Revision set 5 answer

Goodwill arising on acquisition of foreign operations is treated as the foreign operation’s asset. At
each reporting date, it is translated at the closing rate of exchange.

Dinar m Rate $m
Cons trans 368 8 46.00
NCI (210m shares × 40% × 2.62 dinars) 220 8 27.51
FV of NA (s cap 210 + RE 258 +
FV adj (70 - 50)) (488) 8 (61.00)
100 12.51
Impairment loss (20) 8.5 (2.35)
Gain on forex (OCI) (OCE) (1.73)
At YE 80 9.5 8.42

Goodwill is an asset of subsidiary. It is first translated to $ at acquisition date, and retranslated

(together with other assets and liabilities) to year end rate. Effect of changes in foreign currency
exchange rate will be recognised to other comprehensive income, and retained in exchange reserves
in other component of equity.

(ii) Translation reserve

Foreign exchange differences arise when translating Tyslar into the presentation currency of the
group. This is because:
• goodwill is retranslated every year at the closing rate
• the net assets are retranslated closing rate
• profit for the year is translated in the SOPL at the average rate but net assets in the SOFP are
translated at the closing rate.

Exchange differences arising on the retranslation of an overseas subsidiary are recorded in OCI.

Exchange differences arising on the translation of the subsidiary’s opening net assets and profit are
attributable to the owners of the group and NCI. Exchange differences arising on the translation of
goodwill are attributable to the owners of the group and the NCI if the NCI at acquisition was
valued at its fair value.

Re-translation of F/S of Stem Dinar m Rate $m

S cap 210 8 26.25
RE pre 258 8 32.25
FV adj 20 8 2.50
RE post 34 8.5 4.00
Exchange res (bal fig) (10.05)
522 9.5 54.95

Group translation reserves $m

From goodwill (1.73)
From translation of F/S (10.05)
(11.79)
x 60%
(7.07) Dr

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(iii) The property should have been recognised at $7 million, which is the fair value of the
consideration transferred to acquire it. A profit on the disposal of the land of $2 million ($7m –
$5m) should also have been recorded. The correcting entry is:
Dr PPE $2m
Cr P/L $2m

The staff relocation costs should not have been capitalised. The correcting entry is:
Dr P/L $0.5m
Cr PPE $0.5m

The building should be depreciated over its useful life, giving a current year charge of $0.1 million
($7m/35 × 6/12):
Dr P/L $0.1m
Cr PPE $0.1m

At the reporting date, the building should be revalued from its carrying amount of $6.9 million
($7m – $0.1m) to its fair value of $7.9 million (D75m/9.5). The gain is recorded in other
comprehensive income. The entry to record it is:
Dr PPE $1.0m
Cr OCI $1.0m

The total property, plant and equipment balance is calculated as follows:

$m
Bubble 280.0
Tyslar (D390/9.5) 41.1
Tyslar fair value adjustment (D20m/9.5) 2.1
PPE cost adjustment 2.0
Removal of incorrect costs (0.5)
Depreciation (0.1)
Revaluation 1.0
325.6

(b) Functional currency of an entity is the currency used in its primary economic environment. It is
the currency used mainly in management planning, and the location of business has little relevance
in deciding the functional currency.

Tyslar is a member of a group. Usually, if Tyslar is under tight control of the parent, its functional
currency is most likely same as the group. However, in this case, Tyslar is not an extension of the
group as it has high level freedom to do its own decision.

As the selling price of Tyslar’s output is determined by local supply and demand of the foreign
country which uses Dinar, Tyslar’s planning is most likely in Dinar too. The functional currency of
Tyslar should be Dinar.

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Q2

Intangible asset

An intangible asset has an indefinite useful life only if there is no foreseeable limit to its useful life.
Difficulties in accurately determining an intangible asset’s useful life do not provide a basis for
regarding that useful life as indefinite.

In the case of JonJon, the customer relationship is with individuals so there is, is by definition, a
time limit to that relationship. Therefore JonJon is contravening IFRS. Failing to amortise
intangible assets will overstate profits and assets in the current period.

Investment property

The valuation method used by Jonjon is cost approach, where the depreciated value of a new
property is used to represents fair value (FV). This approach is not the first choice of IFRS, and
there are lots of unobservable input such as estimating the age and level of obsolecense, which are
essentially level 3 input.

The market rental may be used to estimate FV, which is described as income approach in IFRS.
However, the best approach is to use market selling prices, which is known as market approach.

Jonjon should change its FV measurement basis, and follow guidance in IFRS rather than the
industry practice.

