SBR- Reporting the Financial

Performance of Entities
Contents
Leases – Part 1 ........................................................................................................................ 3
IAS 17 VS. IFRS 16: .............................................................................................................. 3
LESSEE’S ACCOUNTING: ...................................................................................................... 5
Leases – Part 2 ........................................................................................................................ 9
PRESENTATION: .................................................................................................................. 9
IMPACT OF NEW STANDARD: ............................................................................................. 9
LESSOR ACCOUNTING: ........................................................................................................ 9
LEASE MODIFICATION: ..................................................................................................... 11
SALE AND LEASE BACK ARRANGEMENTS: ........................................................................ 11
Segment Reporting............................................................................................................... 13
AN INTRODUCTION TO IFRS 8 OPERATING SEGMENTS ................................................... 13
REPORTABLE SEGMENTS .................................................................................................. 13
AGGREGATING OPERATING SEGMENTS ........................................................................... 14
DISCLOSURES FOR EACH OPERATING SEGMENT ............................................................. 14
ADVANTAGES AND DISADVANTAGES OF IFRS 8............................................................... 15
Value added tax, tax administration and the UK tax system ............................................... 16
Income Taxes .................................................................................................................... 16
DEFERRED TAX ASSET EXAMPLE ....................................................................................... 16
DEFERRED TAX ASSET SOLUTION ..................................................................................... 16
DISCLOSURES .................................................................................................................... 17
Corporate Reporting ............................................................................................................ 18
Provisions, contingencies and events after the reporting date ....................................... 18
EXAMPLE ........................................................................................................................... 18
RE-MEASUREMENT OF A PROVISION ............................................................................... 19
DERECOGNITION OF A PROVISION ................................................................................... 20
IAS 10 GOING CONCERN ................................................................................................... 20

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 SOLUTION CONTINGENT LIABILITY ................................................................................... 21
ED 2005 IAS 37 .................................................................................................................. 22
Related Parties ..................................................................................................................... 23
RELATED PARTIES.............................................................................................................. 23
ARMS LENGTH TRANSACTIONS ........................................................................................ 23
UNRELATED PARTIES ........................................................................................................ 24
THE DISCLOSURES ............................................................................................................. 24
DISCLOSING TRANSACTIONS THAT OCCURRED AT ARMS LENGTH.................................. 25

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Leases – Part 1
IAS 17 VS. IFRS 16:

Some of the accounting issues associated with previous accounting standard on lease
account (IAS 17), the issues were based around three areas:

1- Off-balance sheet accounting:

Here we need to remember the distinction between finance lease and operating lease
under IAS 17. For a finance lease there will be an asset and liability in the balance sheet,
together with a depreciation and interest charge going through the income statement. For
operating lease there will be no asset and no liability in the balance sheet and just a rental
charge going through the income statement. Now this meant that if you picked up the set of
account of a company that had significant operating lease, it was very difficult to
understand the asset base the company had and used to generate its returns, because those
assets would not be on the balance sheet. Perhaps ever more important than that was that
the liability associated with those assets was also not on the balance sheet.

2- Understanding risk:

When we calculate gearing, we look at the amount of debt and the amount of equity and
the relationship between the two, but of course, when we have a substantial amount of
operating leases (under the old standard – IAS 17), then the liability would not be including
the commitments that exist under those operating leases, and therefore, the gearing would
appear much lower, compared to an organisation that had finance leases in place. So, it
would have been very difficult to understand the genuine risk profile of the company,
because the significant amount of its liability was off-balance sheet, and therefore, not
included within the gearing ratios.

3- Comparability:

It was very difficult to compare two companies, one with operating leases and one finance
leases and often what would happen is that the business anlaysts would take companies
with operating lease, they would want to compare them with companies with finance
leases, and the only way they could do this was to artificially create some figure that might
exist if the assets under operating lease were, in fact, under finance lease. Now, this not a
very accurate form of analysis, and involved many many assumptions!

