ACCA P2 (INT) Corporate Reporting - Study text

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Paper P2 (INT)

Corporate Reporting

CHAPTER

Reporting financial

performance

Contents

1 Reporting financial performance and IAS1

2 IFRS 5: Non-current assets held for sale and

discontinued operations

3 IAS 24: Related party disclosures

4 IAS 18: Revenue

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Reporting financial performance

 What is financial performance? Comprehensive income

 Reporting requirements for financial performance: IAS1

 Features of a statement of comprehensive income

 Statement of changes in equity (SOCIE)

1 Reporting financial performance and IAS1

1.1 What is financial performance? Comprehensive income

One of the purposes of financial statements is to provide users with relevant and

reliable information about an entity’s financial performance. It is probably tempting

to think of financial performance for a business entity in terms of the profit or loss it

makes from its operations. However, there are other aspects to financial

performance other than operating profit or loss, and entities are now required by

IAS 1 Presentation of financial statements (revised 2007) to report financial

performance in terms of comprehensive income.

Definition of comprehensive income

The difference between total equity at the beginning and end of a financial period

can be explained by two factors:

 ‘owner changes in equity’

 ‘non-owner changes in equity’.

Owner changes in equity are caused by transactions with the equity shareholders

of an entity ‘in their capacity as owners’. These transactions have nothing to do with

the financial performance of the entity, but they create increases or reductions in

total equity. The main examples of these transactions are:

 issues of new equity

 payments of dividends

 purchase of its own shares by the company (and subsequent cancellation of the

shares).

Other changes in equity are caused by transactions or developments that are not

‘owner changes’. Non-owner changes in equity are comprehensive income.

Total comprehensive income consists of:

(1) Profits or losses from normal, recurring income and expenses

(2) Gains and losses that are included in profit and loss and are not expected to

occur regularly (for example, profits and losses on the sale of non-current assets;

costs of a major restructuring)

Chapter 16: Reporting financial performance

(3) Gains and losses that are not included in profit or loss (for example, gains on the

revaluation of assets).

Items (1) and (2) have been reported in the past in the income statement. Total

comprehensive income can be classified as either:

 recognised profits or losses, or

 other components of comprehensive income.

Other components of comprehensive income are items that result in an increase or

reduction in equity, other than owner changes in equity, which are not reported in

profit or loss for the period. These include:

 changes in the revaluation surplus for non-current assets

 actuarial gains or losses on defined benefit pension schemes

 gains or losses on translation of the financial statements of a foreign subsidiary

 gains or losses on revaluation of available-for-sale financial instruments.

IAS1 (revised) uses the following definitions:

 profit or loss, to mean items that are recognised as realised profits or losses in a

period (traditionally reported in the income statement)

 other comprehensive income, to mean the items described above

 total comprehensive income, to mean profit or loss plus other comprehensive

income in the period.

1.2 Reporting requirements for financial performance: IAS1

IAS 1 Presentation of financial statements (revised) requires financial performance to

be reported in either one or two statements:

 a single statement of comprehensive income, or

 two statements, a separate income statement reporting the components of profit

or loss for the period, followed by a statement of comprehensive income which

begins with profit after tax for the period and then reports the other components

of comprehensive income.

When two separate statements are presented, the effect is simply to divide the single

statement of comprehensive income into two separate parts, one following on from

the other.

For convenience, this text refers to ‘income statement’ when it also means the first

part of a single statement of comprehensive income that reports the recognised

profit or loss after tax for the period.

1.3 Features of a statement of comprehensive income

Most of the features of the ‘income statement’ or ‘profit or loss’ section of a

statement of comprehensive income are described in other chapters of this text, and

dealt with by other accounting standards.

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Material items

IAS1 specifies, however, that in order to enable users to obtain a better

understanding of financial performance, material items of profit or loss should be

disclosed, either as separate line items within profit or loss, or in a note to the

financial statements, showing both their nature and the amount. Items that might

give rise to a separate disclosure of material items include:

 a write-down of inventories to net realisable value

 a write-down of property, plant and equipment to its recoverable amount

 a reversal of such write-downs

 the cost of restructuring

 disposals of items of property, plant and equipment

 disposals of investments

 discontinued operations

 the income or expense of settlement of litigation

 a reduction in (reversal of) a provision.

