ACCA P2 (INT) Corporate Reporting - Study text

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(ii) Reflecting revised vesting assumptions

31DecemberYear5

Profitorloss

Equity

Expectedoutcome(atgrantdatevalue)

85%×500×100×$15 637,500

×1/3

Year1charge 212,500

Balancecarriedforward

212,500

31DecemberYear6

Expectedoutcome(atgrantdatevalue)

88%×500×100×$15 660,000

×2/3

440,000

Minusexpensepreviouslyrecognised (212,500)

Year2charge

227,500

Balancecarriedforward

440,000

31DecemberYear7

Actualoutcome(atgrantdatevalue)

44,300×$15 664,500

Minusexpensepreviouslyrecognised (440,000)

Year3charge

224,500

Balancecarriedforward

664,500

27 The Lucky Dairy

The cattle

IAS 41 Agriculture defines a biological asset as a living animal or plant. It requires

that these assets should be measured initially and at the end of each reporting

period at their fair value minus estimated point-of-sale costs. The change in fair

value is recognised in profit or loss for the period in which it arises. Where the fair

value can not be reliably measured, IAS 41 requires that the assets should be

measured at cost minus any accumulated depreciation and impairment losses.

Lucky’s inventory of cows and heifers represent biological assets, however, the herd

of cattle at Dale cannot be fair-valued because of the disease problems. The

valuation of Dale’s cattle must be considered separately.

The table in the appendix to this report shows that the change in fair value during

the year is $1.65m. The notes to the accounts must provide a reconciliation

explaining purchases and sales and further changes due to fair value movements.

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IAS 41 encourages an entity to analyse this movement into the gain due to physical

changes from the cattle being older and hence more valuable and the price changes

due to the market value changing with inflation. As illustrated in the appendix,

$300,000 of the fair value is attributable to physical changes and $350,000 is due to

changes in the market values of cattle.

IAS 41 also requires that disclosure be made as to the physical quantities of each

group of biological asset at the end of each period, and so Lucky must disclose the

quantities of cows and heifers at 31

May 20X2.

Dale region

Where a market value is not available, as is the case with the Dale cattle and any

alternative valuation methods are believed to be unreliable, IAS 41 requires that the

biological asset is valued at cost minus accumulated depreciation and impairment

losses.

The cattle in the Dale region comprise 20,000 cows and 10,000 heifers, all purchased

on 1 June 20X1 when the costs were $50 and $40 respectively. Therefore, the cattle

would initially be recorded at cost of $1.4 million.

The fair value minus costs of sale for the cattle is $1 million and their value in use

from the discounted future sales of milk is $1.2 million. The recoverable amount is

the higher of these two figures, i.e. $1.2 million and so the cattle carrying value must

be impaired by $200,000. They will be held in the statement of financial position at

$1.2 million until a fair value becomes reliably measurable or until they are held for

sale.

Although there are plans to sell the Dale region, IFRS 5

Non-current assets held for sale

and discontinued operations

has strict conditions that must be met before the

component to be sold can be identified, re-measured and re-classified as ‘held for

sale’. The conditions must be met at the end of the reporting period and one key

condition is that the appropriate level of management must be committed to the

plan. This is not the case as the board did not approve the sale until one month after

the year end. If this approval is prior to the 20X2 accounts being approved then

disclosures are required in the notes describing the following:

 The assets to be sold

 The facts and circumstances surrounding the sale

 The segment to which these assets are included for segmental reporting

purposes.

Milk

IAS 41 requires that the agricultural produce from the biological assets should be

measured at the point of harvest at its fair value less any estimated point-of-sale

costs. Lucky has 500,000 kilograms of milk in inventory at the year end, which is

significantly higher than its normal holding of 50,000 kilograms.

In light of this excessive holding and the disease contracted by some of the

purchasers of the milk, an assessment must be made as to whether the milk can

Answers

actually be sold and if so, for how much. If the value of the inventory cannot be

fully recovered, it must be written down and disclosure must be made given the

size of the write down.

