syllabus Sections
Crowdfunding and Impairment of Financial Instruments

This article addresses the application of accounting principles in contemporary contexts (an exam
technique issue) and the impairment of financial instruments (a technical knowledge issue).
Applying Accounting Principles to Different Contexts

 Many candidates perceive accounting to be a technical practice and believe that SBR tests „how
you do accounting‟.
 While some of this is true, SBR also tests the application of accounting principles in different
contexts because accounting is fundamentally a social practice, which guides and influences the
behaviour of people in organisations and society.
 As such, accounting needs to be studied and understood in the contexts within which it operates.
 The SBR syllabus therefore focuses on the concepts, principles and practices that underpin the
preparation and interpretation of corporate reports in different contexts (including ethical
contexts).
 This is because the application of knowledge is a skill that employers‟ value and therefore seek…
after all, an employer will not present you with a problem that has already been solved or one that
you have seen before.
 Understandably, candidates struggle with this because they are expected to be able to use
knowledge in new situations, make connections, explore outcomes and generate ideas.
Crowdfunding
 SBR candidates should be prepared for exam questions to test accounting concepts within
different accounting contexts that they may not necessarily have encountered before. This section
considers crowdfunding as one such context and describes the process that candidates should go
through to apply their knowledge to this particular context.
 Crowdfunding is the funding of a new start-up or project by collecting cash from a variety of
individuals/entities often via the Internet.
 There are 4 common ways of raising funds:
1. Equity-based crowdfunding: The equity-based approach is targeted at investors who
receive shares in the new company.
2. Debt-based crowdfunding: With debt-based crowdfunding, a contributor makes a loan
to a business that‟s looking to crowdfund, with the intention of subsequently being repaid
with interest.
3. Reward-based crowdfunding: This involves promising specific items (rewards) to
contributors before the launch of a new project, product, or business. A reward-based
campaign isn‟t generally targeted at contributors who are looking to profit from their
investment but at those who want to own a new product.
4. Donation-based crowdfunding: Contributors make 'donations' to a project or company
and may receive existing „rewards‟ in return. Some forms of donation-based
crowdfunding don‟t involve any sort of reward as donors wish to contribute to further a
particular cause.
Considerations
 Using the question scenario, candidates would be expected to breakdown a scenario and
understand the information provided – ie candidates may not have considered the crowdfunding
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context before, however, they should be able to understand the accounting implications of the
four options above.
 They should be able to apply their knowledge to the context provided; for example, if the
crowdfund is considered to be a debt instrument it will fall within the scope of IFRS 9, Financial
Instruments, whereas if it gives rise to an issue of capital, it will fall within the scope of IAS
32, Financial Instruments Presentation.
 If the crowdfunding campaign involves the issuing of „rewards‟, then IFRS 15, Revenue from
Contracts with Customers, should be used to determine when to recognise revenue. For each
performance obligation, the company will need to determine whether the performance obligation
is satisfied over time (ie control of the good or service transfers to the customer over time).
 If one or more of the criteria in IFRS 15 are met, then the company recognises revenue over time.
If none of the criteria is met, then control transfers to the customer at a point in time and the
company recognises revenue at that point in time. However, if the company cannot reasonably
measure the outcome but expects to recover the costs incurred in satisfying the performance
obligation, then it recognises revenue to the extent of the costs incurred.
EXAMPLE
On 1 September 20X9, Burnett Co decided to undertake a crowdfunding campaign to finance the
production of a new racing bike, the Cracken. They made a short film with famous cyclists which set out
the qualities of the Cracken bike and posted it on the PeddleStarter crowdfunding platform. The campaign
raised $4 million on which PeddleStarter charged 7% commission. The contributors to the crowdfunding
campaign were promised a reward of 1 Cracken bike for every $4,000 dollars contributed. At the financial
year end of 31 December 20X9, Burnett Co had manufactured only 50 Cracken bikes at a total cost of
$240,000 but none had been delivered to contributors. There was some doubt as to the capability of the
company to develop, manufacture, and deliver the bikes promised but Burnett Co is sure that the funding
will cover any costs incurred.
SUGGESTED ANSWER:
IFRS 15, Revenue from Contracts with Customers, should be used to determine when to recognise
revenue. At 31 December 20X9, it is difficult to know what the outcome will be as only 50 bikes have
been manufactured out of a promised 1000 bikes ($4 million/$4000) and there is a doubt as to whether the
company has the capability to develop, manufacture, and deliver the bikes promised. However, Burnett
Co expects to recover the costs incurred in satisfying the performance obligation, thus it will recognise
revenue to the extent of the costs incurred to date $520,000 ($240,000 + commission $280,000) as at 31
December 20X9. The balance remaining from the crowd funded amount will be shown as accrued
revenue in the financial statements ($3,480,000). The commission ($280,000) would be charged against
profit or loss for the period.
Guidance
 Many SBR candidates may now have some extra time to reflect and rethink values, concerns and
routines, one of which may be their approach to study.
 It may be a time to not focus on accounting techniques but on accounting principles, to maybe
read around the subject and gain an understanding of what lies behind it.
 Remember the following:
a) The importance of a robust conceptual framework
b) An understanding that rules will not be able to cover all situations
c) Use of reasonable judgement is always needed in the decision-making process
 To further help understand what is expected of you, SBR candidates should read all of the
examiner‟s reports that are available at each exam diet; for example, the examiner‟s report for
March 2020 observed that there was a lack of knowledge of some basic accounting concepts and
many candidates did not have an understanding of „equity accounting‟.
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 A significant number of candidates did not know that „the investment is initially recognised at
cost and adjusted thereafter for the post-acquisition change in the investor's share of the investee's
net assets.‟
 If candidates do not understand the basics, it will be almost impossible to apply that knowledge to
different accounting contexts.
 Therefore, it is important that the basic principles of Financial Reporting (FR) are understood by
candidates before attempting the SBR exam. See „Stepping up from Financial Reporting‟ for
more information.
The Impairment of Financial Instruments