IFRS 16:

The new account standard (IFRS 16) is trying to address the identified three main problems.
This standard is applicable for accounting periods beginning on or after 1 st of January 2019.
This means that the companies that have operating leases, having to decide whether those

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operating leases are within the scope of new standard. If they are, then we will see assets
and liabilities in the balance sheets, and they are not within scope, then the existing
treatment of nothing on balance sheet and just a rental charge through the income
statement can continue.

Definition:

Let us take a look at the definition of the lease, to determine which arrangements are in
scope. There are three elements:

1. There must be an identified asset. So, for example, if you go on a holiday and you were
to rent a car. You go over the internet, you book the car, you book a small family
hatchback that might be Astro, Volvo or similar. In other words, there is not an identified
asset as part of the arrangement, and therefore, that rental would not be within scope.

You have to be careful, because even where there is an identified asset, the arrangement
might still not be in scope, if the lessor has the substitution rights. In other words, the lessor
is able to swap the asset it has given you for another one. These substitution rights must be
practical and the lessor must have an economic incentive to make the substitution.

2. The second component of the definition is that the lessee has to obtain the economic
benefits, and we say here that the lessee has to obtain substantially all of the economic
assets associated with the asset. Let us imagine a situation where we are producing cars
and we produce complicated cars seats with heating and electric reclining mechanisms
and so forth. We might outsource the production of these car seats to a third party. Now
it could be that we are essentially leasing the production equipment of that company, in
order to produce these car seats, but we would look at the orders that were going to
this third party. If we were only using 30% of this third party’s production capacity than
we do not have access to substantially all of the economic benefits, and this would not
be a lease agreement. However, if were placing substantial orders, such that we were
taking closer to a 100% of the third party’s manufacturing capacity, then we would have
substantially all of the economic benefit and we would be, in substance, leasing the
manufacturing equipment of that third party.

3. The third element is that the lessee must be able to direct the use of the asset, this
could involve, imagine a power station setting the production levels, the lessee could
determine how much electricity is to be produced, the lessee could determine what
staffing levels are going to take place, and the lessee could determine the operational
procedure level that are going to be followed. If the lessee cannot direct the use of the
asset, them the asset will not under scope.

This is all a matter of professional judgement, there is not necessarily a right of wrong
answer. So, in the exam if you are debating which assets are in the scope, you must consider
all the information the examiner has given to you and think about whether that information

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suggest that there is an identified asset, the lessee has obtained substantial economic
benefits and the lessee directs use of the asset.

Exemptions:

 If you have a lease agreement with a maximum lease term of 12 months or less, it does
not have to be capitalised, it is not within scope.

 If you have a low value asset, these are excluded as well, the indicative level of these low
value assets is currently set at $5,000 or less, when the asset is new.

LESSEE’S ACCOUNTING:

We work out the present value of the minimum lease payments, we then set the asset of
this amount, and thus, we have an asset and a liability. Let us look at this in a little more
detail:

 Lease liability:

When we are looking at what payments to include in the lease liability, we give though to
the following:

a) Fixed payments.

b) Variable payments (only those variable payments that are actually based on an
indexed rate, such as consumer price index).

c) Actual lease term, you might have to deal with optional periods, for example, a
company has a head office on a five years lease, there is an option to extent for a
further five years. Now whether we base the lease term on five or ten years, makes a
substantial difference to the liability we are actually measuring. We must know when
to include this optional period. We include the optional period if there is a
substantial economic incentive for the lessee to take the additional period. For
example, imagine the rental term within the second five years period is so attractive
that the company will be foolish not to take it! Or imagine that the building is very
speicalised or gone through many customisations. The business, in such cases, will be
very likely to take here extension. You must consider all the facts and circumstances
in making this decision.

d) Another area to consider is lease and non-lease components. For example, when we
lease an air craft the money that we pay each month does two things, part of it pays
for the actual lease of the asset, but the other part could be paying for the servicing
of that asset. The servicing itself is not actually a lease, and therefore, that is why we
have to strip-out these non-lease components. What we do is we allocate the
payments based upon the relative fair values of the lease and non-lease

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 components. There is a practical expedient here that says that you do not have to
split out the lease and non-lease components if you do not want to. We are only
looking to split out the non-lease component where the non-lease element is a
substantial component, it is a matter of professional judgement.

