23.09.

2020

Conceptual Framework for Financial Reporting

IFRS

Provides information to help existing and potential investors, lenders and other
creditors to estimate the value of the reporting entity

The conceptual framework for financial reporting (Conceptual Framework)

Describes the objective of, and the concepts for, general purpose financial
reporting

Objective of general purpose financial reporting

Is to provide financial information about the reporting entity that is useful to

existing and potential investors, lenders and other creditors in making decisions
relating to providing resources to the entity

The purpose of the Conceptual Framework is to:

 Assist the International Accounting Standards Board (Board) to develop

IFRS Standards (Standards) that are based on consistent concept;
 Assist preparers to develop consistent accounting policies when no Standard
applies to a particular transaction or other event, or when a Standard allows
a choice of accounting policy;
 Assist all parties to understand and interpret the Standards.

Conceptual framework is not a standard. Nothing in the Conceptual Framework

overrides any Standard or any requirement in a Standard. Provides the foundation
for Standards.

Contents of the conceptual framework:

 The objective of general purpose financial reporting;

1
  Qualitative characteristics of useful financial information;
 Financial statements and the reporting entity;
 Recognition and derecognition;
 Measurement.

Financial performance reflected by:

Accrual accounting:

Depicts the effects of transactions and other events and circumstances on a

reporting entity’s economic resources and claims in the periods in which those
effects occur, even if the resulting cash receipts and payments occur in a different
period

Past cash flows:

Information about cash flows helps users understand a reporting entity’s

operations, evaluate its financing and investing activities, assess its liquidity or
solvency and interpret other information about financial performance

Qualitative characteristics of useful financial information:

If financial information is to be useful, it must be relevant and faithfully represent

what it purports to represent. The usefulness of financial information is enhanced if
it is comparable, verifiable, timely and understandable.

Qualitative characteristics of useful financial information:

 Fundamental qualitative characteristics:

o Relevance
o Materiality
o Faithful representation:
 Complete
 Neutral
 Free from error

2
  Enhancing qualitative characteristics:
o Comparability
o Verifiability
o Timeliness
o Understandability

Fundamental qualitative characteristics:

 Relevance – relevant financial information is capable of making a difference

in the decisions made by users
 Materiality – Information is material if omitting, misstating or obscuring it
could reasonably be expected to influence decisions that the primary users of
general purpose financial reports
 Faithful representation – information is true if it accurately reflects the
economic phenomena of the transactions presented in the statements in
words and numbers

To be a perfectly faithful representation, a depiction would have three

characteristics:

 Complete – a complete depiction includes all information necessary for a

user to understand the phenomenon being depicted, including all necessary
descriptions and explanations;
 Neutral – a neutral depiction is without bias in the selection or presentation
of financial information
 Free from error

If financial information is to be useful, it must be relevant and faithfully represent

what it purports to represent

BUT!

3
Neither a faithful representation of an irrelevant economic phenomenon nor an
inaccurate representation of a relevant economic phenomenon helps users to make
the right decisions

Enhancing qualitative characteristics:

 Comparability – enables users to identify and understand similarities in, and

differences among, items
 Verifiability – helps assure users that information faithfully represents the
economic phenomena it purports to represent
 Timeliness – means having information available to decision-makers in time
to be capable of influencing their decisions
 Understandability – classifying, characterizing and presenting information
clearly and concisely makes it understandable

The elements of financial statements

Reporting items containing information about the organization’s performance

An asset is a present economic resource controlled by the entity as a result of past

events

An economic resource is a right that has the potential to produce economic

benefits:

 Right
 Potential to produce economic benefits
 Control

A present obligation to transfer an economic resource as a result of past events

Only if:

 The entity has already obtained economic benefits or taken an action

 As a consequence, the entity will or may have to transfer an economic
resource that it would not otherwise have had to transfer
4
The unit of account is the right or the group of rights, the obligation or the group of
obligations, or the group of rights and obligations, to which recognition criteria and
measurement concepts are applied

Possible units of account include:

 An individual right or individual obligation

 All rights, all obligations, or all rights and all obligations, arising from a
single source, for example, a contract
 A subgroup of those rights and/or obligations

Equity is the residual interest in the assets of the entity after deducting all its
liabilities

Income is increases in assets, or decreases in liabilities, that result in increases in

equity, other than those relating to contributions from holders of equity claims

Expenses are decreases in assets, or increases in liabilities, that result in decreases

in equity, other than those relating to distributions to holders of equity claims

Recognitions is the process of capturing for inclusion in the statement of financial

position or the statement(s) of financial performance an item that meets the
definition of one of the elements of financial statements – an asset, a liability,
equity, income or expenses

Derecognition is the removal of all or part of a recognized asset or liability from an

entity’s statement of financial position. Derecognition normally occurs when an
item no longer meets the definition of an asset or of a liability

Assets minus liabilities equal equity =

Income minus expenses + contributions from holders of equity claims minus

distributions to holder of equity claims

Measurement is all items in the financial statements usually measured in the

monetary terms

5
Historical cost measures provide monetary information about assets, liabilities and
related income and expenses

The historical cost of an asset when it is acquired or created is the value of the
costs incurred in acquiring or creating the asset, comprising the consideration paid
to acquire or create the asset plus transaction costs

Current cost – information about assets and liabilities on the date of measuring
such items

Current value measurement bases include:

 Fair value
 Value in use for assets and fulfilment value for liabilities
 Current cost

Fair value is the price that

1) Would be received to sell an asset

2) Or paid to transfer a liability, in an orderly transaction between market
participants at the measurement date

Value in use and fulfilment value:

1) Is the present value of the cash flows, or other economic benefits, that an
entity expects to derive from the use of an asset and from its ultimate
disposal
2) Is the present value of the cash, or other economic resources, that an entity
expects to be obliged to transfer as it fulfills a liability

6
 30.09.2020

Accounting policies, changes in accounting estimates and errors

IFRS comprise:

 IFRS
 International Accounting Standards (IAS)
 IFRIC Interpretations
 SIC Interpretations

General purpose financial reports provide information about the financial position
of a reporting entity, which is information about the entity’s economic resources
and the claims against the reporting entity

Accounting policies are the specific principles, bases, conventions, rules and
practices applied by an entity in preparing and presenting financial statements

Consistency of Accounting policies

An entity shall select and apply its accounting policies consistently for similar
transactions, other events and conditions

1) Users of financial statements need to be able to compare the financial

statements of an entity over time to identify trends in its financial position,
financial performance and cash flows
2) Therefore, the same accounting policies are applied within each period and
from one period to the next

Changes in accounting policies

Transition from one principle to another, including methods

Applying changes in accounting policies

An entity shall account for a change in accounting policy resulting from the initial
application of an IFRS in accordance with the specific transitional provisions, if
any, in that IFRS
7
When an entity changes an accounting policy upon initial application of an IFRS
that does not include specific transitional provisions applying to that change, or
changes an accounting policy voluntarily, it shall apply the change retrospectively

Early application of an IFRS is not a voluntary change in accounting policy

Is required by an IFRS; or results in the financial statements providing reliable and

more relevant information about the effects of transactions, other events or
conditions on the entity’s financial position, financial performance or cash flows

NOT changes in accounting policies are: the application of an accounting policy

for transactions, other events or conditions that differ in substance from those
previously occurring; and the application of a new accounting policy for
transactions, other events or conditions that did not occur previously or were
immaterial

Changes in accounting policies:

1) Result from appearing of new information or development of events

2) Are not correcting prior period errors

Estimates – professional judgement

As a result of the uncertainties inherent in business activities, many items in

financial statements cannot be measured with precision but can only be estimated.
Estimation involves judgements based on the latest available, reliable information

A change in accounting estimates is an adjustment of the carrying amount of an

asset or a liability, or the amount of the periodic consumption of an asset, that
results from the assessment of the present status of, and expected future benefits
and obligations associated with, assets and liabilities

Accounting estimates:

Bad debts

Inventory obsolescence

8
The fair value of financial assets or financial liabilities

The useful lives of, or expected pattern of consumption of the future economic
benefits embodied in, depreciable assets

Warranty obligations

Accounting estimates

 The use of reasonable estimates is an essential part of the preparation of

financial statements and does not undermine their reliability
 An estimate may need revision if changes occur in the circumstances on
which the estimate was based or as a result of new information or more
experience
 By its nature, the revision of an estimate does not relate to prior periods and
is not the correction of an error
 A change in the measurement basis applied is a change in an accounting
policy, and is not a change in an accounting estimate
 When it is difficult to distinguish a change in an accounting policy from a
change in an accounting estimate, the change is treated as a change in an
accounting estimate
 To the extent that a change in an accounting estimate gives rise to changes in
assets and liabilities, or relates to an item of equity, it shall be recognized by
adjusting the carrying amount of the related assets, liability or equity item in
the period of the change

Restatements

Retrospective – is correcting the recognition, measurement and disclosure of

amounts of elements of financial statements as if a prior period error had never
occurred

Prospective – means that the change is applied to transactions, other events and
conditions from the date of the change in estimate

9
Retrospective application: the entity shall adjust the opening balance of each
affected component of equity for the earliest period presented and the other
comparative amounts disclosed for each prior period presented as the new
accounting policy had always been applied

Prospective application – a change in an accounting estimate may affect only the

current period’s profit or loss, or the profit or loss of both the current period and
future periods

1) For example, a change in the estimate of the amount of bad debts affects
only the current period’s profit or loss and therefore is recognized in the
current period
2) However, a change in the estimated useful life of a depreciable asset affects
depreciation expense for the current period and for each future period during
the asset’s remaining useful life

In both cases, the effect of the change relating to the current period is recognized
as income or expense in the current period. The effect, if any, on future periods is
recognized as income or expense in those future periods

Limitations on retrospective application

If it is impossible to

Measure error

Measure its impact

Errors

Can arise in respect of the:

 Recognition
 Measurement
 Presentation
 Or disclosure of elements of financial statements

10
Financial statements do not comply with IFRSs if they contain either material
errors or immaterial errors made intentionally to achieve a particular presentation
of an entity’s financial position, financial performance or cash flows

Types of errors:

Potential current period errors – discovered in that period are corrected before the
financial statements are authorized for issue

Prior period errors – However, material errors are sometimes not discovered until a
subsequent period, and these prior period errors are corrected in the comparative
information presented in the financial statements for that subsequent period

Errors:

1) A prior period error shall be corrected by retrospective restatement

2) The correction of a prior period error is excluded from profit and loss for the
period in which the error is discovered

Restatements:

Retrocpective

1) Changes in accounting policies

2) Material prior period errors

Prospective

1) Changes in accounting estimates

11
 07.10.2020

Finished products, Cost and expenses

The operating activities of the entity:

A transaction or event that has or may have an impact on the financial results, the
financial position of the organization and/or cash flow

 Logging (harvesting)
 Manufacturing (producing)
 Selling

Classifying costs:

Element:

 Materials
 Labor
 Depreciation, amortization
 Other costs

Function:

 Production
 Non-production

Nature:

 Direct
 Indirect

Behavior:

 Variable
12
  Fixed
 Variable-fixed
 Semi-variable

Fixed and variable costs:

TC = FC + VC

 Costs that do not change with activity levels (constant in total)

 Costs that are very in total with the level of activity

Debit:

Intital balance:

 Materials
 Labor
 Depreciation, amortization
 Insurance premium
 Other costs

Final Balance

Credit:

 Finished goods

Account production: the work-in-progress (WIP)

Account accumulates on the debit side:

 All input costs relating to production (namely prime sosts)

 The relevant share of production overhead/indirect costs

Accounts accumulates on the credit side:

 Goods finished in the period

Account 90 selling:
13
Debit

Initital Balance

Cost of sales

Tax (VAT)

Distribution costs

Administrative expenses

IAS 1

The main financial statements:

The required formats for published company financial statements are provided by
IAS 1 Presentation of Financial Statements

This requires the following components to be presented:

 A statement of financial position

 A statement of profit or loss and other comprehensive income (statements
of financial performance)
 A statement of changes in equity, and
 A statement of cash flows
 Notes to financial statements

The statement of financial position:

Assets Equity and liabilities

I. Current assets (Inventory, II I. Equity
trade receivables,
prepayments, cash
II. Non-current assets (Property, I V. Current liabilities
plant and equipment,
investments, intangibles)
V Non-current liabilities
Total assets (BALANCE) Total capital and liabilities
14
 (BALANCE)

The accounting equation:

 Assets – Liabilities = Capital (UK variant)

 Assets = Capital + Liabilities (International variant)
 Assets – Capital = Liabilities

Current assets:

The suggested statement of financial position format makes a distinction between

current and non-current assets and liabilities

IAS 1 sets down the rules to be applied in making this distinction

An asset should be classified as a current asset if it is:

 Held primarily for trading purposes expected to be realized within 12

months of the statement of financial position date
 Cash or a cash equivalent (i.e. a short term investment, such as a 30-day
bond)

All other assets should be classified as non-current assets

Note that this definition allows inventory or receivables to qualify as current assets
under (a) above, even if they may not be realized into cash within 12 months

Current liabilities:

The rules for current liabilities are similar to those for current assets

A liability should be classified as a current liability if:

 It is expected to be settled in the normal course of the enterprise’s operating

cycle
 It is held primarily for the purpose of being traded

15
  It is due to be settled within 12 months of the statement of financial position
date or the company does not have an unconditional right to defer settlement
for at least 12 months after the statement of financial position date

All other liabilities should be classified as non-current liabilities

The statement of profit and loss and other comprehensive income:

The statement of profit and loss and other comprehensive income shows the
financial performance of a business over a period of time, usually a year. This
summarizes the income earned and expenses incurred during the financial period

It includes two parts:

 The statement of profit and loss, and

 A statement showing other comprehensive income

Revenue

- Cost of sales

= Gross profit

- Distribution costs
- Administrative expenses

= Operating profit (Profit from operations)

+ Investment income

- Finance costs

= Profit before tax

- Income tax (Tax expense)

= NET profit for the period

Items requiring separate disclosure:

They include:
16
 Restructuring or reorganization of the company profits and losses on disposal of
property, plant and equipment (or investments)

Impairments of inventory, property, plant and equipment

All such items should be included on their own, separate line in the statement of
profit and loss

The statement of cash flows (IAS 7):

It requires that cash flows are listed under one of three headings:

- Cash flows from operating activities

- Cash flows from investing activities
- Cash flows from financing activities

TOTAL = Net increase in cash and cash equivalents

The statement of changes in equity:

Represents the owners’ interests in the company

An alternative way of defining it is that it represents what is left in the business

when it is ceased to trade

Equity comprises:

- Share capital
- Share premium
- Reserves. The main reserves are the revaluation surplus and retained
earnings

Disclosure notes:

Are required for a variety of reasons, including:

- To explain the accounting policies used in preparing the accounts

- To explain the movement between the opening and closing balances of
major statements of financial position

17
 - Items to show how certain balances are calculated
- And to provide further detail/explanation to users of the financial statements,
as necessary for the accounts to be understandable to the users

18
 14.10.2020

Statement of cash flows IAS 7

Profit and cash:

1) Whilst a business entity might be profitable this does not mean it will be
able to survive
2) To achieve this, a business entity needs cash to be able to pay its debts
3) If a business entity could not pay its debts it would become insolvent and
could not continue to operate

The main reason for this problem is that profit is not the same as cash flow

Profits (from the statement of profit and loss) are calculated using the accruals
basis

Most goods and services are sold on credit so that, at the point of sale, revenue is
recognized but no cash is received

The same can be said of purchases made on credit. There are also a number of
expenses that are recognized that have no cash impact, e.g. depreciation

The importance of cash position:

Therefore, it is possible for a business entity be profitable but have insufficient

cash available to pay its suppliers

For this reason, it is important that users of the financial statement can:

