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Lecture Notes, Lectures 1-9 | Advanced Financial Accounting

Advanced Financial Accounting (Tilburg University)

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Lecture 1 Business Combinations

Two types of business combinations:
- Mergers, two equal companies
- Acquisitions, one dominant company

Impact on financial performance:

- Acquisition price, contingent consideration. For example: part of the acquisition price is variable
on future performance
- Financing of acquisition, shares vs. cash with loan
- Combined earnings, synergies

Why is transparency so important?

- Organic growth versus “acquired growth”
- Entities need to disclose in the year of acquisition the impact on revenue and income. In this
way you can see what the organic growth (company itself) was and what the contribution from
the acquired company was.

Various forms of acquisitions:

- Acquisition of shares in another entity
- Acquisition of a business without acquiring shares
- Combination of both

When they acquirer already has an interest in the acquiree, for example: A has 20% in B and now
acquires the remaining 80% and gets control. IFRS considers this a transaction where the 20% interest is
sold and 100% of the acquired company is acquired in a business combination. So A has to book a gain
or loss on the 20% already owned.

What is a business?
Integrated set of activities and assets that is capable of being conducted and managed for the purpose
of providing a return in the form of dividends, lower costs or other economic benefits directly to
investors or other owners, members or participants. So not only share deals, also acquisitions of
businesses by buying assets and assuming liabilities in combination with activities.

Mergers versus acquisitions

- From an accounting perspective there are no mergers, all business combinations must be
accounted for as acquisitions

Purchase method (acquisition accounting)

1) Identify the acquirer. The acquirer is the combining entity that obtains control of the other
combining entities or businesses. Usually it is the entity that becomes the parent of the other
combining party or parties, but not always: in a reverse acquisition, the entity that becomes the
legal subsidiary of the other entity is the acquirer. Indicators to identify who has control in
substance: majority of voting rights, control over nomination of management and the largest in
term of fair value.

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2) Measure the value of the business acquired (normally consideration given up). The fair values, at
the date of the exchange, of Assets given up (usually cash), liabilities incurred or assumed and
equity instruments issued by the acquirer in exchange for control of the acquired company. Plus
the fair value of any existing interest in the acquired company the acquirer already owns.
3) Determine the fair value of the assets acquired and liabilities and contingent liabilities assumed.
Recognize the identifiable assets and liabilities of the acquired company that existed at the date
of acquisition at their fair values at that dat. Even if those assets and liabilities had not been
recognized by the acquiree yet.
4) The difference is goodwill. Difference between fail value of business and fair value of net assets
recognized. Why pay for goodwill? Synergies and non-recognizable assets (workforce).Recognize
purchased goodwill as an asset, no amortization, test for impairment annually and more
frequently when there are indications of impairment. Negative goodwill can be recognized as a
gain.

Date of business combination: date that control passes is the date the acquirer can decide about
management of the company. Relevance of this date:
- Date from which earnings are consolidated
- Date as at which fair value of business acquired must be determined
- Date as at which fair values of net assets acquired must be determined to assess goodwill

Contingent consideration: where the consideration is subject to adjustment depending on the outcome
of future events:
- Include in the consideration that is initially recorded the estimated amount of any adjustment
that is probable and can be measured reliably.
- If consideration is paid in cash or other assets: subsequent adjustments to this are recognized as
a gain or loss in income.
- If consideration is settled in shares of the acquirer: no adjustment. (Zie aantekening
voorbeeldvraag bij slide 30)

What is fair value? Amount at which asset would be exchanged in arm’s length transaction between
knowledgeable and willing parties. For example:
- Exit price
- Highest and best use assumption
- No block discount
Three levels of fair value:
- Level 1: fair value can be assessed directly from market observed data (FV of listed Shares)
- Level 2: entity uses model to assess fair value, but model only contains input factors that are
readily observable in the market (interest rate swap)
- Level 3: entity uses model and at least one significant input factor is not readily observable in
the market (intangible asset)

Provisions: The acquirer cannot recognize liabilities for future losses or costs based on its intentions for
the future. Liabilities that were existing obligations of the acquired company at the acquisition date may
be recognized.
- Restructuring provisions will therefore be recognized only if they were already a liability of the
acquired company
- Contingent liabilities of the acquired company (such as contractual obligations to employees), if
triggered by the acquisition will be recognized.