 One technical area of the SBR syllabus that candidates often struggle with is the impairment rules
of IFRS 9, Financial Instruments.
 IFRS 9 uses an Expected Credit Loss (ECL) model which requires a calculation of the expected
value decrease in a financial asset.
 Essentially, a provision is required for expected credit losses on the financial asset over a period
of time.
 Expected losses should be discounted to the reporting date using the effective interest rate of the
financial asset that was determined at initial recognition.
 The impairment model of IFRS 9 introduces a three-stage approach:
1. Stage 1 deals with financial instruments that have not had a significant increase in
credit risk since they were first recognised or that have low credit risk at the financial
year end.
 For these assets, 12-month ECL are recognised which means that the entity has to
calculate the expected losses in the next 12 months taking into account the risk of
default. Any interest revenue is calculated on the gross carrying amount of the
asset without the deduction of the credit loss.
2. Stage 2 deals with financial instruments that have had a significant increase in credit
risk since they were first recognised unless the credit risk is still low at the financial
year end.
 These instruments are not credit-impaired. The expected losses over the life of
the financial instrument are recognised (lifetime ECL) taking into account the
risk of default. Interest revenue is still calculated on the gross carrying amount of
the asset.
3. Stage 3 deals with financial assets that are credit-impaired, which is where events have
occurred that have a detrimental impact on the estimated future cash flows from the
financial asset.
 For these assets, lifetime ECL are also recognised. However, interest revenue is
calculated on the carrying amount less the ECL allowance.
EXAMPLE
On 1 January 20X6, Lunar Co granted Skyzer Co a $5 million secured loan repayable on 31 December
20X9 with an interest rate of 3% payable annually at the reporting date.
Stage 1 Stage 2 Stage 3
On 31 December 20X6, there On 31 December 20X7, the On 31 December 20X8, the
has been no increase in credit credit risk of the loan has loan is credit impaired. The
risk and the probability of increased significantly. estimated present value that is
default in the next 12 months is expected to be recovered (less
5%. The present value of the The probability of default costs) is $4 million.
cash shortfalls expected over occurring over the remaining
the life of the instrument if the life of the loan is 45%. The The gross carrying amount of
default occurs in the next 12 present value of ECLs from the loan is $5,150,000 which is
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months is $200,000. default events over the life of the loan plus unpaid interest
the loan are expected to be for the year.
$400,000.
12-month ECLs = $10,000 Lifetime ECLs = $180,000 Lifetime ECLs = $1.15 million
($200,000 × 5%). ($400,000 × 45%) ($5.15 – $4) million
Interest revenue = $150,000 The change of $170,000 in the The change of $970,000
(3% × $5m – ie no adjustment cumulative impairment ($1.15–$0.18)m in the
for any loss allowance). allowance is recognised in cumulative impairment
profit or loss. allowance is recognised in
profit or loss.
Interest revenue = $150,000
(3% × $5m – ie no adjustment 20X9 interest revenue =
for any loss allowance). $120,000 (3% × $4 million)
which is based on gross
carrying amount minus loss
allowance.
 For trade receivables or contract assets that do not contain a significant financing component, the
loss allowance should be measured, at initial recognition and throughout the life of the receivable,
at an amount equal to lifetime ECL.
 As an exception to the general model, if the credit risk of a financial instrument is low at the
reporting date, management can measure impairment using 12-month ECL, and so it does not
have to assess whether a significant increase in credit risk has occurred.
Guidance
 If you are struggling with a technical issue in the SBR syllabus, try to pair it back to basic
principles that you can use in any context. For example, the suggested solution above relies on an
understanding of the accounting principles that apply at each stage of credit impairment.
 Understanding and applying these principles in an exam context will demonstrate a deep
understanding of the issue and an ability to apply it to the question scenario. It is these skills that
employers are looking for and examiners will award marks for.
Conclusion
This article addresses two issues that SBR candidates have struggled with in recent exam diets; one
relates to exam technique and the other a more technical issue.
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Business Combinations, Share-Based Payments and