Government grant

The promise of government compensation for the drop in the price and

consumption of milk can only be recognised as income in profit or loss when the

grant becomes receivable. The official government letter confirming the $1.5 million

grant was received six days after the year end and so IAS 41 does not permit the

income to be recognised in 20X2. It will however be recognised in the 20X3 financial

statements.

Legal claims

IAS 37 Provisions, contingent liabilities and contingent assets requires that a

provision should be made where the entity has a present obligation as a result of a

past event and it is believed probable that an outflow of resources will be required

to settle the obligation. The sale of the milk by Lucky took place before the year end,

and the lawyers believe it is probable that Lucky will be found liable and so a

provision for $2million, being the estimated amount to settle the case, should be

made.

Lucky hopes that some of this cost may be reimbursed by the government.

However, IAS 37 only allows a reimbursement to be recognised where it is virtually

certain that the reimbursement will be received. Lucky’s lawyers believe that the

compensation is only possible and so no asset/ income should be recognised.

Appendix

CattleatShireandHam

$000

Fairvalueat1June20X1

‐50,0002yearoldcowsat$50

2,500

Fairvalueat31May20X2

‐50,0003yearoldcowsat$60 3,000

‐25,00011/2yearoldheifersat$46 1,150

4,150

Gainresultingfromchangeinfairvalue

1,650

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Analysis of gain

50,000cows

25,000

heifers

Change

$000

$000

Purchases1December20X1

‐25,000heifersatfairvalue$40

1,000

Fairvaluegainduetochangeinmarketprice

‐2yearoldcowsat$501June20X1 2,500

at$5531May20X2 2,750

250

‐1yearoldheifersat$401June20X1

1,000

at$4231May20X2

1,050

Fairvaluegainattributabletophysicalchange

at31May20X2

‐2yearoldcowsat$55 2,750

3yearoldcowsat$60 3,000

250

‐1year‐oldheifersat$42

1,050

11/2year‐oldheifersat$46

1,150

100

Totalchangeinfairvalue

$1,650

28 Cohort

Note for presentation to partner

Subject: Deferred Taxation

The calculation and presentation of deferred tax is considered by IAS 12

Income

taxes

. A company is required to provide deferred tax on all material temporary

differences using the full provision method. Temporary differences arise because

there is a difference in timing between transactions being reflected in the financial

statements and the item being taxed.

In light of the recent acquisitions of Legion and Air, deferred tax must be considered

for the group accounts. Additional tax issues arise at the group level that will not

have been reflected in the individual entity’s accounts and these points are outlined

below.

Once the temporary differences have been identified, deferred tax must be provided

at the tax rate expected to be effective at the date when the tax is settled. Given this

Answers

rate is not known when the differences arise, a provision is made using the rates

enacted at that time and the estimate is then confirmed as tax changes arise.

Air

(a) The acquisition of air mid-year gives rise to a number of issues:

(1)

Intangible asset

There is some concern that the acquisition of the database of key

customers may not be allowed for tax purposes but it has nevertheless

been included in the tax calculation on the assumption that a deduction

will be allowed by the tax authorities. If this deduction is not allowed,

then an additional tax payment will need to be made to the authorities,

hence it would be prudent to recognise a liability for this amount

(probably classified as current taxation, rather than deferred taxation).

(2)

Inter-company sales

When goods are sold between group members, the profits made are

seen as unrealised in the group accounts until the items are sold outside

of the group. However, the tax authorities tax the individual entities, not

the group, and so the profit will be subject to tax at the time of the inter-

company sale. The unrealised profit represents the temporary difference

on which deferred tax must be provided. The goods were sold at a

margin of 33

⅓%. Goods sold for $1.8m remain in inventory at the year

end, and hence the unrealised profit, and therefore temporary

difference, is $0.6m.

