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STUDY NOTES ON FINANCIAL REPORTING

CHAPTER 1 THE CONCEPTUAL FRAMEWOK FOR FINANCIAL REPORTING CONCEPTUAL FRAMEWORK VS GAAP The framework is an attempt to institute a theoretical concept which shall provide a basis for the preparation of financial statements and provide a guide for standard setters in setting accounting standards. Before any conceptual framework, GAAP (generally accepted accounting practices) had been used by reporting entities for the preparation and presentation of financial statements. During this era, there were alternative methods for applying GAAPs of different countries which affected comparability of financial statements among entities in the same industry but in different countries. During the regime of GAAP, every country adopted a set of accounting statements using its local environment as the basis for choosing accounting policies. Hence, the argument of what constitute, a GAAP became a matter of debate even up to recent times. GAAP then refers to the general principles governing the practices of accounting and financial reporting. These principles or rules could be ascertained from: Stock Exchange Requirements of various countries, National Accounting Standards, Corporate law in various jurisdictions. In essence, the conceptual framework for financial reporting became a compendium of theories guiding accounting practices and the standard setting process. THE NEED FOR A CONCEPTUAL FRAMEWORK The under listed are some of the salient points that had driven the need for a conceptual framework for the presentation of financial statements: To reduce variation to alternative treatment of similar items by entities. To provide a guide for standard setters in different countries on the standard setting process. To provide a disciplined approach to the accounting standard setting processes. To reduce political pressure on standard setters in various legislations in the standard setting process this is possible as the responsible standard setters follow the framework and not the dictates of the pressure groups. The framework helped to eliminate the rigid rules adopted by the US FASB thereby entrenching principles which are better suited for financial reports to possess its qualitative characteristics. To narrow the different GAAPs around the world. To reduce ambiguities, inconsistencies and contradictions arising from the different interpretations of GAAPs,

2.1 ADVANTAGES OF THE CONCEPTUAL FRAMEWORK It provides a direction for standard setters to identify areas of accounting needing standard setting rather than dissipate energy and resources on areas that do not pose any real challenge. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 1

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The conceptual framework helps to reduce the level of distraction and pressure on standard setters by self interest groups which may attempt to circumvent the basic principles of accounting to their personal interest e.g. the government. 2.2 DISADVANTAGES OF CONCEPTUAL FRAMEWORK It is difficult to conceive how a set of principles will be capable of satisfying the information needs of all interested parties. The framework is only a statement of best practices. Its implementation is left for individual reporting entities. Thus, compliance may be compromised at entity stage. THE IASB FRAMEWORK As discussed earlier, the need for harrowing in approaches to the presentation of financial statements led the IASB to carry out a project in 1989 to compile a book known as the framework for the presentation of financial statements. CONTENTS OF THE FRAMEWORK The book has sections containing the following; Preface Introduction Objectives of financial statements Qualitative characteristics of financial statements. Measurement criteria for items in financial statements Elements of financial statements Recognition criteria for items in financial statements Assumptions underlying the preparation of financial statements. Concept of capital and capital maintenance. The contents of the framework will become the subject of our discussion for the remaining parts of this note. THE PREFACE Similar to any other published material, the preface of the framework for the presentation of financial statements prepared by the IASB has a section dedicated to its preface. The preface contains the submission by IASB that the presentation of financial statements in different countries had been bedeviled with environmental challenges ranging from social, economic, religious, legal and technological factors. The preface also states the intention of the IASB for producing the framework. This is to promote the presentation of financial statements which is convergent on basic accounting principles. It also went further to state that the objective of general purpose financial statements is to help users to make informed economic decisions regarding the reporting entity. Some of these economic decisions include but not limited to: Decisions regarding whether to invest or divest from the reporting entity, Assessment of management performance. Assessment of financial position and liquidity of the reporting entity. Determination of tax position and politics of the reporting entity. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 2

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Information regarding national statistics etc. INTRODUCTION The framework also has an introductory paragraph which highlighted the following: Purpose and status of the document. Scope of the document. Information needs of various users. 3.2.1 PURPOSE OF THE FRAMEWORK The framework was complied to serve the following purposes: To assist stand setters in setting accounting standards. To assist the preparers of financial statements to fuller prescribed principles. To assist auditors to form an opinion on the true and fair view of financial statements and whether such FSs have been prepared in accordance with IASs/IFRSs. To promote harmonization of regulations, national standards and alternative methods of treating similar elements of financial statements by different reporting entities. 3.2.2 STATUS OF THE FRAMEWORK The framework is not an accounting standard on its own. In the event that there is a clash between an accounting standard and the framework, the accounting standard prevails. 3.2.3 SCOPE OF THE FRAMEWORK The framework covers issues bothering on the following; - Objectives of financial statements - Assumptions underlying the presentation of financial statements. - Qualitative characteristics of financial statements. - Elements of financial statements. - Recognition criteria for elements of financial statements. - The concept of capital and capital maintenance. The framework also deliberates on issues bothering on general purpose financial statements including: the SOFP, the SOCI, changes in equity and changes in financial position, including the notes to the accounts. 3.2.4 USERS AND THEIR INFORMATION NEEDS The framework identified various users of the financial statements and their information needs as follows: Investors: need information about share prices, dividends and profitability of the reporting entity. Employees: need information regarding their job prospects and the ability of the firm to pay attractive remunerations. Customers: need information regarding the ability of the firm to provide high quality goods at affordable prices. Suppliers: are interested in knowing whether the reporting entity is capable of paying their bills as at when due. Lenders: have interest in the entitys ability to repay loan principal and interest promptly not also forgetting the mix of debt and equity in the capital structure (gearing). PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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Governments: are also interested in the accounting data for planning and more so for assessing the reporting entitys tax liabilities. 3.3 OBJECTIVES OF FINANCIAL STATEMENTS The major objectives of financial statements are to assist users of such reports in making informed economic decisions regarding the reporting entity. The economic decision will mostly bother on issues regarding liquidity, profitability, and changes in financial position. The liquidity and solvency of an entity can be determined using the items recognized in the SOFP. Liquidity is the ability of an entity to meet its short term obligations as they fall due; while solvency refers to the ability of a reporting entity to settle its long term obligation as they fall due. The profitability (financial performance) of a reporting entity can be ascertained from its statement of comprehensive income and statement of other comprehensive income. The changes in financial position can be ascertained from the interaction between operating activities, investing activities and financial activities otherwise known as cash flow statement. 3.4 ASSUMPTIONS UNDERLYING THE PRESENTATION OF FINANCIAL STATEMENTS: 3.4.1 ACCRUAL BASIS Financial statements are prepared on accrual basis, this assumption underpin the fact that income and expenditure is recognized at the point which position the transactions occur and not necessarily when cash is received or paid. This concept is in conformity with the matching and prudence concept. Matching involves aggregate items of income and expenses which occur at the same period to ascertain profit or losses, while prudence connotes the tendency of not overstating profits or understating losses by recognizing items in Financial statement when the criteria for its recognition is not met. 3.4.2 GOING CONCERN Financial statements are prepared as though the reporting entity is going to operate into the foreseeable future period. A period of twelve months is considered a foreseeable future. Thus, the basis should not be applied if there are clear indications that the reporting entity may not survive the following twelve months from the date of the present financial statements

3.5 QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS. The framework highlighted four qualities of financial statement as follows: UNDERSTANDABILITY This quality connotes that Financial statements should be presented in a manner that its contents should be understood by a user having adequate knowledge reasonable to deduce facts from such Statements, preparers of financial statements are however admonished not to omit complex items while trying to achieve understandability. This is because if such complex items are not included, the financial statements may be incomplete. Thus, it is only those users who have technical knowledge that will be able to understand those users lacking such technical knowledge should consult experts to assist them in interpreting financial statements. 3.5.1 RELEVANCE PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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Financial statements are relevant if its contents are capable of guiding a user to take economic decisions regarding the reporting entity. The type of economic decisions) have been highlighted in the section dealing with the preface. However, materiality have a roe to play in determine the relevance of an item. An item is said to be material in nature and size if it will provide a guide for a user to make informed economic decisions regarding the reporting entity the size will determine its materiality. For instance, a transaction between a reporting entity and one of its directions not matter how small is regarded to be material because of its nature and not its size. This is because a director is a related party (IAS 24). Again, the EDS figure recognized in the face of the financial statement is relatively small but its significance to the financial statement and decision making is material in nature. Therefore the EPS figure is relevant to the financial statement. 3.5.2 RELIABILITY Reliability connotes the ability of a financial statement to truly represent what if purports to represent. Thus, the quality of reliability demands that financial statements should be free from bias resulting from misstatements and misrepresentation of facts the concept of reliability demands faithful representation and the recognition of substance over form. 3.5.2.1 Faithful Representation This derives from the need for preparers of financial statements to state elements of financial statements in a manner that will present a true and fair view of the reporting entitys financial position, performance and changes in financial position. In achieving faithful representation, the integrity, and objectivity of the management of reporting entities should be considered including their technical expertise. 3.5.2.2 Substance Over Form The reliability of financial information could greatly be affected by the way in which the substances of items in a financial statement are treated in relation to their legal form. Thus, the framework demands that the substance of transactions should be given greater prominence than their legal form e.g., in finance leases, the lessee usually recognize an asset held on lease while in the legal sense of it, such item may not meet the definition of an asset to the lessee. 3.5.2.3 Prudence The reporting entity shall strive to be prudent in reporting financial position and changes thereon and financial performance. To this end, revenue and expenses shall be matches to conform to the accrual concept discussed earlier. Revenue and costs shall not be recognized until when the criteria for recognition are met. 3.5.2.4 Completeness If material items of transactions are omitted in financial reports, then such a report shall lack the quality of reliability as it does not contain all relevant facts necessary to convey information that will make users to make an informed economic decision regarding the reporting entity. 3.6 COMPARABILITY Financial statements prepared by a reporting entity should be capable of being compared from period to period and between other entities in the same industry. The concepts of comparability have also been highlighted by the use of prior period comparative results. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 5

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3.6.1 Tradeoff between Qualitative Characteristics In real sense of it, some of the qualitative features of financial statements are being inhibited by one another and by the consideration of costs and benefits of achieving those qualities. In trying to achieve some features, a reporting entity may well be made to exhaust much resource. However, management is advised to apply judgment to ensure a balance. ELEMENTS OF FINANCIAL STATEMENTS These refer to the fire broad headings in which the items contained in a complete set of finance statements may be classified. The table below can throw more light on this: SOFP Assets Liabilities Equity SOCI Income Expenses

4.1.1 DEFINITIONS ASSETS These are resources controlled by a firm as a result of past events which will lead to an inflow of resources embodying economic benefits and can be measured reliably. LIABILITIES These are obligations upon a firm as a result past events which settlement will lead to outflow of resources embodying economic benefits and can be measured reliability. EQUITY This is the residue interest in a firm which arises from the deduction of liabilities from assets. INCOME These are increases in assets or reduction in liabilities which arises to a reporting entity as a result of activities accruing in the normal course of business but not as a result of contribution of more equity. EXPENSES These are decreases in assets or increases in liabilities arising from activities in the normal course of business rather than contribution of equity. In essence, it could be seen that the whole items appending in a set of financial statements must belong to any of these five elements no matter its nature or size. If this is not so, then such items are not supposed to appear in a finance statement. The elements have those specifically recognized in SOFP and the SOCI. 5.0 RECOGNITION CRITERIA OF ELEMENTS OF FINANCIAL STATEMENTS Recognition refers to the instatement of an item on the face of financial statements. An item is recognized in the financial statement if such item is stated with a financial value in the financial statement. In order for an item (element) to be recognized, such item must possess these criteria: PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 6