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Contingent liabilities: Fair value must be reliably measurable, but outflow of future economic benefits
need not be probable. Subsequently there are measured at the higher of:
- The amount that would be recognized under IAS 37 Provisions, and
- The initial amount
When chances of costs increase, increase contingent liability. When chances of costs decreases, do
nothing. See example slide 41 .

Intangible Assets: fair value must be reliably measurable, but inflow of future economic benefits need
not be probable. Must also meet the definition of an intangible asset under 38 i.e.
- Identifiable non-monetary asset without physical substance
- Must be separable from the entity, or arise from contractual or other legal rights.

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Lecture 2 Consolidation
Consolidation: process of preparing single set of financial statements for group of entities under control
of one of those entities.
Involves combining financial statements of individual entities to show financial position and
performance of group as if it were single entity:
- Group: a parent and its subsidiaries
- Parent: an entity that controls one or more entities
- Subsidiary: an entity that is controlled by another entity

Purpose of consolidation: Present a set of financial statements as if all entities within a group are one
entity:
- Adding line by line the individual items of each of the single entities
- Use uniform accounting policies
- Eliminate intra group transaction and balances
- Adjust for effects of business combination
- Measure and present rights of non-controlling interest (NCI) holders

Who makes consolidation adjustments?

- Choice: parent makes consolidation adjustments on information reported by subsidiary and
subsidiary is instructed to make adjustments before reporting to parent
- Choice made based upon practical grounds: in US: push down accounting so subsidiary adjusts
its own accounts after business combination

The following three elements are required in order for an investor to have control: All three elements
must be present for control to exist
1) Power over the investee
Power is defined as existing rights that give the current ability to direct the relevant activities. Power
arises from rights which generally arise from a legal contract. These include:
- Voting rights
- Rights to appoint, reassign or remove members of the investee’s key management personnel
- Rights to appoint or remove another entity that participates in management decisions
- Rights to direct the investee to enter into, or veto any changes to, transactions that affect the
investee’s returns
Power must be substantive. The holder must have the practical ability to exercise the rights. If a right is
protective then the holder does not have power. Protective rights are designed to protect the interest of
the party holding those rights without giving the party power over the entity to which the rights relate.
(For example: the rights of a lender to seize (beslag leggen op) the assets of a borrower in the event of
default).
2) Exposure or rights to variable returns from its involvement with the investee
The second element of the control definition requires that the investor has the rights to variable returns
from the investee (examples of returns include: dividends, cost savings, economies of scale)
3) The ability to use its power over the investee to affect the amount of the investor’s returns
The third element requires that the parent have the ability to increase its benefits and limit its losses
form the subsidiary’s activities.

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Second part lecture 2: Consolidation; Wholly owned subsidiaries

Before consolidating, it may be necessary to adjust the subsidiary’s financial statements where:
1) The subsidiary’s balance date is different to the parent’s
2) The subsidiary’s accounting policies are different to the parent’s

Consolidation involves adding together the financial statements of the parent and subsidiaries and
making a number of adjustments:
- Business combination valuation entries: required to adjust the carrying amounts of the
subsidiary’s assets and liabilities to fair value
- Pre-acquisitions entries: required to eliminate the carrying amount of the parents investment in
each subsidiary against the pre-acquisition equity of that subsidiary
- Transactions between entities within the group subsequent to acquisition date

An acquisition analysis compares the cost of acquisition with (not the book value) the fair value of the
identifiable net assets and contingent liabilities (FVINA) that exist at acquisition to determine whether
there is:
- Goodwill on acquisition (where cost > FVINA)
- Bargain (gelegendheidsaankopen, koopjes, onderhandelen) purchase (where cost < FVINA)
See example page 8-10 sheets

If the book value of subsidiary assets and liabilities differs from fair value, or if a contingent liability
exists, it is necessary to make business combination valuation adjustments. These adjustments:
- Increase or decrease subsidiary’s recorded assets and liabilities book values to fair value
- Recognize previously unrecognized assets
- Recognize subsidiary’s contingent liabilities at fair value
Business Combination Valuation Reserve (BCVR) account is used to record these adjustments.

