International Accounting Standard

International Accounting Standards

Candidates will be required to have a basic knowledge of the following standards and how these
standards relate to topics in the syllabus.

IAS Topic

IAS 1 Presentation of financial statements

IAS 2 Inventories

IAS 7 Statement of cash flows

Accounting policies, changes in accounting estimates and

IAS 8
errors

IAS 10 Events after the reporting period

IAS 16 Property, plant and equipment

IAS 36 Impairment of assets

IAS 37 Provisions, contingent liabilities and contingent assets

IAS 38 Intangible assets

Users of financial statements

Financial statements are used by a variety of groups for a variety of reasons. The framework
surrounding IAS identifies the typical user groups of accounting statements. The table below identifies
the user groups (stakeholders) and gives likely reasons for the user groups to refer to financial
statements.

Main users Reasons for use

• to assess efficiency of the stewardship of management

Owners • to assess performance in relation to payment of
dividend

• to assess efficiency of their strategies by comparing

Managers
with previous years or with similar businesses

• to assess past performance as a basis for future

Investors
investment

• to assess performance as a basis of future wage and

Employees
salary negotiations

1
Main users Reasons for use

• to assess performance as a basis for continuity of

employment and job security

• to assess performance in relation to the security of their

loan to the business
Lenders
• to assess the performance in relation to payment of the
interest (finance cost) on the loan provided

• to assess performance in relation to receiving payment

Suppliers
of their liability

• to assess performance in relation to the likelihood of

Customers
continuity of trading

• to assess performance in relation to compliance with

Government
regulations and assessment of taxation liabilities

Public and environmental

• to assess performance in relation to ethical trading
bodies

2
IAS 1: Presentation of financial statements

The purpose of financial statements

Financial statements provide information, about the financial position, financial performance and cash
flows of an entity that is useful to a wide range of users in making economic decisions. To meet that
objective, financial statements provide information about an entity:
• assets
• liabilities
• equity
• income and expenses, including gains and losses
• contributions by and distributions to owners (in their capacity as owners)
• cash flows.
The financial statements must ‘present fairly’ the financial position, financial performance and cash
flows of an entity.
The components of the financial statements
A complete set of financial statements as set out in the standard, comprises:
• a statement of financial position at the end of the period
• a statement of profit or loss and other comprehensive income for the period
• a statement of changes in equity for the period
• a statement of cash flows for the period (see IAS 7)
• accounting policies and explanatory notes (see IAS 8)
• comparative information.
Accounting concepts
The standard requires compliance with a series of accounting concepts:

• Going concern – the presumption is that the entity will not cease trading in the foreseeable
future. (This is generally taken to mean within the next 12 months).
• Accrual basis of accounting – with the exception of the statement of cash flows, the
information is prepared under the accruals concept; income and expenditure are matched to
the same accounting period.
• Consistency of presentation – the presentation and classification of items in the financial
statements should be retained from one period to the next unless a change is justified by a
change in circumstances or the requirement of a new IFRS.
• Materiality and aggregation – information is material if omitting, misstating or obscuring it
could reasonably be expected to influence decisions by the primary users of the financial
statements. Each material class of similar items should be presented separately in the
financial statements. This would apply to a grouping such as current assets.
• Offsetting – assets and liabilities, and income and expenditure may not be offset unless
required or permitted by an IFRS. For example, it is not permitted to offset a bank overdraft
with another bank account not in overdraft.
• Comparative information – there is a requirement to show the figures from the previous
period for all the amounts shown in the financial statements. This is designed to help users
make relevant comparisons.