Accounting Considerations of a Pandemic or Natural
Disaster
This article identifies the kinds of 'control' issues that candidates should be considering when
constructing their response to such exam questions. It also reflects upon how share-based payments
should be accounted for when they are made as part of the purchase consideration for a subsidiary in a
business combination. Finally, it uses the Covid-19 pandemic as a context within which to consider what
IFRS standards might be applicable to reporting entities and why.
 Recent examiner reports have stated that SBR candidates often do not provide an effective
consideration of whether or not control has been obtained by the acquirer in a business
combination.
 This article therefore identifies the kinds of 'control' issues that candidates should be considering
when constructing their response to such exam questions. It also reflects upon how share-based
payments should be accounted for when they are made as part of the purchase consideration for a
subsidiary in a business combination.
 Finally, it uses the Covid-19 pandemic as a context within which to consider what IFRS standards
might be applicable to reporting entities and why.
Business Combinations
Revision of the Basic Principles of Consolidation
 When answering SBR exam questions that test control, candidates don‟t often focus on the inter-
related principles of control despite the fact that the requirement asks them to do so.
 Control is not simply a matter of owning more than 50% of the voting share capital of an entity
and consideration of the individual elements of control in isolation can give rise to the conclusion,
incorrectly, that almost any „involvement‟ with another entity creates a controlling relationship.
 However, it is important to note that the three criteria that define control (considered below) are
inter-related and that all three must be present to conclude that the acquirer (investor) has control
of the subsidiary.
 IFRS 10 Consolidated Financial Statements (para 7) states that an investor controls an investee
when the investor has all of the following:
1. Power over the investee
2. Exposure, or rights, to variable returns from its involvement with the investee, and
3. The ability to use its power over the investee to affect the amount of the investors returns
 The following table considers each of the control criteria and identifies issues that candidates need to
apply to the SBR exam question scenario to identify whether (or not) control has been transferred to
the acquirer:
Control criteria (IFRS 10) Considerations to apply to the SBR exam question
scenario:
Power over the investee  Owning a majority of the voting rights is not always
necessary to have control.
 Instead, control requires that the investor‟s power/rights
are sufficient for it to unilaterally direct the relevant
activities that most affect the investee‟s returns.
 For example, SBR candidates should consider who makes
the operating, financing and capital decisions, and who
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appoints key management personnel.
 More analysis and judgement is required to determine
whether an investor with a significant minority of voting
or other rights has control.
 For example, power over an investee can still exist even
when another entity has significant influence and SBR
candidates must be prepared to consider this.
Exposure or rights to variable returns  Returns should be interpreted broadly, for example, to
include synergy benefits as well as financial returns
 Returns can be negative or positive
 A right to returns that is fixed is not normally
consistent with control
The ability to use its power to affect  In more complex control assessments, IFRS 10
returns requires identification of the activities that most affect
the investee‟s returns and how they are directed
 In simple assessments, it is sufficient to consider
activities at the financial and policy level.
If, after applying these considerations to the SBR exam question scenario, the outcome of the assessment
of control is still unclear, other evidence must be considered, including:
1. ability to direct investee to act on investor‟s behalf
2. key management personnel or the majority of governing body are related parties of
investor
3. special relationships between investee and investor
EXAMPLE
Joo Co and Cat Co hold 40% each of the voting rights of Door Co. The remaining 20% are held by Hag
Co. A shareholders‟ agreement states that the purpose of Door Co is to generate capital gains from buying
and selling properties. All decisions concerning buying and selling properties, and their financing require
the unanimous agreement of both Joo Co and Cat Co. Joo Co is responsible for all management activities
for which it receives payment and additionally has the final decision on appointments to the board of
directors.
SUGGESTED ANSWER
The major finance and management activities will both affect Door Co‟s returns. Therefore, Joo Co and
Cat Co should evaluate which set of activities has the greatest effect on returns. Given the purpose of
Door Co is to achieve capital gains, this may indicate capital investment activities have the most
significant impact. If so, the conclusion would be that Joo Co and Cat Co have joint control because these
activities are directed by joint decision-making. The deemed significant influence of Hag Co would not
change this assessment of which entity has power over Door Co. If however management activities and
key management personnel appointments are considered more significant, the conclusion would be that
Joo Co has control of Door Co because it solely directs these relevant activities.
Guidance
 Different exam question scenarios will provide different amounts of information and sometimes it
won‟t be possible to consider all of the control criteria that have been identified in the table
above.
 However, SBR candidates should ensure that their response considers more than just the 50%
ownership criteria.
 In doing so, they can demonstrate that they are aware that other criteria exist and that they know
how to apply them.
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 Such an approach is likely to produce an answer that has both breadth and depth.
Share-Based Payment – Replacement Awards On Acquisition

 Another issue that SBR candidates appear to struggle with is the accounting treatment required
when an entity includes a share-based payment as part of the consideration paid for a subsidiary
in a business combination; for example, when the acquirer agrees to take over any existing share-
based payment awards that have already been issued to the employees of the acquiree.
Alternatively, the acquirer may change the terms of the share-based payment awards to provide
an incentive for key employees to remain an employee of the acquired entity. Such transactions
are included within the scope of IFRS 2, Share-based Payment.
 Such an arrangement needs to be analysed to determine whether it represents compensation for
services in the pre-combination/acquisition period, the post-combination/acquisition period, or
both. Amounts attributable to the pre-acquisition period should be accounted for as part of the
purchase consideration. Amounts attributable to the post-acquisition period should be recognised
as a cost of that period. Amounts attributable to both the pre- and post- acquisition periods should
be allocated to the purchase consideration and post-acquisition costs accordingly.
 Transactions that benefit the acquiree before the acquisition is included as part of the purchase
consideration. If the transaction was arranged for the economic benefit of the acquirer, the
transaction is not deemed to be part of the purchase consideration.
EXAMPLE
On 1 April 20X3, Natural Co granted equity share-based payment awards to its employees. These shares
awards had a fair value of $20 million and were subject to the employees remaining in employment for
the next 3 years.
On 1 April 20X5, Digital Co purchased all of the share capital of Natural Co for cash of $80 million. A
condition of the acquisition is that Digital Co is required to issue replacement equity share awards to the
employees of Natural Co that will vest on 31 March 20X6.
On 1 April 20X5, the fair value of Natural Co‟s net assets was $90 million, the fair value of the original
share award was $24 million and that of the replacement share awards was $28 million.
The financial year end is 31 March each year.
Required: calculate the impact of the share-based payment awards when accounting for the acquisition,
including goodwill.
SUGGESTED ANSWER
The amount of the replacement share award that is attributable to pre- acquisition services is determined
by multiplying the fair value of the original award by the ratio of the vesting period completed at the date
of the business combination to the greater of:
 The total vesting period, as determined at the date of the business combination, and
 The original vesting period
The period before the date of acquisition is (a) 2 years [1 April 20X3 to 31 March 20X5].
The vesting period of the replacement awards is (b) 1 year (b) [1 April 20X5 to 31 March 20X6].
The original vesting period is (c) 3 years [1 April 20X3 to 31 March 20X6].
Therefore, the total vesting period at 1 April 20X5 is 3 years (a+b) which is the same as the original
vesting period.
The pre-acquisition service amount is $24 million x 2 years/3 years = $16 million – this is accounted for
as part of the purchase consideration (see below).
The post-acquisition service amount therefore is ($28-$16) million – $12 million – this is accounted for as
a cost for the year ended 31 March 20X6.
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Goodwill at 1 April 20X5 $m

Cash consideration 80
Equity-share based awards 16
96
Net assets of Natural Co (fair value) 90
Goodwill 6
At 31 March 20X6 (vesting date) $m

Remuneration cost (PL) 12
Equity-share based awards (SFP- Equity) 12
Note
1. The above approach is a sensible one which is also logical and clear to mark.
2. Therefore, it is an approach that the SBR examining team recommends that you follow when
answering similar such questions.
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The Accounting Considerations of a Pandemic or Other Natural

