ACCA Strategic Business

Reporting (SBR)
Achievement Ladder
Step 8 Questions & Answers
Strategic Business Reporting Achievement Ladder Step 8

Section A

Question 1
Question text
The following draft statements of financial position relate to Ribby, Hall, and Zian, all public limited
companies, as at 31 May 20X8.
Ribby Hall Zian
$m $m Dinars m
Assets
Non-current assets:
Property, plant and equipment 247 120 360
Investment in Hall 98 – –
Investment in Zian 33 – –
Financial assets 10 5 148
Current assets 22 17 120
Total assets 410 142 628
Equity
Ordinary shares 60 40 209
Other components of equity 30 10 –
Retained earnings 120 80 307
Total equity 210 130 516
Non-current liabilities 90 5 40
Current liabilities 110 7 72
Total equity and liabilities 410 142 628
The following information needs to be taken account of in the preparation of the group financial
statements of Ribby.
(1) Ribby acquired 70% of the ordinary shares of Hall on 1 June 20X6 when Hall's other components
of equity were $10 million and retained earnings were $60 million. The fair value of the net assets
of Hall was $120 million at the date of acquisition. The excess of the fair value over the net
assets of Hall was due to an increase in the value of non-depreciable land.
(2) Ribby acquired 60% of the ordinary shares of Zian for 330 million dinars on 1 June 20X7 when
Zian's retained earnings were 220 million dinars. The fair value of the net assets of Zian was
equal to their carrying amount at the date of acquisition. The finance director of Ribby is unsure
of how to include Zian in the consolidated financial statements and has started by translating
Zian's statement of financial position at the closing rate on 31 May 20X8.
(3) Zian is located in a foreign country and imports its raw materials at a price which is normally
denominated in dollars. The product is sold locally at selling prices denominated in dinars, and
determined by local competition. All selling and operating expenses are incurred locally and paid
in dinars. Distribution of profits is determined by the parent company, Ribby. Zian's management
have a considerable degree of authority and autonomy in carrying out the operations of Zian and
are not dependent upon group companies for finance.
(4) Ribby has a long-term loan of $10 million which is owed to a third party bank. At 31 May 20X8,
Ribby decided that it would repay the loan early on 1 July 20X8 and formally agreed this
repayment with the bank prior to the year end. The agreement sets out that there will be an early
repayment penalty of $1 million.
(5) Ribby operates a defined benefit pension plan that provides a pension of 1.2% of the final salary
for each year of service, subject to a minimum of four years' service. On 1 June 20X7, Ribby
improved the pension entitlement so that employees receive 1.4% of their final salary for each
year of service. This improvement applied to all prior years' service of the employees. As a result,
the present value of the defined benefit obligation on 1 June 20X7 increased by $3.5 million as
follows:
$m
Employees with more than four years' service 3.0
Employees with less than four years' service (average service of two years) 0.5
3.5
Ribby had not accounted for the improvement in the pension plan.
(6) The following exchange rates are relevant to the preparation of the group financial statements:
Dinars to $
1 June 20X7 10
31 May 20X8 12
Average for year to 31 May 20X8 10.5
(7) It is the group's policy to value the non-controlling interest at acquisition at fair value. The fair
value of the non-controlling interest in Hall on 1 June 20X6 was $42 million. The fair value of the
non-controlling interest in Zian on 1 June 20X7 was 220 million dinars.
(8) Goodwill on the acquisition of Hall was impaired by 20% in the year to 31 May 20X7. An
impairment review conducted by Ribby in the current year identified that no further impairment to
goodwill on the acquisition of Hall was necessary, however, goodwill on the acquisition of Zian
was impaired by 30%.
(9) Zian paid a dividend of 20 million dinars on 31 May 20X8. No ordinary shares have been issued
by Zian or by Hall since acquisition. Ribby records its investments in subsidiaries at their
acquisition cost.
Required
(a) Discuss and apply the principles set out in IAS 21 The Effects of Changes in Foreign Exchange
Rates in order to determine the functional currency of Zian. (6 marks)
(b) Calculate, providing explanations in support of your workings, the goodwill balance for inclusion
in the consolidated statement of financial position of Ribby at 31 May 20X8. (8 marks)
(c) Explain, with supporting calculations, how Zian should be accounted for in the consolidated
statement of financial position of Ribby at 31 May 20X8. (10 marks)
(d) Calculate the retained earnings balance for inclusion in the consolidated statement of financial
position of Ribby as at 31 May 20X8. (6 marks)
(Total = 30 marks)
Feedback

Top tips. Part (a) of Question 1 asked you to determine the functional currency of an overseas
subsidiary. Make sure you produce arguments for and against your decision, as it is not clear cut.
Parts (b) and (d) required you to prepare extracts from the consolidated financial statements. In
Part (b), you were asked to calculate the goodwill for inclusion in the consolidated financial
statements. The goodwill of Hall should have been relatively easy and it is important to grab these
easy marks when they are available. The calculation for Zian was a little trickier but should be
achievable if you follow a standard approach. Part (c) asked for explanations and calculations of how
to include Zian in the consolidated financial statements. Keep your explanations brief and focused on
what rates should be used to translate Zian's financial statements and how to treat exchange gains
and losses. In Part (d) you were required to calculate the retained earnings figures, which required
you to take account of the adjustments in respect of the early loan repayment and the past service
cost on the pension. It is a good idea to provide a brief explanation of the adjustments, in case the
figures are wrong. The adjustments were to the retained earnings of the holding company which
meant you did not need to consider the effects of translation of non-controlling interests.
Easy marks. There are easy marks available for calculating the goodwill of Hall and for simply
translating the statement of financial position of Zian at the correct rate.

