Case 32 Tyre i) Revenue recognition

IAS 18 Revenue has the following requirements:

The revenue should be recognized when the risks and rewards are transferred to the buyer; The company should not retain any managerial involvement in owning or controlling the goods; Revenues and costs must be reliably measured; It is probable that the economic benefits will flow to the company. Sale to customers - Because the company promises to refund the customer in case it cannot deliver the vehicle, the value of the initial deposit (20%) should be recognized as revenue when the vehicle has been delivered to the customer, and treated as liability before the delivery. If the customer cancels the order, the deposit is recognized as revenue at the date the order was cancelled. Sale of fleet cars The company does not transfer the risks to the buyer, therefore the transaction should not be treated as a sale, but as an operating lease (only 60% vehicles value will be received by Tyre). The vehicles are shown in property, plant and equipment at carrying amount and depreciated in accordance with IAS 16. Lease income should be recognized on straight line basis over the lease term of 3 years. The discount will not be taken into account in estimating the fair value of the vehicles because it is a normal discount. The buyback option is a financial liability and is measured at fair value and amortized at cost. ii) Former administrative building

The land and the building are treated as separate elements:

The demolition of the building is proof of impairment under IAS 36; the building will not generate any future cash flows and the carrying amount is written down to zero. The loss will be charged in Profit or Loss in year up to 31 May 20x6. Demolition costs are expensed when incurred and a financial provision for environmental costs will be recognized when it arises (i.e. financial year up to 31 May 20x7). The land value will be in excess of carrying amount (the company uses cost model and prices are rising); No impairment change is recognized. After the building is demolished, the land is accounted for as investment property (IAS 40) and the gain is recognized through P&L. iii) Retail outlets

Finance lease: Lease premiums paid should be capitalized and added to the amount recognized as asset; The finance lease will be recognized at the lower of: fair value or present value of lease payments; The premium will be depreciated over the lower of: lease term or assets useful life. Operating lease: Lease premiums will be spread over lease term on a straight line basis; The premium is treated as prepayment of rent and amortized over the life of the agreement; iv) Car accessories According to IAS 37, no obligation should be recognized or provision created, because the accessories cannot be obtained until the vehicle is purchased; When the car is purchased, the accessories are treated as part of cost of sales; The revenue from the sale is the amount received from the client, and does not include the value of the accessories.

Case 40 Johan

Intangible assets are identifiable when is separable or arises from contractual or legal rights; are recognized when it is probable that future economic benefits will flow to the entity and their costs can be reliably measured. License meets above criteria and should be recognized as intangible asset at cost. Amortization is the systematic allocation if the depreciable amount (i.e. assets cost minus residual value) of the intangible assets over its useful life. The license has no residual value and should be amortized on a straight line basis (because the economic benefits of the license depend on Johans ability to benefit from its usage). The license should be amortized from the date the network is ready for use (i.e. 1 Dec 2007). Impairment The small market share and the fierce competition are evidence that the license may be impaired. An impairment test should be made, for which the license and the network assets should be classified as a single cash-generating-unit (because they cannot generate revenues on their own). Renewal Although the license is expected to be renewed, Johan has no experience and cannot reliably determine the amounts payable; therefore the license should be amortized over the initial period of 5 years. Property, plant and equipment (PP&E) Cost the cost of an item of PP&E should be recognized when: it is probable that future economic benefits will flow to the entity the items cost can be measured reliably

Feasibility study - the cost of the initial feasibility study ($250,000) should be expensed as incurred (the flow of economic benefits to Johan as a result of the study were uncertain). Location and condition + Capitalized costs - The cost of PP&E also includes the cost of bringing the asset to the location and condition necessary for it to be capable of operating (IAS 16); Therefore. The cost with the independent consultant ($50,000) should be capitalized as part of the cost of constructing the network and depreciated accordingly. Leases Operating lease a finance lease is a lease that transfers the risks and rewards of ownership of the asset to the buyer. An operating lease is a lease other than a financial lease. In the case of the land contract, the risks and rewards are not transferred; therefore it should be treated as an operating lease. Prepayment the $300,000 payment should be treated as prepayment in the statement of financial position and charged to the income statement over the life of the contract on the straight line basis. Inventory the inventory of handsets should be measured at the lower of cost and net realizable value. Johan should recognize a provision at the point of purchase for the handsets to be sold at a loss. The inventory should be written down to its net realizable value (NRV) of 149/handset as they are sold both to prepaid customers and dealers. NRV = estimated selling price estimated selling costs