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There must be probability that such transaction must occur now or in the determinable future time. The value of such item must be capable of being measured reliably. Probable criteria here connotes that the element in question is more likely than not to occur (if it has not occurred). The likelihood of occurrence can be assumed if the event has a fifty percent chance of occurrence. Reliable measurement is achieved if such element attracts a determinable financial value. Any element that does not satisfy these criteria should not be recognized. 6.0 MEASUREMENT CRITERIA OF ELEMENT OF FINANCIAL STATEMENT The framework highlighted several methods of measuring the elements of financial statements after initial recognition as: 6.1 Historical Cost Basis: which uses the values for which an asset or liability was assumed on the date it was inherited/purchased. 6.2 Fair Value Basis: uses the amount for which an asset or a liability could be exchanged among parties having knowledge of market conditions on a measurement date. 6.3 Present Value Basis: is the discounted net cash flow from an element using an appropriate cost of capital. 6.4 Replacement Value Basis: is the amount for which an asset or a liability could be acquired at the current date. 6.5 Break-Up Value Basis: refers to the amount which the assets of an entity could realize if the entity was liquidated on that date. 7.0 COMPLIANCE WITH IFRS The framework recommends that reporting entities should comply with all IAS and IFRS except where non compliance will lead to better free and fair view of the financial statement ( although rare). However, if any IAS or part thereof was not complied with, the reporting entity shall make disclosure in notes to the accounts regarding; The fact that the financial statements have been prepared in accordance with IASs/IFRSs except for the departure. The IAS/IFRS that has not been complied with. The reason for the departure and the justification for the departure. The alternative treatment applied to the item(s) giving rise to the departure from the standard. The cumulative effect of the non compliance the financial performance and position of the entity. 8.0 CONCEPT OF CAPITAL AND CAPITAL MAINTENCE This concept discusses the measurement of the wealth of shareholders in a reporting entity. It holds that the financial reports shall be capable of showing users the causes of changes in equity between the opening and closing dates in the period under review. The concept of capital was defined in the Framework and that of capital maintenance too. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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STUDY NOTES ON FINANCIAL REPORTING REGULATORY FRAMEWORK FOR FINANCIAL REPORTING


INTRODUCTION Every professional activity in the world have are regulated to guarantee quality service delivery to the users of the services of those professionals. Financial reporting as a professional service is not an exception. Regulation can be defined as the process of establishing a framework or machinery through which the conduct of an activity (in this case financial reporting) should be carried out so as to achieve the objectives for which such regulated activities are carried out. In this study session, we are going to look into the regulation of financial reporting in both international and national perspectives. At the end of the session, readers will be able to understand the evolution of IASC (now IASB) and its structural functionality, the process of international accounting standard setting, the relationship between the IASB and other intergovernmental agencies and economic groupings, the convergence project between IASB, UK and FASB, USA and then the challenges facing the IASB. WHY REGULATE FINANCIAL REPORTING? The need for the regulation of financial reporting activity is not farfetched from the fact that users of financial information need to be protected to ensure that financial reports are prepared in accordance with the IASB (framework) which was discussed in the opening study session. The internationalization of capital markets and the growing influence and expansion of multinational companies across the globe have given rise to proper regulation of financial reporting. If there was no regulation, there will be no guarantee that reporting entities will prepare their financial statements in conformity with the Framework. The Framework is the basis for the setting of accounting standards by IASB therefore, it is necessary to have a machinery in place to ensure that the standards so set are being followed, any necessary changes made at appropriate intervals and interpretations given to conflicting and complex areas. THE HISTORY FINANCIAL REPORTING REGULATION INTERNATIONAL ACCOUNTING STUDY GROUP (IASG) The need to have an IASB was highlighted by the Institute of Chartered Accountants in England and Wales (ICAEW) as far back as 1966. In 1967, such a Study Group was set up to provide guidance on the use of GAAPs of member states. INTERNATIONAL ACCOUNTING STANDARDS COMMITTEE (IASC) In 1973, the International Accounting standards Committee (IASC) was formed by ten countries namely; UK, France, USA, Germany, Australia, Canada, Japan, Mexico, Netherlands and Ireland to effectively set standards to be followed by preparers of financial statements among member states and globally. These were known as International Accounting Standards. Between 1973 and 2000, the IASC had issued 41 IASs on various areas of need in trying to achieve harmonization of financial reporting practices to achieve global economic objectives and to reduce the extent of variations in the application of GAAPs. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB) In April 2001, the IASC metamorphosed into the IASB, this time around, the IASB started producing IFRSs and not IASs. Between 2008 to date, thirteen IFRSs have produced and many Exposure Drafts are in place as WIP. The IASB was formed by the International Accounting Standards Committee Foundation (IASCF). The IASCF have two divisions Trustees and IASB. The IASCF appoints the members of the IASB and provides funding for the Board. The Board is made up of 14 members who serve a term of five years each with an option of renewal. The board is made up of members from the profession and academia comprising preparers of financial statements, analyst, academic and financial experts. The major criteria for selection are technical expert. THE STRUCTURE OF THE IASB The IASB has for organs as follows: INTERNATIONAL ACCOUNTING STATNDARD COMMITTEE FOUNDATION (IASCF) This is the parent body of IASB. It has a Board of Trustees comprising of 22 members drawn as follows: Six from Europe, six from North America, four from Asia and others from other regions provided it accords a geographical balance. BOARD OF TRUSTEES The Trustees are those who hold all the assets of the Foundation in Trust. They appoint the members of the Board and other organs of the IASB to ensure it functions effectively. They provide funding for IASB and governs its operations. INTERNATIONAL ACCOUNTING STANDARD BOARD (IASB) This is a board of 14 members which is saddled with the following responsibilities: 1. To set international accounting standards in form of IFRSs. 2. To ensure compliance with the IFRS by reporting entities through explaining its applications and uses. 3. To work closely with national accounting standard setting bodies from members. The IASB has its headquarters in London, England. STANDARDS ADVISORY COMMITTEE (SAC) This is an organ of the IASCF which is saddled with providing advisory services to the IASB during the standard setting process. The SAC is made up of 50 members drawn mostly from the standard setting bodies of member states of IASB. The IASB works closely with SAC to ensure that all grey areas spotted in a proposed standard are fine tuned before an IFRS is issued.

INTERNATIONAL FINANCIAL REPORTING INTERPRETATIONS COMMITTEE (IFRIC) PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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This body was set up in 1977 by the IASC as Standards Interpretation Committee (SIC) to provide an interpretation on areas of conflict between the contents of one or more accounting standards and then work closely with the IASB to resolve such conflicting issues. In short, this body provides interpretation to any matters of conflicts arising from any IFRS adoption. It has 12 members drawn from the finance, accounting and the academia. IASB AND OTHER INTER GOVERNMENTAL AGENCIES THE EUROPEAN UNION AND IASB The IASB have been working to the admiration of the EU since 1977 to date. This is deduced from the fact that the EU have mandated all multinational operating in its member states to adopt IFRS in the presentation of their consolidated financial statements since 2005, the EU also have a steering committee which makes input into the standard setting process of the IASB. THE UNITED NATIONS AND IASB The UN have always expressed its desire to have a disciplined approach to financial reporting process. However, the involvement of the UN have been bedeviled with too much political harbinger mainly from member countries from the developing nations. Meanwhile, or recent, many UN member states are gradually adopting IFRS. INTERNATIONAL FEDERATION OF ACCOUNTANTS (IFAC) This is a body comprising professional accounting bodies from more than 80 countries of the world. The body have over 100 accounting bodies in its fold having been set up in 1977, the body is engaged in providing guidance on professional accounting practices, ethics and code of conduct for its members. It also has a Board (IAASB) which sets auditing standard for practicing auditors. IFAC have been working closely with IASB to promote high quality accounting standards. Although IFAC on its own does not set accounting standards, it has promoted the adoption of IFRS and IASs by ensuring that its IAASs recognize the application of IFRSs in its guidance. ORGANISATION OF ECONOMIC COPERATION DEVELOPMENT (OECD) This is an international economic grouping made of members from first world countries tp promote the interests of multinational companies operating in the developing countries of the world. The OECD has always supported the activities of IASB by even undertaking research to help them make meaningful contribution to proposed accounting standards by the IASB. THE STANDARD SETTING PROCESS The IASB have teo principles guiding the standard setting process namely; due process and collaboration with accountants, financial experts and national regulation around the world. The due process relates to the laid down processes which must be followed: 1. The IASB consults the SAC on any propose area of accounting isssues which needs standardization. This early stage gives the SAC the opportunity to take a critical look at the proposed standard. 2. The IASB produces a Discussion Paper which is circulated among interested parties for contribution, criticize and review. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 10

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3. The comments received from the earlier DPs are taken into consideration and the Exposure Draft is issued for public commentary. This period lasts for up to three months after which a standard issued. 4. Voting is done by the 14 members of the IASB where 9 must vote in favor of the ED before an IFRS is issued. The collaboration with national standard setters is very paramount to achieve the acceptability of IFRSs in different countries. The IASB takes several steps to achieve this collaboration such as: 1. Encouraging standard setting bodies to make comments on Exposure Drafts. 2. Advising standard setting bodies to carry put similar projects with them simultaneously to reduce the time lag between globally adoptions of an international accounting standard with the national accounting standards. 3. Allowing the IASB to make comments on Exposure drafts of other standard setting bodies. This encourages harmonization of standard setting. 4. IASB has liaison officers who are assigned to the standard setting bodies in its membership. This is achieved by delegating members represented on the SAC to be liaising with their local standard setting bodies. GLOBAL EFFECTS OF IFRSs The acceptance of IFRSs in different countries have not had similar effects.this is because of differences arising between countries from economic, legal, technological, cultural, social,and religious environments. In Europe, IFRSs have received general acceptability as countries within EU have adopted IFRS far back 2005. The Securities and Exchange Commission (SEC) in USA, have allowed companies quoted on US StockExchanges to present their consolidated financial statements prepared IFRS with since 2000; although, there are some items which have been exempted from this acceptances. Such items must be treated according to the FASB requirements. The dawn of the twenty first century has led to the awareness of the need for the adoption of IFRS in Asia and Africa. IFRS are now being adopted in several countries in Asia and Africa such as China, India, Singapore, South Africa, Indonesia and lately Nigeria, to mention a few. The adoption of IFRS have led to growth in international investments and multinational companies have had to save costs in accounting and auditing service personnel. SCOPE AND APPLICATION OF IFRSs IFRSs are not applied in retrospection. They are expected to be adopted by reporting entities from its effective date future accounting periods, although entities who uses an IFRS before its effective should make adequate disclosure in the notes as pre IFRS 1: First Time Adoption of IFRSs. On application, IFRSs have been focused of areas of significant importance. The contents and o wordings have been made tp be simple to ensure they can be applied globally.