3
Example statement of profit or loss

XYZ Limited
Statement of profit or loss for the year ended 31 December 2020

31 December 2020 31 December 2019

$000 $000

Revenue 101 000 80 000

Cost of Sales (60 000) (45 000)

Gross Profit 41 000 35 000

Distribution Costs (8 000) (7 000)

Administrative Expenses (11 000) (10 000)

Profit from Operations 22 000 18 000

Finance Costs (3 000) (2 000)

Profit before Tax 19 000 16 000

(4 500) (4 000)
Tax

14 500 12 000
Profit for the Year

4
Example statement of financial position

XYZ Limited
Statement of financial position as at 31 December 2020

2020 2019
$000 $000
ASSETS
Non-current assets
Intangible assets Goodwill 7 700 8 000
Property, plant & equipment 100 000 92 100
107 700 100 100
Current assets
Inventories 1 000 800
Trade and other receivables 5 000 4 000
Cash and cash equivalents 500 300
6 500 5 100

Total assets 114 200 105 200

EQUITY & LIABILITIES

Equity
Issued capital 40 000 40 000
Share premium 2 000 2 000
General reserve 10 000 10 000
Retained earnings 52 500 43 000
Total equity 104 500 95 000
Non-current liabilities
Bank loan 5 000 5 200

Current liabilities
Trade and other payables 1 200 1 000
Tax liabilities 3 500 4 000
4 700 5 000
Total liabilities 9 700 10 200
Total equity and liabilities 114 200 105 200

5
IAS 2: Inventories

The term inventory refers to the stock of goods which a business holds in a variety of forms:

• raw materials for use in a subsequent manufacturing process

• work in progress, partly manufactured goods
• finished goods, completed goods ready for sale to customers
• finished goods that the business has bought for resale to customers.
The principle of inventory valuation set out in IAS 2 is that inventories should be valued at the lower of
cost and net realisable value

Cost should include all costs of purchase (including transport and handling), costs of conversion
(including manufacturing overheads) and other costs incurred in bringing the inventory to its present
location and condition.
Net realisable value is the estimated selling price in the normal course of business, less the
estimated cost of completion and the estimated costs necessary to make the sale.

Inventory valuation methods

IAS 2 allows two different methods to be used for valuing inventory:
• First in, first out (FIFO). This assumes that the first items to be bought will be the first to be
used, although this may not match the physical distribution of the goods. The valuation of the
remaining inventory will therefore always be the value of the most recently purchased items.
• Average cost (AVCO). Under this method a new average value (usually the weighted
average using the number of items bought) is calculated each time a new delivery of inventory
is received.
IAS 2 does not allow for inventory to be valued using the last in, first out (LIFO) method. Inventories
which are similar in nature and use to the business will use the same valuation method. Only where
inventories are different in nature or use, a different valuation method be used. Once a suitable
method of valuation has been adopted by a business then it should continue to use that method
unless there are good reasons why a change should be made. This is in line with the consistency
concept.

6
Closing inventories for a manufacturing business
A manufacturer may hold three categories of inventory:
• raw materials
• work in progress
• finished goods.
Valuing raw materials
Raw (direct) materials will be valued at the lower of cost (applying either FIFO or AVCO) and their
realisable value.
Valuing work in progress and finished goods
IAS 2 requires that the valuation of these two items includes not only their raw or direct material
content, but also includes an element for direct labour, direct expenses and production overheads.
The valuation of work in progress and finished goods therefore consists of:
• direct materials which includes the purchase price, including import duties, transport and
handling costs, less trade discounts and rebates
• direct labour
• direct expenses (for example royalties or licence fees)
• production overheads (costs to bring the product to its present location and condition)
• other overheads which may be applicable to bring the product to its present location and
condition.
The inventory value of work in progress and finished goods excludes:

• abnormal waste in the production process

• storage costs
• selling costs
• administrative overheads not related to production.

7
IAS 7: Statement of cash flows

• operating activities – the main revenue-generating activities of the business, together with
cash outflows relating to interest and tax
• investing activities – the acquisition and disposal of long-term assets and other investments
that are not considered to be cash equivalents, together with interest and dividends received
• financing activities – receipts from the issue of new shares, changes in long-term borrowings
and payment of dividends.

• Cash is defined as cash on hand and demand deposits.