(3)

Unremitted profits

Un-remitted earnings represent a temporary difference in the group

accounts. This is because the tax base is the cost of the investment, yet in

the consolidated accounts, this cost is uplifted by the post-acquisition

un-remitted profits. IAS 12 requires a provision to be made on this

timing difference unless the parent controls the timing of the reversal

and it is probable that the difference will not reverse for the foreseeable

future. The payment of dividends is under the control of Cohort, but we

understand that the intention is to realise these un-remitted earnings

through future dividends and hence a provision must be made.

(b)

Legion

The acquisition of Legion at the start of the year brings further deferred tax

issues in the group accounts as outlined below.

(1)

Fair value through the profit or loss investments

The fair value adjustment has been reflected in the financial statements,

yet the gain is not taxed until the investments are sold. Hence the fair

value adjustment of $4m gives rise to a temporary difference upon

which deferred tax must be provided. As the gain has been taken to

profit or loss rather than other comprehensive income or reserves, the

deferred tax must also be expensed to profit or loss.

(2)

General allowance

The allowance against the loan portfolio has reduced the carrying value

of the loans but the tax relief is not available until the loan is written off,

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and hence a temporary difference is created on the provision. As the tax

relief will reduce future tax charges, the temporary difference of $2m

gives rise to a deferred tax asset. The temporary difference is accounted

for even though there is no expectation that the difference will reverse in

the immediate future. However, a deferred tax asset can only be

reflected to the extent that it is probable that there will be future taxable

profits against which the temporary difference can be relieved.

(3) Unrelieved tax losses

When Legion was acquired, it had unused tax losses brought forward

which could, in principle, give rise to a deferred tax asset. However, it

can only be recognised to the extent that it is believed that the loss can

be recovered. Given your belief that there will not be sufficient future

profits, the deferred tax can only be partially recognised. If the fortunes

of Legion change in the future, the deferred tax asset should then be

recognised, leading to a compensating amendment to goodwill.

29 Reporting performance

In relation to the first element of the statement given, it is undoubtedly true that

financial reporting is of little value unless it communicates effectively with the

recipients of the report and the communication is of little value unless the recipients

can understand the information.

The primary user group of the corporate report is seen to be the shareholder/

investor group. Most shareholders are not specialists in accounting and will not be

familiar with the conventions adopted or all the terminology used. This point has

been put forward as an argument in favour of simplified financial statements and

will be developed below. Whether or not one is in favour of simplified accounts, a

clear presentation and the absence of unnecessary technical jargon will always be

desirable.

Turning now to the second part of the statement, a number of factors have

contributed to the increasing length and complexity of companies' financial

statements in recent years.

(a)

Implementation of legislative requirements. In a European context, the EU

Regulation regarding the adoption of IFRSs by listed companies in their group

accounts is a clear example of entities sharing common accounting policies.

This makes it easier for the reader to understand the accounts and to compare

the financial statements of different entities

(b)

Changes in the business environment. Increased overseas activities and

fluctuating exchange rates have reinforced the need for disclosure of policies

adopted in respect of foreign currency translation. Inflation has prompted

disclosure of information relating to the effects of price changes. The ‘global’

nature of the activities and financing of large companies has led to the need

for GAAP reconciliations where companies have dual listings.

(c)

Publication of accounting standards. As more standards are published, more

information is required in company accounts. The effect of this is exaggerated

as standard setters tackle more complex areas, such as Financial Instruments

(IAS 32/39) and share based payments.

Answers

Traditionally, company law has required companies to circulate full statutory

accounts to all shareholders who wished to receive them. No account was taken in

the legislation of the shareholders' varying abilities to understand the content of

those accounts. The problem is now more widely acknowledged, though more often

in the context of the information needs of employees rather than the needs of

shareholders and other investors. Some companies already produce employee

reports, providing financial and employment information to employees in a form

they are likely to understand. At the very least, it is essential to ensure that the

statutory accounts are no more complicated than they need to be and clear

presentation and avoidance of accounting jargon can both contribute to easier

understanding.