Marking guide

Marks

(a) Consideration of factors 4

Conclusion 2
6
(b) Goodwill: Hall 2
Goodwill: Zian 6
8

(c) Correct exchange rates 2

Translation 2
Calculation of gains and losses 3
Explanation 3
10

(d) Early repayment of loan 1

Pension 1
Retained earnings: Hall 1
Zian 1
Ribby 2
6
Total 30

(IAS 21: paras. 8–10)

(a) Factors to consider in determining functional currency of Zian
IAS 21 The Effects of Changes in Foreign Exchange Rates defines functional currency as 'the
currency of the primary economic environment in which the entity operates'. Each entity, whether
an individual company, a parent of a group, or an operation within a group, should determine its
functional currency and measure its results and financial position in that currency.
 An entity should consider the following factors:
(i) Is it the currency that mainly influences sales prices for goods and services (this will often
be the currency in which sales prices for its goods and services are denominated and
settled)?
(ii) Is it the currency of the country whose competitive forces and regulations mainly
determine the sales prices of its goods and services?
(iii) Is it the currency that mainly influences labour, material and other costs of providing
goods or services? (This will often be the currency in which such costs are denominated and
settled.)
Applying the first of these, it appears that Zian's functional currency is the dinar. Zian sells its
products locally and its prices are determined by local competition. However, point (ii) on sales
prices and point (iii) on operating costs suggest that the functional currency is the dollar. Zen
imports goods which are paid for in dollars, and while selling and operating costs are paid in
dinars, it is the currency that determines the pricing of transactions that is important.
Other factors may also provide evidence of an entity's functional currency:
(i) It is the currency in which funds from financing activities are generated.
(ii) It is the currency in which receipts from operating activities are usually retained.
Zian does not depend on other group companies for finance. Furthermore, Zian operates
with a considerable degree of autonomy, and is not under the control of the parent as regards
finance or management. These aspects point away from the dollar as the functional currency.
The position is not clear cut, and there are arguments on both sides. However, on balance it is
the dinar that should be considered as the functional currency, since this most faithfully
represents the economic reality of the transactions, both operating and financing, and the
autonomy of Zian in relation to the parent company.
(b) Goodwill calculations
Group structure
Ribby

1.6.20X6 70% 60% 1.6.20X7

Cost $98m Cost 330m dinars

Hall ($) Zian (dinars)

Retained earnings: $60m Retained earnings: 220m dinars
Other components of equity: $10m Fair value net assets: 220m + 209m = 429m dinars
Fair value net assets: $120m
Both Hall and Zian are subsidiaries of Ribby. Goodwill on each is calculated as follows.
Goodwill: Hall
$m
Consideration transferred 98
Non-controlling interests 42

Fair value of identifiable net assets at acq'n (per

question) (120)
20
Impairment loss (20% × 20) (4)
16
The goodwill of Hall is calculated by comparing the total consideration transferred by Ribby to
acquire the subsidiary plus the fair value of the non-controlling interests at the date of acquisition
with the fair value of the identifiable net assets of Hall at that date. This gives goodwill at
acquisition of $20 million which must be tested for impairment annually. The goodwill of Hall was
 impaired by 20% in the prior year, hence the goodwill to be included in the consolidated financial
statements is $16 million.
Goodwill: Zian
Dinars (m) Rate $m
Consideration transferred 330 33.0
Non-controlling interests 220 22.0
10
Less: fair value of net assets at acquisition
(209m + 220m dinars) (429) (42.9)
At 1 June 20X7 121 10 12.1
Impairment loss at 30% (36.3) 10.5 (3.5)
Exchange loss (balancing figure) – (1.5)
At 31 May 20X8 84.7 12 7.1
The goodwill of a foreign subsidiary is considered to be an asset of that foreign subsidiary and is
therefore calculated in the functional currency of the subsidiary (dinars) and translated into the
presentation currency of the group (dollars) at the date of acquisition and again at each year end
date. The goodwill calculated at the date of acquisition should be translated at the actual rate at
that date. The 30% impairment of goodwill should be calculated on the dinar balance and
translated to dollars at the average rate for the year. The impaired goodwill balance at the end of
the year is then translated at the closing rate at the reporting date. An exchange gain or loss will
arise as a result of applying, in this case, three different exchange rates in the calculation of
goodwill. The exchange loss is the balancing figure and is allocated to the group and the non-
controlling interest based on their relative interests in the subsidiary at the year end.
The total goodwill to be included in the consolidated financial statements of Ribby at 31 May
20X8 is therefore ($16m + $7.1m) $23.1 million.
Tutorial Note. IAS 21 does not specify the rate at which impairment losses should be translated,
therefore credit would be given for using either the average rate or the closing rate.
(c) Accounting for Zian
Zian's statement of financial position (SOFP) should be consolidated with that of the group.
Before it can be consolidated, the SOFP should be translated into dollars. The finance director
has translated the SOFP at the closing rate at 31 May 20X8. Whilst this is the correct rate at
which to translate the assets and liabilities of Zian, different rates should be applied when
translating the equity balances.
Zian's share capital and pre-acquisition retained earnings should be translated at the rate at the
date of acquisition.
Zian's post-acquisition retained earnings should be translated as follows:
(i) Profit for the year at the average rate for that year
(ii) Dividends paid at the actual rate at the date of payment
The resulting exchange difference on Zian's net assets (loss of $8.4m at 31 May 20X8 – see
Appendix 1) can then be calculated as the balancing figure in Zian's translated statement of
financial position.
In the consolidated financial statements, Zian's assets and liabilities should be consolidated on a
line-by-line basis. Goodwill on acquisition of Zian, less impairment losses as calculated in (b)
should be included in consolidated non-current assets ($7.1m at 31 May 20X8).
Group equity should include a 'translation reserve' within other components of equity, comprising
of the group's share of the exchange loss on the net assets and the group share of the exchange
loss on the goodwill of Zian (($8.4m + $1.5m)  60% = $5.94m at 31 May 20X8).
The non-controlling interest balance should include its share of the exchange loss on net assets
and its share of the exchange loss on the goodwill of Zian (($8.4m + $1.5m)  40% = $3.96m at
31 May 20X8).
 Appendix 1
TRANSLATION OF SOFP OF ZIAN AT 31 MAY 20X8
Dinars (m) Rate $m