Equity balances that existed in the subsidiary prior to acquisition date are referred to as pre-acquisition
equity. All movements after the date of acquisition are referred to as post-acquisition. You cannot have
an investment in yourself, nor can you have equity in yourself. From a consolidated viewpoint, these
items should not exist i.e. they must be eliminated to avoid double counting. (You can never end-up
with a BCVR in your consolidated accounts. It is just a help for consolidating)

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Lecture 3 Consolidation: Intragroup transactions and non-controlling

interest

Rationale for adjusting intragroup transactions:

- Intragroup transactions: transactions that occur between entities in the group
- The purpose of consolidated financials are to provide information on the group as a result of its
dealings with external parties
- IFRS 10 requires: 1)Intragroup balances, transactions, income and expenses to be eliminated in
full 2)Tax effect accounting to be applied where temporary difference arise due to elimination of
profits and losses

Profit in opening inventory:

- If inventory is sold between entities within the group one year and not sold by the end of the
year, then we need to consider how this affects the following year’s consolidated accounts
- The profit will become realized when the inventory is sold to an external party (in the next
financial year)

Intragroup Services:
- Often in a group, one entity (normally the parent) provides services (such as accounting, HR, IT)
to the other entities (normally the subsidiaries) to reduce duplication
- Provider normally charges a management fee to the user. This must be eliminated on
consolidation as follows:
o DR Services revenue
o CR Services expense
- If payable/receivable balances also exist, these balances must be eliminated on consolidation

Non-Controlling Interest
- IFRS 10 defines non-controlling interest as “equity in a subsidiary not attributable, directly or
indirectly, to a parent”
- NCI is presented and identified within equity separately from the parent’s equity
- The NCI is entitled to a share of the equity of the subsidiary adjusted for the effects of profits
and losses made on intragroup transactions

Effects of NCI on the consolidations process:

- IFRS 3 para 19 permits alternative treatments for measuring the NCI in a subsidiary
- The selected treatment affects the determination of goodwill and the subsequent consolidation
adjustments.
o Full goodwill method: NCI measured at fair value on the basis of market price for shares
not acquired by the parent.. NCI receives a share of goodwill.
o Partial goodwill method: Under the partial goodwill method the NCI is measured as the
NCI’s proportionate share of the acquiree’s net assets.

Adjusting for the effects of intragroup transactions:

- The justification for considering adjustments for intragroup transactions in the calculation of the
NCI share of equity is that the NCI is classified as a contributor of capital to the group
- The calculation of the NCI is based on a share of consolidated equity
- Consolidated equity = equity of parent and subsidiaries - effects of intragroup transactions

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Lecture 4 it
Recognition of deferred tax
- A deferred tax liability is recognised for all taxable temporary differences
- A deferred tax asset is recognised for all deductible temporary differences

Temporary differences
- Temporary differences are differences between the carrying amount of an asset or liability and its tax
base
• Taxable temporary differences are those that will result in taxable amounts ...
• Deductible temporary differences are those that will result in amounts that are deductible ...

Tax loss carry-forward are the same of other Temporary differences

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Lecture 5 Foreign Currency Translation

IAS 21: Definitions:
- Functional currency is the currency of the primary economic environment in which the entity
operates. For Oil always  US Dollar
- Foreign currency is a currency other than the functional currency of the entity.
- Presentation currency is the currency in which the financial statements are presented. This is
usually the functional currency of the entity, but sometimes a foreign currency is used for
presenting the financial statements.
- Spot exchange rate: the exchange rate for immediate delivery
- Closing rate: the spot exchange rate at the balance sheet date
- Monetary items: units of currency held, and assets and liabilities to be received or paid in fixed
or determinable units of currency

Accounting for transactions in foreign currency

- Initial measurement
o The transaction is translated into the functional currency at the spot rate ruling at the
date of the transaction
- Measurement at the balance sheet date
o Monetary items: at the closing rate
o Non-monetary items measured at historical cost: at the exchange rate ruling at the date
of the transaction
o Non-Monetary items measured at fair value: at the exchange rate ruling at the date of
valuation

Treatment of exchange differences:

- These are included in income for the period
o Gains or losses arising when monetary items are settled at amounts different from their
carrying value
o Differences arising when monetary items held at the year-end are retranslated at the
closing rate.