As well as being material, most of these items are relatively unusual and may not

occur every year. Users need to be made aware that these items are included in

profit and loss because they may distort the overall result for the period. For

example, if an entity has sold several properties at a profit, its profit for the current

period may be exceptionally high, but will fall to a more normal level in the

following period.

Material items are normally disclosed in the notes, but they may be disclosed as a

separate line item on the face of the income statement/statement of comprehensive

income if they are sufficiently material or unusual to justify this treatment.

Components of other comprehensive income

Component items of ‘other comprehensive income’ should be shown individually in

the statement of comprehensive income, and the income tax relating to each item

must also be disclosed, either in the statement itself or in a note to the financial

statements.

IAS1 requires both profit (or loss) for the period and also total comprehensive

income for the period to be analysed between the amounts attributable to:

 owners of the parent entity and

 non-controlling interests.

Reclassification adjustments

A consequence of reporting other comprehensive income, which is not recognised

and reported profit or loss, is that an item that is reported as other comprehensive

income in one year might be reported as a recognised profit or loss (in the income

statement) in a subsequent year.

Chapter 16: Reporting financial performance

For example, an entity might revalue an available-for-sale financial investment, and

report the gain as other comprehensive income in Year 1. In Year 2, it might then

sell the investment and report a realised gain on the sale. As a consequence, the gain

is reported twice, as other comprehensive income in Year 1 and as a realised profit

in Year 2. To avoid this double-counting, the statement of comprehensive income

should also report ‘reclassification adjustments’ as other comprehensive income.

For example suppose that an entity holds an available for sale financial investment

which it revalues from $1 million to $1.4 million in Year 1. The unrealised gain of

$400,000 should be reported as other comprehensive income (net of tax) in Year 1. If

the investment is then sold in Year 2 for $1.6 million, there is a reported gain of

$600,000 within profit or loss, and other comprehensive income in Year 2 should be

reduced by $400,000 (less tax) to reverse the unrealised gain reported in Year 1.

Reclassification adjustments are needed for most items of other comprehensive

income, when a gain or loss is subsequently recognised in profit or loss. Exceptions

are:

 changes in the revaluation surplus on a non-current asset, and

 actuarial gains or losses on defined benefit pension schemes.

These are exceptions because the realised gain or loss on these items is not reported

through profit or loss.

1.4 Statement of changes in equity (SOCIE)

The purpose of a statement o f changes in equity is to show how each component of

equity has changed between the beginning and the end of the reporting period.

IAS1 (revised) requires all ‘owner changes in equity’ (transactions with equity

owners in their capacity as owners) to be reported in the statement of changes in

equity, and to be distinguished from changes in equity due to profit or loss and

other comprehensive income.

For each component of equity, a SOCIE shows the amount at the beginning of the

period for that component of equity, changes during the period, and its amount at

the end of the period. Components of equity include:

 share capital

 share premium

 retained earnings

 revaluation reserve

 non-controlling interests.

In a SOCIE for a group of companies, the amounts attributable to owners of the

parent entity and the amounts attributable to the non-controlling interest (NCI)

should be shown separately.

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For each component of equity, the SOCIE should show changes resulting from:

 profit or loss for the period

 each item of other comprehensive income (e.g. a property revaluation)

 ‘transactions with owners in their capacity as owners’.

Retrospective adjustments

IAS8 requires that when an entity introduces a change of accounting policy or re-

states amounts in the financial statements to correct prior period errors, the

adjustments should be made retrospectively (to the extent that this is practicable).

Retrospective adjustments result in changes in the reported amount of an equity

component, usually retained earnings. Retrospective adjustments and re-statements

are not changes in equity, but they are adjustments to the opening balance of

retained earnings (or other component of equity).