1) Assess the cash position of a business entity at the end of the year
2) How cash has been generated
3) How cash has been used by the business entity during the accounting period

Definitions:

19
Cash consists:

- Of cash in hand and deposits repayable upon demand, less overdrafts

Cash equivalents:

- Are ‘short-term, highly liquid investments that are readily convertible to

known amounts of cash and are subject to an insignificant risk of changes in
value’

Cash flows:

- Are ‘inflows and outflows of cash and cash equivalents’

Usefulness of cash flow:

It helps to assess:

1) Liquidity and solvency – an adequate cash position is essential in the short

term both to ensure the survival of the business entity and to enable debts
and dividends to be paid
2) Financial adaptability – will the business entity be able to take effective
action to alter its cash flows in response to any unexpected events?
3) Future cash flows – an adequate cash position in the longer term is essential
to enable asset replacement, repayment of debt and fund further expansion
4) The statement of cash flows also highlights how cash is being generated, i.e.
either from operating, financing or investment activities

Objective of the statement of cash flows is:

1) To ensure that cash flows are reported in a form that highlights the
significant components of cash flow and facilitates comparison of the cash
flow performance of different businesses
2) Each cash flow should be classified according to the substance of the
transaction that gives rise to it

The statement of cash flows (IAS 7):

20
It requires that cash flows are listed under one of three headings:

+/- Cash flows from operating activities;

+/- Cash flows from investing activities;

+/- Cash flows from financing activities;

TOTAL = Net increase in cash and cash equivalents

+/- Cash and cash equivalents at the beginning of the period;

= Cash and cash equivalents at the end of the period

Cash flows from operating activities:

+ Cash generated from operations

- Interest paid
- Income taxes paid

= Net cash from operating activities

There are two methods of presenting cash flows from operations:

- The direct method

- The indirect method

The direct method:

- Provides more detailed information

- Is based upon cash flow information extracted directly from the accounting
records
- As this method discloses information that would otherwise remain
confidential, most business entities do not use the direct method

The gross cash flows necessary for the direct method can be derived:

1) From the accounting records of the entity by totaling the cash receipts and
payments directly, or

21
 2) From the opening and closing statements of financial position and statement
of profit and loss for the year by constructing summary control accounts for:
- Sales (to derive cash received from customers)
- Purchases (to derive cash payments to suppliers)
- Wages (to derive cash paid to and on behalf of employees)

EXAMPLE в тетради

The indirect method: Profit before tax + Adjustment

Finance costs X
Investment income (X)
Depreciation X
Profit on sale of non-current assets (X)
Provisions increase/decrease X (X)
Government grant amortization X
Increase/decrease in prepayments (X) X
Increase/decrease in accruals X (X)
Operating profit before working capital X
changes
Increase/decrease in inventories (X) X
Increase/decrease in trade receivables (X) X
Increase/decrease in trade payables X (X)

KEYPOINTS

- This method starts with profit before tax

- Finance costs are added back
- Investment income is deducted in order to work back to profit from
operations
- Any non-cash items are then adjusted for in order to find cash generated
from operations
- Non-cash expenses are added back to remove them (such as depreciation,
loss on disposal)
- Non-cash income items are deducted in order to remove them (such as profit
on disposal)
22
 - Adjustments are also made to working capital, to remove the impact of
credit sales/purchases

Adjustments to profit before tax: Depreciation

- Depreciation is not a cash flow

- Depreciation has to be added back to reported profit in deriving cash from
operating activities
- Capital expenditure will be recorded under ‘investing activities’ at the time
of the cash outflow

Profit/loss on disposal of non-current asset

When a non-current asset is disposed of:

The cash inflow from sale is recorded under ‘investing activities’

- A loss on disposal is added to profit in deriving cash from operating

activities similarly,
- A profit on disposal is deducted from profit

Adjustments in inventory

- An increase in receivables is a deduction from profit in deriving cash from

operating activities
- A decrease in receivables is an addition to profit

Adjustments to profit before tax: Change in inventory

 An increase in inventory is a deduction from profit in deriving cash from

operating activities
 A decrease in inventory is an addition to profit

Adjustments to profit before tax: Change in payables

 An increase in payables is an addition to profit in deriving cash from

operating activities
 A decrease in payables is a deduction from profit
23
Adjustments to working capital:

 Change in receivables
 Change in inventories
 Change in payables

EXAMPLE

Calculation of interest/income taxes paid:

The cash flow should be calculated by reference to:

 The charge to profits for the item (shown in the statement of profit and loss)
 And any opening or closing payable balance shown on the statement of
financial position
 To calculate interest and tax paid, workings may be needed. These can be
done using either columns or T accounts

Calculation of interest paid:

Interest paid is normally shown as part of operating activities

Dividends paid are shown in the IAS 7 specimen format as part of financing
activities, but may alternatively be shown under operating activities

Interest liability b/f X

Finance cost per SPL X

Interest liability c/f (X)

Interest paid (X)

Calculation of income taxes paid:

Liabilities b/f (both current and deferred) X

Tax charge per SPL X

24
Deferred tax on revaluations of PPE X

Liabilities c/f (both current and deferred) (X)

Tax paid (X)

The statement of cash flows (IAS 7)

Cash flows from investing activities:

- Purchase of property, plant and equipment

+ Proceeds from sale of property, plant and equipment

+ Interest received

+ Dividends received

= Net cash from investing activities

Cash flows from financing activities:

+ Proceeds from issue of shares

+ Proceeds from issue of long-term borrowings

- Redemption of long-term borrowings

- Dividends paid

= Net cash from financing activities

Revenue

Other income

Changes in inventories

25
 10.11.2020

IAS 2. Inventories

Variation of inventory:

1) Raw materials and components (used in the production process)

2) Finished products (which have been manufactured by the business)
3) Products (usually called work in progress – WIP)
4) Goods purchased for resale
5) Consumable stores (such as oil)

Live circle of every asset:

1) Acquisition
2) Use within business
3) Disposal

Acquisition cost:

1. Purchase
2. Gift-given
3. Contribution in share-capital
4. Exchange
5. Surplus (as a result of stocktaking)
6. Creating (producing)

Cost:

1) Cost of purchase
2) Cost of conversion

Cost of purchase:

26
 - Purchase price

Including import duties, transport and handling cost

- Any other directly attributable costs, less trade discounts, rebates and
subsidies

Cost of conversion:

- Costs which are specifically attributable to units of production, e.g. direct

labor, direct expenses and subcontracted work
- Production overheads, which must be based on the normal level of activity
- Other overheads, if any, attributable in the particular circumstances of the
business to bringing the product or service to its present location and
condition

The following costs should be excluded and charged as expenses of the period in
which they are incurred:

- Abnormal waste
- Storage costs
- Administrative overheads which do not contribute to bringing inventories to
their present location and condition
- Selling costs

Example:

The entity has bought 1000 pens, cost of purchase - $12 per unit, including VAT

The delivery was made by the special transport organization. The costs incurred in
bringing the inventories to their current location are $600, including VAT. Define
the bookkeeping cost (acquisition cost) per 1 pen.

Answer: $10.5 ($10 + $.5)

Inventory is included in the statement of financial position at:

The lower of cost/net realizable value

27
Net realizable value (NRV)

Is the estimated selling price, in the ordinary course of business, less the estimated
costs of completion and the estimated costs necessary to make the sale

Example 1:

Materials costing $12000 bought for processing and assembly for a special order

Since buying these items, the cost price has fallen to $10000

Solution:

Cost = $12000

NRV = $10000

NRV < Cost

Martials = NRV

Example:

Equipment constructed for a customer for an agreed price of $18000. This has
recently been completed at cost of $16800.

It has now been discovered that, in order to meet certain regulations, conversion
with an extra cost of $4200 will be required.

The customer has accepted partial responsibility and agreed to meet half the extra
cost.

Cost = $16800

NRV = contract price, $18000 – our share of modification cost, $2100

NRV = $18000 - $4200/2 = $15900

NRV < Cost

Finished products = NRV

28
Net realizable value (NRV)

Is the net amount that would be realized after incurring any further costs required
to make the sale

In effect, it is the fair value of the item, less any further costs that must be incurred
in order to sell that item

This may include, for example, further work and costs required in order to make
items of work in progress into finished goods before they could be sold

If IAS 2 is applied, when items of inventory are old or obsolete, they are likely to
be valued at net realizable value, rather than cost

Inventory valuation methods:

Unit cost – This is the actual cost of purchasing identifiable units of inventory –
not ordinarily interchangeable

FIFO – first items of inventory received are assumed to be used the first ones. The
cost of closing inventory is the cost of the most recent purchases of inventory

AVCO – The cost of an item of inventory is calculated by taking the average of all
inventory held

Unit cost:

Only used when items of inventory are individually:

- Distinguishable
- And of high value

AVCO:

- Periodically
- Continuously

AVCO: Periodic weighted average cost

29
With this inventory valuation method, an average cost per unit is calculated based
upon the cost of opening inventory plus the cost of all purchases made during the
accounting period

This method of inventory valuation is calculated at the end of an accounting period

when total quantity and cost of purchases for the period is known

Continuous weighted average cost:

With this inventory valuation method, an updated average cost per unit is
calculated following a purchase of goods.

The cost of any subsequent sales are then accounted for at that weighted average
cost per unit.

This procedure is repeated whenever a further purchase of goods is made during

the accounting period

Note: When using either of the two methods of weighted average cost to determine
inventory valuation, it is possible that small rounding differences may arise. They
do not affect the validity of the approach used and can normally be ignored.

IAS 2 disclosure requirements:

1) According to IAS 1 Presentation of Financial Statements entities are

required to disclose the accounting policies adopted in preparing their
financial statements, including those used to account for inventories
2) IAS 2 also requires that the total carrying amount of inventories are broken
down into appropriate subheadings of classifications and the total amount of
inventory carried at net realizable value is disclosed

An example of a specimen disclosure note is as follows:

Inventories are valued at the lower of cost and net realizable value for each
separate product or item

30
Cost is determined by recognizing all costs required to get inventory to its location
and condition at the reporting date and is applied on a ‘first in, first out’ basis.

Net realizable value is the expected selling price of inventory, less any further
costs expected to be incurred to achieve the sale.