Property, plant and equipment 360 12 30.0

Financial assets 148 12 12.3
Current assets 120 12 10.0
628 52.3
Share capital 209 10 20.9
Pre-acqn retained earnings 220 10 22.0
Post-acqn retained earnings:
1.6.X7-31.5.X8 profit (307 – 220 + 20) 107 10.5 10.2
31.5.X8 dividend (20) 12 (1.7)
Exchange gain/(loss) – ß (8.4)
516 43.0
Non-current liabilities 40 12 3.3
Current liabilities 72 12 6.0
628 52.3
(d) CONSOLIDATED RETAINED EARNINGS
Ribby Hall Zian
$m $m $m
At year end 120.0 80.0
as translated (22 + 10.2 – 1.7)) 30.5
At acquisition (60.0)
as translated (220/10) (22.0)
20.0 8.5
Adjustments:
Loan penalty (W1) (1.0)
Past service cost (W2) (3.5)
Group share: Hall: 20  70% 14.0
Zian: 8.5  60% 5.1

Impairment losses on goodwill ((4  70%) + (4.9)

(3.5  60%))
129.7

Workings
1 Early repayment of loan
The decision to repay the loan early has two implications:
(i) The loan must be transferred from non-current liabilities to current liabilities.
(ii) A penalty for early repayment.
The double entries are:
DEBIT Non-current liabilities $10m
CREDIT Current liabilities $10m
Being transfer to current liabilities
DEBIT Profit or loss for the year $1m
CREDIT Current liabilities $1m
Being accrual of early repayment penalty
 2 Past service cost
Per IAS 19, all past service costs must be charged to profit or loss.
The double entry is as follows:
On 1 June 20X7:
DEBIT Profit or loss (retained earnings) $3.5m
CREDIT Present value of obligation
(non-current liabilities) $3.5m

Question 2
Question text
(a) Tango is the parent company of a number of companies operating in the retail industry. Tango is
considering selling its subsidiary, Salsa. Just prior to the year end, Salsa sold inventory to Tango
at a price of $6 million. The carrying amount of the inventory in the financial records of Salsa was
$2 million. The cash was received before the year end, and as a result the bank overdraft of
Salsa was virtually eliminated at 31 May 20X8. After the year end the transaction was reversed,
and it was agreed that this type of transaction would be carried out again when the interim
financial statements were produced for Salsa, if the company had not been sold by that date.
Required
With reference to the above scenario, discuss how the manipulation of financial statements by
company accountants is inconsistent with their responsibilities as members of the accounting
profession, setting out the distinguishing features of a profession and the privileges that society
gives to a profession. (8 marks)
(b) You are the financial controller of Rumba, a company operating in the retail industry with a
significant number of stores. Rumba has purchased the rights to a number of clothing brands in
the past year in an attempt to boost falling sales and improve profitability. Employees at Rumba
are rewarded with an annual bonus if profits exceed a certain amount at the year end.
You have received the following email from a new junior employee of your finance team, who
recently qualified as an accountant whilst working at a competitor.
To: Rumba Financial Controller
From: Accountant
Re: Improving profits
I used to work in the accounting department at Foxtrot, our key competitor. Just before I left I was
involved in a project to improve Foxtrot's reported profit. One of the proposals considered was to
change some of Foxtrot's accounting policies, all permissible under IFRS, of course.
I made a copy of the proposal document I worked on and think we could use it here at Rumba.
I will forward it on to you. The part of the proposal that I think we should apply to Rumba is to
change our accounting policies for property, plant and equipment and intangible assets by
extending the useful lives of these assets. This is particularly applicable to us because we have
significant property and brand balances.
Please can you let me know what you think? I would appreciate it if you didn't mention that the
proposal came from Foxtrot, because I am still in touch with the Foxtrot finance team and I
wouldn't want it to get back to them!

Required
Write an email to the junior employee, explaining whether or not her suggestion is appropriate.
Your email should include consideration of relevant accounting standards and ethical principles.
(10 marks)
Professional marks will be awarded in this question for the application of ethical principles.
(2 marks)
(Total = 20 marks)
Feedback

Top tips. Question 2 Part (a) required you to discuss the manipulation of financial statements and the
nature of an accountant's responsibilities to the profession and to society. Make sure you relate your
answer to the information regarding the sale of inventory at an inflated price as you are asked to. In
Part (b) you need to explain to the junior accountant why it would not be appropriate to change the
useful lives of assets purely to improve reported profits. Make sure you discuss the ethical reasons as
well as the accounting reasons.
Easy marks. Relating your answer to the ethical principles in Part (b) should be reasonably easy.