Some countries allow listed companies to send a summary financial statement (SFS)

to those shareholders who do not want (or are indifferent about) full accounts. This

measure was not however introduced to make the accounts easier to understand but

to reduce the costs of printing and posting the full glossy report to millions of small

shareholders. The mandatory contents of the SFS are few and the main exclusions

are from the notes. The SFS is in fact required to include a warning that it does not

contain enough information to allow a full understanding of the results and state of

affairs of the company.

Commenting on the introduction of the SFS, one of the major accounting and

auditing practices said 'this approach could merely exacerbate the common

misunderstanding that the results and financial position of a highly complex

organisation can be encapsulated in simple measures such as EPS and gearing'.

It seems therefore, that instead of making accounts more understandable, the

introduction of the SFS indicates that the government and many large companies do

not think that most shareholders are really interested in the accounts. The annual

reports of many large companies relegate the accounts to the back or to a relatively

unattractive supplement, leaving the optimistic words of the chairman and the

photographs, pie charts and so on to take pride of place.

A number of arguments can be advanced against the publication of simplified

accounts.

(a) Accounting information is, by nature, complex. Companies operate in a

complicated and rapidly changing business environment. To gloss over the

complexities may present a misleading picture.

(b) Shareholders need to satisfy themselves that the directors have carried out

their stewardship function satisfactorily. Simplified accounts may not provide

sufficient information for them to do so.

view and the work of the IASB is also directed towards ensuring that they do.

The publication of simplified accounts might be regarded as a lowering of

professional standards.

(d) There is a danger that simplified accounts might be used for purposes for

which they are not suitable. For example, shareholders or potential investors

might be tempted to base investment decisions on them. To an extent, the

same difficulty applies with full statutory accounts which also are not

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designed primarily to aid investment decisions, but the problem is aggravated

in the case of simplified accounts.

(e) Shareholders who find difficulty in understanding full accounts may have

recourse to a professional adviser to assist them.

30 Rowsley

Introduction

All four scenarios relate to the rules of IAS 37 Provisions, contingent liabilities and

contingent assets

. In each scenario, the key issue is whether or not a provision

should be recognised.

Under IAS 37, a provision should only be recognised when three conditions are met:

 there is a present obligation as a result of a past event; and

 it is probable that a transfer of economic benefits will be required to settle the

obligation; and

 a reliable estimate can be made of the amount of the obligation.

Factory closure

As the factory closure changes the way in which the business is conducted (it

involves the relocation of business activities from one part of the country to another)

it appears to fall within the IAS 37 definition of a restructuring.

The key issue here is whether the group has an obligation at the end of the reporting

period to incur expenditure in connection with the restructuring. There is clearly no

legal obligation, but there may be a constructive obligation. IAS 37 states that a

constructive obligation only exists if the group has created valid expectations in

other parties such as employees, customers and suppliers that the restructuring will

actually be carried out. As the group is still in the process of drawing up a formal

plan for the restructuring and no announcements have been made to any of the

parties affected, there cannot be an obligation to restructure. A board decision alone

is not sufficient. Therefore no provision should be made.

If the group starts to implement the restructuring or makes announcements to those

affected after the end of the reporting period but before the accounts are approved

by the directors it may be necessary to disclose the details in the financial statements

as a non-adjusting post event after the reporting period in accordance with IAS 10.

This will be the case if the restructuring is of such importance that non-disclosure

would affect the ability of the users of the financial statements to reach a proper

understanding of the group’s financial position.

Operating lease

The lease contract appears to be an ‘onerous contract’ as defined by IAS 37 as the

unavoidable costs of meeting the obligations under it exceed the economic benefits

expected to be received from it.

