Descriptive Accounting 21st Edition

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Descriptive Accounting
Twenty-first edition
Descriptive
Accounting
Twenty-first edition
ZR Koppeschaar K Papageorgiou
DCom (Accounting) (UP), CA(SA) MCom (Accounting) (UP), CA(SA)
Associate Professor, Senior lecturer,
Department of Financial Governance, Department of Financial Accounting,
University of South Africa University of South Africa
J Rossouw C Smith
MCom (Taxation) (UP), CA(SA)
M Acc (UFS), CA(SA)
Senior lecturer,
Associate Professor, Department of Financial Governance,
Department of Accounting, University of South Africa
University of the Free State
A Schmulian
HA van Wyk MCom (Taxation) (UP), CA(SA)
PhD (Public Sector Management) (UFS), Senior lecturer,
CA(SA) Department of Accounting,
University of the Free State University of Pretoria
J Sturdy Assisted by: C Brittz

MCom (Accounting) (UNISA), CA(SA) University of the Free State
Senior lecturer,
Department of Financial Governance,
University of South Africa
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© 2018
ISBN 978 0 409 12828 4
E-BOOK ISBN 978 0 409 12829 1
First edition 1997 Seventh edition 2002 Thirteenth edition 2008 Nineteenth edition 2014
Second edition 1997 Eighth edition 2003 Fourteenth edition 2009 Revised 2015
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Fifth edition 2000 Eleventh edition 2006 Seventeenth edition 2012
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Editor: Lisa Sandford

Technical Editors: EDS team
Preface
The purpose of this book is to set out the basic principles and conceptual issues of the
International Financial Reporting Standards (IFRS).
The book attempts to:
• provide an accounting basis against which professional accounting publications can be
assessed;
• review such publications critically, and identify possible shortcomings; and
• focus on the nucleus of the publications and supply specific related examples.
Descriptive Accounting is suitable for third-year and postgraduate students, as well as
practising accountants. However, another book by the same authors, i.e. Introduction to
IFRS, is designed for second-year students and provides a seamless introduction to
Descriptive Accounting.
Each chapter in Descriptive Accounting reflects the requirements of the International
Financial Reporting Standards (IFRS) that serve as the main sources of the chapters.
Principles are explained by means of practical examples, including journal entries where
appropriate. As far as disclosure is concerned, the focus is on best practice, rather than
minimum disclosure requirements.
Although accounting standards in issue at 1 January 2018 were used as point of
departure in this work, new standards, as well as improvements and amendments to
existing standards issued subsequent to that date were also taken into account. This edition
is also updated to include, among others, the requirements of the Conceptual Framework of
Financial Reporting 2018.
The South African Institute of Chartered Accountants (SAICA) finalised its syllabus
overload review in 2017 and some aspects were excluded or moved to an awareness level
– this edition also includes these changes.
We trust that students, lecturers and practitioners will find the contents of this book useful
when lecturing or studying, as well as in general practice.
THE AUTHORS
Pretoria
v
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Contents
Page
Preface ......................................................................................................................... v
Table of acronyms ........................................................................................................ ix
Index of Accounting Standards .................................................................................... xi
Part A
Chapter 1 The South African regulatory framework .................................................. 1
Chapter 2 The Conceptual Framework ..................................................................... 7
Chapter 3 IAS 1; IFRIC 17 Presentation of financial statements .............................. 27
Chapter 4 IAS 2 Inventories ...................................................................................... 57
Chapter 5 IAS 7 Statement of cash flows ................................................................. 83
Chapter 6 IAS 8 Accounting policies, changes in accounting estimates
and errors ................................................................................................. 111
Chapter 7 IAS 10 Events after the reporting period .................................................. 141
Chapter 8 IAS 12; FRG 1, IFRIC 23 Income taxes ................................................... 149
Chapter 9 IAS 16; SIC 29; IFRIC 1 Property, plant and equipment.......................... 209
Chapter 10 IAS 19; IFRIC 14, FRG 3 Employee benefits .......................................... 249
Chapter 11 IAS 21 The effects of changes in foreign exchange rates ....................... 271
Chapter 12 IAS 23 Borrowing costs ........................................................................... 299
Chapter 13 IAS 24 Related party disclosures ............................................................ 313
Chapter 14 IAS 36 Impairment of assets ................................................................... 329
Chapter 15 IAS 37; IFRIC 1, 5, 6 and 21 Provisions, contingent liabilities and
contigent assets ....................................................................................... 361
Chapter 16 IAS 38; SIC 32; IFRIC 12 Intangible assets ............................................ 385
Chapter 17 IAS 40 Investment property ..................................................................... 415
Chapter 18 IFRS 2; FRG 2 Share-based payment .................................................... 437
vii
viii Descriptive Accounting
Page
Chapter 19 IFRS 5 Non-current assets held for sale, and discontinued operations .. 475
Chapter 20 IAS 32; IFRS 7 and 9; IFRIC 19 Financial instruments .......................... 519
Chapter 21 IFRS 13 Fair value measurement............................................................ 579
Chapter 22 IFRS 15 Revenue from contracts with customers ................................... 601
Chapter 23 IFRS 16 Leases ....................................................................................... 629
Part B
Chapter 24 IAS 27; IFRS 10 and 12 Consolidated and separate financial
statements ............................................................................................... 723
Chapter 25 IAS 28; IFRS 12 Investments in associates and joint ventures .............. 761
Chapter 26 IFRS 3 Business combinations................................................................ 795
Chapter 27 IFRS 11 and 12 Joint arrangements ....................................................... 839
Chapter 28 Financial reporting for small and medium-sized entities ......................... 847
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Table of acronyms
Acronym Meaning / Brief explanation

APB Accounting Practices Board, a body consisting of a wide spectrum of
representative role-players in the South African economy that approves Standards of
Generally Accepted Accounting Practice (GAAP) as well as recommended
accounting practice.
APC Accounting Practices Committee, a committee of the South African Institute of
Chartered Accountants (SAICA) which is responsible for the distribution of documents
(in limited instances also developing documents) containing what is considered to be
Generally Accepted Accounting Practices in the form of Exposure Drafts (EDs), receiving
comments from interested parties and submitting the final draft to the APB for approval.
BEE Black economic empowerment. Usually “BEE transactions” – to empower black
people to participate meaningfully in the South African economy.
ED Exposure Draft, the first attempt by SAICA or the International Accounting
Standards Board (IASB) to develop an accounting standard or a guideline on a
particular topic.
FASB Financial Accounting Standards Board, an accounting body in the USA.
FRSC, Financial Reporting Standards Council (FRSC), a body corporate existing also in
FRSs terms of the new Companies Act of 2008, with the objective of establishing Financial
Reporting Standards (FRSs) in accordance with IFRSs for listed companies as well
as profit and non-profit companies in consultation with representatives of such
companies.
GAAP Generally Accepted Accounting Practice, documents (called Statements or
Standards; the current accepted term is “Standards”) published by SAICA, after
approval by the APB. GAAP Standards are internationally also published by the
IASB. Before the establishment of the IASB, its predecessor, the International
Accounting Standards Committee (IASC) published International Accounting
Statements (IASs), which also form part of GAAP. The IASB currently issues
International Financial Reporting Standards (IFRSs). South African Standards of
GAAP conform to relevant IASs and IFRSs.
gaap Generally accepted accounting practice, not codified in standards, but
nevertheless generally accepted.
GMP GAAP Monitoring Panel, a joint initiative between SAICA and the Johannesburg
Securities Exchange Limited (JSE Limited) to monitor compliance with Accounting
Standards.
IAS International Accounting Standard, an accounting standard, published by the
IASC (see also “GAAP”) and later endorsed by the IASB.
ix
x Descriptive Accounting
Acronym Meaning / Brief explanation

IASB International Accounting Standards Board, a body which is committed to
developing, in the public interest, a single set of high quality, global Accounting
Standards that require transparent and comparable information in general purpose
financial statements. In pursuit of this objective, the IASB co-operates with national
accounting standard-setters to achieve convergence in accounting standards around
the world (see also “GAAP”).
IASC International Accounting Standards Committee, the IASB’s predecessor (see also
“IASB”).
IFRIC International Financial Reporting Interpretations Committee, a committee of the
IASB that assists the IASB in establishing and improving standards of financial
accounting and reporting. The IFRIC provides guidance on financial reporting issues
not specifically addressed in International Financial Reporting Standards (IFRSs) or
issues where unsatisfactory or conflicting interpretations have developed, or seem
likely to develop. The IFRIC has superseded the Standards Interpretations Committee
(SIC), a committee of the (former) IASC.
IFRSs International Financial Reporting Standards, Standards issued by the IASB (see
also “IASB” and “GAAP”).
IRBA Independent Regulatory Board for Auditors, the statutory body that superseded
the Public Accountants’ and Auditors’ Board in terms of Act 26 of 2005.
JSE Johannesburg Securities Exchange (JSE Limited).
SAICA South African Institute of Chartered Accountants.
SIC Standing Interpretations Committee, the IFRIC’s predecessor (see “IFRIC”) which
used to publish SIC Interpretations.
Standard, Used interchangeably to refer to publications on GAAP. Currently “Standard” is the
Statement accepted term.
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Index of
Accounting Standards
Publication Title Chapter
Accounting framework
Conceptual The Conceptual Framework for Financial Reporting 2010 2
Framework
International Accounting Standard (IAS)

IAS 1 Presentation of Financial Statements 3
IAS 2 Inventories 4
IAS 7 Statement of Cash Flows 5
IAS 8 Accounting Policies, Changes in Accounting Estimates and
Errors 6
IAS 10 Events after the Reporting Period 7
IAS 12 Income Taxes 8
IAS 16 Property, Plant and Equipment 9
IAS 19 Employee Benefits 10
IAS 20 Government Grants and Government Assistance –
IAS 21 The Effects of Changes in Foreign Exchange Rates 11
IAS 23 Borrowing Costs 12
IAS 24 Related Party Disclosures 13
IAS 26 Accounting and reporting by retirement benefit plans –
IAS 27 Consolidated and Separate Financial Statements 24
IAS 28 Investments in Associates and Joint Ventures 25
IAS 29 Hyperinflationary Economies –
IAS 32 Financial Instruments: Disclosure and Presentation 20
IAS 33 Earnings per Share –
IAS 34 Interim Financial Reporting –
IAS 36 Impairment of Assets 14
IAS 37 Provisions, Contingent Liabilities and Contingent Assets 15
IAS 38 Intangible Assets 16
IAS 39 Financial Instruments: Recognition and Measurement –
IAS 40 Investment Property 17
IAS 41 Agriculture –
xi
xii Descriptive Accounting
International Financial Reporting Standards (IFRS)

IFRS 1 First-time adoption of International Financial Reporting
Standards –
IFRS 2 Share-based Payment 18
IFRS 3 Business Combinations 26
IFRS 4 Insurance contracts –
IFRS 5 Non-current Assets Held for Sale and Discontinued
Operations 19
IFRS 6 Exploration for and evaluation of mineral resources –
IFRS 7 Financial Instruments: Disclosure 20
IFRS 8 Operating Segments –
IFRS 9 Financial Instruments 20
IFRS 10 Consolidated Financial Statements 24
IFRS 11 Joint Arrangements 27
IFRS 12 Disclosure of Interests in Other Entities 24, 25, 27
IFRS 13 Fair Value Measurement 21
IFRS 15 Revenue from Contract with Customers 22
IFRS 16 Leases 23
IFRS 17 Insurance Contracts –
Interpretations
SIC 7 Introduction of the Euro –
SIC 10 Government assistance – no specific relation to operating
activities –
SIC 25 Income taxes – changes in the tax status of an entity or its
shareholders –
SIC 29 Service concession arrangements: disclosures 16
SIC 32 Intangible assets – web site costs 20
IFRIC 1 Changes in existing decommissioning, restoration and
similar liabilities 9, 15
IFRIC 2 Members shares in co-operative entities and similar
instruments –
IFRIC 5 Rights to interests arising from decommissioning
restoration and environmental rehabilitation funds 15
IFRIC 6 Liabilities arising from participating in a specific market –
Waste electrical and electronic equipment 15
IFRIC 7 Applying the restatement approach under IAS 29 15
IFRIC 10 Interim financial reporting and impairment –
IFRIC 12 Service Concession arrangements
(Updated to July 2008) –
IFRIC 14 The limit on a defined benefit asset, minimum funding
requirements and their interaction 10
IFRIC 16 Hedges of a net investment in a foreign operation –
IFRIC 17 Distributions of non-cash assets to owners –
IFRIC 19 Extinguishing financial liabilities with equity instruments 20
Index of Accounting Standards xiii

IFRIC 21 Changes in existing decommissioning, restoration and
similar liabilities 15
Financial Reporting Guides (FRG)

FRG 1 Substantively Enacted Tax Rates and Tax Laws 8
FRG 2 Accounting for black economic empowerment (BEE)
transactions 18
FRG 3 IAS 19 (AC 116) The limit on a defined benefit asset,
minimum funding requirements and their interaction in the
South African Pension Fund environment 10
Small and Medium-sized entities

IFRS for SMEs IFRS for Small and Medium-sized entities 28
CHAPTER
1
The South African
regulatory framework
Contents
1.1 Background ....................................................................................................... 2
1.2 The due process of the IASB ............................................................................ 2
1.2.1 Introduction ............................................................................................. 2
1.2.2 Exposure Drafts ..................................................................................... 2
1.2.3 Finalising a Standard .............................................................................. 3
1.2.4 Publication .............................................................................................. 3
1.3 Accounting publications ..................................................................................... 3
1.3.1 IFRSs/IASs ............................................................................................. 3
1.3.2 IFRICs/SICs ............................................................................................ 3
1.3.3 IFRS for SMEs ........................................................................................ 4
1.4 Regulatory requirements for financial reporting in South Africa ........................ 4
1.4.1 The Companies Act, 2008 ...................................................................... 4
1.4.2 The King IV Report ................................................................................. 5
1.4.3 The JSE Limited Listings Requirements ................................................. 5
1.4.4 The Financial Reporting Investigation Panel .......................................... 6
1
2 Descriptive Accounting – Chapter 1
1.1 Background
South Africa fully harmonised the South African Statements of Generally Accepted
Accounting Practice (SA GAAP) with the International Financial Reporting Standards (IFRS)
in 1995, effective 2003. Since then, the Accounting Practices Board (APB), a private
accounting standard-setting body established in South Africa in 1973, has issued IFRS
without amendments as SA GAAP. All companies, listed and unlisted, in South Africa were
required to use SA GAAP (which was identical to IFRS) as their reporting framework. Since
SA GAAP is identical to IFRS, SA GAAP was withdrawn as a reporting framework in South
Africa for all companies with reporting periods commencing on or after 1 December 2012.
The JSE Limited has, since 1 January 2005, required all listed companies to use IFRS as a
reporting framework.
Financial reporting standards, in terms of the Companies Act 71 of 2008 (Companies Act,
2008), allows companies to adopt either IFRS or IFRS for Small and Medium-sized entities
(IFRS for SMEs) depending on whether they meet the scope requirements of the respective
frameworks.
The Financial Reporting Standards Council (FRSC) was established in 2011 in terms of the
Companies Act, 2008. The FRSC is now South Africa’s constituted governmental
accounting standard-setter, and is responsible for advising the Minister on matters relating
to financial reporting standards.
1.2 The due process of the IASB
1.2.1 Introduction
The IASB is the accounting standard-setting body of the IFRS Foundation. The IFRS
Foundation is governed by a body of trustees that in turn is monitored and reports to the
Monitoring Board, a body representing the public authorities that oversee the standard
setters. The IASB has a mandate from the IFRS Foundation to develop and publish IFRS
and IFRS for SMEs. In order to fulfil its mandate, the IASB follows a transparent and
comprehensive due process to develop new Standards or amend existing Standards. The
due process of the IASB is based on the principle of transparency and protects the integrity
of accounting standard-setting.
The requirements of the due process of accounting standard-setting are contained in the
Due Process Handbook of the IASB. The handbook specifies the minimum steps the IASB
must take to ensure the development of quality Standards. The handbook also prescribes
the thorough consultation process that the IASB must follow when developing a new
Standard or amending a Standard.
The publication of an Exposure Draft on a proposed or amended Standard represents an
important step in the consultative arrangements of the due process of the IASB.
1.2.2 Exposure Drafts

An Exposure Draft (ED) is generally set out in the same format as the proposed or amended
Standard. An ED is the IASB’s principal attempt to consult the public on a proposed or
amended Standard. When the IASB publishes an ED, it normally allows a minimum period
of 120 days for the public to comment. At the same time, SAICA also publishes the ED in
South Africa to invite comments from interested parties, who thus have the option of raising
their views on an ED in either a comment letter to SAICA or directly to the IASB.
The South African regulatory framework 3
Once the comment period ends, the IASB analyses and summarises the main points raised
by the interested parties in their comment letters. Any technical matters arising from the
comment letters are addressed by the IASB and resolved through a consultative process. If
the IASB is satisfied that all technical matters relevant to the ED are resolved, the new
Standard is finalised and prepared for balloting. If the IASB is not satisfied that all technical
matters are resolved, or concludes that fundamental changes to the ED are required, based
on the comments received, it has to publish a revised ED for public comment.
1.2.3 Finalising a Standard

All finalised Standards should include at least the following:
the defined terms used in the Standard;
the principles and an application guidance; and
the effective date of the Standard and transitional provisions.
A Standard, or an amendment thereto, has an effective date to allow the various
jurisdictions time to prepare for the implementation of the new Standard or amendment.
Transitional provisions are generally included in a new Standard to provide preparers with
the procedure to follow to account for any change in accounting policy due to the initial
application of the Standard.
In addition to the above, each Standard also includes a table of contents, an introduction,
the Basis of Conclusions, and dissenting opinions, where applicable.
1.2.4 Publication
A new Standard is published as an IFRS. The publication of an IFRS or amendment to an
existing IFRS is accompanied by a press release and various communication materials. If
necessary, the IASB will embark on educational initiatives to ensure that a new IFRS is
implemented and applied consistently.
1.3 Accounting publications

1.3.1 IFRSs/IASs
The IASB publishes accounting standards called IFRSs. IFRSs deal with recognition,
measurement, presentation and disclosure requirements in general purpose financial
statements, namely those that are directed towards the common information needs of a
wide range of users such as shareholders, creditors, employees and the public at large. In
order to achieve consistent and logical formulation, IFRSs are based on the Conceptual
Framework for Financial Reporting (discussed in chapter 2). Requirements for transactions
and events in specific industries are, however, sometimes also addressed. IFRSs apply to
the financial reporting of all profit-oriented entities, such as those engaged in commercial,
industrial, financial and similar activities, regardless of whether they are organised in
corporate or other forms.
IASs are the Standards issued from 1973 to 2001 by the IASB’s predecessor, the
International Accounting Standards Committee (IASC). The IASs continue to be designated
as part of IFRSs.
1.3.2 IFRICs/SICs
The IASC set up the Standing Interpretations Committee (SIC) to issue interpretations of
IASs. These interpretations are known as SIC Interpretations. During March 2002, the SIC
was replaced by the International Financial Reporting Interpretations Committee (IFRIC), a
committee of the IASB. The committee is currently referred to as the IFRS Interpretations
Committee.
IFRIC Interpretations provide guidance on the application of IFRSs and on financial

reporting issues not specifically addressed in IFRSs. IFRIC Interpretations do not change or
conflict with IFRSs, but promote the rigorous and uniform application of IFRSs. Since IFRIC
Interpretations form part of IFRSs, they must be ratified by the IASB.
1.3.3 IFRS for SMEs

The IASB issued the IFRS for SMEs, which is intended for use by small and medium-sized
entities that do not have public accountability and publish general purpose financial
statements for external users. The IFRS for SMEs can be described as a scaled down
version of the complete IFRSs.
1.4 Regulatory requirements for financial reporting in South Africa

There are various regulatory requirements that govern and monitor financial reporting in
South Africa. A brief explanation of the relevant legislation is provided below.
1.4.1 The Companies Act, 2008

The Companies Act, 2008 was signed by the President in April 2009 and became effective
on 1 May 2011. In terms of the Act, two categories of companies are recognised, namely
profit companies and non-profit companies.
1.4.1.1 Profit companies
Profit companies are defined as companies incorporated for the purpose of financial gain for
their shareholders, and include the following categories of companies:
State-owned company (SOC Ltd):
A company that falls within the meaning of ‘state-owned enterprise’ or is owned by a
municipality.
Private company ((Pty) Ltd):
A company that is neither a state-owned company nor a personal liability company. Its
Memorandum of Incorporation (MOI) also prohibits it from offering its securities to the
public and restricts the transferability of those securities.
Personal liability company (Inc.):
A private company, whose MOI states that it is a personal liability company.
Public company (Ltd):
A profit company that is not a state-owned company, a private company or a personal
liability company. A public company can either be listed on the JSE Limited or it can be a
non-listed entity.
1.4.1.2 Non-profit companies
A non-profit company (NPC) is incorporated for public benefit or for an object relating to
social or cultural activities. Its income and property are not distributable to its members,
incorporators, directors, officers or related persons. This category of company may be
regarded as the successor of the former Section 21 Company.
The South African regulatory framework 5
1.4.1.3 Financial reporting of respective companies

The respective financial reporting frameworks applicable to the different categories of profit
companies are as follows:
Category of profit company Financial reporting framework

State-owned companies (SOCs) and non- IFRS (but should there be any conflict with the
profit companies that require an audit. Public Finance Management Act 1 of 1999, the
latter prevails).
Listed public companies. IFRS.
Public companies not listed. IFRS or IFRS for SMEs.
Profit companies, other than SOCs or public IFRS or IFRS for SMEs.
companies.
Profit companies, other than SOCs or public The financial reporting standards as determined
companies, whose public interest score is by the company for as long as no financial
less than 100, and whose financial reporting standards are prescribed.
statements are internally compiled.
In all cases, a company can choose to comply with a ‘higher’ level of financial reporting
framework (i.e. applying IFRS even if IFRS for SMEs was allowed). Companies that apply
IFRS for SMEs may only do so if the company meets the scoping requirements of IFRS for
SMEs.
1.4.2 The King IV Report

The King Committee issued a third edition of the King Report on 1 September 2009. King III
has been revised to bring it up to date with international governance codes and best
practice. King IV was released on 1 November 2016. The King Code and Report on
Governance for South Africa (King IV) is effective from 1 April 2017. In terms of the JSE
Limited’s Listings Requirements, all listed companies have to comply with the King Report.
All other companies and other business entities incorporated in, or resident in, South Africa
are strongly encouraged to apply the principles in this Code, irrespective of their manner or
format of incorporation or establishment and should also consider the best practice
recommendations in the King Report.
In terms of reporting and disclosure, King III requires the board of directors of a company to
prepare an integrated report that should be integrated with the company’s financial
reporting. The integrated report should be prepared annually and should present financial
information with sustainability issues of social and environmental impacts. The board of
directors is also required to comment on the financial results and disclose whether the
company is a going concern. The integrated report should be independently assured.
1.4.3 The JSE Limited Listings Requirements

In terms of section 8.62 of the JSE Limited Listings Requirements, the annual financial
statements of listed companies must be prepared in accordance with the national law
applicable to a listed company and in accordance with IFRSs and South African accounting
standards. The financial statements should also be audited in accordance with International
Standards on Auditing.
Furthermore, the financial statements of a listed company with subsidiaries should usually
be in consolidated form, but the listed company’s own financial statements must also be
published if they contain significant additional information. Financial statements must also
fairly present the financial position, changes in equity, results of operations and cash flows
of the group.
In addition to complying with IFRSs and the Companies Act, 2008, section 8.63 of the
Listings Requirements requires companies to provide a narrative statement in their financial
statements of their compliance with the principles of the King Report. Section 8.63 also
requires other extensive information to be disclosed on specific aspects in both the annual
report and the annual financial statements.
1.4.4 The Financial Reporting Investigation Panel

The Financial Reporting Investigation Panel (FRIP), previously known as the GAAP
Monitoring Panel (GMP), is an advisory panel first formed in 2002 as a joint initiative
between SAICA and the JSE Limited. The role of the Financial Reporting Investigation
Panel (the Panel) is to investigate and advise the JSE Limited about alleged cases of non-
compliance with financial reporting standards in annual and interim reports and any other
company publication.
It is important to note that the Panel’s authority is limited to companies listed on the JSE
Limited, and other companies in the same group.
In order to further improve market securities regulation, the JSE Limited announced, in
February 2010, their decision to proactively monitor the financial statements of all listed
companies, in a bid to pick up any non-compliance with IFRS. This means that all company
results could be proactively reviewed and possibly investigated at any time. Under the
proactive review and monitoring process, the financial statements of every listed company
will be reviewed at least once every five years, in addition to any other queries arising from
public or other complaints. Previously, reviews were conducted on the JSE Limited’s own
initiative or upon the JSE Limited receiving a query or complaint from an investor.
CHAPTER
2
The Conceptual Framework
(Conceptual Framework for Financial
Reporting 2018)
Contents
2.1 Background ....................................................................................................... 8
2.1.1 The Conceptual Framework project ....................................................... 8
2.1.2 The purpose of the Conceptual Framework ........................................... 9
2.2 The objective of general purpose financial reporting ......................................... 9
2.3 Qualitative characteristics of useful financial information .................................. 10
2.3.1 Fundamental qualitative characteristics ................................................. 10
2.3.2 Enhancing qualitative characteristics ..................................................... 12
2.3.3 The cost constraint on useful financial reporting .................................... 13
2.4 Financial statements and the reporting entity.................................................... 13
2.4.1 Objective and scope of financial statements .......................................... 13
2.4.2 Reporting period ..................................................................................... 13
2.4.3 Perspective ............................................................................................. 14
2.4.4 Going concern assumption ..................................................................... 14
2.4.5 The reporting entity ................................................................................. 14
2.5 The elements of financial statements ................................................................ 14
2.5.1 Assets ..................................................................................................... 15
2.5.2 Liabilities ................................................................................................. 15
2.5.3 Unit of account ........................................................................................ 16
2.5.4 Equity ...................................................................................................... 17
2.5.5 Income .................................................................................................... 17
2.5.6 Expenses ................................................................................................ 17
2.6 Recognition and derecognition .......................................................................... 17
2.6.1 Recognition ............................................................................................. 18
2.6.2 Derecognition.......................................................................................... 19
2.7 Measurement .................................................................................................... 19
2.7.1 Measurement bases ............................................................................... 19
2.7.2 Factors to consider when selecting a measurement basis ..................... 21
2.7.3 Measurement of equity ........................................................................... 22
2.8 Presentation and disclosure .............................................................................. 22
2.8.1 Classification........................................................................................... 22
2.8.2 Aggregation ............................................................................................ 23
2.9 Concepts of capital and capital maintenance .................................................... 23
2.10 Overview of the Conceptual Framework ........................................................... 25
7
2.1 Background
2.1.1 The Conceptual Framework project
During 1989, the then International Accounting Standards Committee (IASC) issued a
statement entitled Framework for the Preparation and Presentation of Financial Statements,
which was formally adopted in 2001 by its successor body, the International Accounting
Standards Board (IASB) as the Framework. This document was based on the American
Financial Accounting Standards Board’s (FASB) conceptual framework.
In 2004, the FASB and the IASB initiated a joint project to develop a common conceptual
framework. The existing frameworks of the IASB and FASB served as the point of departure
for the development of the new conceptual framework. The joint project was to be
conducted in a number of phases and Phase A – Objectives and Qualitative Characteristics
was finalised in 2010, and published as chapters 1 and 3 of The Conceptual Framework for
Financial Reporting 2010.
The Conceptual Framework (2010) contained the following:
Chapter 1: The objective of general purpose financial reporting.
Chapter 2: The reporting entity (to be added).
Chapter 3: Qualitative characteristics of useful financial information.
Chapter 4: The Framework (1989): The remaining text.
Chapters 1 and 3 replaced the relevant paragraphs in the Framework for the Preparation
and Presentation of Financial Statements of 1989 (Framework). Although the Framework
was partially replaced by certain chapters in the Conceptual Framework (2010), the
International Financial Reporting Standards (IFRS), and specifically the older Standards (the
International Accounting Standards (IAS), are still based on the concepts contained in the
Framework. These Standards will therefore, in many instances, still refer to the concepts
and principles contained in the Framework (1989).
The joint framework project was suspended in 2010 but ‘resumed’ in 2012 as an IASB-only
project. The IASB issued a revised Conceptual Framework in 2018. This Conceptual
Framework (2018) is effective immediately for the IASB and effective for annual periods
beginning on or after 1 January 2020 for preparers who develop accounting policies based
on the Conceptual Framework.
The revised Conceptual Framework introduces new concepts and guidance on
measurement, presentation and disclosure, and derecognition. It has also updated the
definitions of the elements of financial statements and the recognition criteria. Further, it has
clarified the concepts of prudence, stewardship, measurement uncertainty, and substance
over form.
The revised Conceptual Framework (2018), entitled “Conceptual Framework for Financial
Reporting” contains the following chapters:
Chapter 1: The objective of general purpose financial reporting;
Chapter 2: Qualitative characteristics of useful financial information;
Chapter 3: Financial statements and the reporting entity;
Chapter 4: The elements of financial statements;
Chapter 5: Recognition and derecognition;
Chapter 6: Measurement;
Chapter 7: Presentation and disclosure; and
Chapter 8: Concepts of capital and capital maintenance.
The Conceptual Framework 9
2.1.2 The purpose of the Conceptual Framework

The Conceptual Framework serves primarily to assist the IASB in developing and revising
Standards that are based on consistent concepts and also discusses the factors the IASB
needs to consider in making judgements when application of the concepts does not lead to
a single answer. In addition, the Conceptual Framework also assists preparers of financial
reports in developing consistent accounting policies for transactions or other events when
no Standard applies or a Standard allows a choice of accounting policies. Further, it aims to
assist all parties understand and interpret Standards. The Conceptual Framework, therefore,
provides the foundation for Standards that:
contribute to transparency;
strengthen accountability; and
contribute to economic efficiency.
While the Conceptual Framework provides concepts and guidance that underpin the
decisions the IASB makes when developing Standards, the Conceptual Framework is not a
Standard. The Conceptual Framework does not override any Standard or any requirement
in a Standard and any revision of the Conceptual Framework will not automatically lead to
changes in the Standards.
2.2 The objective of general purpose financial reporting
This chapter was issued in 2010. The Conceptual Framework (2010) established the
purpose of financial reporting and not just the objective of financial statements, which
was the objective addressed in the Framework (1989). This chapter was not
fundamentally reconsidered in the Conceptual Framework (2018).
The Conceptual Framework defines the objective of general purpose financial reporting as:
To provide financial information about the reporting entity that is useful to existing
and potential investors, lenders and other creditors in making decisions about
providing resources to the entity.
These decisions include decisions about buying, selling or holding equity and debt
instruments; providing or settling loans and other forms of credit; or exercising rights to vote
on (or otherwise influence) management’s actions that affect the use of the entity’s
economic resources. These decisions depend on the returns that the potential investors,
lenders and other creditors expect from their investment. Expectations about returns are
based on an assessment of the amount, timing and uncertainty of future net cash inflows to
the entity as well as an assessment of management’s stewardship of the entity’s economic
resources. Thus, existing and potential investors, lenders and other creditors need
information that will help them to make these assessments. Therefore, information is
needed about the economic resources of the entity and the claims against the entity
(financial position) as well as changes in those resources and claims (resulting from the
entity’s financial performance or other events (such as issuing debt or equity instruments)).
Further, information is needed about how efficiently and effectively the entity’s
management have discharged their responsibilities to use the entity’s economic resources.
Information in financial reports is often based on estimates, judgements and models, rather
than exact calculations. The Conceptual Framework establishes certain concepts that
underlie those estimates, judgements and models.
Information about a reporting entity’s economic resources and claims, and changes in its
economic resources and claims, during a period, provides a better basis for assessing the
entity’s past and future performance, than information solely about cash receipts and
payments during that period. Therefore, accrual accounting is applied in financial reports.
Accrual accounting depicts the effects of transactions and other events and circumstances
on a reporting entity’s economic resources and claims in the periods in which those occur,
even if the resulting cash receipts and payments occur in a different period.
The primary users of financial reports are identified as existing and potential investors,
lenders and other creditors. The term ‘primary users’ refers to those users who are not in a
position to demand specific information from the entity. They have to rely on the general
purpose financial reports as their main source of information. General purpose financial
reports are not primarily intended for the use of management and regulators. General
purpose financial reports are not intended to provide information about the value of a
reporting entity but to provide information to the users in order for them to be able to
estimate the value of the entity. General purpose financial reports do not and cannot
provide all of the information that users need. The IASB, in developing financial reporting
standards, has as its objective the provision of information that will meet the needs of the
maximum number of users. Users, however, also need to consider information from
other sources, including the conditions of the general economic environment in which the
reporting entity operates, political events, and industry- and company-related matters.
2.3 Qualitative characteristics of useful financial information
The qualitative characteristics in the Framework (1989) were relevance, reliability,

understandability and comparability. The chapter as it is now, was issued in 2010. This
chapter was not fundamentally reconsidered in the Conceptual Framework (2018).
To achieve the objective of financial reporting, the information contained in the financial
reports must have certain qualitative characteristics. The qualitative characteristics are
the attributes that increase the usefulness of the information provided in the financial
reports.
The Conceptual Framework distinguishes between fundamental and enhancing qualitative
characteristics. For information to be useful, it needs to be both relevant and faithfully
represented. These qualitative characteristics are fundamental to ensuring useful
information is provided during financial reporting.
The usefulness of financial information is further enhanced when it is comparable,
verifiable, timely and understandable.
Verifiable information
Comparable information
Timely information
Financial reporting
Relevant information
Faithful representation
Understandable information
2.3.1 Fundamental qualitative characteristics

2.3.1.1 Relevance
Relevant information is information that is useful and has the ability to make a difference to
the decisions made by users. Such information can enable users to make more accurate
forecasts regarding specific future events, or can supply feedback on previous expectations.
Relevant information, therefore, has one or both of the characteristics of predictive value or
confirmatory value. Financial information has predictive value if it can be used as an input
to processes employed by users to predict future outcomes. Financial information has
confirmatory value if it provides confirmation about previous evaluations.
Materiality plays an important role when evaluating the relevance of information.
Information is considered to be material if its omission or misstatement could influence the
decisions made by users based on this information. Materiality is an entity-specific aspect,
based on the nature or magnitude of the items.
Financial reports provide information about the reporting entity’s economic resources, claims
against the reporting entity, and the effects of transactions and other events and conditions
that change those resources and claims (economic phenomena) in words and numbers. For
financial reports to be useful, the financial information contained in them must not only be
relevant, it must also be a faithful representation of the substance of the events (and not
merely the legal form) it purports to represent.
2.3.1.2 Faithful representation
The Conceptual Framework indicates that the following three characteristics would ensure
faithful representation:
completeness;
neutrality; and
free from error.
Completeness
Information included in the financial reports is complete when it includes all the
necessary information that a user would need to be able to understand the economic
phenomena being presented. This should include all necessary descriptions and
explanations.
Neutrality
Faithfully represented information should be neutral in that it should not present
information in a manner that will achieve a predetermined result. A neutral presentation
is without bias when selecting or presenting financial information. A neutral depiction is
not slanted, weighted, emphasised or de-emphasised or otherwise manipulated to
increase the probability that information will be received favourably or unfavourably.
Neutrality is supported by the exercise of prudence. Prudence is the exercise of caution
when making judgements under conditions of uncertainty. Prudence does not allow for
overstatement or understatement of assets, liabilities, income or expenses.
Free from error
Faithful representation of information does not imply that the information is absolutely
accurate. It does, however, imply that the description of the event and/or transaction
(economic phenomena) is free from error or omissions and that the process followed to
provide the reported information was selected and applied without errors.
When monetary amounts in financial reports cannot be observed directly and need to be
estimated, measurement uncertainty exists. The use of estimates is an essential part of
the preparation of financial information. The estimates do not undermine the usefulness
if the information if they are clearly and accurately described and explained.
2.3.1.3 Applying the fundamental qualitative characteristics
For information to be useful, it must be both relevant and faithfully represented. Users
cannot make good decisions based on either a faithfully represented but irrelevant event or
transaction, or an unfaithfully represented relevant event or transaction. However, a faithful
representation by itself does not necessarily result in useful information. If something is not
considered relevant, then the view taken is that the item does not really need to be
disclosed, perhaps regardless of whether it can be faithfully represented. However, if an
event or transaction is considered to be relevant to the users of the financial statements, it
would be important to represent the information faithfully. In some cases a trade-off between
the fundamental qualitative characteristics may need to be made.
The Conceptual Framework suggests the following steps as the most efficient and effective
process when applying the fundamental qualitative characteristics:
Step 1: identify an economic phenomenon that has the potential to be useful to users.
Step 2: identify the type of information about that phenomenon that would be most relevant.
Step 3: determine whether that information is available and can be faithfully represented.
Once this process has been followed, the process ends and the relevant information is
presented faithfully in the financial report. Should any of the steps be impossible to perform,
the process is repeated from the start.
2.3.2 Enhancing qualitative characteristics

The usefulness of information that is already relevant and faithfully represented can further
be enhanced by applying the following enhancing qualitative characteristics to it:
comparability;
verifiability;
timeliness; and
understandability.
2.3.2.1 Comparability
To meet their decision-making needs, users of financial information should be given
comparable information in order to identify trends over time and between similar companies.
This means that the accounting treatment should be consistent for:
the same items over time;
the same items in the same period; and
similar items of different but similar companies over time and in the same period.
Consistency is not the same as comparability. Consistency helps to achieve the goal of
comparability.
The most visible example of comparability is the comparative amounts included in the
financial statements, as required by IAS 1. The disclosure of accounting policies in financial
statements also assists readers of such statements to compare the financial statements of
different entities. The accounting policy notes indicate the accounting treatment of specific
items; thus it is possible to compare such treatment with the treatment of similar items in
different entities. The financial statements of different but similar entities can therefore be
appropriately analysed in order to evaluate a particular entity’s performance relative to the
performance of its peers.
It is undesirable to permit alternative accounting methods for the same transactions or
events, because comparability and other desirable qualities such as faithful representation
and understandability may be diminished. Nevertheless, comparability should not be
pursued at all costs. Where new accounting standards are introduced, or when the
application of a more appropriate accounting policy becomes necessary, the current
accounting policy should be changed. In such circumstances, there are measures to ensure
the highest possible degree of comparability, but absolute and complete comparability are
sometimes not achieved.
2.3.2.2 Verifiability
Verifiability is a characteristic of financial information that enables users to confirm that the
presented information does in fact faithfully present the events or transactions it purports to
present.
When different knowledgeable and independent observers can reach consensus on whether
a specific event or transaction is faithfully presented, the information would be deemed
verifiable.
2.3.2.3 Timeliness
Information can influence the decision of users when it is reported timeously (in a timely
manner). Usually, older information is less useful, but some information could still be useful
over a longer period of time when it is used for purposes of identifying and assessing certain
trends.
2.3.2.4 Understandability
To achieve the stated objective of financial reporting, the financial statements should be
understandable to the average user who has a reasonable knowledge of business and a
willingness to review and analyse the information with the necessary diligence. In order to
achieve understandability, information should clearly and concisely be classified,
characterised and presented.
2.3.2.4 Applying the enhancing qualitative characteristics
According to the Conceptual Framework, the application of the enhancing qualitative
characteristics should be maximised to the extent possible. It is, however, very important to
note that the enhancing characteristics cannot make information useful if it is not already
relevant and faithfully represented.
2.3.3 The cost constraint on useful financial reporting
A pervasive constraint on the presentation of financial information is the cost involved in
supplying the information. Reporting financial information imposes costs, and it is important
that those costs are justified by the benefits of reporting that information.
2.4 Financial statements and the reporting entity
This chapter is new and was not included in the Framework (1989) or the Conceptual
Framework (2010).
2.4.1 Objective and scope of financial statements

Financial statements are a particular form of general purpose financial reports. Financial
statements provide information about economic resources of the reporting entity, claims
against the entity, and changes in those resources and claims, that meet the definitions of
the elements of financial statements.
The objective of financial statements is to provide financial information about the entity’s
assets, liabilities and equity (in the statement of financial position) and income and
expenses (in the statement(s) of financial performance) that is useful to users of financial
statements on assessing the prospects for future net cash inflows to the reporting entity and
in assessing management’s stewardship of the entity’s economic resources. Information can
also be provided in other statements or notes.
2.4.2 Reporting period
Financial statements are prepared for a specific period of time (this is the reporting period)
and provide information about:
assets and liabilities and equity that existed at the end of the reporting period, or during
the reporting period; and
income and expenses for the period.
Forward looking information is provided if it relates to these items and is useful to the users
of financial statements. Information about transactions and other events that have occurred
after the end of the reporting period is provided if it is necessary to meet the objective of
financial statements.
Comparative information is provided for at least one preceding reporting period.
2.4.3 Perspective
Financial statements provide information about transactions and other events viewed from
the perspective of the reporting entity as a whole, not from the perspective of any particular
group of the entity’s existing or potential investors, lenders or other creditors. This is
important for matters such as non-controlling interests in a group.
2.4.4 Going concern assumption

Financial statements are prepared on the assumption that the reporting entity is a going
concern and will continue in operation for the foreseeable future and has neither the
intention or the need to enter liquidation or cease trading. If this assumption is not valid, the
financial statements may have to be prepared on a different basis.
2.4.5 The reporting entity

A reporting entity is an entity that is required, or chooses, to prepare financial statements. A
reporting entity can be a single entity or a portion of an entity (such as a branch or activities
within a defined region) or more than one entity. A reporting entity is not necessarily a legal
entity.
Where one entity has control over another entity, a parent-subsidiary relationship exists. If
the reporting entity is the parent alone, the financial statements are referred to as
‘unconsolidated’ (other Standards use the term separate financial statements). If the
reporting entity comprises both the parent and the subsidiary, the financial statements are
referred to as ‘consolidated’. If the reporting entity comprises two or more entities that are
not all linked by a parent-subsidiary relationship, the financial statements are referred to as
‘combined’.
Determining the boundary of a reporting entity can be difficult if the reporting entity is not a
legal entity and does not comprise only of legal entities linked by a parent-subsidiary
relationship. The boundary is driven by the information needs of the users of the reporting
entity’s financial statements. To achieve this:
the boundary of a reporting entity does not include arbitrary or incomplete information;
the set of economic activities within the boundary of a reporting entity includes neutral
information; and
an explanation is provided as to how the boundary was determined and what constitutes
the reporting entity.
2.5 The elements of financial statements
The definitions of an asset and a liability have been refined in the Conceptual
Framework (2018) and the definitions of income and expenses have been updated to
reflect this refinement.
The elements of financial statements in the Conceptual Framework are:

assets, liabilities and equity, which relate to a reporting entity’s financial position; and
income and expenses, which relate to a reporting entity’s financial performance.
The elements are linked to economic resources, claims and changes in economic resources
and claims.
2.5.1 Assets
Previous definition (1989 and 2010) New definition (2018)
A resource controlled by the entity as a A present economic resource controlled
result of past events and from which by the entity as a result of past events
future economic benefits are expected to An economic resource is a right that has
flow to the entity the potential to produce economic
benefits
Main changes in the definition of an asset:
separate definition of an economic resource – to clarify that an asset is the economic
resource, not the ultimate inflow of economic benefits.
deletion of ‘expected flow’ – it does not need to be certain, or even likely, that economic
benefits will arise. A low probability of economic benefits might affect recognition
decisions and the measurement of the asset.
2.5.1.1 Rights
An economic resource is not seen as an object as a whole, but as a set of rights. These
rights could include rights that correspond to an obligation of another party (such as rights to
receive cash), and rights that do not correspond to an obligation of another party (such as
rights over a physical object). Rights are established by contract, legislation, or other means.
In principle, each right could be a separate asset. However, to present the underlying
economics, related rights will be viewed collectively as a single asset that forms a single unit
of account. Legal ownership of a physical object may, for example, give rise to several
rights, such as the right to use, the right to sell, the right to pledge the object as security, and
other undefined rights. Describing the set of rights as the physical object will often provide a
faithful representation of those rights.
2.5.1.2 Potential to produce economic benefits
It is necessary for the right to already exist and that, in at least one circumstance, it would
produce for the entity economic benefits beyond those available to all other parties. An
economic resource derives its value from its present potential to produce future economic
benefits. The economic resource is the present right that contains that potential. The
economic resource is not the future economic benefit that the right may produce.
2.5.1.3 Control
Control links a right (in other words the economic resource) to an entity. Control
encompasses both a power and a benefits element: an entity must have the present ability
to direct how a resource is used, and be able to obtain the economic benefits that may flow
from that resource.
2.5.2 Liabilities
Previous definition (1989 and 2010) New definition (2018)
A present obligation of the entity arising A present obligation of the entity to
from past events, the settlement of which transfer an economic resource as a result
is expected to result in an outflow from the of past events
entity of resources embodying economic An obligation is a duty or responsibility
benefits that the entity has no practical ability to
avoid
Main changes in the definition of a liability:

economic resource – to clarify that a liability is the obligation to transfer the economic
resource, not the ultimate outflow of economic benefits.
deletion of ‘expected flow’ – it does not need to be certain, or even likely, that economic
benefits will be required to transfer the economic resource. A low probability might affect
recognition decisions and the measurement of the liability.
Introduction of the ‘no practical ability to avoid’ criterion to the definition of obligation.
2.5.2.1 Obligation
Many obligations are established by contract, legislation or similar means and are legally
enforceable by the party to whom they are owned. Obligations can also arise from an
entity’s customary practices, published policies or specific statements, if the entity has no
practical ability to act in a manner inconsistent with those practices, policies or statements
(constructive obligation). If the duty or responsibility is conditional on a particular future
action that the entity itself may take, the entity has an obligation if it has no practical ability to
avoid taking that action.
The factors used to assess whether an entity has the practical ability to avoid transferring an
economic resource may depend on the nature of the entity’s duty or responsibility.
2.5.2.2 Transfer of an economic resource
It is necessary that the obligation already exists and that, in at least one circumstance, it
would require the entity to transfer an economic resource.
2.5.2.3 Present obligation as a result of past events
A present obligation exists as a result of past events only if:
the entity has already obtained economic benefits (for example goods or services), or
taken an action (for example constructing an oil rig in the ocean); and
as a consequence, the entity will or may have to transfer an economic resource that it
would not otherwise have had to transfer (for example the oil rig needs to be removed
and the ocean bed restored in the future).
2.5.3 Unit of account
Unit of account affects decisions about recognition, derecognition, measurement as well as
presentation and disclosure.
The unit of account is the right or group of rights, the obligation or group of obligations, or
the group of rights and obligations, to which the recognition criteria and measurement
concepts are applied.
A unit of account is selected to provide useful information, which means that the information
about the asset or liability and about any related income and expenses must be relevant and
must faithfully represent the substance of the transaction or other event from which they
have arisen. Treating a set of rights and obligations that arise from the same source and
that are interdependent and cannot be separated as a single unit of account, is not the same
as offsetting.
In terms of the cost constraint, it is important to consider whether the benefits of the
information provided to users of financial statements by selecting that unit of account are
likely to justify the costs of providing and using that information.
2.5.3.1 Executory contracts
An executory contract is a contract that is equally unperformed. It establishes a combined
right and obligation to exchange economic resources.
2.5.3.2 Substance of contractual rights and contractual obligations
In some cases, the substance of the rights and obligations is clear from the legal form of the
contract. In other cases, the terms of the contract or a group or series of contracts require
analysis to identify the substance of the rights and obligations. Explicit and implicit terms in a
contract, that have substance (have an effect on the economics of the contract), are
considered.
A group or series of contracts may be designed to achieve an overall commercial effect. To

report the substance of such contracts, it may be necessary to treat rights and obligations
arising from that group or series of contracts as a single unit of account.
A single contract may, however, create two or more sets of rights or obligations that may
need to be accounted for as if they arose from separate contracts, in order to faithfully
represent the rights and obligations.
2.5.4 Equity
The definition of equity – the residual interest in the assets of the entity after deduction all its
liabilities – is unchanged (E = A – L). The IASB has, however, already expressed their
intention to update this definition.
Equity claims are claims against the entity that do not meet the definition of a liability.
Different classes of equity claims, such as ordinary shares and preference shares, may
confer on their holders different rights.
2.5.5 Income
Income is increases in assets, or decreases in liabilities, that result in increases in equity,
other than those relating to contributions from holders of equity claims.
2.5.6 Expenses
Expenses are decreases in assets, or increases in liabilities, that result in decreases in
equity, other than those relating to distributions to holders of equity claims.
2.6 Recognition and derecognition
The previous recognition criteria required that an entity should recognise an item that
meets the definition of an element, if it was probably that economic benefits would flow,
and if the item had a cost or value that could be measured reliably. The revised
recognition criteria refer to the qualitative characteristics of useful information.
Derecognition has not been previously covered by the Framework or Conceptual
Framework.
Recognition is the process of capturing for inclusion in the statement of financial position or
the statement(s) of financial performance an item that meets the definition of an asset,
liability, equity, income or expense.
In addition to meeting the definition of an element, items are only recognised when their
recognition provides users of financial statements with information about the items that is
both relevant and can be faithfully represented.
Recognition involves depicting the item in the financial statements – either alone or in
aggregation with other items – in words and by a monetary amount, and including that
amount in one or more totals in the financial statements.
This chapter of the Conceptual Framework provides a high-level overview of how different
types of uncertainty (e.g. existence, outcome and measurement) could affect the recognition
decisions.
Derecognition is the removal of all or part of a recognised asset or liability from an entity’s
statement of financial position.
Derecognition aims to faithfully represent both:
any assets and liabilities retained after the transaction or other event that led to the
derecognition (this represents a control approach); and
the change in the entity’s assets and liabilities as a result of the transaction or other
event (this represents a risks-and-rewards approach).
2.6.1 Recognition
Recognition links the elements of financial statements (Diagram 5.1 in the Conceptual
Framework (2018)):
Statement of financial position at beginning of reporting period
Assets minus liabilities equal equity
+
Statement(s) of financial performance
Income minus expenses

+ Changes
Contributions from holders of equity claims minus distributions to in equity
holders of equity claims
=
Statement of financial position at end of reporting period
Assets minus liabilities equal equity
2.6.1.1 Relevance
Recognition of a particular asset or liability and any resulting income, expenses or changes
in equity, may not always provide relevant information, for example if:
it is uncertain whether an asset or liability exists (existence uncertainty); or
an asset or liability exists, but the probability of an inflow or outflow of economic benefits
is low.
Whether a faithful representation can be provided may be affected by the level of
measurement uncertainty (uncertainty that arises when monetary amounts in financial
reports cannot be observed directly and must instead be estimated).
The use of reasonable estimates is an essential part of the preparation of financial
information and does not undermine the usefulness of the information if the estimates are
clearly and accurately described and explained. However, in some cases, the level of
uncertainty involved in estimating a measure of an asset of liability may be so high that it
may be questionable whether the estimate would provide a sufficiently faithful
representation of that asset and of any resulting income, expenses or changes in equity.
This could be the case, for example, if the range of possible outcomes is exceptionally wide
and the probability of each outcome is exceptionally difficult to estimate (outcome
uncertainty is uncertainty about the amount or timing of any inflow or outflow of economic
benefits that will result from an asset or liability).
2.6.1.3 Other factors
It is important to consider whether related assets and liabilities are recognised. If they
are not recognised, recognition may create a recognition inconsistency (accounting
mismatch).
Whether or not the asset or liability is recognised, explanatory information about the
uncertainties associated with it may need to be provided in the financial statements.
The simultaneous recognition of income and related expenses is sometimes referred to
as the matching of costs with income. However, matching is not an objective in the
Conceptual Framework.
information provided to users of financial statements by recognition are likely to justify
the costs of providing and using that information.
2.6.2 Derecognition
For an asset, derecognition normally occurs when the entity has lost control of all or part of
the recognised asset. For a liability, derecognition normally occurs when the entity no longer
has a present obligation for all or part of the recognised liability.
In some cases, an entity might appear to transfer an asset or liability, but that asset or
liability might nevertheless remain an asset or liability of the entity, and therefore
derecognition of that asset or liability may not be appropriate. Appropriate presentation and
disclosure may be required in such cases.
2.7 Measurement
The Framework 1989 and the Conceptual Framework (2010) included little guidance on
measurement. The revised Conceptual Framework (2018) describes what information
measurement bases provide and explains the factors to consider when selecting a
measurement basis.
Measurement is quantifying, in monetary terms, elements that are recognised in financial

statements. To measure is the result of applying a measurement basis to an asset or liability
and related income and expenses.
A measurement basis is an identified feature – for example, historical cost or current value –
of an item being measured. The Conceptual Framework does not favour one basis over the
other, but notes that under some circumstances one may provide more useful information
than the other.
When selecting a measurement basis, it is important to consider the nature of the
information that the measurement basis will produce in both the statement of financial
position and the statement(s) of financial performance and the confirmatory or predictive
value of that information. The information provided by the measurement basis must be
useful to users of financial statements. The information must be relevant, must faithfully
represent what it purports to represent and be, as far as possible, comparable, verifiable,
timely and understandable.
The choice of measurement basis for an asset or liability and the related income and
expenses, is determined by considering both initial and subsequent measurement.
2.7.1 Measurement bases

2.7.1.1 Historical cost
Historical cost measures are entry values and provide monetary information about assets,
liabilities and related income and expenses, using information derived, at least in part, from
the price of the transaction or other event that gave rise to them. Transaction costs are
taken into account if they are incurred in the transaction or other event giving rise to the
asset or liability:
Dr Asset / liability
Cr Bank
The historical cost of an asset is updated over time to depict, if applicable:
The consumption of part or all of the economic resources that constitutes the asset
(depreciation);
Payments received that extinguish part or all of the asset;
The effect of events that cause part or all of the historical cost of the asset to be no
longer recoverable (impairment); and
Accrual of interest to reflect any financing component of the asset.
The historical cost of a liability is updated over time to depict, if applicable:

Fulfilment of part or all of the liability;
The effect of events that increase the value of the obligation to transfer the economic
resources needed to fulfil the liability to such an extent that the liability becomes onerous
(it is onerous if the historical cost is no longer sufficient to depict the obligation to fulfil the
liability); and
Accrual of interest to reflect any financing component of the liability.
For financial assets and financial liabilities, a way to apply the historical cost basis, is to
measure the items at amortised cost. The amortised cost of a financial asset or financial
liability is updated over time to depict subsequent changes.
2.7.1.2 Current value
Current value measures provide monetary information about assets, liabilities and related
income and expenses, using information updated to reflect conditions at the measurement
date.
Current value measurement bases include:
Fair value The price that would be received to sell an asset, or paid to
transfer a liability, in an orderly transaction between market
participants at the measurement date. An exit value.
Reflects market participants’ current expectations about
the amount, timing and uncertainty of future cash flows. In
some cases it can be determined directly by observing
prices in an active market. In other cases it is determined
indirectly by using measurement techniques. Transaction
costs are excluded.
Value in use (assets) The present value of the cash flows, or other economic
benefits, that an entity expects to derive from the use of an
asset and from its ultimate disposal. An exit value.
Determined by using cash-flow-based measurement
techniques. Transaction costs incurred on acquiring the
asset are excluded. Takes into account transaction costs
expected on ultimate disposal.
Fulfilment value Present value of the cash flows, or other economic
(liabilities) resources, that an entity expects to be obliged to transfer
as it fulfils a liability. An exit value. Reflects entity-specific
current expectations about the amount, timing and
uncertainty of future cash flows. Determined by using
cash-flow-based measurement techniques. Transaction
costs incurred on taking on the liability are excluded.
Takes into account transaction costs expected on fulfilling
the liability.
Current cost (assets) Cost of an equivalent asset at the measurement date,
comprising the consideration that would be paid plus the
transaction costs that would be incurred at that date. An
entry value. Reflects conditions at the measurement date.
In some cases, cannot be determined directly and must be
determined indirectly.
Current cost (liabilities) Consideration that would be received for an equivalent
liability minus the transaction costs that would be incurred
at that date. An entry value. Reflects conditions at the
measurement date. In some cases, cannot be determined
directly and must be determined indirectly.
Cash-flow-based measurement techniques:

When measuring an asset or liability by reference to estimates of uncertain future cash
flows, a factor to consider is possible variations in the estimated amount or timing of those
cash flows. Those variations are considered in selecting a single amount from within the
range of possible cash flows.
2.7.2 Factors to consider when selecting a measurement basis