Marking guide

Marks

(a) Accounting 4
Ethical discussion 4
8
(b) Accounting 6
Ethical discussion 4
10
Professional marks 2
20

(IAS 8: para. 14)

(a) Ethical implications of sale of inventory
Members of the accounting profession enjoy a number of privileges. These include:
(i) Special status and respect within the community
(ii) Self-regulation; that is regulation by the accountants' professional body
(iii) An exclusive right to certain functions; for example, auditors must be members of certain
professional bodies
Like other professions, the accounting profession has features that distinguish it from non-
professional jobs. The most important of these is specialist knowledge, but also recognition as
being committed to the good of society, rather than just commercial gain.
To earn this status and these privileges, accountants should, as a minimum:
(a) Be committed to the presentation of true, fair and accurate financial statements.
(b) Show independence and objectivity in applying financial reporting standards.
(c) Be committed to an ethical approach to business, and apply this in the preparation of
financial statements.
Ethical behaviour in the preparation of financial statements, and in other areas, is of paramount
importance. This applies equally to preparers of accounts, to auditors and to accountants giving
advice to directors. Company accountants act unethically if they use 'creative' accounting in
accounts preparation to make the figures look better.
In treating the inventory as sold, Tango is indulging in 'window dressing'. This is not a genuine
sale; its purpose is purely to show Tango's subsidiary Salsa in a better financial position
than is truly the case, in order to increase the likelihood of the sale of Salsa. The 'sale' of
inventory would increase cash and retained earnings by $4 million, boosting the appearance of
both profitability and liquidity. This would mislead a potential buyer. Nor would this manipulation
be a 'one-off'; if the subsidiary is not sold, the transaction would be carried out again in the
 interim accounts. Neither the final accounts for 31 May 20X8, nor the interim accounts would give
a fair presentation of the true picture.
The treatment of the inventory is therefore unethical, and should be reversed when preparing
the consolidated financial statements.
(b) Revisions to accounting policies
To: Accountant
From: Rumba Financial Controller
Re: Improving profits
Thank you for your suggestions, I appreciate your thoughts on this but please give consideration
to the accounting and ethical implications of what you are suggesting.
Changing accounting policies
In general, IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors only permits
a change in accounting policy if the change:
 Is required by an IFRS; or
 Results in information that is more relevant and reliable.
Changing any of our accounting policies simply to boost profits contravenes IAS 8 and is
ethically dubious.
Extending the useful life of our property, plant and equipment and intangible assets would reduce
the amount of depreciation or amortisation charged each year, and would therefore improve the
profit figure. This would not be a change in accounting policy, but a change in accounting
estimate. Accounting estimates are based on judgement. It is sometimes necessary to change
the useful life of an asset if changes occur in the circumstances on which the useful life was
based, or more information comes to light. It is possible therefore that we can use this
opportunity to conduct a review of the useful lives of our assets to determine if they are still
appropriate. However, it would be unethical to change the useful lives simply to boost profits.
Ethical considerations
There are significant ethical concerns with what you are proposing. As an ACCA qualified
accountant, you need to ensure that you abide by the fundamental principles in the ACCA Code
of Ethics and Conduct. To help with your learning, here are my thoughts on how your suggestion
could contravene these principles:
Confidentiality
You only have access to the proposed changes to accounting policies as a result of your
previous employment. As professional accountant, you have a continuing duty to protect the
confidentiality of your previous employer, which includes not sharing commercially sensitive
information with a third party.
Objectivity
Your suggestion to change the useful lives of assets appears to be based solely on boosting
profits. This could be perceived to be so that you can also achieve your bonus, and is therefore a
self-interest threat to your objectivity.
Professional competence
The duty of professional competence means that you must have sufficient training and
experience to carry out a task. Here you seem to be unaware of the rules in IAS 8 regarding
when an accounting policy can be changed, and also that extending the useful life of assets
would be a change in accounting estimate, not accounting policy. I advise that you revise your
learning materials in these areas, please ask if you require help.
Integrity
The principle of integrity requires you to be honest in your professional relationships. Your
request for me not to mention where the proposal came from suggests that you know that using
this information would not be a good idea. It is likely that an independent observer may perceive
this as dishonest. Rumba's senior management and external stakeholders may feel that
operating in this manner lacks honesty and transparency.
In conclusion, it would be worthwhile to review the useful lives of our assets to confirm that they
are appropriate. However, changing the useful lives purely with the intention of boosting profits
would not be appropriate and is ethically dubious.
Kind regards
Financial Controller
Section B
Question 3
Question text
Tele2 is a company in the telecommunications industry providing landline and mobile telephone
connections and equipment and other telecommunications services such as internet access. The
company is currently preparing its consolidated financial statements for the year ending 31 December
20X8.
(a) When Tele2 charges an activation fee to a customer together with the fee for the related
equipment, the entire activation fee is recognised at the date of connection even if the length of
the customer contract spans a number of accounting periods. (4 marks)
(b) The purchase of licences for operations from governments are treated as intangible assets and
are capitalised at their initial cost. In cases where Tele2 is confident that the licence will be
renewed (at no additional cost) then the licence is not amortised. (4 marks)
(c) Tele2 has recently been suffering a shortage of cash and to help to alleviate this had sold one of
its office buildings to a third-party institution on 1 January 20X8 and then leased it back for a
period of 15 years. The sale price of the building was equal to its fair value of $8.5 million at the
date of sale, which is also the present value of the future lease payments at that date. At the end
of the agreement, the building will be transferred back to Tele2 at nil cost.
At 31 December 20X7 the carrying amount of the building was $7 million. The building had a
remaining useful life of 15 years at that date. The rental under the lease agreement is $0.8 million
per annum payable in advance on 1 January each year and the interest rate implicit in the lease
is 5.44%.
The directors of Tele2 are proposing to include the profit on disposal of $1.5 million in profit or
loss for the year. (9 marks)
(d) On 1 January 20X8 Tele2 held a 30% holding in a communications software development
company CSD, which originally cost $24 million a number of years ago. On 31 March 20X8 Tele2
sold a 15% holding in CSD reducing its investment to a 15% holding meaning that Tele2 no
longer exercises significant influence over CSD.
Before the sale of the shares the net asset value of CSD at 31 March 20X8 was $100 million,
having risen from $70 million on the date of the original acquisition. Tele2 received $20 million for
its sale of the shares in CSD and the fair value of its remaining holding in CSD at 31 March 20X8
was $17 million. At 31 December 20X8 the fair value of this holding was $19 million. (8 marks)
Required
Write a report to the directors of Tele2 explaining how each of these matters should be dealt with in
the group financial statements for the year ending 31 December 20X8.
(Total = 25 marks)
Feedback