Choosing a functional currency (zie slides 16-20):

- When determining the functional currency of a foreign subsidiary consideration must be given
as to whether:
o The subsidiary is acting as an intermediary for the parent’s activities (in which case it is
likely that the functional currency of the subsidiary is the same as that of the parent)
o The subsidiary is acting as a free standing unit (in which case it is likely that the
functional currency of the subsidiary is the local currency of the subsidiary)
o It is possible that the functional currency is neither of the above – ie. It is another
currency

Translation of financial statements:

- There are two possible translations required under IAS 21:
o From the local to the functional currency
o From the functional to the presentation currency

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- In some cases both translations may be required

- The method for each type of translation is different

Consolidating foreign subsidiaries:

- When a parent holds an investment in a foreign subsidiary the normal consolidation procedures
coverd in earlier chapters will still apply
- When calculating the amounts to be recorded in the consolidation journals however,
consideration must be given to foreign currency translation issues

Net investment in a foreign operation:

- The investment in a foreign operation may consist of more than just share ownership
- Loans payable/receivable between the parent and foreign subsidiary commonly exist
- Where such balances are unlikely to be settled in the foreseeable future they are considered to
be part of the net investment in the subsidiary
- Foreign exchange gains/(losses) arising on such loans are required to be transferred to the FCTR
on consolidation

Extension of net investment:

- If net investment in foreign entity extended by ‘equity-like’ other finances such as loans with no
repayment date
- Treated as if equity had been provided
- So exchange gains/losses go to equity

Hedge of net investment risk in foreign entity:

- If loan issued that effectively hedges foreign currency risk on investment in foreign entity, than
exchange rate gain or loss on loan does not go to income, but to equity

Recycling of FCTR:
- Foreign Currency Translation Reserve is ‘recycled’ through comprehensive income statement
when subsidiary disposed of
- Meant to measure book gain or loss on disposal as difference between proceeds in currency of
parent less original cost plus undistributed profits

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Lecture 6 Associates an Joint

Arrangements
Degrees of influence:
- 0%-20% = financial interest, 20% or more is financial asset
- More than 20%, Significant influence  Associate
- 50%, joint control  Joint venture
- More than 50%, Control  subsidiary

Identifying Associates:
- An entity over which the investor has significant influence and that is neither a subsidiary nor an
interest in a joint venture
- Significant influence is defined as: the power to participate in the financial and operating policy
decisions of the investee but is not control or joint control over those policies. The holding of
20% of more of the voting power leads to the presumption of significant influence. Evidence of
significant influence:
o Representation on the board of directors or equivalent governing body
o Participation in policy-making processes
o Material transactions between the investor and the investee
o Interchange of managerial personnel
o Provision of essential technical information

The equity method:

- 99% of associates are accounted for using the “equity method”
- Commonly referred to as the “single-line” method or “one-line consolidation” method
- All entries are recorded against the single line investment account
- Involves revaluing the investment and crediting the P&L with the investor’s share of post-
acquisition profits (after certain adjustments)

Applying the equity method:

- Initial investment in the associate (cost)
- +/- share of post-acquisition retained earnings
- +/- share of current year profits/(losses)
- - share of post-acquisition dividends
- +/- share of increases/(decreases in post-acquisition reserves
- = Equity carrying amount (zie voorbeelden slides 3e pagina)

The equity method requires adjustments to the investors share of post-acquisition equity for:
- Goodwill/gain on bargain purchase and fair value adjustments on acquisition
- Unrealized profits on inter-entity transactions (zie voorbeelden slides 4e pagina)

Step acquisitions:
- When an investment in an associate is achieved in stages this is referred to as a step acquisition:
- At the date that significant investment is achieved:

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o The previously held investment is revalued to fair value with any gain/loss being taken
to profit & loss; or
o If the previously held investment had been measured at fair value with changes in fair
value being recognized directly in equity, those amounts are transferred to profit & loss
(zie voorbeeld pagina 4-5)

Share of losses of associate

- The investors share of losses of an associate is recognized, but only to the point where the
carrying amount of the investment in the associate is zero
- The share of losses may be offset against other investments the investor has in the associate –
e.g. long term receivables
- If, after reporting losses, as associate earns a profit, the investor recognizes a share of profits
only after the share of profits exceeds the share of past losses not recognized

Joint Arrangements: Characteristics & Classification

- A joint arrangement arises where two or more entities have an arrangement between each
other such that these entities have joint control of the arrangement
- Two main characteristics:
o The parties are bound by a contractual arrangement
o The contractual arrangement gives the parties joint control of the arrangement

What is joint control?