Disaster
Learning outcome F1(c) of the SBR syllabus states that candidates should be able to:
Discuss the impact of current issues in corporate reporting. This learning outcome may be tested by
requiring the application of one or several existing standards to an accounting issue. It is also likely to
require and explanation of the resulting accounting implications (for example, accounting for
cryptocurrency in the Digital Age or accounting for the effects of a natural disaster and the resulting
environmental liabilities).
 The Covid-19 pandemic is an example of a natural disaster which has undoubtedly had an impact
on the financial reporting practices of many entities in different business contexts.
 Indeed, many entities are experiencing conditions that are often associated with a significant
economic downturn.
 However, there is no one particular IFRS standard that is more relevant than any other.
 The SBR examining team has often commented that candidates incorrectly think that only one
IFRS standard can be used to provide an answer to an exam question scenario.
 Such an approach is likely to produce a response that is very narrow in its consideration of the
issues applicable to the exam question scenario.
 By using the context of the Covid-19, the following table demonstrates the wide number of IFRS
standards that are impacted by this pandemic which would also apply to other situations like
economic downturns.
 The following tables consider some of the existing accounting requirements that should be
considered when addressing the financial effects of the Covid-19 outbreak:
IFRS Standards Issues for discussion
 Assessment of an entity‟s ability to continue as a going concern at
the dates the financial statements are approved.
 Disclose uncertainties – significant judgements and sources of
IAS 1, Presentation of estimation/uncertainty need to be appropriately disclosed. This will
Financial Statements also have impacts on the going concern assessments if judged
material.
 If going concern is at issue consider preparation of financial
statement on net realizable basis/net settlement value.
 Inventory must be stated at the lower of cost or net realisable value
(NRV) however NRV calculation may be challenging (no market
prices or no demand for products).
IAS 2, Inventories
 Entities may need to reassess their practices for fixed overhead cost
allocation as production levels fall materially.
 Obsolete inventory considerations, especially perishable inventory.
 The evaluation of Covid-19 information that becomes available after
the end of the reporting period but before the date of authorisation of
the financial statements.
IAS 10, Events after the
 Entities will need to judge how much of the impact of Covid-19
reporting period
should be considered to arise from adjusting or non-adjusting events
given the dates when knowledge of the pandemic became known
and events like travel bans, lockdowns and similar took effect.
 Recovery of deferred tax (DT) assets arising from accumulated tax
IAS 12, Income Taxes losses and therefore assess probable future taxable profits or tax
planning opportunities or whether sufficient DT liabilities which are
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expected to reverse.
 Will entities have to restrict the Dt Asset recognised?
 Consequences of adjustments to the carrying amounts of assets and
liabilities will have DT impact. Some examples will include the
Impact of impairment losses or decreases in the value of a pension
surplus.
 Adjustments/provisions for severance.
 Falls in interest rates and plan asset portfolios may require
IAS 19, Employee Benefits
significant adjustments requiring the services of actuaries to reflect
changes in any defined benefit schemes.
IAS 20, Accounting for  Government assistance to help entities that are experiencing
Government Grants and financial difficulty.
Disclosure of Government  Reimbursement of employment costs is recognised in profit or loss.
Assistance Disclosure of aid such as short-term debt facilities.
 Suspension of capitalisation of borrowing costs if Covid-19 has
interrupted the acquisition, construction or production of a
IAS 23, Borrowing Costs
qualifying asset. Any borrowing costs incurred during such periods
should be expensed through P/L.
 Assess whether the impact of Covid-19 has potentially led to an
asset impairment (tangible, intangibles and financial assets) –
effectively Covid-19 is a trigger event that indicates an impairment
review is required.
IAS 36, Impairment of  Management may face significant challenges in preparing the
Assets budgets and forecasts necessary to estimate the recoverable amount
of an asset (or CGU) because of decreased demand, business
interruptions, cancelled orders and similar issues.
 Difficulty assessing fair values when no active market or market
participants
 Potential restructuring provisions and onerous contract provisions
may need measured and recognised and insurance recoveries
IAS 37, Provisions,
disclosed (need to assess certainty of these recoveries).
Contingent Liabilities and
 If material expenses or income for example restructuring and
Contingent Assets
onerous contract provisions and impairment losses) should they be
disclosed separately?
IFRS 2, Share-based  Vesting conditions for share-based payments with performance
Payment conditions may not be met.
 An asset (or a disposal group) no longer meets the conditions for
„held for sale‟ for example an entity may now face difficulties in
IFRS 5, Non-current
identifying a buyer or in completing the sale within the 12-month
Assets Held for Sale and
period from classification.
Discontinued Operations
 Ceased operations that meet the definition of discontinued
operations will require separate presentation and disclosure.
 Allowance for expected credit losses (ECL) - reductions in forecasts
in economic growth increase the probability of default and entities
will need to revisit the provision matrix approach for trade
IFRS 9, Financial receivables.
Instruments  Classification of financial assets – consider whether there has been a
change in the entity‟s business model. An entity may decide or need
to sell receivables classified as „held to collect‟ which will therefore
change classification.
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 Hedge accounting – entities may need to consider whether the
transaction is still a 'highly probable forecasted transaction'.
 There will be many more considerations with IFRS 9 regarding
interest rate changes/debt covenants/modifications to payment
terms.
 Companies need to look at the decisions, assumptions and inputs to
IFRS 13, Fair Value fair value measurement as market-based measures are likely to
Measurement change significantly and perhaps in unpredictable ways. If using
level 2 or 3 inputs will require more extensive disclosure.
 Contract enforceability - may not be able to approve a contract
under an entity‟s normal business practices
 Collectability – may be a significant deterioration of a customer‟s
ability to pay.
 Contract modifications – entity may grant a price concession to a
customer.
IFRS 15, Revenue from
 Variable considerations – an entity may need to consider updating
contracts with customers
its estimated transaction price
 Significant financing component -an entity may provide extended
payment terms.
 Revenue recognition - an entity may need to reconsider the timing of
revenue recognition if it is unable to satisfy its performance
obligations on a timely basis.
 Impairments to right-of use assets.
 Economic stimulus measures have led to lower interest rates and
IFRS 16, Leases
changes to lease terms – lease liabilities may need remeasured.
 Impairments of lease receivables for lessors.
Other non-IFRS
considerations
Many central banks have cut their base rates – this will affect the measurement of
Discount rates
many assets and liabilities
Alternative Entities may consider providing new alternative performance measures (APMs)
performance or adjust existing APMs – adequate/extensive disclosures will be required to
measures ensure they do not mislead
Note
 While the SBR examining team is not stating that consideration of all of these IFRS standards
would be required, or could be expected, to answer an SBR exam question, the table does
demonstrate that the accounting context of Covid-19 requires the consideration of a range of
accounting standards and has wide and varied implications.
 Likewise, an SBR exam question is unlikely to require the consideration of only one IFRS
standard in isolation.
 SBR candidates should use the signposts and clues contained in the question scenario to identify
which IFRS standards that they should consider.
Conclusion
 This article should be used to stimulate thoughts about how these issues might impact on
responses when practicing SBR exam questions.
 However, this article should not be interpreted as a signpost to the content of future SBR exam
questions.
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 ACCA candidates should focus on wider reading including making use of the learning resources
that ACCA have available such as technical articles and the examiner reports.
 By using these resources now, exam technique can be refined and improved.
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Asset Ceiling Test (IAS 19), Initial Coin Offerings, Non-