Answers

Because the enterprise has signed the lease contract there is a clear legal obligation

and the enterprise will have to transfer economic benefits (pay the lease rentals) in

settlement. Therefore, the group should recognise a provision for the net present

value of the remaining lease payments.

In principle, a corresponding asset may be recognised in relation to the future

rentals expected to be received, if these receipts are virtually certain. The current

arrangement with the charity generates only nominal rental income and so the asset

is unlikely to be material enough to warrant recognition. The chances of renting the

premises at a commercial rent are less than 50% and so no further potential rent

receivable may be taken into account as the outcome is not virtually certain and so

recognition would not be prudent.

The financial statements should disclose the carrying amount of the onerous lease

provision at the end of the reporting period, a description of the nature of the

obligation and the expected timing of the lease payments. Disclosure should also be

made of the contingent assets where the amount of any expected rentals receivable

from sub-letting are material and the likelihood is believed probable.

Legal proceedings

It is unlikely that the group has a present obligation to compensate the customer;

therefore no provision should be recognised. However, there is a contingent

liability. Unless the possibility of a transfer of economic benefits is remote, the

financial statements should disclose a brief description of the nature of the

contingent liability, an estimate of its financial effect and an indication of the

uncertainties relating to the amount or timing of any outflow.

Environmental damage

It is clear that there is no legal obligation to rectify the damage. However, through

its published policies, the group has created expectations on the part of those

affected that it will take action to do so. There is, therefore, a constructive obligation

to rectify the damage and a transfer of economic benefits is probable.

The group must recognise a provision for the best estimate of the cost. As the most

likely outcome is that more than one attempt at re-planting will be needed, the full

amount of $30 million should be provided. The expenditure will take place some

time in the future, and so the provision should be discounted at a pre-tax rate that

reflects current market assessments of the time value of money and the risks specific

to the liability.

The financial statements should disclose the carrying amount at the end of the

reporting period, a description of the nature of the obligation and the expected

timing of the expenditure. The financial statements should also give an indication of

the uncertainties about the amount and timing of the expenditure.

PaperP2: Corporate reporting (International)

31 Engina

Report to: The Board of Directors of Engina

From: XXXXXXXX

Date:

Subject: Related party transactions

Related party transactions

This report addresses the disclosure requirements of IAS 24 Related Party Disclosures

with regard to Engina. IAS 24 requires that all entities, listed or otherwise, provide

disclosure of such transactions as they may affect the assessments made by users of an

entity’s operations, risks and opportunities.

It is understood that Engina is reluctant to disclose related party transactions

because they are believed to be both politically and culturally sensitive, however the

following advice must be followed in order to secure a listing/stock exchange

registration.

IAS 24: Scope and purpose

IAS 24 does not provide any exclusion from its scope, and so disclosure must be

made. Related party transactions are a normal feature of business, but an entity’s

ability to succeed in business is often affected by the strength of its relationship with

other entities and individuals. The results of the entity may be affected if these

relationships were to be terminated. For example, the ability of an entity to trade in

a particular country may only be possible because of the presence of its subsidiary

in that local market. Similarly, prices and terms of trade may be preferential because

of the strength of the relationship. Therefore IAS 24 requires knowledge of these

transactions to be provided to the reader of the financial statements.

The results of an entity may be affected even if the related party transactions do not

occur. A parent may cease trading with a business partner upon acquisition of a

subsidiary that can supply similar products.

Disclosure must be given irrespective of whether the transactions took place at an

arm’s length value, as such transactions may still be lost if the relationship is

terminated. Hence the knowledge of such transactions provides valuable

information to investors and regulators.

Disclosure requirements

IAS 24 requires that, at a minimum, the following disclosures must be given:

 The amount of the transaction

 The amount of any outstanding balance and the terms, conditions and

guarantees attached

 Allowance for any irrecoverable debts or amounts written off in the period

 Disclosure that transactions were at an arm’s length value can only be given if

this information can be substantiated.

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

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