- Contractually agreed sharing of control by two or more ventures
- No one party can unilaterally dominate financing and operating activities
- Decisions in essential areas require the consent of the ventures
- One party may be appointed manager of the JV, however they must act within the policies
detailed in the contract

There are two types of joint

arrangements:
- Joint operation
- Joint venture
The assessment of the classification
requires judgment about:
- Structure of the arrangement
- The legal form of the separate
vehicle
- The terms of the contractual
arrangement
- Any other relevant facts and
circumstances

Joint VentureEquity method

Joint Operation Account for assets and liabilities which you have access to or to which you are
exposed (zie voorbeelden laatste 3 pagina’s)

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Lecture 7 Financial Instruments –

Classification and Measurement
What is a financial instrument?
- A two-sided contract. All financial instruments will give rise to a financial asset of one party, with
a corresponding financial liability or equity instruments of another party.
o E.g. sales contract gives rise to a receivable in the sellers books and a payable in the
purchases books
- Definition requires a legal/contractual right. Non contractual liabilities are not financial
instruments.
o E.g. Income taxes arise from a statutory right

What is a financial instrument?

1) Primary instruments
a. E.g. cash, receivables, investments, payables
b. Few issues with accounting for these
2) Secondary (derivative) instruments:
a. Its value is derived from underlying item: share price, interest rate, etc.
b. E.g. financial options, forward exchange contracts
c. More difficult to account for

Derivatives:
- Derivatives transfer financial risks of the underlying primary financial instrument
- One party acquires a right to exchange a financial asset or liability with another party under
potentially favorable condition. The other party takes on the right to exchange under potentially
unfavorable conditions
- Parties to derivatives are “ taking bets” on what will happen to it in the future

Illustration:
- Which of the following items are financial instruments?
o Cash: yes
o Trade receivables: yes
o Inventory: no
o Pension liability: no, because dependent on uncertain thing like life expectancy
o Loan: yes
o Shares issued: yes
o Shares held in a subsidiary: yes
o Environment liability: no

2 types of accounting:
1) Debt: payment of remuneration (whether dividend or interest) is deducted from profit
2) Equity: payment of remuneration (whether dividend or interest) is considered part of profit
appropriation

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Example see sheet 21

Debt/equity classification of instruments

- Anti-abuse: if an instrument can be settled in shares it is only equity if the entity receives a fixed
amount of currency for a fixed number of shares
- This is to make sure the holder of the instrument runs an equity risk

Example:
1) A has an obligation to deliver 100.000 worth of shares to B in 3 months’ time.
 The value is fixed and the number of shares will vary, depending on the share price. The holder
of the instrument is not exposed to equity risk. The obligation should be classified as a liability.

2) A issues an option to B entitling B to buy 100.000 shares at $1 each in 3 months’ time.

 The numbers of shares are fixed. The holder of the instrument is exposed to equity risk. The
obligation should be classified as equity.

Compound financial instruments:

- Compound financial instruments are instruments that contain both the characteristics of equity
and liability (e.g. convertible bond)
- Has to be split into equity and liability component
- Calculate liability component, remainder is equity

Treatment in income statement:

- Treatment in income statement follows classification in balance sheet:
o Any benefits paid on equity instrument: part of profit appropriation (no charge to
income statement)
o Any benefits paid on liability instrument: charged to income statement as interest
expense
o Any benefits paid on compound financial instrument: split between interest expense
and profit appropriation

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Three main characteristics in derivatives:

1) Value changes in response to the change in a specified variable (interest, foreign exchange rate)
2) Requires no/minimal net investment
3) Settled at some time in the future

Most derivatives are settled on a net basis. May be standalone or embedded in a host contract.

4 categories of financial instruments:

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Subsequent measurement:

Impairment model:
- Currently: incurred loss model
- Proposed: expected loss model
- Why?
o Banking regulators: crisis has shown bank provide for loan losses too late and too little

What if debt instrument is impaired?