Have a look at this simple example, to work out the lease and non-lease component of a
lease agreement. Imagine an arrangement where the total payments under the lease
agreement are £600,000 (in present value terms). This is a lease agreement where we are
leasing the product and paying for its servicing as well. So some of the £600,000 relates to
the leasing of the product, and some of it relates to servicing. The servicing is the non-
leasing component. We might consider splitting out the amount of payments that relate to
the non-lease component. In order to do this we need to find some market based
evidences, the standalone prices of leasing a product and the standalone prices of servicing
the product. Suppose that the standalone prices of leasing the product is £34,500 per
annum, and the standalone price of servicing the product is £2,000 per annum. This would
have a total of £36,500. What we can just see here from the numbers is that the leasing of
the product accounts for (34,500 / 36,500 =) 95%; and the servicing of the product accounts
for (2,000 / 36,500 =) 5% of the total. Therefore, of the £600,000, 95% of that is for leasing
the product 5% of it is for servicing the product. So, in terms of lease accounting we would
take £600,000 and multiply it by 95% and we could just include (600,000 x 95% =) £570,000
when we are measuring our lease liabilities. The remaining (600,000 – 570,000 =) £30,000
will be treated as expense in the normal way. Remember that this is optional, you do not
have to split out the non-lease component.

e) Also when calculating the lease liabilities we calculate the present value of the lease
payments, which employs that we have to use a discount rate. In exam we may be
told what the interest rate implicit in the lease agreement is, however, if it is difficult
to ascertain this information, then we are allowed to use the entity’s incremental
borrowing rate.

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 Right-of-Use asset

The right of use asset is basically the present value of the lease payments that we have just
calculated, however, in addition to these lease liability we would, on top of this, for the right
of use asset, also include:

a) Any initial direct costs;

b) Any prepaid lease payment;

c) Any estimated costs to dismantle; and

d) We would take-off (exclude) lease incentives received.

Example:

Assume a lease agreement where there are annual payments of $150,000 per annum and
these payments are made in advance, it’s a five years lease agreement and we were told
that the interest rate implicit in the lease was 5%.

Year 1:

The first task would be to work out the minimum lease payments; this can be shown in
tabular form as:

Year Payments ($) DF @ 5% PV

1 150,000 1 150,000
2 150,000 0.952 142,857
3 150,000 0.907 136,054
4 150,000 0.864 129,576
5 150,000 0.823 123,405
PV of minimum lease payments 681,893

The opening liability is:

PV of minimum lease payments = $681,893

Payment made in advance = $150,000

Opening lease liability = $681,893 – $150,000 = $531,893

The right-of-use asset:

Lease liability = $531,893

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Prepaid lease payments = $150,000

Right-of-use assets = $531,893 + $150,000 = $681,893

Now as we go out through the year, we have to charge the interest on the liability and
depreciate the right-of-use asset.

The right-of-use asset it being written-off over five years:

Annual depreciation = $681,893 / 5 = $136,379

Closing right-of-use asset = $681,893 – $136,379 = $545,514

On the liability side of things:

Opening liability = $531,893

Effective interest (@ 5%) = $531,893 x 5% =

Closing liability = $531,893 + $26,595 = $558,487

Year 2:

Imagine that agreement the payments are based on consumer price index, we are told that
due to this the payments in year 2 are increased by 3%. This would take our payment from
$150,000 (last year) to (150,000 x 1.03 =) $154,500.