2.7.2.1 Relevance
The relevance of information provided by a measurement basis for an asset or liability and
for the related income and expenses is affected by:
the characteristics of the asset or liability (for example, the variability of cash flows and
whether the value of the asset or liability is sensitive to market factors or other risks); and
how the asset or liability contributes to future cash flows (for example, whether cash
flows are produced directly or indirectly in combination with other economic resources,
and the nature of the business activities conducted by the entity).
Whether a measurement basis can provide a faithful representation is affected by:
measurement inconsistency (accounting mismatch) (using different measurement bases
for assets and liabilities that are related); and
measurement uncertainty (when a measure cannot be determined directly by observing
prices in an active market and must instead be estimated).
2.7.2.3 Enhancing qualitative characteristics and the cost constraint
information provided to users of financial statements by that measurement basis are likely to
justify the costs of providing and using that information.
Consistently using the same measurement bases for the same items, either from period to
period within a reporting entity, or in a single period across entities, can help make financial
statements more comparable.
A change in measurement basis can make financial statements less understandable.
Therefore, if a change is made, users of financial statements may need explanatory
information to enable them to understand the effect of that change.
Verifiability is enhanced by using measurement bases that result in measures that can be
independently corroborated either directly (for example by observing prices) or indirectly (for
example by checking inputs into a model).
Timeliness has no specific implications for measurement.
2.7.2.4 More than one measurement basis
In most cases, the most understandable way is to:
use a single measurement basis for both the asset or liability in the statement of financial
position and for related income and expenses in the statement(s) of financial
performance; and
provide in the notes additional information applying a different measurement basis (if
more than one measurement basis is needed in order to provide relevant information
that faithfully represents both the entity’s financial position and its financial performance).
However, in some cases, different measurement bases are used in the statement of
financial position and statement of profit or loss.
2.7.3 Measurement of equity

The total carrying amount of equity is not measured directly. It equals the total of the
carrying amounts of all recognised assets less the total of the carrying amounts of all
recognised liabilities.
The total carrying amount of an individual class of equity or component of equity is normally
positive, but can be negative in some circumstances.
2.8 Presentation and disclosure
This chapter is new and was not included in the Framework (1989) or the Conceptual
Framework (2010). This chapter includes concepts that describe how information should
be presented and disclosed in financial statements, and guidance on including income
and expenses in the statement of profit or loss and other comprehensive income.
Information about assets, liabilities, equity, income and expenses is communicated through
presentation and disclosure in the financial statements of a reporting entity. Effective
communication of information in financial statements makes that information more relevant
and contributes to a faithful representation. Including presentation and disclosure objectives
in Standards can support effective communication because it helps entities identify useful
information and to decide how to communicate that information in the most effective
manner.
In terms of the cost constraint, it is important to consider whether the benefits provided to
users of financial statements by presenting or disclosing particular information are likely to
justify the costs of providing and using that information.
2.8.1 Classification
Classification is the sorting of assets, liabilities, equity, income or expenses on the basis of
shared characteristics for presentation and disclosure purposes. Classifying dissimilar items
together (for example offsetting assets and liabilities) can obscure relevant information,
reduce understandability and comparability, and may not provide a faithful representation of
what it purports to represent.
2.8.1.1 Classification of assets and liabilities
Classification is applied to the unit of account. Sometimes it may be appropriate to separate
an asset or liability into components, and to classify those components separately (for
example current and non-current components).
Offsetting occurs where an entity recognises and measures both an asset and liability as
separate units of account, but groups them into a single net amount in the statement of
financial position.
2.8.1.2 Classification of equity
It may be necessary to classify equity claims separately if those claims have different
characteristics. It may also be necessary to classify components of equity separately if those
components are subject to particular legal, regulatory or other requirements.
2.8.1.3 Classification of income and expenses
Classification is applied to income and expenses resulting from the unit of account selected
for an asset or liability; or components of such income and expenses, if those components
have different characteristics that are identified separately.
Income and expenses are classified and included either:
in the statement of profit or loss; or
in other comprehensive income.
The statement of profit or loss is the primary source of information about an entity’s financial
performance for the reporting period. In principle, all income and expense items are included
in that statement. The IASB may, however, decide in exceptional circumstances that income
or expenses arising from a change in the current value of an asset or a liability are to be
included in other comprehensive income (in the statement of other comprehensive
income), when doing so would result in the statement of profit or loss providing more
relevant information or providing a more faithful representation of the entity’s performance
for that period. This discretion applies only to the IASB. Preparers of financial statements
will not be able to choose to exclude items from profit or loss when using the Conceptual
Framework to develop accounting policies.
In principle, income and expenses included in other comprehensive income in one period
are reclassified from other comprehensive income into the statement of profit or loss in a
future period, when doing so results in the statement of profit or loss providing more relevant
information or providing a more faithful representation of the entity’s performance for that
future period. Only in exceptional circumstances may the IASB decide that income and
expenses will not be reclassified to profit or loss.
2.8.2 Aggregation
Aggregation is the adding together of assets, liabilities, equity, income or expenses that
have shared characteristics and are included in the same classification. Different levels of
aggregation may be needed in different parts of financial statements, for example the
statement of financial position provides summarised information and more detailed
information is provided in the notes.
2.9 Concepts of capital and capital maintenance
This chapter has remained unchanged from the Framework (1989) to the Conceptual
Framework (2010) and the Conceptual Framework (2018).
The concept of capital maintenance relates to the capital that an entity strives to maintain
and also serves as a point of departure for the measurement of profit.
Two different concepts of capital are identified in the Conceptual Framework – a financial
concept of capital, and a physical concept of capital.
According to the financial concept of capital, capital is equal to the net assets or equity
of an entity.
In terms of the physical concept of capital, capital is equal to: the production capacity/
physical productive capacity/operating capability/resources or funds needed to achieve
that capability, of an entity – for example, the number of units produced per day.
The selection of the appropriate concept of capital by an entity should be based on the
needs of the users of its financial statements. In South Africa, most entities adopt a financial
concept of capital, but if the main consideration of users is to maintain operating capacity,
the physical concept of capital is selected.
Capital maintenance is linked to the concepts of capital:
In terms of the financial concept of capital, capital is maintained if net assets at the
beginning of a period are equal to net assets at the end of that period after excluding any
distributions to or contributions by owners of the entity during the period. In other words,
the financial concept of capital states that profit is only earned if the financial (or money)
amount of the net assets at the end of a period exceed the financial (or money) amount
of the net assets at the beginning of that period. Measurement is done in nominal
monetary units (without taking inflation into account) or in units of constant purchasing
power.
Should capital be measured using nominal monetary units, profit represents an

increase in the nominal monetary capital over a period. Increases in the values of assets
held during a period are known as holding gains, but nevertheless remain profits from a
conceptual point of view.
Should capital be measured in units of constant purchasing power, profit is
represented by an increase in invested purchasing power over a period. Consequently,
only the portion of the increase in the prices of assets that exceeds the general level of
price increases would represent profits. The rest are considered to be capital
maintenance adjustments and form part of equity, not profits.
In terms of the physical concept of capital, capital is maintained if the physical
production capacity of an entity at the beginning of a period is equal to the physical
production capacity at the end of the period after excluding any distributions to or
contributions by owners of the entity during the period. Consequently, profit under the
physical concept of capital is only earned if the physical production capacity at the end of
a period exceeds the physical production capacity at the beginning of the period.
Measurement takes place on a current cost basis.
All price changes in the assets and liabilities of the entity are considered to be changes
in the measurement of the physical production capacity of the entity. These changes are
consequently accounted for as capital maintenance adjustments against equity, and are
not recognised as profits.
Example 2.1
2.1 Capital maintenance
A company has net assets of R3 000 at the beginning of the year and R4 500 at the end of the
year. Assume that net assets of R3 750 are required to maintain the company’s physical capacity
and that the general price level increased by 10% during the year.
The income under the various capital maintenance options will be as follows:
Financial capital maintenance:
Money maintenance: R4 500 – R3 000 = R1 500
General purchasing power maintenance: R4 500 – (R3 000 + (R3 000 × 10%)) = R1 200
Physical capital maintenance:
Productive capacity maintenance: R4 500 – R3 750 = R750
2.10 Overview of the Conceptual Framework
The objective of general purpose

financial reporting is to provide
useful financial information
Qualitative characteristics of
useful financial information
fundamental
enhancing
Reporting entity is
Financial statements are a required to or
particular form of general chooses to prepare
purpose financial report financial statements
Concepts of capital
and capital
maintenance adopted
in preparing financial
statements
The elements of financial

statements Recognition
Assets Derecognition
Liabilities Measurement
Equity Presentation
Income Disclosure
Expenses
CHAPTER
3
Presentation of financial statements
(IAS 1 and IFRIC 17)
Contents
3.1 Overview of IAS 1 Presentation of Financial Statements .................................. 28
3.2 Background ....................................................................................................... 29
3.3 Objective and components of financial statements ........................................... 30
3.4 General features ................................................................................................ 31
3.4.1 Fair presentation and compliance with IFRSs ........................................ 31
3.4.2 Going concern ........................................................................................ 33
3.4.3 Accrual basis .......................................................................................... 33
3.4.4 Materiality and aggregation .................................................................... 33
3.4.5 Offsetting ................................................................................................ 34
3.4.6 Frequency of reporting ........................................................................... 34
3.4.7 Comparative information ........................................................................ 34
3.4.8 Consistency of presentation ................................................................... 36
3.5 Structure and content ........................................................................................ 36
3.5.1 Identification of financial statements ....................................................... 36
3.5.2 Statement of financial position ................................................................ 38
3.5.3 Statement of profit or loss and other comprehensive income ................ 44
3.5.4 Statement of changes in equity .............................................................. 49
3.5.5 Statement of cash flows ......................................................................... 51
3.5.6 Notes ...................................................................................................... 51
3.6 Statutory reporting requirements ....................................................................... 55
27
3.1 Overview of IAS 1 Presentation of Financial Statements
PRESENTATION OF FINANCIAL STATEMENTS
Prescribes the basis for preparation of general purpose financial statements.

Purpose of
Sets out minimum requirements for presentation as well as guidelines for
IAS 1
structure and content of financial statements.
Objective of To provide useful information about the financial position, financial performance
financial and cash flows of an entity to a wide range of users for making economic
statements decisions.
Complete set of
financial Structure and content
statements
Certain line items should be presented on the face of the SFP (e.g.
property, plant and equipment, inventories, provisions, etc.).
Statement of Certain information should be presented either on the face of the SFP or in
financial the notes (e.g. sub-classifications of line items and details regarding share
position (SFP) capital).
Assets and liabilities should be presented as either current or
non-current, unless presentation is based on liquidity.
All income and expense items recognised in a period are presented as

either:
– a single statement of profit or loss and other comprehensive income;
OR
– two separate statements (one displaying profit or loss and the other
displaying other comprehensive income together with profit or loss as an
opening amount).
Expenditure items should be classified either by their function or their
nature.
Specific line items are required to be presented in the profit or loss section
Statement of (e.g. revenue, finance cost, tax expense, share of profit of associates and
profit or loss joint ventures, etc.).
and other The nature and amount of material items to be presented either on the face
comprehensive of the SPLOCI or separately in the notes.
income Other comprehensive income items to be classified as either:
(SPLOCI)
– items that will not be classified subsequently to profit or loss; OR
– items that will subsequently be reclassified to profit or loss.
Items of other comprehensive income must be presented as either:
– net of related tax effects; OR
– before related tax effects, with one amount shown for the aggregate
amount of income tax relating to those items.
Reclassification adjustments relating to components of other
comprehensive income need to be disclosed, either on the face, or in the
notes.
The notion of extraordinary items has been abandoned.
continued
Presentation of financial statements 29
Reconciliation of equity at the beginning of the reporting period with equity

at the end of the reporting period.
Includes:
– total comprehensive income for the period, separated between amounts
Statement of
attributable to the owners of the parent and non-controlling interests;
changes in
– effect of retrospective restatements; and
equity
– transactions with owners in their capacity as owners (e.g. issue of
shares, dividends paid).
Dividends paid and the related dividends per share should be presented
either on the face, or in the notes.
Statement of
Refer to chapter 5.
cash flows
Basis of preparation of the financial statements.

Specific accounting policies applied.
Present information required by IFRS not already presented elsewhere.
Notes Supporting information for items presented in the financial statements.
Additional information on items not presented in the financial statements.
Sources of estimation uncertainty.
Disclosures regarding capital.
Fair presentation and compliance with IFRSs.

Financial statements are prepared on the going concern assumption.
Items recognised on the accrual basis (i.e. when items satisfy the
definitions and recognition criteria of the Conceptual Framework for
Financial Reporting).
General
Materiality and aggregation (present each material class of similar items
features for the separately).
presentation of
Offsetting (not allowed unless required/permitted by an IFRS).
financial
statements Frequency of reporting (at least annually).
Comparative information (in respect of preceding period for all amounts
presented and for the beginning of the earliest period presented where
prior year numbers have been restated).
Consistency of presentation (retain presentation and classification between
periods).
3.2 Background
The aim of IAS 1 is:
to set out guidelines for the structure and content of financial statements;
to set out the overall requirements for the presentation of financial statements; and
to establish certain underlying assumptions.
This Standard provides guidance on the overall presentation by setting out the basic
requirements for general purpose financial statements. Other IFRSs set out specific
disclosure requirements which should be added to the basic general purpose financial
statements as required by IAS 1 Presentation of Financial Statements.
Although the scope of IAS 1 applies to all general purpose financial statements, the
terminology is more suited to profit-oriented entities. It may therefore be necessary to
amend descriptions and line items in the financial statements when IAS 1 is applied to
non-profit organisations and to entities other than companies, such as sole traders,
partnerships and close corporations.
General purpose financial statements are those statements that are intended to satisfy
the needs of the group of interested parties who are not in a position to demand that
financial statements should be specifically compiled for their purposes. Non-controlling
shareholders and creditors are examples of interested parties who must depend on general
purpose financial statements. In contrast, members of management can ensure that
management information is compiled in such a way that their needs are adequately
addressed. IAS 1 attempts to serve the interests of the former group.
IAS 1 applies to financial statements in documents such as prospectuses, but not to
condensed interim financial statements. Condensed interim financial statements fall under
the scope of IAS 34 Interim Financial Reporting. IAS 1 also applies to both separate and
consolidated financial statements in accordance with IFRS 10, Consolidated Financial
Statements.
3.3 Objective and components of financial statements
The objective of financial statements is:
to provide information;
about the financial position, financial performance and cash flows of an entity;
that is useful to a wide range of users;
in making economic decisions.
A complete set of financial statements comprises (IAS 1.10):
a statement of financial position as at the end of the period;
a statement of profit or loss and other comprehensive income for the period;
a statement of changes in equity for the period;
a statement of cash flows for the period;
notes to the financial statements, including a summary of significant accounting policies;
comparative information in respect of the preceding period; and
a statement of financial position as at the beginning of the preceding period when an entity
applies an accounting policy retrospectively or makes a retrospective restatement of
items in its financial statements, or when items in the financial statements were reclassified
(refer to section 3.4.7.1).
An entity may use titles for the components of financial statements other than those used in
IAS 1.
A single statement of profit of loss and other comprehensive income may be presented, with
profit or loss and other comprehensive income presented in two separate sections. In this
single statement, the two sections will be presented together, with the profit or loss section
presented immediately before the other comprehensive income section. The profit or loss
section may, however, be presented in a separate statement of profit or loss.
When a statement of profit or loss is presented separately, it is part of the complete set of
financial statements and should be displayed immediately before the statement presenting
comprehensive income. The statement presenting comprehensive income should begin with
the profit or loss amount.
IAS 1 acknowledges that preparers of financial statements do provide additional information,
such as a value added statement and environmental reports, if required by users. A financial
overview of the entity’s activities can also be provided to include the following information:
the main factors that influenced the performance of the entity in the current period and
will continue to do so in future periods;
the entity’s policy regarding the maintenance and enhancement of performance;
its policy in respect of dividends;

the sources of funding and the policies on gearing and risk management;
the strengths and resources of the entity that are not reflected in the statement of
financial position; and
the changes in the environment within which the entity functions, how it reacts to the changes
and the effect thereof on its performance.
The content and format of these reports falls outside the scope of IAS 1.
3.4 General features

The following general features for the presentation of financial statements are identified in
IAS 1.15 to .46:
fair presentation and compliance with IFRSs;
going concern;
accrual basis of accounting;
materiality and aggregation;
offsetting;
frequency of reporting;
comparative information; and
consistency of presentation.
Each of these concepts is discussed below.
3.4.1 Fair presentation and compliance with IFRSs

3.4.1.1 Fair presentation
The concept of fair presentation is not new to accounting literature, yet it is one that is, by its
very nature, one of the most difficult to apply. IAS 1.15 states that financial statements
should present the financial position (referring to the statement of financial position), the
financial performance (referring to the statement of profit or loss and other comprehensive
income) and the cash flows (referring to the statement of cash flows) of an entity fairly.
IAS 1 states that fair presentation is achieved by faithful representation of the effects of
transactions, other events and conditions in accordance with the definitions and recognition
criteria for assets, liabilities, equity, income and expenses as set out in the Conceptual
Framework.
Concepts of the Conceptual Framework are employed in an attempt to describe the rather
difficult term ‘fair presentation’. These concepts are:
faithful representation;
definitions of elements (assets, liabilities, equity, income and expenses) of financial
statements; and
recognition criteria for elements of financial statements.
Faithful representation refers to that characteristic of financial reports that will reassure
users of such reports that they can rely on the information contained therein to faithfully
represent the economic circumstances and events that it purports to represent or would
reasonably be expected to represent. Users of financial statements are assured that all
items that impact on the financial position, financial results and cash flows of an entity are
represented appropriately. At a practical level, this means that, for example, the item
‘inventories’ in the statement of financial position actually represents those units and only
those units that qualify for inclusion as inventory (and would therefore meet the definition of
assets), appropriately recognised and measured in accordance with the relevant
Standards.
By complying with the Standards and Interpretations of the IASB, and fairly presenting the
effects of transactions and other events in accordance with the definitions and recognition
criteria for assets, liabilities, equity, income and expenses as set out in the Conceptual
Framework, fair presentation in the financial statements is usually accomplished. It should
be stated in financial statements that they comply with IFRSs. However, unless compliance
with all applicable IFRSs, as well as each applicable approved Interpretation has been
achieved, the statement should not be included. IFRSs include all Standards of the IFRS
series and IAS series and all applicable Interpretations, IFRIC, or the SIC series.
3.4.1.2 Non-compliance with IFRSs
IAS 1 recognises that there may be rare circumstances where compliance with a particular
requirement of a Standard or Interpretation may be misleading and in conflict with the
objectives of financial statements as set out in the Conceptual Framework. In such
extremely rare cases, the entity shall depart from the requirement in the Standard if the
relevant regulatory framework requires or does not otherwise prohibit such a departure.
When assessing whether a specific departure is necessary, consideration is given to the
following:
why the objective of financial statements is not achieved in the particular circumstances;
and
the way in which the entity’s circumstances differ from those of other entities that follow
the requirement. There is a rebuttable presumption that if other entities in similar
circumstances comply with the requirement, the entity’s compliance with the requirement
would not be so misleading that it would conflict with the objective of financial statements
as set out in the Conceptual Framework. The entity departing from the particular
requirement will therefore have to motivate and justify the departure.
Where departure from a requirement in IFRSs is deemed necessary in order to achieve fair
presentation, and where the regulating authority permits departure from a requirement in a
Standard, the following are disclosed (IAS 1.20):
the fact that management has concluded that the financial statements fairly present the
entity’s financial position, financial performance and cash flows;
the fact that the financial statements comply in all material respects with the applicable
Standards and Interpretations, except for the departure in question;
the Standard or Interpretation from which the entity has departed;
the nature of the departure, including the treatment that the Standard would require;
the reason why the treatment would be so misleading in the circumstances that it would
conflict with the objective of financial statements as set out in the Conceptual
Framework;
the treatment adopted; and
the financial impact of the departure on each item in the financial statements that would
have been reported in compliance with the requirement, for each period presented.
If an entity departed from a Standard or Interpretation in a previous year and the departure
still affects amounts recognised in the financial statements, the information in the last five
bullet points above must be disclosed.
Should management conclude that compliance with a requirement in a Standard or an
Interpretation would be misleading, but the regulatory authority under which the entity
operates prohibits departure from the requirement, the entity is required to reduce the
perceived misleading aspects to the maximum extent possible by disclosing (IAS 1.23):
the title of the Standard or Interpretation requiring the entity to report information concluded
to be misleading;
the nature of the requirement;

the reason why management has concluded that complying with that requirement is
misleading and in conflict with the objective of financial statements as set out in the
Conceptual Framework; and
for each period presented, the adjustments to each item in the financial statements that
management has concluded would be necessary to achieve fair presentation.
In assessing fair presentation, the management of a reporting entity should also consider the
definitions of elements, as well as the recognition criteria in the Conceptual Framework, as
discussed in chapter 2.
3.4.2 Going concern

In terms of this concept, it is assumed that the entity will continue to exist in the foreseeable
future. More specifically, it means that the statement of profit or loss and other
comprehensive income, and the statement of financial position are drafted on the
assumption that there is no intention or need to cease or materially curtail operations.
This concept has an effect on the valuation of assets and liabilities. If the entity is no longer
a going concern, IFRS does not prescribe the basis under which the financial statements
should be prepared. Consideration should be given to the use of the liquidation valuation
method, while provision could also be made for liquidation expenses. These facts, with the
basis used and the reason why the entity is no longer a going concern, should be disclosed.
When management assesses whether the going concern assumption is appropriate, it takes
all appropriate information for at least 12 months from the end of the previous reporting
period into account. The existence of material uncertainties about the possibility of a going
concern problem should be disclosed. How an entity applies this disclosure requirement
requires the exercise of professional judgement as IAS 1 does not provide detailed
disclosure requirements.
3.4.3 Accrual basis

Financial statements (except the statement of cash flows) are prepared on an accrual basis.
This implies that transactions are accounted for when they occur and not when the related
cash is received or paid (i.e. when the items satisfy the definitions and recognition criteria for
those items as per the Conceptual Framework). In terms of the accrual concept, only the
value that has been earned during a specified period may be recognised in profit
calculations, irrespective of when the revenue was received.
In addition, only the cost that has been incurred within the same specified period may be
recognised as expenses in the profit calculation, irrespective of when payment took place.
3.4.4 Materiality and aggregation

According to IAS 1.29, each material class of similar items should be presented
separately in the financial statements. Items of a dissimilar nature or function should be
presented separately, unless they are immaterial. For example, a single event that leads to
the write-off of 85% of the inventories is shown separately and not merely aggregated with
other instances of the routine write-off of assets.
A line item may not be sufficiently material to warrant disclosure in the statement of profit or
loss and other comprehensive income, but it can be material enough to warrant inclusion in
the notes to the financial statements. A user of the financial statements usually regards an
item as being material if its non-disclosure may lead to a different decision.
Materiality is established with reference to both the nature and the size of an item. Individual
items belonging to the same category (nature) are aggregated, even though they may all be
of large amount (size). Items belonging to different categories are not aggregated.
3.4.5 Offsetting
IAS 1.32 to .35 states that:
assets and liabilities may not be offset against one another, except when such offsetting
is required or permitted by a Standard or Interpretation;
income and expenditure items should likewise not be offset against one another, except
when a Standard or Interpretation requires or permits it;
offsetting of profits, losses and related expenditure is allowed when amounts are not
material and relate to similar items; and
offsetting is also permitted where set-off is required to reflect the substance of the
transaction or event (in such cases, the amounts are aggregated and indicated on a net
basis).
Examples of offsetting are the sale of equipment as well as gains and losses in respect of
foreign currency, in which event only the net amount of the gains or losses is included in the
profit or loss section of the statement of profit or loss and other comprehensive income.
When income and expenditure are offset against one another, the entity should, in the light
of the materiality thereof, nevertheless consider disclosing the amounts that were offset
against one another in the notes to the financial statements.
Assets measured net of valuation allowances, such as obsolescence allowances on
inventories and allowance for credit losses on receivables, are not regarded as offsetting.
Gains and losses on the disposal of other non-current assets, including investments, are
reported by deducting the carrying amount of the asset and related selling expenses from
the proceeds on disposal. Expenditure related to a provision that is recognised in
accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets and
reimbursed under a contractual arrangement with a third party (e.g. a supplier’s warranty
agreement) may be netted against the related reimbursement (refer to chapter 19).
3.4.6 Frequency of reporting
A complete set of financial statements should be published at least annually (IAS 1.36). In
exceptional cases, in which an entity’s reporting date changes, with the result that the
financial statements are presented for a period shorter or longer than one year, the following
additional information should be provided:
the reason why the reporting period is not one year; and
the fact that the comparative amounts in the various components of the financial
statements (statement of profit or loss and other comprehensive income, statement of
cash flows, statement of changes in equity and related notes) are not entirely comparable.
3.4.7 Comparative information
All numerical information presented in financial statements should be accompanied by a
comparative amount for the preceding period, unless a Standard or Interpretation permits
otherwise (IAS 1.38). Even narrative and descriptive information should be accompanied
by comparative information if it is necessary for the understanding of the current period’s
It is of vital importance that users of financial statements should be able to discern trends in
financial information. Consequently, comparative information should be structured in such a
way that the usefulness of the financial statements is enhanced.
When presenting comparative information, an entity shall present as a minimum
(IAS 1.38A):
two statements of financial position;
two statements of profit or loss and other comprehensive income;
two separate statements of profit of loss (if presented);
two statements of cash flows;

two statements of changes in equity; and
related notes.
In addition to the above minimum requirements, an entity may present additional
information. This additional information need not consist of a full set of financial statements,
but must be prepared in accordance with IFRSs (IAS 1.38C and .38D).
3.4.7.1 Change in accounting policy, retrospective restatements or reclassification
An entity must present a third statement of financial position as at the beginning of the
preceding period (this is in addition to the minimum comparative financial statements
required, as mentioned above) under the following circumstances:
the retrospective application of a change in accounting policy;
the retrospective restatement of items in financial statements; or
the reclassification of items in financial statements.
This additional statement of financial position is only required if the application, restatement
or reclassification is considered to have a material effect on the information included in the
statement of financial position at the beginning of the preceding period.
The date of this third statement of financial position should be the beginning of the
preceding period, regardless of whether earlier periods are being presented. IAS 8
Accounting Policies, Changes in Accounting Estimates and Errors lists the full disclosure
requirements when an entity changes an accounting policy or corrects an error (refer to
chapter 6).
Example 3.1
3.1 Third statement of financial position
During the audit of the financial statements for the year ended 31 December 20.15, the auditors of
Olympics Ltd detected a material error that was made during the financial year ended
31 December 20.13. Olympics Ltd will have to restate the amounts in its financial statements
retrospectively to correct this error, in accordance with IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors. In accordance with IAS 1, the following periods will have to be
presented in the statement of financial position (SFP) of Olympics Ltd for the year ended
31 December 20.15, provided that full retrospective adjustment is possible in terms of IAS 8:
31 December 20.15 31 December 20.14 1 January 20.14
SFP Current period Preceding period Beginning of preceding period
Where there is a change in the presentation and classification of items in the current period,
comparatives should be amended accordingly wherever possible, for example by
reclassifying the comparative amounts (including as at the beginning of the preceding
period). The following disclosure is called for in such cases:
the nature of the reclassification;
the amount of each item or class of items that is reclassified; and
the reason for the reclassification.
However, where such reclassifications are impracticable, they need not be made, but the
following should be disclosed:
the reasons why they were not changed; and
the nature of the changes that would have been effected had the comparatives indeed
been reclassified.
IAS 1.7 has introduced the notion of impracticability. It defines a requirement as
impracticable when an entity cannot apply it after making every reasonable effort to do so.
An example is where the data may not have been collected in the prior period in a way that
allows for reclassification. Clearly, the preferred treatment is to reclassify comparative
information wherever possible.
3.4.8 Consistency of presentation

In terms of the consistency concept, there should be consistency of the presentation and
classification of like items within each accounting period, and from one period to the next.
Consistency has therefore two aspects: consistency over time and consistency of disclosure
of similar items.
IAS 1.45 states that the presentation and classification of items in the financial statements
should be retained from one period to the next, unless:
a significant change in the nature of the operations has taken place; or
upon a review of its financial statement presentation, it was decided that the change in
presentation or classification is necessary for more appropriate disclosure; or
a Standard or an Interpretation requires a change in presentation.
In such circumstances, comparative amounts should be restated.
Where a Standard requires or permits separate categorisation or measurement of items, a
different, allowed, alternative accounting policy may be applied to each category, and this
policy should then be consistently applied, unless the circumstances described in the
previous paragraph are present. Where separate categorisation of items is not allowed or
permitted by a Standard, the same accounting policy should be applied to all similar
items. For example, in IAS 2 Inventories (refer to chapter 4) separate classifications of
inventories and separate disclosure of the different classifications are allowed. Consequently,
a separate cost allocation method may be employed for each separate classification of
inventory.
3.5 Structure and content

Information may be disclosed on the face of the statement of financial position, statement of
profit or loss and other comprehensive income, statement of changes in equity, or in the
notes. IAS 1, together with other Standards, identifies specifically which disclosures should
be on the face of the financial statements.
3.5.1 Identification of financial statements

Financial statements should be clearly distinguished and identified separately from other
information that forms part of the annual report. The following information should be
indicated prominently, preferably on each page of the financial statements (IAS 1.51):
the name of the reporting entity or any other form of identification, as well as any change
since the previous reporting date to the name of the reporting entity;
whether the financial statements cover an individual entity or a group of entities;
the date of the end of the reporting period or period covered by the report, whichever
is applicable to the particular financial statements;
the relevant component of the financial statements, for example statement of cash flows
or statement of financial position;
the currency used in the financial statements; and
the level of precision of the amounts presented, for example that the amounts have been
rounded off to the nearest thousand or million.
Example 3.2
3.2 Identification of financial statements
The following points out the application of the requirements of IAS 1.51 regarding the identification
of financial statements:
London Ltd Group1
Consolidated statement of financial position4 as at 31 December 20.143
Company2 Group2
20.14 20.13 20.14 20.13
R’0005 R’000 R’0005 R’000
1 Name of the reporting entity.

2 Whether the information is for a single company or a group of entities.
3 Date of the end of the reporting period.
4 The component of the financial statements.
5 The currency used and precision of amounts presented.
The structure of financial statements can be illustrated as follows:
Statement of profit or
Statement of changes in
loss and other
equity
comprehensive income
Profit or loss section (P/L)
• income/expenses
Retained earnings
Choice to
present as
one or two
separate
statements
Other comprehensive Recognise directly in
income (OCI) section equity: mark-to-market
• items not reclassified reserve, revaluation
surplus, cash-flow hedge Statement of
to P/L and
reserve financial position
• items reclassified to
P/L. Assets – Liabilities
= Equity
Transactions with owners

in their capacity as
owners:
dividends,
share capital issues,
transfers between
reserves
3.5.2 Statement of financial position

According to IAS 1.60, an entity should present current and non-current assets, and
current and non-current liabilities, as separate classifications on the face of its
statement of financial position, except when a presentation based on liquidity provides
information that is reliable and more relevant. When this exception applies, all assets and
liabilities should be presented broadly in order of liquidity. For some entities, such as
financial institutions, a presentation of assets and liabilities in increasing or decreasing order
of liquidity provides information that is reliable and more relevant than a current/non-current
presentation, because the entity does not supply goods or services within a clearly
identifiable operating cycle.
An entity is permitted to present some of its assets and liabilities using a current/non-current
classification, and others in order of liquidity when this provides information that is reliable
and more relevant. The need for a mixed basis of presentation may arise when an entity has
diverse operations (IAS 1.64).
Regardless of which method of presentation is being applied, each asset or liability line item
should be separated between:
the amount that is expected to be recovered or settled after more than 12 months after
the end of the reporting period (non-current); and
the amount that is expected to be recovered or settled within 12 months after the end of
the reporting period (current).
Disclosure of the expected realisation of assets and liabilities is also useful, as it allows
users to assess the liquidity and solvency of the entity.
3.5.2.1 Current assets and current liabilities
An asset is classified under current assets if it satisfies the following criteria (IAS 1.66):
it is expected to be realised in, or is intended for sale or consumption in, the entity’s
normal operating cycle;
it is held primarily for the purpose of being traded;
it is expected to be realised within 12 months after the end of the reporting period; or
it is cash or a cash equivalent, unless it is restricted from being exchanged or used to
settle a liability for at least 12 months after the end of the reporting period.
All other assets, including tangible, intangible and financial assets, are classified as
non-current assets.
The operating cycle of an entity is the average time that elapses from the acquisition of raw
material or inventories until they have been sold and converted into cash.
A liability is classified under current liabilities if it satisfies the following criteria (IAS 1.69):
it is expected to be settled in the entity’s normal operating cycle;
it is held primarily for the purpose of being traded;
it is due to be settled within 12 months after the end of the reporting period; or
the entity does not have an unconditional right to defer settlement of the liability for
at least 12 months after the end of the reporting period.
All other liabilities are classified as non-current liabilities. Certain liabilities, such as trade
payables, are part of the working capital of the entity and are classified as current liabilities,
even if they are settled more than 12 months after the end of the reporting period. Other
current liabilities include financial liabilities held for trading, bank overdrafts, dividends
payable, income taxes and the current portion of non-current financial liabilities.
Note that the same normal operating cycle applies to the classification of an entity’s assets
and liabilities. When the entity’s normal operating cycle is not clearly identifiable, its duration
is assumed to be 12 months.
An entity classifies its financial liabilities as current when they are due to be settled within
12 months after the end of the reporting period, even if:
the original repayment term was for a period longer than 12 months; and
an agreement to refinance, or to reschedule, payments on a long-term basis, is
completed after the end of the reporting period and before the financial statements are
authorised for issue (IAS 1.72).
The determining factor for classification of liabilities as current or non-current is whether
the conditions existed at end of the reporting period. Information that becomes available
after the reporting period is not adjusted, but may qualify for disclosure in the notes, in
accordance with IAS 10 Events after the Reporting Period (refer to chapter 7).
If an entity expects, and has the discretion, to refinance or roll-over an obligation for at
least 12 months after the reporting period under an existing loan facility, it classifies the
obligation as non-current, even if it would otherwise be due within a shorter period.
However, when refinancing or rolling-over the obligation is not at the discretion of the
entity (e.g., there is no agreement to refinance), the potential to refinance is not considered
and the obligation is classified as current (IAS 1.73).
If an entity breaches an undertaking under a long-term loan agreement on or before the
end of the reporting period, with the effect that the liability becomes payable on demand, the
liability is classified as a current liability. This applies even if the lender has agreed, after
the reporting period and before the authorisation of the financial statements for issue, not
to demand payment as a result of the breach. The liability is classified as a current liability
because, at the end of the reporting period, the entity does not have an unconditional right
to defer its settlement for at least 12 months after the reporting date (IAS 1.74).
However, the liability is classified as a non-current liability if the lender agreed by the end of
the reporting period to provide a period of grace, ending at least 12 months after the end of
the reporting period, within which the entity can rectify the breach and during which the
lender cannot demand immediate repayment (IAS 1.75).
The following diagram gives an indication of the classification of liabilities in circumstances

where a long-term refinancing agreement has been concluded or is being contemplated:
Current liability
Concluded after Concluded before

end of reporting end of reporting
period period
Long-term
refinancing
agreement
Expected
NO YES Reclassify as
Discretion non-current
Current of entity? liability
liability
Example 3.3
3.3 Classification of financial liabilities
Sport Ltd has a 30 June year end and its financial statements are authorised for issue on
30 September of each year.
During the year ended 30 June 20.15, Sport Ltd purchased a piece of land from Team Ltd. The
land was registered in the name of Sport Ltd on 1 January 20.15. Sport Ltd financed the purchase
of the land with a loan from ABC Bank on 1 January 20.15. The loan is repayable in full on
31 December 20.15. In terms of the loan agreement, refinancing of the obligation is not at the
discretion of Sport Ltd.
On 31 May 20.15, Sport Ltd applied to the bank for the refinancing of the loan. On
15 August 20.15, ABC Bank agreed to refinance the loan. In terms of the refinancing granted, the
loan is now only repayable in full on 31 December 20.16.
Discussion
According to IAS 1.73, if an entity expects, and has the discretion, to refinance or roll-over an
obligation for at least 12 months after the reporting period under an existing loan facility, it
classifies the obligation as non-current, even if it would otherwise be due within a shorter period.
However, when refinancing or rolling-over the obligation is not at the discretion of the entity, the
potential to refinance is not considered and the obligation is classified as current.
Consequently, Sport Ltd will classify the loan from ABC Bank as current in the statement of
financial position as at 30 June 20.15, even though refinancing for a period longer than 12 months
after the end of the reporting period was granted before the financial statements were authorised
for issue. The determining factor for classification of liabilities as current or non-current is whether
the conditions existed at the end of the reporting period. On 30 June 20.15, Sport Ltd did not
have the discretion to refinance the loan.
Sport Ltd will have to disclose the refinancing of the loan as a non-adjusting event after the end
of the reporting period in terms of IAS 10.4.
If, for loans classified as current liabilities, the following events occur between the end of the
reporting period and the date on which the financial statements are authorised for issue, these
events qualify for disclosure as non-adjusting events in accordance with IAS 10 Events after
the Reporting Period:
refinancing on a long-term basis;
rectification of a breach of a long-term loan agreement; and
the receipt from the lender of a period of grace to rectify a breach of a long-term loan
agreement ending at least 12 months after the end of the reporting period (IAS 1.76).
3.5.2.2 Items presented on the statement of financial position
IAS 1 does not prescribe the format or order of items to be presented on the statement of
financial position. The statement of financial position should however, present at least the
following line items:
property, plant and equipment;
investment property;
intangible assets;
financial assets (excluding investments accounted for using the equity method, trade and
other receivables, and cash and cash equivalents);
investments accounted for using the equity method;
biological assets;
inventories;
trade and other receivables;
cash and cash equivalents;
total assets classified as held for sale, and assets included in disposal groups in
accordance with IFRS 5, Non-current Assets Held for Sale and Discontinued Operations;
trade and other payables;
liabilities and assets for current tax;
deferred tax liabilities and deferred tax assets;
provisions;
financial liabilities (excluding trade and other payables, and provisions);
liabilities included in disposal groups classified as held for sale in accordance with
IFRS 5;
issued capital and reserves attributable to owners of the parent; and
non-controlling interests presented within equity.
Assets held for sale, or assets and liabilities forming part of discontinued operations, are
included as separate line items on the statement of financial position. Additional line items,
headings and subtotals should also be presented on the face of the statement of financial
position when such presentation is relevant to an understanding of the entity’s financial
position.
When an entity presents current and non-current assets and current and non-current
liabilities as separate classifications on the face of its statement of financial position, it
should not classify deferred tax assets (liabilities) as current assets (liabilities) (IAS 1.56).
Line items are included if the size, nature or function of an item or the composition of
similar items is such that separate disclosure is appropriate to understanding the financial
position of the entity and to supplying information necessary to understand the financial
position. The descriptions and order of the items or aggregation of separate items are
adapted in accordance with the nature of the entity and its transactions.
The following criteria are applied in deciding whether an item should be disclosed separately:
the nature and liquidity of the assets, leading to a distinction between, for example, long-
term assets and liabilities, tangible and intangible assets, monetary and non-monetary
items, and current assets and liabilities;
the function of the relevant items, leading to a distinction between, for example,
operating assets and financial assets; and
the amount, nature and settlement date of liabilities, leading to a distinction between, for
example, interest-bearing and non-interest-bearing liabilities and provisions.
3.5.2.3 Items presented on the statement of financial position or in the notes
Sub-classifications of items presented (see above), appropriately classified, are provided in
either the statement of financial position or in the notes. The requirements of IFRSs would
supply the detail that is required under these sub-classifications. The details would also
depend on the function, size and nature of the amounts involved.
For share capital, in particular, the following are disclosed for each class (IAS 1.79):
the number of authorised shares;
the number of shares issued and fully paid;
the number of shares issued but not fully paid;
the par value per share, or that the shares have no par value;
a reconciliation of the number of shares outstanding at both the beginning and the end of
the period;
the rights, preferences and restrictions applicable to each category, including restrictions
on the distribution of dividends and the repayment of capital;
the shares in the entity held by the entity or its subsidiaries or associates; and
the shares reserved for issuance under options and sales contracts, including the terms
and amounts thereof.
Furthermore, a description of the nature and purpose of each reserve that forms part of
equity is required. Entities without share capital, for example partnerships and trusts, should
disclose, to the extent applicable, information equivalent to the above. Movements during the
accounting period in each category of equity interest and the rights, preferences and
restrictions attached to each category of equity interest should be duly disclosed.
The timing and reasons for reclassification between financial liabilities and equity should be
disclosed. Reclassifications include puttable financial instruments classified as equity and
instruments providing a pro rata share of net assets on liquidation classified as equity.
Example 3.4
3.4 Presentation of the statement of financial position
The following is the trial balance of the Ngwenya Ltd Group. The group has a 31 December year end.
The information will be used to prepare a consolidated statement of financial position.
Ngwenya Ltd Group
Consolidated trial balance on 31 December 20.15
Dr Cr
R R
Advertising costs 29 600
Delivering costs 44 200
Income tax expense 687 190
Profit on expropriation of land 100 000
Dividends paid 160 000
Dividends received 14 000
Rental received 6 000
Share of profit of associate/joint venture 300 000
Goodwill – impairment loss 12 000
Cost of sales 2 093 200
Non-controlling interests in profit for the year 90 200
Interest paid 66 600
Salaries 356 000
Administrative personnel 187 600
Sales agents 168 400
Stationery 22 000
Sales 4 022 400
Depreciation 69 800
Delivery vehicles 53 400
Office buildings 16 400
Bank 805 010
Investment in associate/joint venture 586 000
Debtors 90 000
Property, plant and equipment 550 000
Goodwill 96 000
Investments in equity instruments 113 600
Other intangible assets 50 000
Creditors 51 000
Current portion of long-term borrowings 40 000
Non-controlling interests (cumulative) 189 450
Long-term borrowings 404 000
Retained earnings (1.1.20.14) 600 000
Revaluation surplus (net of tax) (20.13: Rnil) (parent only) 32 750
Revaluation surplus (net of tax) (20.13: Rnil) (associate/joint venture) 10 000
Cash flow hedge reserve (net of tax) (20.13: Rnil) (parent only) 28 400
Issued ordinary share capital 200 000
Deferred tax (cumulative) 3 000
Preference share capital 110 000
Inventories (20.13 – R160 400) 189 600
Raw materials (20.13 – R43 000) 46 000
Consumables (20.13 – R8 400) 10 000
Work-in-progress (20.13 – R57 800) 71 200
Finished goods (20.13 – R51 200) 62 400
6 111 000 6 111 000
continued
Ngwenya Ltd Group

Consolidated statement of financial position as at 31 December 20.15
Assets R
Non-current assets
Goodwill 96 000
Investment in associate/joint venture 586 000
Investment in equity instruments 113 600
Other intangible assets 50 000
1 395 600
Current assets
Inventories 189 600
Trade receivables 90 000
Cash and cash equivalents 805 010
1 084 610
Total assets 2 480 210
Equity and liabilities
Equity attributable to owners of the parent
Share capital (200 000 + 110 000) 310 000
Retained earnings (600 000 (opening balance) + 971 610 (refer to Example 3.5
for the consolidated statement of profit or loss and other comprehensive income)
– 160 000 (dividends paid)) 1 411 610
Other components of equity (32 750 + 10 000 + 28 400) 71 150
1 792 760
Non-controlling interests 189 450
Total equity 1 982 210
Non-current liabilities
Long-term borrowings 404 000
Deferred tax 3 000
407 000
Current liabilities
Trade payables 51 000
Current portion of long-term borrowings 40 000
91 000
Total liabilities 498 000
Total equity and liabilities 2 480 210
3.5.3 Statement of profit or loss and other comprehensive income

All income and expense items recognised in a period should be presented in either a single
statement of profit or loss and other comprehensive income, or in two separate
statements, where one statement displays the items of profit or loss (statement of profit or
loss) and the other displays the items of comprehensive income together with the total profit
or loss as an opening amount.
The statement of profit or loss and other comprehensive income therefore consists of the
following two sections:
profit or loss for the year; and
other comprehensive income for the year.
In addition to the above, the statement of profit or loss and other comprehensive income
should also present:
profit or loss;
total other comprehensive income; and

comprehensive income for the period, being the total of profit or loss and other
comprehensive income.
On the face of the statement of profit or loss and other comprehensive income (or on the
statement of profit or loss) profit or loss for the year should be allocated as follows:
attributable to owners of the parent; and
attributable to non-controlling interests.
On the face of the statement presenting comprehensive income, total comprehensive
income for the year should be allocated as follows:
attributable to owners of the parent; and
attributable to non-controlling interests.
All income and expense items are recognised in profit or loss for a specific accounting
period, unless a Standard requires or permits otherwise. This implies that the effect of
changes in accounting estimates is also included in the determination of profit or loss.
Only in a limited number of circumstances may particular items be excluded from profit or
loss for the period. These circumstances include the correction of errors and the effect of
changes in accounting policies in terms of IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors (IAS 8.14 to .31 and .41 to .48).
There are a number of items (including reclassification adjustments) that meet the
Conceptual Framework’s definitions of income or expense, but are excluded from the
determination of profit or loss and presented separately as items of other comprehensive
income. Examples of items of other comprehensive income include the following:
revaluation surpluses and deficits against existing revaluation surpluses;
remeasurements of defined benefit plans;
gains and losses arising from the translation of the financial statements of a foreign
entity;
gains or losses on remeasuring equity instruments classified as financial assets at fair
value through other comprehensive income;
gains and losses on cash flow hedges;
changes in credit risk based on changes in fair value for liabilities held at fair value
through profit or loss; and
share of other comprehensive income of associates or joint ventures.
The profit or loss section of the statement of profit or loss and other comprehensive income
may be presented in two ways: either by classifying expenditure in terms of the functions
that give rise to them, or by classifying expenditure in terms of their nature (IAS 1.99). Note
that expenses are sub-classified in terms of frequency, potential for gain or loss, and
predictability.
When items of profit or loss are classified in terms of the functions that give rise to them,
additional information about the nature of the expenditure should be provided in the notes to
the statement of profit or loss and other comprehensive income, including:
depreciation;
amortisation; and
employee benefit expense.
The above additional disclosure is required in the case of a presentation of items of profit or
loss in terms of function because the nature of expenses is useful in predicting future cash
flows. The method selected should be the one most suitable to the entity, depends on
historical and industry factors, and should be consistently applied.
3.5.3.1 Information to be presented in the profit or loss section or the statement of

profit or loss
In addition to items required by other IFRSs, the profit or loss section, or the statement of
profit or loss, should include the following line items as a minimum (IAS 1.82):
revenue;
gains and losses arising from the derecognition of financial assets measured at
amortised cost;
finance cost;
the share of the profit or loss of associates and joint ventures accounted for using the
equity method;
when a financial asset is reclassified so that it is measured at fair value, any gain or loss
arising from a difference between the previous carrying amount and its fair value at the
reclassification date (refer to IFRS 9, Financial Instruments);
a single amount for the total of discontinued operations (refer to IFRS 5 Non-current
Assets Held for Sale and Discontinued Operations);
income tax expense (this line item includes only taxes that are income taxes within the
scope of IAS 12 Income Taxes discussed);
a single amount comprising the total of:
– the post-tax profit or loss of discontinued operations; and
– the post-tax gain or loss recognised on the measurement to fair value less costs to
sell or on the disposal of the assets or disposal group(s) constituting the discontinued
operation; and
profit or loss.
Additional line items, headings and subtotals should be added where required by a Standard
or where it is in the interest of fair presentation, for example in the case of a material item, or
when such presentation is relevant to an understanding of the entity’s financial performance.
Factors considered include materiality and the nature of the components of income and
expenses. Descriptions are adapted to suit the activities of the reporting entity. It is important
to note that the notion of extraordinary items has been abandoned, and no disclosure
whatsoever of such an item is allowed. An entity is also no longer required to present a line
item headed results from operating activities but it can do so voluntarily or if local regulation
requires such disclosure. The selection of the items that make up operating activities requires
professional judgement as IFRS does not provide specific guidance.
3.5.3.2 Information to be presented in the other comprehensive income section
The other comprehensive income section shall present line items for each component of
other comprehensive income, classified by nature, and grouped into the following categories,
in accordance with other IFRSs:
items that will not subsequently be reclassified to profit or loss; and
items that will subsequently be reclassified to profit or loss when specific conditions are met.
An entity should also disclose the amount of income tax relating to each item of other
comprehensive income, including reclassification adjustments, in the statement of profit or
loss and other comprehensive income, or in the notes.
Each item of other comprehensive income is shown:
net of the related tax effects; or
before the related tax effect, with a separate line item for the aggregate amount of
income tax relating to those items.
When an entity presents an amount showing the aggregate tax amount, this tax amount
should also be grouped into items that will not subsequently be reclassified to profit or loss
and those that will subsequently be reclassified to profit or loss.
Reclassification adjustments are amounts that are reclassified to profit or loss in the
current period that were previously recognised in other comprehensive income in the current
or previous periods. These adjustments may be presented in the statement of profit or loss
and other comprehensive income, or in the notes. When presented in the notes, the items of
other comprehensive income are presented after any related reclassification adjustments.
3.5.3.3 Information to be presented in the statement of profit or loss and other
comprehensive income, or in the notes
Items of such material size, nature or incidence that the users of financial statements should
be specifically referred to them to ensure that they are able to assess the performance of
the entity, should be disclosed separately. The following are examples of items that will
probably require specific separate disclosure in particular circumstances (IAS 1.98):
the write-down of inventories to net realisable value, or of property, plant and equipment
to the recoverable amount, as well as the reversal of such write-downs;
the restructuring of the activities of an entity and the reversal of any provisions for the
cost of restructuring;
the disposal of property, plant and equipment;
the disposal of investments;
discontinued operations;
the settlement of litigation; and
other reversals of provisions.
Example 3.5
3.5 Presentation of the statement of profit or loss and other comprehensive
income
The following is an example of the presentation of a single statement of profit or loss and other
comprehensive income in which income and expenditure are presented in terms of their function,
using the same trial balance as given in Example 3.4:
Ngwenya Ltd Group
Consolidated statement of profit or loss and other comprehensive income
for the year ended 31 December 20.15
R
Revenue 4 022 400
Cost of sales (2 093 200)
Gross profit 1 929 200
Other income (100 000 + 14 000 + 6 000) 120 000
Distribution costs (168 400 + 53 400 + 44 200 + 29 600) (295 600)
Administrative expenses (187 600 + 16 400 + 22 000) (226 000)
Other expenses (12 000)
Finance costs (66 600)
Profit before tax 1 749 000
Income tax expense (687 190)
Profit for the year 1 061 810
Other comprehensive income, after tax:
Items that will not be reclassified to profit or loss:
Revaluation surplus 32 750
Share of other comprehensive income of associate/joint venture 10 000
continued
R
Items that may subsequently be reclassified to profit or loss:
Cash flow hedges 28 400
Other comprehensive income for the year, net of tax 71 150
Total comprehensive income for the year 1 132 960
Profit attributable to:
Owners of the parent 971 610
1 061 810
Total comprehensive income attributable to:
Owners of the parent 1 042 760
1 132 960
The following is an example of the presentation of a single statement of profit or loss and other
comprehensive income in which income and expenditure are presented in terms of their nature:
Ngwenya Ltd Group
R
Revenue 4 022 400
Other income (100 000 + 14 000 + 6 000) 120 000
Changes in inventories of finished goods and work-in-progress
(62 400 + 71 200 – 57 800 – 51 200) 24 600
Raw materials and consumables used
(43 000 + 8 400 – 46 000 – 10 000 + 2 093 200 – 160 400 + 189 600) (2 117 800)
Employee benefits expense (356 000)
Depreciation (69 800)
Impairment loss on goodwill (12 000)
Other expenses (29 600 + 44 200 + 22 000) (95 800)
Finance costs (66 600)
Income tax expense (687 190)
Other comprehensive income, after tax:
Share of other comprehensive income of associate/joint venture 10 000
Cash flow hedge 28 400
1 061 810
continued
R
1 132 960
3.5.4 Statement of changes in equity

A statement of changes in equity forms part of a minimum set of financial statements.
Essentially what is required is a reconciliation of equity at the beginning of the reporting
period with equity at the end of the reporting period.
3.5.4.1 Information to be presented in the statement of changes in equity
The statement should include the following information:
the total comprehensive income for the period, showing separately the total amounts
attributable to owners of the parent and to non-controlling interests;
the effect of retrospective application or restatement as a result of changes in accounting
policy and the correction of errors for each component of equity (refer to IAS 8
Accounting Policies, Changes in Accounting Estimates and Errors); and
for each component of equity, a reconciliation between the carrying amount at the
beginning and the end of the period, separately disclosing movements resulting from:
– profit or loss;
– other comprehensive income; and
– transactions with owners in their capacity as owners, showing contributions by and
distributions to owners separately, and including the following:
• issue of shares;
• buy back of shares;
• dividends paid;
• transfers between reserves; and
• changes in ownership interests in subsidiaries that do not result in a loss of control.
3.5.4.2 Information to be presented in the statement of changes in equity or in the
notes
An entity shall present, either in the statement of changes in equity or in the notes, an
analysis of each item of other comprehensive income.
Dividends declared or declared and paid for the period, and related dividends per share can
be disclosed either on the face of the statement of changes in equity, or in the notes
(IAS 1.107).
Example 3.6
3.6 Presentation of statement of changes in equity in columnar format
The following information relates to the Umbaba Ltd Group for the year ended 31 December 20.15:
1. The balances of the capital accounts and reserves of Umbaba Ltd (parent) on 31 December
20.14 were as follows:
R
Ordinary share capital (1 550 000 shares) 2 350 000
Redeemable preference share capital (200 000 shares) 200 000
Revaluation surplus –
Retained earnings 1 200 000
continued
2. On 1 January 20.15, Umbaba Ltd’s property was revalued upwards by R50 000 (net amount).
The revaluation reserve is realised through the use of the asset. The revaluation resulted in an
increase in the annual depreciation charge of R5 000.
3. On 31 March 20.15, Umbaba Ltd issued 100 000 ordinary shares at R1,20 per share.
4. On 30 June 20.15, the total preference share capital of Umbaba Ltd was redeemed. Shares
were not issued to fund this redemption.
5. On 15 July 20.15, a material error amounting to R32 500 (net amount) was discovered in the
books of Umbaba Ltd, relating to the 20.14 financial year. This error was corrected during
20.15 (increase in net profit), by restating the 20.14 amounts.
6. Umbaba Ltd acquired a controlling interest in a subsidiary during the 20.15 financial year. The
equity of the subsidiary only comprised share capital and retained earnings at acquisition date.
The subsidiary has no other components of equity. The subsidiary did not declare any
dividends during the 20.15 financial year. The fair value of the non-controlling interests at
acquisition date was R25 000, correctly calculated.
7. Consolidated profit for the year amounted to R110 000 (non-controlling interests R17 400).
Dividends amounting to R35 000 were declared and paid by Umbaba Ltd on
31 December 20.15. It is the accounting policy of Umbaba Ltd to present dividends per share
in the statement of changes in equity.
8. On 31 December 20.145, the cash flow hedge reserve of Umbaba Ltd amounted to R40 000.
Umbaba Ltd Group
Statement of changes in equity for the year ended 31 December 20.15
Revalua- Cash flow Non-
Share Retained Total
tion hedge Total controlling
capital earnings equity
surplus reserve interests
R R R R R R R
Balance at
31 Dec 20.14 2 550 000 – – 1 200 000 3 750 000 – 3 750 000
Correction of error – – – 32 500 32 500 – 32 500
Restated balance 2 550 000 1 232 500 3 782 500 – 3 782 500
Changes in equity
for 20.15
Issue of ordinary
share capital 120 000 – – – 120 000 – 120 000
Redemption
of preference shares (200 000) – – – (200 000) – (200 000)
Acquisition of
subsidiary 25 000 25 000
Dividends – – – (35 000) (35 000) – (35 000)
Total comprehensive
income – 50 000 40 000 92 600 182 600 17 400 200 000
Profit for the year – – – 92 600 92 600 17 400 110 000
Other comprehensive
income – 50 000 40 000 – 90 000 – 90 000
Realisation of
revaluation surplus to
retained earnings – (5 000) – 5 000 – – –
Balance at
31 Dec 20.15 2 470 000 45 000 40 000 1 295 100 3 850 100 42 400 3 892 500
20.14
R
Dividend per share 0,02
(35 000 / 1 650 000) (2,12 cents)
Comment
¾ IAS 1.107 does not specify whether the number of shares to be used to calculate the
dividends per share should be the actual number of shares outstanding as at the date the
dividend is declared, the actual number of shares outstanding as at the reporting date, or the
weighted average number of shares used to calculate earnings per share. A reporting entity
should develop an appropriate accounting policy and apply it consistently.
3.5.5 Statement of cash flows