Raw materials - $200

Work in progress - $600

Finished products - $350

Within the carrying amount of inventories, the amount carried at net realizable
value is $150000

Inventory in the financial statements

A business can calculate exactly how much inventory it has used in the year to
calculate cost of sales

The standard proforma for calculating sales, cost of sales and gross profit:

Revenue X
Opening inventory X
Purchases X
Less: Closing inventory (X)
Cost of sales (X)
Gross profit X

When calculating gross profit, we match the revenue generated from the sales of
goods in the year with the costs of manufacturing those goods

You should appreciate that the costs of the unused inventories should not be
included in this figure

These costs are carried forward into the next accounting period where they will be
used to manufacture goods that are sold in that period

31
The goods carried forward are classified as assets on the statement of financial
position

!!! Inventory costs are matched to the revenues they help generate

Example:

At the beginning of the financial year a business has $1,500 of inventory left over
from the preceding accounting period.

During the year it purchases additional goods costing $21,000 and make sales
totaling $25,000

At the end of the year there are $3,000 of goods left that have not been sold.

What is the gross profit for the year?

Answer: 5500

The impact of valuation methods on profit and the statement of financial position:

1. Different valuation methods will result in different closing inventory values.

This impacts both profit and statement of financial position asset value
2. For this reason, it is important that once a method has been selected it is
applied consistently
3. It is not appropriate to keep switching between methods to manipulate
reported profits
4. Similarly, any incorrect valuation of inventory will impact the financial
statements:
- If inventory is overvalued, then: assets are overstated in the statement of
financial position is overstated in the statement of profit or loss (as cost of
sales is too low)
- If inventory is undervalued, then: assets are understated in the statement of
financial position profit is understated in the statement of profit or loss (as
cost of sales is too high)

32
 IAS 37. Provisions, contingent liabilities and contingent assets

Provision:

Is a liability

- Of uncertain timing
- Or amount
1) A present obligation as a result of past event

The obligation needs to exist because of events which have already occurred at the
year-end and give rise to a potential outflow of economic resources

This obligation can either be:

(a) Legal/contractual
(b) Constructive

Legal obligation:

Is an obligation that derives from:

- The terms of contract

- Legislation
- Or other operation of law

Constructive obligation:

Is an obligation that derives from an entity’s actions where:

- By an established pattern of past practice, published policies, or a

sufficiently specific current statement, the entity has indicated to other
parties that it will accept certain responsibilities
- And as a result, the entity has created a valid expectation on the past of those
other parties that it will discharge those responsibilities

EXAMPLE:

33
A retail store has a policy of refunding purchases by dissatisfied customers, even
though it is under no legal obligation to do so. Its policy of making refunds is
generally known.

Should a provision be made at the year end?

Solution:

- The policy is well known and creates valid expectations

- There is a constructive obligation
- It is probable some refunds will be made
- These can be measured using expected values

Conclusion: A provision is required

2) A reliable estimate can be made

Provisions should be recognized at the best estimate

If the provision relates to one event, such as the potential liability from a court
case, this should be measured using the most likely outcome

If the provision is made up of numerous events, such as a provision to make repairs

on goods within a year of sale, then the provision should be measured using
expected values

Example 1:

An entity sells goods with a warranty covering customers for the cost of repairs of
any defects that are discovered within the first two months after purchase.

Past experience suggests that 88% of the goods sold will have no defects, 7% will
have minor defects and 5% will have major defects.

If minor defects were detected in all products sold, the cost of repairs would be
$24,000. If major defects were defected in all products sold, the cost would be
$200,000.

34
What amount of provision should be made?

Answer: $11680

3) There is a probable outflow of economic resources

If the likelihood of the event is not probable

No provision should be made

If there is a possible liability

Then the company should record a contingent liability instead

A contingent liability:

Is:

- A possible obligation that arises from past events and whose existence will
be confirmed only by the occurrence or non-occurrence of one or more
uncertain future events not wholly within the control of the entity
- Or a present obligation that arises from past events but is not recognized
because:
o It is not probable that an outflow of resources embodying economic
benefits will be required to settle the obligation, an,
o Or the amount of the obligation cannot be measured with sufficient
reliability

Accounting for contingent liability:

- Should not be recognized in the statement of financial position

- Should be disclosed in a note unless the possibility of a transfer of economic
benefits is remote

A contingent asset:

Is a possible asset that:

- Arises from past events

35
 - And whose existence will be confirmed only by the occurrence or non-
occurrence of one or more uncertain future events
- Not wholly within control of the entity

Accounting for contingent asset:

Contingent assets should not generally be recognized, but if the possibility of

inflows of economic benefits is probable, they should be disclosed

If a gain is virtually certain, it falls within the definition of an asset and should be
recognized as such, not as a contingent asset

Summary:

The accounting treatment can be summarized in a table:

Degree of probability Outflow Inflow

Virtually certain Recognize liability Recognize asset
Probable Recognize provision Disclose contingent asset
Possible Disclose contingent Ignore
liability
Remote Ignore Ignore

Warranty provisions:

A warranty is often given in manufacturing and retailing businesses. There is either

a legal or constructive obligation to make good or replace faulty products.

A provision is required at the time of the sale rather than the time of the
repair/replacement as the making of the sale is the past event which gives rise to an
obligation

This requires the seller to analyze past experience so that they can estimate:

- How many claims will be made – if manufacturing techniques improve,

there may be fewer claims in the future then there have been in the past
- How much each repair will cost – as technology becomes more complex,
each repair may cost more
36
The provision set up at the time of sale:

- Is the number of repairs expected in the future multiplied by the expected

cost of each repairs
- Should be reviewed at the end of each accounting period in the light of
further experience

Guarantees:

In some instance (particularly in groups) one entity will make a guarantee on

behalf of another to pay off a loan, etc.