Once again what we will do is calculate the present value of the liability (we have only four
years left to run):

Year Payments ($) DF @ 5% PV

1 154,500 1 154,500
2 154,500 0.952 147,143
3 154,500 0.907 140,136
4 154,500 0.864 133,463
Revised liability 575,242
Existing liability (558,487)
Increase in liability 16,755
To record this increase we simply:

DR 4 Right-of-use asset 4 $16,755

CR 4 Lease liability 4 $16,755

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Leases – Part 2
PRESENTATION:

 Statement of financial position:

a) Right-of-use asset (can appear as part of property, plant and equipment – split in
notes)

b) Lease liability (can appear as part of liabilities – split in notes)

 Income statement:

a) Depreciation

b) Interest charge

IMPACT OF NEW STANDARD:

 Under the old treatment of operating leases all the expense was just recongnised on a
straight-line basis. However, under of the new standard, at the start of the lease the
asset will be big and the liability will be big, and therefore, we will see that the interest
change will be larger at the start of the lease agreement. Therefore, we are achieving a
front loading of expense, more expense at the start of the lease agreement and less
expense towards the end.

 There is a further impact on gearing now, as we have put the liability on the balance
sheet, in exams you might have to recalculate the gearing ratios based upon the liability
that has now been recognised. Looking out for companies that have existing debt or
baking covenants, because of course, the recognition of liability under the lease
agreement could result in a breach of that covenant.

 Another area that will be affected is the interest cover, how many times does the
operating profit cover the finance charges, and with this IFRS 16 presentation, we can
see that one of the components in the income statement is the interest charge on the
lease. We may have to manage the stakeholder expectations.

LESSOR ACCOUNTING:

The good news is that there are no major changes on the lessor accounting. IFRS 16 requires
us to identify whether we are dealing with a finance or operating lease. If we are dealing
with a finance lease, then what we have to calculate is the net investment in lease. This is
calculated as the present value of the lease payments that are receivable together by the
present value of any unguaranteed residual value accruing to the lessor and based upon this

9
net investment in the lease we will calculate the interest income using the interest rate
implicit in the lease.

If we are leasing the equipment under the operating lease, then we still have the equipment
in our accounts and just continue to recognise the rental income on a straight-line basis. You
might argue that the how can the lessee and lessor both have the same equipment
appealing under their books under this treatment, you should note that the lessee has not
actually capitalised the physical asset, but the right-to-use that equipment, there is a
difference.

Example:

From the lessor’s point of view, the first activity is to calculate an asset for the balance
sheet, and as we know the assets are access to economic benefit, so what is our accessed
economic benefit? Well, we have the right to recover money from the lessee in the form of
lease payments. So, what we will calculate the present value of those lease payments
receivables, this will give us the first part of our computation, in lessor’s accounting this is
called ‘net investment in the lease’. This is made up of present value of the minimum lease
payments receivable by the lessor, but also include present value of unguaranteed residual
value.

Let us assume that the present values of the minimum lease payments is $30, at the end of
the lease term the lessee has guaranteed that they will actually give us $4 in respect of the
asset (as it has some residual value remaining) and our expectation is that we would be able
to sell the asset for $5. So, we have an unguaranteed residual value of ($5 – $4 =) $1, and
this, from our point of view, is a further investment. The effective interest rate implicit in
the lease is 5%. Therefore, the investment in the lease will be:

Present value of minimum lease payments receivable by lessor $30

Present value of unguaranteed residual value

Guaranteed by lessee $4
Expected selling price $5
1
31
Opening net investment in lease 31
Effective interest (@ 5%) 1.55
Closing net investment in lease 32.55

In respect of the income statement, what we want to do is, we want to earn some finance
income, and this is a simple case of applying amortised cost to our net investment in lease:

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CR 4 Finance income 4 $1.55

DR 4 Net investment in lease 4 $1.55

LEASE MODIFICATION:

Let us just spend a couple of minutes now thinking about lease modifications and what we
have to decide when we modify the lease, whether it is a modification to the existing lease
or it constitutes a brand new separate lease.