The statement of cash flows provides the users of financial statements with useful
information regarding the historical changes in cash and cash equivalents of the entity, and
enables the users to formulate an opinion and make a better estimate of the cash
performance of an entity. IAS 7 Statement of Cash Flows sets out the presentation and
disclosure requirements of cash flow information. Refer to chapter 5 in this regard.
3.5.6 Notes
The notes to the financial statements provide additional information on items that are
presented in the financial statements in order to ensure fair presentation. The notes are
presented systematically, with cross-references to the financial statements. The following is
the usual sequence in which the notes are presented:
a statement that the financial statements comply with the International Financial Reporting
Standards;
a statement in which the basis of preparation and accounting policies are set out;
supporting information on items that are presented in the statement of financial position,
statement of profit or loss and other comprehensive income, statement of changes in
equity, or statement of cash flows;
additional information on items that are not presented in the statement of financial
position, statement of profit or loss and other comprehensive income, statement of
changes in equity, or statement of cash flows; and
other disclosures, such as contingencies, commitments and disclosures of a financial and a
non-financial nature, for example financial risk management targets.
The sequence may vary according to circumstances. In some cases, the notes on
accounting policies are presented as a separate component of the financial statements.
3.5.6.1 Accounting policies
The notes on accounting policy should disclose the following:
The measurement basis used in the compilation of the financial statements, for example
historical cost, current cost, net realisable value, fair value and recoverable amount.
Where more than one measurement basis is used, for example when particular classes
of assets are revalued, an indication is given of only the categories of assets and
liabilities to which each measurement basis applies.
Each specific accounting policy matter that is relevant to an understanding of the
financial statements. Management has to decide whether disclosure of a particular
accounting policy would assist users in understanding how transactions, other events
and conditions are reflected. Disclosure of accounting policies is especially important
where the Standards allow alternative accounting treatments, for example whether an
entity applies the cost model or the fair value model of IAS 40 Investment Property to its
investment property.
Accounting policies relating to at least the following, but not limited thereto, should be
disclosed:
revenue recognition;
consolidation principles;
application of the equity method of accounting for investments in associates or joint
ventures;
business combinations;
joint arrangements;
recognition and depreciation/amortisation of tangible and intangible assets;
capitalisation of borrowing costs and other expenditure;

construction contracts;
investment properties;
financial instruments and investments;
leases;
inventories;
taxes, including deferred taxes;
provisions;
employee benefit costs;
foreign currency entities and transactions;
definitions of business and geographical segments, and the basis for the allocation of
costs between segments;
government grants; and
definitions of cash and cash equivalents.
Each entity is expected to disclose the accounting policies that are applicable to it, even if
the amounts shown for current and prior periods are not material – the accounting policy
may still be significant.
In its choice of appropriate accounting policy, the management of an entity often makes
judgements when formulating a particular policy, for example when determining whether
financial assets should be classified as at amortised cost or not. In order to enable the users
of financial statements to better understand the accounting policies and be able to make
comparisons between entities, those judgements that have the most significant effect on the
amounts of items recognised in the financial statements are disclosed in the summary of
significant accounting policies (when accounting policies are disclosed in a separate
summary) or in the notes to the financial statements (IAS 1.122). Some of these judgements
are required disclosures in terms of other Standards.
3.5.6.2 Sources of estimation uncertainty
In the determination of the carrying amounts of certain assets and liabilities, it is often necessary
for management to estimate the effects of uncertain future events. Management has to
make certain assumptions about these uncertain future events in order to be able to
determine the carrying amounts of assets and liabilities that are influenced by such events.
The following are examples of items that are influenced by such uncertain future events that
management is called upon to assess:
the absence of recent market prices in thinly-traded markets used to measure certain assets;
the recoverable amount of property, plant and equipment;
the rate of technological obsolescence of inventories;
provisions subject to the effects of future litigation or legislation; and
long-term employee benefit liabilities, such as pension obligations.
Factors that should be taken into account in making the judgement on the carrying amounts
of these items include assumptions about future interest rates, future changes in salaries,
the expected rate of inflation, and discount rates. Disclosure of estimates is, however, not
required if assets and liabilities are measured at fair value based on a quoted price in an
active market for an identical asset or liability at the end of the reporting period (refer to
IFRS 13, Fair Value Measurement). It is also not necessary to disclose information on
budgets and forecasts.
In order to enhance the relevance, reliability and understandability of the information reported
in the financial statements, entities are required to disclose (see IAS 1.125 and .129):
information regarding key assumptions about the future (such as interest rates, future
changes in salaries and the expected rate of inflation); and
other sources of measurement uncertainty at the end of the reporting period that
have a significant risk of causing a material adjustment to the carrying amounts of
assets and liabilities within the next reporting period. In respect of such assets and
liabilities, details should be disclosed about:
– the nature of the asset or liability;
– the nature of the assumption or estimation uncertainty; and
– their carrying amounts as at the end of the reporting period, for example:
• the sensitivity of carrying amounts to the methods, assumptions and estimates
underlying their calculation, including the reasons for the sensitivity;
• the expected resolution of an uncertainty and the range of reasonably possible
outcomes within the next reporting period in respect of the carrying amounts of the
assets and liabilities affected; and
• an explanation of changes made to past assumptions concerning those assets and
liabilities, if the uncertainty remains unresolved;
when it is impracticable to disclose the possible effects of key assumptions or other
sources of measurement uncertainty, the entity discloses:
– the nature and carrying amount of the asset or liability affected; and
– a statement that it is reasonably possible, based on existing knowledge, that changes
in conditions within the next reporting period may require a material adjustment to the
carrying amount of the asset or liability affected.
In certain IFRSs, disclosure of estimates is already required, for example the major
assumptions on future events which affect classes of provisions (IAS 37 Provisions,
Contingent Liabilities and Contingent Assets) and the disclosure of assumptions when
measuring the fair values of assets and liabilities that are carried at fair value (IFRS 13 Fair
Value Measurement).
Note that IAS 1 defines impracticability as instances when the entity cannot apply a
requirement after making every reasonable effort to do so. Note further that key sources of
estimate uncertainty should not be confused with the judgements of management made in
the process of selecting an accounting policy (which are disclosed in terms of
paragraph 122).
3.5.6.3 Capital disclosure
The purpose of the capital disclosure is to enable users to assess the objectives, policies
and processes of the entity relating to the management of its capital (IAS 1.134). The
following should be disclosed:
The entity discloses qualitative information on:
– how it manages its capital;
– any external capital requirements (such as regulatory or legislative requirements); and
– a performance assessment on the meeting of its objectives.
The quantitative information disclosed includes:
– the level of capital;
– the definition applied to capital;
– changes during the previous period; and
– the extent of compliance to externally imposed capital requirements.
Note that IAS 1 does not specifically require quantification of externally imposed capital
requirements. The disclosure focuses instead on the extent of compliance with such
externally imposed requirements. If an entity does not comply with such requirements, the
consequences of non-compliance should be disclosed. This assists users to evaluate the
risk of breaches of capital requirements.
Although some industries may also have specific capital requirements, IAS 1 does not
require disclosure of such requirements because of the different practices among industries
that will affect the comparability of the information. Similarly, an entity may have internally
imposed capital requirements. IAS 1 also does not require disclosure of such capital targets,
or the extent or consequences of any non-compliance.
3.5.6.4 Dividends
In accordance with IAS 1.107, the entity must disclose the amount of dividends recognised
as distributions to equity-holders, as well as the dividends per share, in the statement of
changes in equity or in the notes to the financial statements.
In addition, IAS 1.137 requires that the entity should disclose the dividends proposed or
declared before the financial statements are authorised for issue, but after the end of the
reporting period, and the related dividend per share in the notes to the financial statements.
In terms of the definition of a liability in the Conceptual Framework, a dividend declared after
the end of the reporting period may not be recognised as a liability, because no current
obligation exists at the end of the reporting period, yet such declaration provides useful
information to users and should therefore be disclosed.
The entity should also disclose any cumulative preference dividends that may be in arrears
and have therefore not been recognised in the financial statements.
IAS 1 does not, however, address how an entity should measure distributions of assets
other than cash when it pays dividends to its owners. As a result of a significant diversity in
practice in this respect, IFRIC 17 Distributions of Non-cash Assets to Owners was issued.
IFRIC 17 applies to the entity making the distribution, not to the recipient. It applies when
non-cash assets are distributed to owners or when the owner is given a choice of taking
cash in lieu of the non-cash assets. IFRIC 17 clarifies that:
a dividend payable must be recognised when the dividend is appropriately authorised
and is no longer at the discretion of the entity;
the dividend payable must be measured at the fair value of the net assets to be
distributed;
if owners are given a choice of receiving either a non-cash asset or a cash alternative, the
entity must estimate the value of the dividend payable by considering both the fair value of
each alternative as well as the associated probability of owners selecting each alternative;
the liability must be remeasured at each reporting date and at settlement, with changes
recognised directly in equity;
the difference between the dividend paid and the carrying amount of the net assets
distributed must be recognised in profit or loss, and must be disclosed as a separate line
item; and
additional disclosures must be provided if the net assets being held for distribution to
owners meet the definition of a discontinued operation.
IFRIC 17, Distributions of Non-cash Assets to Owners, applies to pro rata distributions of
non-cash assets (all owners are treated equally) but does not apply to common control
transactions.
Example 3.7
3.7 Distribution of non-cash assets to owners
Spitfire Ltd is a mining company with a 31 December year end. Spitfire Ltd declared a dividend to
its 100 shareholders of either a cash payment of R600 or 1 oz of gold. At 31 December 20.14, the
dividend was appropriately authorised and no longer at the discretion of the entity.
At 31 December 20.14, management estimated that 50% of the shareholders would take the cash
option and 50% of shareholders would take the gold. At 31 December 20.14, the fair value of 1 oz
of gold was R900 and the carrying value was R500. On 28 February 20.15, the actual distribution
of the dividend occurred. On 28 February 20.15, the fair value of 1 oz gold is R750 and 40% of the
shareholders took the gold as a dividend.
Spitfire Ltd accounted for the dividend at 31 December 20.14 and 28 February 20.15 as follows:
Dr Cr
31 December 20.14 R R
Equity (Dividends declared) 75 000
Liability (Dividends payable) 75 000
Recording of the distribution at expected fair value of R75 000
((50 × R600) + (50 × R900))
28 February 20.15
Equity (Dividends declared) 9 000
Remeasurement of liability to fair value of R66 000
((60 × R600) + (40 × R750)) directly in equity
Cash 36 000
Inventories (500 x 40) 20 000
Fair value gain (P/L) 10 000
Extinguishment of liability and de-recognition of cash (60 × R600) and
de-recognition of inventories of gold (40 × R500) and recognition of
fair value gain in relation to gold ((40 × R750) – (40 × R500)).
3.5.6.5 Other disclosures

The following additional information should be provided unless it is already contained in the
information that is published with the financial statements:
the domicile of the entity;
the legal form of the entity;
the country of incorporation;
the address of the registered office (or principal place of business, if it is different from
the registered office);
a description of the nature of the entity’s operations and its principal activities;
the name of the parent and the ultimate parent entity of the group; and
if it is a limited life entity, details regarding the length of its life.
3.6 Statutory reporting requirements

In addition to the requirements of the Standards and Interpretations of IFRS and the
requirements of the Companies Act 71 of 2008 (the Companies Act, 2008/the Act), the
financial statements of companies listed on the JSE Limited should also meet the disclosure
requirements of the JSE Limited.
The annual financial statements must (in terms of The Listing Requirements,
paragraph 8.62):
be drawn up in accordance with the national law applicable to a listed company;
be prepared in accordance with International Financial Reporting Standards and the

Financial Reporting Pronouncements (FRPs) (previously AC 500 Standards) issued by
the Financial Reporting Standards Council (FRSC);
be audited in accordance with International Standards on Auditing or, in the case of
overseas companies, in accordance with national auditing standards acceptable to the
JSE Limited;
be in consolidated form if the listed company has subsidiaries, unless the JSE Limited
otherwise agrees, but the listed company’s own financial statements must also be
published if they contain significant additional information;
fairly present the financial position, changes in equity, results of operations and cash flows of
the group;
comply with the Companies Act, 2008; and
comply with the requirements of the King Code on corporate governance (including the
requirement to prepare an integrated report that replaces the annual report and
sustainability report).
The JSE Limited requires that the annual reports of companies listed on the JSE Limited
should disclose at least the following (Listing Requirements, paragraph 8.63):
a narrative statement of how the company has applied the principles set out in the King
Code, providing explanations that enable its shareholders to evaluate how the principles
have been applied; and
a statement about the extent of the company’s compliance with the King Code and the
reasons for non-compliance with any of the principles therein, specifying whether the
company has complied throughout the accounting period with all the provisions of the
King Code, and indicating for what part of the period any non-compliance occurred.
CHAPTER
4
Inventories
(IAS 2 and Circular 09/2006)
Contents
4.1 Overview of IAS 2 Inventories ........................................................................... 58
4.2 Background ....................................................................................................... 59
4.3 Nature of inventories ......................................................................................... 60
4.4 Measurement of inventories .............................................................................. 60
4.5 Cost of inventories ............................................................................................. 60
4.5.1 Introduction ............................................................................................. 60
4.5.2 Allocation of overhead costs ................................................................... 64
4.6 Application of cost allocation techniques and cost formulas ............................. 67
4.6.1 Standard cost.......................................................................................... 68
4.6.2 Retail method.......................................................................................... 68
4.6.3 Cost formulas.......................................................................................... 68
4.6.4 Other cost formulas ................................................................................ 71
4.7 Determining net realisable value ....................................................................... 71
4.8 Lower of cost and net realisable value .............................................................. 72
4.8.1 General rule ............................................................................................ 72
4.8.2 Exceptions .............................................................................................. 74
4.9 Recognition of an expense ................................................................................ 76
4.10 Taxation implications ......................................................................................... 77
4.11 Disclosure .......................................................................................................... 78
4.12 Comprehensive example ................................................................................... 79
57
4.1 Overview of IAS 2 Inventories
The scope of IAS 2: Measure at lower of cost

Includes: and net realisable value
held for sale in the ordinary course of business; (Evaluation of total inventories
in the process of production for such sales; and is unacceptable if it results in
to be consumed in the production of goods and services the netting of losses against
for sale. unrealised profits.)
Excludes: (Note the exclusions in
work-in-progress arising from construction contracts; section 4.2, as well as the fact
financial instruments; and that certain inventories are
biological assets to point of harvest. disclosed at fair value less
Partially excludes: costs to sell rather than at net
mineral and mineral products; realisable value.)
commodity brokers; and
producers of agricultural and forest products after harvest.
Cost Net realisable value

Use either: (The estimated selling price in the ordinary course of business
FIFO; less costs of completion and less costs necessary to make
weighted average; the sale.)
identification, only where Based on reliable evidence of expected realisation values
goods have been available at the time of making the estimates.
manufactured for specific Write-down by item or by group of similar items, applied
purposes and are normally consistently.
not interchangeable; Where inventory is being kept in terms of a firm sales
standard costs; or contract, still to be delivered, NRV based on contracted
retail method, only if the price.
results obtained approximate In the case of materials, no write-down to NRV from cost
the lower of costs and NRV. takes place if materials form part of finished goods that are
expected to realise their cost or more.
The historical cost of inventories includes:
Costs of purchasing Conversion costs Other costs

Costs of purchasing Variable production To bring the inventories to their
includes: overheads. present location and condition.
import duties and other Fixed production Expenses incurred in respect of
taxes; and overheads allocated, the design of a specific product
any other directly based on normal for a particular customer.
attributable costs of capacity of production Include borrowing cost if IAS 23
acquisition less rebates, facilities. requires capitalisation.
discounts and subsidies Excludes abnormal Normally excludes administration
on purchases. spillage. and selling expenses.
Inventories 59
4.2 Background
Inventories, one of the two main components of non-monetary assets, represent a material
portion of the assets of numerous entities. The measurement of inventories can have a
significant impact on determining and presenting the financial position and results of the
operations of entities. Inventories should also be presented and disclosed in such a way that
the information is faithful and relevant to the users of financial statements. It is, therefore,
clear that the objective of IAS 2 is twofold, namely to prescribe:
how the cost of inventories is determined; and
what useful and understandable information should be provided in the financial
statements.
There are two categories of exclusion from the requirements of IAS 2, namely those
categories of inventories that are excluded from the scope of IAS 2 entirely, and those that
are excluded from the measurement requirements of IAS 2 only.
IAS 2 does not apply to the following categories of inventories:
work-in-progress under construction contracts (IFRS 15), including directly related
service contracts;
agricultural produce at the point of harvest, and biological assets related to agricultural
activity (IAS 41); and
financial instruments (IAS 32, IFRS 9 and IFRS 7).
IAS 2 applies only partially to certain inventories, as the measurement requirements do
not apply to:
producers of agricultural and forestry products, agricultural produce after harvest, and
minerals and mineral products. These inventories are measured at net realisable value in
accordance with well-established practices in those industries. When such inventories
are measured at net realisable value, changes in that value are recognised in profit or
loss in the period of the change; and
commodity brokers/traders, who measure their inventories at fair value less costs to sell.
In such instances, changes in the fair value less costs to sell of the inventories are
recognised in profit or loss for the period of the change.
Note that there is a difference between net realisable value and fair value less costs to
sell. Net realisable value uses, as point of departure, the entity-specific amount to be
realised from the sale of inventories in the ordinary course of business. Fair value less
costs to sell is not entity-specific but market-specific, and uses, as point of departure,
the price that would be received to sell the same inventories in an orderly transaction
between market participants. Please refer to the meaning of fair value in terms of IFRS 13 in
chapter 21.
The inventories of producers of agricultural and forestry products are often measured at net
realisable value at certain stages of production (rather than at the lower of cost and net
realisable value), for example when an active market exists and there is a negligible risk of
failure to sell, as crops have been harvested or minerals have been extracted. This can also
occur when a sale is assured under a forward contract or a government guarantee. Once
agricultural produce is harvested and measured on initial recognition at fair value less costs
to sell in terms of IAS 41, the requirements of IAS 2, excluding the measurement
requirements, apply, and the fair value less costs to sell becomes the cost in terms of IAS 2.
Brokers/traders typically buy or sell commodities for others or on their own account with the
purpose of selling such commodities in the short-term and generating a profit due to
fluctuations in price or brokers/traders’ margins. Consequently, these inventories are often
measured at fair value less costs to sell, and they are therefore also excluded from the
measurement requirements of IAS 2 only.
Note that IAS 2.3 requires changes in the value of any inventories excluded from its
measurement requirements (discussed earlier) to be recognised in profit or loss for the
period of the change.
4.3 Nature of inventories
Inventories include all assets, both tangible and intangible:
held for sale in the ordinary course of business, for example fuel at a petrol station and
sweets sold by a café;
in the process of production for such sale, for example a partly completed piece of
furniture (work-in-progress) of a furniture manufacturer;
consumed during the production of saleable goods or services, for example materials such
as rivets used during the manufacture of a bus or supplies such as shampoo used in a
hair salon; and
the cost of labour and other related expenses such as supervision and other attributable
overhead costs of a service provider not yet invoiced, for example the cost of interim
audit work not yet invoiced.
The decision whether a certain item, for example a motor vehicle, is classified as inventory,
relates to its purpose to the entity. Should the entity be a motor vehicle dealer and the
motor vehicle be used by the financial manager for travelling purposes, the vehicle would be
classified as a non-current asset and not as inventory. If the motor vehicle is placed in the
showroom so that it can be sold to the public, then the motor vehicle is classified as
inventory within current assets. From this it is evident that neither the item itself nor the kind
of entity in which it is being utilised determines whether it should be classified as inventories,
but rather the abovementioned criteria referred to in IAS 2.6.
4.4 Measurement of inventories
Inventories are measured at the lower of cost and net realisable value. The measurement of
inventories for financial reporting entails the following steps:
determining the cost;
applying a cost allocation technique to measure the cost of inventories;
determining the net realisable value;
recognising the inventories at the lower of cost and net realisable value in the annual
financial statements; and
disclosing of inventories in the notes to the financial statements.
Each of these aspects is now discussed.
4.5 Cost of inventories
4.5.1 Introduction
The historical cost of inventories includes:
purchasing costs;
conversion costs; and
other costs incurred in bringing inventories to their present location and condition.
The cost of inventories excludes:
abnormal spillage of raw materials, labour and other production costs incurred during the
production process, for example production labour hours lost due to a natural disaster;
fixed production costs that are not allocated to production on the grounds that normal
capacity, instead of actual capacity, was used as the basis of allocation. The portion not
allocated is written-off in the profit and loss section (within cost of sales) of the statement
of profit or loss and other comprehensive income;
Inventories 61
storage costs, unless such costs are necessary in the production process prior to a
further production stage, for example incomplete goods in a production process that
should first be frozen before the goods can proceed to the next process;
administrative expenses not related to bringing the inventories to their present location
and condition; and
selling expenses (IAS 2.16).
It is important at this stage to emphasise that IAS 2 relates directly to inventories and
indirectly to cost of sales. This is reflected in the Standard’s name, namely ‘Inventories’,
and not ‘Cost of sales’. Therefore, although abnormal spillage and under- or over-allocated
fixed overheads are excluded from the closing inventories, they are included in cost of sales.
4.5.1.1 Purchasing costs
These costs include the following:
the purchase price of finished goods or raw materials;
import duties and other taxes, other than those subsequently recoverable from the taxing
authorities, such as VAT if the buyer is registered for VAT purposes;
transport costs;
handling costs; and
other costs directly attributable to the acquisition of the inventories.
From these costs, the following are deducted if included:
trade discounts (and cash and settlement discounts in terms of CC 09/06); and
rebates and other similar items, such as subsidies and ‘kick-backs’ on purchases.
Imported inventories settled in foreign currency are recognised at the spot rate ruling at the
transaction date, in terms of IAS 21. Exchange differences due to fluctuations in exchange
rates do not form part of the cost of inventories. If, in terms of IAS 39 (hedge accounting is
at present not covered by IFRS 9, but by IAS 39), the purchase qualifies as a forecast
transaction or unrecognised firm commitment that is covered by a fair value hedge (see
paragraph 89(b) of IAS 39) or a cash flow hedge (see paragraph 98(b)), the exchange
fluctuation on the hedging instrument (underlying derivative) before the transaction date may
form part of the cost of the inventories.
Example 4.1 Purchasing costs
Alpha Ltd was recently incorporated and registered for VAT. Goods were purchased on two
occasions during its first month of business. The details of these purchase transactions are as
follows:
Transaction 1
Goods were purchased from a supplier who wants to establish a long-term business relationship
with Alpha Ltd. With this in mind, the following terms were laid down:
The purchase price of the goods before any rebates or discount is R703 703,70 (including VAT
levied at 15%).
Alpha Ltd will receive a 10% volume rebate on the purchase price of the goods.
Alpha Ltd will receive a further 10% settlement discount if the outstanding amount it is settled
within 30 days.
Transaction 2
Goods were purchased from a foreign supplier (the transaction was denominated in rand) for
R400 000 (excluding VAT). Ownership of the goods was transferred to Alpha Ltd upon delivery at
the harbour. Alpha Ltd entered into a contract with an independent transport company to transport
the goods from the harbour to the entity’s premises at a cost of R50 000.
continued
When the goods were inspected by Alpha Ltd’s foreman, it was discovered that 30 of the 300
containers had suffered water damage during shipping to South Africa. Following negotiations with
the supplier, it was agreed that the goods would be returned to the supplier.
The cost of the two purchase transactions will be calculated as follows:
Transaction 1
R
Purchase price 703 703,70
VAT input (recoverable taxes) (703 703,70 × 15/115) (91 787.44)
Purchase price (excluding VAT) 611 916.26
Volume rebate – deducted from the cost of inventories and not recognised as other
income (Circular 9/2006) (611 916.26 × 10%) (61 191.62)
Amount payable to supplier (excluding VAT) 550 724.64
Settlement discount – the entity has the intention of settling the outstanding
amount within 30 days. Therefore, the discount should be estimated and deducted
from the cost of inventory and not recognised as other income when the creditor
is paid (550 824.64 × 10%) (55 072.46)
Amount to be recognised as the cost of the inventories 495 652.18
Transaction 2
Purchase price (excluding VAT) 400 000,00
Delivery cost 50 000,00
Amount to be recognised as the cost of the inventories 450 000,00
When goods are returned, the cost of inventories is reduced by the initial
cost thereof – note that the delivery cost will not be refunded.
Cost of goods returned (30/300 × 400 000) (40 000,00)
Amount to be recognised as the cost of the inventories 410 000,00
4.5.1.2 Conversion costs

Conversion costs are costs incurred in converting raw materials into finished products ready
for sale. They include the following:
direct labour;
variable production overhead costs; and
fixed production overhead costs based on normal capacity.
IAS 2 adopts, in effect, the full absorption cost approach, on the assumption that a clear
distinction between fixed and variable cost exists.
IAS 2 defines normal capacity in paragraph 13 as the production expected to be achieved on
average over a number of periods or seasons under normal circumstances, taking into
account the normal loss of capacity resulting from planned maintenance. The cost of
normal spillage also forms part of conversion costs.
The production process may sometimes produce two or more products simultaneously, for
example in a chemical process. These are called joint products. If the costs of the
conversion of the joint products cannot be identified separately, a rational and consistent
cost allocation basis should be used. The relative sales value of the products, either at the
stage in production where they originate, or at the stage of completion, may be appropriate
(see paragraph 14).
If the production process results in main products and a by-product, the value of the latter is
usually immaterial. Consequently, no cost is usually allocated to the by-product and it is
carried at its net realisable value – this is an exception to the general rule of net realisable
value (refer to paragraph 4.7). The net realisable value of the by-product is deducted from
the cost of the main product or from the joint costs before it is allocated to the main products.
Inventories 63
Example 4.2 Main products and by-products
Delta Ltd is a pharmaceutical company. The company uses two raw materials (X and Y) in equal
portions in a chemical process that produces two main products, Headeze en Headache, and a
by-product, Calc, which is sold to fertiliser manufacturers. Costs to sell are immaterial.
One production cycle produces:
Headeze: 3 000 units
Headache: 1 000 litres
Calc: 2 000 litres
The sales price for Headeze is R25,00 per unit, for Headache it is R15,00 per litre and for Calc it is
R1,50 per litre. The total cost of production (joint costs) is R60 000 per cycle. You may assume
that the value of the Calc inventory is immaterial.
The relative sales value of the main products and the by-product can be calculated as follows:
Sales value: R Percentage
Headeze 3 000 × R25,00 75 000 83,33%
Headache 1 000 × R15,00 15 000 16,67%
90 000 100%
Calc 2 000 × R1,50 3 000
93 000
The cost of production of the joint main products is allocated on the basis of sales value. The net
realisable value of the by-product is deducted from the main products.
Allocation of costs: Gross
R
Headeze (R60 000 – R3 000) × 83,33% 47 500
Headache (R60 000 – R3 000) × 16,67% 9 500
Calc 3 000
Total cost 60 000
Comment
¾ By-products that are not material (as in most cases) may be measured at net realisable value.
This may result in by-products being valued at above cost, if net realisable value is higher than
actual cost – if it can be determined. This is a departure from the basic rule that inventory
should be measured at the lower of cost and net realisable value. It seems, however, that the
objective of IAS 2 is to provide an expedient and cost-effective solution, and recognise a
generally accepted practice in the measuring of by-products. This departure can also be
justified, as International Financial Reporting Standards are applicable to material items only,
and the by-product amounts are normally not material.
4.5.1.3 Other costs

Included in these costs are all other costs incurred in bringing the inventories to the present
location and condition. Examples are:
costs of designing products for a particular customer;
borrowing costs relating to inventories where substantially necessary long ageing periods
are required, as in the case of wine; and
necessary storage costs in the production process where products are to be kept at a
certain temperature.
Where an entity purchases inventories on deferred settlement terms, and the arrangement
effectively contains a financing element, that element is recognised as interest expense over
the period of the financing, and is therefore not included in the cost of the inventories
(IAS 2.18).
Example 4.3 Deferred settlement terms
A supplier agrees to supply inventories with a cash price of R12 000. This amount will however
only be payable twelve months after delivery. The supplier’s normal interest-free credit term is one
month. Assume that an interest rate of 18,37% per annum (compounded monthly) is similar to the
market rate on similar credit arrangements. In terms of IAS 2.18, read with Circular 9/2006
paragraph 30, the purchaser should recognise the inventories at the present value of the amount
payable in 12 months’ time, assuming that the time value of money is material. Assuming that the
time value of money is material in this instance, the R12 000 should be discounted to a present
value at 18,37% per annum compounded monthly. The calculation of the cost of the inventories
will be as follows: FV = 12 000; i = 18,37 (P/YR = 12); n = 12 months, and then PV = 10 000. The
inventories purchased must therefore be recognised at R10 000. The difference between the cash
purchase price and the final payment of R12 000 must be recognised as a finance cost, using the
effective interest method (IFRS 9). Note that Circular 9/2006 requires that the normal credit term
should be included in the period over which the amount is discounted, as it forms part of the
financing that is provided to the purchaser.
The general rule applicable in determining the cost of the inventories is therefore that all costs
incurred in bringing the inventories to their present location and condition are included.
The theoretical basis for this is that all costs of inventories in the statement of financial
position are expensed in the following accounting period when the related revenue is
recognised.
4.5.1.4 Costs of service providers
The treatment costs of service providers are now dealt with in pargraphs 91-104 of IFRS 15,
Revenue from contracts with customers as it is now seen as contract costs. Please refer to
chapter 22.
4.5.2 Allocation of overhead costs

The determination of cost can be subject to manipulation in practice, especially in respect of
the allocation of production and other overhead costs, and the application of cost formulas.
The choice of cost formula may result in significantly different outcomes that impact on the
profit for the year as well as the earnings per share.
Overheads are sometimes also referred to as indirect costs. For the purposes of this
discussion, a distinction is made between production overhead costs and other overhead
costs:
Production overhead costs are those costs incurred in the manufacturing process
which do not form part of the direct raw material or direct labour costs – for example
indirect materials and indirect labour, rates and taxes of a factory, depreciation on
production machinery, administration of a factory, insurance of plant, etc. These items
are included in what is referred to as ‘product cost’.
Other overhead costs are those costs that do not relate to the production process, and
are normally incurred in running the operations of the entity – for example office rental,
salaries of administrative personnel, selling and marketing costs, etc. These items are
often referred to as ‘expenses’ or ‘period costs’.
The main distinction is that production overhead costs are included in the cost of the
inventories, while the other overhead costs are recognised as expenses and only included in
the costs of inventory in exceptional instances.
Inventories 65
4.5.2.1 Production overhead costs

The general principle is that only those production overheads involved in bringing the
inventories to their present location and condition should be included in the costs. Both fixed
and variable production overhead costs are included in terms of the full absorption cost
approach prescribed in IAS 2.
Variable overhead costs can be allocated to inventories with reasonable ease, as the costs
are normally directly related to the production volumes. The actual number of units
manufactured serves as the basis for allocating such costs.
Fixed production overhead costs are not allocated directly to a product with the same
ease. IAS 2.13 provides the following guidelines in this respect:
The normal capacity of the production plant is used as the basis for allocation, not the
actual production levels. ‘Normal capacity’ can refer to either the average normal
production volume over a number of periods, or to the maximum production which is
practically attainable. IAS 2 adopts the first meaning.
The actual capacity may only be used when it approximates normal capacity or when
the number of units manufactured is substantially higher than the normal capacity (see
the fourth bullet in this list).
The interpretation of the concept ‘normal capacity’ is determined in advance, and should
be applied consistently, unless other considerations of a permanent nature result in
increasing or decreasing production levels.
If the production levels are particularly high in a certain period, the fixed overhead recovery
rate should be revised, to ensure that inventories are not measured above cost
(allocated based on actual capacity).
If the production levels are lower than normal capacity, the fixed overhead recovery rate
is not adjusted (allocated based on normal capacity), and the under-recovered portion is
charged directly to the profit or loss section of the statement of profit or loss and other
comprehensive income, forming part of the cost of sales expense.
The large degree of judgement involved in the calculations may result in numerous practical
problems arising from the allocation of fixed overhead production costs. Nevertheless, it is
imperative that a regulated allocation of both variable and fixed production costs be included in
the costs of inventories, in order to achieve the best possible measurement of the asset.
Example 4.4
4.4 Normal versus actual capacity
Echo Ltd’s budgeted and actual fixed production cost is R100 000 and the normal capacity is
regarded as 10 000 units per annum. What amount will be allocated to finished goods in respect of
fixed costs for the following two cases?
Case 1: Actual capacity 5 000 units
Case 2: Actual capacity 20 000 units
Case 1
Normal capacity will be used to calculate the fixed overhead rate for measuring inventory costs:
R10 per unit (R100 000/10 000 units).
The under-recovered fixed production costs of R50 000 (100 000 – (10 × 5 000)) shall be
recognised as an expense under cost of sales.
Comment
¾ The actual rate is R20 per unit (R100 000/5 000) and cannot be used for the measurement of
inventory. The measurement of inventory cannot be ‘increased’ by under-performance.
continued
Case 2
The actual capacity will be used to calculate the fixed overhead rate for measuring inventory costs:
R5 per unit (R100 000/20 000 units).
Comment
¾ The normal rate cannot be used, as R10 per unit is higher than the actual cost of R5 per unit.
Inventory should be measured at the lower of cost or net realisable value.
4.5.2.2 Other overhead costs

Costs that are not related to the production function of an entity, such as those of
administrative personnel, research and development, financial management and marketing,
are part of other overhead costs. They form a significant part of the expenses of an entity,
and without them there can be no successful production. The relationship between the
production function and the other functions is an indirect connection; therefore other
overhead costs do not normally form part of the cost of inventories. This stipulation is based
on the premise that such costs cannot be seen as being directly related to, or necessary in
bringing inventories into their present location or condition and should be seen as period
costs or expenses.
Certain exceptions to the abovementioned rule exist, namely:
other overhead costs that clearly relate to bringing inventories to their present location
and condition, for example design costs, some research and development, etc.;
borrowing costs that have been capitalised in respect of inventories where long ageing
processes are required to bring them to their saleable condition, for example wine and
spirits; and
storage costs that are necessary in the production process prior to the further production
stage, for example the maturation of cheese or the freezing storage that is necessary in
a manufacturing process.
Example 4.5
4.5 Allocation of overheads
Lima Ltd manufactures electrical motors. The normal capacity of the company is 50 000 units per
annum. If the actual capacity of the company is:
(1) 70 000 units per year (very high level of production); or
(2) 40 000 units per year,
calculate the fixed and variable overheads in the closing balance of finished goods and the
overhead expense in the statement of profit or loss and other comprehensive income.
The following information is available:
Fixed overheads amount to R7 500 000 per annum.
Variable production overheads amount to R200 per unit.
The closing balance of finished goods is 15 000 units. Assume that there was no opening balance.
continued
Inventories 67
Variable Fixed Total

overheads overheads overheads
Closing inventories: R’000 R’000 R’000
Case 1
15 000 × R200 3 000
R7 500 000/70 000 × 15 000 1 607 4 607
Case 2
15 000 × R200 3 000
R7 500 000/50 000 × 15 000 2 250 5 250
Expenses (cost of sales):
Case 1
(70 000 – 15 000)(sold) × R200 11 000
(70 000 – 15 000) × R107,14 (7 500’/70’) (allocated) 5 893 16 893
Case 2
(40 000 – 15 000)(sold) × R200 5 000
(40 000 – 15 000) × R150 (7 500’/50’) (allocated) 3 750
R7 500 000 – R6 000 000 (40 000 × R150) (under-recovery) 1 500 10 250
Comment
¾ Fixed overheads are usually allocated to cost of conversion using normal capacity (50 000 units
in this example). However, if the actual capacity is substantially higher than normal capacity,
actual capacity is used in order to prevent inventories from being measured above cost.
¾ Note that actual capacity may be used in cases where it approximates normal capacity –
however, this is not the case in this example.
¾ The under-recovered fixed overhead (Case 2) shall be recognised as an expense (Cost of
sales).
The principles regarding the allocation of production overhead costs can be presented
diagrammatically as follows:
TOTAL OVERHEAD COSTS
Production overheads Other overheads
Variable Fixed
Always allocated based on Allocation based on normal Allocated in exceptional

actual production capacity (note exceptions) cases only
Basic principle: Allocate costs if they are related (and necessary) to bring the inventories to
their present location and condition.
4.6 Application of cost allocation techniques and cost formulas

Other than the actual cost of inventories (discussed above), various other techniques can be
used to calculate the cost of inventories. The following are possibilities:
the standard cost method; and
the retail method.
4.6.1 Standard cost

This method involves working with expected costs, based on normal levels of operations
and operating efficiency measures, and entails the application of predetermined information.
This method allows management to monitor and control costs. Standard costs can be used for
convenience as long as the measurement of inventory determined in this way approximates
cost. A regular review of the standard costs is required where conditions change, for
example in times of rising costs.
4.6.2 Retail method

This method is particularly suitable for entities that do not maintain complete records of
purchases and inventories. Inventory is measured at the end of the reporting period by
determining the selling price of the inventory, which is reduced by the average gross profit
margin, to determine the approximate cost. Suppose, for example, that the inventories of a
sports shop valued at selling price amounted to R980 000 on a particular date. If the owner
normally adds a mark-up of 25% to the cost price of his products, the retail method is
applied as follows to calculate the approximate cost of the inventories:
100
R980 000 × = R784 000
125
This basis can be applied only if the gross profit margins of homogenous groups of products
are known. If certain inventory items are marked at reduced selling prices as a result of
special offers, the gross profit margins on these items are determined individually. As with
standard costs, this basis may be applied only if the results obtained approximate cost.
4.6.3 Cost formulas

According to IAS 2.23 to .27, the cost of inventories is determined by using one of the
following cost formulas:
first-in, first-out (FIFO); or
weighted average costs; or
specific identification.
Note that last-in, first out (LIFO) is not allowed in terms of IAS 2. See section 4.6.4.
4.6.3.1 First-in, first-out (FIFO)
On this basis, inventories are measured in accordance with the assumption that the entity
will sell the items of inventory in the order in which they were purchased; that is, first the old
inventory items and then the new items. The ‘oldest’ prices are debited first to the statement
of profit or loss and other comprehensive income, forming part of the cost of sales expense.
This method is normally appropriate to interchangeable items of large volumes and is
currently the most popular method used by listed companies in South Africa.
4.6.3.2 Weighted average method
The word ‘weighted’ refers to the fact that the number of items is also taken into account
when calculating cost. The weighted average is calculated either after each purchase, or
periodically, depending on the particular circumstances. This basis, just as in the case of
FIFO, is appropriate to interchangeable inventory items, usually of large volumes.
Inventories 69
Example 4.6
4.6 Weighted average calculation
Assume that an entity purchases 100 units @ R16 each and purchases a further 300 units
@ R16,50 each. The average price is not R16,25 [(R16 + R16,50) ÷ 2]. It should rather be
weighted, as follows:
R
100 @ R16 1 600
300 @ R16,50 4 950
400 6 550
Weighted average price = R16,375 (R6 550/400)
Example 4.7
4.7 Application of cost formulas for perpetual and periodic inventory
recording systems
Romeo Ltd has incurred the following inventory transactions during the month of October 20.14:
Units R/U
01.10 Opening balance 200 20
02.10 Sales 120 40
05.10 Purchases 300 24
15.10 Sales 200 48
25.10 Sales 150 50
The cost price of inventory is determined using
(1) the FIFO method; and
(2) the weighted average method
First-in, first-out method:
31.10 Inventory on hand (200 – 120 + 300 – 200 + 150 – 150) = 180 units
R
Cost price 150 × R30 4 500 (from the purchase of 150 units @ R30/unit)
30 × R24 720 (left from the first purchase of 300 units @ R24/unit)
180 5 220
Comment
¾ Both the perpetual and the periodic inventory recording systems result in the same cost for inventory.
continued
Weighted average method:

31.10 Inventories on hand 180 units
Perpetual inventory recording system:
Cost price Total
Units
per unit cost price
R R
1.10 Opening balance 200 20
2.10 Sales (120) 20
80
380 23,16 *
15.10 Sales (200) 23,16 *
180
330 26,27 **
25.10 Sales (150) 26,27
Closing balance 180 26,27 4 729
Calculations:
*80 × R20 = R1 600
300 × R24 = R7 200
380 R8 800
R8 800/380 = R23,16
**180 × R23,16 = R4 169
150 × R30 = R4 500
330 R8 669
R8 669/330 = R26,27
Periodic inventory recording system:
Cost price Total
Units
per unit cost price
R R
Opening balance 200 20 4 000
Purchases 300 24 7 200
Purchases 150 30 4 500
650 15 700
Weighted average cost price (R15 700/650) R24,15
Closing inventories (180 × R24,15) 4 347
Comment
¾ The cost of inventory calculated using weighted average differs under the perpetual and the
periodic inventory recording systems, as different averages are used.
4.6.3.3 Specific identification

According to IAS 2, this basis allocates costs to separately identified items of inventory,
usually of high value. It is particularly appropriate for items acquired or manufactured for a
specific project and items that are normally not interchangeable. This basis is generally not
suitable for large volumes of interchangeable items, and should not be used as a means of
manipulating profits.
4.6.3.4 Cost formulas in general
It is clear from the above discussion that there is a variety of measurement bases for
determining the costs of inventories. These valuation bases necessarily result in different
operating results and different statement of financial position amounts.
Inventories 71
IAS 2.25 requires that the same cost formula be used for inventories having the same
nature and use for the entity. Where the nature or use of groups of items differs from
others, the application of different methods is allowed. This means that if a group of
companies owns materials with different uses, they may be measured by using different cost
formulas. Where inventories are similar in nature and use, and held in different geographical
locations, different cost formulas may not be applied. For example, where different metals
are used in a production process, the average method is appropriate. However, where
inventories are used on an item-for-item basis in the production process, the FIFO formula is
more appropriate. However, in the computerised environment of costing systems, any cost
formula is appropriate and with even price increases will always produce the same result.
4.6.4 Other cost formulas

Other cost formulas that are sometimes encountered in practice are the LIFO (last-in,
first-out) formula and the formula based on latest purchase price, neither of which is
sanctioned by IAS 2.
The LIFO formula is the opposite of the FIFO formula, inasmuch as it assumes that the unit
of inventory that was purchased last will be the first to be sold. The result is that current
costs are recognised against current revenue in the statement of profit or loss and other
comprehensive income, leading to an improvement in the quality of reported earnings.
However, in the statement of financial position, inventories are reflected at prices that
prevailed long ago, with little or no relationship to current costs.
As IFRS is more focused on the statement of financial position and not on the statement of
profit and loss and other comprehensive income, the measurement of inventories at the
latest purchase price is unacceptable, since such a valuation bears no relationship to the
actual cost at which the inventories were purchased.
4.7 Determining net realisable value

Net realisable value (NRV) is the estimated selling price that could be realised in the
normal course of business, less the estimated costs to be incurred in order to complete the
product and make the sale. Such estimates will take into account changes in prices and cost
changes after the reporting date, in accordance with the requirements of IAS 10, to the
extent that events confirm conditions existing at the end of the reporting period. The diagram
below illustrates net realisable value:
NET REALISABLE VALUE
Estimated selling price in the Costs to make the sale,

Less
normal course of business namely:
costs to complete the inventories
(if cost elements are not fully
completed, e.g. work in progress);
trade and other discounts allowed;
advertising;
sales commission;
packaging; and
transport costs.
As the determination of net realisable value entails the use of estimates, an element of
judgement is involved, and the necessary caution should be exercised when making use of
these estimates. It is often difficult to determine the net realisable value of a product, due to a
lack of information regarding the costs necessary to make the sale. In such cases, the current
replacement value can be used as a possible solution (especially for raw materials) (refer to
IAS 2.32). After having taken everything into consideration, estimates of the NRV should be
based on the most reliable information available at the time of making the estimate.
If the inventories are held in terms of a binding sales contract in terms of which the
inventories will be delivered at a later date, the NRV of these inventories should be based
on the contract price. If the contract quantities are less than the total inventories for this
particular item, the net realisable value of the non-contracted inventories is based on
normal selling prices. Any expected losses on firm sales contracts in excess of the inventory
quantities held are dealt with by IAS 10.
If inventory quantities are less than quantities required for firm purchase contracts, onerous
contracts may arise and the provisions of IAS 37 will apply.
4.8 Lower of cost and net realisable value

4.8.1 General rule
The requirement by IAS 2 that inventories be reflected at the lower of cost or net realisable
value (NRV) is the application of a measure of conservatism when exercising judgement in
making estimates under uncertain conditions.
In accordance with this rule, inventories are measured at cost at the end of an accounting
period and are carried over to the following accounting period. This cost should, however,
not exceed the net amount, which, according to estimates, will be realised from the sales.
Should the cost exceed the NRV, it implies that the inventories are expected to be sold at an
estimated loss. This estimated loss should be recognised in accordance with the
characteristic of faithful representation as soon as it is probable that the loss will occur and it
can be measured. The cost is then reduced to the net realisable value and the write-off is
recognised and shown as a loss in the profit or loss section of the statement of profit or loss
and other comprehensive income as part of the cost of sales line item. If such inventories
are still unsold at the end of the following accounting period, the cost is compared with the
latest NRV, and the carrying amount is adjusted accordingly.
Inventories are written-down to net realisable value on an item-by-item basis, or (where
appropriate) a group-by-group basis. In cases where items relate to the same product
range, have similar purposes or end uses, and are marketed in the same geographical area,
they cannot be evaluated separately; therefore, the items belonging to the range are
grouped together in assessing NRV. It should be noted that ‘finished goods’ or ‘inventory of
shoes’ are probably not product ranges.
Example 4.8
4.8 Net realisable value per item and per group
The following schedules reflect the inventory values of Juliet Ltd on 31 December 20.14:
Net Lowest
Cost realisable value
value per item
R’000 R’000 R’000
Wall tiles
Hand-painted 6 000 7 500 6 000
Normal process 10 000 9 000 9 000
*16 000 16 500 15 000
continued
Inventories 73
Net Lowest
Cost realisable value
value per item
R’000 R’000 R’000
Bricks
A Type 48 000 36 000 36 000
B Type 53 000 58 000 53 000
C Type 16 000 20 000 16 000
117 000 114 000 105 000
Total inventory 133 000 130 500 120 000
According to IAS 2.29, inventories can be measured as follows:
Item-by-item: R15 million + R105 million = R120 million or
Per group (if conditions were met): R16 million* + R114 million = R130 million
Comment
¾ A comparison of the total cost (R133 million) of the inventories with the total net realisable value
(R130,5 million) is not permitted by IAS 2, because unrealised profits and losses may not be
netted against each other.
A new assessment of net realisable value is made in each financial year. Indicators of
possible adjustments to net realisable value may include:
damaged inventories;
wholly or partially obsolete inventories;
declines in selling prices;
increases in estimated costs to completion; and
increases in selling costs.
When there is clear evidence of an increase in net realisable value because of changed
economic circumstances, or because the circumstances that previously caused inventories
to be written-down below cost no longer exist, the amount of the write-down is reversed, but
the amount of the reversal is limited to the amount of the original write-down, as assets may
not be restated above their original cost. The new carrying amount is again the lower of the
cost and the (revised) net realisable value. This may, for example, occur when an item of
inventory that is carried at net realisable value, because its selling price has declined, is still
on hand in a subsequent period, and its selling price has now increased. This will occur in
extremely rare cases, as inventory is normally sold in the subsequent accounting period.
Example 4.9
4.9 Reversal of previous net realisable value adjustment
Pappa Ltd purchases and distributes a medical product, Hasim. On 30 June 20.14, Pappa Ltd had
1 500 units of Hasim on hand. These units were purchased at a cost of R50 each. Two weeks
before the end of the reporting period, an announcement was made in the press that Hasim
contains some ingredients which may have harmful side-effects for users. Management decided
that this product would not be sold until further research into the possible side-effects had been
done. A company that manufactures bathroom cleaner advised that Hasim can be used in its
manufacturing process, and made a public offer to buy the product from Pappa Ltd at a price of
R20 per unit. For accounting purposes, the inventories on hand on 30 June 20.14 should be
written-down as follows:
R
Cost per unit 50
Net realisable value per unit 20
Write-down per unit 30
Total write-down recognised by Pappa Ltd (1 500 × R30) 45 000
continued
Pappa Ltd decided not to sell the product until the results of the research were known. During
December 20.14, the results of the research indicated that there are no harmful side-effects from
the use of Hasim. The market was, however, still sceptical, and as a result sales were slow. On
30 June 20.15, Pappa Ltd still had 600 of the units that had been on hand on 30 June 20.14 on
hand. The market selling price had however increased to R70 per unit.
In terms of IAS 2, Pappa Ltd has to reverse the previous write-offs on Hasim to the net realisable
value on 30 June 20.15. The write-off is limited to the original cost of the inventory. In this case,
the lower of cost (R50) and net realisable value (R70) would be the original cost of R50 per unit.
Note that the reversal can only be done for the 600 units still on hand on 30 June 20.15.
The reversal of write-off for the year ended 30 June 20.15 would amount to R18 000, namely
(600 × (R50 – R20)).
4.8.2 Exceptions
One exception to the general rule that inventories must be valued at the lower of cost and
net realisable value is mentioned in IAS 2.32. In accordance with this stipulation, raw
materials or supplies that will be incorporated in the finished product are not written-down
below cost if the finished product is expected to be sold at or above cost. In the authors’
opinion, IAS 2 gives insufficient guidance in cases where the finished product sells at less
than the cost. By implication, it appears that the raw materials and other supplies should be
written-down to NRV in these cases.
Example 4.10
4.10 Raw materials: Replacement value vs NRV
Consider the following two cases:

Case A Case B
R R
NRV of finished product 190 189
Cost per unit of finished product 190 190
Raw materials @ cost 100 100
Labour 65 65
Overheads 25 25
Profit/(loss) per product – (1)

Replacement value of raw material component of finished product 80 80
Comment
¾ IAS 2.32 states that the replacement value of the materials may be the best indicator of the
NRV of the materials. In this example it is assumed to be R80.
¾ If the current instructions per IAS 2.32 are strictly adhered to, then the raw material component
in Case A should be reflected at R100 per unit in the statement of financial position, while in
Case B it should be reflected at R80 (lower of cost and NRV), if the replacement cost is used as
the net realisable value.
¾ It is apparent that, as a result of a drop of only R1 in the selling price of the finished product, raw
materials must be written down by R20 per unit. Alternatively stated, although R1 of the
historical cost is irrecoverable, R20 of the costs should be recognised immediately in the current
period’s statement of profit or loss and other comprehensive income.
¾ In Case B, the authors propose that the raw material component should be reflected at R99.
The net realisable value of R99 is calculated as the selling price of the finished products, less
costs to sell (given as R189 in Case B), less costs to complete of R90 (R65 + R25).
The principles applicable in this case may be summarised as follows:
– Costs should be deferred only to the extent to which they are expected to be recovered from
the inflow of future revenues.
continued
Inventories 75
– Where materials will be realised, not through direct sale, but through the sale of the finished
product in which the materials are used, the NRV of the materials should be seen as that
amount which will be realised from the sale of the particular finished product ‘in the normal
course of business’.
¾ To complicate the matter further, IAS 2.32 states that the replacement value of the materials
may be the best indicator of the NRV of the materials. The authors, however, abide by the
alternative approach, namely of assessing the realisation value of the finished goods in order to
determine whether raw materials should be impaired.
Example 4.11
4.11 Net realisable value
Beta Limited completed 100 000 units, whilst 20 000 units are 60% completed in respect of
conversion costs. 85 000 units were sold during the year. At reporting date, 16 000 kgs of raw
material were on hand. There were no opening inventories.
R
Estimated selling price of a completed product 200
Raw material 2 kg @ R50 100

Labour 65
Production overhead 25
Unit cost of the completed product 190
Calculate the net realisable value if the expected selling cost is 20%
Net realisable value per unit:
Completed goods: 200 – 10% = R180 per unit
Raw material: 180 – 25 – 65 = R90. Per raw material unit: 90/2 = R45
Completed goods: R’000
At cost: (100 000 – 85 000) × 190 2 850
At net realisable value (15 000 × 180) 2 700
Net realisable value is the lowest
Comment
¾ Seeing that the net realisable value of the completed goods is lower than the cost, the net
realisable value of raw material should also be tested. The work in progress should also be
adjusted accordingly.
Raw material
At cost: (100/2 = R50 per kg, 16 000 × 50) 800
At net realisable value: (R45 (above) × 16 000) 720
continued
Work in progress
At cost:
Raw material (100 × 20 000) 2 000
Labour and production overhead ((65 + 25) × 20 000 × 60%) 1 080
3 080
At net realisable value:
Net realisable value if completed (180 × 20 000) 3 600
Less: Cost to complete ((65 + 25) × 20 000 × 40%) (720)
2 880
Alternatively: 20 000 × 90 + 20000 × 60% × (65 + 25) = R2 880 000
Comment
¾ If the net realisable value of the completed goods is lower then the cost, both the raw materials
and the work in progress should be adjusted accordingly.
Caution should be applied in cases where the NRV of the raw material component drops
below the cost, particularly where the raw materials form a significant part of the finished
product. This could mean that the selling price of the finished product will also have to drop,
particularly in cases where the selling price of a product reacts sensitively to changes in the
cost of the raw material components.
A further exception to the general rule stated in IAS 2.14 relates to by-products. As
mentioned previously, by-products are the inevitable result of a production process directed
at the production of another (primary) product. The costs of the primary product, which
consist of raw material, labour and allocated production overhead costs, are allocated to the
primary product in total. The by-product normally has no cost price and should be valued at
net realisable value, as long as this value is deducted from the joint costs of primary
products before being allocated to the individual products.
A further exception exists in respect of inventories acquired for the construction of own plant
and equipment of the entity. In this case, the principle that applies is that such inventories
are written-down only as the plant and equipment depreciate, after the costs of these
inventories have been incorporated into the cost of the plant and equipment.
4.9 Recognition of an expense

The carrying amount of inventories is recognised as an expense when the inventories are
sold and the revenue is recognised. The sales and corresponding expenses may be
recognised throughout the period if the entity uses a perpetual inventory system. The
expense is recognised only at the end of the period if a periodic inventory recording system
is used.
Any write-down of inventories to NRV for damages, obsolescence or fluctuations in costs or
selling prices forms part of the cost of sales expense, but is written off and recognised
directly in the profit or loss section of the statement of profit or loss and other
These write-downs are, however, disclosed separately in the financial statements. It is
important to distinguish between write-downs that should be disclosed and inventory losses
that do not have to be disclosed separately. Inventory losses arise typically when the
physical inventories on hand differ from the inventory records.
Where write-downs of inventories are reversed due to subsequent increases in NRV, the
amount is recognised as a reduction in the cost of sales expense in the profit or loss section
of the statement of profit or loss and other comprehensive income. The reversal of any
write-downs should also be disclosed separately.
Inventories 77
Example 4.12
4.12 Composition of the cost of sales expense
The cost of sales expense of a manufacturing company may include the following expenses:
R
Cost of inventories (finished products sold) (calc 1) (allocated costs) xxx xxx
Abnormal spillage of raw material, labour and other production costs (not allocated) xxx xxx
Under- or over-allocation of fixed production overheads (not allocated) (calc 4) xxx xxx
Inventory write-downs (inventories losses) xxx xxx
Inventory write-downs to NRV xxx xxx
Recovery of NRV write-down (xxx xxx)
Cost of sales xxx xxx
(1) Cost of inventories (finished products sold)
Opening inventories (finished products) xxx xxx
Transferred from work-in-progress (calc 2) xxx xxx
Closing inventories (finished products) (xxx xxx)
Cost of inventories (sold) xxx xxx
(2) Work-in-progress
Opening inventories (work-in-progress) xxx xxx
Direct raw materials (calc 3) xxx xxx
Direct labour xxx xxx
Variable production overheads (allocated) xxx xxx
Fixed production overheads (allocated) xxx xxx
Closing inventories (work-in-progress) (xxx xxx)
Transferred to finished products xxx xxx
(3) Direct raw materials
Opening inventories xxx xxx
Purchases xxx xxx
Cost xxx xxx
Other purchase costs xxx xxx
Abnormal spillage (xxx xxx)
Closing inventories (xxx xxx)
Transferred to work-in-progress xxx xxx
(4) Under-/over-allocated fixed production overheads
Incurred xxx xxx
Allocated (actual units produced × rate based on normal capacity) (xxx xxx)
Under-/over-allocation of fixed production overheads xxx xxx
4.10 Taxation implications