GAAP, and Non-Financial Performance Measures
A. This article discusses the asset ceiling test in IAS 19, Employee Benefits, and explains how many
IFRS standards and principles might be relevant to an accounting issue for which there is no
existing IFRS standard (in this case Initial Coin Offering (ICO)). Finally, it examines some non-
financial performance measures that have been reported in practice in a global digital entity.
B. This article explains a complex area of the SBR syllabus, the asset ceiling test in IAS
19, Employee Benefits, and explains how many IFRS standards and principles might be relevant
to an accounting issue for which there is no existing IFRS standard (in this case Initial Coin
Offering (ICO)). Finally, it examines some non-financial performance measures that have been
reported in practice in a global digital entity.
C. However, first it is worth reiterating that candidates will not be able to successfully answer SBR
questions by rote learning and reproducing textbook answers. Candidates should always explain
the relevant principles which underpin their answers because in SBR, marks are awarded first for
an explanation of the principles and then for their application to the scenario. An understanding
of the principles will allow candidates to deal with the many accounting issues that arise in
practice and to cope with the changes and developments in the business environment, such as
ICO’s. In addition, candidates will not be awarded professional marks if there is no reference to
the scenario.
Asset Ceiling Test - IAS 19 Employee Benefits

 Defined benefit pension accounting is generally acknowledged to be a complex area of
accounting and asset ceiling test is possibly one of the more complex aspects of IAS
19, Employee Benefits that might be examined.
 A pension asset exists when a defined benefit pension plan has a surplus of plan assets over its
liabilities.
 IAS 19 requires the employer to consider the recoverability of any such surplus and there must be
economic benefit (for example reduced contributions or a cash refund) available to the company
to enable this recovery.
 An entity should recognise a net pension asset in such cases because the entity controls a
resource, and that control is a result of past events. This is in the form of contributions paid by the
entity and service rendered by the employee.
 Future economic benefits are available to the entity in the form of a reduction in future
contributions or a cash refund, either directly to the entity or indirectly to another plan in deficit.
 The asset ceiling is the present value of those future benefits.
 IAS 19 states that, when an entity has a surplus in a defined benefit plan, it should measure the
net defined benefit of the asset at the lower of:
1. the surplus in the defined benefit plan, and
2. the asset ceiling.
Note
1. The asset ceiling will be provided as part of the question scenario in the SBR exam but in practice
is determined using the discount rate based upon market yields at the end of the reporting period
on high quality corporate bonds
2. A further issue can arise when a plan amendment, curtailment or settlement occurs. An entity
should recognise any past service cost, or a gain or loss on settlement in profit or loss. In doing
so, the entity should not consider the effect of the asset ceiling. After the plan amendment,
Page 101 of 109

curtailment or settlement has been accounted for, the entity should then determine the effect of
the asset ceiling.
3. A plan amendment, curtailment or settlement might reduce or eliminate a surplus, which could
impact on how the asset ceiling is measured. Any change in the value of the asset ceiling is
recognised in other comprehensive income, as opposed to being recognised in the statement of
profit or loss.
Illustrative example
Apolline Co manages a defined benefit scheme for its employees. At 1 January 20X8, the fair value of the
pension scheme assets was estimated to be $137 million and the present value of the pension scheme
liabilities were $122 million. The asset ceiling has been calculated at $4 million. The discount rate on
high quality corporate bonds is 4%. The following are the details of the scheme for the year to 31
December 20X8.
$m
Cash contributions 7
Benefits paid 6
Current service cost 5
At 31 December 20X8, the asset ceiling has been calculated at $11 million. During the year, there was a
scheme curtailment which resulted in a gain on settlement of $3 million. Immediately after the scheme
curtailment the actuary valued the scheme‟s assets as $148 million and the scheme‟s liabilities as $136
million.
Suggested answer
At 1 January 20X8, the surplus of the scheme/net plan asset is $15 million ($137 million – $122 million).
However, the asset ceiling is $4 million so the net defined benefit pension asset is restricted to this figure.
Interest on the opening asset will be based upon this figure at $160,000 (4% X $4 million) and will be
recorded in profit or loss. The cash contributions of $7 million will be added to the scheme assets, and the
current service cost of $5 million charged to profit or loss. The benefits paid of $6 million are deducted
from both the schemes assets and the schemes liabilities and therefore have a nil effect.
As any past service cost does not consider the effect on the asset ceiling, a gain on settlement of $3
million should therefore be recognised in profit and loss.
The pension scheme surplus at 31 December 20X8 is summarised here.
At 31 December 20X8, the scheme is now valued at the lower of the:

 surplus of the scheme, $12 million ($148 million – $136 million), and
 the present value of the economic benefits in the form of refunds from the plan or
reductions in the future combinations (the asset ceiling) – ie $11 million.
This means that there is a net gain of $1.84 million being the difference between the net plan asset in the
scheme ($9.16 million) and the asset ceiling ($11 million). This gain is credited to other comprehensive
income.
If the effect of the asset ceiling had not been taken into account, there would have been a remeasurement
loss of $8.6 million ($20.6 million – $12 million) at 31 December 20X8 which would have been
recognised in other comprehensive income.
Page 102 of 109