For example, if you went from a situation from where you leased one vehicle to a situation
where you leased two vehicles and the amount of lease payments increased by an amount
that was a fair market price for leasing an incremental vehicle, then we would have a
separate lease, we would now be leasing two separate vehicles.

If, however, you simply remained with the one vehicle but increased the amount of time
that you were leasing that vehicle for, then this would not constitute a separate lease. All
that has happened to this situation is that you have increased the scope of the existing lease
agreement. In this case we simply re-measure the liability and adjust the right-of-use asset
accordingly.

Alternatively, there could be situation where we are actually decreasing the scope of the
agreement. Imagine that we have retail outlet with a 1,000 square-feet, there was an
economic downturn and now you have to cut the footage in half that you were actually
renting. So, you go to the landlord looking for a reduction in the rented area. Here what we
have to do is to reduce the right-of-use asset by the amount, however, when we come to
reduce the liability, it is very unlikely that you will be able to achieve a similar reduction in
the liability. If there is a difference between the reduction in the right-of-use asset and the
liability, then balancing figure goes as gain or loss to the profit and loss account.

SALE AND LEASE BACK ARRANGEMENTS:

In order to account for these properly, what we have to do is to decide that when we sell
and lease the asset back, in substance the sale has occurred, or in substance the sale has not
occurred. We use the criteria in IFRS 15 – Revenue recognition to help use make that
decision.

If the substance of the transaction is that the sale has occurred, we have to derecognise the
carrying amount of the asset and that now we are leasing it back we have to recognise the
right-of-use asset. Finally, we will recognise a gain or loss.

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If the substance is that the sale has not occurred, then in relation to the proceeds that we
have actually received we must debit cash and credit financial liability in accordance with
IFRS 9.

Example:

Let us assume that a sale and lease back agreement takes place such that the substance of
the transaction is

that the sale has occurred. We are provided with the following information:

Selling price $86

Lease it back 10 years
Fair value of the asset $90
NBV $50
Present value of minimum lease payments $30

First thing that we have to do is to calculate the right-of-use asset, now we did have an asset
in our accounts at $50, although we have sold the in some respect, some of the original
asset of $50 remains, because we are getting access to it. So, what we will do is:

Carrying amount x Present value of lease payments / fair value of the asset = 50 x 30 / 90 =
$16.67

Adjust this for prepayment to the lease:

Fair value of the asset – selling price = 90 – 86 = $4

The right-of-use asset = 16.67 + 4 = $20.67

Now we account this as:

DR 4 Cash 4 $86
CR 4 Asset 4 $50
DR 4 Right-of-use asset 4 $20.67
CR 4 Lease liability 4 $30
CR 4 Gain on disposal 4 $26.67
$106.67 $106.67

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Segment Reporting
AN INTRODUCTION TO IFRS 8 OPERATING SEGMENTS

This standard requires particular classes of entities mainly those with publicly traded securities
to disclose information about their operating segments, products and services, the geographical
areas in which they operate, and their major customers. Information is based on internal
management reports, both in the identification of operating segments and measurement of
disclosed segment information.

The standard defines an operating segment as:

A segment that engages in business (internal or external)

Separate financial information is available

The results are regularly reviewed by the chief decision maker

An operating segment has the following characteristics:

1. Earns revenue and incurs expenses from a business activity

2. Is regularly reviewed by the chief decision maker when handing out resources

3. Has separate financial information

REPORTABLE SEGMENTS

The standard requires that the entity reports financial and descriptive information about its
reportable segments.

A reportable segment is an operating segment or aggregations of operating segments that

meets the following criteria:

The segments reported revenue is 10% or more of the revenue of all segments.

OR

The segments assets are 10% or more of the combined assets of all segments.

BUT if the identified reportable segments revenue is less than 75 per cent of the entity's
revenue then more reportable segments must be identified.

At least 75 per cent of the entity's revenue is included in reportable segments.

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AGGREGATING OPERATING SEGMENTS

Aggregations are operations segments that can be grouped together.