REGULATION OF FINANCIAL REPORTING IN NGERIA PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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Before 2nd June, 2011, financial reporting regulation in Nigeria had been undertaken by the Nigerian Accounting Standards Board (NASB). On that date, the Nigerian National Assembly passed a bill into law giving birth to the Financial Reporting Council (FRC) which inter alia was saddled with the responsibility of: 1. To produce a high quality accounting standards in the public interest, 2. To identify areas of accounting which need standardization, 3. To enforce compliance with the accounting standards, 4. To deal with the issues of taking steps towards disciplinary actions against the directors of a public interest company in which a qualified audit report have been given by external auditors, 5. To register all qualified accountants who has the duty of preparing published financial statements 6. To prosecute quoted companies who do not comply with IFRSs, and 7. To carry out other duties as may be required from time to tim. In 2011, the FRC mandated all quoted companies to adopt IFRS from 1 st January, 2012. This transition period will end by 1st January, 2014. Hence, IFRS is the standard for the presentation of financial statements by all public interest companies operating in Nigeria. This requirement created a challenge among reporting entities in Nigeria. This challenge created the need for accountants in Nigeria to have a good knowledge of IFRS in order to remain relevant in financial reporting. It is hoped that when this transition is completed in 2014, it will help the Nigerian economy to attract the much needed foreign investments thereby promoting a vibrant economic climate and creatibg employment opportunities. MEMBERSHIP OF THE FINANCIAL REPORTING COUNCIL (FRC) Seventeen members make up the FRC as follows: 1. Chairman appointed by the President of the Federal Republic of Nigeria, 2. 2 members from the Institute of Chartered Accountants of Nigeria (ICAN) and Association of National Accountants of Nigeria (ANAN), 3. One member each from the following bodies in Nigeria: Securities and Exchange Commission (SEC) Corporate Affairs Commission (CA) Nigerian chambers of Commerce, Mines and Agriculture (NACCIMA) Federal Inland Revenue Service (FIRS) Chartered Institute of taxation of Nigeria (CITN) National Accounting Association (NAA) Central Bank of Nigeria (CBN) Federal Ministry of Commerce and Industries Federal Ministry of finance Office of the Accountant General of the Federation, and Office of the Auditor General for the federation. STANDARD SETTING PROCESS The process of setting accounting standards in Nigeria is not materially different from that of the IASB. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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CHAPTER 2 FINANCIAL REPORTING ON ASSETS 2.0 OVERVIEW OF CHAPTER This chapter focuses on financial reporting issues relating to tangible and intangible assets excluding financial instruments giving rise to financial assets. The standards to be treated are: IAS 16, IAS 20, IAS 40, IAS 23, IAS 38, IFRS 3 and IAS 36. IAS 16 PROPERTY, PLANT AND EQUIPMENT 2.1.1 INTRODUCTION IAS 16 is an accounting standard which treats the financial reporting issues arising from PPE. 2.1.2 SCOPE This standard covers tangible assets falling under its purview except for: Biological assets (IAS 41) Mineral resources such as oil and gas (IFRS 6). 2.1.3 DEFINITION OF TERMS PPE are tangible assets employed by a reporting entity for the daily operations of an entity in the ordinary course of businesses which are not intended for resale. They have useful life, spanning more than one year. COST is the amount of cash given up for the acquisition of an item of PPE or any other asset used for exchange with an item of PPE or any other consideration given up for the acquisition of PPE. RESIDUAL VALUE is the amount recoverable from the sale or disposal of an item of PPE at the end of its useful life. USEFUL LIFE of an item of PPE is the shorter of the lifespan of an asset or its economic life. CARRYING AMOUNT is the amount at which an item of PPE is stated in the SOFP. This amount is usually the historic cost or revalued amount less accumulated depreciation or accumulated amortization. SELF CONSTRUCTED ASSETS are PPE which the user entity develops using its internal resources such as labor, materials etc. RECOVERABLE AMOUNT is the lower of the carrying amount of PPE and its residual value or disposal value. IMPAIRMENT occurs when the recoverable amount of an item of PPE is lower than its disposal/ realizable value. ENTITY SPECIFIC VALUE is the sum of the cash flows arising from the use of an asset and its residual value discounted using an appropriate cost of capital, this refers to the PVs of all cash flows associated with the use of an item of PPE. These values are as determined by the reporting entity. 2.1.4. RECOGNITION CRITERIA FOR ITEMS OF PPE Recognition refers to the incorporation of an item of PPE in the SOFP of a reporting entity on acquisition. IAS 16 gives two specific criteria for recognizing an item of PPE as follows; There must be evidence that the PPE will probably lead to inflow of resources embodying economic benefits to the entity through its useful life. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 13

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The cost of the PPE must be capable of being measured reliably. 2.1.5. EXPLANATION OF RECOGNITION CRITERIA PROBABLE INFLOW OF ECONOMIC BENEFITS For an item of PPE to be recognized, such an item should be capable of creating resources that will lead to the inflow of economic benefits, thus, such item must be useful for creating revenue in the form of sales income, rent, royalties etc .Therefore, plant, Machinery MV, Buildings, Land etc meets the criteria of PPE depending on the nature of the companys business. COST MUST BE MEASURED RELIABLY The cost of an item which must be classified as PPE must be capable of being measured reliably. Thus, if the cost of acquiring, installing and commissioned of an item of PPE cannot be gathered easily, then the reliability of the recognized value of the PPE will greatly be in doubt. Thus, any item which lacks both criteria should not be recognized in the SOFP as PPE. 2.1.6 COMPLEX ASSETS There are some items which though may seem to be qualified for recognition as PPE in the SOFP; however such items always expensed such as tools, dies and moulds. However some assets have different components possessing different useful lives and different depreciation methods and rates. Examples of such assets are aircrafts and buildings. In an air craft, the body, engine and interiors are treated as separate assets and depreciated separately. These assets are known as complex assets. 2.1.7. INITIAL RECOGNITION OF PPE When an item of PPE is acquired initially, it is recognized at cost. This has been defined in the terminology. 2.1.7.1. WHAT CONSTITUTES COST The following are the components of cost of a PPE; The invoice amount less any sales discount Fair value of any PPE used for exchange of another PPE unless the fair value cannot be ascertained, then the carrying amount will be used. All other costs incidental to bringing the assets to the condition in which the assets will perform its intended purpose e.g. cost of site preparation, installation costs, commissioning costs, test running costs. Import Duties and any other tariff associated with the importation and clearing of the PPE. Dismantling and decommissioning costs estimated at the initial use of the asset. 2.1.8.1. WHAT DOES NOT CONSTITUTE COST The following are not recognized as part of the cost of an item of PPE: Administrative and overhead costs. Pre operational costs and initial wastages recorded by the machine before operating normally to the intended usage. 2.1.9 MEASUREMENT OF PPE After initial recognition at cost, IAS 16 allows subsequent measurement of PPE using either; PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 14

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Cost model: the historic cost less accumulated depreciation and impairment losses or Fair value model: which is the revalued amount using the services of professional valuer. Whichever method is adopted by a reporting entity, the bottom line is consistency to promote reliability. Thus, in preparing a fixed asset schedule, the cost could represent the historic cost or revalued amount. 2.1.10. REVALUATION This refers to placing a value on an item of PPE which reflects the economic value of an item of PPE considering present economic circumstances as suggested by a professional valuer. This concept of revaluation is rampant these days because of inflation which tend to affect the values of landed property. To account for the increase in the value of building materials, IAS 16 allows for revaluation provided it is performed independently and objectively by a professional. This will enable a realistic value to be placed on PPE. However IAS 16 also recommends that for any asset to be revalued, all other assets in the same class shall be revalued accordingly at same time. 2.1.10.1. REVALUATION SURPLUS This occurs when the fair value of a revalued asset is higher than the carrying amount of the same asset. In essence, there is an upward review in the value of such asset. IAS 16 recommends that such upward review shall be passed through equity and not through profit or loss. Thus, an increase in the carrying amount of a PPE is an increase in owners equity and not a P & L item. However, if such revalued item had suffered a downward review in the past, the revaluation surplus should be used to offset such a previous revaluation loss. The balance (if any) should be taken to equity. EXAMPLE 1: Treasurehall Consulting Ltd owned an item of PPE which cost $18,000 four years ago. Two years after, the asset was revealed to $15,000. Now the PPE is value at $25,000. Show the treatment of revaluation in the books of Treasurehall Consulting Ltd. 2.1.11.2 REVALUATION LOSS This refers to a downward review in the value of an item of PPE. When the revalued amount of an item of PPE is less than its carrying amount, then there is a revaluation loss. The treatment of revaluation surplus in the books is the opposite of a revaluation loss. The question in the preceding example can be used to regurgitate this. 2.1.12 REVALUATION AND DEPRECIATION When there is a revaluation surplus, then the surplus is not passed through profit or loss but rather through equity (revaluation reserves). Therefore, this amount is not realized until when the asset is disposed, however, if the asset is not disposed before the end of its useful life, then it will be realized through the use of the asset. The complication is that if there is an upward review, the depreciation charge will increase above the amount that would have been charged as depreciation had the asset not been revalued. The excess PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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depreciation is not expensed through profit and loss rather adjusted through equity just like the treatment of revaluation loss. EXAMPLE 2: Mazy Ltd owned an asset which cost $200,000 in 2010. The asset was revalued at $300,000 in 2013. Assuming the useful life was determined to be 8 years in 2010 and using a straight line method of the upward review in the financial statement of 2013. 2.1.13 SPECIAL CASE OF LAND AND BUILDING IAS 16 recommends that land and building should be separated and treated differently. This is because land is not depreciated as it has unlimited life span against building which has a limited life span. Thus, in exams, candidates should be careful to separate the land component before applying depreciation on building. 2.1.14 CHANGE IN USEFUL LIFE AND DEPRECIATION A review of the useful life of a PPE and a change in the depreciation method is a change in accounting estimate and must be treated prospectively per IAS 18 change in accounting policies, estimates and errors. 2.1.15 DISPOSAL OF ASSETS and PPE When an item of PPE is disposed, such PPE should be withdrawn (derecognized) from the SOFP. In the same vein, when a PPE is derecognized, it means that such PPE is no more incorporated in the SOFP. Any gains on disposal should be shown separately on the SOCI as part of other income and should not be included in revenue per IAS 18. 2.1.16 DISCLOSURE REQUIREMENTS The following disclosure requirements are needed by IAS 16; A schedule of PPE showing cost or revalued and additions during the year, disposals during the year. Depreciation method used. Depreciation rates used for different classes. Classification of assets according to types. Carrying amount at year end Reconciliation of carrying amount with opening balance. Amount of depreciation and impairment losses changed for the year. For revalued assets: The basis for the revaluation. The particulars of the professional valuer (if any). The valuation report. The date of valuation The amount that would have been recognized as carrying amounts had the revaluation not taken place. The standard recommends additional disclosures if any apart from the above. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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2.1.17 DEPRECIATION INTRODUCTION Non current assets depreciate over time as they are put to use in producing resources embodying economic benefits to the reporting entity. The object of depreciation is covered by IAS 16 PPE. The subject of depreciation is related to NCA which have an estimated useful life which can be measured reliably. NCA are those assets which are; Employed for generating output which leads to the inflow of resources embodying economic benefits. Used for administrative purposes. Some of the assets in these categories are plant and machinery, buildings, industrial equipments, office equipments of significant values. Land is not covered by depreciation accounting unless the land is used for mining purposes. This is because land has an unlimited life span. 2.1.18. TERMINOLOGY RELATING TO DEPRECIATION DEPRECIABLE ASSETS are those which have a limited life span and satisfy the criteria for recognition as a NCA. RESIDUAL VALUE is the amount estimated to be received from the disposal of an asset at the end of its economic life. NET REALIASABLE VALUE is the proceeds of disposal less costs of disposal. USEFUL LIFE is the estimated period which a user entity expects an asset to generate resources embodying economic benefits, this time is the shorter of the life of the asset or its economic life. The useful of an asset should be estimated using past experience of other assets in the same class thus, it involves management judgment and the following factors affects the useful life of an asset; The cumulative number of hours in usage or the maximum output within the life of the asset. Obsolescence. Legal requirements (mainly in terms of leases). DEPRECIABLE AMOUNT is the value expected to be written of an asset on a systematic basis in each accounting period. 2.1.19 METHODS OF PROVIDING FOR DEPRECIATION IAS 16 allows alternative methods for providing depreciation such as; Straight Line Method: where a uniform amount is written off an asset over its useful after deducting the residual value. Diminishing / Reducing Balance Method: where a percentage is applied to the carrying amount of an asset over its useful life. Machine Hour / Output Method: Where the depreciable amount of an asset is spread over the useful life of an asset using the hourly usage or hourly output in relation to the total hourly usage or output over the useful life of the asset. Sum-of the-year-digit Method: where the digit of a year is used in reverse order in relation to the total yearly digit to spread the depreciable value of an asset over its useful life. 2.1.20 APPLYING DEPRECIATION METHODS PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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IAS 16 demands that CONSISTENCY should be the watchword for reporting entities when applying any of the allowable methods of depreciation to an asset. This means that whichever method an entity chooses to adopt, such method, should be applied on regular bases to promote comparability and reliability of financial statements per the framework. Any change in depreciation method or estimated useful life of an asset amounts to a change in accounting estimate and should be treated in accordance with IAS 8: Change in Accounting Policies, Estimates and Errors. Thus, such changes should be treated prospectively. The argument behind this is that such changes are permissible by IAS 16 provided that; Recent regulation in the regulating framework permits or demands it. Such changes are warranted by change in circumstances in the economy thus providing a more realistic view of the financial statement to the users. 2.1.21 JUSTIFICATION FOR CHARGING DEPRECIATION IAS 16 argues that depreciation charged in the financial statement, though not involving cash flows, is consistent with the accrual assumption on which the framework is based for presentation of financial statements. Since PPE has a limited life to provide profits for a user entity, then it is justified in the spirit of prudence to change the wear and tear which occurs during the period of usage against the profits generated by the PPE in the same period. 2.1.22 MISCONCEPTIONS ABOUT DEPRECIATION There are two widely held incorrect arguments by some schools of thought regarding depreciation. These are; That depreciation is charged against profits because the market values of some assets tend to be higher than the NBVs because of inflation. Though these arguments seem to be correct, it is not consistent with the accruals concept. If the market value of an asset seems to be higher than its BV, then IAS permits revaluation, through revaluation, the increase shall be credited to revaluation resources as an increase in equity. Some argue that depreciation is a method of providing funds out of profits to replace an asset at the end of its useful life. This is incorrect because profit and depreciation is only a systematic method of financial performance evaluation and thus do not involve actual cash flows. This is the main reason why depreciation is added back to profit in assessing cash flows from operating activities, IAS 7 (Cash Flow Statements). 2.1.23 DISCLOSURE REQUIREMENTS IN RESPECT OF DEPRECIATION IAS 16 requires that the following disclosure should be made in the notes to the accounts regarding depreciation; The method of depreciation adopted. The useful life or depreciation rate used in respect of each class of asset. The depreciation charge for each class of asset for the period under review. The reason for change is depreciation method rate or useful life of an asset where there is any. The cumulative effect of change in depreciation method on the financial performance of the period under review. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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IAS 20: ACCOUNTING FOR GOVERNMENT GRANTS AND GOVERNMENT ASSISTANCE. INTRODUCTION In several cases, businesses receive grants or subsidies or premiums from government as a way of the government trying to encourage investments or for any other reason by. IAS 20 covers the issues relating to accounting grants for monetary or non monetary nature to businesses. SCOPE OF IAS 20 The standard covers asset related grant or income related grants or government assistance to businesses except for; Grants relating to government assistance with respect to changes in prices (inflation or deflation). Grants relating to assets in respect of taxation covered by IAS 12 (Accounting for Taxes). Grants arising from business with government in the normal cause of operations. DEFINITION OF TERMS The under defined are some of the relevant terms as used in IAS 20: their understanding is important to digest the contents of the standard. GOVERNMENT: This refers to any public authority such as council, local govt., municipality, government agencies or any other authority having power to issue such grants as covered by IAS 20. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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GOVERNMENT GRANTS: These are assistance given by government to businesses by providing economic benefits in which the recipients fulfill a required condition. GOVERNMENT ASSISTANCE: These are actions taken by government to provide incentives to recipients on satisfaction of certain conditions. GRANT RELATED ASSEST: An asset which is purchased or constructed by an entity in order to receive a reasonable assistance from govt. as a result of present or past effort made to qualify for the grant. FORGIVABLE LOANS: A loan in which the lender undertakes to forgo its repayment by the borrower on the satisfaction of certain criteria by the borrower. GRANT RELATED INCOME: Any inflow in cash or otherwise which accrues to an entity as a result of past effort made to satisfy a criteria set for the grant. FAIR VALUE: This is the amount for which an asset is exchanged or a liability settled by knowledgeable, willing parties in an arms length transaction. DEFFERED INCOME: An income which though received now will only crystallize in the future on the satisfaction of a condition. It is an income received in advance. RECOGNITION OF GOVERNMENT GRANTS IN FINANCIAL STATEMENTS Grants granted by government which qualify under IAS 20 should not be recognized in the financial statements unless the following criteria are satisfied: The entity must have satisfied the condition on which the grant is attached. The grant has been received or there is reasonable assurance that the grant will be received provided the conditions attached to a grand has been fulfilled, the grant can be recognized even if it has not been received. The manner in which grant is received is not relevant in accounting for it under IAS 20, whether grant is in form of an asset or income, the treatment in the accounts remains the same. ACCOUNTING TREATMENT RELATING TO GRANTS There are two methods for accounting for government grants namely: Capital Approach Income Approach CAPITAL APPROACH This approach explains that grants should be credited to equity in form of capital contribution. This means that any grant which is received from government increases owners equity and so should be treated as such. INCOME APPROACH PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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This approach considers the accrual assumption by matching any grant received from government against expenses incurred in respect of the income in the period relating to the events. That is, grant received should be net off against associated expenses and spread over the period covered by the grant. Thus, the grant is treated as deferred income. THE CHOICE BETWEEN CAPITAL AND INCOME APPROACH IAS 20 recommends the use of the income approach in the presentation of government grants in general purpose financial statements. The argument for income approach is that since a grant is not given for nothing, it is worthwhile to match the grant income against associated grant expenses in the related accounting period (s). It is against the capital approach which assumes that a grant has no cost. Secondly, a grant is an inflow from government. It is not a contribution from shareholders and therefore it should not be credited to equity. PRESENTATION OF GRANTS RELATED TO ASSETS There are two alternative methods of accounting for grants related to an asset example, if government issues grant to an entity because a particular asset was purchased, there are two ways of accounting for such grants: The grant can be used to reduce the BV of the asset over the useful life of the asset. The grant can be treated as deferred income EXAMPLE 1 A company receives a 30% grant to fund the cost of new machinery which costs $120,000. The machinery has an expected useful life of five years and a nil residual value. The expected profit of the company over the years in the machines life is $60,000. Show how the grant will be reported in the books of the company using both approaches for treating asset related grants. REPAYMENT OF GRANTS If grants are repayable, then such repayment should be treated as a revision in accounting estimate per IAS 8 (Accounting policies, estimates and errors). However, the treatment varies depending on the nature of the grants. GRANT RELATED TO INCOME If a grant related to income should be repaid, then the amount to be repaid should be used to reduce the deferred income balance existing from the previous years. This means that the amount payable should be used to set-off the unamortized deferred income. Any amount not covered by the deferred income should be written off as an expense in the period in which the change in accounting estimate occurred. GRANT RELATED TO ASSET If a grant had been used to reduce the value of a grant related asset, then when such grant is repayable, the amount repayable should be used to increase the BV of the asset concerned. Any accumulated depreciation which should have been charged had the grant not been granted should be written off in the SOCI in the year of change in accounting estimate. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 21