• Cash equivalents are defined as short-term, highly liquid investments that can easily be
converted into cash. This is usually taken to mean money held in a term deposit account that
can be withdrawn within three months from the date of deposit.
• Bank overdrafts – usually repayable on demand – are included as part of cash and cash
equivalents.

8
IAS 8: Accounting policies, changes in accounting
estimates and errors

Accounting policies
These are defined as: ‘the specific principles, bases, conventions, rules and practices applied by an
entity in preparing and presenting financial statements.

An entity must apply accounting policies consistently for similar transactions. Changes in accounting
policies can only occur:

• if the change is required by an accounting standard or interpretation, or

• if the change results in the financial statements providing more reliable and relevant
information that faithfully represents the effect of transactions on the financial statements.

Any changes adopted must be applied retrospectively to financial statements. ( (this

means all the account balances from previous years should be adjusted.

Changes in accounting estimates

The use of reasonable estimates is an essential part of the preparation of financial statements. For
example, estimates may be required for allowance for irrecoverable debts, obsolete inventory, the
useful lives of depreciable assets, and warranty obligations.
A change in Accounting estimate must be accounted for Prospectively ( i.e. the previous
accounts are not required to be changed)

Dealing with errors

If errors from previous periods are discovered later then they should be accounted for
Retrospectively ( (this means all the account balances from previous years should be
adjusted.

9
IAS 10: Events after the reporting period

Adjusting events
An adjusting event is defined as an event after the reporting period that provides further evidence of
conditions that existed at the end of the reporting period.
Examples of adjusting events include:

• the settlement after the end of the reporting period of a court case that confirms that a present
obligation existed at the year end
• the determination, after the reporting period of the purchase price or sale price of a non-
current asset bought or sold before the year end

• inventories where the net realisable value falls below the cost price

• assets where a valuation shows that impairment has occurred

• trade receivables where a customer has become insolvent

• the discovery of fraud or errors which show the financial statements to be incorrect.
Non-adjusting events
A non-adjusting event is defined as an event after the reporting period that is indicative of a condition
that arose after the end of the reporting period.
Examples of non-adjusting events include:

• major purchase of assets

• losses of production capacity caused by fire, floods or strike action by employees

• changes in tax rates

• entering into significant commitments or contingent liabilities

• commencing litigation based on events arising after the reporting period

Dividends declared or proposed after the reporting period are non-adjusting events and are shown in
a note to the financial statements.

10
IAS 16: Property, plant and equipment

• Property, plant and equipment – tangible assets held for use in the production or supply of
goods and services, for rental to others and for administrative purposes, which are expected to
be used for more than one accounting period. Such assets are classified as non-current
assets on the statement of financial position.
• Depreciation – the systematic allocation of the depreciable amount (cost less residual value)
of a tangible non-current asset over its useful life.
• Useful life – the period over which a tangible non-current asset is expected to be available for
use, or the number of production units expected to be obtained from the tangible non-current
asset.
• Residual value – the estimated amount the entity expects to obtain for a tangible non-current
asset at the end of its useful life, after deducting the estimated costs of disposal.
• Fair value – the amount for which an asset could be exchanged between knowledgeable,
willing parties in an arm’s length transaction. The fair value of a tangible non-current asset is
normally its open market value.
• Carrying amount – the amount at which a tangible non-current asset is recognised in the
statement of financial position, after deducting any accumulated depreciation or accumulated
impairment losses.

Cost of Non-Current Asset include

• the initial purchase price after deducting discounts or rebates

• any import duties, taxes directly attributable to bring the asset to its present location and
condition
• the costs of site preparation
• initial delivery and handling costs
• installation and assembly costs
• cost of testing the asset
• professional fees (e.g. architects or legal fees).