IAS 18 Revenue IAS 18 requires the recognition of revenue by reference to the stage of completion of the transaction at the reporting date. Recognition revenue associated with the provision of services should be recognized as service rendered; - Johan should record the receipt of $21/call as deferred revenue at the point of sale; - Revenue of $18 should be recognized over the six month period from the date of sale; - The unused call credit of $3 should be recognized when the card expired and the obligation of Johan ceases. Agency - IAS 18 does not deal in detail with agency arrangements, but mentions that gross inflows of economic benefits include amount collected on behalf of the principal and which do not result in increases of equity for the entity. Amounts collected on behalf of the principal are not revenue; revenue is the amount of the commission. - Johan should not recognize revenue when the handset is sold to the dealer, as the dealer is acting as an agent for the sale of the handset and

the service contract; Johan has retained the risk of loss and the price of the handset is under Johans control. Separability the handset cannot be sold separately and is commercially linked to the provision of the service; - Johan should recognize the net payment of $130 as customer acquisition cost (which may qualify as intangible assets under IAS 38); - The revenue from the service contract should be recognized when the service is rendered; - The intangible asset should be amortized over the 12 month contract. Case 41 Carpart i) Vehiclex Because there is not contract to sell the machinery to Vehiclex, no revenue can be recognized in respect of the machinery; The machinery is accounted for under IAS 16 - PP&E and depreciated assuming that: - it is probable that future economic benefits will flow to the entity - the items cost can be measured reliably Carpart should also conduct impairment reviews in order to ensure that the carrying amount is not in excess of recoverable amount. The contract to manufacture seats is a contract for production and sale of goods and revenue should be recognized at sale (according to IAS 18) Autoseat Under IFRIC 4, a lease is based on the substance of the arrangement if: Fulfillment of the contract is dependent upon the use of a specified asset; The contract conveys the right to use the asset. In this case, the contract contains a lease because: The completion of the contract depends on the construction and use of specialized machinery; All the output will be sold to Autoseat who can inspect and reject defective seats before delivery; The contract allows Autoseat the right to use the machinery; The only customer is Autoseat who sets the levels of production and has a purchase option at any time; The price of production is not fixed as it is a take or pay contract (Autoseat is committed to fully repay the machinery cost);

ii)

iii)

The lease payments are separable from other elements in the contract because Carpart will recover the cost of the machinery through a price per seat over the life of the contract. The payment under the contract will be separated in: Lease payments; Revenue from sale of car seats; Carpart will recognize a lease receivable equal to the net present value of the minimum lease payments; Lease payments will be split into interest income and receipt of the lease receivables. Car sales the sale and repurchase agreement must be analyzed to determine if the seller has transferred the risks and rewards of ownership to the buyer. In the case of vehicles sold and repurchased at the end of the contract period: - Carpart should recognize revenue on the sale of the vehicle; - The risk is considered to be transferred to the buyer because: o The residual risk that remains with Carpart is not significant at 20% of the sale price because it is significantly less than market price; o The repurchase period covers most of the vehicles useful lif e; o The car has to be maintained and serviced by the buyer and must be returned in good condition; In the case of sale with an option to repurchase: Carpart has not transferred the significant risks and rewards of ownership because: - The repurchase price is significant; - The repurchase period is substantially less than the economic useful life of the vehicle; - The repurchase price is above the fair value of the vehicle. The cars are, therefore, accounted for as operating leases until the option expires. The cars will be taken out of the inventory and debited to assets under operating lease The cars will be depreciated over two years, taking into account the residual value; The cash will be split between: - Rentals received in advance (30%) and - Long-term liabilities (70%) which will be discounted

The rental income will be recognized in Profit or Loss over the period of two years. In the case of demonstration vehicles: The demonstration vehicles should be taken out of inventory and capitalized as PP&E at cost; They meet the recognition criteria as they are held for demonstration purposes and are expected to be used in more than one accounting period; They should be depreciated while being used as demonstration vehicles and when they are sold they should be reclassified from PP&E to inventory and depreciation should stop. Case 42 Burley

According to IAS 18, revenue arising from the sale of goods should be recognized when all the following criteria are met: The seller has transferred the risks and rewards of ownership to the buyer; The seller does not retain managerial involvement or control over the goods sold; The amount of revenue can be measured reliably; It is probable that the economic benefits associated with the transaction will flow to the seller; The costs incurred in respect of the transaction can be measured reliably. i) Burley and Slite Burley should recognize a purchase from Slite for the excess amount extracted (10,000 barrels at $100); Burley should recognize all oil sold to third parties (including the amount purchased from Slite) because the IAS 18 criteria are met. The balance sheet at the end of the year is a financial liability, which should reflect the best estimate (oil price at 30 Nov 2009) of the amount of cash payable (i.e. $1,050,000). This means that the company will record an expense of $50,000 at the year-end. After the yearend, the amount payable will be revised (to $950,000) to reflect changes in oil price. This will give a $100,000 gain to P&L in the next accounting period.