Top tips: This is a mixed question that requires knowledge across a number of areas. It is advisable
to scan read Parts (a) – (d) to identify the parts you are most comfortable with and answer those first,
In Part (a) it is important to consider what the performance obligation is, ie what does the company
have to do to recognise the revenue? Part (b) is a relatively simple discussion of IAS 38 recognition
criteria and accounting treatment. In Part (c) it is important to clearly state whether a sale has or has
not occurred and discuss the accounting treatment that follows. Part (d) requires you to understand
how to account for a simple investment under IFRS 9, discussing the options available for a financial
asset.
Easy marks. There are easy marks available for discussion of IAS 38 in part (b) and the options
available for accounting for financial assets in Part (d).

Marking guide

Marks

(a) Activation fee Revenue recognition issue/IFRS 15 2

Accounting treatment 2
4
(b) Licences Capitalisation 1
Recognition criteria 1
Useful life 1
Amortise 1
4
(c) Sale and leaseback Substance 1
Not a sale (control not transferred) 2
No change to carrying amount 1
Financing arrangement: financial liability 1
Depreciation 1
Finance charge 1
Current liability 1
Non-current liability 1
9
(d) Investment Significant influence lost 2
Remeasure remaining interest to fair value 1
Gain on sale 2
Financial asset remaining 1
IFRS 9 classification 1
31 Dec change in value 1
8
25

(IAS 38: paras. 88–96; IAS 28: para. 22)