The tax aspects of trading stock are contained in sections 11(a), 22 and 22A of the Income
Tax Act 58 of 1962. Although the details are too extensive for the purposes of this
paragraph, the most important aspects are detailed below:
Trading stock may be shown at the lower of cost and net realisable value. However,
financial assets, such as shares, held as inventories may not be written down to their net
realisable value.
The LIFO cost formula may not be applied for tax purposes when determining the value
of the inventories (and is also not allowed under IAS 2).
Any inventories acquired free of charge must be included at the market value on the
date of acquisition. Special rules apply to inventories received from schemes of
arrangement, reconstruction and amalgamation.
Trading stock includes all inventories, according to IAS 2. Spares and consumables such
as unused stationery, maintenance spares, fuel, lubricants and cleaning agents kept by
an entity to be utilised in operation, are also included in the definition of trading stock.
From the above it would appear that there are minimal differences between inventories as
defined for accounting purposes, and trading stock for tax purposes. If differences occur,
their nature should be determined, because deferred tax may have to be provided for on
such differences.
4.11 Disclosure
The following disclosure requirements regarding inventories are prescribed by IAS 2.36
to .39:
the accounting policy pertaining to the measurement and the cost formula used;
the total carrying amount of inventories in classifications suitable for the entity, for example:
– materials (materials and spares included);
– finished goods;
– merchandise shown under appropriate subheadings;
– consumable goods (including maintenance spares);
– work-in-progress (including the inventory of a service provider); and
– work-in-progress – construction work;
the carrying amount of inventories carried at fair value less costs to sell of commodity
brokers/traders;
the amount of inventories recognised as an expense during the period;
the amount of any write-down of inventories recognised as an expense;
if such a write-down is reversed in a subsequent period, the amount reversed and the
circumstances which resulted in the reversal; and
the carrying amount of any inventories pledged as security.
Note that the disclosure of the carrying amount of inventories carried at net realisable value
is not required, but that the amount of any write-down of inventories should be disclosed,
typically in the note on profit before tax. Note also that disclosure of the carrying amount of
inventories carried at fair value less costs to sell is required, for example in the case of
commodity brokers/traders.
In terms of IAS 1, the format of the profit or loss section of the statement of profit or loss and
other comprehensive income may be dictated by the nature or the function of expenses. In
accordance with the functional approach, the cost of sales will be disclosed as a line item
and the disclosure requirements of IAS 2 will be met, provided that separate disclosures of
write-downs and the reversals of write-downs and their circumstances are given.
Entities using the nature of expenses approach will disclose operating costs such as raw
materials, labour costs, other operating costs and the net movement in finished goods and
work-in-progress, where applicable. To comply with IAS 2, the cost of such expenses will
have to be disclosed elsewhere in the financial statements. The disclosure of the cost of
sales expense does allow for the calculation of the gross profit margin, but the calculation may
not support comparison with other entities, as the composition of the amounts may differ.
Inventories 79
Example 4.13
4.13 Disclosure of the statement of profit or loss and other comprehensive
income using function or nature
Assume that the following are the details for the calculation of the profit before tax of a
manufacturing entity for the year ended 31 December 20.14:
R
Revenue 7 500 000
Cost of finished goods sold 3 995 100
Direct materials used 910 100
Labour 1 200 000
Variable production overhead costs allocated 800 000
Fixed production overhead costs allocated 845 000
Packing material 310 000
Cost of finished goods manufactured 4 065 100
Opening inventory: finished goods 70 000
Closing inventory: finished goods (140 000)
Selling and administrative expenses 1 735 000
Write-down of cost of materials to net realisable value 25 000
Over-recovery of fixed production overhead costs (41 000)
Abnormal spillage of materials 15 000
This will be disclosed as follows in the first part of the statement of profit or loss and other
comprehensive income:
Statement of profit or loss and other comprehensive income
If by function:
Revenue 7 500 000
Cost of sales (3 995 100 + 25 000 – 41 000 + 15 000) (3 994 100)
Other expenses (1 735 000)
OR
If by nature:
Revenue 7 500 000
Changes in inventories (140 000 – 70 000) 70 000
Direct material used (910 100 + 310 000 + 15 000 + 25 000) (1 260 100)
Labour costs (1 200 000)
Other expenses
Production overhead costs:
Variable (800 000)
Fixed (845 000 – 41 000) (804 000)
Selling and administrative expenses 1 735 000
4.12 Comprehensive example

Inyati Ltd’s inventories consist of the following:
Opening Closing Net realisable
inventories inventories value
R’000 R’000 R’000
Raw materials 35 000 15 000 14 500
Work-in-progress 15 000 25 500 20 000
Finished goods 40 000 20 500 30 000
Packaging materials 1 750 1 600 1 135
The following information is available for the year ended 31 December 20.14:
R’000
Sales 275 000
Administrative expenses 75 000
Raw material purchases 90 000
Transport costs – raw materials 250
Variable production overhead costs, including direct labour 50 250
Fixed production overhead costs, including indirect labour 41 500
Selling expenses 2 750
Inyati Ltd measures raw materials and work-in-progress using the first-in, first-out method. Finished
goods and consumables are measured using the weighted average method. Fixed production
overhead costs are allocated at R40 per unit on the basis of a normal capacity of 1 million units.
Inyati Ltd
Extract from the statement of financial position as at 31 December 20.14
Note R’000
Assets
Current assets
Inventories 3 62 135
Inyati Ltd
Extract from the statement of profit or loss and other comprehensive income
R’000
Revenue 275 000
Cost of sales (211 465)
Gross profit 63 535
Inyati Ltd
Extract from the notes for the year ended 31 December 20.14
1. Accounting policy
1.1 Inventories
Inventories are measured at the lower of cost and net realisable value using the following
valuation methods:
Raw materials and work-in-progress: first-in, first-out method
Finished goods and consumables: weighted average method
2. Profit before tax
Profit before tax includes the following item: R’000
Consumables written off to net realisable value (1 600 – 1 135) 465
3. Inventories
Raw materials 15 000
Work-in-progress 25 500
Finished goods 20 500
Consumables 1 135
62 135
Calculations
Raw Work in Finished
materials progress goods
R’000 R’000 R’000
Inventories
Opening inventories 35 000 15 000 40 000
Plus purchases/transfers received 90 000 110 250 190 000
Plus other costs 250 *90 250 –
Less transfers/sales (110 250) (190 000) (209 500)
Closing inventories 15 000 25 500 20 500
* 50 250 000 + (40 × 1 000 000)
continued
Inventories 81
Cost of sales R’000
Cost of inventories (finished goods) sold 209 500
Fixed production overhead costs – under-recovery (41 500 000 – 40 000 000) 1 500
Consumables written off to net realisable value** 465
211 465
** Raw materials, work-in-progress and other supplies held for use in the production of inventories are not
written-down below cost if the finished products in which they will be incorporated are expected to be sold at
or above cost. The consumables are however written down to their net realisable value.
CHAPTER
5
Statement of cash flows
(IAS 7)
Contents
5.1 Overview of IAS 7 Statement of Cash Flows .................................................... 84
5.2 Background ....................................................................................................... 85
5.3 Objective of the statement of cash flows ........................................................... 85
5.4 Elements of cash flows ...................................................................................... 86
5.4.1 Cash and cash equivalents .................................................................... 86
5.4.2 Cash flows from operating activities ....................................................... 87
5.4.3 Cash flows from investing activities ........................................................ 89
5.4.4 Cash flows from financing activities ........................................................ 92
5.4.5 Net increase or decrease in cash and cash equivalents ........................ 92
5.5 Specific aspects ................................................................................................ 93
5.5.1 Group statements ................................................................................... 93
5.5.2 Interest and dividends ............................................................................ 98
5.5.3 Taxes ...................................................................................................... 98
5.5.4 Value-added tax (VAT) ........................................................................... 99
5.5.5 Gross figures .......................................................................................... 100
5.5.6 Foreign currency cash flows ................................................................... 101
5.5.7 Leases .................................................................................................... 103
5.5.8 Discontinued operations ......................................................................... 103
5.6 Disclosure .......................................................................................................... 103
83
5.1 Overview of IAS 7 Statement of Cash Flows

Objectives of the statement of cash flows
to provide users with useful information in respect of historical changes in cash and cash
equivalents of an entity; and
to enable the users to formulate an opinion and make a better estimate of the cash
performance of an entity.
Cash and cash equivalents

Cash consists of cash on hand and demand deposits.
Cash equivalents consist of short-term (<3 months) highly liquid investments that are readily
convertible to known amounts of cash.
Elements of Cash flows from operating activities

cash flow: Chief revenue-producing activities.
Cash effect of transactions that are used in determining profit or loss.
Cash flows are Present in one of two ways: Indirect method or Direct method.
divided into
three +/–
categories. Cash flows from investing activities
There is a Activities which relate to the acquisition and disposal of long-term assets
mathematical and other investments.
relationship Distinguish between maintenance of operating capacity and increase in
between these operating capacity.
categories. Present gross receipts and gross payments.
+/–
Cash flows from financing activities
Activities that result in changes in size and composition of the borrowings
and contributed equity.
Present gross receipts and gross payments.
=
Net movement in cash and cash equivalents.
Specific aspects
Group statements: control gained or lost in a subsidiary = single line item in consolidated
statement of cash flows as part of investing activities.
Interest and dividends paid and received are disclosed separately.
Taxes:
– Taxation paid is normally shown separately as cash flows relating to operating activities.
– Deferred tax is not a cash flow.
– The cash flow effect of VAT is disclosed under cash generated from operating activities.
Foreign currency cash flows:
– Unrealised foreign exchange gains and losses do not represent cash flows.
– Realised foreign exchange gains and losses are viewed as cash flows.
– Exchange gains or losses relating to cash and cash equivalents must be reported separately.
Repayments of a lease for the lessee are divided between capital and interest portions:
– Interest = classified as operating activities.
– Capital = classified as financing activities.
Cash flows from discontinued operations should be disclosed under each category of cash
flows.
Additional disclosure requirements:
– Information on non-cash financing and investing activities;
– Components of cash and cash equivalents;
– Reconciliation of cash and cash equivalents in the statement of cash flows and the
corresponding items in the statement of financial position;
– Cash and cash equivalents not available for use by the group; and
– Accounting policy for composition of cash and equivalents.
Statement of cash flows 85
5.2 Background
In terms of IAS 1.9 and .10, a statement of cash flows is one of the components of a
complete set of financial statements prepared by entities that provide information about the
financial position, performance and changes in financial position of such entities. A
statement of cash flows is presented in accordance with IAS 7.
For cash flows, the activities of an entity are categorised into three main classes (IAS 7.10):
operating activities (activities that are revenue-producing);
investing activities (activities that are needed to support the income-generating
process, e.g. investing in fixed and other long-term assets); and
financing activities (activities that have as their objective the organising of the financing
requirements of the entity, e.g. obtaining loans and issuing shares).
Non-cash transactions are not included in the statement of cash flows (IAS 7.43). Where
an asset is, for example, acquired via mortgage bond financing, no cash changes hands and
the transaction is therefore not reflected in the statement of cash flows. This also applies
where assets are exchanged, shares are issued to acquire another entity, or where liabilities
are converted to equity. These transactions are, however, disclosed in the notes to the
financial statements, so that all relevant information is supplied to the users of the statements.
In reality, the statement of cash flows represents a summary of the movement of the cash
and bank balances (cash and cash equivalents) of entities for the period under review.
‘Cash’ refers to cash on hand and demand deposits, while ‘cash equivalents’ refers to short-
term highly liquid investments that are readily convertible to known amounts of cash and are
subject to an insignificant risk of changes in value.
5.3 Objective of the statement of cash flows

The objective of the statement of cash flows is:
to provide useful information on how an entity generates cash and how an entity
utilises cash;
in respect of the historical changes;
in cash and cash equivalents.
The statement of cash flows enables the users of financial statements to formulate an opinion
and make a better estimate of the cash performance of an entity. The users may find the
information useful for the following purposes:
to formulate an opinion regarding the risk profile of an entity by paying particular
attention to the ability of the entity to:
– pay interest and dividends;
– make capital repayments on borrowed funds; and
– access the appropriate sources of financing to finance the activities of the entity;
to forecast the cash that will probably be available in the future to finance expansions;
to determine which sources of cash have been used to finance operating and investing
activities;
to evaluate whether the entity is capable of generating sufficient cash flows from
operating activities for a part thereof to be ploughed back into the entity;
to evaluate the timing and certainty of generated cash in order to assess the ability of the
entity to adapt to changing circumstances;
to enhance the comparability of the operating results of different entities by eliminating
the effects of different accounting policies; and
to determine the relationship between the profitability and cash flows of the entity.
The provision of cash flow information is primarily aimed at more effectively informing users
about the liquidity and solvency of the entity. This information is of the utmost importance,
as a cash deficit could result in financial failure. A statement of cash flows could timeously
identify possible problems in this regard, as it provides quality information about the timing
and amounts of the cash flows of an entity.
IAS 7 is applicable to all entities, even financial institutions where cash is viewed as
inventories of the entity. To accommodate financial institutions such as banks and
investment companies, IAS 7 allows certain cash flows to be reported on a net basis.
Remember that financial statements (except the statement of cash flows) are prepared on
an accrual basis, namely accounting for transactions when they occur. However, the
statement of cash flows presents the actual cash receipts and cash payments of the
transactions for the period.
5.4 Elements of cash flows

Cash flows in the statement of cash flows are divided into three categories as follows:
cash flows from operating activities;
cash flows from investing activities; and
cash flows from financing activities.
There is a mathematical relationship between these three categories, in that cash retained
from operating activities plus the cash proceeds of financing activities is used in investing
activities. Conversely, cash retained from operating activities may be utilised for both
investing and financing activities. Other combinations also exist.
IAS 7.11 does not prescribe a specific format for the statement of cash flows but suggests
instead that the format most appropriate to the entity’s business be used to present the cash
flows from operating, investing and financing activities.
The classification of cash flows by activity may result in cash flows originating from one
transaction being disclosed under two activities. For instance, the repayment of a loan is
shown under financing activities, while the payment of interest is shown under operating
activities. Furthermore, items such as interest and dividends may be shown under operating,
investing or financing activities (IAS 7.31).
5.4.1 Cash and cash equivalents

Cash consists of cash on hand and demand deposits, while cash equivalents consist of
short-term highly liquid investments that are readily convertible to known amounts of cash
that are subject to an insignificant risk of changes in value (IAS 7.6).
Short-term is usually viewed as three months or less from the date of acquisition. Equity
investments are usually not classified as cash equivalents, while bank overdrafts normally
are. Bank borrowings are generally considered to be financing activities. Cash movements
between cash and cash equivalents are not reflected separately, as they are part of the
normal cash management activities of the entity to which the statement of cash flows
reconciles.
The reporting entity discloses the accounting policy for determining cash and cash
equivalents and discloses a reconciliation of the components to the equivalent items in the
statement of financial position (IAS 7.45 and .46). If the policy adopted for determining
components is changed by the entity, it is accounted for in accordance with IAS 8
Accounting Policies, Changes in Accounting Estimates and Errors.
If cash and cash equivalents are held in a foreign currency and are subsequently
converted to the reporting currency, the effect of the changes in foreign currency exchange
rates is reported in the statement of cash flows in order to reconcile cash and cash
equivalents at the beginning and the end of the period. This amount should be disclosed
separately from cash flows from operating, investing and financing activities (IAS 7.28).
5.4.2 Cash flows from operating activities

Operating activities are normally the principal revenue-producing activities of the entity,
and include other activities that do not constitute investing or financing activities (IAS 7.14).
The cash generated from operating activities (or conversely, the cash deficit from operating
activities) is normally the cash effect of transactions and other events that is used in
determining profit or loss. This represents the difference between the cash received from
customers during the period and cash paid in respect of goods and services. It also
includes the following:
cash receipts from royalties, fees, commissions and other revenue;
cash payments to and on behalf of employees (such as contributions to pension funds);
cash payments or refunds of income taxes (unless they can be specifically linked to
financing and investing activities); and
cash receipts and payments from contracts held for dealing or trading purposes, since
such contracts constitute the inventories of the particular entity (IAS 7.14).
The amount of cash flows from operating activities enables the users of the financial
statements to evaluate the cash component of the normal operating activities for the period,
and in doing so, to assess the quality of the earnings. It also gives an indication of the
extent to which the operations of the entity have generated sufficient cash flows to repay
loans, maintain the operating capability of the entity, pay dividends and make new
investments without having to resort to external sources of financing.
Cash generated from operations is calculated in one of two ways (IAS 7.18) i.e.:
the indirect method; or
the direct method,
and is disclosed as such in the statement of cash flows.
Although IAS 7.19 encourages entities to use the direct method to report cash flows from
operating activities, no prescriptive guidance is given in IAS 7 about the circumstances
under which the respective methods should be used. This situation calls for the application
of consistency in terms of IAS 8 Accounting Policies, Changes in Accounting Estimates
and Errors. If a Standard allows a choice of accounting policy, but is silent on the manner of
exercising that choice, one is chosen and applied consistently. Here the entity should
choose between the direct or indirect method, and the chosen method should be applied
consistently from year to year.
5.4.2.1 The indirect method
Under the indirect method (IAS 7.18(b)), cash generated by operations comprises two
disclosable components, namely profit before working capital changes, and changes in
working capital.
Profit before working capital changes: This amount is calculated by adjusting the
profit before tax for investment income and interest charges (because investment
income and interest charges are disclosed separately as components of cash flow from
operating activities) and for those items that do not involve a flow of cash. Examples of
the latter include the following:
– depreciation charges;
– gains or losses on disposal of property, plant and equipment;
– impairment losses;
– unrealised foreign exchange gains or losses;
– fair value adjustments;
– undistributed profits of associates/joint ventures; and
– non-controlling interests.
Changes in working capital: Movements in working capital, in other words, changes in

current assets and current liabilities, are taken into consideration in determining the cash
generated from operations. Examples of the latter include the following:
– inventories;
– receivables;
– payables;
– provisions;
– income received in advance;
– expenses payable; and
– prepaid expenses.
However, tax and dividends payable are excluded, as these are dealt with individually in the
statement of cash flows. In addition, cash at bank, cash on hand and cash equivalents such
as money market instruments are also excluded from the calculation, as these represent the
opening and closing balances respectively of the statement of cash flows.
5.4.2.2 The direct method
In accordance with the direct method (IAS 7.18(a)), cash generated from operations is
disclosed as being the difference between the following two items:
gross cash receipts from customers; and
gross cash paid to suppliers and employees.
Only the major classes of gross cash receipts and gross cash payments are disclosed in
accordance with this method. These two amounts cannot be deduced directly from the profit
or loss section of the statement of profit or loss and other comprehensive income, and they
therefore provide additional useful information that can be used in estimating future cash
flows.
The amounts are determined either by referring to the entity’s accounting records, or making
the necessary additional calculations. For a trader, these ‘additional calculations’ entail
adjusting sales and cost of sales for changes in inventories, receivables, payables and other
non-cash items, and other items for which the cash effects are investing or financing cash
flows.
The following example illustrates the difference between disclosures using the indirect and
direct methods.
Example 5.1 Indirect and direct method
Indirect method:
Cash flows from operating activities R
Profit before tax 250 000
Adjustments:
– Depreciation 15 000
– Gain on disposal of equipment (2 500)
– Investment income (5 000)
– Finance costs 20 000
Net changes in working capital 3 000
Cash generated from operations 280 500
continued
R
Direct method:
Cash flows from operating activities
Cash receipts from customers 950 000
Cash paid to suppliers and employees (669 500)
5.4.3 Cash flows from investing activities

Investing activities are activities that relate to the acquisition and disposal of long-term
assets and other investments which do not fall within the definition of cash equivalents.
The separate disclosure of cash flows arising from investing activities is important because
the cash flows represent the extent to which expenditures have been made for resources
intended to generate future income and cash flows. Only expenditure that results in a
recognised asset in the statement of financial position is recognised under investing
activities.
In IAS 7.16, the following examples of cash flows arising from investing activities are given:
cash payments to acquire property, plant and equipment, including capitalised
development costs and self-constructed property, plant and equipment, intangible assets
and other long-term assets;
cash receipts from the disposal of property, plant and equipment, intangible assets and
other long-term assets;
cash payments to acquire or cash receipts to dispose of equity or debt instruments of
other entities and interests in joint ventures;
cash advances and loans to other parties (other than financial institutions), or cash receipts
from their repayment; and
cash payments or receipts for financial futures contracts, forward contracts, options and
swap contracts, except where these are held for speculative purposes, or if they are
classified as financing activities.
Cash flows of a hedging instrument are classified in the statement of cash flows in the same
way as the hedged item (IAS 7.16).
It should be remembered that movements in property, plant and equipment and investments
may not, in all instances, result in a flow of cash. Amongst such non-cash transactions are
internal transactions such as revaluations, impairments, the scrapping of assets, and
routine depreciation charges. Certain external transactions, such as the purchase of assets
financed by a mortgage bond, via an equity issue or a lease arrangement, will also not
lead to cash flows.
Example 5.2 Assets acquired without cash outflows or via indirect cash flows
Case 1: Asset acquisition financed via a mortgage bond

A Ltd purchased a piece of land on 1 December 20.17 for R600 000 and financed this transaction
by way of a mortgage bond.
The journal entry to account for this transaction would be as follows:
Dr Cr
Land 600 000
Mortgage bond 600 000
Recognise asset financed by way of mortgage bond
This journal entry illustrates the fact that no direct cash flows took place on acquisition of the
asset.
On 31 December 20.17, the following line items will appear in the financial statements of A Ltd in
respect of the above transaction:
Extract from statement of financial position as at 31 December 20.17
R
Assets
Non-current assets
Mortgage bond 600 000
For the purposes of the statement of cash flows, this transaction would have no cash flow effect
(it is neither an investing activity nor a financing activity) and the fact that the asset was acquired
by way of a mortgage bond will be disclosed in the notes to the financial statements.
Case 2: Asset acquired in exchange for shares issued
A Ltd acquires a machine with a fair value of R500 000 on 1 December 20.17 in exchange for
100 000 ordinary shares at a fair value of R500 000.
The journal entry to account for this transaction would be as follows:
Dr Cr
Machine at cost 500 000
Share capital 500 000
Recognise asset acquired in exchange for shares issued at fair value
in terms of IAS 16 Property, Plant and Equipment.
From the above journal entry it is clear that there was no cash flow involved in this transaction.
At 31 December 20.17, the following line items will appear in the financial statements of A Ltd in
R
Assets
Non-current assets
Equity
continued
When the statement of cash flows is prepared, it should be borne in mind that an increase in
property, plant and equipment took place that did not result in a cash outflow. Similarly, there
would be an increase in share capital that did not result in a cash inflow. These asset and
equity movements for the year must thus be excluded from the amounts that will be presented in
the financing and investing sections of the statement of cash flows. The fact that there was no
direct cash flow involved with the acquisition of the asset is disclosed elsewhere in the notes to
the financial statements.
Case 3: Asset acquired under a lease agreement
A Ltd entered into a lease agreement with Bank B on 1 December 20.17 to acquire a machine.
The fair value of the machine as well as the present value of the minimum lease payments
amounts to R400 000 on 1 December 20.17.
The journal entry to account for this transaction is the following:
Dr Cr
Machine under lease arrangement 400 000
Finance lease obligation 400 000
Recognise asset acquired by way of a lease agreement
in terms of IFRS 16 Leases.
This journal entry clearly illustrates that the transaction has no cash flow implications.
At 31 December 20.17, the following line items will appear in the financial statements of A Ltd in
R
Assets
Non-current assets
Lease obligation 400 000
For the purpose of preparing the statement of cash flows, it must be borne in mind that there is an
increase in property, plant and equipment that did not result in a cash outflow. The same
applies in the respect of the increase in the lease obligation that also did not result in a cash
inflow. The increase in property, plant and equipment and increase in the lease obligation are
excluded from the amounts that will be presented in the financing and investing sections of the
statement of cash flows.
It is important to the users of financial statements to evaluate whether the entity’s reinvestment
(i.e. the amount ploughed back) is sufficient for achieving the following objectives:
the maintenance of operating capacity; and
the increase in operating capacity.
For this reason, a distinction should be made as far as practically possible between investing
activities to replace property, plant and equipment (maintaining operating capacity), and the
cash used in investing activities to expand investments in property, plant and equipment
(purchasing additional items to increase operating capacity) (IAS 7.51).
The major classes of gross cash receipts and gross cash payments arising from investing
activities are reported separately in the statement of cash flows. Refer to section 5.5.5 for an
exception to this rule where cash flows are reported on a net basis.
5.4.4 Cash flows from financing activities

Financing activities are activities that result in changes in the size and composition of the
borrowings and contributed equity of the entity. These activities include raising new
borrowings, the repayment of existing borrowings, and the issuing and redemption of shares
or other equity instruments. Paragraph 18 of IAS 32 Financial Instruments: Presentation
may have an impact on the equity and liability classifications of certain items.
Cash flows arising from financing activities include (IAS 7.17):
proceeds from the issuing of shares or other equity instruments;
payments to acquire or redeem shares of the entity;
proceeds from the issuing of debentures, loans, notes, bonds, mortgages and other
short- and long-term borrowings;
repayments in respect of amounts borrowed; and
payments by a lessee to reduce the liability resulting from a lease.
The major classes of gross cash receipts and gross cash payments arising from financing
activities are shown in the statement of cash flows.
Example 5.3 Financing section of the statement of cash flows
The following is an illustration of the possible line items that will appear in the financing activities
section of the statement of cash flows:
Extract from the statement of cash flows of A Ltd for the year ended 31 December 20.17:
R
Cash flows from financing activities (150 000)
Ordinary shares issued 100 000
Redemption of redeemable preference shares (200 000)
Repayment of mortgage bond (300 000)
Long-term loan obtained during the year 400 000
Lease agreement entered into (refer to Example 5.2) –
Lease repayments (150 000)
Cash flows as well as non-cash flow related changes in liabilities arising from financing
acivities should be disclosed (IAS 7.44A). This enables users to evaluate changes in liabilities.
The Standard recommends a reconciliation between the opening and closing balances for
liabilities arising from financing activities. In the issued amendments to IAS 7, an illustrative
example is available for this specific disclosure. The effective application date is for annual
periods beginning on or after 1 January 2017. Non-cash flow changes include:
financing changes;
changes from obtaining or losing control of subsidiaries;
foreign exchange changes;
fair value changes; and
any other changes.
5.4.5 Net increase or decrease in cash and cash equivalents

In this single line, the net cash result of the operating, investing and financing activities is
aggregated. This amount is used to reconcile the cash and cash equivalents at the
beginning of the year with the cash and cash equivalents at the end of the year, as reported
in the statement of financial position.
Example 5.4 Reconciliation between cash and cash equivalents at the beginning
and end of the year
The following is an extract from the statement of financial position of P Ltd, as it appears in the
published financial statements for the year ended 31 December 20.17:
20.17 20.16
R R
Assets
Current assets
Cash and cash equivalents – 150 000
Current liabilities
Overdrawn bank account (100 000) –
The following extract from the statement of cash flows for the year ending 20.17 illustrates the
reconciliation between cash and cash equivalents at the beginning and the end of the year as it
will appear at the end of the statement of cash flows:
Extract from the statement of cash flows for the year ended 31 December 20.17
R
Cash flows from operating activities* 300 000
Cash flows from investing activities* (350 000)
Cash flows from financing activities* (200 000)
Net decrease in cash and cash equivalents (250 000)
Cash and cash equivalents at the beginning of the year 150 000
Cash and cash equivalents at the end of the year (100 000)
* Note that a comprehensive statement of cash flows will have several line items under the above
sections of cash flows from operating activities, investing activities and financing activities.
5.5 Specific aspects
5.5.1 Group statements

When control in a subsidiary is obtained or lost, the resultant cash flows are reflected as a
single line item in the consolidated statement of cash flows as part of the investing
activities. Details regarding the assets and liabilities acquired are disclosed by means of a
note (IAS 7.40). In this note, a distinction is made between cash, cash equivalents and other
assets and liabilities. The consideration paid or received for subsidiaries is therefore treated
in the same way for statement of cash flow purposes as the sale of any other investments.
Where cash or cash equivalents are obtained or lost as part of obtaining or losing control of
an investment in a subsidiary, the amounts are not reflected as part of the cash flow
resulting from the transaction – only the net figures are reflected in the statement of cash
flows.
The following information is disclosed in aggregate in a note:
the total consideration paid or received;
the cash and cash equivalents portion of the total consideration paid or received;
the amount of cash and cash equivalents in the subsidiary over which control is obtained
or lost; and
the amount of assets and liabilities other than cash or cash equivalents in subsidiaries or
other businesses over which control is obtained or lost per major category (IAS 7.40).
Cash flows that arise from changes in owner's equity in a subsidiary that do not result in a
loss of control are:
classified as cash from financing activities (IAS 7.42A); and
accounted for as equity transactions (IAS 7.42B).
Where the equity method or cost method of accounting is applied to an investment, only the
cash flow between the company and the investment should be included in the statement of
cash flows, as it is only this amount that represents a flow of cash (IAS 7.37).
Examples are dividends and advances. These dividends are disclosed with other investment
income in the statement of cash flows.
A pure and consistent application of the technique as proposed by IAS 7 for the preparation
of statements of cash flows may result in cash flows that were not actual cash flows for any
of the respective entities being consolidated being reported as cash flows. The same
argument can be applied to many other aspects of group statements. The fundamental
reason for this is that group statements are not prepared for a single entity, but rather for a
number of entities, and the combined entities consequently take on the status of a separate
accounting entity.
Example 5.5 Consolidated statement of cash flows
The following are extracts from the statements of financial position of two companies, P Ltd and
S Ltd, as at 31 December:
P Ltd 20.17 20.16 20.15
Assets R’000 R’000 R’000
Investment in S Ltd at fair value 88 88 –
Property, plant and equipment 420 250 200
Trade receivables 90 80 70
Cash 80 50 50
678 468 320
Share capital 250 250 250
Trade payables 78 68 50
678 468 320
S Ltd
Assets
Cash 50 20 30
205 140 80
Trade payables 45 30 20
205 140 80
continued
P Ltd obtained control over S Ltd with the acquisition of an 80% interest in S Ltd on
31 December 20.16 for a cash amount of R88 000. On the acquisition date of S Ltd, no
unidentified assets or liabilities existed and the fair value of all the assets and liabilities was
considered to be equal to the carrying amount thereof. P Ltd elected to measure the non-
controlling interests at the proportionate share of the acquiree’s identifiable net assets at the
acquisition date. No dividends have been paid for the years ended 31 December 20.16 and 20.17.
Assume there are no intragroup transactions and no other comprehensive income items. The
consolidated financial statements for the year ended 31 December 20.17 will be prepared as
follows:
P Ltd Group
Extract from the consolidated statement of profit or loss and other comprehensive income
20.17 20.16
R’000 R’000
Profit for the year (350(P) – 150(P)) + (110(S) – 60(S)); (150(P) – 20(P)) 250 130
Other comprehensive income for the year – –
Total comprehensive income for the year 250 130
Total comprehensive income and profit for the year attributable to:
Non-controlling interests [20% × (110(S) – 60(S))] 10 –
250 130
P Ltd Group
20.17 20.16
R’000 R’000
Assets
Non-current assets
Property, plant and equipment (420(P) + 100(S)); (250(P) + 80(S)) 520 330
Current assets
Trade receivables (90(P) + 55(S)); (80(P) + 40(S)) 145 120
Cash and cash equivalents (80(P) + 50(S)); (50(P) + 20(S)) 130 70
275 190
Total assets 795 520
Retained earnings (350(P) + (110(S) – 60(S) – 10(NCI)) 390 150
640 400
Non-controlling interests (20% × 160); (20% × 110 (50 + 60)) 32 22
Total equity 672 422
Current liabilities
Trade payables (78(P) + 45(S)); (68(P) + 30(S)) 123 98
Total equity and liabilities 795 520
continued
P Ltd Group
Extract from the consolidated statement of changes in equity
Non-
Share Retained
controlling
capital earnings
interests
R’000 R’000 R’000
Balance at 31 December 20.15 250 20 –
Changes in equity for 20.16
Total comprehensive income for the year – 130 22
Profit for the year (150 – 20) – 130 –
Other comprehensive income for the year – – –
Balance at 31 December 20.16 250 150 22
Total comprehensive income for the year – 240 10
Profit for the year – 240 10
Other comprehensive income for the year – – –
P Ltd Group
Consolidated statement of cash flows for the year ended 31 December 20.17
20.17 20.16
R’000 R’000
Cash flows from operating activities (see calculation below) 250 138
Cash flows from investing activities (190) (118)
Obtaining control of a subsidiary (see note 1)/(88 – 20) – (68)
Addition to property, plant and equipment
(520(GS) – 330(GS)); (330(GS) – 200(P) – 80(S)) (190) (50)
Cash flow from financing activities – –

Net increase in cash and cash equivalents 60 20
Cash and cash equivalents at beginning of year 70 50
Cash and cash equivalents at end of year 130 70
P Ltd Group
Notes to the consolidated cash flow statement for the year ended 31 December 20.17
20.17 20.16
R’000 R’000
1. Obtaining control of a subsidiary
Property, plant and equipment (specify) – 80
Receivables – 40
Payables – (30)
Cash – 20
Net asset value – 110
Non-controlling interests (110 000 × 20%) – (22)
Total consideration paid in cash – 88
Cash of subsidiary – (20)
Net cash flow at acquisition of subsidiary – 68
continued
20.17 20.16
R’000 R’000
Calculations
1. Cash flow from operating activities
Profit for the year 250 130
Change in operating capital:
Increase in receivables (145(GS) – 120(GS)); (120(GS) – 70(P) – 40(S)) (25) (10)
Increase in payables (123(GS) – 98(GS)); (98(GS) – 50(P) – 30(S)) 25 18
250 138
Comment
¾ Due to limited information provided, the full disclosure of the operating activities section cannot
be presented.
2. Analysis of owners’ equity of S Ltd
P Ltd 80% 20%
Total At Since NCI
At acquisition (31 Dec 20.16) R’000 R’000 R’000 R’000
110 88 22
Equity represented by goodwill – – –
Consideration and NCI 110 88 22
Since acquisition
• Current year
Profit for the year (110 – 60) 50 40 10
160 40 32
Comment
¾ The calculation of the change in the receivables and payables for the year ended
31 December 20.16 includes the effect (acquisition) of the subsidiary from the date on which
control was obtained, to the reporting date. In the period since control of the subsidiary was
acquired, during 20.17, there is no additional effect of the subsidiary on the receivables and
payables as the subsidiary is already included in the consolidated statement balances.
¾ The calculation for the 20.16 year can be explained as follows:
Receivables
R’000 R’000
Opening balance 70
Acquisition of subsidiary 40
Bank (balancing amount) 10 Closing balance (80(P) + 40(S)) 120
120 120
¾ The opening balance represents only the receivables amount for P Ltd, as at the beginning of
the 20.16 financial year the P Ltd Group did not exist. However, at year end (31 December
20.16) P Ltd acquired control of S Ltd and thereby formed the P Ltd Group. The closing balance
used at year end is a consolidated amount of R120 000, which includes the receivables of both
P Ltd and S Ltd. The acquisition of the subsidiary during the year needs to be taken into
account before the cash movement can be calculated. This results in a cash flow movement of
R10 000, and not R50 000. The same approach will be followed for PPE and payables.
continued
¾ The calculation for the 20.17 year can be explained as follows:

Receivables
R’000 R’000
Opening balance (80(P) + 40(S)) 120
Bank (balancing amount) 25 Closing balance (90(P) + 55(S)) 145
145 145
¾ During the 20.17 financial year there were no acquisitions or disposals of subsidiaries, therefore
the consolidated amounts as per the P Ltd Group’s records can be used in the opening and
closing balances.
5.5.2 Interest and dividends

Payments to the suppliers of finance, and amounts received on investments, are disclosed
separately in the statement of cash flows. Accrued and unpaid amounts are not included
here and the necessary adjustments must therefore be made to the amounts reflected in the
statement of profit or loss and other comprehensive income and the statement of financial
position.
In terms of IAS 7.31, cash flows associated with interest and dividends paid and received
must be disclosed separately and classified on a consistent basis, as operating, investing
or financing activities. Since there is no consensus regarding the classification of these
items, consistency in the treatment of these items is encouraged.
Some argue that these items are the fruits of financing and/or investing activities and should
therefore be disclosed under operating activities. Alternatively, it may be argued that
dividends and interest received are the result of investing activities, or that dividends and
interest paid are the result of financing activities; therefore the items should be disclosed
accordingly. Interest and dividends are treated as operating activities in this chapter.
Note that interest paid and capitalised in terms of IAS 23 Borrowing Costs will be shown in
the statement of cash flows. The fact that the interest is capitalised does not have a direct
impact on the cash flow associated with it.
The effect of the application of IAS 32 Financial Instruments: Presentation on the
classification of items as either equity or liabilities also impacts on the resulting classification
of associated statement of profit or loss and other comprehensive income items.
Consequently, it also has an impact on the statement of cash flows.
Dividends paid to shareholders or any other distributions to owners are also shown
separately, under cash flows from operating activities. This could provide users with an
indication of the entity’s ability to pay dividends out of operating cash flows.
5.5.3 Taxes
As the principle of the statement of cash flows is to show the flow of cash and cash
equivalents, the proper ‘matching’ of cash inflows with the relevant cash outflows cannot
always occur. This is particularly true of taxes, where the tax arising from items reflected in
the current statement of cash flows is shown only in the next statement of cash flows, as the
tax is only paid after the date of the current statement of cash flows. For this reason, it is
difficult to conceive that the tax cash flows related to items reflected in the statement of cash
flows can be matched against the relevant items.
To illustrate this point, suppose that the sale of depreciable assets results in the recoupment
of tax allowances, and thus in a tax expense. In the profit or loss section of the statement of
profit or loss and other comprehensive income, the tax expense could be connected to the
gain on the disposal of the asset and be disclosed as such. In the statement of cash flows,
this would not be possible, as the actual tax paid is only reflected in the statement of cash
flows of the ensuing year, even though the proceeds from the disposal of the asset are
reflected under investing activities in the current year’s statement of cash flows.
For this reason, IAS 7.35 and .36 state that taxes paid are normally shown as cash flows
relating to operating activities. However, when it is practicable to match the tax cash flow
with an individual transaction classified as an investing or financing activity, the tax cash
flow should also be classified as an investing or financing activity. Taxes paid, such as
transfer duty on property, stamp duty on shares and tax on dividends (where appropriate)
can normally be linked to the appropriate investment or activity. If the tax cash flows are
allocated over more than one activity, the total amount of taxes paid is disclosed in the
notes.
The tax charges in the statement of profit or loss and other comprehensive income often
include an amount in respect of deferred tax. The annual charge for deferred tax is not a
flow of cash and must therefore not be reflected in the statement of cash flows.
5.5.4 Value-added tax (VAT)

The treatment of VAT in a statement of cash flows is not addressed in IAS 7. Entities should
however disclose whether they present their gross cash flows as inclusive or exclusive of
VAT.
Example 5.6 Treatment of VAT
S Ltd is a registered vendor for VAT purposes and all purchases and sales are subject to VAT of
15%. Gross cash flows are disclosed excluding VAT. The following extract was obtained from the
trial balance of S Ltd:
20.17 20.16
Debits
Trade receivables 18 300 22 650
Inventories 19 300 21 850
VAT control account 80 100
Cost of sales 62 400 52 300
Other expenses 8 594 6 700
Credits
Trade payables 25 870 27 500
Revenue 96 000 89 650
By using the direct method, disclose “the cash flow generated from operations” section in the
statement of cash flows for the year ending 31 March 20.17.
The cash flow generated from operations will be disclosed as follows in the statement of cash flows:
S Ltd
Extract from the statement of cash flows for the year ended 31 March 20.17
(Direct method)
R
Cash flows from operating activities
Cash receipts from customers (calc 1) 99 783
Cash payments to suppliers and employees (calc 2) (69 861)
VAT cash in/(out)flow (calc 3)* 374
*The cash flow from VAT may also be presented in the tax note to the statement of cash flows if
the indirect method is used.
continued
Calculations
1. Cash receipts from customers (net of VAT) R
Revenue 96 000
Decrease in trade receivables ((22 650 – 18 300) x 100/115) 3 783
99 783
Comment
The accounting treatment for the total sales for the year is recorded as follows:
Dr Cr
R R
Revenue 96 000
VAT control account 14 400
Alternative reconstruction of the general ledger for illustrative purposes:

Trade receivables
Net VAT Gross Net VAT Gross
Opening balance 19 696 2 954 22 650 Bank 99 783 14 967 114 750
Revenue 96 000 14 400 110 400 Closing balance 15 913 2 387 18 300
133 050 133 050
Trade receivables movement net of VAT: 19 696 – 15 913 = 3 783 (rounding difference)
2. Cash payments to suppliers and employees (net of VAT) R
Changes in working capital:
Decrease in trade payables ((27 500 – 25 870) × 100/115) (1 417)
Decrease in inventories (21 850 – 19 300) 2 550
(69 861)
3. VAT cash inflow R
Decrease in VAT control account (100 – 80) 20
VAT included in decrease of trade receivables ((22 650 – 18 300) × 15/115) 567
VAT included in decrease of trade payables ((27 500 – 25 870) × 15/115) (213)
374
5.5.5 Gross figures

In terms of IAS 7.21, information relating to investing and financing activities is reflected at
gross rather than at net amounts. This reduces the potential loss of important information
as a result of disclosing net figures. Expenditure on new investments is therefore shown
separately from the proceeds on disposal of investments, and the repayment of borrowings
is shown separately from newly-obtained borrowings.
The following exceptions to the general rule are however permitted by IAS 7.22 and .23:
cash receipts and payments on behalf of customers when these cash flows reflect the
cash flows of the customer rather than the cash flows of the entity, for example:
– the acceptance and repayment of demand deposits of a bank;
– funds held for customers by an investment entity; and
– rent collected on behalf of and paid over to the owners of properties; and
cash receipts and payments for items of which the turnover is quick, the amounts are
large, and the maturities are short, for example:
– capital amounts in respect of credit card customers; and
– the purchase and disposal of investments and short-term borrowings.
5.5.6 Foreign currency cash flows

Foreign currency transactions are converted into the reporting entity’s functional currency
(in South Africa, this is the Rand) for disclosure in the statement of cash flows. Only if such
transactions result in a flow of cash will the cash flow be translated at the exchange rate
applicable on the date of the transaction and disclosed as such (IAS 7.25). The cash flows
of a foreign subsidiary are translated at the exchange rates between the reporting entity’s
functional currency and the foreign currency on the dates of the cash flows (IAS 7.26). A
weighted average rate may also be used if it approximates the actual rate.
Unrealised gains and losses on foreign exchange transactions do not represent cash
flows and will therefore not be reflected in the statement of cash flows. Only the actual cash
flows in the functional currency are therefore shown.
There is one exception to this rule: Where cash and cash equivalents are held in foreign
currency at the end of a period, or are payable in foreign currency, these items are
translated at the exchange rate ruling at the reporting date. This results in an associated
foreign exchange gain or loss on the reporting date. In order to reconcile the cash and cash
equivalents at the beginning and the end of the current reporting period, this foreign
exchange gain or loss will appear in the statement of cash flows. IAS 7.28 requires that this
difference be reported separately from cash flows from operating, investing and financing
activities.
Realised foreign exchange gains and losses are therefore viewed as cash flows.
Unrealised exchange differences arising due to translations on the reporting date are simply
added back. Only translation differences relating to cash and cash equivalents are not
added back; instead, they are disclosed separately in the statement of cash flows.
Example 5.7 Foreign currency transactions
A Ltd has entered into a number of foreign currency transactions. Indicate how the transactions
will be treated in the statement of cash flows for the year ended 30 September 20.17:
Transaction 1: Acquired inventories from abroad on 1 September 20.17 for FC5 000. Paid
creditor on 15 October 20.17.
Transaction 2: Raised a long-term loan abroad of FC15 000 on 1 September 20.17. Interest is
payable quarterly in arrears at 5% per annum.
Transaction 3: Acquired machinery from abroad at FC10 000 on 15 September 20.17 and
took out forward exchange cover on the same day for payment on
30 September 20.17.
Transaction 4: A foreign currency bank account is used to deposit any receipts in foreign
currency. The account had a balance of FC500 000 on 1 September 20.17.
Only one amount was deposited into the account during the year – a customer
deposited FC100 000 on 30 September 20.17. Therefore, on 30 September 20.17,
the balance amounted to FC600 000.
The following exchange rates apply:
Spot rate Forward rate
20. 17 FC1 = R FC1 = R
01 September 2,00
15 September 2,20 2,30
30 September 2,25
Average rate for September 2,18
continued
Transaction 1
The cash flow takes place on 15 October 20.17, when the creditor is paid and the transaction is
then reflected in the cash flows from operating activities section. At 30 September 20.17, the
creditor (a monetary liability) is remeasured and an exchange difference is recognised:
R
01 September FC5 000 × 2,00 10 000
30 September FC5 000 × 2,25 (11 250)
Foreign exchange loss (1 250)
The unrealised foreign exchange loss is reflected in the profit or loss section of the statement
of profit or loss and other comprehensive income as unrealised, and under the indirect method is
added back to profit for the year as a non-cash item. No flow of cash is therefore recognised in
the statement of cash flows for the year ended 30 September 20.17.
Transaction 2
A cash flow takes place when the loan is raised on 1 September 20.17 at:
FC15 000 × 2,00 = R30 000
The cash flow is shown under the cash flows from financing activities section as a loan raised. At
30 September 20.17, the loan is remeasured, the interest accrued and an exchange difference is
recognised in the statement of profit or loss and other comprehensive income (profit or loss):
Capital: R
01 September 30 000
30 September FC15 000 × 2,25 (33 750)
Foreign exchange loss (3 750)
Interest: 30 September 5% × FC15 000 × 1/12 × 2,18 = R136
The interest is not yet paid; therefore no cash flow is shown as interest paid under operating
activities for the year. The expense in the statement of profit or loss and other comprehensive
income (profit or loss) is raised via the creditor. As the unrealised exchange loss is also a
non-cash transaction, the amount is added back against profit for the year in the statement of
cash flows.
A reconciliation disclosing the movement of cash and non-cash changes in the liabilities arising
from finance activities is required (IAS 7.44A–D). This reconciliation includes the cash inflow
related to the newly acquired loan as well as the non-cash flow change related to the foreign
exchange difference.
Transaction 3
Investing activities reflect the acquisition of machinery at the cash flow amount of:
FC10 000 × 2,30 = R23 000
The exchange difference is realised and is not adjusted against profit for the year in the
statement of cash flows. The forward cover contract of 15 September does not result in a flow of
cash and is therefore not shown in the statement of cash flows.
Comment
¾ If the creditor in transaction 3 was paid after the reporting date, the machinery acquisition is
reflected net of the creditor, while the unrealised exchange difference on the creditor is added
back to profit for the year as a non-cash flow item. It is recommended that the machinery
acquisition be disclosed in the notes to the statement of cash flows.
Transaction 4
The reconciliation between the opening and closing balances of cash and cash equivalents will be
as follows:
R
Opening balance (500 000 × 2,00) 1 000 000
Closing balance (600 000 × 2,25) 1 350 000
Total movement for the year 350 000
Exchange differences (500 000 × (2,25 – 2,00)) 125 000
Change in cash and cash equivalents (100 000 × 2,25) 225 000
IAS 7.28 requires the movement in cash and cash equivalents and related exchange differences to
be disclosed separately.
5.5.7 Leases
When the lessee repays a lease instalment, the payments are divided into capital and
interest portions. The capital portion is the repayment of a loan that is classified under
financing activities, while the interest is shown with other interest cash flows, probably under
operating activities. When the lease is initially recognised, there is no flow of cash and
therefore no entry in the statement of cash flows (refer to Example 5.2). The transaction
should, however, be reflected in the notes to the statement of cash flows.
5.5.8 Discontinued operations

The cash flows from discontinued operations are not specifically addressed in IAS 7. The
cash flows from discontinued operations of an entity should be disclosed separately for
operating, investing and financing activities (IFRS 5 Non-current Assets Held for Sale and
Discontinued Operations paragraph 33(c)). These disclosures may be presented either in
the notes or in the financial statements. This enables the users to differentiate between
streams of cash, namely those that are likely to continue and those that will discontinue. The
predictive value of the information is thus enhanced. Comparative amounts in the statement of
cash flows should be restated accordingly.
5.6 Disclosure
The following is a summary of the disclosure requirements of IAS 7:
Cash flows from operating activities are shown using either the direct or the indirect
method. In both cases, the disclosure of the following is required:
– cash flow generated by operations, which, in terms of the direct method, is merely
the difference between cash receipts from customers and cash paid to suppliers and
employees. In accordance with the indirect method, this constitutes a reconciliation of
the profit before tax as reflected in the profit or loss section of the statement of profit or
loss and other comprehensive income and the cash generated by operations (this
reconciliation is carried out by adjusting the profit before tax for the non-cash items
appearing in the profit or loss section of the statement of profit or loss and other
comprehensive income, and for movements in working capital, excluding movements
in cash and cash equivalents); and
– interest paid, dividends and taxation, except in cases where interest paid and dividends
are shown as part of investing and financing activities.
Cash flows from investing activities, distinguishing as far as possible between the main
categories, gross cash receipts and gross cash payments, except where gross disclosure
is not required (refer to section 5.5.5).
Cash flows from the acquisition and disposal of subsidiaries and other entities are
shown separately under investing activities (refer to section 5.5.1).
Cash flows from financing activities, distinguishing as far as possible between the main
categories, gross cash receipts and gross cash payments, except where gross disclosure
is not required (refer to section 5.5.5).
The following additional disclosures are recommended in appropriate circumstances:
the policy followed in determining the composition of cash and cash equivalents;
the components of cash and cash equivalents;
a reconciliation between the amounts of cash and cash equivalents in the statement of
cash flows and the corresponding items in the statement of financial position;
the amount of significant cash and cash equivalent balances held by the entity and not
available for use by the group, with commentary from management – for example where a
subsidiary operates in a country where exchange controls or other legal restrictions apply;
information on non-cash financing and investing transactions;
a reconciliation of liabilities arising from financing activities, presenting cash flow and
non-cash flow movements (IAS 7.44D);
the amount of the undrawn borrowing facilities available for future operating activities and
to settle capital commitments, with an indication of any limitations on the use of such
facilities; and
the aggregate amount of cash flows that represent increases in operating capacity
separately from those cash flows that are required to maintain operating capacity.
Furthermore, an entity is required to disclose the following in terms of the Standard on
discontinued operations for each discontinued operation (IFRS 5.33(c)) during the current
financial reporting period:
the amounts of net cash flows attributable to:
– operating activities;
– investing activities; and
– financing activities.