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DISCLOSURE REQUIREMENTS PER IAS 20 The standard requires the reporting entities to disclose the following with respect to government grants: Accounting policy regarding the treatment of government grants and the method of presentation adopted. Any unfulfilled contingencies regarding grants Nature and extent of government grants advanced to the reporting entity.

IAS 40: INVESTMENT PROPERTIES INTRODUCTION Some businesses (reporting entities) own property or hold on lease properties which are not being used in the ordinary course of business nor intended for resale in the ordinary course of business but which are held for generating income in form of rental etc. Such property is regarded as Investment Property and the accounting treatment of such property is the focus of IAS 40. SCOPE OF IAS 40 The standard does not cover the following: Property held for resale in the ordinary course of business IAS 2. Property held for use in the ordinary course of business or for administrative purposes IAS 16 Property held on construction on behalf of a client in the ordinary course of business IAS 11, construction contracts. EXAMPLES OF INVESTMENT PROPERTY Land or building held for the generation of income to the entity or for capital appreciation. Property held on a finance lease which shall be put to use in conformity with the definition of investment property per IAS 40. CRITERIA FOR RECOGNITION AS INVESTMENT PROPERTY Before an asset (property) is classified as investment property, the following two conditions must be met: The property must be held in a manner as to probably generate an inflow of resources embodying economic benefits to the reporting entity The cost of the property must be capable of being measured reliably. INITIAL COST OF INVESTMENT PROPERTY Invoice cost plus transaction costs FV value of lease rentals or property cost whichever is lower. This is if the property is held under a finance lease SUBSEQUENT MEASUREMENT OF INVESTMENT PROPERTY IAS 40 recommends two methods for measurement investment property after initial recognition as: PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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FAIRVALUE MODEL This is a model encouraged to be used by IAS 40. It involves the placement of value on all investment properties held by the reporting entity based on the definition of FV. This is different from revaluation per IAS 16. However, the striking difference is that in a revaluation, the difference between the carrying amount and the revalued amount is passed through equity, but in a FV model per IAS 40, the difference between the carrying amount and FV is passed through the P&L in the period in which the difference arises. CONSISTENCY REQUIRED IAS 40 recommends that any entity which chooses the FV model must apply it to all its classes of investment property.

COST MODEL The cost model is as explained in IAS 16 in which the investment property is disclosed at historic cost and depreciated annually. However, by this method, the reporting entity must also disclose the FV of the investment property as a note to the accounts. TRANSFERS FROM IAS 40 TO IAS 16 AND VICE VERSA An item of investment property can also be transferred to be recognized as PPE if and only if there is a change in use. SCENARIO 1 If an owner occupied property held as PPE under IAS 16 is now being let out as an investment property, IAS 40 recommends that the asset should be recognized as IP using the FV of the property. However, a complication will arise where the carrying amount of the PPE (IAS 16) is different from its FV per IAS 40. The difference shall be written off against statement of changes in equity as a revaluation loss or gain. SCENARIO 2 An investment property carried at FV may be transferred to either PPE per 16 or inventories per IAS 2. The fair value of the IP should be used for recognition as IAS 16 or IAS 2. In this case, there will be no difference arising as the FV is the intrinsic value of the item. WHAT CONSTITUTES A FAIR VALUE The parties to the deal participated willingly hence it is not a forced sale. The buyer is motivated to buy by factors which were evaluated by him without compulsion. FV is determined using current market and economic factors unlike value in use which is determined using factors known only to the reporting entity. FV does not double count assets. For example, the cost of a building includes the cost of the land, physical structure and other fittings on the structure such as lifts, heaters, A/Cs etc. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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DISPOSAL OF INVESTMENT PROPERTY If an item of IP is permanently put out of use by a reporting entity through abandonment or disposal, the item should be derecognized. De-recognition is the process which expunge an item from a set of financial statements. DISCLOSURE REQUIREMENTS IAS 40 requires the following disclosure regarding IP: The model used for recognizing IP The FV of all investment properties Whether the services of a professional valuer was used in determining FV. The list of the investment properties held Whether the IPs are held as finance leases Whether any operating lease is held as IPs. DECISION TREE PER IAS 40 START

Is the property meant for resale in OCB? No Is the property owner occupied No Is the property being developed? No

YES

Inventory IAS 2

YES PPE IAS 16

YES

PPE IAS 16 completion

until

This is investment property

an

IAS 16 with disclosure notes per IAS 40 PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) FV Model IAS 40

Cost Model Which model of valuation do you use?

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Fair Value Model

IAS 23: BORROWING COSTS INTRODUCTION Reporting entities sometimes take out locus or other forms of advances to acquire self constructed assets. The treatment of interest on such borrowings made with respect to funds for financing those self constructed assets is the focus of IAS 23. Before the revision of IAS 23, costs of borrowing for qualifying assets where hitherto expensed in the P&L in the period they are incurred. TERMINOLOGY BORROWING COSTS The cost of finance related to amounts borrowed to fund the construction (not acquisition) of qualifying assets. QUALIFYING ASSETS - These are those assets which are covered by the scope of IAS 23. EXAMPLES OF QUALIFYING ASSETS Inventory meant for resale but will take a substantial long time to construct or produce. Plant and machinery or other heavy duty equipment which the reporting entity is constructing for itself and in which the construction shall span over some accounting period. Property held as an investment per IAS 40 but which the reporting entity has borrowed funds to develop. NON QUALIFYING ASSETS The following does not qualify as per IAS23 Inventory held for resale but which does not take substantial time to produce. Assets acquired out rightly, having been completed by the vendor before being acquired with borrowed funds. EXPENSES QUALIFYING FOR CAPITALISATION IAS 23 recommends that all costs directly attributed to funds borrowed to finance a qualifying asset shall be capitalized by being added to the original amount borrowed less any income realized from the temporary re-investment of the part of the borrowed funds before they are used. Consequently, the following expenses qualify for capitalization; Interest paid on long term loans, overdrafts or other forms of advances taken for the development of qualifying assets Finance costs relating to finance leases paid on items qualifying under IAS 23. Premiums and other charges payable in respect of funds borrowed to finance qualifying assets. Any fund which would not have been taken out as borrowing had the qualifying asset not been undertaken is eligible for capitalization.

PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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WHEN TO START CAPITALIZATION Capitalization of borrowing cost starts: When construction work on the qualifying asset begins When the costs of borrowing is being incurred When technical and administrative processes relating to the qualifying assets is in progress. WHEN TO STOP CAPITALIZATION When the self constructed property or inventory is partly or fully completed If a part of the property is completed, borrowing costs related to the part of the property should be discontinued. When there is a permanent obstruction on the progress of work being done on the qualifying asset. Technical and administrative processes which obstruct work are not regarded as permanent obstruction. Therefore, borrowing costs should also be calculated even in periods of such temporary obstruction. FUNDING QUALIFYING ASSETS FROM MIX OF BORROWINGS When a qualifying asset is being funded with different sources of borrowing, then the capitalization rate shall be the weighted average cost of borrowing excluding the cost of borrowing to finance a specific asset. EXAMPLE 2 Okemos PLC had the following loans in place at the beginning and end of 2006: 1st Jan 31st Dec 10% loan repayable 2008 120 120 9.5% loan repayable 2009 80 80 8.9% debenture repayable 2007 150 The 8.9% debenture was issued to fund the construction of a qualifying asset of which construction began on 1st July 2006. On 1st January 2006, Okemos PLC began construction of a qualifying asset using existing borrowings. Expenditure on construction was $30m on 1st January, 2006 and $20m on 1st October 2006. Calculate the borrowing costs that can be capitalized for the qualifying asset, on which construction began on 1st January, 2006. EXAMPLE 1 On 1st January 2007, Enema Plc borrowed $1.5m to finance two projects A & B. The loan facility was drawn on 1/1/06 and the uses of the funds were as follows: A B 1/1/2007 250 500 1/7/2007 250 500

PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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The cost of borrowing is 9% while the company can reinvest surplus funds at 7%. Assuming Enema Plc invests surplus funds; calculate borrowing cost which may be capitalized for each asset and consequently the cost of each asset as at 31st Dec., 2007. DISCLOSURE REQUIREMENTS The following disclosure is required by IAS 23: The amount of borrowing costs capitalized for the period under review. The capitalization rate used to determine the borrowing costs capitalized. REFERENCES: ACCA F7 Study Text BPP publication, 2009. IFRS Learning Materials, ICAEW Publishing, UK.

ACCOUNTING STANDARDS RELATING TO THE MEASUREMENT OF FINANCIAL PERFORMANCE TOPIC OVERVIEW In the course of presentation of financial statements, certain errors, changes in estimates and misrepresentation of facts and figures may occur. When this happens, the reliability of the financial PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 27

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statements may be undermined. IAS 8, Accounting Policies, Changes in Estimates and Errors and IFRS 5, Non Current Assets Held for Sale and Discontinued Operations are the two accounting standards which provide the guide to these situations. IAS 8 is much concerned with the treatment of such changes, errors and approximations while IFRS 5 deals with how a reporting entity which has either and asset held for sale or a component of an entity which is classified as a discontinued operation should be presented in the financial statements. IAS 8: ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS INTRODUCTION This accounting standard treated three issues relevant for the understanding and reliability of financial statements. We are going to handle these issues one after another. ACCOUNTING POLICIES These are the basis, principles and policies applied by a reporting in the presentation of figures contained in the financial statements. Reporting entities are required to select accounting policies which are relevant to their circumstances and disclose such accounting policies as part of the notes to the accounts. In attempting to select appropriate accounting policies, reporting entities should give regard to: The provisions of the Conceptual Framework for financial reporting Ensure that the policies selected will not undermine the relevance and reliability of the financial reports. In essence, when an item which has not been treated in any accounting standard is involved, then the qualitative characteristics of financial reports should be taken into consideration. WHAT CONSTITUTES A CHANGE IN ACCOUNTING POLICY? The following can be attributed to changes in accounting policies: A change from the cost model to revaluation model in the measurement of non current assets in the SOFP. A change from the recognition of government grants from the income to the capital approach or a change from the method of reducing the value of the grant related asset to recognizing the full value of the asset and treating the grant as a deferred income. In a nutshell, any accounting issue which provides for an alternative treatment, when a change is to be made from a treatment (not measurement) to the alternative treatment, such a change is a change in accounting policy.

WHEN A CHANGE IN ACCOUNTING POLICY IS PERMITTED The standard discourages a change in accounting policy as it states that any accounting policy chosen by a reporting entity should be applied consistently. However a change may be permitted under the following circumstances: When the law in force requires such a change When a new accounting standard requires such a change, and When the change will lead to the presentation of a more reliable financial report. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 28

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ACCOUNTING TREATMENT OF CHANGE IN ACCOUNTING POLICY A change in accounting policy is treated retrospectively in the accounts. This means that the effect of the change in the results of prior periods will need to be adjusted through the Statement of Changes in Equity by restating the opening balance of retained earnings or revaluation surplus of all past periods affected by the change to reflect the changed circumstance as if such a change had not taken place. CHANGE IN ACCOUNTING ESTIMATE A change in accounting estimate occurs where the projections or approximations made by management regarding the estimation of certain variables are revised or methods of making such estimates are changed. An accounting estimate a predetermined approximation made by management regarding the recognition of items in the financial statement which requires management judgment and the use of acceptable methodologies. WHAT CONSTITUTES A CHANGE IN ACCOUNTING ESTIMATE The following are changes in accounting estimates: A change in the method of calculating depreciation, A change in depreciation rate or useful life of an asset, A change in stock valuation method, A write down of receivables to reflect realistic figure for recoverable debts, Write down of inventory to expunge obsolete stock And any other revision in projected accounting measures which do not constitute a change in accounting policy. TREATMENT OF CHANGES IN ACCOUNTING ESTIMATES Changes in accounting estimates are treated prospectively in financial statements. This means that changes in accounting estimates does not require an adjustment to prior period account balances. They only affect the results of the current year in which the change occurs and the results of future years following the year the change occurred. PRIOR PERIOD ERRORS These are errors which occurred in the presentation of financial statements of previous years which was discovered in the current accounting year. A prior period error arises as a result of one or more of the following situations: Omission of transactions in the financial statements of previous years, Misapplication of accounting standards or accounting policies, Misrepresentation of facts, Mathematical errors, Fraud The onus is that an error arises from the wrong treatment of a situation which existed at the accounting date but was not taken into consideration in the preparation of the accounts. If such errors come to light in future periods, adjustments need to be made to correct errors. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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TREATMENT OF PRIOR PERIOD ERRORS Prior period errors are treated retrospectively in the accounts. This means that such errors should be adjusted from the periods in which they existed until the current year. When it is impracticable to adjust the balances of previous periods affected by the adjustments, the opening balances of the components of equity affected will be restated to reflect the accurate figures as if such an error had not occurred at all. Impracticability occurs when management have taken all necessary steps to correct an error in previous periods accounts without success as a result of factors beyond the organizations control. In essence, corrections of prior period errors are effected through the statement of changes in equity. DISCLOSURE REQUIREMENTS RELATING TO CORRECTION OF ERRORS The standard requires that the following disclosure should be made regarding prior period errors: The nature of the error, The cumulative effect of the error on the prior years accounts balances on item by item basis, The effect of the correction of the error on the basic and diluted Earnings per Share (EPS). EXAMPLE 1 During 2008, Epee Plc discovered that certain inventory worth $4.5m which had been sold but not delivered to the buyer were wrongly included in the final accounts at 31 st December, 2007 as closing inventory. The following are the results of 2007 and 2008 financial years: 2007 $000 47,400 (34,570) 12,830 (3,880) 8,950 2008 $000 67,200 (55,800) 11,400 (3,400) 8,000

Revenue Cost of Sales PBT Taxation PROFIT FOR THE YEAR

Retained earnings at 1st January, 2007 were $14m. The cost of goods sold in 2008 includes the stock of $4.5m error in opening inventory. The income tax rate for both years was 25%. No dividends were paid in both years. Required: Show the income statement for 2008 with comparative figures and retained earnings. EXAMPLE 2 Using the following information, prepare the statement of changes in equity of Organza PLC for the year ended December 31, 2012: Organza PLC Statement of Comprehensive Income (extract) $000 PBIT 792 PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 30

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Finance Income 24 Finance Cost (10) PBT 806 Income Tax Estimate (240) PROFIT FOR THE YEAR 566 OTHER COMPREHENSIVE INCOME Gain on property revaluation 120 TOTAL COMPREHENSIVE INCOME FOR THE YEAR 686 Non Current Assets: Freehold land and building were revalued to $500,000; the carrying amount prior to revaluation was $380,000. A previously revalued asset was sold for $60,000. Details of the revaluation are as follows: $ Carrying amount at revaluation 30,000 Revaluation Surplus 50,000 80,000 Organza Plc has been following paragraph 41 of IAS 16 which allows for a reserve transfer of the realized revaluation surplus (the difference between the amount that would have been charged as depreciation had the asset not been revalued (historic cost) and the amount charged as depreciation on the revalued amount) as the asset is used or disposed to retained earnings.

Details of investment property are as follows:

$ Original Cost 120,000 Revaluation Surplus 40,000 Value at 1/1/2012 160,000 The properties had a revaluation on 31st December, 2012 of $110,000. Organza Plc previously accounted for its investment properties by crediting gains to a revaluation surplus as allowed by local GAAP. Organza plc now wishes to apply the fair value model of IAS 40 which states that gains and losses should be treated as changes in accounting policy in accordance with IAS 8. No adjustment has been made for the change in accounting policy or subsequent fall in value. Share capital: During the year the company had the following changes to its capital structure: An issue of $200,000 $1 ordinary bonus share capitalizing its share premium reserve An issue of $400,000 $1 ordinary shares at $1.40 per share. Equity: $ PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 31

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Share Capital Retained Earnings Share Premium Revaluation Surplus 2,800,000 2,120,000 1,150,000 750,000 6,820,000

Dividends: Dividends of $200,000 were paid during the year as agreed at the companys AGM.

IFRS 5: NON CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS
INTRODUCTION This is a financial reporting standard which attempts to give users of financial statements an insight into the classification of assets in terms of management decision regarding whether such assets will continue to be the entitys asset in the nearest future or otherwise (fixed assets held for sale/disposal group) and also the classification of financial performance with respect of how permanent an entitys operational divisions will be in the nearest future (discontinued operations). It is a replacement for IAS 35; Discontinued Operations as fallout out of a joint project between the IASB UK and FASB US. Our discussion shall be focused on the issue of Assets Held for Sale separately and Discontinued Operations separately. IFRS 5 is superior to IAS 35 because it is more encompassing in scope having treated both held for sale assets and discontinued operations. SCOPE OF IFRS 5 The standard does not cover accounting issues arising from other assets treated in other standards such: Employee Benefits Scheme (IAS 19) Deferred Tax Assets (IAS 12) Assets held on construction contracts (IAS 11) PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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Financial Assets (IAS 39 & 32) Biological Assets (IAS 41) NON CURRENT ASSETS HELD FOR SALE These are assets which qualify to be classified as such. They are either tangible fixed assets held by an entity or a disposal group such as a subsidiary which the entity intends to dispose for a consideration or in exchange for another asset in the nearest future. The logic behind this issue is that since the entity is still using such asset, the effect of its use in the period under review on the financial position of the reporting entity is supposed to be shown on the face of the SOFP. This will promote reliability and understandability of the financial statements in conformity with the Framework. CLASSIFICATION OF AN ASSET AS HELD FOR SALE IFRS 5 states that when an asset qualifies to be classified as held for sale, such an asset shall be disclosed separately in the SOFP and the liabilities arising from such assets shall equally be disclosed separately in the liability side of the SOFP. CONDITIONS FOR CLASSYING ASSETS AS HELD FOR SALE However, for an asset to be classified as held for sale, the following conditions must be met: Management must show an intention of disposing the asset by making reasonable effort towards achieving the sale. The sale must be probable, this means that the sale is more likely than not. Arrangements are ongoing to locate an active buyer. The sale should be likely to take place not more than twelve months from the date that the asset is classified as held for sale. The asset must be available for sale in its present state and condition. The disposal price must be fixed at a reasonable amount. However what constitutes a reasonable amount is a matter of judgment. Abandonment does not constitute held for sale because it is only through continued use that the asset can be realized. MEASUREMENT OF ASSETS HELD FOR SALE Once an asset qualifies to be classified as held for sale, depreciation on such asset should cease. This is because since the asset is no longer held for use, it is not prudent to charge deprecation to profit or loss in order not to understate profits. 2. However, the asset should be recognized at the lower of the carrying amount before being reclassified as held for sale and its net realizable value (fair value less cost to sale). If the net realizable value is less than the carrying amount, then there is an impairment loss and such a loss should be written off profit or loss in the period it arose. RECLASSIFICATION OF ASSETS HELD FOR SALE If an asset which was hitherto classified as held for sale cannot be sold within twelve months or does not meet the other criteria for recognition, such assets should be reclassified as lower of: Restate the asset at the carrying amount before classification as held for sale less any depreciation that would have been charged had the asset not been classified as held for sale.Recoverable amount at the date of reclassification as not held for sale. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 33