Operating segments can only be aggregated if they have the following similar economic
features:

 They provide a similar product or service

 They share a similar production process

 They share a similar customer

 They have similar distribution methods

 They are regulated similarly

Example:

A chocolate factory has the following operating segments:

1. Sugar free sweets division

2. Chocolate bar division

3. Individual chocolate division

4. Boiled sweets division.

The chocolate division could be aggregated as the only difference is the product size, everything
else is the same. The other two departments although have similar production processes
should not be aggregated together. This is because they don’t satisfy any of the other criteria.

DISCLOSURES FOR EACH OPERATING SEGMENT

Information that needs to be disclosed for each segment:

 Profit

 Total Assets and Liabilities

 External Revenues

 Internal Revenues

 Interest income and expense

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 Depreciation

 Profit from Associates and JVs

 Tax

 Other material non-cash items

Also further analysis of:

 Revenues and certain non-current assets need to be disclosed by geographical area.

 Main clients and their segment must be disclosed. Main clients are clients whose
revenues account for more than 10% of the entities revenue.

ADVANTAGES AND DISADVANTAGES OF IFRS 8

The main advantages are:

 The reports are easy to prepare;

 The segments that are reported reflect the organisation's business strategy.

The disadvantages are:

 Subjectivity;

 Difficult to understand.

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Value added tax, tax
administration and the UK tax system
Income Taxes

This section examines a practical application of the standard that deals with reporting
employee benefits in corporate reports:

 IAS 12 Income Taxes

This standard has already been covered in F7 - Please refer to this section for notes on the
standard. These notes will focus on a sample question examining the area of deferred tax
benefits.

DEFERRED TAX ASSET EXAMPLE

WOWZA Inc is an IT company. Since its creation five years ago it has been developing an app
which they plan to launch in two years time. The company has gained losses of $ 1 million over
the past five years and in the current year 20x7 it has made a further loss of $200,000. The
current corporation tax rate is 20%

How should this be recorded in the financial statements?

DEFERRED TAX ASSET SOLUTION

In 20x7 there are $1 million taxable losses carried forward. In 20x7 taxable losses of $200,000
were incurred.

At the end of 20x7 the total taxable losses carried forward are $1.2 Million. These losses are
carried forward and reduce a potential future tax bill.

IAS 12 states a deferred tax asset is recognised for an unused tax loss carried forward if, it is
considered probable that there will be sufficient future taxable profit against which the loss or
credit carried forward can be utilised.

It is not probable that WOWZA Inc will be profitable in the future. Therefore no deferred tax
asset should be recognised.

DEFERRED TAX ASSET EXAMPLE 2

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WOWZA Inc is an IT company. Since its creation five
years ago it has been developing an app which they
plan to launch in two years time. The company has gained losses of $ 1 million over the past
five years and in the current year 20x7 it has made a further loss of $200,000. At the end of
20x7 the company enters into a contract

with the local government. This contract will result in profits of $5 million in 20x8.

The current corporation tax rate is 30%

How should this be recorded in the financial statements?

DEFERRED TAX ASSET SOLUTION 2

The circumstances permit a deferred tax asset to recognised as it is probable that the tax losses
brought forward will be utilised.

Taxable losses brought forward at the end of 20x7 are $1.2 million. The current tax rate is 30%:

$1.2 million @ 30% = $360,000

The journals are:

Dr Deferred Tax asset $360,000

Cr Tax $360,000

DISCLOSURES

IAS 12 requires:

When recording a taxable asset or loss the following must be disclosed:

 Details of deferred tax assets and liabilities.

 The tax consequences of any future dividend payments.

 The major components of the tax expense.

IAS 1 requires:

 That current and deferred tax assets or liabilities are disclosed on the face of the
statement of financial position.

 That any tax expense is disclosed in the profit or loss section of the statement of profit
or loss and other comprehensive income.