Valuation of the tangible non-current asset

An entity must adopt one of two models as its accounting policy for its valuation of each class of
tangible non-current assets:
• Cost model – the asset is carried at cost less accumulated depreciation and any accumulated
impairment losses.
Revaluation model – the asset is included (carried) at a revalued amount. This is taken as its fair
value less any subsequent depreciation and impairment losses. Revaluations are to be made
regularly.
11
If a tangible non-current asset is revalued, then every asset in that class must be revalued.
Thus, if one parcel of land and buildings is revalued then all land and buildings must be
revalued.

Depreciation
Depreciation should be allocated on a systematic basis over the tangible non-current asset’s useful
life. The depreciation method should reflect the pattern in which asset’s future economic benefits are
expected to be consumed by the entity.

Allowable methods of depreciation are:

• straight line
• diminishing or reducing balance
• revaluation model.
A depreciation method that is based on revenue that is generated by an activity that
includes the use of an asset is not appropriate. The entity must choose a method of
depreciation which reflects the pattern of its usage over its useful economic life.

12
IAS 36: Impairment of assets

• Impairment loss – the amount by which the carrying amount of an asset or cash generating
unit exceeds its recoverable amount.
• Recoverable amount – the higher of the asset’s fair value less costs of disposal (net selling
price) and its value in use.
• Fair value – the price that would be received to sell an asset, or paid to settle a liability
between knowledgeable, willing parties in an arm’s length transaction.
• Value in use – the present value of the estimated future cash flows expected to be derived
from an asset or cash generating unit.

Identifying an asset that may be impaired

Indications of impairment
External sources:
• market value declines
• negative changes in technology, markets, economy or laws
• increases in interest rates
• net assets of the company higher than market capitalisation.
Internal sources:

• obsolescence or physical damage

• asset is idle or is being held for disposal
• worse economic performance than expected.

13
IAS 37: Provisions, contingent liabilities and contingent
assets

• Provision – a liability of uncertain timing or amount.

• Liability – a present obligation arising from past events, where settlement is expected to result
in an outflow of resources (payment).

• Contingent liability – either a possible obligation that arises from past events but which
depends on some uncertain future event occurring not wholly within the control of the entity,

or a present obligation where payment is not probable or the amount cannot be reliably
measured.

• Contingent asset – a possible asset that arises from past events and whose existence will be
confirmed only by the occurrence of one or more uncertain future events not wholly within the
control of the entity.

Recognition of a provision
A provision must be recognised if, and only if:

• a present obligation exists as a result of a past event (the obligating event)

• payment is probable (more than 50% likelihood of occurrence)
• the amount can be estimated reliably.

14
IAS 38: Intangible assets

An intangible asset is defined as an identifiable non-monetary asset without physical substance.

The three critical attributes of an intangible asset are:
• it must be identifiable (the asset is either separate from the entity and can be sold or
transferred or arises due to contractual or other legal rights)
• it must be controlled by the entity ( power to obtain benefits from the asset)
• the entity must be able to obtain future economic benefits from the asset such as revenue or
reduced costs.
Intangible assets can be acquired:

• by separate purchase
• as part of a business combination
• by the exchange of assets
• by internal generation (self-produced).

Examples of intangible assets

The following is not an exhaustive list, but gives some examples of intangible assets:
• patented technology, computer software, databases and trade secrets
• trademarks and internet domains
• customer lists
• licensing and royalty agreements
• marketing rights
• franchise agreements.

Specific cases
The standard details initial recognition criteria and accounting treatment for specific cases as follows.
Research and development costs
• Research costs – charge all costs to the statement of profit or loss.

• Development costs may be capitalised as an intangible asset only after the technical and
commercial feasibility of the asset for sale or use have been established. The entity must
demonstrate how the asset will generate future economic benefits.
Internally generated brands, customer lists, etc.
These should not be recognised as assets.
Computer software
If purchased, this may be capitalised. If internally generated, whether for sale or for use, it should be
charged as an expense until technical and commercial feasibility has been established.
Other types of cost
The following items must be charged to expenses in the when incurred, not classed as intangible
assets:
15
• internally generated goodwill
• start-up costs
• training costs
• advertising and promotional costs
• relocation costs.

16