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The focal point is that the assets on which depreciation had been suspended will still have to be depreciated to show that there is a change in its status in the financial statements. Secondly, it is not proper to state an asset at an amount higher than its recoverable amount in the SOFP. This promotes reliability and is consistent with the prudence concept. SPECIAL NOTE ON ASSETS HELD FOR SALE Asset classified as held for sale is mostly concerned with the SOFP. Here is a format of a SOFP with assets held for sale: Mazy Plc STATEMENT OF FINANCIAL POSITION AS AT 31ST DEC., 2012. $000 PPE xxx Investment property xxx Intangible assets xxx xxxx Non current assets held for sale xxxx Total non current assets xxxx Current assets xxx Total assets xxxxx Financed by: Equity xxxx Reserves xx Non current liabilities xxx Current liabilities xx xxxx Liabilities with respect to assets held for sale xxxx Total liabilities xxxx

DISCONTINUED OPERATIONS A discontinued operation is an operational segment of a reporting entity which has an identifiable cash flows and profitability separate from other components of the entity. Thus a discontinued operation can be a segment of an entity operating in a major line of business different from the other components of the reporting entity or a subsidiary of a group which is acquired primarily for sale within twelve months. A discontinued operation can be identified through its operations being separate from the rest of the other components of the entity or have a separate geographical location. The disclosure of discontinued operations enables the users of financial statements to be abreast of effects of a discontinued operation on the financial performance of a reporting entity. PRESENTATION OF DISCONTINUED OPERATIONS IN FINANCIAL STATEMENTS PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 34

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IFRS 5 provides that results of financial performance from discontinued operations shall be stated separately on the face of statement of comprehensive income from continuing operations. The cash flows arising from operating, investing and financing activities of the discontinued operations should also be stated separately in the cash flow statement. This is justified as it will enable the user of the financial statement to know the likely financial impact of the discontinued operations after its disposal. The effect of financial performance of any asset classified as held for sale shall also form part of the results of the discontinued operation. The disclosure shall include: Expenses, revenue and other charges attributable to discontinued operations, Related income tax expenses associated with the results of operations of discontinued operations, The results of the reclassification to fair value less cost to sale arising from the discontinued operations (possible impairment loss), and The related income tax expenses arising from the reclassification made above. All these amounts shall be netted of to give the post tax profit or loss arising from discontinued operations. The following proforma income statement exemplifies the disclosure of discontinued operations: Mazy Plc Statement of Comprehensive Income for the year ended 31st Dec., 2012. CONTINUED OPERATIONS Revenue Cost of Sales GROSS PROFIT Distribution costs Admin Costs Finance Income Finance Costs Profit before tax Income tax estimate PROFIT FOR THE YEAR DISCONTINUED OPERATIONS: Profit or (loss) from discontinued operations net of tax TOTAL COMPREHENSIVE INCOME FOR THE YEAR

$000 xxxxx (xxx) xxx (xx) (xx) xxx (xx) xxx (xx) xxx xxx xxxx

DISCLOSURE REQUIREMENTS IFRS 5 requires the following disclosure with respect to discontinued operations in the notes to the accounts: The asset classified as held for sale or disposed The result gains or losses from the classification of an asset as held for sale or discontinued operations, The facts and circumstances leading to the classification of an asset as held for sale. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 35

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IAS 36: IMPAIRMENT LOSSES


INTRODUCTION PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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IAS 36, Impairment Losses deals with the controversial topic of impairment of assets (both tangible and intangible assets) including goodwill on acquisition of subsidiaries. The main aspects of discussion considered in this reading text relate to: indications of impairment of assets, measurement of the recoverable amount of assets, measurement of value in use, consideration of cash generating units (CGU), treatment of impairment losses in financial statements and the treatment of reversal of impairment losses. TERMINOLOGY The following terminologies are relevant for the understanding of IAS 36: IMPAIRMENT LOSS: this occurs when the recoverable amount of an asset is lower than its carrying amount in the SOFP. CARRYING AMOUNT: this is the amount at which an item of asset or a cash generating unit is disclosed in the SOFP. RECOVERABLE AMOUNT: this is measured as the higher of: The fair value less cost to sale (NRV) or The value in use of such an asset or CGU. CASH GENERATING UNIT: this is an identifiable portion of a unit in the whole of an asset for the purpose of determining the recoverable amount of the unit. A CGU may be a segment or a component of an assets or disposal group for which separate cash flows can not be attributable as a unit but as a group of units. The concept of CGU is important because it provides a guide for apportioning impairment loss or identifying the recoverable amount of an asset when it is not possible to allocate cash flows to a particular unit. SCOPE OF IAS 36 The standard does not cover the following assets treated in other accounting standards: Financial assets (IAS 39 & 32) Assets arising from Employee Benefits Scheme (IAS 19) INDICATIONS OF IMPAIRMENT LOSS ON ASSETS There are two sorces for identifying indications of mparment of assets namely; internal evidenece and external evidence. EXTERNAL FACTORS When there is a significant drop in the market value of an asset as compared with its carrying amount in the SOFP. Significant adverse technological changes which could possible throw the assets out of fashion. When the market interest rate rises significantly above the cost of capital which was applied in determining the value in use of such an asset. When the net assets of a firm is significantly higher than its market capitalization. INTERNAL FACTORS - Obsolescence - Physical damage to an asset which makes it impossible for the assets to perform to its original capacity even after repair PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 37

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The inability of an asset to function and produce up to the managements original projectio ns when the plan to acquire the asset was made. NET REALISABLE VALUE OF AN ASSET This is the amount that will remain when the attributable cost of disposal is deducted from the sales proceeds of an asset. Such attributable costs are: refurbishment costs, professional fees, Capital Gains Tax etc such as below: $m xxxxx xxx xxx xxx -

Sales Proceeds Cost to Sale: Refurbishment Costs Legal fees Other statutory fees NET PROCEEDS

(xx) xxx

VALUE IN USE The value in use of an asset is the sum of the discounted net cash flows arising from the future use of an assets including its residual value using the companys cost of capital in determining the value in sue of an asset, the following variables are relevant: - The predicted future cash inflows, - The predicted future cash outflows - The net inflows - The required rate of return (cost of capital), - The residual value of the assets (if any). Thus it can be said that the value in use of an asset is the intrinsic value of such asset. However much judgment is involved in determining value in use, thus VIU suffers from all the shortcomings of the NPV method of investment appraisal. VALUE IN USE- EXAMPLE Amoco Plc has machinery which manufactures a component whose unit selling price is $5. The annual production and sales of this product is 50,000,000 units. The associated cost of operating the machine is $18m per annum. This machine has an estimated useful life of 5 yrs from the date of purchase after which it will be disposed for $0.8m. Required: Calculate the value in use of this machine if the companys cost of capital is 10%. Assuming that the current market value of this machine is $27m and that legal expenses associated with the disposal is $0.5m, calculate the recoverable amount of the machine. CASH GENERATING UNITS There are situations when it is impracticable to identify cash flows attributable to an individual assets separately from other assets in the entity. In this situation, the cash flows attributable to the CGU should be used. A CGU is an identifiable group of assets treated as a single unit. A CGU is comparab;e to an operating segment per IFRS 8. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 38

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EXAMPLE OF A CGU Assuming a logistics company acquires the license to operate a railway bus to three different routes which cannot be operated in isolation based on the agreement signed with the government. Some years after, it was discovered that one of the rail routes is running at a loss. The firm now wishes dispose off the loss making route but the government refuses, could the route alone be said to be a CGU? The answer is obviously no! Since the route cannot be disposed individually; the whole of the three routes is a CGU. RULES FOR APPORTIONING IMPAIRMENT LOSSES TO CGUs When impairment is identified in a CGU, the loss should be spread to components of the asset as follows: - First, to the particular which is impaired - Secondly, to goodwill arising on the acquisition of the asset, - To other components of the asset on a pro rata basis. MEARUREMEMTN OF IMPAIRMENT LOSS The measurement of impairment loss depends on whether the asset is carried at historic cost or at a revalued amount as follows: WHEN AN ASSETS IS CARRIED AT HISTORIC COST The difference between the recoverable amount and the carrying amount i.e. the impairment loss is taken directly to profit or loss as an expense in full in the year in which the impairment occurred. WHEN THE ASSET IS CARRIED AT A REVALUED AMOUNT The impairment loss is firstly used to write of any existing revaluation surplus which had been credited to equity, if there is any remnant, the amount is written off in full from profit and loss in the period under review. This is to say that the impairment first affects owners equity before the profitability for the year. EXAMPLE OF IMPAIRMENT LOSS WHEN AN ASSET IS CARRIED AT REVALUED AMOUNT An asset which has a carrying amount of $30m in the SOFP now has a recoverable amount of $28m. The original cost of the asset was $29m. Show the treatment of the assets in the financial statements at year end. IMPAIRMENT LOSSES AND GOODWILL Impairment tests are conducted on cash generating units on annual basis. Any asset which generated goodwill on acquisition must be tested together with the goodwill on its acquisition. However, there is always a complication there is non controlling interests in the acquisition. In this case, the impairment loss is shared between the owners of the parent and the NCI if the NCI is valued at its proportionate share of the identifiable net assets of the subsidiary. An example is given below: IMPAIRMENT TESTING INVOLVING NON CONTROLLING INTEREST PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 39

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EXAMPLE P acquires 80% of S for the sum of $1,600,000 when the net assets of S were $1,500,000 on 1st January, 2010. The identifiable net assets of S on 31 st December, 2010 were $1,350,000. The recoverable amount of S on that date was $1,000,000. Calculate the impairment loss as at 31st December, 2010. IMPAIRMENT TESTING INVOLVING PARTIAL GOODWILL EXAMPLE P has interest in two companies as follows: BRICKSTONE Acquired 80% of Brickstone some years ago for $600,000 when the fair value of Brickstone net assets was $400,000. All available profits were distributed at year ends therefore the net assets remained $400,000 at the relevant date. The recoverable amount of Brickstone was $520,000. DULLER Acquired 85% interest in Duller when the net assets of Duller were $700,000 at a cost of $800,000. At year end, the net assets remained the same but the recoverable amount of the net assets was $660,000. Required: a. The carrying amount of Brickstone that will be used to compare the recoverable amount for impairment testing purpose. b. The carrying amount of goodwill in respect of Brickstone after the recognition of any impairment loss. c. The carrying amount of any non controlling interest in Duller after the recognition of any impairment loss. REVERSAL OF IMPAIRMENT LOSS An asset which had previously suffered a write down as a result of an impairment loss will need to be restated at its current value as follows: - Recognize the revaluation surplus in the statement of comprehensive income as an income in the period of the reversal. - Restate the carrying amount of the asset in the SOFP to its current value.