If the other entity is unable to do so

A provision should be made for this guarantee it is probable that the payment will
have to be made

It may otherwise require disclosure as a contingent liability

Future operating losses/future repairs:

No provisions may be made for future operating losses or repairs because they
arise in the future and can be avoided (close the division that is making losses or
sell the asset that may need repair) and therefore no obligation exists.

Onerous contracts:

- An onerous contract is a contract in which the unavoidable costs of meeting

the obligations under the contract exceed the economic benefits expected to
be received under it
- The signing of the contract is the past event giving rise to the obligation to
make the payments

37
 17.11.2020

IAS 16 Property, Plant and Equipment

Non-current assets:

1) Property, plant and equipment

2) Intangible assets
3) Investment property, other assets

Live circle of every asset:

1) Acquisition
2) Use within business
3) Disposal

PPE:

Are tangible assets

 Held by an entity for more than one accounting period

 For use in the production or supply of goods and services
 For rental to others
 Or for administrative purposes

Recognition:

An item of PPE should be recognized as an asset when:

1) It is probable that future economic benefits associated with the asset will
flow to the entity
2) The cost of the asset can be measured reliably

Ways of entering the assets into the entity:

1. Purchase
2. Gift-given
38
 3. Contribution in Share-capital
4. Exchange
5. Surplus (as a result of stocktaking)
6. Creating (Capital expenditure)

Measurement:

An item of PPE should initially be measured at its cost

 Purchase price (capital costs)

 Subsequent expenditure
 Delivery costs
 Legal fees
 Installation costs
 Borrowing costs (in according with IAS 23)
 Dismantling costs – the PV of these costs should be capitalized, with an
equivalent liability set up

Includes: all costs involved in bringing the asset into working condition

Excludes:

 Repairs
 Renewals
 Repainting
 Administration
 General overheads
 Training costs
 Wastage

Example:

If an oil rig was built in the sea.

39
If the asset cost $10 million to construct, and would cost $4 million to remove in
20 years. Interest rates were 5%

Answer: $10 million + $4 million/(1+5%)^20

Subsequent costs (последующие расходы) on the non-current asset can only be

recorded as part of the cost (or capitalised),

 It enhances the economic benefits provided by the asset (this could be

extending the asset’s life, an expansion or increasing the productivity of the
asset)
 It relates to an overhaul or required major inspection of the asset – the costs
associated with this should be capitalized and depreciated over the time until
the next overhaul or safety inspection
 It is replacing a component of a complex asset. The replaced component will
be derecognized. A complex asset is an asset made up of a number of
components, which each depreciate at different rates, e.g. an aircraft would
comprise body

Borrowing costs (IAS 23):

 Borrowing costs must be capitalized

As part of the cost of an asset is a qualifying asset (one which ‘necessary takes a
substantial period of time to get ready for its intended use or sale’)

IAS 23 states that capitalization of borrowing costs should commence when all of
the following conditions are met:

 Expenditure for the asset if being incurred

 Borrowing costs are being incurred
 Activities that are necessary to prepare the asset its intended sale are in
progress

The rate of interest to be taken:

40
Where funds are borrowed specifically to acquire a qualifying asset, borrowing
costs which may be capitalized are those actually incurred, less any investment
income on the temporary investment of the borrowings during the capitalization
period

Evaluation of non-current assets

In accounting – acquisition cost

In the statement of financial position – the carrying amount (booking value)

The carrying amount (booking value) = to the acquisition cost of the non-current
asset less accumulated depreciation on the asset to date

Use within business – depreciation

The systematic allocation of the depreciable amount of an asset over its useful life

 In simple terms, depreciation spreads the cost of the asset over the period in
which it will be used
 Depreciation matches the cost of using a non-current asset to the revenues
generated by that asset over its useful life
 The depreciation method applied to an asset should reflect the pattern in
which the assets future economic benefits are expected to be consumed
 The estimated useful life of items of PPE must be regularly reviewed and
may be changed if the method no longer matches the usage of the asset

The purpose of depreciation is:

 Not only to show the asset at its current value in the statement of financial
position
 Nor it is intended to provide a fund for the replacement of the asset
 It is simply a method of allocating the cost of the asset over the periods
estimated to benefit from its use (the useful life)
 Depreciation of an asset begins when it is available for use

41
According to IAS 16, the estimated useful life of items of PPE must be:

 Regularly reviewed
 And may be changed if the method no longer matches the usage of the asset

This is achieved by recording a depreciation charge each year, the effect of which
is twofold (‘the dual effect’):

1) Reduce the statement of financial position value of the non-current asset by

accumulated depreciation to reflect the wearing out
2) And record the depreciation charge as an expense in the statement of profit
or loss to the revenue generated by the non-current asset

Depreciable amount is the cost of an asset, or other amount substituted for cost,
less its residual value

Depreciation of an asset begins when it is available for use

Depreciation is continued even if the asset is idle

An estimate of the value of an asset at the end of its useful life

Depreciable amount is the cost of an asset less its residual value

Review:

1) Useful life
2) And residual value

Should be:

- Reviewed at the end of each reporting period

- And revised if expectations are significantly different from previous
estimates

Methods of calculating depreciation (PPA):

Straight-line method – results in the same charge every year and is used wherever
the pattern of usage of an asset is consistent throughout its life
42
Reducing balance method – results in a constantly reducing depreciation charge
throughout the life of the asset