The following are the draft annual financial statements of Alfa Ltd for the year ended 30 June 20.17:
Alfa Ltd
for the year ended 30 June 20.17
20.17 20.16
R’000 R’000
Revenue 4 830 4 643
Cost of sales (2 898) (3 186)
Gross profit 1 932 1 457
Other income 660 20
– Gain on disposal of land 660 –
– Reduction in allowance for credit losses – 20
Distribution costs (390) (125)
Other expenses (480) (360)
– Audit fees 100 90
– Depreciation – machinery 220 210
– furniture 20 20
– Allowance for credit losses 100 –
– Loss on disposal of machinery 20 –
– Finance costs 20 40

Income tax expense (500) (100)
Other comprehensive income
Items that will not be reclassified to profit or loss
Gain on property revaluation 2 000 –
Income tax on other items of comprehensive income (448) (–)
Alfa Ltd
Statement of financial position as at 30 June 20.17
20.17 20.16
R’000 R’000
Assets
Non-current assets
Property, plant and equipment 4 920 2 000
Land at valuation 4 000 –
Land at cost – 1 240
Machinery 800 660
Cost price 1 600 1 400
Accumulated depreciation (800) (740)
Furniture 120 100
Cost price 200 160
4 920 2 000
Current assets
Inventories 3 200 2 800
Debtors 4 400 3 600
Cash on deposit 600 200
Bank 480 –
8 680 6 600
Total assets 13 600 8 600
Alfa Ltd
Statement of financial position as at 30 June 20.17
20.17 20.16
R’000 R’000
Share capital – ordinary 3 300 1 460
Retained earnings 690 700
Other components of equity
– Revaluation surplus 1 552 –
Total equity 5 542 2 160
Long-term borrowings 2 200 2 000
Deferred tax 610 40
2 810 2 040
Current liabilities
Creditors 2 800 3 200
Current portion of long-term borrowings 1 200 200
Tax payable: South African Revenue Service (SARS) 38 100
Shareholders for dividends 1 200 800
Unclaimed dividends 10 –
Bank overdraft – 100
5 248 4 400
Total liabilities 8 058 6 440
Total equity and liabilities 13 600 8 600
Alfa Ltd
Statement of changes in equity for the year ended 30 June 20.17
Share Revaluation Retained
Total
capital surplus earnings
R’000 R’000 R’000 R’000
Balance at 30 June 20.15 1 460 – 640 2 100
Preference dividend – – (32) (32)
Ordinary dividend – – (800) (800)
Total comprehensive income for the year – – 892 892
Profit for the year – – 892 892
Other comprehensive income, net of tax – – – –
Balance at 30 June 20.16 1 460 – 700 2 160

Ordinary shares issued 1 840 – – 1 840
Preference dividend – – (32) (32)
Ordinary dividend – – (1 200) (1 200)
Total comprehensive income for the year – 1 552 1 222 2 774
Profit for the year – – 1 222 1 222
Other comprehensive income, net of tax – 1 552 – 1 552
Balance at 30 June 20.17 3 300 1 552 690 5 542
Additional information
1. Land at a cost of R540 000 was sold during the year and new land was acquired. This was not
done to replace the land that was sold.
2. Machinery with a cost of R400 000 was purchased on 31 October 20.16 to replace existing
machinery which cost R200 000 and was sold on 1 July 20.16.
3. Depreciation on machinery and furniture is calculated at 15% per annum and 10% per annum
respectively on the straight-line basis.
4. Furniture with a cost of R40 000 was purchased on 1 July 20.16, as a replacement of old furniture.
The statement of cash flows using the indirect method will be prepared as follows:
Alfa Ltd
Statement of cash flows for the year ended 30 June 20. 17
(Indirect method)
Notes 20.17
R’000
Cash flows from operating activities (1 540)
Adjusted for:
Gain on disposal of land (660)
Depreciation (220 + 20) 240
Increase in the allowance for credit losses 100
Loss on disposal of machinery 20
Interest paid 20
Operating profit before changes in working capital 1 442
Changes in working capital (1 700)
Increase in inventory (3 200 – 2 800) (400)
Increase in debtors (4 400 + 100 – 3 600) (900)
Decrease in creditors (2 800 – 3 200) (400)
Cash generated from operations (258)

Interest paid (20)
Tax paid (4) (440)
Dividends paid (800 + 1 232 (1 200 + 32) – 1 210 (1 200 + 10)) (822)
Cash flows from investing activities (520)
Investments to maintain operating capacity (440)
Replacement of machinery (given) (400)
Replacement of furniture (given)/(200 – 160) (40)
Investments to expand operating capacity (80)
Additions to land (1 240 – 540 + 2 000 – 4 000) (1 300)
Proceeds on disposal of land (540 + 660) 1 200
Proceeds on disposal of machinery (– 740 – 220 + 800 + 200 – 20) or (see (5)) 20
Cash flows from financing activities 3 040

Proceeds from long-term borrowings ((2 200 + 1 200) – (2 000 + 200)) 4 1 200
Proceeds from issue of share capital (3 300 –1 460) 2 1 840
Net increase in cash and cash equivalents 980

Cash and cash equivalents at beginning of year 1 100
Cash and cash equivalents at end of year 1 1 080
Notes to the financial statements (limited to cash flow items)

1. Cash and cash equivalents
Cash and cash equivalents consist of cash on deposit and bank account balances. Cash and cash
equivalents included in the statement of cash flows comprise the following statement of financial
position amounts:
20.17 20.16
R’000 R’000
Cash on deposit 600 200
Bank balances 480 (100)
1 080 100
2. Issuing of share capital
20.17
R’000
During the period, additional share capital was issued as follows:
1 840 000 ordinary shares (assumption) 1 840
1 840
3. Reconciliation from liabilities arising from financing activities

20.16 Cash flows 20.17
Non-cash changes
R’000 R’000
Foreign Fair value
exchange changes
Loans 2 200 1 200 – – 3 400
The statement of cash flows using the direct method will differ from that using the indirect method in
one respect only: ‘Cash generated from operations’ will be reflected as follows:
Alfa Ltd
Statement of cash flows for the year ended 30 June 20. 17
(Direct method)
Note R’000
Cash receipts from customers (4 830 – 900 (4 400 + 100 – 3 600)(1)) 3 930
Cash paid to suppliers and employees
(3 698 (3) + 390 (distribution costs) + 100 (audit fees)) (4 188)
or (2 898 (cost of sales) + 390 + 100 + 400 (inventory) + 400 (creditors))
Cash generated from operations 1 (258)
Comment
¾ Cash receipts from customers and cash paid to suppliers and employees, are calculated as
follows:
Calculations
(1) Debtors
R’000 R’000
Opening balance 3 600 Bank (Balancing amount) 3 930
Sales 4 830 Allowance for credit losses 100
Closing balance 4 400
8 430 8 430
(2) Inventories
R’000 R’000
Opening balance 2 800 Cost of sales 2 898
Payables (Balancing amount) 3 298 Closing balance 3 200
6 098 6 098
(3) Creditors
R’000 R’000
Bank (Balancing amount) 3 698 Opening balance 3 200
Closing balance 2 800 Inventories (2) 3 298
6 498 6 498
continued
(4) SARS
R’000 R’000
Opening balance 100
Bank (Balancing amount) 440 Income tax expense 378
Closing balance 38
590 478
Deferred tax
R’000 R’000
Closing balance 610 Opening balance 40
Revaluation on property 448
Income tax expense (Balancing 122
amount)
610 610
Income tax expense
R’000
SARS 378
Deferred tax 122
Statement of profit or loss 500
(5) Alternative calculation for proceeds on disposal of machinery: R’000

Carrying amount of machine on date of disposal (calculated below) 40
Loss on disposal of machine (given – statement of profit or loss) (20)
Proceeds on disposal of machine – to disclose in statement of cash flows 20
Carrying amount of machine on date of disposal 40
Cost (given) 200

Accumulated depreciation (–740 – 220 + 800) (160)
The following note will accompany the statement of cash flows when prepared in accordance with the
direct method, in addition to the notes already indicated above:
Notes to the financial statements
1. Reconciliation of profit before tax with cash generated from operations
20.17
R’000
Adjusted for:
Gain on disposal of land (660)
Depreciation (220 + 20) 240
Increase in allowance for credit losses 100
Loss on disposal of machinery 20
Interest paid 20
1 442
Working capital changes: (1 700)
Increase in inventory (3 200 – 2 800)* (400)
Increase in debtors(4 400 + 100 – 3 600) (900)
Decrease in creditors(2 800 – 3 200)* (400)
Cash generated from operations (258)

continued
Comment
¾ When the inventory balance increases from the prior period, it is an indication that the company
purchased more inventory in the current year; therefore there will be a cash outflow in the
statement of cash flows for the current period.
¾ When the creditors (trade payables) balance decreases from the prior period, it is an indication
that the company settled more of their outstanding debt in the current year, instead of obtaining
credit from their suppliers. Therefore there will be a cash outflow in the statement of cash flows
for the current period. The counter-arguments will also hold.
CHAPTER
6
Accounting policies, changes in
accounting estimates and errors
(IAS 8)
Contents
6.1 Overview of IAS 8 Accounting Policies, Changes in Accounting Estimates
and Errors .......................................................................................................... 112
6.2 Background ....................................................................................................... 112
6.3 Accounting policies ............................................................................................ 112
6.3.1 Selection of accounting policies ............................................................. 113
6.3.2 Consistency of accounting policies ......................................................... 113
6.4 Changes in accounting policies ......................................................................... 114
6.4.1 Schematic representation of changes in accounting policies ................. 116
6.4.2 Changes in accounting policy due to the initial application of
a Standard or Interpretation .................................................................... 117
6.4.3 Voluntary change in accounting policy ................................................... 117
6.4.4 Disclosure requirements in case of non-application of a new
Standard or Interpretation ....................................................................... 123
6.5 Changes in accounting estimates ..................................................................... 123
6.5.1 Disclosure requirements ......................................................................... 125
6.5.2 Example in respect of change in accounting estimate ........................... 125
6.6 Errors ................................................................................................................. 127
6.6.1 Prior period errors ................................................................................... 127
6.6.2 Material prior period errors ..................................................................... 128
6.6.3 Disclosure requirements ......................................................................... 130
6.6.4 Example in respect of a material prior period error ............................... 131
6.7 Impracticability of retrospective application and retrospective restatement ...... 138
111
6.1 Overview of IAS 8 Accounting Policies, Changes in Accounting

Estimates and Errors
Determined by Accounting
Accounting policies Initial decision Standards and
Interpretations.
Application of accounting policy

If no Standard or Interpretation
should be consistent from
exists, management should
period to period and for all
apply its judgement.
similar transactions.
Accounting policies are only Accounting policy changes

changed if: must be applied in terms of
required by an the transitional provisions of a Changes in accounting policy
Accounting Standard or new Accounting Standard, or should be appropriately
Interpretation; or retrospectively disclosed.
the change will provide (including all comparative
more relevant and periods shown and their
reliable information. opening balances).
Changes in estimates
Changes are applied
should be appropriately
prospectively, namely
Changes in estimates disclosed, including the
current reporting period and
effect of the change on
future periods (where
future reporting periods
appropriate).
(where appropriate).
Corrections are made

retrospectively as if the Corrections must be
error was never made. appropriately disclosed.
Prior period errors Note that only corrections
Restate comparative amounts of prior period errors are
and opening balances, where disclosed.
appropriate.
6.2 Background
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors prescribes the
criteria for selecting and changing accounting policies, together with the accounting
treatment and disclosure of such changes as well as changes in accounting estimates and
corrections of prior period errors in the entity’s financial statements. The objective of IAS 8 is
to enhance the relevance and reliability of an entity’s financial statements as well as the
comparability of those financial statements over time and with the financial statements of
other entities (IAS 8.1).
6.3 Accounting policies

IAS 8 addresses the selection, adoption and consistent application of accounting policies
and the required and voluntary changes in accounting policies.
Accounting policies, changes in accounting estimates and errors 113
Accounting policies are defined in IAS 8.5 as the specific principles, bases, conventions,
rules and practices adopted by an entity in preparing and presenting financial statements.
These principles, bases, conventions, rules and practices are found in the Standards and
Interpretations of the International Accounting Standards Board (IFRSs).
6.3.1 Selection of accounting policies

Management must select and apply an entity’s accounting policies so that the financial
statements comply with all the requirements of each applicable Standard and Interpretation.
Accounting policies prescribed by the Standards need not be applied when the effect of
applying them is immaterial. An item would be material if it might influence the economic
decisions of the users of the financial statements (also refer to sections 3.4.4 and 6.6.2).
However, it is inappropriate to make, or leave uncorrected, immaterial departures from
IFRSs to achieve a particular presentation of an entity’s financial position, financial
performance or cash flows (IAS 8.8). The Conceptual Framework requires that financial
information should be a faithful representation and be neutral.
Where there is no specific IFRS that applies to a specific transaction or event, management
must use its judgement to develop and apply accounting policies to ensure that the financial
statements provide information that is:
relevant to the decision-making needs of users; and
reliable, in that the financial statements:
– faithfully present the financial position, financial performance and cash flows of the
entity;
– reflect the economic substance of transactions, events and conditions and not merely
the legal form;
– are neutral, that is, free from bias;
– are prudent; and
– are complete in all material aspects (IAS 8.10).
In making this judgement, management must refer to, and consider the applicability of, the
following sources (in descending order):
the requirements and guidance in Standards and Interpretations dealing with similar and
related issues; and
the definitions, recognition criteria and measurement concepts for assets, liabilities, income
and expenses in the Conceptual Framework for Financial Reporting (the Conceptual
Framework) (IAS 8.11).
Management may also consider the most recent pronouncements of other standard-setting
bodies that use a similar conceptual framework to develop accounting standards, other
accounting literature and accepted industry practices, to the extent that these do not conflict
with the sources above (IAS 8.12).
6.3.2 Consistency of accounting policies

In terms of the consistency concept (that also implies comparability) (also refer to chapters 2
and 3), there must be consistent accounting treatment of like items within each accounting
period, and from one period to the next. Consistency has two aspects: consistency over time
and consistency of disclosure of similar items.
IAS 1.45 states that the presentation and classification of items in the financial statements
should be retained from one period to the next, unless:
a significant change in the nature of the entity’s operations has taken place, or upon a
review of its financial statement presentation, it was decided that another presentation or
classification would be more appropriate; or
a Standard or Interpretation requires a change.
In such circumstances, comparative amounts are restated.

IAS 8.13 requires that accounting policies must be applied consistently for similar
transactions, events and conditions, unless a Standard or Interpretation specifically requires
or permits categorisation of items for which different policies may be appropriate. If a
Standard or Interpretation requires or permits categorisation of items, an appropriate
accounting policy is selected and applied consistently to each category. For example,
different accounting policies may be chosen for different categories of property, plant and
equipment in terms of IAS 16 Property, Plant and Equipment (e.g. at cost or revalued
amounts). Once the appropriate policy has been chosen, however, it is applied consistently
to the particular category.
However, where separate categorisation of items is not allowed or permitted by a Standard,
the same accounting policy must be applied to all similar items (e.g. where the same
model is required for all investment properties – refer to chapter 17).
A chosen accounting policy must be maintained unless a significant change in the nature of
the entity’s activities has occurred, a review of its presentation indicates that a change in
presentation will provide a more faithful representation of the transactions, events or
conditions, or if a change in presentation is required by an Accounting Standard or
Interpretation.
6.4 Changes in accounting policies

Changes in accounting policies are not expected to occur often. One of the enhancing
qualitative characteristics prescribed by the Conceptual Framework for the financial
statements is comparability, requiring that the financial statements of the same entity of one
year can be compared to the results in subsequent years in order to identify trends. If
changes in accounting policy take place too often, this goal is negated.
A change in accounting policy can take place in terms of IAS 8.14 only if:
it is required by a Standard or an Interpretation; or
the change results in the financial statements providing reliable and more relevant
information about the effects of transactions, events or conditions on the entity’s financial
position, financial performance or cash flows.
The first instance mentioned arises from where particular reporting practices were used that
are now prohibited by law or a new Standard. In these instances, it is necessary to
incorporate the change in accounting policy in the statements in order to comply with the
newly accepted reporting method.
If an entity enters into a new type of transaction, or transactions that differ in substance from
those previously entered into, it requires the adoption of a new accounting policy. However,
this does not constitute a change in accounting policy (IAS 8.16). The initial adoption of a
policy to carry assets at revalued amounts constitutes a change in accounting policy in terms
of IAS 8.17, but must be accounted for in accordance with IAS 16 Property, Plant and
Equipment (refer to chapter 9) and IAS 38 Intangibles (refer to chapter 16), and not in
accordance with IAS 8.
IAS 8 requires that changes in accounting policies must be applied retrospectively, unless
the transitional provisions of a Standard prescribed otherwise. In extraordinary
circumstances where it is not practicable to apply the policy retrospectively, the policy may
be applied prospectively.
Disclosures regarding changes in accounting policies need only be presented in the year of
the change and not in subsequent periods.
IAS 1 Presentation of Financial Statements has introduced a requirement to include a third

statement of financial position (as at the beginning of the preceding period) whenever an
entity:
retrospectively applies an accounting policy;
makes a retrospective restatement of items in its financial statements; or
reclassifies items in its financial statements; and
such adjustments have a material effect on the information in the statement of financial
position at the beginning of the preceding period (IAS 1.40A).
In the above circumstances, an entity is required to present, as a minimum, three
statements of financial position. A statement of financial position must be prepared as at:
the end of the current period;
the end of the preceding period; and
the beginning of the preceding period.
Disclosure in terms of IAS 8 (see below) is specifically required, but the other related notes
to the statement of financial position as at the beginning of the preceding period are not
required.
6.4.1 Schematic representation of changes in accounting policies
Change in Accounting Policy IAS 8.14 to .27
Is a new Standard being

Initial application of a new Voluntary change to achieve
applied or will the
Standard or reliable and more relevant
proposed change in policy
Interpretation information
achieve more reliable or
(paragraphs 7 and 14(a)) (paragraphs 10 and 14(b))
relevant information?
NO
Apply transitional Refer to:

provisions in Standard A change in accounting Other Standards or
or Interpretation policy may not be made Interpretations (on similar and
(paragraph 19(a)) related issues)
Conceptual Framework
Pronouncements by other
standard-setting bodies (with a
similar conceptual framework)
Other accounting literature
If there are no transitional
Accepted industry practices
provisions (paragraph 19(b))
(paragraphs 11 and 12)
Apply retrospectively as if
new policy has always been
applied
(paragraph 22)
If application is impracticable
or partially impracticable
(paragraph 23)
The cumulative effect of the change Cumulative effect is not known at

in accounting policy is known beginning of current period
(paragraph 24) (paragraph 25)
Apply new policy prospectively from earliest

Determine period-specific effects
date practical in determining the cumulative
(paragraph 24)
effect
Apply new policy to earliest period practical

for retrospective application
(including the current period)
6.4.2 Changes in accounting policy due to the initial application of a Standard

or Interpretation
If the change in accounting policy is necessary due to the adoption of a new Standard or
Interpretation, the treatment follows the transitional provisions contained in the respective
Standard (IAS 8.19(a)). Where there are no such transitional provisions, a retrospective
change in accounting policy shall be effected (IAS 8.19(b)). This entails adjusting the
opening balances of each affected component of equity for the earliest (and each) prior
period presented, as if the new accounting policy had always been applied (IAS 8.22).
There is an exemption clause in IAS 8 that allows comparative amounts not to be restated if
doing so is not practicable in terms of IAS 8.23 to .27. When it is impracticable to calculate
the period-specific effects of applying the change in policy to comparatives, the entity
applies the new accounting policy to the carrying amounts of assets and liabilities at the
beginning of the earliest period presented where retrospective application is possible (which
may be the current period). A corresponding adjustment is made to the opening balances of
each affected component of equity for that period.
If it is impracticable to calculate the cumulative effect of the change in accounting policy at
the beginning of the current period for all prior periods, the entity will apply the policy
prospectively from the earliest date from which it is practicable to determine the cumulative
effect. This implies that in certain instances the cumulative effect of changes in accounting
policies will only be partially recognised if it is impracticable to recognise it fully (i.e. it is not
possible to calculate it).
6.4.2.1 Disclosure requirements in case of the initial application of a Standard

or Interpretation (IAS 8.28)
When a change in accounting policy results from the initial application of a Standard or
Interpretation, the following must be disclosed:
the title of the Standard or Interpretation;
when applicable, that the change in accounting policy is made in accordance with its
transitional provisions;
the nature of the change in accounting policy;
when applicable, a description of the transitional provisions;
when applicable, the transitional provisions that may have an effect on future periods;
for the current period and each prior period presented, to the extent practicable, the
amount of the adjustment for each financial statement line item affected;
the amount of the adjustment relating to periods before those presented, to the extent
practicable (i.e., the cumulative adjustment against the opening balance of retained
earnings); and
if retrospective application is impracticable for a particular prior period, or for periods
before those presented, the circumstances that led to the existence of that condition and
a description of how and from when the change in accounting policy has been applied.
6.4.3 Voluntary change in accounting policy

When the management of an entity decides voluntarily to adopt a new accounting policy in
terms of IAS 8.14(b), the change of policy is applied retrospectively. A policy is only
changed voluntarily if it results in reliable and more relevant information about the
transactions, events or conditions reported in the financial statements.
If, however, it is impracticable, the comparatives need not be restated retrospectively. In
such instances, the new accounting policy is applied prospectively, subject to the
requirement addressed above in section 6.4.2. The reason for not applying the policy
retrospectively must be stated in the notes to the financial statements.
A voluntary change in accounting policy takes place because the new policy will result in a
fairer presentation of the events and transactions in the financial statements, but it can also
lead to misuse. It is, for example, possible that certain changes in accounting policies can
be adopted in practice with the particular aim of manipulating the reported profit figures.
Only by applying professional judgement and ensuring that the financial statements comply
with the qualitative characteristics of financial statements as per the Conceptual Framework
can such manipulation be prevented.
6.4.3.1 Retrospective application of a change in accounting policy
A retrospective application of a change in accounting policy results in financial statements
that are adjusted to show the new accounting policy being applied to events and
transactions as if the new accounting policy had always been in use – in other words,
applied since the founding of the entity. This implies that the financial statements, including
the comparative amounts, must be adjusted to reflect the new policy. If the change in
accounting policy affects periods prior to the comparative period, a cumulative adjustment is
made to the opening balance of the retained earnings in the comparative year, or the
earliest period presented if more than one year’s comparative amounts are given. Note that
IAS 8 allows for partial recognition, subject to the limitations on retrospective application, as
discussed earlier.
6.4.3.2 Disclosure requirements in case of voluntary change in accounting policy
(IAS 8.29)
In addition to presenting a third statement of financial position (as discussed above in
section 6.4), when a voluntary change in accounting policy takes place, the following must
be disclosed:
the nature of the change in accounting policy;
the reasons why applying the new accounting policy provides reliable and more relevant
information;
for the current period and each prior period presented, to the extent practicable, the
amount of the adjustment for each financial statement line item affected;
the amount of the adjustment relating to periods before those presented, to the extent
practicable (i.e., the cumulative adjustment against the opening balance of retained
earnings); and
if retrospective application is impracticable for a particular prior period, or for periods
before those presented, the circumstances that led to the existence of that condition and
a description of how and from when the change in accounting policy has been applied.
Example 6.1 Change in accounting policy (retrospective restatement)
Comment
¾ A suggested method to approach the current and retrospective adjustments to the financial
statements resulting from an entity’s change in accounting policy, as well as the required
disclosure in the notes, is as follows:
¾ Calculate the current and retrospective cumulative and period-specific effects. (Be aware of
any possible impracticable retrospective applications (refer to section 6.7)).
¾ Prepare the applicable journals to account for the current and retrospective application of the
new accounting policy.
¾ Apply these journals to each individual line item affected in the financial statements.
¾ Disclose the effect of the changes to each financial statement line item in the notes to the
The preliminary statement of profit or loss and other comprehensive income and other information
of Gazelle Ltd for the year ended 31 December 20.19 is provided:
continued
20.19 20.18
R R
Revenue 1 401 000 1 000 000
Cost of sales (1 000 500) (700 000)
Opening inventory 300 000 200 000
Purchases 1 100 500 800 000
1 400 500 1 000 000
Closing inventory (400 000) (300 000)
Gross profit 400 500 300 000

Other expenses (100 500) (100 000)
Profit before tax 300 000 200 000
Income tax expense (only current tax) (84 000) (56 000)
Profit for the year 216 000 144 000
Retained earnings at the beginning of the year:
20.18: R150 000
20.19: R294 000
In 20.19, the company decided to change the method used to value its inventories from the weighted
average cost method to the first-in, first-out cost method. Management is of the opinion that this
would result in a fairer presentation of the financial position and operating results because of
fluctuations in inventory prices. The closing inventories valued in accordance with the new basis are as
follows:
31 December 20.17 R240 000
31 December 20.18 R390 000
31 December 20.19 R480 000
The normal income tax rate is 28%. There are no temporary differences other than those arising from
the above information. The South African Revenue Service (SARS) accepted the new valuation
method of inventories on 31 December 20.19.
Comment
¾ It is important to note that the opening and closing inventory as included in the preliminary cost
of sales above are based on the old method. Both these amounts should be adjusted to reflect
the new valuation method.
The change in accounting policy will be disclosed in the financial statements of Gazelle Ltd as follows:
Gazelle Ltd
20.19 20.18 20.17
Note R R R
Assets
Current assets
Inventories 3 480 000 390 000 240 000
continued
Gazelle Ltd
20.19 20.18
Note
R R
Revenue 1 401 000 1 000 000
Cost of sales (1 010 500) 1 (650 000) 2
Gross profit 390 500 350 000
Other expenses (100 500) (100 000)
Income tax expense 2 (81 200) 3 (70 000) 4
Other comprehensive income – –
Total comprehensive income for the year 208 800 180 000
1
R1 000 500 + R10 000 (Jnl 4) = R1 010 500
2
R700 000 – R50 000 (Jnl 2) = R650 000
3
R84 000 – R2 800 (Jnl 5) = R81 200
4
R56 000 + R14 000 (Jnl 3) = R70 000
Gazelle Ltd
Extract from the statement of changes in equity
Retained
Note earnings
R
Balance at 1 January 20.18 150 000
Change in accounting policy (R40 000 – R11 200) (Jnl 1) 3 28 800
Balance at 1 January 20.18 – restated 178 800
Other comprehensive income –
Balance at 31 December 20.18 – restated (R294 000 + R64 800) 358 800
Balance at 31 December 20.19 567 600

Gazelle Ltd
Notes for the year ended 31 December 20.19
1.1 Inventories
Inventories are valued at the lower of cost and net realisable value according to the first-in,
first-out cost method. This represents a change in accounting policy (refer to note 3).
2. Income tax expense
Major components of tax expense:
20.19 20.18
R R
Current tax expense (2) (20.18: R200 000 × 28%) 106 400 56 000
Deferred tax expense (3) (20.18: Jnl 3) (25 200) 14 000
Tax expense 81 200 70 000
continued
3. Change in accounting policy

During the year, the company changed its accounting policy in respect of the valuation of inventories
from the weighted average cost method to the first-in, first-out cost method. Management is of the
opinion that the new valuation method for inventories will result in a fairer presentation of the financial
position and operating results since there have been fluctuations in the market prices. This change in
accounting policy has been accounted for retrospectively and the comparative amounts have been
restated. The effect of this change in accounting policy is as follows:
20.19 20.18 20.17
R R R
(Increase)/Decrease in cost of sales (10 000) 50 000
Decrease/(Increase) in tax expense 2 800 (14 000)
(Decrease)/Increase in profit for the year (7 200) 36 000
Increase in inventories 80 000 90 000 40 000
(Increase)/Decrease in current tax owing
(R106 400 (2) – R84 000 given) (22 400)
(Increase)/Decrease in deferred tax liability (25 200) (11 200)
Increase/(Decrease) in equity (retained earnings) 57 600 64 800 28 800
Increase in retained earnings – beginning of year 64 800 28 800
Calculations
1. Effect of change in accounting policy
Cumu- Period- Cumu- Period- Cumu-
lative specific lative specific lative
20.19 20.19 20.18 20.18 20.17
R R R R R
SFP P/L SFP P/L SFP
Weighted average (old policy) (400 000) (300 000) (200 000)
First-in, first-out (new policy) 480 000 390 000 240 000
Increase in inventory* per SFP 80 000 90 000 40 000
Increase/(Decrease) in profit before tax (10 000) 50 000
Tax @ 28% (22 400) 2 800 (25 200) (14 000) (11 200)
57 600 (7 200) 64 800 36 000 28 800
* An increase in closing inventories = decrease in cost of sales = increase in profit
2. Calculation of current tax expense
20.19
R
Reported profit (adjusted) (R300 000 – R10 000 (Jnl 4)) 290 000
Temporary differences 90 000
Opening inventories – new policy (per accounting as restated) 390 000
– old policy (per taxation – not restated) (300 000)
Taxable income 380 000

Current tax expense (R380 000 × 28%) 106 400
continued
20.19
R
Alternative calculation for the current tax expense in 20.19:
Revenue – taxable in full 1 401 000
Opening inventory 300 000
(old basis, as SARS accepted new basis for closing inventory)
Purchases 1 100 500
Closing inventory (new basis) (480 000)
Other expenses – deductible in full (100 500)
Current tax expense (R380 000 × 28%) 106 400
3. Calculation of deferred tax
Deferred Movement
Carrying Tax Temporary
tax – SFP to P/L
amount base differences
@ 28% @ 28%
Dr/(Cr) Dr/(Cr)
R R R R R
20.17 – Restated 240 000 200 000 40 000 (11 200) 11 200
20.18 390 000 300 000 90 000 (25 200) 14 000
20.19 480 000 480 000 – – (25 200)
Comment
¾ SARS does not normally go back to previous years and re-open assessments for changes in
accounting policies. This means that the tax base of inventories in prior years will be determined
using the ‘old’ method of valuation. IAS 8 however, requires that the carrying amounts of
inventories in the financial statements be changed retrospectively so that the prior years’ values
will be in accordance with the ‘new’ basis of valuation. This gives rise to a temporary difference for
deferred tax purposes.
4. Journal entries to account for the change in accounting policy
The full cumulative and period-specific effect for all comparative periods are available as is evident
from the calculation above; therefore the amounts in the financial statements for the year ended
31 December 20.18 (comparative period) can be restated for the cumulative effect of the change
in accounting policy on all prior periods, assuming that the comparative period can be re-opened
for purposes of processing these journals. Full retrospective application is therefore practicable.
Dr Cr
R R
Journal 1
1 January 20.18
Inventories (SFP) 40 000
Deferred tax (SFP) 11 200
Retained earnings – opening balance (Equity) 28 800
Restate the earliest period presented for the cumulative effect of the
change in accounting policy (change in the 20.17 closing inventories
balance) (R240 000 – R200 000); (R40 000 × 28%)
Journal 2
31 December 20.18
Cost of sales (P/L) 50 000
Account for the period-specific effect of 20.18
Journal 3
31 December 20.18
Income tax expense (P/L) 14 000
Tax effect for the period-specific effect of 20.18
continued
Dr Cr
R R
Journal 4
31 December 20.19
Account for the period-specific effect of 20.19
Journal 5
31 December 20.19
Current tax payable (SFP) (R80 000 × 28%) (note 3) 22 400
Deferred tax (SFP) (3) 25 200
Tax effect for the period-specific effect of 20.19
Comment
¾ The cumulative effect of Journals 1 and 2 is an increase in the inventories balance of R90 000
at the end of 20.18, which is in line with the calculations above.
¾ The cumulative effect of Journals 1, 2 and 4 is an increase in the inventories balance of
R80 000 at the end of 20.19, which is in line with the calculations above.
6.4.3.3 Prospective application of a change in accounting policy

Prospective application of changes in accounting policy should only be used when the
amount of the adjustment to the opening balance of the retained earnings cannot be
determined reliably, or if the transitional provisions of a new Standard specify such
treatment.
A prospective application of a change in accounting policy means that the new policy is only
applied to transactions, events and conditions after the date of implementation of the new
policy. Retrospective adjustments are not made, as is in the case of a retrospective change
in accounting policy, and the comparative amounts are not changed, nor are any
adjustments made to retained earnings. The new policy is applied only to new transactions,
events and conditions.
6.4.4 Disclosure requirements in case of non-application of a new Standard

or Interpretation
When the IASB issues a new or revised Standard or Interpretation, it will specify an effective
future date for it. When an entity has not applied a new Standard or Interpretation that has
been issued but is not yet effective, the entity must disclose:
this fact; and
known or reasonably estimable information relevant to assessing the possible impact
that application of the new Standard or Interpretation will have on the entity’s financial
statements in the period of initial application. The information disclosed must include:
– the title of the Standard or Interpretation;
– the nature of the impending changes in policy;
– the date by which the application of the Standard or Interpretation is required;
– the entity’s expected application date; and
– a discussion of the expected impact of the initial application, or if not known, a
declaration to that effect.
6.5 Changes in accounting estimates

Estimates are commonly used to measure the carrying amounts of assets and liabilities,
such as provisions, allowance for credit losses on debtors, depreciation, impairment losses, etc.
Some items in the financial statements cannot be measured precisely due to uncertainties
inherent in business activities. The use of estimates is thus necessary which involves
professional judgement based on the latest reliable information available at the time the
estimate is made. As professional judgement is often used in preparing financial statements,
it is possible that the exercise of judgement may prove to have been incorrect at a later
date. This does not imply, however, that an error was made. The preparer of the financial
statements merely used the information available at the date of estimation with reasonable
care in order to come to a conclusion that subsequent events proved to be incorrect. An
example is the estimate of the useful life of a depreciable asset. On the date of acquisition of
a depreciable asset, the expected useful life is estimated, based on the facts available at
that date. If the estimate proves to be incorrect at a later stage due to changes in
circumstances, new information or more experience, steps are taken to correct the estimate.
The correction of the estimate is called a ‘change in accounting estimate’, and takes place
continually. The financial statements are not less accurate as a result of the changes in
estimates. The use of reasonable estimates is an essential part of the preparation of
financial statements and does not undermine the faithful representation thereof.
A change in accounting estimates is either an adjustment of:
the carrying amount of an asset or a liability; or
the amount of the periodic consumption of an asset,
that results from the assessment of the present status of, and expected future benefits and
obligations associated with, assets and liabilities. Changes in accounting estimates are not
the same as the corrections of errors, as these changes result from new information or new
developments that became available, and are not the result of fixing mistakes, omissions,
misuse of information, etc.
Examples of the adjustment of the carrying amount of an asset or liability are the estimates
involved in determining the recoverable amount of an asset (e.g. value in use or net realisable
value) and determining the balance of a provision (e.g. a provision for environmental
restoration – also refer to IFRIC 1, which is addressed in chapter 15). The effect of the
changes in these estimates is recognised merely by adjusting the carrying amount of the
asset or liability. Estimates relating to the periodic consumption of an asset are made for the
residual value, pattern of economic benefits and useful life of the asset. The effect of the
changes in these estimates is recognised in profit or loss by changing the amount of the
depreciation expense to be recognised for the current (and future) period.
Changes in accounting estimates affect only the current period, or the current and future
periods. This implies that changes in estimates are recognised and disclosed prospectively,
in the periods affected by the change. An example of a change in estimate that affects only
the current period is a change in the allowance for credit losses (adjustment of the carrying
amount of receivables). Such a change in estimate is merely included in the profit or loss of
the current period and, if material, is disclosed as an item requiring specific disclosure in terms
of IAS 8, unless it is impracticable to do so. Even if the item does not have a material effect
on the results of the current period, but is expected to have a material effect in the future,
the item is disclosed separately as an item requiring disclosure in the current period in terms
of IAS 8, unless estimating it is impracticable.
Changes in the useful life, residual value and the depreciation method of a depreciable
asset are examples of items which affect both the current and future periods. The change of
estimate applicable to the current period is included in profit or loss. Once again, if the
amount is material in relation to the results of the current period or is expected to have a
material effect on future periods, the item will be disclosed in accordance with the specific
disclosure requirements of IAS 8, unless estimating it is impracticable, in which instance this
fact is disclosed in the financial statements.
A change of estimate made in the current period need not again be disclosed separately in
future periods.
In the exceptional instance where it is not possible to distinguish whether a transaction,

event or condition is a change in estimate or a change in accounting policy, then IAS 8
recommends that it be treated as a change in estimate.
6.5.1 Disclosure requirements

The following must be disclosed in respect of material changes in accounting estimates:
the nature of the change;
the amount of the change; and
the effect on future periods (if practicable to estimate) or else a statement that the future
effect is impracticable to estimate.
6.5.2 Example in respect of changes in accounting estimate
Example 6.2 Change in accounting estimate: Depreciation pattern
The following information was obtained in respect of the equipment of Londo Ltd for the year
ended 31 December 20.13:
The original cost of the equipment was R125 000 on 1 January 20.11.
According to the company’s management, the accounting estimate in respect of the depreciation
of equipment has changed, as the previous pattern of depreciation differed from the actual pattern
of economic benefits from depreciable assets. The reducing balance method is applied from 20.13
at 20% per annum, instead of the straight-line method over five years. The depreciation for the
20.13 financial year was calculated on the reducing balance method, as follows:
R’000
Balance at beginning of year – carrying amount of asset (R125 000 – R25 000 – R25 000) 75
Depreciation for the year (R75 000 × 20%) (15)
Balance at end of year 60
Comment
¾ The depreciation for the current year should reflect the newest estimate (of the pattern of
economic benefits). The approach is then to start with the carrying amount of the asset at the
beginning of the current year and to apply the newest estimates to it.
¾ Changes to the estimates that relate to the consumption of the future economic benefits
embodied in a depreciable asset affect the depreciation expense for the current year (refer to
IAS 8.38). As such, the newest estimates are used to calculate the depreciation expense for
the current year, irrespective of when the estimates change (i.e. at the beginning of, during, or
at the end of the year).
¾ The same approach would also have been followed, if, for example, the estimates for the
residual value and/or the useful life of the depreciable asset were changed as is illustrated in
the next example.
continued
The change in accounting estimate will be disclosed in the notes to the financial statements of
Londo Ltd as follows:
Londo Ltd
1. Property, plant and equipment Equipment Equipment
20.13 20.12
R’000 R’000
Carrying amount at the beginning of the year 75 100
Cost 125 125
Depreciation for the year (15) (25)
Carrying amount at the end of the year 60 75
Cost 125 125
The following items are included in profit before tax:
20.13 20.12
R’000 R’000
Expenses:
Depreciation 15 25
A change in the method of determining depreciation, from the straight-line method to the reducing
balance method, resulted in a change in estimate, which decreased depreciation on equipment for
the year by R10 000 (R25 000 – R15 000). The effect on future periods is an increase in the total
depreciation expense of R10 000 for the remaining useful life (1).
Comment
¾ The actual amount of depreciation (R15 000) is presented in the notes for property, plant and
equipment and profit before tax. Furthermore, IAS 8 requires disclosure of the amount of the
change itself (R10 000). IAS 8 does not specify where (in which note) such disclosure is to be
made.
Calculations
1. Change in accounting estimate
Effect of change in estimate on future periods R’000
Depreciation expense still to be written-off – old basis (R75 000 – (R125 000/5)) 50
Depreciation expense still to be written-off – new basis (given) 60
Increase in depreciation 10
Example 6.3 Change in accounting estimates: Useful life and residual value
Wifi Ltd bought a new item of plant on 1 January 20.11 at a total cost of R1 000 000. The plant
was depreciated evenly over its useful life of 6 years, with a residual value of R100 000.
New technology became available on 1 January 20.14. Wifi Ltd realised that the plant would need
to be replaced sooner than expected. On 1 January 20.14 the remaining useful life was estimated
to be 2 years (the new total useful life was considered to be 5 years), with a residual value of
R50 000.
continued
The depreciation for the year ended 31 December 2014 is calculated as follows:
R
Cost of the plant 1 000 000
Accumulated depreciation at 1 January 2014
((R1 000 000 – R100 000)/6 × 3 years) (450 000)
Carrying amount of the plant at the beginning of the year 550 000
Depreciation for the year ((R550 000 – R50 000)/2 years remaining from the
beginning of the current year) (250 000)
Carrying amount at the end of the year 300 000
Comment
¾ The depreciation for the current year should reflect the newest estimates (of the useful life and
residual value). The approach is then to start with the carrying amount of the asset at the
beginning of the current year and to apply the newest estimates to it.
¾ The estimates are changed as a result of new information (new technology) that became
available. This does not represent a prior period error.
¾ The effect of the change in the estimates for the periodic consumption of the plant (i.e. how
depreciation is calculated based on the new estimates for the useful life and residual value) to
be disclosed in the notes is:
Depreciation based on new estimates R250 000
Depreciation based on previous estimates (R150 000)
Effect of the change in the accounting estimates R100 000
Also refer to chapter 9 for more examples on the changes in estimates of the periodic
consumption of assets.
6.6 Errors
Errors can arise in respect of the recognition, measurement, presentation or disclosure of
elements of financial statements. Financial statements do not comply with IFRSs if they
contain either material errors, or immaterial errors made intentionally to achieve a particular
presentation of an entity’s financial position, financial performance or cash flows.
Errors discovered in the current period (and relating to it) are corrected before the financial
statements are authorised for issue and therefore do not require special treatment or
disclosure. Errors are, however, sometimes not discovered until a subsequent period, and
are called prior period errors. They may need special treatment, depending on the
materiality thereof.
6.6.1 Prior period errors

Prior period errors are omissions from, and misstatements in, the entity’s financial
statements for one or more prior periods arising from a failure to use (or misuse of) reliable
information that was available when the financial statements for those periods were
authorised for issue and could reasonably be expected to have been obtained and taken
into account in the preparation and presentation of those financial statements. Such errors
include the effects of mathematical mistakes, mistakes in applying accounting policies,
oversights or misinterpretations of facts, and fraud.
An example of an error made in the application of an accounting policy is the incorrect
application of the calculation of the recoverable amount of an asset that is possibly impaired
as required by IAS 36 Impairment of Assets. According to IAS 36, the recoverable amount of
an asset is the higher of its value in use and its fair value less costs of disposal. Should an
entity have used the lower of the two amounts when calculating the impairment loss in a
prior period, the resultant impairment loss would have been incorrect and it would constitute
an error that should be corrected retrospectively in accordance with IAS 8.
It is important to note that a change in an accounting estimate is not a correction of an error,
as a change in estimate results from new information, more experience or a change in
circumstances, whereas the correction of an error relates to information that was available in
prior periods. A change in estimate is inherent in accounting and will therefore not result in
financial statements that are incorrect or unreliable as is the case with errors. For example,
a gain or loss recognised on the outcome of a contingency is a change in estimate (based
on new information) and not an error.
6.6.2 Material prior period errors

Prior period omissions or misstatements of items are material if they could, individually or
collectively, influence the economic decisions of users made on the basis of the financial
statements. Materiality depends on the size and/or nature of the omission or misstatement
judged in the surrounding circumstances. The size, or nature of the item, or a combination of
both, could be the determining factor. An entity should correct material prior period errors
retrospectively in the first set of financial statements authorised for issue after the
discovery of the error. By the retrospective restatement or correction of an error, an entity
corrects the recognition, measurement and disclosure of amounts of the relevant element of
the financial statements as if the prior period error had never occurred.
Retrospective correction of a material prior period error involves (IAS 8.42):
restating the comparative amounts for the prior period(s) presented in which the error
occurred; or
if the error occurred before the earliest prior period presented, restating the opening
balances of assets, liabilities and equity for the earliest prior period presented.
Example 6.4
6.4 Retrospective correction of material prior period errors
The preliminary financial statements of Oops Ltd for the three years ended 31 December 20.18,
before any of the additional information below has been taken into account, reflected the following
items:
20.18 20.17 20.16
R R R
Assets:
Building – cost 1 000 000 1 000 000 1 000 000
Prepaid expense – 50 000 –
Equity:
Retained earnings:
Balance at the beginning of the year 4 700 000 3 800 000 3 000 000
Profit for the year 1 020 000 900 000 800 000
Balance at the end of the year 5 720 000 4 700 000 3 800 000
After reviewing the preliminary financial statements, the new financial director discovered the following
prior period errors. Both errors are regarded as material.
1. Oops Ltd acquired a new building on 1 January 20.14 at a cost of R1 000 000. The accountant
forgot to recognise any depreciation on the building.
The building should have been depreciated on the straight line basis over 10 years, with no residual
value.
continued
2. During 20.17, the company paid its annual insurance premium of R50 000 and incorrectly
recognised it as a prepaid expense. The insurance premium should have been expensed
during 20.17 in full.
Ignore any taxes.
The material prior period errors will be corrected retrospectively in the prior periods as follows:
Oops Ltd
Extract from statement of financial position as at 31 December 20.18
20.18 20.17 20.16
R R R
Assets as at the end of the year:
Building – cost 1 000 000 1 000 000 1 000 000
1 1 1
Accumulated depreciation (500 000) (400 000) (300 000)
2
Prepaid expense – – –
Equity:
Retained earnings (see below) 5 170 000 4 250 000 3 500 000
Oops Ltd
Extract from statement of changes in equity for the year ended 31 December 20.18
20.18 20.17
R R
Retained earnings:
Balance at the beginning of the year 4 250 000 3 500 000
As presented previously 4 700 000 3 800 000
3
Correction in respect of depreciation (400 000) (300 000)
Correction in respect of prepaid expenses (50 000) –
6
As presented previously 900 000
4
Correction in respect of depreciation (100 000)
5
Correction in respect of prepaid expenses (50 000)
Balance at the end of the year 5 170 000 4 250 000
1 The annual depreciation on the building was recognised against accumulated depreciation:
20.16: (R1 000 000/10 × 3 years)
20.17: (R1 000 000/10 × 4 years)
20.18: (R1 000 000/10 × 5 years)
2 The prepaid expense has now been corrected to reflect no prepaid expenses anymore.
3 20.17: The cumulative effect of the annual depreciation of R100 000 for 20.14, 20.15 and 20.16 is
corrected to the retained earnings as at the beginning of 20.17: R100 000 × 3 years = R300 000.
4 The annual depreciation for each period after 20.14 would also be corrected with R100 000. As
the error relates to the prior period presented, the comparative amounts for 20.17 are restated.
5 The error in respect of the insurance premium is corrected in the year in which it occurred (i.e.
20.17). As the error relates to a prior period presented (20.17), the comparative amounts for
20.17 are restated.
6 The financial statements for the current year (20.18) were not yet published. It is therefore not
needed to show the effect of the correction separately. The amount for the profit for the year is
corrected as: R1 020 000 – R100 000 = R920 000.
continued
Comment
¾ IAS 1.40A requires a third statement of financial position to be presented where a prior period
error was restated retrospectively. Therefore, 20.16 and 20.17 are presented as prior periods in
the statement of financial position.
¾ A third statement of changes in equity is not required (IAS 1.38A). Therefore, only the
comparative amounts for 20.17 are presented.
¾ The error relating to the depreciation that was not recognised occurred (in 20.14) before the
earliest prior period presented. Therefore, the opening balance for retained earnings3 for the
earliest prior period presented (i.e. 20.17) is restated with the cumulative effect of R300 000
(R100 000 for each of 20.14, 20.15 and 20.16).
¾ The comparative amounts for the prior period presented (20.17) are also restated with the
depreciation expense4 corrected.
¾ The comparative amount for the ‘profit for the year’ for 20.17 is restated for the insurance
premium5 that was now recognised as an expense in 20.17.
¾ The purpose of this example was to illustrate where the cumulative effect and period-specific
effect of the prior period errors are to be corrected. Full disclosure for prior period errors is
illustrated in the next example.
When a retrospective correction of a material prior period error is required, it may happen
that it is impracticable to determine either the period-specific effects (i.e. the effect for a
specific period) or the cumulative effect of the error (IAS 8.43 to .45). Should the
impracticability relate to period-specific effects on comparative information for one or more
prior periods presented, determine the earliest period for which retrospective restatement is
practicable. The necessary adjustment is then made against the opening balance of each
affected component of equity for that specific period, after which restatement will commence
from that period onwards. If it is impracticable to determine the cumulative effect of the error
on all prior periods at the beginning of the current period, comparative information should be
restated prospectively from the earliest date practicable. The cumulative restatement of
assets, liabilities and equity arising before that specific date is then disregarded. Note that
the above treatment is identical to the treatment of a change in accounting policy where
retrospective application of such a change is impracticable.
6.6.3 Disclosure requirements

Disclosures in respect of the correction of prior period errors will only be presented in the
year of the correction of the error and not in subsequent periods. The following information
regarding the correction of errors must be disclosed in the financial statements:
the nature of the prior period error;
for each prior period presented, to the extent practicable, the amount of the correction:
– for each financial statement line item affected; and
– for basic and diluted earnings per share, if presented;
the amount of the correction at the beginning of the earliest prior period presented
(i.e., the cumulative correction against the opening balance of retained earnings); and
if retrospective restatement is impracticable for a particular prior period, the
circumstances that led to the existence of that condition and a description of how and
from when the error has been corrected.
The requirement of IAS 1 to present a third statement of financial position (as discussed
above in section 6.4) also applies where a prior period error was restated retrospectively.
6.6.4 Example in respect of a material prior period error
Example 6.5
6.5 Prior period error and reclassification
The preliminary statements of profit or loss and other comprehensive income of Badger Ltd for the
three years ended 31 December 20.19, before any of the additional information below has been
taken into account, are provided:
20.19 20.18 20.17
R R R
Revenue 2 778 000 2 095 000 1 790 000
Cost of sales (1 348 000) (869 000) (800 000)
Gross profit 1 430 000 1 226 000 990 000
Other expenses (662 000) (672 000) (545 000)
Profit before tax 768 000 554 000 445 000
Income tax expense (215 040) (155 120) (124 600)
– Current tax (227 040) (116 120) (116 600)
– Deferred tax 12 000 (39 000) (8 000)
Profit for the year 552 960 398 880 320 400
1. Retained earnings on 1 January 20.17 was R763 000.
2. During the preparation of the financial information for the year ended 31 December 20.19, the
accountant established that a material error had been made in the published financial
statements for the years ended 31 December 20.17 and 20.18.
On 1 January 20.17, Badger Ltd purchased computer equipment for R800 000. The computer
equipment was installed at a cost of R110 000 and was available for use as intended by
management on 1 February 20.17. There is no residual value, and management estimated the
useful life to be 4 years. Depreciation is calculated on the straight-line basis.
During the year ended 31 December 20.17, when the asset was accounted for, only the
R800 000 was capitalised and the R110 000 was expensed (as professional fees paid).
3. The accountant immediately informed the South African Revenue Services (SARS) of the
error. SARS agreed to re-open the 20.17 and 20.18 tax assessments and make the necessary
adjustments. The tax rate has remained unchanged at 28%. No penalties were levied.
4. Assume SARS allowed a tax allowance on computer equipment as a straight-line deduction
over three years, without apportionment for parts of a year.
5. The following items are included in other expenses: 20.19 20.18 20.17
R R R
Depreciation (computer equipment and other items) 230 000 230 000 210 000
Professional fees paid – – 110 000
Staff costs 180 000 175 000 40 000
Distribution costs 97 000 77 000 –
Administrative expenses 155 000 190 000 185 000
662 000 672 000 545 000
Assume that the depreciation, professional fees and staff costs are correctly classified as
‘other expenses’. During 20.19, the accountant also realised that the distribution costs and
administrative expenses should be presented separately in the statement of profit or loss and
other comprehensive income.
6. Badger Ltd has not paid a dividend for the last 3 years.
continued
The financial statements and the relevant notes of Badger Ltd for the year ended
31 December 20.19 will be prepared as follows:
Badger Ltd
Notes 20.19 20.18 20.17
R R R
Assets
Non-current assets
Property, plant and equipment
Computer equipment 246 458 473 958 701 458
Other items xx xx xx
Equity
Retained earnings 2 056 689 1 523 528 1 144 450
Badger Ltd
20.19 20.18
Notes
R R
Revenue 2 778 000 2 095 000
Cost of sales (1 348 000) (869 000)
Gross profit 1 430 000 1 226 000
Distribution costs (97 000) (77 000)
Administrative costs (155 000) (190 000)
Other expenses (4) (437 500) (432 500)
Income tax expense 3 (207 339) (147 422)
Badger Ltd
Retained
earnings
R
Balance at 1 January 20.18 – as presented previously (R763 000 + R320 400) 1 083 400
Correction of error (note 1) 61 050
Balance at 1 January 20.18 – restated (8) 1 144 450
Total comprehensive income for the year – restated 379 078
Profit for the year (R398 880 – R19 802) 379 078
Balance at 31 December 20.18 – restated 1 523 528

Profit for the year (R552 960 – R19 799) 533 161
continued
Badger Ltd
1. Prior period error
In 20.17, an error was made in the calculation of property, plant and equipment. Installation costs for
computer equipment were expensed instead of being capitalised. The depreciation, tax allowances,
income tax expense and deferred tax were incorrectly calculated. The comparative amounts for 20.18
have been restated. The effect of the restatement on the financial statements is summarised below.
20.18 20.17
R R
(Increase)/Decrease in other expenses * (4) (27 500) 84 791
(Increase)/Decrease in income tax expense * (7) 7 698 (23 741)
(Decrease)/Increase in total comprehensive income for the year * (19 802) 61 050
(Decrease)/Increase in property, plant and equipment – cost * 110 000 110 000
(Increase)/Decrease in accumulated depreciation * (52 709) (25 209)
1 1
(Decrease)/Increase in property, plant and equipment * 57 291 84 791
2 2
Decrease/(Increase) in deferred tax liability * (5 775) (3 207)
3 3
Decrease/(Increase) in current tax owing * (10 268) (20 534)
4
Increase in equity * 41 248 61 050
Increase in retained earnings – opening balance * 61 050
1 20.17: (R701 458 (2) – R616 667 (2)) = R84 791 (R110 000 – R25 209 (Jnl 1))
20.18: (R473 958 (2) – R416 667 (2)) = R57 291 or cumulative change amount at end of 20.18 =
R84 791 – R27 500 (cumulative change at end of 20.17) = R57 291 (period change for 20.18);
2 Calc 6.3 or R5 775 is the cumulative change to end of 20.18: [R3 207 cumulative for 20.17
(calc 6.4) + period change of R2 568 for 20.18 (calc 6.4) = R5 775)]; [R3 207 (Jnl 1) + R2 568
(Jnl 3) = R5 775]
20.17: R3 207 (Jnl 1) and calc 6.3;
3 20.18: R10 268 is the cumulative change to end of 20.18: [(R20 534) cumulative for 20.17 +
period change of R10 266 for 20.18 = (R10 268)]; [R20 534 (Jnl 1) – R10 266 (Jnl 3) =
R10 268]
20.17: R20 534 (Jnl 1) and calc 5;
4 Proof: R61 050 (cumulative change 20.17) – R19 802 (period change 20.18) = R41 248
(cumulative change 20.18); [R61 050 (Jnl 1) – R27 500 (Jnl 2) + R10 266 (Jnl 3) – R2 568 (Jnl 3)
= R41 248]
Comment
¾ IAS 1.40A requires that when an entity retrospectively restates items in its financial statements
as a result of the correction of an error and the restatement has a material effect on the
information in the statement of financial position at the beginning of the previous year, it shall
present, as a minimum, three statements of financial position.
¾ In this case, the restatement resulting from the correction of the error affects 20.18 and 20.17.
Disclosure in terms of IAS 8 is required, whereby the comparative amounts (for 20.18) are
restated (IAS 8.42(a); 49(b)) and the opening retained earnings is adjusted with the cumulative
effect (for 20.17) (IAS 8.42(b); 49(c)). In terms of IAS 1.40C detailed notes for the statement of
financial position as at 1 January 20.18 (end of 20.17) are not required. A statement of profit or
loss and other comprehensive income for 20.17 is also not required (comparative amounts are only
required for one year (IAS 1.38)). Therefore, full disclosure of the amounts for 20.17 in the note for
the prior period error above, may perhaps not be needed, but were given for illustrative purposes.
¾ The effect on each of the line items in the statement of financial position that make up the net
effect on equity must be indicated.
continued
¾ According to IAS 8.49(b), an entity shall disclose* for each prior period presented, the amount
of the correction for each financial statement line item affected. This prior period error note
therefore has to indicate the effect of the correcting journal entry on all the financial statement
line items and not only those directly affected as a result of the prepared journal entry.
2. Reclassification
A portion of other expenses was reclassified to distribution costs and administrative expenses
during the current and comparative financial years. The separate disclosure of these items is
required by IFRSs. The comparative amounts have been restated accordingly as follows
(IAS 1.41):
20.18
R
Decrease in other expenses (Jnl 6) (267 000)
Increase in distribution costs (Jnl 6) 77 000
Increase in administrative expenses (Jnl 6) 190 000
20.19 20.18
3. Income tax expense R R
Current tax expense (5)
(R227 040 – R10 267 (Jnl 5)); (R116 120 – R10 266 (Jnl 3)) 216 773 105 854
Deferred tax expense (6.4)
((R12 000) + R2 566 (Jnl 5)); (R39 000 + R2 568 (Jnl 3)) (9 434) 41 568
Tax expense (7) 207 339 147 422
Calculations
1. Journal entries
To account for prior period error, assuming that the comparative period can be re-opened for
purposes of processing these journals:
Dr Cr
R R
Journal 1
1 January 20.18
Property, plant and equipment (SFP) (given) 110 000
Accumulated depreciation (SFP) (R208 542 – R183 333) (2) 25 209
Current tax payable (SFP) (5) 20 534
Deferred tax liability (SFP) (6.3) 3 207
Retained earnings – opening balance (Equity) 61 050
((R110 000 – R25 209) × 72%)
Restate earliest period presented for the cumulative effect of the
correction of the prior period error
Journal 2
31 December 20.18
Other expenses (Depreciation) (P/L) (R227 500 – R200 000) 27 500
Accumulated depreciation (SFP) 27 500
Account for the period-specific of the correction of prior period error
for 20.18
continued
Dr Cr
R R
Journal 3
31 December 20.18
Deferred tax expense (P/L) (6.4) 2 568
Deferred tax liability (SFP) 2 568
Current tax expense (P/L) (7) 10 266
Current tax receivable (SFP) 10 266
Account for the tax effects of the period-specific effect of the
correction of prior period error for 20.18
Journal 4
31 December 20.19
Other expenses (Depreciation) (P/L) 27 500
Account for the period-specific effect of the correction of prior period
error for 20.19
Journal 5
31 December 20.19
Deferred tax expense (P/L) (6.4) 2 566
Current tax expense (P/L) (7) 10 267
Current tax receivable (SFP) 10 267
Account for the tax effects of the period-specific effect of the
correction of prior period error for 20.19
To account for reclassification:
Journal 6
31 December 20.18
Distribution costs (P/L) 77 000
Administrative expenses (P/L) 190 000
Other expenses (P/L) 267 000
Reclassification of expense items
2. Depreciation of computer equipment
Before After
correction correction
of error of error
R R
Cost 800 000 910 000
Depreciation 20.17 (R800 000/4 × 11/12); (R910 000/4 × 11/12) (183 333) (208 542)
Carrying amount 31/12/20.17 616 667 701 458
Depreciation 20.18 (R800 000/4); (R910 000/4) (200 000) (227 500)
Carrying amount 31/12/20.18 416 667 473 958
Depreciation 20.19 (R800 000/4); (R910 000/4) (200 000) (227 500)
Carrying amount 31/12/20.19 216 667 246 458
continued
3. Tax allowances of computer equipment

Before After
correction correction
of error of error
R R
Cost 800 000 910 000
Tax allowance 20.17 (R800 000/3); (R910 000/3) (266 667) (303 333)
Tax base 31/12/20.17 533 333 606 667
Tax allowance 20.18 (R800 000/3); (R910 000/3) (266 667) (303 333)
Tax base 31/12/20.18 266 666 303 334
Tax allowance 20.19 (R800 000/3); (R910 000/3) (266 666) (303 334)
Tax base 31/12/20.19 – –
4. Other expenses
20.19 20.18 20.17
R R R
Amount disclosed in preliminary financial
statements (before correction of error) 662 000 672 000 545 000
Adjustments needed for corrected error 27 500 27 500 (84 791)
Professional fees that should have been
capitalised to the cost of asset – – (110 000)
1 1 2
Depreciation correction 27 500 27 500 25 209
Reclassification – Distribution costs and
3 4
Administrative expenses (252 000) (267 000) (185 000)
437 500 432 500 275 209
1 20.18 and 20.19: R227 500 – R200 000 = R27 500
2 20.17: R208 542 – R183 333 = R25 209
3 20.19: (R97 000 + R155 000)
4 20.18: (Jnl 6) or (R77 000 + R190 000)
5. Current tax
Adjustments needed for corrected error (36 668) (36 666) 73 334
Professional fees incorrectly expensed – – 110 000
2 1 1
Tax allowance adjustments (3) (36 668) (36 666) (36 666)
Thus adjustment to current tax expense
(decrease)/increase at 28% (10 267) (10 266) 20 534
Comprehensive calculation of current tax:
Amount as given before correction of error 227 040 116 120 116 600
Thus taxable income (R227 040/28%);
(R116 120/28%); (R116 600/28%) 810 857 414 714 416 429
Adjustments needed for corrected error (36 668) (36 666) 73 334
Professional fees incorrectly expensed – – 110 000
2 1 1
Tax allowance adjustments (3) (36 668) (36 666) (36 666)
Adjusted taxable income 774 189 378 048 489 763

Current tax at 28% thereof (new) 216 773 105 854 137 134
Current tax (old) (227 040) (116 120) (116 600)
Thus adjustment to current tax expense
(decrease)/increase (10 267) (10 266) 20 534
1 20.17 and 20.18: R303 333 – R266 667 = R36 666
2 20.19: R303 334 – R266 666 = R36 668
continued
6. Deferred tax relating to computer equipment

6.1 Before error was corrected
Deferred Movement
tax – SFP to P/L
amount base differences
@ 28% @ 28%
Dr/(Cr) Dr/(Cr)
R R R R R
31/12/20.16 – – – – –
31/12/20.17 616 667 533 333 83 334 (23 334) 23 334
31/12/20.18 416 667 266 666 150 001 (42 000) 18 666
31/12/20.19 216 667 – 216 667 (60 667) 18 667
6.2 After error was corrected
31/12/20.16 – – – – –
31/12/20.17 701 458 606 667 94 791 (26 541) 26 541
31/12/20.18 473 958 303 334 170 624 (47 775) 21 234
31/12/20.19 246 458 – 246 458 (69 008) 21 233
6.3 Adjustments needed to deferred tax balance
20.19 20.18 20.17
R R R
Deferred tax balance before error corrected (60 667) (42 000) (23 334)
Deferred tax balance after error corrected 69 008 47 775 26 541
Increase/(Decrease) 8 341 5 775 3 207
6.4 Effect on deferred tax movement – tax expense
20.19 20.18 20.17
R R R
Movement before correction of error (6.1) (18 667) (18 666) (23 334)
Movement after correction of error (6.2) 21 233 21 234 26 541
Thus increase in deferred tax expense 2 566 2 568 3 207
Deferred tax expense given in P/L (12 000) 39 000 8 000
Adjusted deferred tax expense amount (9 434) 41 568 11 207
7. Income tax expense (Test calculation))

20.19 20.18 20.17
R R R
Total tax expense given in P/L 215 040 155 120 124 600
Total adjustment (7 701) (7 698) 23 741
Increase in deferred tax expense (6.4) 2 566 2 568 3 207
(Decrease)/Increase in current tax expense (5) (10 267) (10 266) 20 534
207 339 147 422 148 341

Comment
¾ Due to the effect of the rounding on the various individual calculations that is included in the
calculations above, the total tax adjustment is not always exactly 28% of the adjustments made to
profit or loss. For example, the depreciation of 20.19 is adjusted with R27 500 and the tax effect is
expected to have been R7 700 (R27 500 × 28%).
continued
8. Retained earnings 1/1/20.18

20.17
R
Balance given as at 1/1/20.17 763 000
Total comprehensive income for 20.17 before correction of error (given) 320 400
Correction of error:
Decrease in other expenses (4) 84 791
Increase in income tax expense (7) (23 741)
1 144 450
6.7 Impracticability of retrospective application and retrospective

restatement
The retrospective application for changes in accounting policies or the restatement of
amounts for prior period errors cannot be achieved in all circumstances. In certain instances,
it is impracticable to restate comparatives, as the information of previous periods is
unavailable, not collected or not available in a format that allows for restatement. IAS 8
defines impracticable as when an entity cannot apply a requirement after making every
reasonable effort to do so. For retrospective application or restatement, it includes:
the effects of retrospective application (change of policy) or retrospective restatement
(errors) are not determinable;
the retrospective application or retrospective restatement requires assumptions about
what management's intent would have been in a prior period;
the retrospective application or retrospective restatement requires significant estimates
of amounts and it is not possible to objectively distinguish information about those
estimates that:
– provides evidence of circumstances that existed at the initial date the amounts were
recognised, measured or disclosed; and
– would have been available when the financial statements were authorised for issue,
from other information.
Consequently, the determination of estimates such as fair values of assets that are not
based on market values of recognised securities exchanges is probably impracticable to
determine. It is important to note that when determining the estimates, the information
available on the date of the transaction, event or condition should be considered in the
measurement, but the benefits of hindsight should not be considered. For example, the
classification of a financial asset may not be changed if, with the knowledge of hindsight, it
was found that management changed the classification in subsequent years.
Example 6.6
6.6 Impracticability of retrospective restatement
On the date of incorporation, namely 1 January 20.11, Bella Ltd acquired an item of property, plant
and equipment at a cost of R2 250 000 with an estimated insignificant residual value. The asset is
depreciated on the straight-line method over its estimated useful life of 15 years. All estimates
were revised annually and it was deemed that no change was necessary in any financial year. At
the end of each year, an impairment loss was recognised on this asset. The asset was written
down to its fair value. Value in use was never calculated and costs of disposal were never taken
into account. The current financial year end is 31 December 20.16. The error in the calculation of
the recoverable amount and the resultant impairment loss was only discovered in the current
financial year. Ignore any tax implications.
continued
Comment
¾ In this scenario the recoverable amount was only based on the fair value of the asset. In terms
of IAS 36, the recoverable amount should have been the higher of the fair value less costs of
disposal, and value in use.
The following information is available:
20.15
Com- End of
parative 20.14*
year
Carrying amount at the beginning of the financial year 1 402 500 1 602 000
(based on incorrect recoverable amount)
Less: depreciation for the year (R1 402 500/11); (R1 602 000/12) (127 500) (133 500)
Carrying amount before impairment loss 1 275 000 1 468 500
Less: impairment loss (45 000) (66 000)
Recoverable amount at end of financial year (based on fair value) 1 230 000 1 402 500
Correct recoverable amount a 1 245 000 ?b
Fair value less costs of disposal 1 212 000 ?