TESTING QUESTION On 1st January, 2012, Multiply Plc acquires Steamdays, a company that operates a railway from Lagos to Maiduguri. The summarized SOFP at FV of Steamdays on 1 st January, 2012 reflecting the terms of the acquisition is as follows: PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 40

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Goodwill Operating License Property (train stations and land) Rail tracks and coaches 2 units of steam engines PURCHASE CONSIDERATION $000 200 1200 300 300 1000 3000

The values of property and rail tracks and coaches are based on their value in use. The engines are valued at their net selling prices. On 1st February, 2012, Boko Haram the insurgents in Northern Nigeria targeted and bombed one of the steam engines and it damaged beyond repair. As a result of the damage of one of the steam engines, the passenger capacity of the company reduced and the value in use of the whole business after the incident was determined at $2m. As a result of fear of a repeated attack on the facilities of Multiply Plc, passenger capacities continued to reduce sporadically. In the light of this, the value in use of the whole business was further reduced to $1.8m on 31st March, 2013. On this date Multiply Plc received an offer of $900,000 for the operating license (it is transferable). The realizable value of the other net assets has not changed significantly. Require: Calculate the carrying amount of assets of Steamdays in Multiplys SOFP at 1 st February, 2012 and 31st March 2012 after recognizing the impairment losses.

IAS 37: PROVISIONS, CONTIGENT LIABILITIES AND CONTIGENT ASSETS INTRODUCTION PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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IAS 37, Provisions, Contingent Liabilities and Contingent Assets is an accounting standard which deals with the controversial issues regarding the making of provisions and the recognition of contingent assets by reporting entities. Before now, there was no accounting standard on these issues thereby prompting reporting entities to adopt varying accounting practices regarding provisions. The objective of IAS 37 is to provide basis for the recognition, measurement and disclosure requirements relating to provision; this is necessary to discourage the use of provisions for creative accounting through profit smoothing. Prior to IAS 37, reporting entities make provisions of huge amounts in years when there are huge profits only to unwind them when there are little or no profits in future years thereby undermining the reliability of the financial reports. TERMINOLOGIES The following terms are necessary for the understanding of IAS 37: PROVISION: A liability with uncertain timing and amount LIABILITY: An obligation on a reporting entity arising from past events in which settlement will probably lead to an outflow of resources embodying economics benefits. CONSTRUCTIVE OBLIGATION: An obligation created by a reporting entity through its actions which have created a valid expectation among other parties that the entity will settle such obligation on its occurrence. PROVISIONS As stated in the terminology, a provision is a liability of an uncertain timing and amount. Thus, a provision is an obligation (legal or constructive) on a reporting entity but the time such an obligation will crystallize and the actual amount to be used to settle such obligation may not be certain until a future period. Thus, the issue of recognizing provisions in financial statements is complex and subjective in nature. RECOGNITION OF PROVISIONS IN FINANCIAL STATEMENTS The standard prescribes the criteria for the recognition of provisions in financial statements as follows: 1. The reporting entity must be under legal or constructive obligation to settle the liability, 2. There is probable outflow of resources embodying economics benefits from the reporting entity. 3. The amount of the provisions must be capable of being measured reliably. PROBABLE OUTFLOW OF RESOURCES EMBODYING ECONOMIC BENEFITS The issue of probable outflow of resources embodying economic benefits can be viewed from the degree of certainty attached to the crystallization of the obligation. A probability of more than 50% can be assumed to be enough to imply that the reporting entity is obliged to settle a liability an so, a provision should be created.

OBLIGATION The reporting entity must be obliged either by law or by its own undertaking to settle a liability before a provision could be created. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 42

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COSTS MUST BE CAPABLE OF BEING MEASURED RELIABLY For a provision to be created, the cost of settling the legal or constructive obligation must be capable of being measured reliably. This means that if the estimate of the amount that will be involved in settling an obligation is not certain, a provision should not be created instead disclosure should be made of a contingent liability. MEASUREMENT OF PROVISIONS There are two methods of estimating provisions viz: expected values method (probability) and discounted cash flow technique or the present value method. EXPECTED VALUE METHOD: in this approach, the amounts involved shall be determined applying the probability of occurrence to the expected outflow. An expected value is the product of an assigned probability and the amount of liability. EXAMPLE 1 Emeka plc sells goods to its customers with a warranty which covers free fault rectification on any of those products sold within its first six months. The companys past history of product returns as a result of defaults shows the following: % of goods sold Defaults Cost of repairs on those items 60 None 0 30 Major $1.5m 10 Minor $5.0m Estimate the provision required. DISCOUNTED CASH FLOW METHOD This method is used when the effects of the time value of money is significant. In essence, the obligation will be settled gradually over some years. In this method, the amounts which will be needed to settle the obligations in future years will be discounted using the companys cost of capital . The discounted amounts shall be used as the provision and the difference between the provision in an earlier and later years will be treated as a finance cost used for unwinding the discounted amount. An example will buttress this fact: EXAMPLE 2 A company has an obligation of paying clean up costs in one of its mining sites at the end of the mining period. The mining activities will last for five years, the relevant cost of capital is 10% and the amount to be incurred in the clean up exercise is $6m in the fifth year. Show how this will be treated in the books of the company in the first and second years of operation. WHAT CONSTITUTES POSSIBLE PROVISIONS WARRANTY COSTS: These constitute provisions as the company has incurred a legal obligation by embedding warranties into the sales contracts with customers. If any sales agreement includes a PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 43

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commitment to make good any defect arising from the product sold within a specified period, then all products sold which are still eligible within the threshold of time are having a liability attached to them until the warranty period expires. ENVIRONMENTAL COSTS: If there is any legislation demanding a reporting entity to spend a stipulated amount for the maintenance of the environment a part of the conditions to operate, then such constitutes a liability to the reporting entity hence a provision should be created. DISMANTLING AND DECOMMISIONING COSTS: Companies who are engaged in activities which require that temporary structures put in place for the purpose of their activities will need to be dismantled at the end of their operations will need to make a provision for dismantling and decommissioning costs. A typical example of this are oil exploration companies who are required by law to dismantle their oil platforms at the of the exploration period. ONEROUS CONTRACTS: These are contracts in which the revenue accruable is less than the expenses involved in generating the revenue and the entity is under obligation to execute the contract under such unfavourable terms. Once a situation like this occurs, a provision should be recognized for the onerous contract and written off over the period of undertaking the contract. RESTRUCTURING COSTS: These qualify for provisions provided that certain criteria are met as will be discussed later on. WHAT DOES NOT CONSTITUTE PROVISIONS REPAIR COSTS: The cost of carrying out a major repair on an asset was used to being capitalized and amortized over the useful life of the assets. IAS 37 has abolished this practice. Hence, all repairs are not qualified to be recognized as provision as the company is not under any obligation to carry out major repairs on its assets. SELF INSURANCE: The practice of some companies setting aside a special fund for the purpose of using them to recover from any possible loss incurable from any insurable risk has been abolished by IAS 37. Hence, self insurance does not meet the criteria spelt out for the recognition of provisions as the company is not under any obligation for such captive insurance and secondly, there is no certainty attached to what could be the amount that may be needed to make good the losses until such losses occur. RESTRUCTURING COSTS MEANING IAS 37 defines restructuring as a planned activity which will lead to a significant change into the management structure of the company or the manner in which its business is carried out. CRITERIA FOR RECOGNITION OF RESTRUCTURING COSTS The following are the criteria for recognition of restructuring costs: - Management has created a valid expectation on those to be affected by the planned activity. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 44

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Those to be affected by the plan have been communicated formally about the restructuring and activities are in progress to implement the plan. It then follows that a mere announcement of a planned restructuring without concrete evidence to show that management is committed to implement such plans does not qualify to be created as a restructuring provision. WHAT QUALIFIES AS RESTRUCTURING COSTS The following qualify as restructuring costs: 1. A planned relocation of a business operation from one region of a country to another region or from one country to another. 2. The closing down of one product line for another product line or the changing of the critical business processes. 3. The change in the management structure of an organization such as the introduction of a new layer of management or the introduction of outsourcing of various support services thereby eliminating a particular management cadre. 4. A change on the major focus of an organization such as change from importation of finished products to establishing a factory to produce such goods locally. MEASUREMENT OF RESTRUCTURING COSTS The following costs are the costs of restructuring: 1. All expenses directly attributed to the execution of the restructuring activities i.e. any expenses which would not have been incurred had the restructuring exercise not taken place. 2. Any expenditure which does not fall into the ongoing operations of the company. NON QUALIFYING COSTS OF RESTRUCTURING The following costs are not permissible in determining restructuring costs: 1. Training and retraining costs 2. Marketing costs 3. Investment in new technology DISCLOSURE REQUIREMENT IN RESPECT OF RESTRUCTURING COSTS IAS 37 requires that the following disclosure shall be made in the notes to the financial statements: 1. The change in the carrying amount of the restructuring costs between the opening period and the closing period. 2. The circumstances surrounding the recognition of the restructuring costs i.e. details of the restructuring program including progress made in its implementation. CONTIGENT LIABILITIES INTRODUCTION When a provision is not likely to be created, then a contingent liability may arise. A contingent liability is defined in two ways: 1. A present obligation arising from past events in which settlement will be determined by the occurrence of an event which is beyond the control of the entity. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 45 -

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2. A possible obligation on the entity arising from past events in which: - It is not probable that those resources embodying economics benefits will flow from the entity. - The amount of the obligation cannot be measured reliably. It then goes that contingent liabilities arise when it is not quite certain that a firm will incur an obligation from a matter under consideration. EXAMPLES OF CONTINGENT LIABILITY The following are examples of contingent liabilities: - A pending litigation against the company by a client, the government, an employee or group of employees etc in which if the matter is determined against the company will lead to the company settling a liability. - An impending legislation which will be in force in the nearest future in which the reporting entity may incur a liability from non compliance as a result of inability to provide resources to effect the requirement of the law. E.g. if there is a law soon to be enacted that all food outlets operating a recycling of their waste products, any of the food outlets who does not have the resources to acquire a recycling machine within the shortest possible time should disclose a contingent liability. ACCOUNTING TYREATEMENT OF A CONTINGENT LIABILITY A continue liability should NOT be recognized instead DISCLOSURE should be made by way of notes to the accounts. DISCLOSURE REQUIREMENTS WITH RESPECT TO CONTINGENT LIABILITIES The relevant disclosures are: 1. The nature and circumstances surrounding the contigent liability. 2. The financial effects in the accounts 3. The extent of uncertainties involved, and 4. The possibility of any reimbursements. CONTIGENT ASSETS A contingent asset is a converse to a contingent liability. It is defined as a possible asset arising from past events which existence will be confirmed by the occurrence of one or more uncertain future events which is beyond the control of the reporting entity. A contingent liability should not be recognized in the face of the SOFP rather it should be disclosed as notes to the accounts. EXAMPLES OF CONTIGENT ASSETS 1. A court case in which its settlement will possibly be in the advantage of the company to receive compensation from a third party in the form of cash or other resources embodying economic benefits. 2. A yet to be enacted legislation which will be in the favor of the company through the use of existing facilities to help clients to comply with the legislation by receiving fees or other resources embodying economic benefits by the reporting entity. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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3. A promise by a trust to bequeath a property held under a trust to a third party (the reporting entity) on a conditional basis and the condition for which the bequeathed may not have the wherewithal to fulfill. DISCLOSURE REQUIREMENTS WITH RESPECT TO CONTINGENT ASSETS 1. The financial effects of the contingent assets on the financial results of the year. 2. The uncertainty surrounding the contingent asset. 3. The possibility of any reimbursement. PRACTICE QUESTIONS 1. In 2002, Smoky Plc gives a guarantee of certain borrowings of Coolheaded Plc one of its subsidiaries whose financial condition at that time was sound. In 2003, the financial condition of Coolheaded deteriorates and at 30th June, 2003, Coolheaded Plc filed for bankruptcy and sought protection from its creditors. Required: Explain the accounting treatments of the scenarios in the books of Smoky Plc on: i. 31st December, 2002. ii. 31st December, 2003. Assume that the accounting year of Smoky Plc (the guarantor) runs from 1st January to 31st December annually. 2. Treasurehall Consulting gives warranties to candidates studying for the ICAN professional exams program from them. Under the terms of the agreement, Treasurehall undertakes to refund at least 10% of ICAN exam registration fee to any final level candidate who has reference in more than two papers out of four. The condition underlying the warranty is that such candidate must have passed a mock exam in those papers failed prior to writing the ICAN exam. Records show that all the candidates passed all their mock exam papers before attempting the ICAN exams. Should a provision be made? 3. After a birthday party in 2010, ten people died, possibly as result of food poisoning from products sold by Megacow Restaurants Plc. Legal proceedings have commenced seeking damages from Megacow restaurants Plc but it disputes the liability. Up to the date of approval of the financial statements for the year 2010, Megacows lawyers are optimistic that no liability will be incurred from the case. However on 28th December, 2011, the lead counsel advised the management of Megacow that the matter is gradually turning against the company as a result of the result of an autopsy test submitted as an evidence from the counsel representing the litigants ( the customer who celebrated a birthday party). What is the accounting treatment of the above scenario in the books of Megacow restaurant Plc on: i. 31st December, 2010 ii. 31st December, 2011. 4. IAS 37 Provisions, Contingent Liabilities and Contingent Asset was issued in 1998. Prior to its publication, there was no IAS that dealt with the general subject of accounting for provisions. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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Extractor Oil & Gas Plc is involved in extracting minerals in different oil rich nations of the world. The exploration activity involves contamination of the physical environment were the exploration is carried out. Extractor Plc is conservative and only clean up sites in countries where the law makes it obligatory. During the years 2010 and 2011 the following events occurred: The company has been extracting oil and gas from the Niger Delta region of Nigeria since 2008 and it is expected that the exploration will end by 2015. On 23 rd December 2010, it became clear to Extractor Plc that the government of Nigeria was virtually certain to pass a law requiring the making good of exploration sites at the end of its useful life. The legislation was passed on 20th April 2011. The directors estimate that the cost of cleaning up the Niger Delta site will be $3m when the site is decommissioned in 2015. Required: i. Explain why there is need to have an accounting standard with respect to provisions, and outline the criteria for recognition of provisions in financial statements. ii. Compute the effect of the clean up costs in the financial statements of Extractor for both 2010 and 2011 accounting years. Explain the figures derived and how they will be disclosed in the accounts. The discount rate to be used is 10%. Round off discount factors to three decimal places.