Understanding the Context of Initial Coin Offering (ICO) Tokens
SBR will often provide candidates with a scenario that they have not encountered before. These scenarios
allow candidates to demonstrate their ability to apply accounting principles and show how more than one
IFRS standard might be relevant. The next few paragraphs use an ICO to demonstrate how candidates
should use accounting principles (such as control) and existing IFRS standards to suggest potential
accounting treatments.
Initial Coin Offering (ICO) Tokens

 In an ICO (also called a „token sale‟), instead of receiving shares, participants (also known as
supporters) receive „tokens‟ and, instead of paying cash, participants often pay in cryptocurrency.
 They are similar in many ways to crowdfunding but for their „support‟ they receive a reward – ie
the tokens.
 The tokens are a digital asset based on the same logic as cryptocurrencies, like Bitcoin.
 Although the tokens have no inherent value, if the ICO is successful, these new tokens will
become valuable and a market to trade them will subsequently develop.
 If unsuccessful, then the tokens would have no value.
 ICOs raise money by issuing a „white paper‟ that provides details of the proposed venture.
 This may be the development of a new app or product or service; for example, the development
of an app to subsequently support the trade of the tokens.
 The tokens are usually issued in exchange for either conventional currency or cryptocurrency.
 As the ICO issues a token, rather than shares, they are not considered to be a securities offering,
so the associated regulation and controls have not been applied.
Note
There are ethical issues for accountants because the white paper may not properly represent the nature of
the offer. For example, unrealistic forecasts or factual inaccuracies.
 During the preparation for the ICO, the costs should be recognised as expenses if they don‟t
satisfy the requirements for recognition of intangible assets in accordance with IAS 38, Intangible
Assets.
 Following the circulation of the tokens, the issuing company generally loses control of the market
of these tokens.
 However, if the issuer is able to get further economic benefits from token holders by providing
them with intermediary or similar services that are not related to the subsequent sale of
uncirculated tokens, then the costs may satisfy the requirements of IAS 38.
 Examples may be the management of the platform supporting the market of circulated tokens by
annulling purchased tokens or changing the content of smart contracts (a computer program that
executes, controls and documents legal events).
 If all inflows received for tokens are in excess of the expenses of the initial ICO and are not
related to further commitments to holders of tokens, such further inflows are considered as
revenue by the issuer.
 Sometimes the rights given to the token holders may be similar to the rights of the holders of
debt, equity instruments or other financial instruments. For example, the issuer may contract to
pay a fixed amount of annual profits to the token holder but not to redeem the tokens.
 At the initial recognition, such a right is recorded as a contingent liability, the value of which
depends on a future uncertain event – ie the annual profit margin.
 During the reporting period, the liability should be increased as the issuer earns profits.
 Alternatively, the issuer may commit to the holders of tokens to pay annual interest based upon
the fair value of a cryptocurrency. Such a liability should be recognised as a financial derivative.
Page 103 of 109

 Revenue recognition in accordance with IFRS 15, Revenue from Contracts with Customers is
based on the transfer of control. Control is defined as the ability to direct the use of and obtain
substantial control over the remaining benefits associated with the asset. The issuer therefore
needs to determine if the transfer of control happens over time.
 If control happens over time, revenue cannot be recognised in full at the time of the initial ICO
sale. Instead, it must be recognised as the performance obligation is satisfied. This will most
likely occur if the token is presented to the issuer for redemption into goods or services, such as
granting access to software.
A useful background article can be found within the SBL technical articles here. Please note that this
article is not examinable but is purely for additional reading.
Non-GAAP/Non-Financial Performance Measures and Quarterly Press Releases

Finally, SBR candidates need to be able to understand additional performance measures (APMs) that are
produced by companies in the context of their different business models. This final part of the article uses
a social media company to demonstrate the range of APMs reported in practice.
 Some companies issue quarterly press releases which contain forward-looking statements
regarding the future expectations of the business.
 Often, they will supplement the consolidated financial statements with some non-GAAP financial
measures. For example, some social media companies will report advertising revenue excluding
foreign exchange effect and free cash flow. Investors are often cautioned that there is material
limitations associated with the use of non-GAAP financial measures as an analytical tool.
 In addition, they state that these measures may be different from non-GAAP financial measures
used by other companies, limiting their usefulness for comparison purposes.
 These non-GAAP measures are reported because they provide investors with useful supplemental
information and allow for greater transparency with respect to key metrics used by management
in operating their business.
 SBR candidates need to be aware how these additional performance measures might be useful to
users when provided in conjunction with financial statements that are compliant with IFRS
standards.
 These measures are usually derived from the business model of the company; for example, a
social media company will often publish „Operational and Other Financial Highlights‟ which
include a range of metrics that the directors feel are important to investors. They may include
conventional profitability ratio‟s such as earnings per share but also such things as:
a) Social media monthly active users
b) Family daily and monthly active people
c) Family average revenue per person
d) Revenue by user geography
e) Advertising revenue by user geography
f) Effective tax rate
g) Free cash flow reconciliation
 Well known social media companies are quick to point out the limitations of some of the above
ratios. For example, Facebook states that the numbers for their key metrics are calculated using
internal company data based on the activity of user accounts. They try and eliminate the number
of 'duplicate' and 'false' accounts among their users as many people use more than one of their
products, and some have multiple user accounts within an individual product. The data regarding
the geographic location of their users is estimated based on a number of factors, such as the user's
IP address and self-disclosed location. These factors do not always accurately reflect the user's
actual location.
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 It seems that for some digital companies, conventional financial accounting ratios cannot account
for the importance of other effects such as the network or the increase in the value of a resource
with its use. Hence, some companies will use ratios which are particular to their type of digital
business model.
 SBR candidates must be able to discuss the issues raised by the increasing demand by various
stakeholders for non-financial additional performance measures including transparency,
consistency and comparability. There is a technical article that discusses additional performance
measures which can be found here.
 SBR candidates must be able to discuss the ethical issues associated with regards non-
GAAP/non-financial performance measures being used, for instance conflicts of interests
between managements interests and the investor perspective. The examples provided above raise
many of these issues on the tensions between demand for more information from stakeholders
and how it should be calculated and presented alongside IFRS standard disclosures.
Page 105 of 109