(R1 230 000 – R18 000)
Value in use 1 245 000 ?
* End of 20.14 is opening balance of comparative year (20.15)

a Based on the higher of fair value less costs of disposal and value in use (IAS 36.6).
b It is not possible to go back to previous years and determine the cash flows, discount rates and
related costs of disposal in order to calculate the correct recoverable amount. The first time it
was possible to calculate these amounts was on 31 December 20.15. Therefore the cumulative
effect of the error is only determinable at the end of the comparative year (20.15). It is however
not possible to calculate the correct impairment loss that should be recognised in profit or loss
of the 20.15 financial year, as the cumulative effect of the error is the result of an incorrect
impairment loss and resultant depreciation recognised in all previous years. The full cumulative
effect of the error cannot be recognised in one year’s profit or loss. Full retrospective
restatement is therefore not possible, as the prior year’s period-specific effect is not
known.
Journal entry to account for the correction of the prior period error:
Because the period-specific effect of the 20.15 comparative year cannot be determined, the
opening balances of the 20.16 financial year is the earliest period for which retrospective
restatement is practicable. (Refer to IAS 8.44, which states ‘When it is impracticable to determine
the period-specific effects of an error on comparative information for one or more periods
presented, the entity shall restate the opening balances of assets, liabilities and equity for the
earliest period for which retrospective restatement is practicable (which may be the current
period).’)
The following journal entry will therefore be applicable: Dr Cr
1 January 20.16 R R
Property, plant and equipment (SFP) (R1 245 000 – R1 230 000) 15 000
Retained earnings – opening balance (Equity)c 15 000
Correction of error at the beginning of the year
c Previous years’ adjustments should have been made to all previous impairment losses and all
previous depreciation amounts (had the information been available to do these adjustments).
The effect of previous years’ incorrect impairment losses and depreciation would have
accumulated in retained earnings. Since the period specific effect could not be determined, the
full cumulative effect is adjusted against retained earnings.
continued
In calculating the depreciation for the 20.16 financial year, the entity will start with the correct
carrying amount of R1 245 000 and depreciate that over the remaining useful life of ten years. If,
at the end of the year, there is an indication of possible impairment, the entity will test for
impairment by calculating the recoverable amount (being the higher of fair value less costs of
disposal and value in use) and compare that to the correct carrying amount at the end of the
year.
Restate the line items in the financial statements for the effect of the correction of the prior
period error, as follows:
Bella Ltd
Statement of changes in equity year ended 31 December 20.16
Retained
earnings
Note R
Balance at 31 December 20.15 – as presented previously xxx
Correction of prior period error (Jnl 1) 5 15 000
Restated balance xxx + 15 000
Total comprehensive income for the year xxx
Profit for the year xxx
Other comprehensive income xxx
Dividends (xx)
Balance at 31 December 20.16 xxx
Disclose the effect of the prior period error in the notes:

Bella Ltd
5. Prior period error
The carrying amount of property, plant and equipment has been restated for the effect of a prior
period error. The recoverable amount of the item was incorrectly calculated as its fair value without
comparing it to its value in use and using the higher of fair value less costs of disposal and value in
use. The effect of the error could not be restated retrospectively, because the cash flows, discount
rates and related costs of disposal needed to calculate the correct recoverable amount were not
available for prior periods. The cumulative effect could be calculated for the first time on
31 December 20.15. This effect was accounted for by adjusting the opening balances of assets
and equity in the current financial year.
Comment
¾ The disclosure requirements for a prior period error (IAS 8.49) require that the amount of the
correction for each financial statement line item affected for each prior period presented
should be disclosed. Due to the impracticability of full retrospective adjustment in this example,
none of the prior period amounts have been adjusted. Consequently, there are no line items to
disclose.
The statement of changes in equity for the year ended 31 December 20.16 (refer above) and
the note for property, plant and equipment will however indicate the amount of the adjustment
as a restatement to the opening retained earnings and the opening carrying amount of the
property, plant and equipment, which will be cross-referenced to this note.
¾ If the period-specific effect for the financial year ended 31 December 20.15 could have been
determined, the correcting journal entries would have adjusted the amounts included in the
financial statements for the year ended 31 December 20.15, provided that the accounting
system can be re-opened for the purpose of processing these journals. The prior period error
note would then have indicated the effect of the correction on all applicable line items in the
financial statements of the prior period presented.
CHAPTER
7
Events after the reporting period
(IAS 10)
Contents
7.1 Overview of IAS 10 Events after the Reporting Period ......................................... 142
7.2 Background .......................................................................................................... 142
7.3 Date of authorisation of the issue of financial statements .................................... 142
7.4 Adjusting events ................................................................................................... 143
7.5 Non-adjusting events ............................................................................................ 143
7.6 Dividends .............................................................................................................. 144
7.7 Going concern ...................................................................................................... 144
7.8 Presentation and disclosure ................................................................................. 144
7.9 Examples .............................................................................................................. 145
141
7.1 Overview of IAS 10 Events after the Reporting Period

EVENTS AFTER THE REPORTING PERIOD
Events that occur after the reporting period are those favourable or unfavourable events that occur
between the end of the reporting period and the date of authorisation of the financial statements for
issue.
ADJUSTING EVENTS NON-ADJUSTING EVENTS

Provide evidence of conditions that existed Indicative of conditions that arose after the
at the end of the reporting period; reporting period;
Irrespective of whether the fact was Unrelated to conditions that existed at the
actually known at the end of the reporting end of the reporting period;
period; Disclose in note to the financial
Update the relevant amounts in financial statements, if material:
statements to reflect adjusting events. – nature of events;
– financial effect or a statement that the
financial effect cannot be determined.
SPECIFIC ISSUES
Dividends Going concern

Declared after the reporting period: Financial statements must not be prepared
not a present obligation at reporting period; on the basis of a going concern if:
therefore do not recognise at reporting entity plans to go into liquidation; or
period; ceases its commercial activities; or
disclose in note to financial statements if there is no realistic alternative but to
(IAS 1). liquidate.
7.2 Background
Events that occur after the reporting period are both favourable and unfavourable events
that occur between the end of the reporting period and the date of authorisation of the
financial statements for issue. Two types of events can therefore be identified, namely:
those that provide additional evidence of the conditions that existed at the end of the
reporting period (adjusting events); and
those that are indicative of conditions that arose after the reporting period (non-
adjusting events).
These two categories require different accounting treatments. The alternatives are:
inclusion in the financial statements as adjustments to assets and liabilities and
accompanying income and expense items; or
no accounting recognition, but, if material, disclosure in the notes.
7.3 Date of authorisation of the issue of financial statements

The date on which the financial statements are authorised for issue is the date on which the
board of directors approves the financial statements.
In all cases, the date that is used for purposes of this Standard is the date on which the full
board authorises the statements for issue, even if a supervisory board of non-executive
directors subsequently still has to peruse the statements.
Events after the reporting period 143
The date on which authorisation for issue was given, together with an indication of the
identity of the authorising body, must be disclosed in the financial statements by means of a
note. This is important information for the users of financial statements, because it gives an
indication of the date until which information has been included in the financial statements.
In terms of IAS 10.17, if the owners of the entity have the power to change the financial
statements after they have been issued, this fact must be disclosed.
7.4 Adjusting events

Events that provide additional information on the conditions that existed at the end of the
reporting period are included as adjustments to the amounts in the financial statements,
irrespective of whether the fact was actually known at the end of the reporting period.
An example of an adjusting event is where evidence that a trade debtor was insolvent at the
end of the reporting period was only received after the reporting period. This would require
the principles of impairment in respect of financial assets carried at amortised cost be
applied at the end of the reporting period. If, however, a catastrophe affected the debtor
after the reporting period, resulting in the debtor being declared insolvent, the catastrophe
does not refer to conditions that prevailed at the end of the reporting period, and therefore
not an adjusting event.
The following are examples of adjusting events (IAS 10.9):
Obligations: the settlement after the reporting period of a court case that confirms that
the entity had a present obligation at the end of the reporting period.
Assets/Investments: the receipt of information after the reporting period indicating that an
asset/investment was impaired at the end of the reporting period, or that the amount of a
previously recognised impairment loss for that asset/investment needs to be adjusted.
Inventory: the sale of inventories after the reporting period may give evidence about their
net realisable value at the end of the reporting period.
Assets: the determination after the reporting period of the cost of assets purchased, or
the proceeds from assets sold, before the end of the reporting period.
Profit-sharing or bonus payments: the determination after the reporting period of the
amount of profit-sharing or bonus payments, if the entity had an obligation at the end of
the reporting period to make such payments.
Fraud or errors: the discovery of fraud or errors that show that the financial statements
are incorrect.
7.5 Non-adjusting events

Events that refer to conditions that arise after the reporting period require no accounting
recognition, except when the going concern concept no longer applies as a result of the
event. Such material events that are not recognised, but whose non-disclosure may be
relevant to users of these financial statements, may warrant certain disclosure in the notes.
The following examples of non-adjusting events will normally lead to disclosure
(IAS 10.22):
A large business combination or, conversely, the sale of a subsidiary after the reporting
period.
Discontinuation of operations, sale of assets or liabilities as a result of operations that
are being discontinued, conclusion of binding agreements on the sale of such assets or
the settlement of such liabilities.
Substantial purchase or sale of assets, or expropriation of major assets by the government.
Destruction of a major plant after the reporting period.
Plans for restructuring.

Issue of shares and debentures after the reporting period.
Abnormal changes in the value of assets or exchange rates after the reporting period.
Changes in tax rates or tax legislation that were promulgated after the reporting period
and that will have a major impact on the figures for tax and deferred tax reflected in the
Conclusion of material commitments, for instance issuing of material warranties.
Litigation as a result of events that occurred after the reporting period.
7.6 Dividends
Dividends declared after the end of the reporting period, but before the financial statements
are authorised for issue, may not be recognised as a liability at the reporting period, as no
present obligation to pay the dividend existed at the end of the reporting period. Such a
dividend is nevertheless, in terms of IAS 1, disclosed in the notes to the financial
statements.
The following must be disclosed in the notes to the financial statements:
the amount of dividends proposed or declared before the financial statements were
authorised for issue but not recognised as a distribution to equity holders during the
period; and
the related amount per share.
7.7 Going concern

The rules that apply to the going concern assumption are not the same as those that pertain
to events after the reporting period.
IAS 10.14 requires that financial statements must not be prepared on the basis of a going
concern if the entity plans to go into liquidation, or cease its commercial activities, or if there
is no realistic alternative but to liquidate.
When financial statements are prepared in accordance with liquidation principles, specific
additional disclosures in terms of IAS 1.25 are required. Refer to chapter 3 for an
explanation in this regard.

In terms of IAS 10 the following information must be disclosed:
Authorisation of the issue of financial statements
– the date when the financial statements were authorised for issue;
– who gave the authorisation;
– if the entity’s owners or others have the power to amend the financial statements after
issue, that fact should be disclosed.
Adjusting events
– update the relevant amounts and other disclosures to reflect the new information.
Non-adjusting events
– nature of events
– financial effect or a statement that the financial effect cannot be determined.
In terms of IFRIC 17, the following information must be disclosed:

IFRIC 17 determines that if an entity declares a dividend after the end of the reporting period
but before the financial statements are authorised for issue, and the dividend takes the form
of a distribution of a non-cash asset, the following should be disclosed:
nature of the non-cash asset to be distributed;
carrying amount of the non-cash asset at the end of the reporting period;
fair value of the non-cash asset at the end of the reporting period if it is different from the
carrying amount at that date;
information about the method used to measure the fair value of the asset.
7.9 Examples
Example 7.1 Events after the reporting period
In the schematic exposition below, position (1) represents the first day of the financial year of
Alpha Ltd, namely 1 January 20.12; position (2) represents the last day of the financial year (end of
the reporting period), namely 31 December 20.12, and position (3) represents the date of the
authorisation of the financial statements for issue, namely 31 March 20.13. The dotted lines A to E
represent conditions that should probably be accounted for, where the beginning of the dotted line
represents the commencement of the condition and the end of the dotted line represents the final
achievement of clarity on all uncertainty, and confirmation that the condition must have been
accounted for at its commencement, if no uncertainties had existed.
Reporting period Authorisation date

(1) (2) (3)
1 January 20.12 31 December 20.12 31 March 20.13
E
Assume that each of the dotted lines A to E refers to a material debtor who is experiencing
financial problems. Whereas it is uncertain at the outset whether the debt will be recovered (start of
the dotted line), it subsequently becomes certain that the debtor is insolvent and that the account
must therefore be impaired (end of the dotted line).
Case A
Case A does not present a problem. Since the uncertainty about the possible recovery of the debt
is resolved before the end of the reporting period, the impairment can take place in 20.12.
Case B
Case B is an uncertain situation that exists at the end of the reporting period (31 December 20.12)
and the outcome of the situation will only become known at a later date. In this example,
uncertainty exists about the collectability (measurement uncertainty) of the debt prior to the end of
the reporting period, but the final confirmation of the recoverability of the debt is only received after
the reporting period. At the end of the reporting period an allowance for expected credit losses will
be recognised.
continued
Case C
Case C is classified as an event after the reporting period, because it did indeed take place after
the end of the reporting period. However, it differs from Case B, because the uncertain
circumstances arose only after the reporting period, whereas in Case B, the uncertain
circumstances arose before the end of the reporting period. In this scenario, Alpha Ltd’s debtor
encountered problems only after the reporting period. It is therefore apparent that there are two
categories of events: those presenting additional information on uncertain conditions that existed
at the end of the reporting period (Case B) and those that only arose after the reporting period
(Case C). Events such as those in Case C must not be recognised in the current financial year
(20.12), because they do not refer to conditions that existed at the end of the reporting period. The
circumstances and events must, however, be disclosed in a note if it is relevant.
Case D
As Case D does not refer to circumstances that existed prior to the end of the reporting period, it is
not recognised in the current financial year (20.12). As with Case C, disclosure of the information
in a note must be considered, but measurement uncertainty exists as the confirmed event only
took place after the authorisation date.
Case E
Case E refers to circumstances that already existed prior to the end of the reporting period. There is
no fundamental difference between Case E and Case B. The only difference is that, in Case B, there
is no measurement uncertainty at authorisation date.
Example 7.2
7.2 Events after the reporting period
In all the examples mentioned below, the end of the reporting period of Beta Ltd is 31 December 20.12
and the annual financial statements are authorised for issue on 30 March 20.13. Ignore taxation.
(i) Inventories destroyed
On 15 February 20.13, half of the inventories of Beta Ltd was destroyed by a fire, which resulted in
a loss of R250 000 to the company. Of the inventories destroyed, R120 000 was on hand on
31 December 20.12. Since the event does not refer to a condition that existed at the end of the
reporting period, it will not be accounted for in the financial year ended 31 December 20.12. If,
however, the loss of R250 000 was material, disclosure could be required. If the company was no
longer a going concern as a result of the loss, the loss must be provided, but not in accordance
with the rules governing events after the reporting period.
37. Events after the reporting period
On 15 February 20.13, half of the inventories of entity was destroyed by a fire. The amount of the
loss of inventories is estimated at R250 000.
(ii) Insolvency of debtor
On 5 January 20.13, one of Beta Ltd’s significant debtors was liquidated. On 31 December 20.12,
the carrying amount of debtors in the financial records of Beta Ltd included an amount of
R600 000 relating to this debtor. Beta Ltd will only be entitled to a liquidation dividend of R100 000.
Closer investigation revealed that the debtor was experiencing financial difficulties for quite some
time, but this was covered by means of inappropriate accounting practices. The conditions that
lead to the weakened financial position of the debtor already existed on 31 December 20.12,
although Beta Ltd only came to know of it five days later. This event must therefore be recognised
in the financial statements for the year ended 31 December 20.12 as an adjusting event.
continued
Extract from the financial statements of Beta Ltd for the year ended 31 December 20.12
Other expenses (xxx + (600 000 – 100 000)) xxx
Profit before tax (xxx – 500 000) xxx

Assets
Current assets xxx
Trade receivables (xxx – 500 000) xxx
Total assets xxx

(iii) Decrease in market value of investment
On 31 December 20.12, Beta Ltd has an investment of R10 million in a listed company. On
15 January 20.13, the market value of the investment was R6 million. On 15 March 20.13, the
market value showed no sign of recovery. As the event does not refer to circumstances that
existed at the end of the reporting period, it is categorised as a non-adjusting event. The loss of
R4 million appears to be material and must therefore be disclosed as follows in the financial
statements:
37. Events after the reporting period
The market value of an investment of R10 million in a listed company declined to R6 million during
January 20.13. The investment has not yet shown any sign of recovery, and the company could
consequently suffer a loss of R4 million.
(iv) Dividends declared
Before the end of the reporting period (31 December 20.12), the board of directors proposed a
dividend of R100 000, subject to approval at the annual general meeting. The annual general
meeting was held on 25 March 20.13 and the proposed dividends were declared at that meeting –
the financial statements were authorised for issue on 30 March 20.13.
As no obligating event had taken place by 31 December 20.12, there is no present obligation and
recognition of a liability at the end of the reporting period – the obligating event is the approval by
shareholders at the annual general meeting. The disclosure is as follows:
38. Dividends declared after the reporting period
An ordinary dividend of R100 000 related to 20.12 was proposed before the end of the reporting
period and declared after the reporting period at the annual general meeting held on
25 March 20.13. The related dividend per share is Rx,xx.
CHAPTER
8
Income taxes
(IAS 12, FRG 1, IFRIC 23)
Contents
8.1 Overview of IAS 12 Income Taxes .................................................................... 150
8.2 Background ....................................................................................................... 150
8.3 Recognition and measurement of current tax ................................................... 152
8.3.1 Current income tax on companies .......................................................... 152
8.3.2 Capital Gains Tax on companies ............................................................ 152
8.4 Nature of deferred tax ....................................................................................... 155
8.5 Temporary differences ...................................................................................... 157
8.5.1 Tax base ................................................................................................. 158
8.5.2 Taxable temporary differences ............................................................... 162
8.5.3 Deductible temporary differences ........................................................... 166
8.5.4 Assessed tax losses ............................................................................... 170
8.6 Recognition of deferred tax assets – specific aspects ...................................... 173
8.7 Enacted or substantively enacted tax rates and tax laws.................................. 184
8.8 Recognition and measurement of deferred tax ................................................. 185
8.8.1 Reversal of deferred tax ......................................................................... 185
8.8.2 Measuring of deferred tax in case of change in tax rate ......................... 188
8.8.3 Measuring of deferred tax allowing for the expected manner
of recovery .............................................................................................. 190
8.9 Dividend tax ....................................................................................................... 198
8.10 Foreign tax ........................................................................................................ 198
8.11 Consolidation and equity method ...................................................................... 200
8.12 Uncertainty over Income Tax treatments .......................................................... 202
8.13 Presentation and disclosure .............................................................................. 203
8.13.1 Statement of profit or loss and other comprehensive
income and notes ................................................................................. 204
8.13.2 Statement of financial position and notes ............................................. 204
149
8.1 Overview of IAS 12 Income Taxes
Current tax
Amount of income tax payable on taxable profit for a period based on tax law
Measurement: Recognition: Dr Cr
R R R
Accounting profit xx Current tax expense xx
Add back: Liability xx
Accounting items xx Tax expense usually in
(e.g. depreciation) P/L, but recognises tax
Include tax treatment xx consequence where item
(e.g. tax allowance) was recognised
(P/L, OCI, Equity)
Taxable profit xx
Current tax @ 28% xx
Deferred tax
Recovery or settlement of carrying amount of assets and liabilities will make future tax payments
larger or smaller than they would have been if they had no tax consequence
= recognised deferred tax, with limited exceptions
Carrying Temporary
– Tax base =
amount difference
Some temporary
Taxable: Deductible: Deferred tax asset
differences are exempt: No
Deferred tax liability (to the extent probable that could utilise)
deferred tax
Measurement: Recognition:
Tax rate expected to apply when Movement in deferred tax
temporary differences reverse; balance usually in P/L, but Detailed
recognises tax consequence disclosure
Based on manner in which carrying
amount expected to be recovered or where item was recognised
settled. (P/L, OCI, Equity)
8.2 Background
IAS 12 Income Taxes is applicable to:
South African taxes that are levied on taxable profits;
foreign taxes levied on taxable profits obtained from foreign sources (refer to
section 8.10) (IAS 12.2); and
withholding taxes payable by an entity on distributions to them (refer to section 8.9).
Income taxes 151
The objective of the requirements of IAS 12 is to ensure that the appropriate amount of tax
is recognised and disclosed in the financial statements of an entity. The tax expense
(/income) in the statement of profit or loss and other comprehensive income comprises of
both current tax and deferred tax (IAS 12.6). The Standard therefore prescribes the accounting
treatment of both current and deferred tax.
The principal issue in accounting for incomes taxes is how to account for the current and
future tax consequences of items in the financial statements. The accounting profit is
determined by applying IFRSs, while the taxable income is determined by applying the
Income Tax Act 58 of 1962 (the Income Tax Act). As such, IAS 12 defines the taxable profit
(/loss) as the profit (/loss) for a period, determined in accordance with the rules established
by the taxation authority (i.e. the South African Revenue Service (SARS)), upon which
income taxes are payable (/recoverable). The taxable income is normally calculated by
adjusting the accounting profit for the reporting period with certain items that are treated
differently for tax purposes. The current tax expense (/payable) is then based on the taxable
income for the applicable year. Current tax is discussed in section 8.3 below.
The amount of tax that is payable by an entity in a specific accounting period is often out of
proportion to the reported accounting profit before tax for the period. The reason for this
difference is that the basis used for establishing the accounting profit often differs from the
rules used to determine the taxable profits (and thus the tax payable).
These differences mainly arise from the following circumstances:
the carrying amount of assets in the accounting records differs from the tax base of the
assets, or amounts are expensed for accounting purposes in a particular period and
deducted for income tax purposes in a different period;
the carrying amount of assets and accounting expenses are not deductible for income
tax purposes;
the carrying amount of liabilities in the accounting records differs from the tax base thereof;
the carrying amount of liabilities in the accounting records is not deductible for income tax
purposes;
income that is not taxable, or income that is recognised for accounting purposes in a
specific accounting period and taxed for income tax purposes in another;
income tax losses are set-off against taxable income in later years, thereby disturbing
the relationship between the accounting profit and the taxable income; and
adjustments relating to the correction of errors and/or changes in accounting policies are
either taken into account in different periods for income tax and accounting purposes, or
are excluded because they are neither taxable nor deductible.
The abovementioned items are commonly known as non-taxable, non-deductible and
temporary differences. They are discussed in more detail later in this chapter. The non-
taxable and non-deductible differences are never accounted for in the financial statements
or they are never taken into account in determining the taxable income (e.g. dividends that
are not taxable). These differences are merely explained in the financial statements
(normally in the tax (rate) reconciliation in the note for the income tax expense). Deferred tax
is recognised on the other (temporary) differences. Deferred tax is discussed in detail in
section 8.4 below. These differences can be summarised as follows:
Differences between accounting profit and taxable income
Non-taxable and non-deductible differences Temporary differences
Explained in tax reconciliation in notes Deferred tax recognised

8.3 Recognition and measurement of current tax

In South Africa, current tax and capital gains tax (CGT) are raised on the taxable income and
capital gains of entities.
8.3.1 Current income tax on companies
Current income tax is the amount of income tax payable (recoverable) in respect of the
taxable profit (tax loss) of a company or close corporation for a tax period (IAS 12.5). The
taxable profit is determined in accordance with the Income Tax Act. The taxable income is
normally calculated by adjusting the accounting profit for the reporting period with certain
items that are treated differently for tax purposes. There may be various non-taxable and non-
deductible differences that are never accounted for in the financial statements or are never
taken into account in determining the taxable income (e.g. dividends that are not taxable,
donations that are not deductible, etc.). As a result of these differences, the income tax
expense may not be in proportion (28%) to the accounting profit. Consequently, these
differences are explained in the financial statements (normally in the tax reconciliation in the
note for the income tax expense). Deferred tax is recognised on the other (temporary)
differences between the accounting and tax treatments of items, as will be indicated in the
following sections.
Companies are provisional tax payers and are required to make provisional tax payments
in terms of the Income Tax Act. Provisional payments are merely advance payments of the
company’s estimated liability for normal tax for a particular year of assessment (refer to the
first two journal entries in Example 8.1 below for the recognition of provisional tax). Unpaid
current tax for the current and preceding periods is recognised as a current liability (refer to
the third journal entry in Example 8.1 below for the recognition of current tax in respect of a
financial year/year of assessment). Where the tax for the current and previous periods is
paid in advance, a current asset is recognised (IAS 12.12).
Current tax liabilities (assets) for the current and preceding periods must be measured at the
amount that is expected to be paid to or recovered from SARS, using the tax rates and tax
laws that have been enacted or substantively enacted at the reporting date (IAS 12.46) (also
refer to section 8.7).
The amount of current tax remains an accounting estimate, which may change once the tax
return is finally received. The correction of the accounting estimate takes place in the period
in which the tax return is received and is shown as an under- or over-provision for current
tax in the tax expense of the current year. This correction must, in terms of IAS 12.80(b), be
disclosed separately (refer to the comprehensive example at the end of this chapter for an
illustration).
For accounting purposes, the current income tax in respect of a transaction or event is
treated in the same manner as the relevant transaction or event (IAS 12.57). This implies,
for example, that current tax will be charged to other comprehensive income in cases in
which the underlying transaction or event is accounted for in other comprehensive income.
A similar treatment applies to deferred tax, which is explained by means of an example in
section 8.8 dealing with recognition and measurement of deferred tax.
Penalties and interest paid in respect of tax payments are not included in the tax expense of
an entity. These items do not fall under the scope of IAS 12 as it does not represent a tax
levied on taxable profit. These items would probably be presented as ‘other expenses’ in the
statement of profit or loss and other comprehensive income.
8.3.2 Capital Gains Tax on companies
Capital Gains Tax (CGT) (part of current tax) is payable on capital gains after 1 October 2001,
unless ‘roll-over’ relief is applicable. The capital gain is calculated as the difference between
the proceeds on disposal of an asset and the ‘base cost’ of the asset as defined in the
Income Tax Act. The inclusion rate of capital profits is currently 80% for companies. This
Income taxes 153
means that the total gain on disposal of an asset may be partly taxable and partly exempt. If
the portion is a loss, it may be set-off against other capital gains during that financial year. If
the sum of all the capital gains and losses for the financial year results in a capital gain, 80%
thereof must be included in the company’s taxable income and subjected to tax at a rate of
28%. The effect is thus an effective tax rate of 22,4%. If the sum of all capital gains and
losses for the financial year results in a capital loss, that loss must be carried forward to the
following year of assessment. (Refer to section 9.10.4 of chapter 9, Property, plant and
equipment, for the accounting treatment and disclosure of CGT, as well as section 8.8.3
below).
Example 8.1 Current tax
The accounting profit of Blom Ltd for the year ended 31 December 20.15 amounted to R2 106 500
before any items for which the accounting and tax treatment differs (see items below), were taken
into account.
The final accounting profit of Blom Ltd for the year ended 31 December 20.15 amounted to
R2 000 000 after all items were correctly accounted for. The following differences between the
accounting and tax treatment were identified:
• During the current year, Blom Ltd received a dividend of R80 000 that is not taxable.
• Blom Ltd also incurred research costs of R100 000 during the current year and correctly
expensed it. Assume that 150% of this amount is deductible for tax purposes for the current
year.
• Included in Blom Ltd’s other expenses are a tax penalty and donations paid to the amount of
R24 000 that were not allowed as tax deductions during the current year.
• Blom Ltd acquired an item of plant on 1 January 20.15 at a cost of R500 000. The plant is
depreciated evenly over 8 years with no residual value. For tax purposes, a 40/20/20/20 tax
allowance is applied.
The normal income tax rate is 28%.
Blom Ltd made two provisional tax payments of R230 000 and R250 000 respectively during the
year.
Calculation of accounting profit and current tax for the year ended 31 December 20.15:
Accounting
Taxable income
profit
R R
Gross amount (balancing) 2 106 500 2 106 500
Dividends received 80 000 –
Research costs (100 000) (150 000)
Tax penalty and donations (24 000) –
Plant: Depreciation (R500 000/8 years); (62 500)
Tax allowance (R500 000 × 40%) (200 000)
Accounting profit and taxable income 2 000 000 1 756 500
Comment
¾ This example illustrates the calculation of the taxable income and the current tax payable on it.
The calculation above may typically not be done too often, but is given here to highlight and
illustrate the differences between the accounting and tax treatment of these items. The taxable
income is usually calculated by adjusting the accounting profit for the reporting period with certain
items that are treated differently for tax purposes, as is done below.
continued
Calculation of current tax for the year ended

31 December 20.15 by starting with the accounting profit:
Gross
Tax at 28%
amount
R R
Accounting profit 2 000 000 560 000
Non-taxable items and additional deductions:
Dividends received – accounting income reversed (80 000) (22 400)
Extra research costs deductible (R100 000 × 50%) (50 000) (14 000)
Accounting expense reversed 100 000
Tax deduction claimed (R100 000 × 150%) (150 000)
Non-deductible expenses (tax penalties and donations) 24 000 6 720
1 894 000 530 320
Temporary differences*:
Depreciation and tax allowance on plant (137 500) (38 500)
Depreciation on plant reversed (R500 000/8 years) 62 500
Tax allowance on plant claimed (R500 000 × 40%) (200 000)
Taxable income and current tax payable 1 756 500 491 820
Journal entries:
Dr Cr
R R
Current tax payable (SFP) 230 000
Bank 230 000
Recognition of first provisional payment
Bank 250 000
Recognition of second provisional payment
Recognition of current tax payable to SARS
Deferred tax* (SFP) 38 500
Recognition of movement in deferred tax* for the current year
Notes
2. Current tax payable (current liability)
R
Total current tax payable 491 820
Provisional tax payments made (R230 000 + R250 000) (480 000)
Amount payable as at 31 December 20.15 11 820

Major components of tax expense
Current tax expense 491 820
Deferred tax expense* 38 500
Tax expense 530 320
continued
Income taxes 155
The tax reconciliation# is as follows:

R
Accounting profit 2 000 000
Tax at the standard tax rate of 28% (R2 000 000 × 28%) 560 000
Dividends received (R80 000 × 28%) (22 400)
Extra research costs deductible (R50 000 × 28%) (14 000)
Non-deductible expense (tax penalty and donations) (R24 000 × 28%) 6 720
Tax expense 530 320
Effective tax rate (R530 320/R2 000 000 × 100) 26,52%
Comment
Comment
¾ Certain differences (such as the dividend received or the penalty and donations paid) are not
included in, or deducted from the taxable income, based on the rules of the Income Tax Act.
Other differences (such as the extra 50% of the research costs that are deductible for tax
purposes) are not included in the accounting profit in accordance with IFRSs. These differences
caused the total tax expense to be out of proportion (28%) to the accounting profit. The effect of
these differences are explained to the users of financial statements by the reconciliation
between the expected tax expense (R560 000) on the accounting profit and the actual tax
expense (R530 320). Refer to IAS 12.81(c), and .84 to .86.
¾ The tax reconciliation# could also be done by reconciling the applicable tax rate to the effective
tax rate (as percentages), as is illustrated in the comprehensive example (see section 8.13).
¾ Other differences (such as the depreciation and tax allowance on the plant) are only of a
temporary nature. The entire cost of the plant will be depreciated for accounting purposes and
will be claimed as a tax deduction over time. The period (timing) in which it will be included in
the accounting profit and taxable income may differ. Deferred tax is recognised on such
temporary differences. The nature of temporary differences* and the recognition of deferred
tax* will be explained in detail in the remainder of this chapter.
¾ The format used for the calculation of the current tax illustrates the amounts disclosed in the
note for the income tax expense.
8.4 Nature of deferred tax

Deferred tax arises as a result of differences between the carrying amounts of assets and
liabilities presented in the statement of financial position determined in accordance with the
International Financial Reporting Standards (IFRSs), and their carrying amounts (referred to
as ‘tax bases’) determined in accordance with the Income Tax Act. Deferred tax is regarded
as an obligation/asset that will be payable or recoverable at a future date when the carrying
amount of the asset/liability is recovered/settled.
A deferred tax liability is the amount of income tax payable in future periods in respect of
taxable temporary differences (IAS 12.5). A deferred tax asset is the amount of income tax
that will be recoverable in future periods in respect of:
deductible temporary differences;
the carryforward of unused tax losses; and
the carryforward of unused tax credits (IAS 12.5).
It is inherent in the recognition of an asset or liability that an entity expects to recover or
settle the carrying amount of that asset or liability (refer to the concept of the ‘future
economic benefits’ in the definitions of assets or liabilities in the Conceptual Framework for
Financial Reporting). If it is probable that recovery or settlement of that carrying amount will
make future tax payments larger (smaller) than they would be if such recovery or settlement
were to have no tax consequences, IAS 12 requires an entity to recognise a deferred tax
liability (deferred tax asset), with certain limited exceptions.
The concept of deferred tax can simplistically be explained as follows (IAS 12.16 and .25):
Example 8.2 Basic explanation of the concept of deferred tax
Deferred tax liability:

A company bought an item of plant for R120 000 at the beginning of the year. Assume
depreciation for the year amounted to R20 000 and the tax allowance amounted to R40 000. At
the end of the year, the carrying amount is R100 000 (R120 000 – R20 000) and the tax base is
R80 000 (R120 000 – R40 000).
Following from the definition of an asset (see the Conceptual Framework), the plant is an
economic resource that has the potential to produce economic benefits. The company expects to
receive future economic benefits of R100 000 from this asset. When it receives these benefits, the
company will receive tax allowances of R80 000 (the remaining balance) in total. This implies that
the company will have a taxable profit of R20 000 (R100 000 – R80 000) on which R5 600
(R20 000 × 28%) tax would be payable. Thus the net future economic benefits of the company is
only R94 400 (R100 000 – R5 600). The company cannot then recognise an asset at R100 000
from which net economic benefits of R94 400 is expected to flow to the company itself.
To achieve the correct effect in the statement of financial position, the company would recognise a
deferred tax liability of R5 600, resulting in an asset of R100 000 and a liability of R5 600. The
net amount (R94 400) reflects the future expected benefits of R94 400 as calculated above.
Deferred tax asset:
The company also recognised a liability for accrued leave of R5 000 at the end of the year which
will be settled in cash during the next year. Assume the payment for the accrued leave will be
deductible for tax purposes during the next year.
Following from the definition of a liability (see the Conceptual Framework), the settlement of the
liability will result in the transfer an economic resource from the entity. When it settles the leave
liability, the company will receive a tax deduction of R5 000. This implies that the company will
save R1 400 (R5 000 × 28%) on the tax payment. Thus the net outflow of economic resources is
only R3 600 (R5 000 – R1 400). The company cannot then recognise a liability at R5 000 which
will only result in an outflow of net economic benefits of R3 600.
To achieve the correct effect in the statement of financial position, the company would have to
recognise a deferred tax asset of R1 400, resulting in a liability of R5 000 and an asset of R1 400.
The net amount (R3 600) reflects the expected future net outflow of R3 600 as calculated above.
Comment
¾ The fundamental principle of IAS 12 is that an entity must recognise a deferred tax liability or
asset whenever recovery or settlement of the carrying amount of an asset or liability would make
future tax payments larger or smaller than they would be if such recovery or settlement were to
have no tax consequences.
¾ The recovery of the carrying amount of the plant will make future tax payments larger (by R5 600)
than they would be if such recovery were to have no tax consequences. Therefore, a deferred tax
liability is recognised.
¾ The settlement of the carrying amount of the liability for the accrued leave will make future tax
payments smaller (by R1 400) than they would be if such settlement were to have no tax
consequences. Therefore, a deferred tax asset is recognised.
To calculate and recognise deferred tax, an entity needs to determine the following:
the carrying amount of the asset or liability;
the tax base thereof;
the difference between the carrying amount and the tax base and whether this temporary
difference is taxable (a deferred tax liability is recognised), deductible (a deferred tax
asset is recognised if it is recoverable) or exempt (no deferred tax is recognised);
the applicable measurement of the deferred tax balance; and
Income taxes 157
the movement between the newly calculated deferred tax balance and the balance at the
end of the preceding period.
The resultant deferred tax movement is accounted for in the same way as the transaction
or event was recognised. For example, if the transaction was recognised within profit or loss
(e.g., the depreciation and leave expenses in the previous Example), the tax consequence
is also recognised within profit or loss, and if the transaction was recognised within other
comprehensive income (e.g., a revaluation of land – refer to Example 8.24), the tax
consequence is also recognised within other comprehensive income. All these concepts are
discussed in detail below.
8.5 Temporary differences

In terms of IAS 12, the recognition of deferred tax, either as a deferred tax liability or as a
deferred tax asset, is based on temporary differences. Temporary differences are
differences between the tax base of an asset or liability and its carrying amount in the
statement of financial position (IAS 12.5). At the end of each financial period, these
differences are used to determine the deferred tax liability or asset in the statement of
financial position.
The recognition of deferred tax can be explained schematically as follows:
Carrying amount Tax base of
LESS = Temporary difference
of asset/liability asset/liability
Temporary MULTIPLIED Deferred tax balance (asset/liability) in

Tax rate =
difference BY statement of financial position
Deferred Deferred
Movement in deferred tax
tax balance tax balance
LESS = in statement of profit or loss and other
(asset/liability) (asset/liability)
comprehensive income or equity
of Year 2 of Year 1
Temporary differences are divided into two main categories, namely taxable temporary
differences, and deductible temporary differences. The fundamental principle that
underlies the determination of all temporary differences is that an entity must recognise a
deferred tax liability (asset) whenever recovery or settlement of the carrying amount of an
asset or liability would make future tax payments larger (smaller) than they would be if such
recovery or settlement were to have no tax consequences. It follows that deferred tax is not
recognised when the recovery or settlement of the carrying amount of an asset or liability
will have no effect on the future tax payments. In such cases, the taxable or deductible
temporary differences are exempt from the recognition of deferred tax.
Temporary differences can be explained schematically as follows:
TEMPORARY DIFFERENCE
TAXABLE DEDUCTIBLE
temporary difference temporary difference
Recognise deferred tax liability (income tax Recognise deferred tax asset (income tax
payable in future periods) recoverable in future periods)
Assets: Assets:
Carrying amount > Tax base Carrying amount < Tax base
Liabilities: Liabilities:
Carrying amount < Tax base Carrying amount > Tax base
Some taxable or deductible temporary differences are exempt

and a deferred tax liability or asset is not recognised.
The chapter continues with a discussion and examples of the identification of the tax base of
assets and liabilities, followed by a discussion of taxable temporary differences and
deductible temporary differences.
8.5.1 Tax base

Temporary differences are differences that arise between the tax base and the carrying
amount of assets and liabilities on the reporting date. It is therefore important to be able to
determine the tax base of both assets and liabilities. The tax base of an asset or a liability is
the amount attributed to that asset or liability for tax purposes (IAS 12.5).
The tax base can be explained schematically as follows:
TAX BASE
Tax base of Tax base of

ASSET LIABILITY
Amount deductible for tax purposes against Carrying amount less amount deductible
future economic benefits (when carrying for tax purposes in future periods.
amount of the asset is recovered). Revenue received in advance:
If economic benefits are not taxable: Carrying amount less revenue not taxable
tax base = carrying amount. in future periods.
8.5.1.1 Assets
The tax base of an asset is dependent on whether the future economic benefits arising from
the recovery of the carrying amount of the asset are taxable, or not. If the future economic
benefits are taxable, the tax base is the amount that will be deductible for tax purposes.
Where the economic benefits are not taxable, the tax base of the asset is equal to its
carrying amount, for example, trade receivables where the sales have already been taxed
(IAS 12.7).
Income taxes 159
Example 8.3 Tax base of property, plant and equipment
At the end of the reporting period, a company has plant with a cost of R200 000 and accumulated
depreciation of R40 000. For tax purposes, the SARS has permitted a tax allowance of R50 000
on the plant.
Carrying amount Tax base Temporary difference
R R R
Plant (*) 160 000 150 000 10 000
(*) (R200 000 – R40 000); (R200 000 – R50 000)
Comment
¾ The income generated by the plant as it is used (carrying amount recovered) will be taxable in
the future and if the plant is sold at a profit, the profit will also be taxable to the extent that it
represents a recoupment of the tax allowances, and capital gains tax (CGT) is applicable. The
effect of CGT on the measurement of deferred tax is discussed in section 8.8.3.
¾ The remaining tax base of the plant is deductible as a tax allowance and/or a scrapping
allowance in future periods against taxable income.
Example 8.4 Tax base of dividends receivable
A company recognises a debit account (Dividends receivable) in the statement of financial position
for dividends of R60 000 receivable from a listed investment. Dividends are not taxable.
R R R
Dividends receivable 60 000 60 000 –
Comment
¾ When the dividend receivable is recovered (i.e., cash received), the amount is not taxable.
Therefore, the tax base of the asset equals the carrying amount. Thus no temporary difference
arises.
Example 8.5 Tax base of trade receivables
A company’s trade receivables balance at the end of the reporting period amounted to R86 000.
R R R
Trade receivables 86 000 86 000 –
Comment
¾ When the carrying amount of the receivables is recovered (i.e., received in cash), the amount
will not be taxable since it was already taxed when the revenue was recognised (sales). As the
future economic benefits are not taxable, the tax base equals the carrying amount.
Example 8.6 Tax base of capitalised development costs
A company capitalised development costs of R320 000 during the year. An amount of R50 000
was recognised as an amortisation expense. Assume SARS will allow the capitalised cost to be
written-off over a period of 4 years as a tax allowance. The temporary difference is calculated as
follows at the end of the reporting period:
R R R
Development costs (*) 270 000 240 000 30 000
(*) (R320 000 – R50 000); (R320 000 – (R320 000 × 25%))
Comment
¾ The development costs will generate taxable economic benefits as the carrying amount is
recovered.
¾ The balance of the tax base will be deductible for tax purposes over the remaining three years.
Some items are not recognised as assets in the statement of financial position, because
they have already been written-off as expenses, but these items may still have a tax base
that results in a temporary difference (IAS 12.9).
Example 8.7 Tax base of items not recognised as assets
During the year, a company incurred costs of R10 000 in cash and immediately recognised it as
an expense. Assume SARS allows such costs to be deducted over three years on a 50/30/20
basis.
R R R
Costs incurred (*) – 5 000 (5 000)
(*) (R10 000 – (R10 000 × 50%))
Comment
¾ The temporary difference arose because the total expense is not immediately deductible for tax
purposes. The tax base is the amount that is deductible against future taxable income, namely
(30% + 20%) × R10 000.
8.5.1.2 Liabilities and revenue received in advance

The tax base of a liability is:
the carrying amount (for accounting purposes) less any amount that will be deductible in
future periods for tax purposes in respect of that liability (IAS 12.8).
The tax base of revenue received in advance is:
its carrying amount less any amount of the revenue that will not be taxable in future
periods (thus revenue already taxed or revenue that will never be taxed) (IAS 12.8).
Example 8.8 Tax base of a long-term loan and interest accrued
A company received a 12% long-term loan of R800 000 at the beginning of the year. At the end of
the reporting period, no capital has been repaid and no interest has been paid.
R R R
Loan (capital) (800 000) (800 000) –
Interest expense accrual (96 000) (96 000) –
continued
Income taxes 161
Comment
¾ The repayment of the loan does not have tax implications, therefore there is nothing to be
deducted from the carrying amount to determine its tax base (carrying amount of R800 000 less
an amount of Rnil deductible in future).
¾ Interest is deductible for tax purposes as it is actually incurred during the current reporting
period. Thus there will be no future tax deduction (carrying amount of R96 000 less an amount
of Rnil deductible in future).
Example 8.9 Tax base of liabilities
A company recognised the following items at the reporting date:

Water and electricity accrual R1 250
Leave pay accrual R4 500
The expenditure for the water and electricity is deductible for tax purposes during the current year
as it actually incurred. The company has an unconditional obligation to pay for the consumption of
such items (even though the cash payment may only occur in the following period).
The leave pay accrual was created for the first time in the current year, and SARS only allows the
expense when it is paid in cash to employees (i.e. during the next period).
R R R
Water and electricity accrual (1 250) (1 250) –
Leave pay accrual (4 500) – (4 500)
Comment
¾ The water and electricity expense has already been allowed as a deduction for income tax
purposes in the current year, because the service has already been provided to the company.
(It is in the tax year in which the liability for the expenditure is incurred, and not in the tax year
in which it is actually paid (if paid the subsequent year), that the expenditure is actually incurred
for the purposes of section 11(a) of the Income Tax Act.) Consequently, no further amounts will
be deductible for tax purposes in future periods. The tax base is therefore equal to the carrying
amount (carrying amount of R1 250 less an amount of Rnil deductible in future).
¾ The leave pay accrual is only deductible for tax purposes once it has been paid. The tax base
is therefore R4 500 – R4 500 = R0, or the carrying amount less the amount that will be
deductible for tax purposes in future.
Example 8.10 Tax base of revenue received in advance
At the reporting date, a company created a current liability of R380 for subscriptions received in
advance. The subscriptions are taxed immediately because they have been received in cash by
the company.
R R R
Subscriptions received in advance (380) – (380)
Comment
¾ The tax base of the subscriptions received in advance is R380 – R380 = R0, or the carrying
amount of the liability less any amount of the revenue that will not be taxable in future periods
(i.e., the full amount in this instance as the amount was already taxed in the current year).
Example 8.11 Tax base of trade receivables after allowance for credit losses
A company’s trade receivables balance at the end of the reporting period amounted to R74 000
after an allowance for credit losses of R12 000. Assume SARS allows a deduction of 25% of the
doubtful debts (credit losses).
R R R
Trade receivables 74 000 83 000 (9 000)
Gross amount 86 000 86 000 –
Allowance for credit losses (*) (12 000) (3 000) (9 000)
(*) (R12 000 × 25%)
Comment
¾ When the carrying amount of the trade receivables is recovered (i.e., received in cash), the
amount will not be taxable, since it was already taxed when the revenue was recognised. As
the future economic benefits are not taxable, the tax base equals the carrying amount.
¾ The carrying amount of the allowance is R12 000. The tax base of the allowance is R3 000
(carrying amount of R12 000 less amount of R9 000 deductible in future). The temporary
difference is therefore 75% of the allowance, which is deductible against future taxable income
when the full allowance realises.
In group statements, temporary differences are determined by comparing the carrying

amounts of assets and liabilities in the consolidated financial statements with the
appropriate tax bases. The tax bases are determined by referring to the tax returns of the
individual companies in the group (IAS 12.11). Specific adjustments, for example for
intragroup transaction, may be needed on consolidation (refer to Example 24.11).
8.5.2 Taxable temporary differences

Taxable temporary differences are those temporary differences that will result in taxable
amounts in the determination of the taxable profit or tax loss for future periods when the
carrying amount of the asset or liability is recovered or settled (IAS 12.5). A deferred tax
liability is recognised in respect of all taxable temporary differences. There are, however, a
few exceptions to this rule (IAS 12.15).
Taxable temporary differences arise in respect of assets when the carrying amount is
greater than the tax base.
An inherent aspect of the recognition of an asset is that the carrying amount will be
recovered in the form of economic benefits that will flow to the entity in future periods.
Where the carrying amount of the asset exceeds the tax base, the amount of taxable
economic benefits exceeds the amount that is deductible for tax purposes. The difference is
a taxable temporary difference and the obligation to pay the resulting income tax in future
periods is a deferred tax liability. As the entity recovers the carrying amount of the asset,
the taxable temporary difference reverses and the entity recognises the taxable income,
which will result in the payment of income tax (IAS 12.16).
Income taxes 163
Example 8.12 Taxable temporary difference
Taxable temporary differences will give rise to the recognition of a deferred tax liability in the
statement of financial position at the reporting date. Using the temporary differences illustrated in
Examples 8.3 to 8.6 and a normal income tax rate of 28%, the deferred tax liability to be
recognised will be calculated as follows:
Deferred tax Movement
Carrying Temporary – SFP to P/L
Tax base
amount differences @ 28% @ 28%
Dr/(Cr) Dr/(Cr)
R R R R R
8.3 Plant 160 000 150 000 10 000 (2 800) 2 800
8.4 Dividends receivable 60 000 60 000 – – –
8.5 Trade receivables 86 000 86 000 – – –
8.6 Development costs 270 000 240 000 30 000 (8 400) 8 400
(11 200) 11 200
Comment
¾ Taxable temporary differences arise in respect of assets when the carrying amount is greater
than the tax base.
¾ The entity will recognise a deferred tax liability of R11 200. The movement of the deferred tax
balance (opening balance assumed to Rnil) in this case also amounts to R11 200.
The journal entry for the initial recognition of the deferred tax
liability will be as follows:
Dr Cr
R R
Recognition of movement in deferred tax for the current year
In exceptional circumstances, taxable temporary differences arise in liabilities and revenue

received in advance where the tax base is larger than the carrying amount. An example
is found in construction contracts.
IAS 12.15 also identifies circumstances in which a temporary difference may exist but the
deferred tax liability is not recognised. These exceptions include deferred tax liabilities
that arise from taxable temporary differences on:
the initial recognition of goodwill (refer to the comment below); or
the initial recognition of an asset or a liability in a transaction which:
– is not a business combination; and
– at the time of the transaction, affects neither accounting profit nor taxable profit (tax
loss).
Comment
¾ Goodwill is not an allowable deduction for tax purposes; consequently, the tax base of the
goodwill is R0. Although this gives rise to a temporary difference between the carrying amount
of goodwill and its tax base, this temporary difference is not recognised in terms of IAS 12.15
because of the interdependent nature of the relationship between the determination of goodwill
and the calculation of any deferred tax thereon. Any deferred tax recognised will reduce the
identifiable net assets of the subsidiary at acquisition, which in turn will increase the amount of
goodwill.
continued
¾ It is important to note that it is only temporary differences that arise on initial recognition of
assets or liabilities that are exempt from the recognition of deferred tax (refer to the next
example for the temporary differences that arose on the initial recognition of the land and
administrative buildings for which no tax allowances can be claimed). Temporary differences
arising from subsequent remeasurement of assets or liabilities (e.g. revaluation of property,
plant and equipment, as is illustrated in Example 8.24) are not exempt.
¾ Furthermore, temporary differences arising from a business combination are not exempt and
deferred tax shall be recognised on all such temporary differences (refer to section 26.5 for
more information on deferred taxes relating to business combinations).
Example 8.13 Exemption from recognising a deferred tax liability
Tango Ltd is a manufacturing entity, which has diversified its operations, and now owns a
shopping mall and an apartment block. The final accounting profit of Tango Ltd for the year ended
31 December 20.19 amounted to R2 000 000 after all items were correctly accounted for.
Details of the property owned by Tango Ltd for the year ended 31 December 20.19 are as follows:
Land at Building Date brought
Building use
cost at cost into use
R R
Stand 502, Brenton 100 000 270 000 1 Jan 20.15 Administrative
Stand 503, Brenton 110 000 330 000 1 Jan 20.15 Manufacturing
Stand 1112, Bodmin 50 000 180 000 1 Jan 20.15 Commercial
Stand 844, Seadune 120 000 420 000 1 Jan 20.19 Residential
380 000 1 200 000
1. Land is not depreciated.
2. Tango Ltd depreciates buildings on a straight-line basis over 30 years. There are no residual
values.
3. The tax allowances are as follows:
SARS does not allow a deduction on land, nor is a deduction claimable on the administrative
building (purchased 31 December 20.14). Tango Ltd can claim a tax allowance of 5% on the
cost of the manufacturing building in terms of section 13(1), not apportioned for part of the year
(construction completed 31 December 20.14).
Tango Ltd can claim a tax allowance of 5% on the cost of the commercial building in terms of
section 13quin, as the building is mainly used for the purpose of producing taxable income.
Tango Ltd can claim a tax allowance of 5% on the cost of the apartment block (residential units)
as it qualifies in terms of section 13sex for the allowance (construction completed
1 January 20.19).
4. The deferred tax liability at 31 December 20.18 was R9 520.
5. The normal income tax rate is 28% and the carrying amount of all buildings will be recovered
through use.
continued
Income taxes 165
The deferred tax balance on 31 December 20.19 will be calculated as follows:

Deferred Movement
Carrying Temporary tax balance for the year
Tax base
amount difference @ 28% in P/L
Dr/(Cr) Dr/(Cr)
R R R R R
Land 380 000 – 380 000 Exempt
Administration building 234 000 – 234 000 Exempt
Manufacturing building 286 000 264 000 22 000 (6 160)
Residential building 156 000 144 000 12 000 (3 360)
Opening balance at
1 January 20.19 (9 520)
Land 380 000 – 380 000 Exempt
Administration building 225 000 – 225 000 Exempt
Manufacturing building 275 000 247 500 27 500 (7 700)
Commercial building 150 000 135 000 15 000 (4 200)
Residential building 406 000 399 000 7 000 (1 960)
Balance at 31 December 20.19 (13 860) 4 340
Journal entry
Dr Cr
R R
Comment
Comment
¾ The tax base of the land is Rnil as SARS does not allow a deduction on land. However, the
deferred tax has not been recognised, because the temporary difference arises from the initial
recognition of an asset which is not a business combination and which, at the time of the
transaction, affected neither the accounting profit nor the taxable profit (IAS 12.15). The
temporary difference is exempt. (The same result for the deferred tax on land would be
achieved if the tax base is measured at the cost of land, namely R380 000. IAS 12.51B
assumes that the carrying amount of non-depreciable assets (measured using the revaluation
model in IAS 16 – refer to Example 8.24) will be recovered through sale. The cost of the land
would be deductible against the proceeds when the land is sold. In this example, the land was
not revalued.)
¾ The carrying amount of the administration building is R225 000 (270 000 – 45 000
(270 000/30 × 5)) and the tax base = R0 as no amount is deductible in future. However, the
deferred tax has not been recognised, because the temporary difference arises from the initial
recognition of an asset which is not a business combination and which, at the time of the
transaction, affected neither the accounting profit nor the taxable profit (IAS 12.15). The
temporary difference is exempt. There is no tax allowance granted on this administrative
building, while the depreciation is recognised for accounting purposes. This difference is also
explained in the tax reconciliation (see below).
¾ The carrying amount of the manufacturing building is calculated as R275 000 (330 000 –
55 000 (330 000/30 × 5)). The tax base is R247 500 (330 000 – 82 500 (330 000 × 5% × 5)).
¾ The carrying amount of the commercial building is R150 000 (180 000 – 30 000
(180 000/30 × 5)). The tax base is R135 000 (180 000 – 45 000 (180 000 × 5% × 5).
¾ In the first year, the entity depreciates the residential building by R14 000 (420 000/30). The tax
base of the building is calculated as R399 000 (420 000 – 21 000 (420 000 × 5%)).
continued
Calculation of current tax for the year ended