Where retrospective adjustments are made, the SOCIE must show for each

component of equity (usually retained earnings) the effect of the retrospective

adjustment. This is shown first, as an adjustment to the opening balance, before the

changes in equity are reported.

Example: statement of changes in equity

A simplified example of a statement of changes in equity for a single entity is shown

below.

PQR Entity

Statement of changes in equity for the year ended 31 December 20X9

capital

premium

Revaluation

reserve

Retained

earnings

Total

$000

Balance at 31

December 20X8

200

510

860

Change in

accounting policy

(60)

–

–––

–

–––

–

–––

–

–––

–

–––

Re-stated balance 200

450

800

–

–––

–

––

–

–––

–

–––

–

–––

Changes in equity

for 20X9

Issue of share capital 80

100

180

Dividend payments

(90)

Profit for the year

155

Other comprehensive

income for the year

–

–––

–

–––

–

–––

–

–––

–

––

–

Balance at 31

December 20X9

280

170

515

1,057

–

–––

–

–––

–

–––

–

–––

–

–––––

Chapter 16: Reporting financial performance

IFRS 5: non-current assets held for sale and discontinued operations

 The need for an accounting standard on discontinued operations

 Definition of discontinued operations

 The measurement of non-current assets and disposal groups held for sale

 Allocation of an impairment loss on a disposal group

 Presentation and disclosure

2 IFRS 5: Non-current assets held for sale and

discontinued operations

2.1 The need for an accounting standard on discontinued operations

IFRS 5 Non-current assets held for sale and discontinued operations sets out

requirements for disclosure of financial information relating to discontinued

operations and non-current assets that will soon be sold off.

The reason for requiring disclosure of information about discontinued operations is

as follows:

 Closing down some operations will affect the future financial prospects of the

entity.

 It is therefore appropriate that users of the financial statements should be

provided with relevant information about the discontinuation. This will help

them to predict the future performance of the entity.

This information can be produced by providing information about discontinued

operations separately from information about continuing operations.

2.2 Definition of discontinued operations

IFRS 5 defines a discontinued operation as a component of an entity that either:

 has been disposed of in the period, or

 is classified as ‘held for sale’ (but has not yet been disposed of).

A ‘component’ of an entity is defined as operations and cash flows that can be

clearly distinguished, operationally and for financial reporting purposes, from the

rest of the entity. The component of the entity must:

 represent a separate major line of business or a significant geographical area of

operations, or

 be a part of a single and co-ordinated plan to dispose of a separate major line of

business or a significant geographical area of operations, or

 be a subsidiary company acquired exclusively with a view to re-sale.

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If an entity disposes of an individual non-current asset, or plans to dispose of an

individual asset in the immediate future, this is not classified as a discontinued

operation unless the asset meets the definition of a ‘component of an entity’. The

asset disposal should simply be accounted for in the ‘normal’ way, with the gain or

loss on disposal included in the operating profit for the year.

Non-current assets held for sale

Non-current assets ‘held for sale’ can be either:

 specific non-current assets, or

 a ‘disposal group’. A disposal group is a group of cash-generating assets (and

perhaps some liabilities) that will be disposed of in a single transaction.

A non-current asset (or a disposal group) should be classified as held for sale if its

carrying amount will be recovered mainly through a sale transaction rather than

through continuing use. For this to be the case:

 the non-current asset or disposal group should be available for immediate sale,

in its present condition under terms that are usual and customary; and

 its sale should be highly probable.

For the sale to be highly probable:

 management must be committed to the sale

 an active programme to locate a buyer must have been initiated

 the asset or disposal group must be actively marketed for sale at a price that is

reasonable in relation to its current fair value

 the sale should be expected to take place within one year from the date of

classification as ‘held for sale’

 significant changes to the plan or the withdrawal of the plan should be unlikely.