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Corporate Reporting
Provisions, contingencies and events after
the reporting date

This section examines a practical application of:

 IAS 37 Provisions, Contingent Liabilities and Contingent Assets

 IAS 10 Events after the Reporting Period

These standards have already been covered in F7 - Please refer to this section for notes on the
standard. This section will look at an example examining the application of these standards.

EXAMPLE

ECO Inc is a multinational chemical processing company during the financial year ended 20x7
the following happened:

1. Due to the volatility of a new chemical, there is a 90% risk of a fire causing $1
million worth of damage and a 10% risk of a fire causing $10 million worth of
damage. Although there was no fire during the year the finance team thinks the
expense should be recognised given that there is a certainty that there will be
one.

2. A member of staff slipped on a puddle of water and broke his spine. He can no
longer do his job ad has been let go from the company. At the end of 20x7 no
legal claim had been lodged however the HR department think he will lodge a
claim. Based on the accident report cert ECO was negligent and a warning should
have been placed around the spill. ECOs legal advisors believe that there is a 99%
chance ECO will be found to be negligent and will be found liable for $1million.

3. Two weeks after the year-end it was announced that one of ECOs biggest clients
has gone into liquidation. At the date of the statement of financial position 20x7
their balance was $1 million however the liquidators have said only 25% of the
debt will be paid. This was discovered prior to finalising the financial statements.

How should the following transactions be recognised in the financial statements for the year
ended 20x7?

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SOLUTION PART 1 SELF-INSURING

ECO wants to provide for the cost of a future fire in

their financial statements.

To recognise a provision in the financial statements there must be an obliging event.

An obligating event is one that creates a legal or constructive obligation resulting in ECO having
no other realistic alternative but to settle the obligation.

The obliging event would be a fire causing $1.1 million of damage.

There was no fire at the year end.

Therefore no obliging event so a provision should not be recognised.

SOLUTION PART 2 OBLIGING EVENT

During the year an employee was injured and the company was negligent, this was an obliging
event.

A provision is recognised in the financial statements to recognise the expense in the 20x7
financial statements when the obliging event occurred.

Based on legal advice it is highly probable that they will be liable for $1 million.

Measuring the provision

The company must make their best estimate of the cost to settle this obligation.

Their legal council advise the obligation will be $1million. This is the best estimate of the cost.

The following journals recognise the provision:

Dr Legal expenses $1million

Cr Provisions $1 million

A disclosure note will also be needed explaining the details of the provision.

RE-MEASUREMENT OF A PROVISION

IAS 37 requires that provisions are remeasured annually.

What if the injuries sustained are more than originally thought?

In 20x8 the employee lodges a lawsuit for $2million.

There is a 90% certainty that it will be successful.

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At the end of 20x8 the provision should be
remeasured and the extra expense recognised in
the financial statements.

The following journals recognise the re-measurement of the provision

Dr Legal expenses $1million

Cr Provisions $1 million

The re-measurement of an estimate is not an adjusting event.

DERECOGNITION OF A PROVISION

What if in 20x9 the legislation changes and ECO would not be liable for the injuries?
Derecognise the provision in the 20x9 financial statements:

The following journals recognise this:

Dr Provisions $2million

Cr Legal expenses $2million

Not an adjusting event.

If it is material it should be disclosed in the notes.

SOLUTION PART 3 EVENTS AFTER THE FINANCIAL PERIOD

ECO had a debtor of $1 million included in their statement of financial position for 20x7. Soon
after this the debtor went into receivership and will only pay 25% of their final debt. Therefore
$750,000 will go unpaid.

Since the impairment existed at year end this is an adjusting event.

The following journals recognise this:

Dr Bad Debt $750,000

Cr Debtors $750,000

IAS 10 GOING CONCERN

Financial statements are prepared on the going concern principle when it is believed that the
business will continue for 12 months after the financial statements.

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If this is not the case the accounts cannot be
prepared on the going concern basis and must be
prepared on the break – up basis. If there is any indication that the company is not a going
concern after the date of the Statement of Financial Position the accounts must be adjusted to
the break-up basis.