Machine hours method

Which method is used to calculate depreciation, the accounting remains the same

Straight-line method:

Useful life: the estimated number of years during which the business will use the
asset

Depreciation rate – is the annual percentage of transferring the assets of the cost of
finished products

Depreciation amount = Depreciable amount * Depreciation rate

Depreciation rate = 1/Useful life*100%

Reducing balance method:

Depreciation amount = Carrying amount * Depreciation rate

This is used to reflect the expectation that the asset will be used less and less

If an asset is classed as a complex asset, it may be thought of as having separate

components within a single asset

An engine within an aircraft will need replacing before the body of the aircraft
needs replacing

Each separate part of the asset should be depreciated over its useful life

Inspection and overhaul costs are generally expensed as they are incurred

They are, however, capitalized as a non-current asset to the exent that they satisfy
the IAS 16 rules for separate components

Where this is the case they are then depreciated over their useful lives, until the
next inspection or overhaul is due

43
IAS 16 allows a choice of accounting treatment for PPE:

1) The cost model

2) The revaluation model

The cost model: PPE should be valued at cost less accumulated depreciation

The revalueation model:

PPE nay be carried at a relevant amount less any subsequent accumulated

depreciation

If the revaluation alternative is adopted, two conditions must be omplied with:

1) Revaluations must be subsequently be made with ufficient regularity to

ensure that the carrying amount does not differ materially from the fair value
at each reporting date
2) When an item of PPE is revalued, the entire class of assets to which the item
belongs must be revalued

Revaluation gains are recorded:

1) As a component of other comprehensive income either within the statement

of profit or loss and other comprehensive income
2) Or in a separate statement

This gain is then carried in a revaluation surplus within equity

Results:

- Revalutation surplus
- Revaluation loss

44
Revaluation surplus = revaluated amount – Carrying amount

For a non-depreciated asset:

Dr Non-current asset revaluation surplus

Cr Revaluation surplus

For a depreciated asset:

Dr Accumulated depreciation

Dr Non-current asset-cost

Cr Revaluation surplus depreciation to date revaluation gain

IAS 16 says that ‘the carrying amount of an item of PPE shall be derecognized:

- On disposal

45
 - Or when no future economic benefits are expected from its use or disposal

When a tangible non-current asset is disposed of there are a number of adjustments

required to remove the asset and associated accumulated depreciation from the
statement of financial position and to record a profit or loss on the disposal

Disposal:

1. Selling
2. Gift-given
3. Contribution in share-capital
4. Exchange
5. Shortfall (as a result of stocktaking)

Proceeds > CA at disposal date = Profit

Proceeds < CA at disposal date = Loss

Proceeds = CA at disposal date = Neither

This is a three-step process:

1. Remove the original cost of the non-current asset from the noncurrent asset
account
2. Remove accumulated depreciation on the non-current asset from the
accumulated depreciation account
3. Recoginze proceeds

The profit or loss on disposal of a revaluated non-current asset should be calculate

as the difference between the net sale proceeds and the carrying amount

There are two steps to disposing of a revaluated asset:

(1) It should be accounted for in the statement of profit or loss of the period
(2) Any balance on the revaluation surplus relating to this asset should now be
transferred to retained earnings

46
 IAS 40 Investment property

Investment property:

Land or

A building

Held to earn rentals or for capital appreciation or both

Rather than for use by the entity or for sale in the ordinary course of business

Owner-occupied property is excluded from the definition of investment property

These could be spare properties:

Rented out to third parties, or specifically bought in order to profit from a gain in
value

There could be a situation where a building can be accounted for in different ways

If an entoty occupies a premises but rents out certain floors to other companies,
then the part occupied will be classed as PPE per IAS 16, with the floors rented out
classed as investment property

An item of investment property should be reconized as an asset when

1) It is probable that future economic benefits associated with the asset will
flow to the entity
2) The cost of the asset can be measured reliably

IAS 40 gives a choice for subsequent measurement between the flollwong^

1) The cost model

2) Fair value model

Cost model is the same as IAS 16

Under the fair value model:

47
 - The asset is revalued to fair value at the end of each year the gain or loss is
shown directly in the statement of profit or loss
- No depreciation is charged on the asset

If an asset is transferred from PPE to investment property:

1) The fair value model for investment property is used:

The asset must first be revalued per IAS 16 (creating a revaluation surplus in
equity) and then transferred into investment property at fair value

2) The cost model is used:

The asset is transferred into investment properties at the current carrying amount
and continues to be depreciated

The other way around:

1) Fair value – revalue the property first per IAS 40 and then transfer at fair
value
2) Cost model – the asset is transferred and continues to be depreciated

IAS 36 Impairment of assets

IAS 36 applies to all assets other than:

- Inventories (IAS 2)
- Construction contracts (IAS 11)
- Deferred tax assets (IAS 12)
- Assets arising from employee benefits (IAS 19 is ecluded from FR)
- Financial assets included in the scope of IFRS 9
- Investment property measured at fair value (IAS 40)
- Non-current assets classified as held for sale (IFRS 5)

An asset is impaired if:

48
Its recoverable amount is below

The value currently shown on the statement of financial position – the asset’s
current carrying amount

Recoverable amount is taken as the higher of:

1) Fair value less costs to sell (net realizable value)

2) Value in use

49