 REPORT

To: The Directors of Tele2

From: Accountant
Date: Today
Subject: Preparation of financial statements for year ending 31 December 20X8
Terms of reference:
This report considers the accounting treatment of a number issues and in particular:
 Revenue recognition re the activation fee
 Licences
 Sale and leaseback
 Sale of investment in CSD
 Sub-lease costs.
(a) Activation fee
The accounting policy chosen for the activation fees is concerning. The activation fee is a one-off
fee at the start of a contract with the customer. In accordance with IFRS 15 Revenue from
Contracts with Customers, Tele2 needs to consider what the performance obligation (or
obligations) is/are that are satisfied in return for the activation fee and whether each obligation is
satisfied at a point in time or over a period of time.
Although the activity relating to setting up the contract takes place at or near contract inception,
the activity does not result in the transfer to the customer of the promised service (which is a
requirement for revenue to be recognised in accordance with IFRS 15). Therefore it is likely that
the activation fee is in reality an advance payment for future services to be performed over the
period of the customer contract. A more appropriate accounting policy would therefore be to defer
the activation fees and recognise them over the period of the customer contract.
(b) Licences
In accordance with IAS 38 Intangible Assets, the licences purchased from governments should
be treated as intangible non-current assets and capitalised at their initial cost provided that it is
probable that future economic benefits will flow to Tele2 from the licence and that the cost can be
measured reliably. It would seem that both of these conditions are met therefore capitalisation is
the correct accounting treatment.
However, IAS 38 also states that such intangible assets should be amortised over their useful life
unless the useful life is indefinite, in which case annual impairment tests are required. The
assessment of this useful life should take into account many factors including technical,
technological and commercial factors as well as potential actions by competitors. As Tele2 does
not amortise these licences then clearly the directors believe that they have an indefinite useful
life. It would be argued by most that this is an unrealistic assumption even if the directors are
confident of renewal and therefore the licences should be amortised over the period to the next
renewal date.
(c) Sale and leaseback
The directors of Tele2 wish to treat the sale of the building as a genuine sale and include the
profit on disposal in profit or loss in the current year. However, the substance of the transaction
needs to be considered. The fact that the building will be transferred back to Tele2 at the end of
the lease term shows that the third party institution does not obtain control of the building. This is
because the third-party institution is limited in its ability to direct the use of, and obtain
substantially all the remaining benefits from, the building. Consequently, a performance obligation
has not been satisfied per IFRS 15 Revenue from Contracts with Customers and the transfer is
not in substance a sale. Therefore, the building should remain in the statement of financial
position as part of property, plant and equipment with no adjustment to its carrying amount at the
date of the transaction.
The proceeds received of $8.5 million are treated as a financing arrangement and are recorded
as a financial liability and accounted for in accordance with IFRS 9 Financial Instruments. The
property will be depreciated over its 15-year useful life, with a depreciation charge of
$0.47 million ($7m/15 years) each year. There will also be a finance charge in profit or loss of
 $0.42 million in 20X8 (($8.5m – $0.8m paid on 1 January)  5.44%). In the statement of financial
position the building will be shown within property, plant and equipment at a carrying amount of
$6.53 million ($7m – $0.47m).
Finally, the financial liability in the statement of financial position will need to be broken down into
current and non-current elements (IAS 1 Presentation of Financial Statements paras. 60–61).
The financial liability will be $8.12 million ($8.5m – $0.8m + $0.42m from above). The current
element of this will be $0.8 million, the next payment. The non-current element will be
$7.32 million ($8.12m – $0.8m 20X9 payment).
(d) Sale of investment in CSD
The investment in CSD will have been accounted for up to 31 March 20X8 as an associate using
the equity method of accounting per IAS 28 Investments in Associates and Joint Ventures.
However, once the 15% holding is sold then Tele2 has only a 15% holding remaining which does
not enable Tele2 to exercise significant influence. Tele2's holding in CSD has crossed the
boundary from being accounted for under IAS 28 to IFRS 9 Financial Instruments. IAS 28
requires Tele2 to remeasure its remaining shareholding to fair value and recognise a gain on
disposal of $4 million (see Appendix 1). This gain is shown in profit or loss. The remaining 15%
investment will be accounted for in accordance with IFRS 9. This investment in equity
instruments will be held as a financial asset at fair value. The subsequent treatment of this
investment will depend upon how it is classified.
If the investment is classified as at fair value through profit or loss, then any changes in fair value
will be taken to profit or loss. If an election is made the investment in equity instruments can be
measured at fair value with changes taken to other comprehensive income. Therefore, the
investment will be remeasured to $19 million, its fair value, and a gain of $2 million ($19m –
$17m) will be reported either in profit or loss or in other comprehensive income on 31 December
20X8, depending whether an election is made.
Appendix 1
GAIN ON SALE OF CSD
$m $m
Fair value of consideration received 20
Fair value of interest retained 17
Less: carrying amount at disposal:
cost 24
post-acquisition profits [(100 – 70)  30%] 9
(33)
4
Question 4
Question text
(a) The International Accounting Standards Board has expressed concern about 'clutter' in annual
reports. In apparent contradiction to this, ACCA, among others, are keen supporters of Integrated
Reporting, which seeks to expand the remit of reporting beyond the traditional financial statements.
Required
(i) Explain what is meant by 'integrated reporting' and how it differs from conventional financial
reporting. (5 marks)
(ii) Discuss the argument that integrated reporting is onerous and unnecessary because
shareholders are mainly interested in profit. (6 marks)
(b) Geova Healthtech is a biotechnology research and healthcare products company, reporting to a
31 December 20X4 year end. The company is structured into a number of small teams to foster
innovation and entrepreneurial spirit. One of the teams, Team Creovate, has consistently
outperformed the others for the past five years, under the leadership of Tom Tranter, a renowned
specialist in the development of steroids.
This year, Team Creovate has started developing a new product, Trilevidex, a steroidal anti-
inflammatory drug. The following product development information is available with regard to
Trilevidex:
Future prospects
Full technical testing has been undertaken – proposed production complies with Good Production
Practice standards. All trials are proving successful. Technical testing was concluded at the end
of December 20X3. The product development is ahead of schedule. The drug is expected to gain
a reasonable market share. Forecast sales estimates and in-house production still estimate
annual recurring profits of around $545,000 p.a. once the product is established. Total expected
future costs are now estimated at $1.4 million. The project has a remaining budget of $1.9 million
which should easily cover this cost.
20X4 costs
The managing director believes that a total of $905,100 should be capitalised, broken down as follows.
$
Salary costs 495,400
Training costs: $56,000 total for Team Creovate, of which $28,500 relates to
processes used in developing Trilevidex 28,500
Consumables 381,200
Total 905,100
Of the salary costs, $50,000 relates to Tom Tranter, reflecting the proportion of his time spent on
the Trilevidex product. Tom Tranter's total salary is $150,000 per annum. The Managing Director
has raised the issue of whether further costs relating Tom Tranter should be capitalised. He argues
that Tom Tranter is 'an invaluable asset to the team' and that and the International Integrated
Reporting <IR> Framework specifically mentions human capital as one of its key focus points, and
this should be reflected in the financial statements. A consultant friend of the managing director has
used a formula for calculating the value of Tom Tranter based on his age – the present value of his
future earnings from employment – and has calculated this to be $8 million.
Required
(i) Explain what is meant by human capital in the context of the International Integrated
Reporting <IR> Framework. (5 marks)
(ii) Explain, with supporting calculations, how the costs relating to Trilevidex should be treated in
the financial statements of Geova Healthtech for the year ended 31 December 20X4.
(3 marks)
(iii) Discuss the Managing Director's view that Tom Tranter should be recognised in the
statement of financial position. (4 marks)
Professional marks will be awarded in Part (b) for clarity and quality of discussion. (2 marks)
(Total = 25 marks)
Feedback

Top tips: This question focuses on the International Integrated Reporting Framework, particularly on
human capital. Even if you are not familiar with the features of an integrated report in Part (a)(i), you
should still be able to come up with some common sense answers to the arguments for and against
IR in Part (a)(ii). Part (b)(i) is quite tricky as it requires knowledge of the Integrated Reporting
Framework. Part (b)(ii) should be relatively easy as it requires discussion of the PIRATE criteria for
intangible assets. Part (b)(iii) considers how to account for human assets in a business. Use the basic
definition of an asset provided by the Conceptual Framework as the basis to your answer.
Easy marks. There are easy marks available for discussion of IAS 38 in Part (b)(ii) and whether
human assets meet the definition of an asset in Part (b)(iii).