EXAMPLE CONTINGENT LIABILITY

During 20x7 a visiting safety inspector slipped and fell. He has lodged a lawsuit for $1 million.
When ECO Inc examined the incident report it was found that the inspector slipped on wet
floors that were cleaned by a cleaning company that is contracted in.

The cleaning company are found to be at fault. Their insurance will cover $750,000 and due to
the contract between ECO and the cleaning company ECO is liable for the balance.

ECO has sought legal advice, who have estimated that it is highly likely the inspector will win
the lawsuit but based on previous cases there is only a 25% chance the courts will decide to
award him over $750,000 and a 75% chance he will receive $700,000.

SOLUTION CONTINGENT LIABILITY

The important facts:

A personal injury lawsuit was lodged against ECO for $1Million due to an accident an outside
contractor was responsible for.

The contractor’s insurance will cover payments up to $750,000.

There is a 25% chance the courts will award over $750,000 and ECO will be liable for the
balance not covered by ECO.

There is a 75% chance $700,000 will be awarded.

This is a contingent liability. A contingent liability is a possible obligation depending on whether

some uncertain future event occurs, or a present obligation but payment is not probable or the
amount cannot be measured reliably.

How is it recorded in the financial statements?

No provision should be recognised

Disclose it in the notes of the financial statements.

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ED 2005 IAS 37

The result of this ED with respect to IAS 37 was:

Contingent liabilities need to be treated consistently in the financial statements.

The phrase ‘Contingent Liability’ be no longer used as liabilities arise only from unconditional
obligations.

Therefore

 Provisions are unconditional obligations.

 Contingent liabilities are conditional obligations.

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Related Parties
This section examines transactions with related
parties and their disclosure. The standard that guides this is:

 IAS 24 Related Parties

RELATED PARTIES

IAS 24 requires transactions and outstanding balances with an entity's related parties are
disclosed.

A related party transaction is a transfer of resources, services, or obligations between related

parties, regardless of whether a price is charged.

Who are related parties?

A person or an entity are considered related if:

 If the party can exert control over a party or a party exerts control or influence over
them

 If it is under common control with the entity

 If there is no control the party has significant influence over the entity

Example:

Company X sells land, a company asset for $100 to Miss Smith who is the daughter of Mr Smith
the CEO of Company X.

Don’t you think the users of the financial statements would want to know the details of this?

ARMS LENGTH TRANSACTIONS

A transaction carried out “At arm’s length” means the transaction is occurring under normal
market conditions or values.

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UNRELATED PARTIES

The following parties are not related parties unless they satisfy the criteria outlined above.
These parties are:

 Providers of finance

 Two or more companies that share a common director or key manager

 Major clients

 Two parties who share joint control over a joint venture

THE DISCLOSURES

Related party transactions are disclosed in the notes of the financial statements.
The following must be disclosed:

 Relationships between parents and subsidiaries regardless of whether there have been
transactions during the period.

 The name of its parent and if necessary the ultimate controlling party.

 The total of key management’s compensation under the following categories:

- Short-term employee benefits

- Post-employment benefits

- Other long-term benefits

- Termination benefits

- Share-based payment benefits

- Amounts paid to consulting companies for key management services.

If a Related Party Transaction occurs they must be disclosed and the following disclosed:

 The nature of the relationship;

 Details of the transactions and any outstanding balances.

A separate disclosure is needed for each category of related parties and needs to have:

 The amount of the transactions;

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  The amount of outstanding balances;

 The terms and conditions of the transaction;

 Any guarantees provided;

 Any provisions for doubtful debts related to the outstanding balances;

 Any expense recognised during the period in respect of bad or doubtful debts from
related parties.

DISCLOSING TRANSACTIONS THAT OCCURRED AT ARMS LENGTH

 To disclose that transactions occur at arm's length between related parties;

 The arm's length transaction terms must be substantiated;

 The directors must demonstrate that the transactions were at arm’s length.

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