CGU impairment

ICash flow projections used in measuring value in use shall be based on reasonable and supportable
assumptions which represent management’s best estimate of the range of economic conditions
which will exist over the remaining useful life of the asset.

Management must assess the reasonableness of the assumptions by examining the causes of
differences between past cash flow projections and actual cash.

Management should ensure that the assumptions on which its current cash flow projections are
based are consistent with past actual outcomes.

Despite the fact that the realised cash flows for 20X5 were negative and far below projected cash
flows, the directors had significantly raised forecasted cash flows for 20X6 without justification.
There are serious doubts about JonJon’s ability produce realistic and reliable forecasts.

It would seem that the cash flow projections that the finance director of JonJon wants the
accountant to use are not in compliance with IAS 36. These projections will most likely over-state
the recoverable amount of the CGUs, potentially reducing (or eliminating) the amount of any
impairment loss. This would overstate profits and assets in the current period.

Ethics

JonJon has breached several accounting standards. All of these breaches over-state reported profits
and assets. This will make the performance and position of JonJon appear much stronger to the

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users of its financial statements. In particular, it will reduce the likelihood that JonJon will breach
its loan covenants.

Incentives might exist to depart from particular IFRS and IAS Standards. The fact that the
management consistently over-state assets and profits would suggest that the breaches of
accounting standards are purposeful. If so the directors of JonJon lack integrity and objectivity.

Accountant (AC) should discuss the potential negative impacts of the above with directors, and
document down the discussion. If the outcome is not satisfactory, then AC should bring this matter
to non executive board for further action.

Q3

(a) (i) Financial asset

Debt instruments measured at FVOCI are measured at fair value in the SOFP.

Interest income is calculated using the effective interest rate. Fair value gains and losses on these
financial assets are recognised in OCI.

Expected credit losses (ECLs) do not reduce the carrying amount of the financial assets, which
remains at fair value. Instead, an amount equal to the ECL allowance is recognised in OCI.

When these financial assets are derecognised, the cumulative gains and losses previously
recognised in OCI are reclassified from equity to profit or loss.

Therefore the accounting for the instrument should be as follows:

• The bonds will be initially recorded at $6 million
• Interest of $0.24 million will be received and credited to profit or loss.
• At 28 February 20X7, the bonds will be valued at $5.3 million. The loss of $0.7 million will be
charged as an impairment loss of $0.4 million to profit or loss and $0.3 million to OCI.
• When the bond is sold for $5.3 million on 1 March 20X7, the financial asset is derecognised and
the loss in OCI ($0.3 million) is reclassified to profit or loss.

(ii) Revenue recognition

Entities will recognise an asset when costs incurred to fulfil a contract meet certain criteria, one of
which is that the costs are expected to be recovered. For costs to meet the ‘expected to be
recovered’ criterion, they need to be either explicitly reimbursable under the contract or reflected
through the pricing of the contract and recoverable through the margin.

General and administrative costs cannot be capitalised unless these costs are specifically chargeable
to the customer under the contract. Similarly, wasted material costs are expensed where they are
not chargeable to the customer.

Therefore a total expense of $15 million will be charged to profit or loss and not shown as assets.

A penalty is a form of variable consideration. The penalty payable should be estimated and
deducted from the transaction price if it is highly probable that a significant reversal in the amount
of revenue recognised will not occur when the uncertainty is resolved.

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The construction of the separate storage facility is a distinct performance obligation; the contract
modification for the additional storage facility would be, in effect, a new contract which does not
affect the accounting for the existing contract. When the contract is modified for the construction of
the storage facility, an additional $7 million is added to the consideration which Carsoon will
receive. The performance obligation has been satisfied so this revenue can be recognised in full.

(b) Management commentary (MC)

MC is a narrative report in which management provide context and background against which
stakeholders can assess the financial position and performance of a company. It is not mandatory to
produce a management commentary.

MC should include forward-looking information. The commentary should be entity-specific, rather

than generic.

Link to Conceptual Framework for Financial Reporting

The Practice Statement states that MC should include information that possesses the qualitative
characteristics of useful financial information. The fundamental qualitative characteristics are
relevance and faithful representation. The enhancing qualitative characteristics are
understandability, verifiability, comparability and timeliness.

MC provides users with information about risk management, as well as the extent to which current
performance may be indicative of future performance. This forward-looking information is relevant
because it helps users to make decisions about whether to hold or sell investments in an entity.

To enhance relevance, MC should include material information and should focus on the most
important information. Generic information is not relevant and should be avoided.

To maximise understandability, MC should be presented in a clear and straightforward manner.

Management should calculate and report performance measures consistently over time, thus
enabling users to compare the performance of the entity year-on-year.