An operation cannot be classified as discontinued in the statement of financial

position if the criteria for classifying it as discontinued are not met until after the

end of the reporting period. For example, suppose that an entity with a financial

year ending 30 June shuts down a major line of business in July and puts another

major line of business up for sale. It cannot classify these as discontinued operations

in the financial statements of the year just ended in June, even though the financial

statements for this year have not yet been approved and issued.

An asset that has been abandoned cannot be classified as ‘held for sale’.

Example

Entity R had the following assets at 31 March Year 4.

(1) A property that it offered for sale for $5 million during June Year 3. The market

for this type of property has deteriorated and at 31 March Year 4 a buyer had not yet

been found. Management does not wish to reduce the price because it hopes that the

Chapter 16: Reporting financial performance

market will improve. Shortly after the year end the entity received an offer of $4

million and the property was eventually sold for $3.5 million during May Year 4,

shortly before the financial statements were authorised for issue.

(2) Plant with a carrying value of $2.5 million. At 31 March Year 4 the entity had

ceased to use the plant but was still maintaining it in working condition so that it

could still be used if needed. Entity R sold the plant on 14 May Year 4.

Can either of these assets be classified as ‘held for sale’ in the financial statements

for the year ended 31 March Year 4?

Answer

Property

A non-current asset qualifies as ‘held for sale’ if it is available for immediate sale in

its present condition and actively marketed for sale at a price that is reasonable in

relation to its current fair value. The property had not been sold at the year end

although it had been on the market for some time. It appears that the reason for this

was that management were asking too high a price.

Therefore the property cannot be classified as ‘held for sale’.

Plant

At the year-end management had not made a firm commitment to sell the plant.

Even though the plant was sold just after the year-end, IFRS 5 prohibits the

classification of non-current assets as ‘held for sale’ if the criteria are met after the

end of the reporting period and before the financial statements are signed.

Therefore the plant cannot be classified as ‘held for sale’.

2.3 The measurement of non-current assets and disposal groups held for

sale

Assets held for sale and disposal groups should be valued at the lower of:

 their carrying amount, and

 fair value minus costs to sell.

If the value of the ‘held for sale’ asset is adjusted from carrying amount to fair value

minus costs to sell, any impairment should be recognised in profit or loss for the

period.

A non-current asset must not be depreciated (or amortised) while it is classified as

‘held for sale’ or while it is part of a disposal group that is held for sale.

Paper P2: Corporate Reporting (International)

2.4 Allocation of an impairment loss on a disposal group

IFRS 5 requires that if an impairment loss is recognised for a disposal group, the loss

should be allocated to non-current assets in the disposal group in the following

order:

 First, allocate the impairment loss to any goodwill in the disposal group

 If there is no goodwill in the disposal group, or if the impairment loss is greater

than the goodwill in the impairment group, the remaining unallocated loss

should be allocated to the other non-current assets in the disposal group pro rata

on the basis of their carrying values.

Example

An entity has decided to dispose of a group of its assets in an asset sale, and the

assets together form a disposal group that is held for sale. The assets in the disposal

group are measured as follows:

Carrying amount of assets:

At the end of the

reporting period

prior to classification

as held for sale

As re-measured

immediately before

classification as held

for sale

$ $

Goodwill 20,000 20,000

Property, plant and equipment

(carried at re-valued amounts)

60,000 52,000

Property, plant and equipment

(carried at cost)

80,000 80,000

Inventory 25,000 21,000

Available for sale financial

assets

20,000 17,000

Total

205,000 190,000

The entity should recognise an impairment loss of $15,000 (= $205,000 - $190,000)

immediately before classifying the disposal group as held for sale.

Suppose that the entity estimates that the ‘fair value less costs to sell’ of the disposal

group is $160,000. A disposal group should be measured at the lower of:

 the carrying amount of its assets, and

 fair value less costs to sell.

This means that there is a further impairment loss of $30,000 (= $190,000 - $160,000),

and this is recognised immediately the disposal group is classified as held for sale.

 The first $20,000 of the impairment loss should be used to reduce the goodwill to

$0.

ACCA P2 (INT) Corporate Reporting - Study text - 2010 (Emile Woolf)

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