31 December 20.19 by starting with the accounting profit:
Gross
Tax at 28%
amount
R R
Non-taxable items and additional deductions:
Depreciation: Administrative building 9 000 2 520
2 009 000 562 520
Temporary differences*:
Depreciation and tax allowance on buildings: (15 500) (4 340)
Depreciation on manufacturing building (330 000/30) 11 000
Tax allowance on manufacturing building (330 000 × 5%) (16 500)
Depreciation on commercial building (180 000/30) 6 000
Tax allowance on commercial building (180 000 × 5%) (9 000)
Depreciation on residential building (420 000/30) 14 000
Tax allowance on residential building (420 000 × 5%) (21 000)
The tax expense will be disclosed as follows in the notes:
Notes
Deferred tax expense (see journal above) 4 340
Tax expense 562 520
The tax reconciliation is as follows:
Non-deductible depreciation on administrative building (R9 000 × 28%) 2 520
Tax expense 562 520
Comment
¾ There is no tax allowance granted on the administrative building in this example. However, the
accounting depreciation is indeed deducted in determining the accounting profit. This difference
caused the total tax expense to be out of proportion (28%) to the accounting profit. The effect of
this difference is explained to the users of financial statements by the reconciliation between
the expected tax expense (R560 000) on the accounting profit and the actual tax expense
(R562 520).
Taxable temporary differences may also arise from differences in investments in subsidiaries,
branches and associates, interests in joint ventures and in business combinations. These
temporary differences are addressed in the relevant chapters.
8.5.3 Deductible temporary differences

Deductible temporary differences are those temporary differences that will result in amounts
that are deductible in the determination of the taxable profit (tax loss) in future periods when
the carrying amount of the asset or liability is recovered or settled (IAS 12.5). A deferred tax
asset is recognised for all deductible temporary differences to the extent that it is
probable that future taxable profits will be available against which the deductible temporary
differences can be utilised (IAS 12.24).
Income taxes 167
IAS 12.28 indicates that it is probable that future taxable profits will be available for
utilisation against a deductible temporary difference when:
sufficient taxable temporary differences relating to the same tax authority and the same
taxable entity are expected to reverse in the same period as the deductible temporary
differences; or
sufficient taxable temporary differences relating to the same tax authority and the same
taxable entity reverse in the periods in which a tax loss arising from the deferred tax
asset can be carried forward.
Where there are insufficient taxable temporary differences, the deferred tax asset is only
recognised to the extent that:
it is probable that the entity will have sufficient taxable profits in the same periods in
which the reversal of the deductible temporary differences occurs; or
there are tax planning opportunities available to the entity that will create taxable profit in
the appropriate periods (IAS 12.29).
These aspects are discussed in more detail in section 8.6. Deferred tax assets can also
arise from the carryforward of unused tax losses and unused tax credits. These types of
deferred tax assets are described in section 8.5.4.
Deductible temporary differences arise in respect of liabilities and revenue received in
advance when the carrying amount is larger than the tax base. When these economic
resources flow from the entity, part or all of the amount may be deductible in the
determination of taxable income in periods that follow the periods in which the liability is
recognised. In such instances, a temporary difference arises between the carrying amount
of the liability and the tax base. A deferred tax asset arises in respect of the income tax
that will be recoverable in future periods when that part of the liability is allowed as a
deduction in the determination of the taxable profit.
Example 8.14 Deductible temporary differences
Deductible temporary differences will give rise to the recognition of a deferred tax asset in the
statement of financial position at the reporting date. Using the temporary differences illustrated in
Examples 8.7 to 8.11 and a normal income tax rate of 28%, the deferred tax asset to be
recognised will be calculated as follows:
Deferred Movement
Temporary
Carrying Tax tax – SFP for the
differ-
amount base @ 28% year in P/L
ences
Dr/(Cr) Dr/(Cr)
R R R R R
8.7 Costs incurred – 5 000 (5 000) 1 400 (1 400)
8.8 Loan (capital) (800 000) (800 000) – – –
8.8 Interest expense accrual (96 000) (96 000) – – –
8.9 Water and electricity accrual (1 250) (1 250) – – –
8.9 Leave pay accrual (4 500) – (4 500) 1 260 (1 260)
8.10 Subscriptions received in
advance (380) – (380) 106 (106)
8.11 Trade receivables 74 000 83 000 (9 000) 2 520 (2 520)
5 286 (5 286)
Comment
¾ Deductible temporary differences arise in respect of assets and expenses when the tax base is
larger than the carrying amount.
¾ Deductible temporary differences also arise in respect of liabilities and revenue received in
advance when the carrying amount is larger than the tax base.
¾ A deferred tax asset of R5 286 should be created if the debit balance will be recovered in future
by means of sufficient taxable profits being earned to utilise the benefit.
continued
The journal entry for the initial recognition of the deferred tax
asset will be as follows:
Dr Cr
R R
In IAS 12.24, circumstances are identified in which a deferred tax asset is not recognised.
These exemptions include deferred tax assets which arise from:
the deductible temporary difference on the initial recognition of an asset or liability in a
transaction which:
– is not a business combination; and
– at the time of the transaction, affects neither accounting profit nor taxable profit (tax
loss).
Example 8.15 Non-taxable government grant
A company receives a non-taxable government grant of R20 000 on an asset with a cost price of
R100 000. The grant is presented as a deduction from the asset in terms of IAS 20.
R R R
Asset 80 000 100 000 (20 000) #
Comment
¾ For accounting purposes, the carrying amount of the asset is shown at R80 000, which is net of
the government grant of R20 000.
¾ The tax base is larger than the carrying amount and results in a deductible temporary
difference. This deductible temporary difference is, however, not recognised,# because the
difference arose upon the initial recognition of the asset and does not affect the accounting or
the taxable profit.
¾ The reversal of this difference is also not recognised. Also refer to IAS 12.33 in this regard.
¾ Government grants may also be recognised as deferred income, in which case the difference
between the deferred income and its tax basis of Rnil is a deductible temporary difference.
Whichever method of presentation an entity adopts, the entity does not recognise the resulting
deferred tax asset.
Example 8.16 Comprehensive example: Temporary difference over years
Alpha Ltd purchased a new machine on 1 January 20.11 and brought it into use immediately. The
machine is depreciated at 25% per annum on the straight-line basis with no residual value. For tax
purposes, a 40/20/20/20 tax allowance is applied. The reporting date of the company is
31 December. The normal income tax rate is 28%. The profits before tax (after taking depreciation
into account) for each of the four years were as follows:
20.11 R80 000
20.12 R100 000
20.13 R110 000
20.14 R130 000
continued
Income taxes 169
Accoun-
Tax
ting
Calculations in respect of the asset R R
1 January 20.11 Cost 10 000 10 000
31 December 20.11 Depreciation/tax allowance (2 500) (4 000)
7 500 6 000
5 000 4 000
2 500 2 000
– –
Tax calculation
20.11 20.12 20.13 20.14
R R R R
Accounting profit 80 000 100 000 110 000 130 000
Depreciation 2 500 2 500 2 500 2 500
Tax allowance (4 000) (2 000) (2 000) (2 000)
Taxable income 78 500 100 500 110 500 130 500
Current tax @ 28% 21 980 28 140 30 940 36 540
Deferred tax calculation

Deferred Movement
Carrying Tax Temporary tax balance for the year
amount base difference @ 28% in P/L
Dr/(Cr) Dr/(Cr)
R R R R R
20.11 7 500 6 000 1 500 (420) 420
20.12 5 000 4 000 1 000 (280) (140)
20.13 2 500 2 000 500 (140) (140)
20.14 – – – – (140)
Journal entries
Dr Cr
R R
20.11
Income tax expense (P/L) 420
Deferred tax (SFP) 420
20.12
20.13
20.14
continued
The above information will be disclosed as follows in the financial statements:

20.11 20.12 20.13 20.14
R R R R
Profit before tax 80 000 100 000 110 000 130 000
Income tax expense (22 400) (28 000) (30 800) (36 400)
Profit for the year 57 600 72 000 79 200 93 600
Statement of financial position
20.11 20.12 20.13 20.14
R R R R
Deferred tax 420 280 140 –
Current liabilities
Tax owing* 21 980 28 140 30 940 36 540
* This would be the balance after the deduction of any provisional tax paid. Assume for the
purposes of this illustration that no provisional tax was paid.
Notes
20.11 20.12 20.13 20.14
R R R R
Current tax expense 21 980 28 140 30 940 36 540
Deferred tax expense 420 (140) (140) (140)
Tax expense 22 400 28 000 30 800 36 400
Comment
¾ The tax expenses in Years 20.11, 20.12, 20.13 and 20.14 are in line (28%) with the profit before tax
amount to which they relate.
¾ Each year, the deferred tax liability (or asset) is calculated, and the change in the balance from
the preceding year to the current year is recognised in the profit or loss section of the statement
of profit or loss and other comprehensive income. This is done as the item that created the
temporary difference (annual depreciation amount differs from tax allowance) was recognised
in profit or loss.
8.5.4 Assessed tax losses

A deferred tax asset represents the income tax amounts that are recoverable in future
periods in respect of:
deductible temporary differences (section above);
the carryforward of unused tax losses (assessed tax losses); and
the carryforward of unused tax credits.
An assessed tax loss is the amount by which the tax deductions exceed the taxable
income of a company for a particular year of assessment. Such a tax loss can be carried
forward to the next year of assessment and can be deducted from the taxable income in the
next year of assessment. This implies that an assessed tax loss can be regarded as a
specific type of deductible temporary difference. The principles underpinning the
accounting treatment of deductible temporary differences also apply to assessed tax losses.
In terms of IAS 12.34, a deferred tax asset is recognised for the carryforward of unused tax
losses (assessed tax losses) and unused tax credits to the extent that it is probable that
there will be taxable profit in future against which the unused tax losses and unused tax
credits may be utilised. The requirements in respect of the creation of deferred tax assets
resulting from deductible temporary differences also apply to unused tax losses and tax
Income taxes 171
credits. However, where unused tax losses arise as a result of recent operating losses, it
may indicate that future taxable profits may not be available in the future to utilise these tax
losses (IAS 12.35). Other indications that future taxable profits may not be available are an
entity’s history of unused or expired tax losses and tax credits, as well as management’s
expectation of future operating losses. There should be convincing evidence that sufficient
taxable income will be available to utilise the asset in future periods.
IAS 12.36 proposes the following criteria for assessing the probability that sufficient taxable
profits will be generated in future in order to utilise unused tax losses and credits:
the entity has sufficient taxable temporary differences relating to the same tax authority
and the same taxable entity to provide taxable amounts against which the unused tax
losses or unused tax credits may be utilised;
it is probable that the entity will have taxable profits before the unused tax losses or
unused tax credits expire;
the unused tax losses result from identifiable causes which are unlikely to recur; and
the entity has tax planning opportunities (discussed in section 8.6 below) available that
will create taxable profits in the period in which the unused tax losses or unused tax
credits may be utilised.
Example 8.17 Assessed tax losses
The following information is available for a newly-formed company, Omega Ltd. The normal
income tax rate is 28%. The information is for the first two consecutive years:
Year 1 Year 2
R R
Accounting profit for the year: 52 000 100 000
Temporary differences arose as follows:
Property, plant and equipment (cost of R800 000):
Carrying amount
(800 000 – 50 000 depreciation); (750 000 – 118 000 depreciation) 750 000 632 000
Tax base
(800 000 – 107 000 allowance); (693 000 – 63 000 allowance) (693 000) (630 000)
Temporary difference (taxable) 57 000 2 000
Therefore movement on temporary differences 57 000 (55 000)
Tax calculation
Year 1 Year 2
R R
Accounting profit before tax 52 000 100 000
Movement in temporary differences (57 000) 55 000
Depreciation 50 000 118 000
Tax allowance (107 000) (63 000)
(Assessed tax loss)/Taxable income for the year (5 000) 155 000
Assessed tax loss brought forward from previous year – (5 000)
(Assessed tax loss)/Taxable income (5 000) 150 000
Current tax payable (at a tax rate of 28%) – 42 000
continued
Deferred tax
Deferred
Carrying Tax Temporary tax @
amount base difference 28%
Dr/(Cr)
R R R R
Year 1
Property, plant and equipment 750 000 693 000 57 000 (15 960)
Assessed tax loss – (5 000) (5 000) 1 400
Deferred tax liability 52 000 (14 560)
Movement in statement of profit or loss and other comprehensive income
(R14 560 – Rnil = R14 560 Dr)
Deferred
amount base difference 28%
Dr/(Cr)
R R R R
Year 2
Property, plant and equipment 632 000 630 000 2 000 (560)
Assessed tax loss – – – –
Deferred tax liability 2 000 (560)
Movement in statement of profit or loss and other comprehensive income
(R560 – R14 560 = R14 000 Cr)
In Year 2, no assessed tax loss exists since it has been fully utilised in the current tax calculation
of Year 2.
Deferred tax account
R Year 1 R
Tax expense1 1 400 Opening balance –
Balance c/f 14 560 Tax expense2 15 960
15 960 15 960
Year 2
Tax expense3 15 400 Balance b/d 14 560
Balance c/f 560 Tax expense4 1 400
15 960 15 960
1
Assessed tax loss (deferred tax asset fully recognised) (R5 000 × 28%)
2
Temporary differences – Property, plant and equipment (R57 000 × 28%)
3
Temporary differences – Property, plant and equipment ((R57 000 – R2 000) × 28%)
4
Assessed tax loss utilised
The statement of profit or loss and other comprehensive income reflects the following:
Year 1 Year 2
R R
Income tax expense (14 560) (28 000)
continued
Income taxes 173
The notes will reflect the following:

Year 1 Year 2
R R
Current tax expense – 42 000
Deferred tax expense* 14 560 (14 000)
Accelerated tax allowances for tax purposes (15 960 – 0); (560 – 15 960) 15 960 (15 400)
Assessed loss (0 – 1 400); (1 400 – 0) (1 400) 1 400
Effective tax rate 28% 28%
(Year 1: R14 560/R52 000 = 28% effective tax rate)
No current tax was provided for in Year 1, since the company had an assessed tax loss.
3. Deferred tax
Year 1 Year 2
R R
Analysis of temporary differences
Accelerated tax allowances for tax purposes 15 960 560
Assessed loss (1 400) –
Deferred tax liability 14 560 560
Comment
¾ Because the amount of the deferred tax expense for the various categories of temporary
differences is apparent from the changes in the deferred tax balance in the statement of
financial positions (note 3), there is no need to disclose the categories of temporary differences
in the note for the income tax expense* (note 2) (IAS 12.81(g)(ii)). The categories of temporary
differences were presented for the sake of completeness.
¾ Because the effective tax rate and the standard tax rate are the same, a reconciliation of the
tax rate is not required.
8.6 Recognition of deferred tax assets – specific aspects

A deferred tax asset (on deductible temporary differences and assessed tax losses, as was
discussed in the preceding sections) should be created only to the extent that it will be
utilised in future by means of taxable temporary differences, or when acceptable evidence
exists to indicate that sufficient taxable income will be available against which the deductible
temporary differences can be utilised. In essence, the realisation of future taxable income is
largely dependent on the future profitability of the entity. The criteria given for the recognition
of a deferred tax asset in IAS 12 are aimed at establishing whether the entity will be
profitable in future.
It is apparent that a certain measure of professional judgement should be exercised in
recognising deferred tax assets, especially in instances in which the amount of the taxable
temporary differences is smaller than the amount of the deductible temporary differences. A
deferred tax asset may then be recognised to the extent (IAS 12.29) that:
it is probable that the entity will have sufficient taxable profits relating to the same tax
authority and the same taxable entity in the same period as the reversal of the deductible
temporary difference (including assessed tax losses carried forward); or
the entity has tax planning opportunities available that will create taxable profits in the
period in appropriate periods.
Tax planning opportunities arise when the entity institutes measures to create or increase
taxable income in specific periods in order to utilise deductible temporary differences, tax
losses and tax credits. The following examples of tax planning opportunities are presented
in IAS 12.30:
the entity defers the claim for certain tax deductions from taxable income;
the entity sells, and possibly leases back, assets that have appreciated in value, but for
which the tax base has remained constant; and
the entity sells an asset that generates non-taxable revenue in order to purchase another
investment that generates taxable revenue.
An important aspect to consider in the creation of deferred tax assets is timing. The first
step for the recognition of a deferred tax asset in an entity is that taxable temporary
differences which create taxable income, or taxable income itself, will be available against
which the unused losses may be utilised. The second step is to ensure that the timing of the
reversal, realisation and utilisation of these items correspond. If it is assumed that a tax loss
expires or that deductible temporary differences reverse in the near future, but that taxable
temporary differences only reverse several years later (creating taxable income), the
deferred tax asset may not be recognised. An important matter addressed in IAS 12 is the
manner in which deferred tax assets and deferred tax liabilities are recovered or settled.
This aspect influences the assessment of when deductible temporary differences will
reverse and when tax losses and tax credits will be utilised. The deferred tax asset is only
recognised to the extent that it is probable that there will be taxable income in these periods.
Deferred tax assets and liabilities are calculated separately. All deferred tax liabilities are
recognised, but deferred tax assets are only recognised to the extent that it is probable that
taxable income will be available in future, when the unused tax losses and unused tax
credits are utilised.
In instances in which the deferred tax asset cannot be utilised fully, IAS 12 permits the
partial recognition of the deferred tax asset, which is obviously limited to the amount of
expected future taxable profits.
The extent to which deferred tax assets are not recognised in the statement of financial
position should be disclosed in a note to the statement of financial position (IAS 12.81(e)).
The utilisation of previously unrecognised deferred tax assets in the current year should be
disclosed separately as a component of the tax expense (IAS 12.80(e) and (f)).
Income taxes 175
Example 8.18
.18 Deferred tax asset recognised
The following information regarding a newly-formed company, Charlie Ltd, is available. The normal
income tax rate is 28%. The information is for two consecutive years.
Year 1 Year 2
R R
Accounting (loss)/profit for the year: (5 000) 155 000
Temporary differences are as follows:
(see detail in deferred tax calculation below):
Carrying amount 750 000 680 000
Tax base (805 000) (700 000)
Temporary difference (deductible) (55 000) (20 000)
Thus movement in temporary differences (55 000) 35 000
Tax calculation
Accounting (loss)/profit before tax (5 000) 155 000
Movement in temporary differences 55 000 (35 000)
Depreciation 160 000 70 000
Tax allowances (105 000) (105 000)
Taxable income 50 000 120 000

Current tax payable (@ 28%) 14 000 33 600
The calculation of deferred tax is as follows:
Deferred
tax @28%
amount base difference
Dr/(Cr)
R R R R
Property, plant and equipment: Cost 910 000 910 000
Movement for Year 1 – temporary
differences (160 000) (105 000) (55 000) 15 400
Year 1 balance 750 000 805 000 (55 000) 15 400
Movement for Year 2 – temporary
differences (70 000) (105 000) 35 000 (9 800)
Year 2 balance 680 000 700 000 (20 000) 5 600
Assume that it is probable at the end of Year 1 that sufficient taxable income will be earned
in Year 2 and thereafter.
R R
Year 1
Tax expense1 15 400 Opening balance –
Balance c/f Year 1 15 400
15 400 15 400
Year 2
Balance b/f 15 400 Tax expense1 9 800
Balance c/f Year 2 5 600
15 400 15 400
1
Temporary differences – Property, plant and equipment
continued
Year 1 Year 2
R R
(Loss)/profit before tax (5 000) 155 000
Income tax expense 1 400 (43 400)
(Loss)/profit for the year (3 600) 111 600
Notes
Year 1 Year 2
R R
Current tax expense 14 000 33 600
Deferred tax expense (15 400) 9 800
Tax expense (1 400) 43 400
Effective tax rate 28% 28%
3. Deferred tax
Analysis of temporary differences:
Tax allowances on property, plant and equipment (15 400) (5 600)
Deferred tax asset recognised (15 400) (5 600)
The company has recognised a deferred tax asset in respect of deductible temporary differences
on its property, plant and equipment. Management believes that it is probable that sufficient future
taxable profits will be earned to utilise the deductible temporary differences, as the company has
signed various new contracts from which significant profits are expected (IAS 12.82).
Comment
¾ In this example, it is probable that the debit balance on the deferred tax account will realise.
Consequently, the effect of the deductible temporary difference is recognised in full in Year 1.
During Year 2, a portion of the debit balance is utilised due to the reversal of temporary
differences of R35 000. At the end of Year 2, the deferred tax account has a debit balance of
R5 600 ((700 000 – 680 000) × 28%) presented under non-current assets in the statement of
financial position.
Income taxes 177
Example 8.19 Deferred tax asset not recognised
Refer once again to the information in the previous example for Charlie Ltd. The normal income
tax rate is 28%.
The probability that taxable profit will be earned for Year 2 and thereafter is remote (as at
every year end).
Deferred
tax @28%
Dr/(Cr)
R R R R
(refer to detail in preceding example):
Year 1 balance 750 000 805 000 (55 000) 15 400
Deferred tax asset not recognised (15 400)
Balance of deferred tax asset
recognised –
Year 2:
Previously unrecognised asset utilised
against tax expense of current year
(see comment below) 15 400
Movement for Year 2 –
temporary differences (70 000) (105 000) 35 000 (9 800)
Year 2 balance 680 000 700 000 (20 000) 5 600
recognised –

R Year 1 R
Tax expense 1 – Opening balance –
Balance c/f Year 1 – –
Year 2
Balance c/f Year 2 – Balance b/f –
Tax expense 2 –
– –
1
Temporary differences – Property, plant and equipment (R15 400 limited to R0)
2
Temporary differences – Property, plant and equipment (R9 800 limited to R0) or (R15 400
unrecognised from preceding year, now utilised – R9 800 movement for current year – R5 600
unrecognised for current year)
Year 1 Year 2
R R
(Loss)/profit before tax (5 000) 155 000
(Loss)/profit for the year (19 000) 121 400
continued
Notes
Year 1 Year 2
R R
Current tax expense (calculated in previous example) 14 000 33 600
Deferred tax expense – –
(Originating)/reversing deductible temporary differences* (15 400) 9 800
Deferred tax assets not recognised* 15 400 5 600
Previously unrecognised deferred tax asset utilised in current year
to reduce tax expense (IAS 12.80(e) and (f))* – (15 400)
Accounting profit (5 000) 155 000
Tax at the standard tax rate of 28% (R5 000 × 28%); (R155 000 × 28%) (1 400) 43 400
Effect of debit balance on deferred tax account not recognised
(movement for the year) (R55 000 × 28%); (R35 000 × 28%) or
(R5 600 – R15 400) 15 400 (9 800)
Effective tax rate – 280% 21,68%
(Year 1: R14 000/(R5 000) = 280% effective tax rate)
(Year 2: R33 600/R155 000 = 21,68% effective tax rate)
3. Deferred tax
Tax allowances on property, plant and equipment 15 400 5 600
Unrecognised deferred tax asset (15 400) (5 600)
Deferred tax asset recognised – –
The company has deductible temporary differences of R20 000 at the end of Year 2 (Year 1:
R55 000) in respect of tax allowances on property, plant and equipment, but no deferred tax asset
was recognised, as sufficient future taxable income to utilise the deductible temporary difference
was not deemed probable (IAS 12.81(e)).
Comment
¾ The deductible temporary difference of R55 000 in Year 1 would have resulted in a debit of
R15 400 to the deferred tax account. Because it is not probable that the asset will be realised,
the debit balance is not created in terms of IAS 12.24 and .29. The recoverability of the
unrecognised deferred tax asset is reassessed at the end of each reporting period in terms of
IAS 12.37.
¾ The balance of deferred tax for both years is R0. Therefore, the movement for Year 2 is also
R0. However, disclosure should be made of the components of the deferred tax expense
(IAS 12.80(c) and .81(g)). Disclosure of the benefit arising from a previously unrecognised
temporary difference of a prior year (Year 1) that is used to reduce the tax expense during the
current year (Year 2) should also be made (IAS 12.80(e) and (f)). The amounts presented
above* are evident from the calculation of the deferred tax above and represent the detailed
movements in the deferred tax balance.
¾ The benefit arising from utilising a previously unrecognised temporary difference of a prior year
can also be viewed as a change in accounting estimate, as it was estimated at the end of
Year 1 that there will probably not be sufficient taxable income in Year 2 to utilise the deductible
temporary difference of R55 000. No deferred tax asset was recognised then. However, during
Year 2, the taxable income was R120 000 and the full temporary difference could be utilised,
proving that the estimate at the end of Year 1 was incorrect and should be changed.
Consequently, an adjustment of R15 400 is made in Year 2 and this is disclosed separately in
the note for the income tax expense.
Income taxes 179
Example 8.20 Partially recognised deferred tax asset
Beta Ltd correctly recognised a provision during Year 1, which it is deductible for tax purposes
when paid in cash. Details of the provision are as follows:
Provision:
R
Expense recognised during Year 1 and balance at end of Year 1 120 000
Amount paid during Year 2 (20 000)
Balance end of Year 2 100 000
In Year 1, the results of Beta Ltd are as follows:
R
Operating profit (accounting profit) 500 000
Reversing deductible temporary difference (relating to the provision) 120 000
Accounting expense 120 000
Tax deduction –
Tax loss 620 000

Current tax expense at 28% 173 600
Thus, Beta Ltd had a deductible temporary difference of R120 000 in Year 1 in respect of a
provision. Management is of the opinion that there will be sufficient future taxable income
available to utilise only R30 000 of the deductible temporary difference.
Assume that the deferred tax balance in Year 0 is R0, that there is no assessed tax loss carried
forward, and that the normal income tax rate is 28%.
Deferred
tax @28%
Dr/(Cr)
R R R R
Provision: Year 1 balance (120 000) – (120 000) 33 600
Balance of deferred tax asset 8 400
recognised
Beta Ltd will pass the following journal entry relating to deferred tax in Year 1:
Dr Cr
R R
Deferred tax asset (SFP) 8 400
Income tax expense (R30 000 × 28%) (P/L) 8 400
Recognition of partial deferred tax asset for deductible temporary difference
The unrecognised asset is therefore R90 000 × 28% = R25 200
This unrecognised deferred tax asset is disclosed in the notes (see below).
In Year 2, the results of Beta Ltd are as follows:
R
Operating loss (accounting loss) (64 000)
Reversing deductible temporary difference (relating to the provision) (20 000)
Accounting expense –
Tax deduction (20 000)
Tax loss (84 000)

Current tax expense –
The balance of the provision at the end of Year 2 is R100 000. Of the initial deductible temporary
difference of R120 000 in Year 1, R20 000 has reversed, leaving a net balance of R100 000.
continued
The first step is to establish the amount of the deferred tax asset that should be raised:
R
Assessed tax loss 84 000
Deductible temporary difference (relating to the provision) 100 000
184 000
Possible deferred tax asset (at a tax rate of 28%) 51 520
The second step before a deferred tax asset may be recognised in the statement of financial
position is to establish to what extent the asset will realise in the future, in that sufficient future
taxable income will be available when the deductible temporary difference reverses and the
assessed tax loss is utilised.
If management decides that it is probable that there will be taxable profits amounting to
R135 000 in the periods in which the deferred tax asset realises, a deferred tax asset is
recognised at an amount of R37 800 (R135 000 × 28%).
Deferred
tax @28%
Dr/(Cr)
R R R R
Provision: Year 2 balance (100 000) – (100 000) 28 000

Assessed tax loss (84 000) (84 000) 23 520
Possible deferred tax asset 51 520
Balance of deferred tax asset 37 800
recognised
Beta Ltd will pass the following journal entry relating to deferred tax in Year 2:
Dr Cr
R R
Deferred tax (R37 800 – R8 400) (SFP) 29 400
Recognition of partial deferred tax asset and movement for the year
The unrecognised asset is therefore R13 720 ((184 000 – 135 000) × 28%) and it is disclosed in
the notes to the financial statements in terms of IAS 12.81(e), as follows:
The tax notes will be disclosed as follows:
2. Income tax expense Year 1 Year 2
R R
Current tax (Year 1: given); (Year 2: assessed loss) 173 600 –
Deferred tax (see journals above) (8 400) (29 400)
(Originating)/reversing of deductible temporary difference on provision
(Year 1: 120 000 x 28%); (Year 2: 20 000 x 28%) (33 600) 5 600
Assessed loss (Year 2: 84 000 x 28%) – (23 520)
Effect of unrecognised deferred tax asset (movement for the year)
(Year 1: 90 000 x 28%); (Year 2: movement of 25 200 – 13 720) 25 200 (11 480)
Tax expense 165 200 (29 400)
continued
Income taxes 181
Tax reconciliation
Year 1 Year 2
R R
Accounting profit (/loss) 500 000 (64 000)
Tax at the standard tax rate of 28% 140 000 (17 920)
Effect of unrecognised portion of deferred tax asset
(Year 2: movement of 25 200 – 13 720) 25 200 (11 480)
Tax expense 165 200 (29 400)
Effective tax rate 33,04% 45,94%
(Year 1: R165 200/R500 000) = 33,04% effective tax rate)
(Year 2: R29 400/R64 000 = 45,94% effective tax rate)
3. Deferred tax
Provisions (120 000 × 28%); (100 000 × 28%) 33 600 28 000
Assessed loss (84 000 × 28%) – 23 520
Unrecognised deferred tax asset (90 000 × 28%); (49 000 × 28%) (25 200) (13 720)
Deferred tax asset recognised 8 400 37 800
The company has deductible temporary differences of R49 000 (Year 1: R90 000) in respect of a
provision, and an assessed loss at the end of Year 2 for which no deferred tax asset was
recognised, as sufficient future taxable income to utilise the full deductible temporary differences
was not deemed probable (IAS 12.81(e)).
Comment
¾ The effect of unrecognised deferred tax assets on the statement of financial position should be
disclosed. Its effect on the tax expense in profit or loss and the tax reconciliation should also be
disclosed.
The discussion and illustrations above dealt with deductible temporary differences that
relate to normal income tax (taxed at 28%). There may also be deductible temporary
differences that relate to capital losses (for which the inclusion rate is 80%). Capital losses
(other than section 11(0) allowances) can be deducted from capital gains in the current year
of assessment. If the capital losses exceed the capital gains for the current year, that net
capital loss may be carried forward to the following year of assessment. Consequently, a
deferred tax asset for deductible capital losses can also only be recognised to the extent
that it is probable that capital gains will be available in future against which the capital losses
can be utilised (IAS 12.27A). Refer to Example 8.27 for more detail.
As the recognition of a deferred tax asset is dependent on the probability of future taxable
income, the recognised and unrecognised deferred tax assets are reassessed at each
reporting date (IAS 12.37). The entity should reduce or write off the deferred tax asset if it is
no longer probable that there will be sufficient taxable profit in future to utilise all or a portion
of the benefit of the asset (IAS 12.56). Should circumstances change and it becomes
probable that taxable profit will be available in future, the unrecognised portion of the
deferred tax asset is recognised accordingly. An example of such changed circumstances is
when the composition of the management of an entity changes, thereby changing its
expectations regarding future taxable profit.
This remeasurement and adjustment of the deferred tax asset is not an adjustment of the
previous year’s results, but rather a change in accounting estimate. The difference between
the extent to which the asset is recognised in the current and the preceding year is recognised
as a deferred tax adjustment in the current year’s statement of profit or loss and other
comprehensive income. The adjustment is disclosed to users in the tax reconciliation (see
IAS 12.81(c)).
Example 8.21
8.21 Write-down of deferred tax asset and reversal
At the end of December 20.11, Berg Ltd correctly recognised a provision for environmental
restoration at an amount of R100 000. The appropriate discount rate is 10% per annum. Interest of
R10 000 (R100 000 × 10%) would be recognised on the provision during 20.12. Interest of R11 000
(R110 000 × 10%) would be recognised on the provision during 20.13.
Any amount in respect of this provision will be deductible for tax purposes when actually paid. At the
end of 20.11, management was of the opinion that there will be sufficient future taxable income
available to utilise all the deductible temporary differences. The deferred tax asset of R28 000
((R100 000 – Rnil) × 28%) was correctly recognised.
However, at the end of 20.12, Berg Ltd suffered significantly losses due to a recession. At the end
of 20.12, management was of the opinion that there will not be sufficient future taxable income
available to utilise the deductible temporary differences. The deferred tax asset could not be
recognised. The profit before tax amounted to only R1 500 for 20.12.
During 20.13, the local economy recovered and Berg Ltd made substantial profits again. At the
end of 20.13, management was of the opinion that there will be sufficient future taxable income
available to utilise all the deductible temporary differences. The deferred tax asset could be
recognised. The profit before tax amounted to R80 000 for 20.13.
The normal income tax rate is 28%. Details of the provision, the related temporary differences and
deferred tax are as follows:
Deferred tax Deferred

tax @28%
Dr/(Cr)
R R R R
Provision – end 20.11 (100 000) – (100 000) 28 000
Expense recognised during 20.12 (10 000) – (10 000) 2 800
Provision – end 20.12 (110 000) – (110 000) 30 800
Write-down of deferred tax asset
previously recognised (28 000)
recognised – end 20.12 –
Expense recognised during 20.13 (11 000) – (11 000) 3 080

Reversal of previous write-down 28 000
Previously unrecognised asset utilised
against tax expense of current year 2 800
Provision and balance of deferred tax
asset – end 20.13 (121 000) – (121 000) 33 880
Tax calculation
20.12 20.13
R R
Accounting profit before tax 1 500 80 000
Add back expenses recognised for provision 10 000 11 000
Tax deductions (cash paid) – –
Taxable income for the year 11 500 91 000
Current tax payable (at a tax rate of 28%) 3 220 25 480
continued
Income taxes 183
20.12 20.13
R R
Income tax (expense)/income (31 220) 8 400
(Loss)/Profit for the year (29 720) 88 400
Notes
20.12 20.13
R R
Current tax expense 3 220 25 480
Deferred tax expense/(income) 28 000 (33 880)
Originating deductible temporary differences (2 800) (3 080)
Write-down of deferred tax asset/(Reversal of previous write-down) 28 000 (28 000)
Deferred tax assets not recognised/(Previously unrecognised
deferred tax asset utilised in current year to reduce tax expense) 2 800 (2 800)
Tax expense/(income) 31 220 (8 400)

Accounting profit 1 500 80 000
Tax at the standard tax rate of 28% (R1 500 × 28%); (R80 000 × 28%) 420 22 400
Write-down of deferred tax asset/(Reversal of previous write-down) 28 000 (28 000)
Effect of debit balance on deferred tax account not
recognised/(Previously unrecognised deferred tax asset utilised) 2 800 (2 800)
Tax expense 31 220 (8 400)
Effective tax rate 2 801% – 10,50%
(Year 1: R31 220/R1 500) = 2 801% effective tax rate)
(Year 2: (R8 400)/R80 000 = –10,50% effective tax rate)
3. Deferred tax
20.12 20.13
R R
Provision for environment restoration 30 800 33 880
Deferred tax asset not recognised (28 000 + 2 800) (30 800) –
Deferred tax asset recognised – 33 880
The company has deductible temporary differences of R110 000 at the end of 20.12 (20.13: R0) in
respect of a provision for environment restoration, but no deferred tax asset was recognised, as
sufficient future taxable income to utilise the deductible temporary difference was not deemed
probable (IAS 12.81(e)).
At the end of 20.13, the company has recognised a deferred tax asset in respect of deductible
temporary differences on its provision for environment restoration. Management believes that it is
probable that sufficient future taxable profits will be earned to utilise the deductible temporary
differences, as the company has signed various new contracts from which significant profits are
expected (IAS 12.82).
continued
Comment
¾ The deferred tax asset that was recognised at the end of 20.11 was reviewed at the end of
20.12 in terms of IAS 12.56. The recognised deferred tax asset was written down as it was not
probable that sufficient taxable profit would be available to allow the benefit of the deferred tax
asset to be utilised.
¾ The unrecognised deferred tax asset was reassessed at the end of 20.13 in terms of IAS 12.37.
The deferred tax asset was again recognised at the end of 20.13 as it became probable that
future taxable profit would again be available to allow the deferred tax asset to be recovered.
¾ The write-down of the recognised deferred tax asset and the subsequent reversal therefore
should be disclosed separately in terms of IAS 12.80(g).
8.7 Enacted or substantively enacted tax rates and tax laws

IAS 12.46 and .47 require that current and deferred tax assets and liabilities must be
measured on the basis of tax rates and tax laws that have been enacted or substantively
enacted by the reporting date.
The South African Financial Reporting Guide, FRG 1, Substantively Enacted Tax Rates and
Tax Laws, addresses the issue of substantive enactment. It concludes that changes in tax
rates must be regarded as substantively enacted from when they are announced in the
Minister of Finance’s budget statement.
It should be borne in mind that changes in tax rates must be applied to the period to which
they relate. For example, a change in tax rate could be announced during a tax year as being
applicable to the following year, in which case the current tax balances in the statement of
financial position would be based on the previous tax rate, whereas the deferred tax balance
in the statement of financial position would be based on the new tax rate (i.e. at the tax rate
that is expected to apply in the period when the asset is realised or the liability settled – refer
to section 8.8 below).
If the tax rates are regarded as being substantively enacted after the reporting date, they are
regarded as non-adjusting events in terms of IAS 10 Events After the Reporting Period even
when the changes to tax rates are applied retrospectively. In this case, the required
disclosure in terms of IAS 10 is to be provided.
Changes in tax rates need to be distinguished from other changes in tax laws. In the case
of changes in tax laws, the detail of the changes is generally only decided upon at a later
date and substantive enactment therefore only occurs once the legislation is approved,
since prior to this date there is insufficient certainty about the details to be applied in practice
when the changes are actually enacted. As such, FRG 1 proposes that changes in tax laws,
other than changes to tax rates, should be regarded as being substantively enacted only
when they have been approved by Parliament and signed by the President.
FRG 1 recognises that it could be possible that changes in tax rates are inextricably linked
to other changes in the tax laws. If this is the case, then they should be regarded as being
substantively enacted only when they have been approved by Parliament and signed by the
President, and not on the date of the budget speech. An example of such changes was
when CGT was introduced in 2001 (i.e. the tax rate applicable to capital items changed from
0% to 15% (50% × 30%)).
These principles are also applied to interim financial statements prepared in accordance
with IAS 34. In other words, current and deferred tax balances in the interim financial
statements are to be measured using tax rates and tax laws that have been enacted or
substantively enacted by the interim reporting date.
Income taxes 185
8.8 Recognition and measurement of deferred tax

In the preceding examples, the deferred tax effect was recognised against profit or loss (i.e.
the movement in the deferred tax balance was recognised as a debit or credit entry to the
income tax expense). In those examples the items (e.g. property, plant and equipment and
provisions) that gave rise to the deferred tax also relates to items recognised within profit or
loss (e.g. depreciation, expenses for provision raised, etc.). The general guideline for the
recognition of deferred tax is that it should be treated in the same manner as the
accounting treatment of the underlying transaction or event. The deferred tax must be
recognised in other comprehensive income if the tax is related to an item which is
recognised in other comprehensive income either in the same or in another period
(IAS 12.61A). Examples include the revaluation of property, plant and equipment, (which is
addressed in chapter 9) and long-term investments at fair value through other
comprehensive income (refer to chapter 20).
Deferred tax must be recognised as income or an expense in the profit or loss for the year,
except if the tax arises from:
transactions recognised in other comprehensive income (e.g. a revaluation);
transactions recognised directly in equity (e.g. the correction of a prior period error in
retained earnings at the beginning of the year – see Example 6.4); or
a business combination (IAS 12.58).
If the tax status of a company should change through, for example, the restructuring of
equity or the relocation of the major shareholder, the tax consequences of the current and
deferred tax must be recognised in the profit or loss of the year. SIC 25 suggests that the
exception occurs where the tax consequences relate to transactions or events that were
treated as a direct charge to equity or other comprehensive income. In these instances, the
tax adjustment is also charged or credited directly to equity or other comprehensive income.
IAS 12.47 requires deferred tax assets and liabilities to be measured at the tax rates that
are expected to apply in the period when the asset is realised or the liability settled, based
on tax rates and tax laws that have been enacted or substantively enacted at the reporting
date (refer to section 8.7).
8.8.1 Reversal of deferred tax

Deferred tax balances are recognised in respect of temporary differences on assets and
liabilities. This implies that if the specific temporary difference no longer exists at the end of
the reporting period, any related deferred tax balance should be reversed. The deferred tax
balance is recalculated at the end of each reporting period. This recalculated balance is
compared to the balance at the end of the previous reporting period, and the
increase/decrease is recognised against the same component (e.g. profit or loss) of the
financial statements where the related item was recognised (as explained above).
When, for example, an item of plant that lead to the recognition of a deferred tax liability is
sold, the related deferred tax balance is reversed. The profit or loss on the disposal of the
plant would be recognised in profit or loss, and the movement in the deferred tax balance (to
Rnil) would also be recognised in profit or loss (as part of the income tax expense).
Example 8.22
8.22 Reversal of the deferred tax balance, with capital gains tax
The accounting profit of Palm Ltd for the year ended 31 December 20.15 amounted to
R2 000 000. Palm Ltd’s only temporary difference relates to an item of plant. Palm Ltd acquired
the item of plant on 1 January 20.14 at a cost of R500 000. The plant is depreciated evenly over
8 years with no residual value. For tax purposes, a 40/20/20/20 tax allowance is applied. At the
end of 20.15, Palm Ltd sold the plant for R550 000.
The normal income tax rate is 28% and the capital gains tax inclusion rate is 80%.
Deferred tax on plant:
Deferred
tax @28%
Dr/(Cr)
R R R R
Cost 500 000 500 000
Depreciation/tax allowance 20.14 (62 500) (200 000)
Balance end of 20.14 437 500 300 000 137 500 (38 500)
Depreciation/tax allowance 20.15 (62 500) (100 000) 37 500 (10 500)
Balance before disposal 375 000 200 000 175 000 (49 000)
Disposal (375 000) (200 000) (175 000) 49 000
Balance end of 20.15 – – – –
The accounting profit on the sale is as follows:
R
Proceeds 550 000
Carrying amount on the date of the sale (calculated above) (375 000)
Accounting profit on the sale 175 000
The income tax consequences are as follows
(calculation done in the format of the Income Tax Act):
Recoupment:
Proceeds (limited to the cost price) 500 000
Income tax value on the date of the sale (calculated above) (200 000)
Recoupment 300 000
Capital gain:
Proceeds: 250 000
Selling price 550 000
Recoupment (300 000)
Less: Base cost (income tax value on the date of the sale as calculated above) 200 000
Cost price 500 000
Allowances (300 000)
Capital gain 50 000
The capital gains tax inclusion rate is 80% and an amount of R40 000
(50 000 × 80%) will be included in the taxable income. Consequently, R10 000 of
the capital gain will not be taxed.
continued
Income taxes 187
Calculation of current tax for the year ended 31 December 20.15:

Gross
Tax at 28%
amount
R R
Non-taxable items:
Portion of accounting profit on disposal of plant that relates to the
capital gain that is not taxable ((R550 000 – R500 000) × 20%) (10 000) (2 800)
1 990 000 557 200
Temporary differences:
Depreciation and tax allowance on plant (37 500) (10 500)
Depreciation on plant 62 500
Tax allowance on plant (100 000)
Disposal of plant 175 000 49 000
Portion of accounting profit on disposal of plant that relates to the
capital gain that is taxable and the recoupment
((R550 000 – R375 000) – 10 000 above) (165 000)
Recoupment of tax allowances (R500 000 – R200 000) 300 000
Taxable capital gains ((R550 000 – R500 000) × 80%) 40 000
Notes
R
Deferred tax income (10 500 – 49 000) (38 500)
Tax expense 557 200
Portion of accounting profit on disposal of plant that relates to the capital
gain that is not taxable (R10 000 × 28%) (2 800)
Tax expense 557 200
Effective tax rate (R557 200/R2 000 000) 27,86%
Comment
¾ The deferred tax liability amounted to R49 000 before the sale of the item of plant. There are no
temporary differences after the sale of the item of plant and the deferred tax liability should
amount to R0. The deferred tax balance of R49 000 is reversed with the recognition of the profit
on disposal of the asset, by debiting the deferred tax liability and crediting the income tax
expense with R49 000.
note for the income tax expense.
¾ The accounting profit on the disposal of the plant amounted to R175 000 (proceeds of
R550 000 less the carrying amount of R375 000). This amount was deducted from the total
accounting profit (to calculate the taxable income) as two amounts (R10 000 under the
‘permanent’ differences and R165 000 under temporary differences) for illustrative purposes
only, in order to relate this to the capital gain that is not taxable and the recoupment and capital
gains that are taxable in terms of the Income Tax Act.
8.8.2 Measuring of deferred tax in case of change in tax rate

An accounting estimate is made for the purpose of recognising the amount of deferred tax,
by referring to the information at the reporting date. It follows that when the tax rates
change, the deferred tax balance will be adjusted accordingly. The adjustment will be a
change in the accounting estimate that will form part of the income tax expense in the
statement of profit or loss and other comprehensive income of the current year, if the item
that lead to the temporary difference was also recognised in profit or loss.
When a new tax rate has already been announced by the tax authorities at the reporting
date, the announced rate should be used in measuring the deferred tax assets and liabilities
(refer to section 8.8 above).
Example 8.23 Change in the tax rate
Scenario A:
Gamma Ltd had the following temporary differences for the years ended 31 December 20.12 and
20.13.
20.13 20.12
R R
Property, plant and equipment:
Carrying amount 150 000 200 000
Tax base (80 000) (120 000)
Taxable temporary difference 70 000 80 000
Normal income tax rate 28% 29%
The new normal income tax rate of 28% was announced at the beginning of 20.13.
Deferred tax liability
R
31 December 20.12 (R80 000 × 29%) 23 200
31 December 20.13 (R70 000 × 28%) (19 600)
Net change in statement of profit or loss and other comprehensive income (P/L) 3 600
Disclosed as follows: Movement in temporary differences (R10 000 × 28%) 2 800

Tax rate change (R80 000 × 1%) OR (R23 200 × 1/29) 800
Journal entry
Dr Cr
IAS 12.80(c) and (d) require the disclosure of the deferred tax expense or income attributable to
the origination or reversal of temporary differences, as well as disclosure of the amount applicable to
changes in the tax rate or changes in legislation (refer above). The note for the income tax expense
will be presented as follows (assume that the accounting profit for 20.13 amounted to R300 000):
continued
Income taxes 189
Notes
20.13
R
Current tax expense
[(R300 000 + R50 000 depreciation – R40 000 tax allowance) × 28%] 86 800
Deferred tax expense (3 600)
Reversing temporary difference on property, plant and equipment
(R10 000 × 28%) (2 800)
Effect of rate change (R80 000 × 1%) or (R23 200 × 1/29) (800)
Tax expense 83 200

Accounting profit 300 000
Tax at the standard tax rate of 28% (R300 000 × 28%) 84 000
Effect of decrease in tax rate (800)
Tax expense 83 200
Effective tax rate (R83 200/R300 000) 27,73%
The applicable normal income tax rate changed during the current year to 28% (20.12: 29%)
(IAS 12.81(d)).
Scenario B:
If the tax rate for 20.12 is 29% and on 30 December 20.12, a tax rate change to 28% is
announced for the 20.13 tax year, the deferred tax balance on 31 December 20.12 is measured
using the new tax rate at the reporting date (assume taxable temporary differences of R60 000 on
31 December 20.11):
Deferred tax liability
For the year ended 31 December 20.12 R
Opening balance: 1 January 20.12 (R60 000 × 29%) 17 400
Closing balance: 31 December 20.12 (R80 000 × 28%) 22 400
The movement for the year ended 31 December 20.12 is disclosed as follows:
Option 1: Adjust opening balance
Movement of deferred tax for 20.12 (R20 000* × 28%) 5 600
Tax rate change on opening balance (R60 000 × 1%) (600)
* (R80 000 – R60 000)
OR
Option 2: Adjust closing balance
Movement of deferred tax for 20.12 (R20 000 × 29%) 5 800
Tax rate change on closing balance (R80 000 × 1%) (800)
5 000
continued
Comment
¾ IAS 12 refers to tax rates enacted or substantially enacted at the reporting date that must be
used in the measurement of deferred tax. If the new tax rate is announced prior to the reporting
date, the new rate may provide a more accurate estimate of the tax rates that will apply in the
periods when the assets realise or the liabilities are settled.
¾ The inclusion of rate changes in the tax expense or income in the statement of profit or loss
and other comprehensive income means that earnings per share for the current year will be
influenced by adjustments to the deferred tax balance due to tax rate increases or decreases.
¾ In this example, the effect of the change in the tax rate was recognised within profit or loss, as
the temporary difference relates to items that are recognised in profit or loss (annual
depreciation amount differs from tax allowance). However, should the relevant item or event
have been recognised in other comprehensive income (e.g. a revaluation as in Example 8.26
below), an appropriate amount of the effect of the rate change should be recognised in other
8.8.3 Measuring of deferred tax allowing for the expected manner of recovery
It was indicated in section 8.4 that is inherent in the recognition of an asset or liability that an
entity expects to recover or settle the carrying amount of that asset or liability. Furthermore,
it was indicated that deferred tax is then recognised if it is probable that the recovery or
settlement of that carrying amount will make future tax payments larger (smaller) than they
would be if such recovery or settlement were to have no tax consequences.
When deferred tax liabilities and assets are measured, the tax consequences of the manner
in which the entity expects to recover or settle the carrying amount of its assets and
liabilities must be considered (IAS 12.51). The manner in which assets are recovered and
liabilities settled may influence the tax rate, as well as the tax base of items (IAS 12.51A). In
such cases, an entity measures deferred tax liabilities and deferred tax assets using the tax
rate and the tax base that are consistent with the expected manner of recovery or
settlement.
An example of the potential influence of tax rates is a situation in which a tax authority taxes
an entity’s capital gains at an effective tax rate of 22,4% (80% of the capital gain at 28% –
refer to section 8.3.2 for more information on Capital Gains Tax on companies) when an
asset is sold, and at a rate of 28% if revenue is generated through the use of that asset. In
South Africa, different tax rates apply to items of a revenue nature (28%) and items of a
capital nature (0% or 22,4%).
The future economic benefits associated with an asset generally arise from three manners
of recovery (how the carrying amount of an asset will be recovered) namely:
through sale (the tax consequences may be a recoupment (at 28%) and/or a capital gain
(at 80% × 28%));
through use (e.g. as the plant is used, the inventory sold will be taxed at 28%); or
through use and then subsequent sale (e.g. a revalued depreciable asset where the
residual value is lower than the carrying amount but higher than the original cost).
Depreciating an asset implies that the carrying amount of the asset is expected to be
recovered through use. If this premise is applied to an asset that is not depreciated, for
example land (unlimited life), then land will be recovered only through sale. Therefore
deferred tax recognised for a non-depreciable asset will reflect the tax consequences of
selling the asset.
The carrying amount of a depreciable asset in terms of IAS 16 can be recovered through the
use of the asset, which will generate taxable profits, or by selling the asset. It is considered
that the carrying amount of an asset will be recovered through sale once it has been
classified as a non-current asset held for sale in terms of IFRS 5.
Income taxes 191
If a non-depreciable asset is revalued under IAS 16 Property, Plant and Equipment, then
IAS 12.51B requires that the deferred tax liability or asset that arises from such a revaluation
is measured based on the tax consequences that will follow from recovering the carrying
amount of that asset through sale.
Example 8.24 Deferred tax on revalued land
Sigma Ltd acquired land at a cost of R800 000 on 1 July 20.10. The entity’s year end is
31 December. The land was revalued to R950 000 on 31 December 20.12. Assume a normal
income tax rate of 28% and the capital gains tax inclusion rate is 80%.
Deferred
Carrying Temporary
Tax base tax
amount difference
(liability)
R R R R
Land at cost (non-depreciable asset) 800 000 800 000 – –
Revaluation surplus 150 000 – 150 000 (33 600)
Land at revaluation 950 000 800 000 150 000 (33 600)
Journal entries relating to the land:

Dr Cr
R R
1 July 20.10
Land 800 000
Bank 800 000
Initial recognition of purchase of land
31 December 20.12
Land 150 000
Revaluation surplus (OCI) 150 000
Revaluation of land
31 December 20.12
Revaluation surplus: Tax effect (OCI) 33 600
Deferred tax liability (SFP) (150 000 × 80% × 28%) 33 600
Recognition of deferred tax on revaluation of land
Comment
¾ Land is a non-depreciable asset revalued under IAS 16 and the deferred tax liability is measured
on the basis that the carrying amount of land will be recovered through sale.
¾ The tax base of the land is the amount deductible in future. When the land is recovered through
sale (deemed), the cost would be deductible. Therefore, the tax base is equal to the cost of
R800 000.
¾ The deferred tax on the revaluation of land is recognised against other comprehensive income
as the item to which it relates (the revaluation led to the temporary difference) was recognised in
¾ Non-depreciable assets, for example, land, will not lead to the recognition of deferred tax under
the cost model. The temporary difference that arises on initial recognition is exempt in terms of
IAS 12.15, as the difference arises from the initial recognition of an asset in a transaction which
at the time of the transaction does not affect either the accounting profit or the taxable profit.
¾ If the non-depreciable asset is revalued in terms of IAS 16, the revaluation no longer relates to
the initial recognition of the asset as it is a subsequent remeasurement and is therefore no
longer an exempt temporary difference.
Example 8.25 Deferred tax on revalued plant
Plant with a carrying amount of R400 000 and a tax base of R375 000 was revalued to R650 000.
The original cost of the plant was R500 000. Assume a normal income tax rate of 28% and the
capital gains tax inclusion rate is 80%.
If the carrying amount is recovered through use, the deferred tax will be calculated as follows:
Deferred
Carrying Tax Temporary tax
amount base difference (liability)
R R R R
Plant 400 000 375 000 25 000 (7 000)
Revaluation 250 000 – 250 000 (70 000)
650 000 375 000 275 000 (77 000)
Deferred tax is measured on both temporary differences at 28%.
If the carrying amount is recovered through sale, the deferred tax will be calculated as follows:
Deferred
tax
(liability)
R R R R
Plant 400 000 375 000 25 000 (7 000)
Revaluation 250 000 – 250 000 (61 600)
Up to cost* 100 000 (28 000)
Above cost** 150 000 (33 600)
650 000 375 000 275 000 (68 600)
* R500 000 – R400 000 = R100 000