Q4

(b) Fair value model (includes revaluation model) are widely used in IFRS. For example,
investment property, property, plant and equipment, impairment test, agriculture, etc.

However, such model is only available as an alternative, and cost model is still used in many areas
of financial reporting as at today. Moreover, there are some IFRS restricts the use of fair value. For
example, if an entity wishes to apply revaluation model on intangible asset, such asset must be
quoted in an active market in order for the entity to have a reference fair value.

It is wrong to say IFRS implements fair value model.

The objective of financial statements (F/S) is to provide information on economic resources (assets),
claims against (liabilities), and changes in economic resources and claims against (equity, profit) to
wide range of users for their economic decision making.

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F/S are never prepared to show financial value of an entity. Such value cannot be determined by
only refering to accounting and it should be the outcome from the discussion of buyer and seller.

Therefore F/S does not fail the users of F/S.

(b ) Advantages

Foreign exchange gains and losses are volatile. Eliminating these may give the stakeholders a better
understanding of Aspire’s underlying performance. This is particularly true if the foreign exchange
gains and losses are likely to reverse before the transaction is settled.

Eliminating foreign exchange gains and losses may make Aspire’s performance more comparable
with entities that do not trade so heavily overseas.

Disadvantages

It would seem that Aspire is trying to disguise its weak performance in the current year. Adding
back the foreign exchange losses turns the $2 million operating loss of Aspire into a $1 million
profit.

Aspire’s exposure to foreign exchange losses is not wholly outside of management control.
Management could, for instance, enter into hedging arrangements to reduce their foreign currency
risk exposure. Eliminating foreign exchange losses may disguise management inactivity with
regards to foreign exchange risk management.

Whilst foreign exchange movements on long-term items (such as loans) are likely to reverse over
time, this is not the case on short-term items. A foreign exchange loss on a relatively short term
receivable means that the entity has received, or will receive, less money from their customers than
the value at which the sale was originally recorded. This is a real loss to Aspire that will affect their
cash flows and liquidity. Eliminating these foreign exchange losses is therefore inflating the
economic performance of Aspire.

It would also seem that Aspire intends to disclose this APM prominently. This might cause users of
the financial statements to wrongly believe that it is a subtotal identified within IFRS and IAS
Standards. This could have a material, and potentially misleading, impact on current and potential
investors.

(c )
Subsidiary
If accounted for as a subsidiary:
• The assets, liabilities, incomes and expenses of Kata would be consolidated in full.
• Goodwill of $1.92 million (W1) would be recognised.
• The group would recognise its share of Kata’s post-acquisition retained earnings. This amounts to
$0.27 million (45% × ($2m – ($2.4m – $1.0m)).
• The group would recognise a non-controlling interest in respect of Kata of
$1.65 million (W2).

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(W1) Goodwill
$m
Consideration 3.0
NCI at acquisition (55% × $2.4m) 1.32
Fair value of net assets at acquisition (2.40)
Goodwill 1.92

(W2) Non-controlling interest

$m
NCI at acquisition 1.32
NCI % of post-acq’n net assets
55% × ($3m – $2.4m) 0.33
1.65

Associate
If accounted for as an associate, the investment in Kata at the year-end would be carried at $3.27
million (W3).

In the statement of profit or loss, the group would show its share of Kata’s profit of $0.27 million
(W3).

(W3) Investment in associate

$m
Cost 3.0
Group % of post-acq’n P/L
45% × ($2m – ($2.4m – $1.0m)) 0.27
3.27

Assets

Consolidating Kata would lead to a higher non-current asset position than if equity accounting was
used (PPE of $14 million and goodwill of $1.92 million compared with an investment in the
associate of $3.27 million).

This will make the group look more asset rich, which may help it to raise finance in the future.
However, consolidating Kata’s large PPE balance may have a detrimental impact on the group’s
non-current asset turnover, thus making the group look less efficient at generating profits.

Liabilities

Consolidating the loans of Kata may have a negative impact on the group’s gearing ratio. This may
have the effect of making the group look riskier than if equity accounting was used. A higher
gearing ratio may make it harder for the group to raise finance in the future.

Profit or loss

Consolidating the incomes and expenses of Kata line by line will impact key profit or loss figures,
such as revenue, gross profit and profit from operations. Increased revenues will make the group’s
market share look more impressive.

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Kata is profitable so consolidating its results will improve the group’s profit from operations. This
may have a positive impact on investor perception. If Kata was accounted for using the equity
method, the group would simply shows its share of Kata’s profits as a single line below profit from
operations. This would therefore have no impact (positive or negative) on the group’s operating
profit.