ACCA P2 (INT) Corporate Reporting - Study text

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Answers

(3) Taxation

Taxation

$000

Cashpaid 2,400 Balanceb/d 2,400

Balancec/d 2,950 Incomestatement 2,950

5,350

18 IMPS

(a) Impairment loss

$m

Carryingvalue

500

Recoverableamount (385)

Impairmentloss

115

Recoverable amount is value in use (Working 1) as this is higher than net

realisable value (Working 2).

Workings

(1) Value in use:

Forecast cash flows discounted at 12%:

Year1(185×0.893)

165.2

Year2(160×0.797) 127.5

Year3(130×0.712)

92.6

Total

385.3

(2) Net realisable value:

Goodwill

Freehold 270

Freeholdlandandbuildings

320

(b) Treatment of impairment loss

IAS 36 requires the impairment loss to be allocated to the various non-current

assets in the following order: firstly, goodwill, secondly, to other assets, either

pro-rata or on another more appropriate basis.

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Before

impairment

Impairment

loss(W1)

After

impairment

$m

Goodwill 70

(70)

‐

Landandbuildings

320

(33)

287

Plantandmachinery

110

(12)

98

500

(115)

385

Because the land and buildings have been re-valued, the impairment is treated

as a revaluation decrease until the carrying amount of the asset reaches its

depreciated historical cost. The revaluation reserve relating to the asset is $65

million and so is adequate to cover the full impairment of $33m. The

impairment must be separately disclosed and the notes to the accounts must

specify by class of asset the impairment recognised directly to equity.

The impairment loss on the goodwill and plant ($66 million) must be

recognised in profit or loss for the year. The notes to the accounts must specify

the line item in which the impairment loss has been included.

Where the impairment write-down is material, information must also be

provided as to the events and circumstances that led to the loss, the nature of

the assets affected, the segment to which the asset belongs, that recoverable

amount was based on value in use and the discount rate used to calculate this.

Workings

Loss on the various non-current assets

After the impairment loss has been recognised on the goodwill there is still

115 - 70 = 45 loss to be allocated to the other non current assets, on a pro-rata

basis.

Loss on land and buildings:

320

320 +110

x 45 = 33

Loss on plant and machinery:

110

320 +110

x 45 = 12

19 Prima

Holiday villas

IAS 16 allows property, plant and equipment to be re-valued or left at historical

cost. Revaluation should be based on the fair value (the open market value in an

arm’s length transaction). Revaluation is not required every year, but must be

conducted when it is believed that the fair value differs materially from the carrying

value.

Answers

The method of accounting for the villa that is to be sold is covered by IFRS 5 which

requires that where, at the end of a reporting period, an asset is held for sale it

should be reclassified, re-measured and no longer depreciated. An asset is only

classified as held for sale where the following conditions are all met:

 The asset is available for sale in its present condition.

 The sale is believed to be highly probable:

−

Appropriate level of management is committed to the sale;

−

There is an active programme underway to find a buyer;

−

The asset is marketed at a realistic price.

 Completion of sale expected within 12 months of classification.

From the limited information provided it appears that these conditions have been

met and therefore, under the rules of IFRS 5, the villa should be re-measured to the

lower of its carrying value and its fair value minus costs to sell.

Therefore, the villas should be valued at 31 December Year 4 as follows:

Fair

value

Carrying

value

Allvillas 25

Propertyheldforsale

(1)

(1.25)

Propertiestoberetained

18.75

The villas to be retained should be re-valued to $24m, resulting in an increase in the

revaluation reserve of $5.25m (24-18.75).

The villa to be sold should be written down from its carrying value to its fair value

minus costs to sell of $0.95m ($1m – 50,000). This impairment of $300,000 (1.25m –

0.95m) will be charged against the revaluation reserve for this asset. If there is

insufficient revaluation reserve, then the write down must be charged to profit or

loss.

The villa held for sale must be re-classified from ‘Non-current assets’ to ‘Current

assets’ as a separate line item.

Depreciation should not be charged when an asset has been classified as held for

sale. However, the other villas should be depreciated. IAS 16 states that expenditure

on repairs and maintenance does not remove the need to depreciate an asset. The

villas have a finite useful life and therefore must be depreciated. If the residual

value of these assets is greater than the carrying value then the depreciation charge

will be zero. It is not acceptable therefore to have a policy of non-depreciation on

such assets, and a prior year adjustment should be made to correct the error if the

error is material.

Head office

The head office should be recorded under property, plant and equipment at cost.

IAS 23 (revised 2007) requires that borrowing costs should be capitalised as part of

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the cost of an asset if they are directly attributable to the acquisition, construction or

production of a ‘qualifying asset’. A qualifying asset is an asset that necessarily

takes a long period of time to get ready for its intended use or sale.

In this situation the company is therefore required to capitalise the borrowing costs

as part of the asset cost. Capitalisation must cease when the asset is substantially

complete. Construction finished on 31 May Year 4 and, although minor

modifications continued for a further three months, the standard states that minor

modifications indicate that the asset is substantially complete.