FINANCIAL INSTRUMENTS OVERVIEW Financial instruments are covered by three international accounting standards namely: 1. IAS 32- which deals with the accounting issues relating to the presentation of financial instruments including the treatment of compound instruments in terms of valuation and split into long term liabilities and equity considering its substance over form. 2. IAS 39 deals with recognition and measurement of financial instruments considering the nature of classification of financial instruments, not also forgetting the topic of hedging using derivatives. 3. IFRS 7 discusses the disclosure requirements with respect to financial instruments. It is an international accounting standard which replaced parts of the revised IAS 32. THE IMPORTANCE OF FINANCIAL INSTRUMENTS The need for an accounting standard dealing on financial instruments can be attributed to the following factors: 1. The growth of international trade has led to a rapid increase to the use of financial instruments in settling indebtedness and sourcing for funds for business financing. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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2. The use of financial instruments is complex and subject to manipulation hence affecting the reliability of financial statements. This also creates risk of misstatement which increase audit risk. 3. Cases of high profile corporate failures due to the use of derivatives for creative accounting have raised awareness regarding the knowledge of financial instruments. DEFINITION OF TERMS IAS 32 and IAS 39 has the following terminology which their understanding is essential for the understanding of the remaining notes: FINANCIAL INSTRUMENTS: a contractual agreement between two parties which gives rise to a financial asset to one party and a financial liability of the other party. FINANCIAL ASSET: a contractual agreement which gives the holder the right to receive cash or other financial asset in exchange in a manner which is favorable to the holder. FINANCIAL LIABILITY: a contractual agreement between two parties in which the issuer is obliged to part with cash or other financial instruments in settlement of a consideration in a manner which is unfavorable to the issuer. DERIVATIVES: a contractual agreement which will either give rise to a financial asset or a financial liability depending on the outcome of an event which is beyond the control of the holder. CONTRACT: a contractual agreement (written or unwritten) between parties which creates a right or an obligation on either party arising from an offer and acceptance which is enforceable in law. WARRANTS: a derivative which gives the holder the right but not an obligation to receive cash or other financial assets of the issuer on the occurrence of an event beyond the control of the issuer. OPTIONS: a derivative which gives the holder the right but not an obligation to the equity instrument of the issuer at an agreed amount and at an agreed period.

IAS 32: FINANCIAL INSTRUMENTS - PRESENTATION IAS 32 discusses the issues relating to the presentation of financial statements with respect to classification between financial assets and financial liabilities. It also handles the valuation of convertible debts focusing on the split of convertible debts into long term liability and equity according to the substance of the instrument and not on its legal form. SCOPE OF IAS 32 The standard does not cover issues treated in other standards such as subsidiaries, associates and joint ventures. EXAMPLES OF FINANCIAL ASSETS 1. Cash, 2. Receivables, 3. Equity instrument of other entities, and 4. Options EXAMPLES OF FINANCIAL LIABILITIES 1. Payables, 2. Bonds and debentures, 3. Redeemable preference shares. PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 49

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LIABILITY AND EQUITY DISTINGUISHED There is a distinction between liability and equity which need to be highlighted to facilitate the explanation of why debts are stated separately from liabilities. The distinction is a matter of substance over form. A liability makes the issuer obliged to settle interested parties on periodic basis while an equity does not confer an obligation on the issuer because an entity is not compelled to pay dividends while the interest and principal repayments on debts must be paid as at when due. In essence, fixed interest securities are liabilities while variable income securities are equity. COMPOUND FINANCIAL INSTRUMENTS Some financial instruments have equity embedded in them. An example is a convertible loan which gives the holder the right but not an obligation to convert them to equity. IAS 32 states that such instruments shall be split into long term debt (depending on maturity) and equity portion using the discounted cash flow technique using an appropriate cost of capital derived from the effective interest rate of the loan. This split is justified because the substance of such debts is that there is equity in the debt therefore the debt is the sum of the equity portion and debt portion.x2 EXAMPLE 1 Ratrace Ltd issues 4,000 convertible loan on 1st January, 2012. The bonds have a four year term and issued at a nominal price of $500 each. Interest is payable annually in arrears at an annual coupon rate of 5%. Each unit of loan is convertible at any time at 200 ordinary shares per unit. The market interest rate for similar loans is 8%. Required: 1. Calculate the equity portion of the loan, and 2. Show the presentation of the financial instrument in the accounts for the year ended 31 st December, 2012. EXAMPLE 2 Samoa Plc issues a $30m convertible debt at 5% nominal rate on 1st January, 2006.the loan is convertible to 30 shares per $100 loan notes at the option of the holder up till 31 st December, 2010. Similar loans carry an interest rate of 7%. Show how this debt is presented in the financial statements of the reporting entity on 31st December, 2010. TREATMENT OF INTERESTS, DIVIDENDS, LOSSES AND PROFITS IAS 32 clarified the manner in which profit and loss items relating to the classification of financial liabilities and equity instruments as follows: 1. When there are interests, and gains or losses arising from financial liabilities, such gains and losses should be written off in P & L in the period they relate. 2. The dividends payable on equity instruments are passed through the statement of changes in equity, this dividends are written off share premium (if any) or against retained earnings. 3. The costs of issuing an equity instrument is used to write down the proceeds of the share issue and not written of P & L as finance cost as one would think ordinarily. DISCLOSURE REQUIREMENTS: IFRS 7 PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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IFRS 7 was used to amend the disclosure requirements of IAS 32 as part of the revision done to the standard. It contains the issues relating to the extent of disclosure expected from entities that has items of financial instruments in its financial statements. The following are relevant: 1. There is no fast rule to disclosure; however enough explanatory notes are expected to promote the understandability of the financial statements. 2. The entity shall give report on the use of financial instrument for risk management purposes. 3. Judgment shall be exercised in providing details of financial instruments in the financial statements. 4. The classifications of financial instruments by characteristics are encouraged. IAS 39: RECOGNITION AND MEASUREMENT IAS 39 is a continuation of IAS 32 dealing with the recognition of financial instruments in the financial statements. Recognition is a process of incorporating an item in the financial statements. RECOGNITION OF FINANCIAL INSTRUMENTS Financial instruments should be recognized in financial statements when an entity enters into a contract giving rise to the instrument. This is contrary to other standards which gives recognition on the bases of if the contract would probably lead to an inflow of resources embodying economics and the costs can be measured reliably. Financial instruments should be derecognized when the right to receive the benefits or the obligation to settle a contract does not lie on the issuer or holder. For a financial liability, it will be when the firm is no longer having an obligation with respect to a debt instrument; while in the case of a financial asset, it will be at the point where one of these two things happen; 1. The holder no longer have the right to receive any more cash flows from the instrument, or 2. When the risk and reward underlying the instrument is transferred to another party.

INITIAL MEASUREMENT OF FINANCIAL INSTRUMENTS Financial instruments shall be measured at cost on initial recognition. The cost of a financial instrument is the acquiring costs plus the transactions costs i.e. directly attributed costs of issue. However, fair values can be used for the recognition of traded instruments except for instruments designated at fair value through profit or loss whereby the issue costs are written off to P & L immediately they are incurred. The FV can be determined using DCF techniques unless there is a realistic market value for the instrument. SUBSEQUENT MEASUREMENTS OF FINANCIAL ASSETS After initial recognition, subsequent measurements depend on the classification of the instrument. The following are possible classification of financial assets and the methods of subsequent measurements: 1. FAIR VALUE THROUGH PROFIT OR LOSS This method assumes the fair value of the instrument without adjustment for costs of disposal. In this case, the instrument is revalued annually in group and adjustments in carrying amount written off to P & L. This is the method recommended by IAS 39; however it is not to be used when other classification had been used for initial recognition. This classification is appropriate for assets held for trading as PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate) Page 51

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part of a portfolio. Any asset classified initially, as fair value through profit or loss cannot be reversed in the future. 2. HELD TO MATURITY These are financial assets which the holder intends to hold to maturity as a way of receiving the returns on the investment in the form of interests. They are measured at amortized costs. The holder of such a financial asset must be capable of holding them till maturity by demonstrating the financial strength to do such, the instrument must not be held for trading or resale during capital appreciation. 3. LOANS AND RECEIVABLES These are advances made to third parties in the form of outright lending or through the supply of goods and services with unconditional terms of repayment. They also measured at amortized cost. 4. AVAILABLE FOR SALE FINANCIAL ASSETS These are other financial assets which do not fall into any of the above three classifications. They are measure at fair value. Any adjustments through FV measurement should be taken to statement of changes in equity in the period they occur. THE USE OF AMORTIZED COSTS IN MEASURING FINANCIAL ASSETS An amortized cost is the initial cost of a financial instrument minus principal repayments, plus interest payable and or impairment write off and the amortization of the difference between the original amount and the carrying amount to the end of the tenor of the asset. This in essence means that the asset shall be valued at its adjusted cost annually until the instrument is liquidated. The computation of the amortized cost of a financial instrument involves taking into consideration, the nominal value, the issued value, the coupon (nominal) rate and the effective interest rate. The effective interest rate is the rate which is used for discounting the cash flows arising from a financial instrument until the end of its tenor. The effective interest rate method is a method of calculating the amortized cost of a financial instrument whereby the interest income and expense is added or deducted from the carrying amount of the instrument and spread over its tenor. An example will better illustrate all these: EXAMPLE 3 Adam Plc purchased a debt instrument on 1st January, 2000 for its fair value of $537,907.40. The maturity date of the debt is 31st December, 2004. The nominal value of the debt is $500,000 with a fixed interest rate of 12% per annum. Similar debts traded on the alternative investment markets have an interest rate of 10%. What is the value of this debt over its life? SUBSEQUENT MEASUREMENT OF FINANCIAL LIABILITIES All financial liabilities are to be measured at amortized costs, except if the financial liabilities were measured at fair value through profit or loss which should be carried at fair value.

PREPARED BY: EMEZI FRANCIS OBISIKE, AAT, ACA, ACCA (affiliate)

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