Marking guide

Marks

(a)(i) Definition 1
1 mark per feature, max 4
5

(ii) 1 mark per valid comment out of the following to a max 6

Against IR:
Cost 1
Time/training 1
Need for consultant 1
Loss of competitive advantage 1
Other 1
For IR:
Shareholders may be interested in future value 1
Focus on stakeholders other than shareholders 1
Information collated as a result of IR which is useful to
management 1
Other 1

(b)(i) 1 mark per valid comment out of the following to a max 5

(ii) Correct treatment of development costs 2
Exclusion of training costs 1
3

(iii) Capitalisation of human asset 1 mark per valid point to a max 4

Human capital accounting versus human capital in IR
Human beings as assets
Conceptual Framework
Unreliability of measurement
Absence of control

Professional marks 2
25

(International <IR> Framework: paras. 2.12, 2.15; IAS 38: paras. 57, 67;
Conceptual Framework: paras. 4.4, 4.38)
(a) (i) Features of integrated reporting
An integrated report is a concise communication about how an organisation's strategy,
governance, performance and prospects in the context of its external environment lead to
the creation of value in the short, medium and long term.
It differs from conventional financial reporting in the following ways:
(1) Wider performance appraisal. Integrated reporting is concerned with conveying a
wider message on an entity's performance. It is not solely centred on profit and the
company's financial position but aims to focus on how the organisation's activities
interact to create value over the short, medium and long term. It is thought that by
producing a holistic view of organisational performance that this will lead to improved
management decision-making as business decisions are not taken in isolation.
(2) Value creation. In the context of integrated reporting an organisation's resources are
referred to as 'capitals'. The International Integrated Reporting Council have identified
six capitals which can be used to assess value creation. Increases or decreases in
these capitals indicate the level of value created or lost over a period. Capitals cover
various types of resources found in a standard organisation. These may include
financial capitals, such as the entity's financial reserves, through to its intellectual capital
which is concerned with intellectual property and staff knowledge.
Performance evaluation of the six capitals is central to integrated reporting. The other
capitals are financial capital, manufactured capital, intellectual capital, social and
relationship capital and natural capital.
(3) Short term versus long term. In many ways, integrated reporting forces management
to balance its short term objectives against its longer term plans. Business decisions
which are solely dedicated to the pursuit of increasing profit (financial capital) at the
expense of building good relations with key stakeholders such as customers (social
capital) are likely to hinder value creation in the longer term.
(4) Performance measures. Integrated reporting is not aimed at attaching a monetary
value to every aspect of the organisation's operations. It is fundamentally concerned
with evaluating value creation, and uses qualitative and quantitative performance
measures to help stakeholders assess how well an organisation is creating value. The
use of Key Performance Indicators (KPIs) to convey performance is an effective way of
reporting. For example when providing detail on customer satisfaction, this can be
communicated as the number of customers retained compared to the previous year.
Best practice in integrated reporting requires organisations to report on both positive
and negative movements in 'capital', ensuring that a balanced view of performance is
presented.
(5) Materiality. When preparing an integrated report, management should disclose matters
which are likely to impact on an organisation's ability to create value. Internal
weaknesses and external threats regarded as being materially important are evaluated
and quantified. This provides users with an indication of how management intend to
combat such instances should they materialise.
(ii) Usefulness of integrated reporting
It is generally true that shareholders are mainly interested in profit, and may see additional
reporting beyond legal and regulatory requirements as burdensome. Why add to the
workload, especially as integrated reporting is voluntary? The following points could be
made supporting this argument.
(1) There will be cost implications as systems are upgraded to collect data.
(2) Staff will need extra time for training and adjustments in attitude.
 (3) When a company produces its first integrated report, the board may seek external
guidance from an organisation which provides specialist consultancy on reporting. Any
advice is likely to focus on the contents of the report. The consultant's fees are likely to
be significant and will increase the associated implementation costs of introducing
integrated reporting.
(4) There may be a competitive disadvantage in disclosing more information than is
necessary.
(5) It may be difficult to determine which areas to report on and therefore which data to
collect/generate, especially since there are no recognised criteria for determining the
level of importance of each 'capital'.
However, a case may be made in favour of integrated reporting:
(1) While profit is important to shareholders, many will also be interested in how a company
proposes to create value in the future. If the company wishes to appease both groups
its focus should be on maximising shareholder value, the achievement of which requires
the successful implementation of both short and long term strategies.
(2) Shareholders are not the only stakeholders. Unlike traditional annual accounts,
integrated reports highlight the importance of considering a wider range of users. Key
stakeholder groups such as customers and suppliers are likely to be interested in
assessing how the company has met or not met their needs beyond the 'bottom line'.
Integrated reporting encourages companies to report performance measures which are
closely aligned to the concepts of sustainability and corporate social responsibility. This
is implied by the different capitals used: consideration of social relationships and natural
capitals do not focus on financial performance but instead are concerned, for example,
with the impact an organisation's activities have on the natural environment.
(3) Integrated reporting may prove useful to senior management by providing it with a
greater quantity of organisational performance data, and this should identify areas for