Onerous Lease Contracts and Impairments, and Investor

Issues
This article addresses the technical matter of onerous lease contracts and their impairment and then
considers two types of approach to SBR exam questions:
(i) investors issues in SBR questions and
(ii) the application of knowledge to SBR question scenarios.
This article addresses the technical matter of onerous lease contracts and their impairment and then
considers two types of approach to SBR exam questions:
(i) investors issues in SBR questions and
(ii) the application of knowledge to SBR question scenarios
Specifically, question 3 from the March 2020 exam is used to illustrate this point.
Onerous Lease Contracts And Impairments

 IFRS 16, Leases has brought significant change to the accounting treatment of leases, the most
important of these changes being that lessees now have to recognise operating leases as a right-
of-use (ROU) asset and a lease liability.
 As with other assets, this ROU asset may have to be tested for impairment. Since the ROU asset
is a non-financial asset, the requirements of IAS 36 apply. However, there are two exemptions to
the IAS 36 impairment model.
 Firstly, when a lessee applies the fair value model in accordance with IAS 40 for its investment
properties, it also applies the fair value model to the ROU asset.
 Secondly, if a ROU asset relates to a class of PPE to which the lessee applies the revaluation
model, then the lessee can elect to apply the revaluation model to all of the ROU assets that relate
to that class of PPE.
 In accordance with IAS 36, the ROU asset is tested for impairment on a standalone basis unless it
forms part of a cash-generating unit (CGU). If the ROU asset is tested for impairment as a part of
the CGU then it should be included in the CGU‟s carrying amount.
 IAS 36 requires entities to consider whether a buyer would be required to assume any liabilities,
which could include the lessee‟s lease liability. In such a case, the lease liability needs to be
included in the recoverable amount of the CGU and in the carrying amount of CGU as well.
 When considering onerous contracts, these are governed by IAS 37, Provisions, Contingent
Liabilities and Contingent Assets and this IFRS standard is applied to any contract for which
unavoidable costs of meeting the contract obligations exceed the economic benefits expected to
be received under that contract. However, it is interesting to consider whether IAS 37 and IFRS
16 can co-exist.
 The IASB (the Board) decided not to specify any particular requirements in IFRS 16 for onerous
contracts. The Board made this decision because:
a. for leases that have already commenced, no requirements are necessary. After the
commencement date, an entity can appropriately reflect an onerous lease contract by
applying the requirements of IFRS 16. A lessee will determine and recognise any
impairment of right-of-use assets applying IAS 36, Impairment of Assets.
b. for leases that have not already commenced, the requirements for onerous contracts in
IAS 37, Provisions, Contingent Liabilities and Contingent Assets are sufficient. The
requirements in IAS 37 apply to any contract (and hence any lease contract) that meets
the definition of an onerous contract in that standard.
The question also arises as to how to deal with onerous contracts when initially applying IFRS 16. A
company can either:
Page 106 of 109

 apply IAS 36 to its right-of-use assets, or
 not apply IAS 36 on the date of initial application, but instead rely on its assessment of whether
any of its leases are onerous under IAS 37. Any onerous lease provision is derecognised and an
equal amount is deducted from the carrying amount of the relevant right-of-use asset.
This choice can also be applied on a lease-by-lease basis.
 Thus, candidates should carefully read the question before answering to determine whether IAS
36 or IAS 37 should be applied to the onerous leasing contract.
 If the examining team wants candidates to consider the matter under a specific IFRS standard (ie
IAS 37 or IFRS 16), then that standard will be specifically referred to in the requirement.
 However, candidates should also appreciate that marks will be awarded for any discussion that is
rational and logical, even though it doesn’t appear in the suggested solution.
Investors Issues in SBR

 Every SBR exam will include a question that tests an investor‟s perspective.
 Although the nature of the question will vary, it will normally include 2 professional marks.
 The question may require candidates to comment upon the usefulness of certain types of
information to investors and their needs.
 When answering a question on a specific IFRS standard, candidates should use their knowledge
of that accounting standard to discuss how this could impact on the investment decisions of
investors. For example, there may be a need for a clear explanation of deferred tax balances in
financial statements and an analysis of the expected timing of reversals so that investors can see
the time period over which deferred tax assets arising from losses might reverse.
 As a general rule, the principles of good disclosure would be useful to investors. Thus, candidates
can use these principles as a framework for answering generic questions which involve an
investor perspective.
 The Board has received feedback from investors along the following lines:
a) Investors are concerned about ineffective communication. In particular, they highlight the
importance of proper application of materiality by entities when deciding what to disclose
and how best to communicate that information.
b) Investors consider comparability and entity-specific information to be particularly
important but note that there is potential for conflict between these two principles.
c) Many investors think that the inclusion of IFRS information outside the financial
statements could be useful in some circumstances but have some concerns about
understandability, assurance and the on-going availability of information.
d) Many investors agree that the Board should not prohibit the inclusion of non-IFRS
standard information in financial statements. However, investors have concerns about the
risk of entities providing misleading information, or clouding IFRS standard information.
e) Investors think that the Board should require an entity to clearly identify, label, explain
and reconcile any non-IFRS standard information presented in the financial statements.
f) Many investors feel that the Board should define performance measures. Many investors
have encouraged the Board to define one or more of the following: EBIT, EBITDA and
other performance measures such as operating profit.
g) Most investors support the suggestion to develop definitions of, and requirements for the
presentation of, unusual or infrequently occurring items. Investors think that this would
help to avoid misleading or inconsistent use of those terms.
h) Investors think that useful accounting policy disclosures are those that relate to material
items, transactions or events or provide insight into how an entity has exercised
judgement in selecting and applying accounting policies.
Page 107 of 109

The above principles could be used when SBR candidates answer several types of investor related
questions but would only gain marks if applied to the scenario.
The Application of SBR Knowledge to Question Scenarios