Costat30JuneYear4:

$000

Land

1,000

Building: Constructioncost 8,000

Interest9%×5million×20/12(1.10×2to1.6×4) 750

8,750

Total

9,750

Prima is to receive a government grant. IAS 20 requires that the grant be recognised

when there is reasonable assurance that the entity will meet any conditions and

receive the grant. As the grant has not been received, a receivable will be recorded

under current assets. The credit can be treated in one of two ways:

 Option 1: Record as deferred income and release to profit or loss over the useful

life of the asset

 Option 2: Deduct the grant from the carrying amount of the asset.

If the second option is taken, the asset will be carried at $8.25m rather than at

$9.75m. The effect on profit or loss will be the same in both cases.

Land should not normally be depreciated, because land has an indefinite useful life

in most situations. However, as buildings have a limited useful life, a residual value

must be allocated to the building and the depreciable amount must then be written

off over the 50 year useful life. Depreciation will be charged in Year 4 for the four

months from 1 September to 31 December.

The estimates of residual value and useful life must be revised each year and the

depreciation amended prospectively.

Yachts

It is important to note that the yachts are held for rental purposes, so they are non-

current assets, not inventory.

The yachts cost $20m to build, but the recoverable amount on completion (higher of

value in use and net selling price) is only $18m, and so the assets must be initially

recognised at their recoverable amount. The impairment write down of $2m will be

charged to profit or loss in 20Year 4 in accordance with IAS 36.

Answers

Cost Recoverableamount

$ $

Engines(15%) 3

2.7

Interior(25%)

4.5

Remainder(60%)

10.8

18

IAS 16 requires that each part of the asset that has a cost that is significant in relation

to the total cost must be depreciated separately. Therefore, in the first year the

depreciation charge will be as follows:

Engines $2.7m×1/3×9/12= $0.675m

Interior

$4.5m×1/2×9/12= $1.688m

Remainder

$10.8m×1/5×9/12= $1.620m

ChargetoprofitorlossinYear4

$3.983m

20 Financial instruments

(a) IAS 39 requires that, initially, all financial instruments be recorded at cost.

Only in rare circumstances (see below) may the investment remain at

historical cost. In most cases the instrument will be recorded at fair value or

amortised cost.

When a financial instrument is acquired or issued it must be classified into

one of four asset categories or one of two liability categories. The classification

will then determine the re-measurement model at the end of each subsequent

reporting period. The position can be set out as follows:

Financialassets Financialliabilities

Fairvaluethroughprofitorloss

Fairvalue Fairvalue

Heldtomaturity Amortisedcost 

Loansandreceivables

Amortisedcost 

Availableforsale

Fairvalue 

Other

Amortisedcost

The three valuation models are:

(i) Historical cost

This model must only be used for investments in equity instruments

where there is no active quoted market price and the fair value cannot

otherwise be reliably determined. Derivatives linked to such

instruments are also permitted to be carried at historical cost.

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(ii) Amortised cost

Amortised cost is calculated as:

Initial cost recognised

Plus: Interest at the effective rate

Minus: Cash received/paid

This model is used to measure the following instruments:

 Assets held to maturity – non-derivative financial assets with fixed

or determinable payments and a fixed maturity. The entity must

have positive intention and financial ability to hold these

investments to maturity. It will not contain investments that have

been designated as fair value through profit or loss, available for sale

or where the investments meet the definition of loans and

receivables.

 Loans and receivables – non-derivative financial assets with fixed or

determinable payments that are not quoted in an active market. It

will not contain investments that are held for trading or otherwise

designated as fair value through profit or loss nor designated as

available for sale.

 Financial liabilities not treated as fair value through profit or loss.

(iii)

Fair value

Fair value is the amount for which an asset can be exchanged or a

liability settled, between knowledgeable and willing parties in an arm’s

length transaction. This model is used as follows:

 Fair value through profit or loss – where the financial asset or

liability is either:

−

held for short term trading, or

−

a derivative not accounted for under hedging rules, or

−

designated as such upon initial recognition.

 Available for sale – those financial assets are not classified or

designated as fair value through profit or loss, nor classified as loans

and receivables or held to maturity.

(b) (i)

3% Bond

The bond must initially be recorded at its purchase price of $250,000. If

classified as ‘held to maturity’, it must be re-measured at the end of the

reporting period to its amortised cost. The market value is not relevant.

Interest will be credited to profit or loss using the effective interest rate,

resulting in finance income of $24,250 (9.7% × 250,000). The effective rate

reflects the total return received by the investor over the duration of the

bond – being the coupon + $50,000 premium on redemption. The

coupon recorded in the statement of cash flows is $9,000 (3% × 300,000).

The difference between the effective interest and the actual coupon is

added to the investment to give an amortised cost at the end of Year 3 of

$265,250 (250,000 + 24,250 – 9,000).

Answers

(ii) Equity shares in XYZ

The shares will initially be recorded at their cost of $30,000. As they have

been classed as ‘fair value through profit or loss’ the transaction costs

must be expensed to profit or loss immediately. At the end of each

reporting period, the shares must be re-measured to their market value,

with the resulting gain or loss being taken to profit or loss.