Events after the reporting period are those events that occur between the end of the financial period and the date when the financial statements are issued. Inventory inventories are required to be stated at the lower of cost and net realizable value (NRV). NRV=estimated selling price estimated cost of completion estimated sale costs.

Burley should calculate NRV by reference to the market price of oil at the reporting date.

Events after reporting period - The changes in oil price are non-adjusting events, as they have occurred after the reporting date. Therefore, the decline in oil price since the date of reporting will not be adjusted in the financial statements. The inventory is valued at cost of $98/barrel as this is lower than NRV of $103 ($105-$2) at the end of the year; ii) Burley, Jorge and Heavy A jointly controlled entity is a corporation, partnership or other entity in which two or more venturers have an interest, under a contractual arrangement that establishes joint control over the entity. Jointly controlled entities can be accounted for under two treatments (according to IAS 31) proportionate consolidation and equity method. Joint control only exists when the strategic, financial and operating decisions related to the entitys activity require unanimous consent of the parties. Accounting for entity - Burley cannot use proportionate consolidation because Wells is not jointly controlled. Each investor should account their interest in the entity as an associate, as they have significant influence, but not control. Equity accounting should be used. As compared to other costs, decommissioning costs will not become payable until some future date. Management should record the best estimation of the companys obligations. Discounting is used to address the problem of the delayed cash flows. The amount capitalized as part of the assets will be the amount estimated to be paid, discounted at the date of initial recognition. The related credit is recognized in provisions. The pipeline is a jointly controlled asset. Burley should show the asset as PP&E and show its portion of liabilities or expenses incurred. iii) Oil exploration license Asset definition an asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. According to IAS 38, the probability of future economic benefits must be based on reasonable and supportable assumptions about conditions that will exist over the life of the assets. According to IAS 36, the assets recoverable amount should be calculated if there is an indication that the asset may be impaired. Therefore, the license can be capitalized and if the exploration of the area does not lead to the discovery of oil and activities will be discontinued, then an impairment test will be performed.

Case 53 - Holocombe

a) i) The information available to users in the notes to the financial statements is often insufficient to make reliable adjustments to the financial statements. Because there are two different accounting methods for finance and operating leases, similar transactions can be account very differently. This also affects the comparability of the financial statements. In case the company obtains an operational lease, the company has a source of financing that can be difficult for users to understand as it is not recognized in the financial statements. The existing accounting methods have been criticized for their complexity, as it has been difficult to define a dividing line between principles related to finance and operating leases. ii) An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Holocombe has the unconditional right to use the leased plant and it controls the right to use to leased item during the lease term because the lessor is unable to recover or have access to the resource without consent or breach of contract. Also, future economic benefits are expected to flow to Holocombe from using the asset. It can, therefore, be concluded that the lessees right to use a leased item for the lease term meets the definitions of an asset in the Framework . A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. The obligation to pay rentals is a liability. Holocombe has an unconditional obligation to pay the rent because the lessor cannot take possession of the item until the end of the lease term and because the lessee cannot terminate the lease and avoid paying rentals. Thus, the entity has a present obligation to pay rentals, which arises out of a past event and which is expected to generate future economic cash flows to the entity. Therefore, Holcombes obligation to pay rentals meets the definition of a liability in the Framework. b) i) On sale of the building, Holocombe will recognize the following in the financial statements to 30 April 2010:
Cash Cr Office building Cr Deferred Income (SOFP) Recognition of gain on the sale of the building

Dr

$150m $120m $30m

Deferred income (SOFP) Cr Deferred income (I/S) Release of the gain on sale of the building ($30/5 years)

Dr

$6m $6m

Operating lease asset $63.89m Cr Obligation to pay rentals $63.89m Recognition of the leaseback at the net present value of lease payments using 8%discount rate

Dr

In the first year of the leaseback, Holocombe will recognize the following:
Lease obligation rentals Cr Cash Recognition of payment of rentals

Dr

$16m $16m

Dr

Cr Recognition of interest expense ($63.89m*8%)

Interest expense Ease obligation

$5.11m $5.11m

Depreciation expense $12.78m Cr Right-of-use asset $12.78 m Recognition of depreciation of operating lease asset over five years ($63.89m/5 years)

Dr

The statement of financial position will show a carrying value of $51.11m being cost of $63.89 m less depreciation of $12.78m. ii) Inflation adjustments should be recognized in the period in which they are incurred as they are effectively contingent rent and are not included in any minimum lease calculations. Holocombe should recognize operating rentals of $5 million each year, plus inflation adjustment. Based on current inflation, the rent would be: $5.2 million in year 2 and $5.408 million in year 3.