 It is important to explore this latter point further. The SBR exam requires candidates to answer
questions using the application of knowledge to a question scenario. However, in SBR,
candidates often fail to gain valuable marks through not using the scenario in their answer.
 The verb used in the question requirement and the number of marks allocated to it gives the
candidate an idea about the nature and degree of detail required. A purely discursive answer will
lose marks if computations are required and no marks will be awarded to calculations that have
not been asked for. Simply repeating facts from the scenario or an accounting standard without
any further explanation or application of that knowledge is insufficient. This is because markers
are looking for evidence of analysis and professional judgment.
 There is some evidence that some candidates practice poor time management. Often, these
candidates do not attempt all of the questions with the result that relatively easy marks,
particularly in the final parts of question 4 are lost. Some candidates spend a disproportionate
amount of time addressing the issues in question 1 with the result that there is little time left to
answer question 4. There needs to be a balance between the time spent on all of questions and an
understanding that spending too much time on any one question will affect performance.
 If candidates forget the principles in a particular accounting standard, a good strategy is to refer to
the Conceptual Framework. If candidates feel that they cannot answer part of a question, then the
principles in the Conceptual Framework, applied correctly, will always gain some marks. This is
the case even if the Conceptual Framework is not mentioned in the suggested solution.
Candidates are advised to structure and present their answer in a way that assists the marking
process and so it is not advisable to merge many parts of an answer into one.
 SBR consciously includes challenging and contemporary question scenarios. Candidates will be
awarded marks for discussion of issues which do not appear in the suggested solution but are
relevant to the scenario. Additionally, extra marks may be gained if a candidate discusses a point
particularly well.
Note
A good example of this approach can be seen in question 3 March 2020, which you can find here.
The question required candidates to discuss how to account for contingent performance conditions where
individual football players are paid bonuses which represent additional contract costs. Candidates needed
to be able to discuss when the bonuses would be recognised. There is no existing IFRS standard to refer
to in this question, therefore candidates were required to use accounting principles. There is diversity in
practice where accounting for contingent performance conditions is concerned.
So, how should SBR candidates have answered this question?

 There are several ways in which this question could have been answered and candidates could
either refer to the Conceptual Framework or other existing accounting standards.
 For example, candidates could use the definition of a liability in the Conceptual Framework to
help: 'a liability is a present obligation of the entity to transfer an economic resource as a result of
past event'. So, the entity should have an obligation. When a player‟s contract is signed,
management should make an assessment of the likely outcome of performance conditions in
order to determine if there is an obligation.
 Secondly, there needs to be an obligation to transfer an economic resource. The economic
resource being transferred will be a cash amount.
 Thirdly, the obligation needs to be a present obligation that exists as a result of past event. Hence,
any contingent amounts will only be recognised from the date management believes that the
Page 108 of 109

performance conditions will be met. Before this date, an obligation will not exist and the past
event can be argued as the signing of the contract.
 Alternatively, the definition of a provision in IAS 37 could be used to answer the question. A
provision is a present obligation that has arisen as a result of a past event, payment is probable,
and the amount can be estimated reliably.
 Leicester City Football Club states in its financial statements that „Contractual obligations are
recognised when they become payable with prepayments/accruals recognised at each period end.
However, Manchester United Football Club states the following re bonus payments to players –
'Any performance bonuses are recognised when the Company considers that it is probable that the
condition related to the payment will be achieved.' The suggested solution to Q3 March 2020 is
written in accordance with this accounting policy.
 However, there is an argument that there is a possible financial liability which should be
recognised at the acquisition of the player. The examining team does not necessarily agree with
this view as players can leave the football club or become injured and not trigger the payments.
However, if candidates argued this point coherently, then marks would have been awarded
accordingly.
 It is worth remembering that the examining team gives credit for answers that are not included in
the suggested solution at every exam. This is because corporate reporting is not an exact science!
It requires judgement and is subjective… it is your judgement and opinions that employers want
to see and so these are the skills that the SBR examining team is attempting to develop.
Therefore, SBR candidates should be prepared to apply their corporate reporting knowledge to
many different business contexts and contemporary SBR questions.
Page 109 of 109

Fundamental Ethical and Professional Principles (A) : Acca Strategic Business Reporting (SBR)

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ACCA STRATEGIC BUSINESS REPORTING (SBR)

SUMMARY OF TECHNICAL ARTICLES

Fundamental ethical and professional principles (A)

The digital age has increased ethical threats such as follows:

Big Data and Artificial Intelligence (AI)

How ethical issues may arise for the accountant:

Ways of addressing an ethical issue:

Recycling (The Reclassification from Equity to P&L)

On reclassification from equity to SOPL $m $m

Different Approaches to Reclassification

No OCI and No Reclassification

Advantages of No OCI and No Reclassification

Narrow Approach to the OCI

Broad Approach to The OCI

Profit, Loss and Other Comprehensive Income

Reclassification: For and Against

Therefore, the Board is suggesting two broad principles, namely:

The Conceptual Framework

The Primary Purpose of Financial Information

Chapter 1 – The Objective of General-Purpose Financial Reporting

Users base their expectations of returns on their assessment of:

Chapter 2 – Qualitative Characteristics of Useful Financial Information

Fundamental qualitative characteristics of useful financial information

Enhancing qualitative characteristics of useful financial information

Substance over form

Measurement Reliability Versus Measurement Uncertainties

Chapter 3 – Financial Statements And The Reporting Entity

The Basic Assumption

Chapter 4 – The Elements of Financial Statements

Chapter 5 – Recognition and Derecognition

New Approach to Derecognition

Measurements of Current Value

Chapter 7 – Presentation And Disclosure

Arguments for IFRS for SMEs

Arguments for IFRS for SMEs

Deferred Tax – IAS 12

The Statement of Profit or Loss

Revaluations of non-current assets (NCA)

The overall double entry is:

The SBR Exam

Carrying amount of asset / Tax base of asset /

Group Financial Statements

Fair value adjustments

Provisions for unrealised profits (PUPs)

Measurement Of Deferred Tax

Deferred Tax and The Framework

IFRS 2 Share-based Payment

Recognition of Share-based Payment

Equity Settled Transactions

Cash Settled Transactions

Deferred Tax Implications

IFRS 9 Financial Instruments

Classification Of Financial Assets

(3) Financial assets measured at amortised cost

Illustration 1 – Classification and Measurement of Financial Assets

ii. If classified to be measured at amortised cost

Year Expected cash flows 5% discount factor Present value $m

Impairment Of Financial Assets

Classification Of Financial Liabilities