At 1

January Year 3, the investment has a carrying value of $34,000. By

the 31

December Year 3 this value is now $35,000. A $1,000 gain will

therefore be recognised in profit or loss for the year.

Even though the investment is no longer intended for sale in the short

term, it must remain classified as fair value through profit or loss as IAS

39 does not permit reclassification into or out of this category.

(iii)

Convertible bond

A convertible bond represents a compound instrument. In essence,

issuing a convertible bond is equivalent to issuing a non-convertible

bond plus a call option on the entity’s shares. Therefore, the investment

should be divided into a liability portion and an equity portion.

To establish the liability (debt) element, the future cash flows from the

bond are discounted at the normal market rate to establish the value of

an equivalent but redeemable bond.

Using a rate of 7% this gives a net present value of:

20,000

1.07

20,000

1.07

520,000

1.07

= $460,635

As the bond was issued for $500,000, it implies that the call option

embedded within the bond was sold for $39,365 ($500,000 – 460,635).

Therefore, the proceeds of $500,000 will be shown in the statement of

cash flows as a financing cash flow, and the credit will be split into non-

current liabilities $360,635 and equity $39,365.

21 HAM

(a) Charge to profit or loss: operating lease treatment

Yearsended31

December

Year7 Year8

ItemA

10,000 10,000

ItemB

15,000 15,000

25,000 25,000

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(b) Charge to profit or loss: finance lease treatment

Yearsended31

December

Year7

Year8

Depreciation:

ItemA‐80,000/10 8,000

8,000

ItemB‐117,000/12

9,750

17,750

Financecosts:

ItemA‐Giveninquestion 2,545

2,182

ItemB–Giveninquestion

5,867

5,133

8,412

7,315

(i) Accounting policy note: as required by IAS 1

The capital element of leased asset repayments is treated as a separate

category within non-current assets. Depreciation of leased assets is

consistent with the company’s policy for owned assets as found in note x.

(ii)

Non-current assets

Yearsended31December

Year7

Year8

$

Leasedmachinery



Cost(working(1))

197,000

197,000

Depreciation(working(2))

51,500

69,250

Netbookvalue

145,500

127,750

Answers

(iii) Capital amounts due on finance leases (working (3))

Yearended31

December

Yearended31

December

Year7

Year8

Year8

Minimum

payments

Present

value

Minimum

payments

Present

value

$

Amountsfallingdue:



Withinoneyear 25,000

22,818

25,000

23,182

Inyears2‐5 100,000

78,777

100,000

83,163

After5years 55,000

50,235

30,000

27,800

180,000

155,000



Futurefinancecharges

(28,170)

(20,855)



Presentvalueof

futurepayments

151,830

134,145

134,145

Workings

(1) Cost

Year7

Year8

ItemA 80,000

80,000

ItemB

117,000

197,000

(2) Depreciation

$

ItemA(4×$8,000)

32,000 (5×$8,000) 40,000

ItemB(2×$9,750) 19,500 (3×$9,750) 29,250

51,500

69,250

(3)

Finance lease creditor

ItemA

ItemB

Total

$

EndofYear7 7,818

15,000

22,818

<1year

34,910

43,867

78,777

2‐5years

9,635

40,600

50,235

>5years

52,363

99,467

151,830

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EndofYear8



<1year

8,182

15,000

23,182

2‐5years

36,363

46,800

83,163

>5years

27,800

27,800

44,545

89,600

134,145

(d)

Current proposals

A draft plan was issued in 2003 by the IASB to develop a single method of

accounting whereby all leases would be treated as finance leases and

capitalised.

The argument in favour of a new approach was based on the view that it has

proved impossible to establish a clear definition of a finance lease. Leases can

be very complex agreements and it is often difficult to establish the substance

of the arrangement. This has allowed companies to treat leases as operating

leases if their characteristics are ‘on the margin’ between finance and

operating leases. This keeps the asset and the finance out of the statement of

financial position and tends to have the effect of improving performance

measures such as ROCE.

Another argument in favour of treating all leases as finance leases is that all

leases generate assets and liabilities and therefore should be recognised in the

statement of financial position in order to comply with concepts in the IASB's

‘Framework’.

22 Flow

(a) Sale and operating leaseback

The nature of the leaseback arrangement affects the treatment of the sale

proceeds. As the arrangement is an operating leaseback, it means that Flow

permanently transfers the risks and rewards in the asset when it makes the

sale. Therefore, on the sale, Flow will de-recognise the asset and the leaseback

payments will be charged as rentals to profit or loss.

If the sale is made at fair value, then the profit on disposal is recognised in

profit or loss immediately. However, the transaction here is significantly

above fair value resulting in an abnormally high profit which is then

compensated by higher operating leaseback rentals. In this situation, IAS 17

requires the excess of proceeds over fair value (the ‘abnormal profit’) to be

deferred and amortised over the period during which the asset is expected to

be used. This will serve to offset and normalise the high future rental charges.

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

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