- Debt instruments (loans and receivables or bonds etc):
o If holder no longer expects to receive all contractual cash flows, the asset is considered
impaired
o Carrying amount is written down to net present value of expected cash flows discounted
at the original effective interest rate
o Reversal possible when expectation improve

Impaired of AFS financial asset:

- Equity securities impaired if: default of the entity or fair value of shares significantly or
prolonged below cost. No reversal.
- Debt security impaired if entity no longer expects to receive all contractual payments
o Asset written down to fair value
o Whole AFS reserve on this asset ‘recycled’ through profit and loss
o New effective interest rate determined

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Lecture 8 Financial Instruments – Hedge

Accounting and Disclosure Insurance
Contracts
Hedge accounting-introduction
- Hedge arrangements are entered into to protect an entity from risk, e.g. currency or interest
rate risk
- Hedge accounting generally results in a closer matching of the impacts on profitability and the
statement of financial position
- Protects the reported profit from volatility caused by fair value changes over time

Basic principles of hedge accounting under IFRS

- Derivatives must be marked to market through the income statement
- IFRS recognizes that hedged risks should not affect the income statement
- Therefore under cirucumstances hedge accounting is permitted
- Hedge accounting means that fair value changes of derivatives are not recognized in the income
statement but parked in equity or adjusted to the hedged asset/liability

Hedged item
- To what items can hedge accounting be applied?
o A financial asset recognized on the balance sheet (e.g. loan provided to other party) or
financial liability (e.g. loan issued)
o A future but committed cash flow (e.g. contracted revenue)
o An expected future cash flow (e.g. expected cash inflows from future revenues)

Five conditions must be met in order for hedge accounting to be applied:

1) Must be formal designation and documentation of the hedge at inception
2) The hedge must be expected to be highly effective (80%-125%)
3) For cash flow hedges the transactions must be highly probable
4) The effectiveness of the hedge must be able to be reliably measured
5) The hedge must be assessed on an ongoing basis for effectiveness

Types of hedges:
- Fair value hedge
o A hedge of the exposure to changes in the FV of an asset, liability or commitment
o The gain or loss from remeasuring the hedging instrument is recognized immediately in
P&L
o Gain or loss on the hedged item attributable to the hedged risk adjusts the carrying
amount of hedged item and is recognized immediately in P&L
o Hedged item is not necessarily carried at fair value
- Cash flow hedge
o A hedge of the exposure to the variability in cash flows of a recognized asset or liability
or forecast transaction

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o The portion of the gain or loss on the hedging instrument determined to be an effective
hedge is recognized in equity
o Any ineffective portion is reported immediately in profit or lss if the hedging instrument
is a derivative
- Hedge of a net investment in a foreign operation
o Similar to a cash flow hedge

Two broad types of disclosure:

- Significance of financial instruments for financial position and performance
o Explaining the numbers in the financial statements
- Nature and extent of risks arising from financial instruments
o What could happen to those numbers
o How that risk is managed

Qualitative disclosures:
- For each type of risk arising from financial instruements
o Exposures to risk and how they arise
o Objectives policies and processes for managing the risk (including methods used to
measure risk)
o Changes in the above from the previous period

Quantitative disclosures:
- Summary data based on key management information
- Prescribed minimum disclosures for
o Credit risk
o Liquidity risk
o Market risk
 Foreign currency risk
 Interest rate risk
 Other, e.g. commodity or equity, price risk
o Concentrations of risk (e.g. all accounts receivables at one client)

What is insurance?(examples)
- Life
o Pension insurance by insurance company
o Annuity (fixed income until death)
o Life insurance (payment upon death or upon survival)
- Non-life (also called Property and Casualty)
o Fire insurance
o Car insurance
o Travel insurance

Insurance: characteristics
- Premium paid first
- Uncertainty about whether and what amount will be paid
- May contain significant deposit element
- Participating vs non-participating
o Amount paid depends on performance of financial assets or insurance company

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Proposed Standard insurance accounting

- Two models for insurance contracts
o Short term non-life before claim made
 Liability is unearned premium (unless onerous)
o Rest: insurance contract liability measured on the basis of building blocks
 Best estimate of cash flows
 Discount
 Risk adjustment
 Margins

Insurance contract accounting

- Discount rate
o Risk free rate plus liquidity premium
- All changes in the liability go to profit and loss
- Residual margin amortized over life of insurance contract (see examples last page)

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Lecture 9 Financial Statement

presentation
Content of financial statements:
- A complete set of financial statements includes the following components:
o Statement of financial position
o Income statement and/or
o Statement of comprehensive income
o Statement showing all changes in equity arising distributions to owners
o Statement of cash flows
o Accounting policies and explanatory notes

Financial statements may be accompanied by:

- A management report
- Report of supervisory board
- ‘overige gegevens’

Fair presentation:
- Financial statements should present fairly the financial position, financial performance and cash
flows of an enterprise: the application of IFRS, with additional disclosure where necessary,
virtually always achieves this
- Inappropriate accounting is not rectified by disclosures
- Financial statements that comply with IFRS should disclose that fact: must follow every standard
and interpretation

Departures from IFRS:

- To departure was not acceptable to the SEC
- Therefore, under improved IAS 1:
o Departure is made when the relevant regulatory framework requires or otherwise does
not prohibit departure
o When the relevant regulatory framework prohibits departure the perceived misleading
aspects shall be reduced to the maximum extent possible by making disclosures
- So the application of IFRS may depend on regulatory framework

Comparative information:
- For numerical information:
o Should be disclosed in respect of the previous period for all numerical information in the
financial statements unless an IAS permits or requires otherwise
o Should be amended to remain comparable, if there are changes to the presentation or
classification of items in the current period, and details of changes disclosed
- For narrative and descriptive information:
o Should be included if it is relevant to an understanding of the current period’s financial
statements

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Statement of financial position:

Balance sheet classification:
- The balance sheet format should present either
o Current and non-current assets and current and non-current liabilities as separate
classifications, or
o Assets and liabilities broadly in order of their liquidity
- In either case, disclose for each item that includes current and non-current amounts, any
amount expected to be recovered or settled after more than twelve months

Current assets are defined as:

- Those expected to be realized in, or held for sale or consumption, the normal course of the
enterprise’s operating cycle
- Those held primarily for trading purposes or for the short-term and expected to be realized
within twelve months of the balance sheet date, or
- Cash or a cash equivalent asset that is not restricted as to its use
- All other assets are classified as non-current assets

Current liabilities are defined as:

- Those expected to be settled in the normal course of the enterprise’s operating cycle, or
- Those due to be settled within twelve months of the balance sheet date
- All other liabilities should be classified as non-current liabilities

Classification:
- If company breached debt covenants on long term loan at or before balance sheet date:
o Present debt as current
o Even if breach is remedied after balance sheet date

Statement of comprehensive income:

1) Single statement of comprehensive income, OR
2) Two statements: profit and loss account and statement of other comprehensive income
(beginning with profit or loss and displaying components of other recognized income and
expense)

Classification of expenses:
- Operating expenses can classified either:
o By the nature of the expenses, such as depreciation, purchases of materials, transport
costs, wages and salaries, advertising costs
o By their function, such as cost of sales, distribution costs, administrative costs

Statement of changes in equity:

The statement includes:
- Capital transactions with owners and distributions to owners
- The balance of accumulated profit or loss at the beginning of the period and at the balance
sheet date, and movements for the period, and
- A reconciliations between the carrying amount of each class of equity capital, share premium
and each reserve at the beginning and the end of the period, separately disclosing each
movement (see example sheet 26)

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Upcoming developments: reporting performance:

- Single performance statement
- Subtotal net income
- Ends with comprehensive income
- No recycling
- Distinction between operating and financial sources of income

IAS: Accounting policies, changes in accounting estimates and errors

Errors:
- No distinction between fundamental errors and other errors
o All go through equity (retrospectively corrected)
o Disclosures required

Changes in accounting policies:

- Mandatory change in accounting policies:
o Follow the transitional provisions of the standard/interpretation that requires the
change
- Voluntary change in accounting policy:
o Only under strict conditions
o Retrospectively
o With cumulative effect recognized in equity

Estimates:
- Changes in estimates:
o If affects past or present only: recognize in current year’s income statement
o If affects future as well: recognize prospectively

Events after the balance sheet date:

Adjusting versus non-adjusting event: If information becomes available after the balance sheet but
before the date the financial statements are drawn up:
- And provides new information on the situation as per balance sheet date:
o This is an adjusting event
o Balance sheet and income statement are adjusted for this new information
- And does not relate to the situation as per balance sheet date:
o This is a non-adjusting event
o And should be disclosed if material

Adjusting versus non-adjusting event: Information that becomes available after the date the financial
statements have been drawn up:
o Non-adjusting, even if they relate to the situation as per balance sheet date
o Netherlands: if it makes the accounts misleading: file a statement to that effect at the
trade registrar, together with revised financial statements or a description of the
information and its effect

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