improvement. Focusing management's attention on the non-financial aspects of
performance as well as purely financial performance may lead to performance
improvements in those areas. For example, if innovation is highlighted as a key factor in
sustaining long term value, a focus on innovation could help to encourage innovation
within the company.
(b) (i) Human capital
Human capital is one of six capitals in the International Integrated Reporting <IR>
Framework.
Human capital is defined by the <IR> Framework as people's competencies, capabilities
and experience, and their motivations to innovate, including their:
(1) Alignment with and support for an organisation's governance framework, risk
management approach and ethical values
(2) Ability to understand, develop and implement an organisation's strategy
(3) Loyalties and motivations for improving processes, goods and services, including their
ability to lead, manage and collaborate
The <IR> Framework states that the overall stock of capitals will fluctuate over time, and that
there is a continuous flow between and within the capitals as they are increased,
decreased or transformed. It gives an example relating to human capital:
'Where an organisation improves its human capital through employee training, the related
training costs reduce its financial capital. The effect is that financial capital has been
transformed into human capital.'
(ii) Trilevidex
Development expenditure
Development expenditure is only capitalised under IAS 38 Intangible Assets when criteria
demonstrating the existence of future economic benefits are met. The criteria require the
reporting entity to demonstrate all of the following:
(1) Technical feasibility of completing the intangible asset so that it will be available for
use or sale
(2) Intention to complete the intangible asset and use or sell it
(3) Ability to use or sell it
(4) How the intangible asset will generate probable future economic benefits; among
other things, the entity can demonstrate the existence of a market for the output of the
intangible asset or the intangible asset itself or, if it is to be used internally, the
usefulness of the intangible asset
(5) Availability of adequate technical, financial and other resources to complete the
development and to use or sell the intangible asset
(6) Ability to measure reliably the expenditure attributable to the intangible asset during its
development
If these are not met at the year-end in relation to any given project, all expenditure must be
written-off as an expense on a project by project basis.
The costs of Trilevidex appear to meet the IAS 38 criteria from the start of the year and the
following costs can be capitalised into the development asset.
$'000
Salary costs to capitalise 495.4
Consumables to capitalise 381.2
Total 876.6
Training costs are specifically excluded by IAS 38, and may not be capitalised, even if
the training is directly relevant to the product.
The development expenditure relating to the drugs in commercial production should begin to
be amortised over its expected useful life to a nil residual value as of the date when it is
'available for use', ie when commercial production starts.
(iii) Tom Tranter
The Managing Director may be confusing human capital, one of the six capitals in the <IR>
Framework with 'human capital accounting'. Human capital accounting has at its core the
principle that employees are assets. Competitive advantage is largely gained by effective
use of people. This developed into the concept of human asset accounting, which is the
inclusion of human assets in the financial reporting system of the organisation. In turn,
human asset accounting was broadened and became intellectual assets. One of the three
categories of intellectual assets is 'competencies': the capabilities and skills of individuals.
'Intellectual assets' thus includes 'human assets'. In the case of Geova Healthtech, it could
be argued intellectual assets represent a large proportion of its value, and that a key,
talented expert like Tom Tranter is a considerable intellectual asset.
Tom Tranter's 'competencies, capabilities and experience' appear to be a good fit with the
concept of human capital in the <IR> Framework. However, accounting principles do
not allow the recognition of staff resources within the financial statements.
Specifically, the IASB Conceptual Framework has a precise definition of an asset and sets
very specific criteria that must be met for an asset to be recognised in the statement of
financial position.
The definition of an asset in the Conceptual Framework is:
'A resource controlled by an entity as a result of past events and from which future economic
benefits are expected to flow to the entity.'
It can be argued that:
 Tom Tranter is a resource
 There has been a past event – he was recruited under an employment contract
 Future benefits are expected to flow – he is expected to generate revenue for the entity
either directly or indirectly
However:
 Control is very hard to prove. Even though a contract exists, Tom Tranter can leave,
take time off sick, or not work to the best of his ability. If he goes to a competitor, the
impact on Team Creovate and Geova Healthech as a whole could be severe.
Also, the recognition criteria from the Conceptual Framework must be met:
 There must be probable economic benefits – it is very hard to guarantee benefits
from an employee, however well he or she has performed in the past.
 The cost or fair value must be able to be reliably measured – it is very difficult to put
an objective value on staff skills and those skills have not been purchased in a business
transaction.
It is possible to value assets on a fair value basis. However, for staff, this would involve
establishing future cash flows and discounting to present value. It is difficult to see how
this could be achieved on a reliable basis due to the estimation required. The Managing
Director's consultant friend used one model to arrive at a figure of $8 million, but another
model, such as replacement cost, could produce a very different figure.
Therefore as Tom Tranter's skills neither fully meet the definition of an asset nor the
Conceptual Framework's recognition criteria, they should not be recognised as an asset
in the statement of financial position.
Integrated Reporting and financial reporting appear not to be aligned on this matter, but in
fact they are approaching the issue from different points of view. Integrated Reporting is
broader; some of the other capitals are even more subjective than human capital. Thus,
rather than put an artificial figure on human assets, they are best dealt with by way of
narrative reports and disclosures.