** R650 000 – R500 000 = R150 000; R150 000 × 80% × 28% = R33 600
Comment
¾ A sale of the plant will result in a recoupment of R125 000 that will be taxed at 28%, leading to
a tax consequence of R35 000 (R125 000 × 28%; or 7 000 + 28 000 in calculation above). Only
80% of the capital gain of R150 000 will be taxed at 28%, leading to a tax consequence of
R33 600 (R150 000 × 80%× 28%). The total tax consequence flowing from the recovery of the
carrying amount of the asset through a sale is then R68 600 (R35 000 + R33 600), which
represents the measurement of the deferred tax balance on the plant.
¾ Deferred tax on the temporary difference of R25 000 (as a result of the difference between the
depreciation and the tax allowance) is measured at 28%.
¾ Deferred tax on the revaluation surplus is measured as follows:
on the amount up to the original cost (R100 000) at 28%; and
on the amount above the original cost (R150 000) at 80% × 28%.
¾ It is clear that the expected manner of recovery of the carrying amount of the plant has an
effect on the calculation of deferred tax. If the carrying amount is recovered through use, the
total deferred tax is R77 000. However, if the carrying amount is recovered through sale, the
total deferred tax amounts to R68 600.
¾ Entities do not have a free choice in selecting which tax rates should be applied to the various
temporary differences, nor can they merely specify their selected rates in an accounting policy.
These rates should be determined by applying IAS 12.47 and IAS 12.51. Preparers of financial
statements should consider whether sufficient details have been provided in the financial
statements on how the deferred tax balance was determined. In some cases, the required
disclosures might have to be supplemented by additional information to achieve fair
presentation.
continued
Income taxes 193
The notes relating to the deferred tax balance in the statement of financial position may be
disclosed as follows:
Notes
3. Deferred tax
Recovery Recovery
through through
use sale
R R
Tax allowances on property, plant and equipment 7 000 7 000
Revaluation 70 000 61 600
Deferred tax liability 77 000 68 600
The following information should also be disclosed in respect of the expected recovery through
sale:
The company has revalued its plant (refer to note xx) and expects to recover the carrying amount
through sale. Included in the deferred tax balance is a temporary difference of R150 000 on which
capital gains tax is expected.
During 2016, the inclusion rate of capital profits changed from 66,6% to 80% for companies.
This change will influence the measurement of deferred tax where the carrying amount of
an asset is expected to be recovered through sale. The effect of a change in the tax rate
was also discussed in section 8.8.2.
Example 8.26 Change in tax rate for capital gains
Sigma Ltd acquired land at a cost of R800 000 on 1 July 20.14. The entity’s year end is
31 December. The land was revalued to R950 000 on 31 December 20.15. At that time, 66,6% of
capital gains were taxable. During 20.16, the inclusion rate for capital gains changed to 80%. The
land was revalued to R970 000 on 31 December 20.16. Assume a normal income tax rate of 28%.
Deferred
Carrying Temporary
Tax base tax
amount difference
(liability)
R R R R
Revaluation surplus during 20.15 150 000 – 150 000 (27 972)
Balance at 31 December 20.15
(150 000 × 66,6% × 28%) 950 000 800 000 150 000 (27 972)
Change in tax rate
[150 000 × (80% – 66,6%) × 28%] (5 628)
Deferred tax at 80% × 28% (33 600)
Revaluation surplus during 20.16 20 000 (4 480)
Balance at 31 December 20.16 970 000 800 000 170 000 (38 080)
Journal entries
Dr Cr
R R
31 December 20.16
Recognition of change in tax rate for capital gains
continued
Dr Cr
R R
Land 20 000
Revaluation of land
Deferred tax liability (SFP) (20 000 × 80% × 28%) 4 480
Recognition of deferred tax on revaluation of land
Comment
¾ The revaluation itself and the related deferred tax are recognised in other comprehensive
income (IAS 12.61A). Therefore, the remeasurement of the deferred tax as a result of the new
inclusion rate for the capital gain is also recognised in other comprehensive income.
For the purpose of measuring the deferred tax on a revalued non-depreciable asset, the
assumption is made that the carrying amount of the asset will be recovered through sale.
Consequently, all or a part of the deferred tax is measured at the effective capital gains tax
rate. Similarly, the effective capital gains tax rate should be used for measuring a deferred
tax asset if capital losses are expected. Capital losses (other than section 11(0) allowances)
can be deducted from capital gains in the current year of assessment. However, if the
capital losses exceed the capital gains for the current year, that net capital loss may be
carried forward to the following year of assessment. Consequently, a deferred tax asset for
deductible capital losses can also only be recognised to the extent that it is probable that
capital gains will be available in future against which the capital losses can be utilised
(IAS 12.27A). Refer to section 8.6 above for more detail on the recognition of deferred tax
assets.
Example 8.27 Deferred tax assets on expected capital losses
Dumela Ltd acquired land at a cost of R800 000 on 1 January 20.14 and it was classified as
property, plant and equipment. Ignore the building component for this example. The entity’s year
end is 31 December. On 31 December 20.15, the land was classified as held for sale in terms of
IFRS 5. The land was impaired to the fair value of R700 000. Costs to sell are regarded as
immaterial.
The normal income tax rate is 28% and the capital gains tax inclusion rate is 80%. Dumela Ltd had
no capital gains during 20.15.
Case 1 – Sufficient taxable capital gains are expected in future against which the capital
loss can be utilised:
Deferred tax calculations: Deferred
Carrying Temporary
Tax base tax
amount difference
asset
R R R R
Impairment loss (100 000) – (100 000) 22 400
Balance at 31 December 20.15 700 000 800 000 (100 000) 22 400
continued
Income taxes 195
Journal entries
Dr Cr
R R
31 December 20.15
Impairment loss (P/L) 100 000
Land 100 000
Impairment loss on land held for sale
Deferred tax asset (SFP) 22 400
Recognition of deferred tax on impairment of land
Comment
¾ The impairment loss is recognised within profit or loss as the asset is classified as held for sale,
and the related deferred movement is then recognised against the income tax expense in profit
or loss.
¾ There were no tax allowances granted on the land and, consequently, the section 11(o)
allowance cannot be claimed for the expected loss. The expected loss on the deemed disposal
is then regarded as a capital loss.
¾ Sufficient taxable capital gains are expected in future, against which the expected capital loss
on the disposal of the land in the near future, can be utilised. Consequently, a deferred tax
asset may be recognised.
¾ Capital losses may only be deducted against capital gains to reduce any capital gains tax.
Capital losses may not be deducted from the taxable income of a revenue nature.
Consequently, a deferred tax asset on capital losses may not be offset against a deferred tax
liability on temporary differences on items of a revenue nature for tax purposes. Refer to section
8.11 below related to offsetting of deferred tax.
Case 2 – Sufficient taxable capital gains are not expected in future against which the capital
loss can be utilised:
Deferred tax calculations: Deferred
Carrying Temporary
Tax base tax
amount difference
asset
R R R R
Impairment loss (100 000) – (100 000) 22 400
Possible deferred tax asset at
31 December 20.15 700 000 800 000 (100 000) 22 400
Balance at 31 December 20.15 –
Comment
¾ The journal entry for the impairment loss is the same as in Case 1 above. However, there is no
journal entry for the deferred tax asset, as it is not recognised.
¾ Sufficient taxable capital gains are not expected in future, against which the expected capital
loss on the disposal of the land in the near future, can be utilised. Consequently, a deferred tax
asset may not be recognised.
If a deferred tax liability or asset arises from investment property that is measured using
the fair value model in IAS 40, there is a rebuttable presumption that the carrying amount of
the investment property will be recovered through sale (i.e., the deferred tax liability or asset
will reflect the tax consequences of recovering the carrying amount through sale)
(IAS 12.51C). If this presumption is rebutted, then the requirements of IAS 12.51 and .51A
will be followed. Refer to section 17.7.2 for more detail. The following indicate that the
presumption could be rebutted:
the investment property is depreciable; and
it is held within a business model whose objective is to consume substantially all of the
economic benefits embodied in the investment property over time, rather than through
sale.
Example 8.28 Deferred tax on investment property, with capital gains tax
The accounting profit of Leseli Ltd for the year ended 31 December 20.15 amounted to
R2 000 000. Leseli Ltd’s only temporary difference relates to an investment property that was
acquired on 1 February 20.15 at a cost of R1 000 000. The investment property is measured at fair
value and the fair value was R1 100 000 at 31 December 20.15. The presumption of IAS 12 was
not rebutted. The investment property did not qualify for any tax allowances.
During the current year, Leseli Ltd also sold an item of land (cost of R300 000) for R420 000. This
gain represents a capital gain for tax purposes.
The normal income tax rate is 28% and the capital gains tax inclusion rate is 80%.
Deferred tax on investment property:
Deferred
amount base difference CGT %
Dr/(Cr)
R R R R
Cost 1 000 000 1 000 000
Fair value gain 20.15 100 000 – 100 000 (22 400)
Balance end of 20.15 1 100 000 1 000 000 100 000 (22 400)
Calculation of current tax for the year ended 31 December 20.15:
Gross
Tax at 28%
amount
R R
Non-taxable items:
Portion of accounting fair value gain on investment property for which
deferred tax is not measured ((R1 100 000 – R1 000 000) × 20%) (20 000) (5 600)
Portion of accounting profit on disposal of land that relates to the
capital gain that is not taxable ((R420 000 – R300 000) × 20%) (24 000) (6 720)
Accounting profit reversed (R420 000 – R300 000) (120 000)
Capital gain included in taxable income (R120 000 × 80%) 96 000
1 956 000 547 680

Temporary differences:
Fair value gain on investment property (80 000) (22 400)
Portion of accounting fair value gain on investment property for which (80 000)
deferred tax is not measured ((R1 100 000 – R1 000 000) × 80%)
Fair value gains/tax allowance on investment property –
Comment
note for the income tax expense. The calculation of the current tax could also be done as
follows:
continued
Income taxes 197
Alternative calculation of current tax for the year ended 31 December 20.15:
Gross
Tax at 28%
amount
R R
Accounting profit on disposal of land (R420 000 – R300 000) (120 000)
Capital gain included in taxable income (R120 000 × 80%) 96 000
Fair value gain on investment property reversed (100 000)
(R1 100 000 – R1 000 000)
Fair value gains/tax allowance on investment property –
Notes
R
Deferred tax expense 22 400
Tax expense 547 680
Portion of accounting profit on disposal of land that relates to the capital
gain that is not taxable ((R420 000 – R300 000) × 20% × 28%) (6 720)
Portion of accounting fair value gain on investment property for which
deferred tax is not measured ((R1 100 000 – R1 000 000) × 20% × 28%) (5 600)
Tax expense 547 680
Comment
¾ A deferred tax liability on the temporary difference relating to the investment property is indeed
recognised. However, the deferred tax is not measured at 28% of the temporary difference as
the presumption is made that the carrying amount of the investment property will be recovered
through sale. The tax consequences of the manner in which the carrying amount will be
recovered would be a capital gain, for which the inclusion rate is only 80%. The deferred tax is
then measured at 80% × 28% of the temporary difference.
¾ However, 100% of the fair value gain on the investment property is included in the accounting
profit, but the related deferred tax expense only reflects 80% × 28% thereof. Consequently, the
income tax expense will be out of proportion (28%) to the accounting profit. The effect of this
difference is explained to the users of financial statements in the tax reconciliation.
¾ Similarly, 100% of the realised accounting profit on the disposal of the land is also included in
the accounting profit, but the related current tax expense (capital gains tax) only reflects 80% ×
28% thereof. Consequently, the income tax expense will be out of proportion (28%) to the
accounting profit. The effect of this difference is explained to the users of financial statements
in the tax reconciliation.
IAS 12 prohibits the discounting of deferred tax assets and liabilities (IAS 12.53). It is
argued that discounting requires accurate and detailed scheduling of the timing of the
reversal of each temporary difference. In many cases, this scheduling is impractical and
complex. In addition, discounting results in deferred tax assets and liabilities that would not
be comparable between entities.
8.9 Dividend tax

Dividend tax is a tax imposed on shareholders at a rate of 20% on receipt of dividends. The
dividend tax is categorised as a withholding tax, as the tax is withheld and paid (on behalf of
the shareholder) to the SARS by the company paying the dividend and not the person liable
for the tax (who is the benefitting owner of the dividend).
Example 8.29 Accounting treatment of dividend tax
Delta Ltd declared a cash dividend of R100 000 on 30 November 20.18. The dividend and the
dividend tax was paid in cash on 12 December 20.18.
Journal entries
Dr Cr
R R
30 November 20.18
Dividend declared (Equity) 100 000
Current liability: Shareholders for dividends (SFP) 80 000
Current liability: the SARS – Dividend tax payable (SFP) 20 000
Recognition of dividend declared
12 December 20.18
Current liability: Shareholders for dividends (SFP) 80 000
Current liability: the SARS – Dividend tax payable (SFP) 20 000
Bank 100 000
Payment of dividends to shareholders and dividend tax paid to the SARS
A dividend will be exempt from dividend tax (section 64F(1)) if the recipient is a resident
company. As such, South African companies receiving a dividend from an investment in
another South African company will not be liable for the dividend tax on the dividend
received. The full dividend will merely be recognised in profit or loss, without any tax
consequences as the dividend received is also exempt (section 10(1)(k)) for the purpose of
income taxes. The effect of the exempt dividend received was explained in the tax
reconciliation as was indicated in Example 8.1. However, other entities (e.g. a trust that
applies IFRSs) that receive a dividend will still be subject to the dividend tax. That entity will
then recognise the gross amount (100%) as income, with the dividend tax (20%) as part of
the income tax expense (income taxes include withholding taxes in terms of IAS 12.2).
8.10 Foreign tax

IAS 12 Income Taxes is applicable to South African taxes that are levied on taxable profits,
as well as foreign taxes levied on taxable profits obtained from foreign sources (IAS 12.2).
Foreign taxes may be very complex and the purpose of this text is merely to illustrate the
effect of foreign taxes on the disclosure of the tax expense in the financial statements. A
South African company, as a ‘resident’, will be subject to South African normal tax on its
worldwide income, depending on the provisions of any double tax agreements. This implies
that the foreign income of a South African company may also be taxed in South Africa. The
amount of any foreign tax paid may qualify as foreign tax credits (rebates) (see section 6
quat and quin) and be deducted from the amount of taxation payable to the SARS. Foreign
income and the amount of foreign taxes paid will first be translated to rand.
Income taxes 199
Example 8.30
8.30 Accounting treatment of foreign tax credits
Local Ltd has a branch outside South Africa. The company’s local accounting profit (and taxable
income from SA sources) amounted to R2 000 000. The branch’s accounting profit (and taxable
income from foreign sources) amounted to the equivalent of R500 000. The branch paid foreign
taxes equivalent to R100 000.
The company’s total current tax expense amounts to: R
Income from South Africa 2 000 000
Income from foreign sources 500 000
Total taxable income 2 500 000
SA normal current tax expense (R2 500 000 × 28%) 700 000
Tax payable to South African tax authority (the SARS):
Total tax expense 700 000
Less: Foreign tax credits (section 6quat) (100 000)
Tax payable to the SARS (current liability) 600 000
Comment
¾ The total tax expense of R700 000 is equal to the expected tax expense of 28% of the
accounting profit. Therefore, a tax reconciliation in the note for the income tax expense is not
needed.
A foreign subsidiary (under the control of a South African parent company) would be
included in the consolidated financial statements of the parent. The foreign subsidiary, as a
foreign business establishment, may be taxed in the foreign country and not in South Africa.
The effect of a different foreign tax rate (compared to the South African normal income tax
rate of 28%) should be disclosed in the consolidated financial statements (refer to
IAS 12.85).
Example 8.31
8.31 Disclosure of differences due to foreign tax
Local Ltd has control over Foreign Ltd, a foreign subsidiary that is classified as a foreign business
establishment. Local Ltd’s local accounting profit (and taxable income from SA sources) amounted
to R2 000 000. Foreign Ltd’s accounting profit (and taxable income from foreign sources)
amounted to the equivalent of R500 000. Foreign Ltd paid foreign taxes equivalent to R100 000
(20% of taxable income).
Each company will pay current tax on its own taxable income, as follows:
Calculation of current tax for the separate entities:
Gross Current
amount tax
R R
Local Ltd (R2 000 000 × 28%) 2 000 000 560 000
Foreign Ltd (R500 000 × 20%) 500 000 100 000
Consolidated accounting profit and current tax expense 2 500 000 660 000
continued
The group will present the following note for its income tax expense in the consolidated financial
statements:
Notes
7. Income tax expense R
Deferred tax expense –
Tax expense 660 000
Accounting profit (R2 000 000 + R500 000) 2 500 000
Effect of the different tax rate on foreign income taxed in another
jurisdiction (R500 000 × (28% – 20%)) (40 000)
Tax expense 660 000
Comment
¾ The difference in the consolidated tax expense as a result of the foreign income that are not
taxed at the same rate as South African income, is disclosed in the note for the tax expense
(also refer to IAS 12.85).
8.11 Consolidation and equity method

Consolidations of group entities and the equity method for accounting of associate and joint
venture may also have an effect on the deferred tax balances and the income tax expense.
This section only deals with some basic tax effects of groups (refer to chapters 24 and 26)
and associates and joint ventures (refer to chapter 25).
The consolidation process commences with adding together (combining) like items of assets,
liabilities, equity, income and expenses as they appear in the financial statements of the
parent and its subsidiaries on a line-by-line basis. A subsidiary’s line items for the deferred
tax balance, income tax expense and the tax expense of other comprehensive income are
combined with those of the parent. The following tax related matters may be relevant with
consolidation of a group:
The net identifiable assets of the subsidiary are generally measured at their fair values
with a business combination. The tax bases of these net assets are unaffected and the
resulting temporary differences are not exempt from the recognition of deferred tax. It is
only temporary differences that arose with the initial recognition of an asset or liability in
a transaction, which is not a business combination, that are exempt from the recognition
of deferred tax (refer to section 8.5.2 and 8.5.3 for more detail). Consequently, deferred
tax is to be recognised on all temporary differences arising with a business combination
(refer to section 26.5 for more detail).
Temporary differences may also arise from the elimination of unrealised intragroup
transactions. The unrealised gain or loss is eliminated from the consolidated carrying
amount, while the tax base is unaffected. Consequently, deferred tax is recognised on
the resulting temporary difference (refer to section 25.4.2 for more detail).
Differences in foreign taxes of a foreign subsidiary will be explained in the tax
reconciliation in the note to the consolidated income tax expense (refer to section 8.10).
Deferred tax assets and liability of different group entities may not be offset (refer to
section 8.13 for more detail).
Income taxes 201
The equity method is used to account for an investor’s interest in an associate or joint
venture. The investment in the associate or joint venture is subsequently adjusted with the
investor’s proportionate share of the after tax profit or loss and other comprehensive income
of the associate or joint venture. This implies that the various line items (including the tax
line items) of the associate or joint venture are not combined with those of the investor, as
the case would be with consolidation. The investor’s proportionate share of the after tax
profit or loss of the associate or joint venture is presented as a separate line item (before
the income tax expense) in the statement of profit or loss, while the income tax expense line
item does not include any amount in respect of the associate or joint venture. Consequently,
the amount for the income tax expense will not be in line with (28%) of the profit before tax,
and this will be explained in the tax reconciliation.
Example 8.32
8.32 Consolidation and equity method
Parent Ltd had an 80% interest in Subsidiary Ltd and a 25% in Associate Ltd since their incorporation
in 20.16. The normal income tax rate is 28% and no company had any temporary differences. The
following is an extract from the companies’ statements of profit or loss for the current year ended
31 December 20.19:
Profit or loss Parent Subsidiary Associate
Ltd Ltd Ltd
R R R
Gross profit 800 000 600 000 400 000
Dividends received from Subsidiary Ltd 48 000 – –
Dividends received from Associate Ltd 10 000 – –
Income tax expense (current tax) (224 000) (168 000) (112 000)
The consolidated statement of profit or loss and other comprehensive income reflects the
following:
P = Parent; S = Subsidiary; A = Associate 20.19
R
Gross profit (800 000 (P) + 600 000 (S)) 1 400 000
Dividend income (intragroup dividends are eliminated) –
Share of profit of associate (288 000 (A) × 25%) 72 000
Income tax expense (224 000 (P) + 168 000 (S)) (392 000)
Notes
20.19
R
Deferred tax expense –
Equity accounted share of profit of associate (R72 000 × 28%) (20 160)
Tax expense 392 000
continued
Comment
¾ The parent and subsidiary is consolidated on a line-by-line basis and the parent’s dividends
received from the subsidiary are eliminated.
¾ Parent Ltd’s share of profit of associate is included in the consolidated profit before tax in
accordance with the equity method. Parent Ltd’s dividends received from the associated are
also eliminated from profit or loss and are deducted from the investment in associate. The
investor’s shares of the associate’s after-tax profit in thus included in the line item for profit
before tax. Consequently, the consolidated income tax expense will not be 28% of the
consolidated profit before tax. The investor’s share of the profit of the associate is then included
in the tax reconciliation.
¾ The dividends received by the parent will be in the tax reconciliation of the parent’s separate
financial statements as the dividend are not taxable (refer to Example 8.1). However, these
dividends are eliminated from the consolidated profit before tax and are no longer part of the
consolidated profit before tax, which is the starting point of the tax reconciliation. Consequently,
these dividends are not part of the tax reconciliation of the consolidated income tax expense.
8.12 Uncertainty over Income Tax treatments

In this chapter, it was explained that the current and deferred tax should be based on the
applicable tax laws. The Income Tax legislation in South African is very comprehensive and
arguably addresses most of the transactions an entity would enter into. However, it may
occur that an entity is uncertain about the tax treatment of a unique transaction. Such
cases are addressed in IFRIC 23 Uncertainty over Income Tax treatments.
The acceptability of a particular tax treatment by an entity may not be known until the South
African Revenue Services (SARS) or a court takes a decision in the future. Consequently, a
dispute or examination of a particular tax treatment by SARS may affect an entity’s
accounting for a current or deferred tax asset or liability. IFRIC 23 should be considered
when there is such uncertainty over income tax treatments. IFRIC 23 requires an entity to:
determine whether it considers each uncertain tax treatment separately or together with
one or more uncertainties based on which approach better predicts the resolution of the
uncertainty;
assume that SARS will examine the aspect and have full knowledge of all related
information;
consider whether it is probable that SARS will accept its planned tax treatment:
– if an entity concludes that it is probable, the entity calculates the taxable income, tax
bases, etc. consistently with its planned tax treatment;
– if an entity concludes that it is not probable, the entity shall reflect the effect of the
uncertainty tax treatment by using the most likely amount or the expected value,
depending on which it expects to better predict the resolution of the uncertainty; and
reassess its judgement or estimate, if the facts and circumstances change or when new
information become available. Any change should be treated as a change in accounting
estimate by applying IAS 8 Accounting Policies, Changes in Accounting Estimates and
Errors.
When there is uncertainty over the income tax treatment, an entity shall determine whether
to disclose:
its judgements in determining the taxable income, tax bases, etc. (refer to IAS 1.122);
information about the assumptions and estimates made in determining the taxable
income, tax bases, etc. (refer to IAS 1.125-129); and
the potential effect of the uncertainty as a tax-related contingency (refer to IAS 12.88)
when the entity concluded that SARS will accept its uncertain tax treatment.
Income taxes 203

An entity may only offset current tax assets and current tax liabilities if:
it has a legally enforceable right to offset the recognised amounts; and
the entity intends to either settle on a net basis or to realise the asset and settle the
liability simultaneously (IAS 12.71).
The entity will, as a taxpayer, usually have the right of offset if the taxes are levied by the
same tax authority and the tax authority permits the entity to make or receive a single net
payment (IAS 12.72). This implies, inter alia, that an entity may not offset the current tax
liability for local tax against the current tax asset from foreign tax in the statement of
financial position. In the consolidated financial statements, the current tax asset of one entity
shall only be offset against the current tax liability of another entity in the group if both the
above conditions are met (which may typically not be the case).
Deferred tax assets and deferred tax liabilities shall only be offset if the entity:
has a legally enforceable right to offset current tax assets against current tax liabilities;
and
the deferred tax assets and deferred tax liabilities relate to income taxes levied by the
same tax authority on either:
– the same taxable entity; or
– different taxable entities which intend to either settle current tax liabilities and assets
on a net basis or to realise the assets and settle the liabilities simultaneously, in each
future period in which significant amounts of deferred tax liabilities or assets are
expected to be settled or recovered (IAS 12.74).
These conditions for offsetting allow an entity to offset deferred tax assets and deferred tax
liabilities without requiring a detailed scheduling of the timing of the reversal of each
temporary difference. However, where the entity has a net deferred tax asset after offsetting,
the requirements for the recognition of a deferred tax asset must be met, meaning that there
must be sufficient taxable profit in future periods against which the asset will be utilised.
Example 8.33 Offset of tax assets and liabilities
Echo Ltd has a 60% interest in Kilo Ltd. On reporting date, Echo Ltd has a deferred tax liability of
R100 000 in its statement of financial position. Kilo Ltd has had an assessed tax loss for a number
of years, resulting in a deferred tax asset of R300 000 in Kilo Ltd’s statement of financial position.
When Echo Ltd consolidates the statement of financial position of Kilo Ltd on reporting date, the
question is whether Kilo Ltd’s deferred tax asset can be offset against the deferred tax liability of
Echo Ltd.
In terms of IAS 12.74, deferred tax assets and deferred tax liabilities may only be offset if the entity
(in this case, the group) has a legally enforceable right to offset current tax assets against current tax
liabilities and the deferred tax assets and deferred tax liabilities relate to the same taxable entity or
will be settled on a net basis.
Separate legal persons are liable for income taxes in South Africa, not groups of companies.
Echo Ltd and Kilo Ltd may not settle their current tax liabilities on a net basis. On consolidation,
Echo Ltd may not offset the deferred tax liability of R100 000 against the deferred tax asset of
R300 000.
Capital losses may only be deducted against capital gains to reduce any capital gains tax
payable. Capital losses may not be deducted from the taxable income of a revenue nature.
Consequently, in applying the criteria for offsetting deferred balances, a deferred tax asset
on capital losses may not be offset against a deferred tax liability on temporary differences
on items of a revenue nature for tax purposes. This is because the entity has no legal right
to offset the payment of the two types of taxes levied.
8.13.1 Statement of profit or loss and other comprehensive income and notes
IAS 12 requires the tax expense and tax income related to profit or loss from ordinary
activities to be presented in the profit or loss section in the statement of profit or loss and
other comprehensive income (IAS 12.77), and the following major components to be
disclosed separately in the notes to the statement of profit or loss and other comprehensive
income (IAS 12.79 and .80):
the current tax expense (income);
any adjustment recognised in the reporting period for the current tax of prior periods;
the amount of the deferred tax expense (income) relating to the origination and reversal
of temporary differences;
the amount of the deferred tax expense (income) relating to changes in the tax rate or
the imposition of new taxes;
the amount of the benefit arising from a previously unrecognised tax loss, tax credit or
temporary difference of a prior period that is applied to reduce a current and/or deferred
tax expense;
the deferred tax expense arising from the write-down and reversal of a previous write-
down of a deferred tax asset where the asset is adjusted as a result of a change in the
probability that sufficient taxable profits will realise in future periods; and
the amount of tax expense (income) relating to those changes in accounting policies and
errors that are included in profit or loss in accordance with IAS 8, because they cannot
be accounted for retrospectively.
The following information is also required (IAS 12.81):
a reconciliation of the relationship between tax expense (income) and accounting profit
in either a numerical reconciliation between tax expense (income) and the product of the
accounting profit multiplied by the applicable tax rate, or a numerical reconciliation
between the applicable tax rate and the average effective tax rate;
an explanation of changes in the applicable tax rate(s) compared to the rate for the
previous accounting periods;
for each type of temporary difference, unused tax loss and unused tax credit, the
amount of deferred tax income or expense recognised in the statement of profit or loss
and other comprehensive income, if it is not apparent from the changes in the amounts
recognised in statement of financial position; and
for discontinued operations, the tax expense related to:
– the gain or loss on discontinuance; and
– the profit or loss from the ordinary activities of the discontinued operation, together
with the comparative amounts (refer to IFRS 5).
The tax effect of all items presented in other comprehensive income (IAS 12.81(ab) must,
in terms of IAS 1, be presented either in a note or on the face of the other comprehensive
income section of the statement of profit or loss and other comprehensive income.
8.13.2 Statement of financial position and notes

The following must be disclosed (IAS 12.81):
the aggregate current and deferred tax relating to items that are charged or credited to
equity in terms of IAS 12.62A;
the amount and, where applicable, the expiry date of deductible temporary differences,
unused tax losses and unused tax credits for which no deferred tax asset is recognised
in the statement of financial position;
the aggregate amount of temporary differences associated with investments in
subsidiaries, branches, associates and interests in joint arrangements for which deferred
tax liabilities have not been recognised;
Income taxes 205
for each type of temporary difference, unused tax loss and unused tax credit, the
amount of the deferred tax assets and liabilities recognised in the statement of financial
position for each period presented;
the amount of income tax consequences of dividends declared or paid before the
financial statements were authorised for issue, but not recognised as a liability;
for deferred tax assets, the amount and the nature of the evidence supporting their
recognition, where utilisation of the deferred tax asset is dependent on future taxable
profits in excess of profits arising from the reversal of existing taxable temporary
differences and where the entity has suffered a loss in either the current or preceding
period (IAS 12.82);
the amount of the change in an acquirer’s pre-acquisition deferred tax asset (see
IAS 12.67) as a result of a business combination;
if the deferred tax benefits acquired in a business combination are not recognised at the
acquisition date but are recognised after it (see IAS 12.68), a description of the event or
change in circumstances that caused the deferred tax benefits to be recognised (refer to
section 26.5 for more information on deferred taxes relating to business combinations);
and
any tax-related contingent liabilities/assets in accordance with IAS 37 (see IAS 12.88
and section 8.12 above).

The trial balance of Delta Ltd for the year ended 31 December 20.13 is as follows:
Credits Notes R R
Ordinary share capital 200 000
Retained earnings (1 January 20.13) 1 736 910
Long-term loan 500 000
Bank overdraft 40 000
Trade payables 246 000
Revenue 10 500 000
Dividends received 1 15 000
Deferred tax (1 January 20.13) 2 62 090
Debits
Donations 3 15 000
Interest paid 110 000
Cost of sales 6 000 000
Operating expenses (including depreciation) 2 040 000
Land at cost 1 790 000
Buildings at carrying amount 4 1 600 000
Plant and machinery at carrying amount 5 630 000
Prepaid insurance premium 6 25 000
Dividends paid (30 June 20.13) 30 000
SARS (provisional payments) 8 680 000
13 300 000 13 300 000
1 Dividends received are exempt from income tax and are thus not taxable.
2 The deferred tax balance on 1 January 20.13 arose as a result of a taxable temporary difference on
plant and machinery of R248 000 and a deductible temporary difference on the allowance for credit
losses of R26 250.
3 The donations are not deductible for income taxes purposes.
4 The SARS permits no allowance on the building, while Delta Ltd depreciates the building at
R125 000 per annum.
5 The tax base of the plant and machinery on 31 December 20.13 is R364 000. Depreciation on plant
and machinery for the current year is R170 000, and the tax allowance is R188 000.
6 Assume that the prepaid premium is deductible for tax purposes during the current year, in which it
was actually paid.
7 Trade receivables in the trial balance comprise the following:
R
Allowance for credit losses (50 000)
380 000
The SARS permits an allowance of 25% on the doubtful debts (allowance for credit losses). The
allowance for credit losses for 20.12 was R35 000.
8 The current tax and deferred tax for the current year should still be recognised. The normal income
tax rate is 28%. Delta Ltd’s tax payable, based on the tax return for 20.12, was R5 000 less than
the amount recognised as a liability. Delta Ltd paid R680 000 as provisional tax during the current
year.
The income tax notes to the financial statements of Delta Ltd for the year ended 31 December 20.13
may be compiled as follows from the information provided (ignore comparative amounts):
Calculations
R
Revenue 10 500 000
Cost of sales (6 000 000)
4 500 000
Other income: Dividends received 15 000
4 515 000
Expenses:
Operating expenses (2 040 000)
Donations (15 000)
Interest paid (110 000)
2 350 000
2. Current tax
Non-deductible/non-taxable items 125 000
Dividends received (15 000)
Donations 15 000
Depreciation – building 125 000
Temporary differences (31 750 × 28% = 8 890*) (31 750)
Depreciation – plant and machinery 170 000
Tax allowances – plant and machinery (188 000)
Allowance for credit losses (50 000 – 35 000) 15 000
Doubtful debts (allowance for credit losses): 20.12 (35 000 × 25%) 8 750
Doubtful debts (allowance for credit losses): 20.13 (50 000 × 25%) (12 500)
Prepaid insurance premium (25 000)
Taxable income 2 443 250

Current tax at 28% 684 110
* Agrees to movement as per deferred tax calculation
Income taxes 207
3. Deferred tax
Deferred Deferred
tax tax
balance movement
@ 28% in P/L
Dr/(Cr) @ 28%
R R R R R
01/01/20.13
Plant and machinery 248 000 (69 440)
Allowance for credit losses (26 250) 7 350
(62 090)
31/12/20.13
Land 1 790 000 – 1 790 000 Exempt#İ
Buildings 1 600 000 – 1 600 000 Exempt# 8 890*
Plant and machinery 630 000 364 000 266 000 (74 480)
Prepaid insurance premium 25 000 – 25 000 (7 000)
Trade receivables 380 000 417 500 (37 500) 10 500
Gross 430 000 430 000 – –
Allowance for credit losses (50 000) (12 500) (37 500) 10 500
(70 980)
#
IAS 12.15
İ
Alternative view: The carrying amount of the land is assumed to be recovered through sale under
the assumption relevant to revalued land (IAS 12.51B) (refer to Example 8.24). Therefore, the tax
base would then be equal to the base cost for CGT purposes, namely, R1 790 000, as this amount
will be allowed as a deduction against the proceeds from the sale when calculating the capital gain
on disposal. No deferred tax is recognised under either approach.
Journal entries
Dr Cr
R R
Taxation payable to the SARS (Current liability) (SFP) 684 110
Recognition of current tax payable for current year
Deferred tax (non-current liability) (SFP) 8 890
Recognition of movement in deferred tax balance for current year
Notes
R
Current year 684 110
Overprovision 20.12 (5 000)
Deferred tax – current 8 890
Allowances on plant and machinery (74 480 – 69 440) 5 040
Prepaid insurance premium (7 000 – 0) 7 000
Allowance for credit losses (7 350 – 10 500) (3 150)
688 000
continued
Tax (rate) reconciliation R R

Accounting profit 2 350 000 2 350 000
%
Tax rate 28% 28,00
Tax at the standard tax rate 658 000
Tax effect of:
Donations (R15 000 × 28%); (R4 200/R2 350 000 × 100) 4 200 0,18
Buildings – depreciation
(R125 000 × 28%); (R35 000/R2 350 000 × 100) 35 000 1,49
Overprovision of current tax ((R5 000/R2 350 000) × 100) (5 000) (0,21)
Non-taxable income: dividends received
(R15 000 × 28%); (R4 200/R2 350 000 × 100) (4 200) (0,18)
Income tax expense/Effective tax rate (688 000/2 350 000) 688 000 29,28
5. Deferred tax
R
Accelerated tax allowances for tax purposes (R266 000 × 28%) 74 480
Prepaid expense (R25 000 × 28%) 7 000
Allowance for credit losses (R37 500 × 28%) (10 500)
Deferred tax liability 70 980
CHAPTER
9
(IAS 16; SIC 29 and IFRIC 1)
Contents
9.1 Overview of IAS 16 Property, Plant and Equipment.......................................... 210
9.2 Background ....................................................................................................... 211
9.3 Nature of property, plant and equipment ........................................................... 211
9.4 Recognition ....................................................................................................... 212
9.4.1 Components ...................................................................................... 212
9.4.2 Replacement of components at regular intervals .............................. 213
9.4.3 Major inspections .............................................................................. 215
9.4.4 Spare parts and servicing equipment ................................................ 216
9.4.5 Safety and environmental costs ........................................................ 216
9.5 Measurement .................................................................................................... 218
9.5.1 Initial measurement ........................................................................... 218
9.5.2 Asset dismantling, removal and restoration costs ............................. 220
9.5.3 Deferred beyond normal credit terms ................................................ 223
9.5.4 Exchange of property, plant and equipment items ............................. 224
9.5.5 Subsequent measurement ................................................................ 226
9.6 Depreciation ...................................................................................................... 226
9.6.1 Depreciable amount .......................................................................... 226
9.6.2 Useful life........................................................................................... 226
9.6.3 Useful life of land and buildings ........................................................ 227
9.6.4 Residual value ................................................................................... 228
9.6.5 Depreciation methods ....................................................................... 229
9.6.6 Accounting treatment ........................................................................ 231
9.7 Revaluation ....................................................................................................... 231
9.7.1 Fair value........................................................................................... 231
9.7.2 Non-depreciable assets: subsequent revaluations
and devaluations ............................................................................... 232
9.7.3 Non-depreciable assets: realisation of revaluation surplus ............... 233
9.8 Impairment losses and compensation for loss .................................................. 233
9.9 Derecognition .................................................................................................... 235
9.10 Deferred tax implications ................................................................................... 236
9.10.1 Manner of recovery ........................................................................... 236
9.10.2 Deferred tax implications of cost model ............................................ 236
9.10.3 Non-depreciable assets: deferred tax implications
of revaluation model .......................................................................... 238
9.10.4 Capital Gains Tax .............................................................................. 239
9.11 Disclosure .......................................................................................................... 241
9.12 Comprehensive example of cost model ............................................................ 245
209
9.1 Overview of IAS 16 Property, Plant and Equipment

Held for use in the production of goods; or
the supply of services;
Definition for rental to others; or
for administrative purposes.
Used during more than one period.
Components;
replacement of components at regular intervals;
Recognition major inspections;
spare parts and servicing equipment; and
safety and environmental costs.
Initial cost;
asset dismantling, removal and restoration cost;
Measurement deferred settlement;
exchange of PPE items; and
subsequent measurement.
Cost model Revaluation model

Cost less accumulated Fair value less accumulated depreciation and
depreciation and accumulated accumulated impairment losses since last
impairment losses revaluation
Impairment losses/compensation loss

An item of PPE is measured at cost or revalued amount less accumulated
depreciation and impairment losses irrespective of whether the cost model or the
revaluation model is used.
Derecognition
An item of PPE is derecognised in the statement of financial position:
on disposal; or
when no future economic benefits are expected from its use or disposal.
Tax implications
The measurement of deferred tax liabilities and assets must reflect the tax
consequences that would follow from the manner in which the entity expects, at
the end of the reporting period, to recover the carrying amounts of its assets.
The deferred tax asset or liability that arises when non-depreciable assets are
measured using the revaluation model should reflect the tax consequences of
recovering the carrying amount of the asset through sale.
Disclosure
Depreciation recognised as an expense or shown as a part of the cost of other
assets during a period should be disclosed; and
for each class of asset, the gross carrying amount and accumulated depreciation
(including impairment losses) at the beginning and the end of the period; and
for each class of asset, a detailed reconciliation of movements in the carrying
amount at the beginning and end of the period.
Property, plant and equipment 211
9.2 Background
Property, plant and equipment (PPE) normally constitutes a large proportion of the assets of
an entity. IAS 16 deals with tangible assets that are expected to be used during more than
one period.
IAS 16 excludes from its application:
biological assets related to agricultural activity, other than bearer plants, in accordance
with IAS 41, Agriculture;
mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative
resources;
PPE classified as held for sale in accordance with IFRS 5 Non-current Assets Held for
Sale and Discontinued Operations; and
assets such as investment property (IAS 40 Investment Property).
IAS 16 does apply to:
bearer plants, and are defined as living plants that are used in the production or supply
of agricultural produce and are expected to produce for more than one period and has a
remote likelihood to be sold as agricultural produce. The produce of the bearer plants are
accounted for in terms of IAS 41; and
PPE used in maintaining biological assets and mineral resources; and
PPE acquired through a lease agreements in terms of IFRS 16.
IAS 16 allows two alternative accounting treatments for PPE, without indicating any
preference. After initial recognition of an item of PPE at cost, the asset may either be
shown:
at cost less accumulated depreciation and accumulated impairment losses (the cost
model); or
at a revalued amount, being the fair value of the asset on the date of revaluation, less
accumulated depreciation and accumulated impairment losses since the last revaluation
(the revaluation model).
An entity adopts one of the models as its accounting policy and applies the policy to a
specific class of PPE.
9.3 Nature of property, plant and equipment

Property, plant and equipment (PPE) consists of tangible assets, sometimes also called
fixed assets, which:
are held for use in the production of goods; or
for the supply of services; or
for rental to others; or
for administrative purposes; and
are expected to be used during more than one financial period. The intention is
clearly to use these assets to generate revenue rather than to sell them.
The 2018 Conceptual Framework for Financial Reporting (Conceptual Framework) defines
an asset as a present economic resource controlled by the entity as a result of past events
(refer to chapter 2). However, in terms of IAS 16, the IASB preserved the reference to the
definition of an asset in the 2001 Conceptual Framework. Therefore, in order to be
recognised as an asset, PPE should, in terms of the 2001 Conceptual Framework, be a
resource controlled by the entity as a result of past events from which future economic
benefits are expected to flow to the entity. When an entity controls an asset, it has the power
to obtain the future economic benefits of the underlying resource and can restrict the access
of others to the asset. The past event normally refers to the date of acquisition or the date of
completion when the asset is ready for its intended use. The future economic benefits that
are expected to flow to the entity include the revenue from the goods sold or services
rendered, as well as cost savings and other benefits resulting from the use of the asset.
A class of property, plant and equipment is a grouping of assets of a similar nature and use
in an entity’s operations. IAS 16.37 lists the following examples of separate classes:
land;
land and buildings;
machinery;
ships;
aircraft;
motor vehicles;
furniture and fixtures; and
office equipment.
Land and buildings are normally purchased as a unit, but are recorded separately because of
the differences in their nature:
land normally does not have a limited life and is therefore not depreciated while;
buildings, by contrast, have a limited life and are therefore depreciated.
Plant typically refers to the machinery and production line of a manufacturing concern. This
asset has a limited life and is depreciated, often using depreciation methods such as the unit
of production method.
9.4 Recognition
An item of PPE is recognised as an asset if it is probable that economic benefits associated
with the item will flow to the entity and the cost can be measured reliably.
9.4.1 Components
Upon aquisition of PPE the cost should be allocated to its significant parts. The reason for
the allocation is that each part may have a different useful life. An entity must, where
appropriate, identify the significant parts of an item of PPE on initial recognition.
IAS 16 does not prescribe what a unit or a part of PPE is that should be recognised and
measured. Judgement is therefore always required in identifying such parts or components.
Example 9.1
9.1 Identification of components
A company with a 31 December year end has one asset, namely a helicopter. The helicopter was
acquired on 1 January 20.12 at a cost of R1 000 000. The following components and respective
useful lives were identified on initial recognition:
Engine of the helicopter:
R300 000 (the engine can only be used for 30 000 flight hours before replacement).
Remainder of the helicopter:
R700 000 (the helicopter, excluding the engine, is estimated to be available for use for 10 years).
During 20.12, 7 800 flight hours were undertaken.
Depreciation for the year ended 31 December 20.12, per significant component, is calculated as
follows:
Depreciation on the engine: R300 000 × (7 800/30 000) = R78 000
Depreciation on the remainder of the helicopter: R700 000 × 1/10 = R70 000
continued
The total depreciation on the helicopter for the year ended 31 December 20.12 is R148 000
(78 000 + 70 000).
Assume that the remainder of the helicopter (excluding the engine) consisted inter alia, on initial
recognition, of 5 electronic components of R1 000 each. The entity estimates that the components
will be replaced every 3 years.
In such circumstances, it should be established on initial recognition whether the components are
significant enough to be depreciated separately. In practice, cost efficiency will be a determining
factor when the decision is made.
If the components are significant, they will be depreciated over their separate useful lives as
illustrated earlier.
If the components are not significant, they will be treated as part of the remainder of the helicopter
and be depreciated over a useful life of 10 years. When they are replaced, the recognition criteria
will determine whether the amount incurred should be capitalised or expensed. If the amount is
capitalised, the carrying amount of the components that are replaced is derecognised.
After the initial recognition, an item of PPE is reflected at cost less accumulated depreciation
and accumulated impairment losses. The same recognition rule is applied in determining the
costs that will initially be capitalised as part of the cost of the PPE item and costs that are
capitalised subsequently. As far as subsequent costs are concerned, the costs may result
from additions to assets, replacement of a part thereof or the maintenance or service
thereof. In terms of the general recognition principle as described in IAS 16.7, the normal
day-to-day maintenance cost of an item is, however, recognised as an expense and is not
capitalised to the asset. This expense is described as repairs and maintenance and consists
mainly of the cost of labour, consumables and small spares.
9.4.2 Replacement of components at regular intervals

Certain parts of PPE items are replaced frequently. Examples of these types of assets are:
the relining of a furnace;
the seats and galleys in an aircraft; and
the interior walls of a building, for example an office block.
The main asset, such as the furnace, aircraft or building, has a much longer useful life than
the lining, seats, galleys and interior walls.
IAS 16.43 and .44 require that the initial cost of an item of PPE recognised be allocated to
its significant components, and that each component then be depreciated separately. The
remaining part of the item of PPE, consisting of all the components that are not individually
significant, represents a separate component. The depreciation rates and useful lives used
to depreciate the respective components of the asset may differ from those of the asset as a
whole.
When such a component is replaced, the cost of the replaced component is capitalised as
part of the carrying amount of the item of PPE, provided that the recognition criteria are met.
The remaining carrying amount of the replaced component shall be derecognised at that
stage. If it is not possible to determine the carrying amount of the replaced
component, (e.g. where the part has not been depreciated separately), the cost of the
new component may be used as an indication of what the original cost of the part
would have been (IAS 16.70). It is technically possible for a component of an asset to only
be recognised once the replacement expenditure has been incurred.
Example 9.2
9.2 Replacement of components
Beta Ltd operates a furnace which cost R20 000 000, inclusive of R4 000 000 relating to the cost
of lining the furnace. The useful life of the furnace is 20 years. The furnace linings need to be
replaced every five years and as six years of the useful life of the furnace have already expired,
the linings were replaced a year ago at a cost of R5 000 000. At the end of their useful lives, the
linings will have no residual value.
The original purchase of the furnace took place on 2 January 20.7, and it was also available for
use on that date. The year end is 31 December.
The following are applicable at 31 December 20.12:
Carrying amount of furnace (excluding lining) on 31 December 20.12
R
Original cost including lining 20 000 000
Lining (4 000 000)
Furnace excluding lining 16 000 000
Accumulated depreciation on the furnace (excluding lining) to 31 December 20.11
(16 000 000/20 × 5) (4 000 000)
Depreciation for 20.12 (16 000 000/20) (800 000)
Carrying amount on 31 December 20.12 11 200 000
Carrying amount of the lining on 31 December 20.12
Cost of original lining 4 000 000
Written-off from 2 January 20.7 to 31 December 20.11 (4 000 000/5 × 5) (4 000 000)
–
New lining capitalised on 2 January 20.12 5 000 000
Accumulated depreciation (5 000 000/5) (1 000 000)
Depreciation for 20.12
Furnace 800 000
Lining 1 000 000
Total 1 800 000
Comment
¾ If, at initial recognition of the furnace, the lining was not identified as a separate
component, but the R5 000 000 incurred to replace the lining now qualifies for recognition as
an asset (component), then it would be necessary to derecognise the remaining carrying
amount of the lining that was replaced. Assume the carrying amount of the lining cannot be
determined. The carrying amount will then be based on the cost of the new lining, which amounts
to R5 000 000. Since the total cost of the furnace would be depreciated over 20 years and the
lining component was not identified separately at initial recognition, it follows that the carrying
amount of the replaced ‘lining component’ at replacement date should be the following deemed
amount:
R
Deemed cost 5 000 000
Deemed accumulated depreciation (5 000 000/20 × 5) (1 250 000)
Deemed carrying amount of old lining at date of derecognition 3 750 000
continued
The carrying amount of the furnace on 31 December 20.11, directly after replacement of the lining,
would therefore be as follows:
R
Cost of furnace 20 000 000
Accumulated depreciation of furnace (20 000 000/20 × 5) (5 000 000)
Derecognition of old lining (see above) (3 750 000)
Capitalisation of new lining 5 000 000
16 250 000
9.4.3 Major inspections

Certain assets need regular major inspections for faults, regardless of whether the parts of
the item are replaced – this is done to ensure that operation can continue efficiently. An
example of such an asset is an aircraft which, after (say) every 5 000 hours’ flying time,
needs a major inspection to ensure continued optimum operation. When the inspection
occurs, the inspection cost is capitalised to the asset (provided that the recognition
criteria are met). The cost of the inspection is then depreciated. Any remaining carrying
amount of the previous inspection that was not fully depreciated is derecognised
once the new inspection occurs.
On initial recognition, a part of the cost of the asset is allocated to inspection costs (as if the
inspection had been performed on the day of initial recognition). This component is then
depreciated over the expected period to the next inspection.
The cost of an inspection need not necessarily be identified when the asset is acquired or
erected. The estimated cost of a future similar inspection may be used as an indication
of the cost of what the current inspection component of the asset at acquisition was, if
required. In this way, the amount that needs to be depreciated separately over the useful life
of the remainder of the asset can be estimated.
Example 9.3
9.3 Inspection costs
Charlie Ltd acquired a machine on 2 January 20.11 that needs a major inspection every two years.
The cost price of the machine is R2 000 000, and it is estimated that the cost of a major inspection
will be R200 000. The useful life of the machine is estimated to be eight years and the company
has a 31 December year end.
The depreciation and carrying amounts of the machine on 31 December 20.11 and 20.12:
Inspection
Machine *Total
component
R R R
Cost (2 000 000 – 200 000) 1 800 000 200 000 2 000 000
Depreciation 20.11:
Machine (1 800 000/8) (225 000) – (225 000)
Inspection (200 000/2) – (100 000) (100 000)
Carrying amount on 31 December 20.11 1 575 000 100 000 1 675 000
Depreciation 20.12 (225 000) (100 000) (325 000)
Carrying amount on 31 December 20.12 1 350 000 – 1 350 000
* The inspection component is not a separate asset, but forms part of the machine. In this
example, the cost of inspection was identified on initial recognition as a separate component.
continued
If the inspection was done after 18 months instead of the originally estimated two years, and the
actual cost of the first physical inspection amounted to R300 000, the disclosure of this matter in
the PPE note for the year ended 31 December 20.12 will be as follows:
Charlie Ltd
13. Property, plant and equipment
Machinery
20.12
R
Carrying amount on 1 January 20.11 –
Acquisitions 2 000 000
Depreciation 20.11(see above) (325 000)
R
Cost 2 000 000
Accumulated depreciation (325 000)
Depreciation 20.12 [(225 000 + (200 000/2 × 6/12) + (300 000/2 × 6/12)] (350 000)
Derecognition of initial inspection cost [(200 000 – (100 000 + 50 000)] (50 000)
Capitalisation of inspection cost incurred 300 000
Cost (2 000 000 – 200 000 + 300 000) 2 100 000
Accumulated depreciation (325 000 + 350 000 – 100 000 – 50 000) (525 000)
Comment
¾ If the cost of inspection was not identified as a separate component on initial recognition, the
cost of inspection would have been depreciated as part of the total machine over its useful life
of eight years. The deemed carrying amount of the cost of inspection (based on the cost of
R300 000 of the inspection) is derecognised when the inspection is performed after 18 months.
The carrying amount to be derecognised amounts to R243 750 [300 000 – (300 000 × 1,5/8)].
The cost of the inspection (i.e., R300 000) will be capitalised as a separate component of the
machine and will be depreciated over the expected period to the next inspection.
9.4.4 Spare parts and servicing equipment

The accounting treatments of spare parts and servicing equipment are clearly described in
IAS 16.8 as follows:
(Small) spare parts and servicing equipment are usually carried as inventory and
recognised in profit or loss as consumed.
Major spare parts, stand-by equipment and servicing equipment qualify as items of PPE
if the entity expects to use these assets during more than one period.
Depreciation on these items should commence when they are available for use as intended
by management.
9.4.5 Safety and environmental costs

Sometimes entities are obliged to acquire certain PPE items for safety or environmental
purposes. Although such assets will not directly give rise to increased future economic
benefits embodied in a specific asset itself, the entity is obliged to acquire such assets for
increased future economic benefits from related assets. Consequently, these assets are
therefore recognised as assets.
The combined carrying amount of the related asset and environmental assets must, in terms
of IAS 36, Impairment of Assets, be evaluated for impairment. The recoverable amount will
be determined by viewing the related asset and environmental assets as a single cash-
generating unit.
Example 9.4
9.4 Environmental asset and impairment loss
A Ltd manufactures items which unfortunately cause air pollution. New and stricter environmental
legislation requires that new air filters be attached to the exhaust pipes of all the manufacturing
machines. Relevant monetary values on 31 December 20.13 (year end) were as follows:
Existing manufacturing machines:
R
Cost 2 000 000
Cost of air filters (available for use on 31 December 20.13) 400 000
The manufacturing machines will reach the end of their useful lives after five years, as from
31 December 20.13, and will until then generate pre-tax cash flows of R475 000 per annum. A
suitable discount rate is 7,2% per annum after tax. The normal income tax rate is 28%. The
manufacturing machines have no residual values at the end of their production lives. Currently, the
machines can be sold at a fair value less costs of disposal (net selling price) of R1 780 000.
The carrying amount of the cash-generating unit comprising the manufacturing machines as well
as the air filters, will be R1 900 000 (R1 500 000 (machines) + R400 000 (filters)) at
31 December 20.13.
The above carrying amount of the cash-generating unit, amounting to R1 900 000, must
accordingly be tested for impairment. The value in use is calculated using a financial calculator:
(n = 5; i = 10 (7,2%/72%); PMT = R475 000; Compute PV = ?)
Value in use is R1 800 624, being the present value, whilst the fair value less costs of disposal is
R1 780 000 (given). The recoverable amount in respect of the cash-generating unit is therefore
R1 800 624 (the higher of the two), which represents the value in use.
An impairment loss of R99 376 (1 900 000 – 1 800 624) is recognised and allocated to the
individual assets of the cash-generating unit in proportion to their carrying amounts:
Existing manufacturing machines:
R
Manufacturing machines (1 500 000/1 900 000 × 99 376) 78 455
Air filters (400 000/1 900 000 × 99 376) 20 921
99 376
The journal entry will be as follows:
31 December 20.13 Dr Cr
R R
Accumulated depreciation and impairment losses – machines (SFP) 99 376
Recognition of impairment loss on cash-generating unit
9.5 Measurement
PPE items that qualify for recognition as assets are initially measured at cost.
9.5.1 Initial measurement

Elements of cost
The cost of PPE is derived as the amount of cash or cash equivalent paid, or the fair value
of the other consideration given, to acquire an asset at the time of its acquisition or
completion of construction or, if applicable, the amount attributed to that asset when initially
recognised in accordance with the requirements of other IFRSs. It can also be the fair value
of other forms of payments to acquire the asset. Capitalisation of costs ceases as soon
as the asset is in the condition and location necessary for it to be capable of
operating in the manner intended by management.
IFRS 13 Fair Value Measurement provides guidance on how fair value should be measured.
Please refer to the chapter 21 dealing with IFRS 13 for more information.
The following items are to be included in cost:
the purchase price, including import duties and non-refundable purchase taxes, after the
deduction of trade discounts and rebates. Value-Added Tax (VAT) paid on qualifying
assets by a registered vendor is refundable and is therefore excluded. VAT forms part of
the cost if the buyer is not registered for VAT or no input VAT can be claimed on the
asset;
any directly attributable costs of bringing the asset to the location and condition
necessary for it to operate in the way management intended. Examples of such directly
attributable costs are:
– the cost of employee benefits arising directly from the construction or acquisition of
the item of PPE;
– the cost of site preparation;
– initial delivery and handling costs;
– installation and assembly costs;
– the costs of testing whether the asset is functioning properly, after deducting the net
proceeds from selling any items produced while bringing the asset to that location and
condition (e.g. samples produced when testing equipment). A clear distinction should
however be made between testing costs and initial operating losses (the latter may
not be capitalised); and
– professional fees; and
the initial estimate of the cost of dismantling, removing and restoring the site on which
the asset is located (refer to section 9.5.2). A related obligation would arise in this
context when the item is acquired or as a result of the use of the item for purposes other
than the manufacturing of inventory during that period.
The following items are to be excluded from cost:
costs of opening a new facility;
costs of introducing a new product or service (including costs of advertising and
promotional activities);
costs of conducting business in a new location or with a new class of customer (including
costs of staff training);
administration and other general overhead costs;
costs incurred while an item capable of operating in the manner intended by
management has yet to be brought into use or is operated at less than full capacity;
initial operating losses, for example those incurred while demand for the item’s output
grows; and
costs of relocating or reorganising part or all of an entity’s operations.
Incidental operations
Operations that relate to the construction or development of a PPE item, but are not
necessary to bring the item to the condition and location to be capable of operation in the
manner intended by management, are dealt with in IAS 16.21. Income and expenditure
that result from such incidental operations are not capitalised to the asset, but are
included in profit or loss under appropriate classifications of income and expenses. If a
building site is, for example, rented out as a parking area before commencement of
construction on the site, the rental income (and related costs) will not be taken into account
in determining the cost of the property, but will be included in relevant line items in the profit
or loss section of the statement of profit or loss and other comprehensive income.
Self-constructed assets
IAS 16.22 deals with self-constructed assets and states inter alia that internal profits are
eliminated in arriving at costs. Furthermore, abnormal wastage of materials, labour and
other resources do not form part of the cost price of an asset. The principles of IAS 2
Inventory, regarding the capitalisation of manufacturing costs, should be followed.
Bearer plants are accounted for in the same way as the self-constructed items of PPE.
Therefore, all covering activities that are necessary to cultivate the bearer plants before they
are in the location and condition necessary to be capable of operating in the manner
intended by management form part of the cost of the asset.
Example 9.5
9.5 Determining the cost of PPE
A mine acquires a machine that is used to sink mine shafts. The asset is the first of its kind to be
used in South Africa. The asset is imported and installed at the mine.
The details of the costs incurred to prepare the asset for use are as follows:
R’000
Cost paid to supplier to deliver the asset to the harbour of destination 5 000
Import tax levied on import of machine at the harbour 450
Cost paid to transport company to transport the asset from harbour to mine 250
Twenty of the mine’s current employees were used for 2 months to build a
foundation and install the machine. The annual cost of one of the employees 90
General operating costs of the mine for the 2 months 1 500
A technician supported the employees during the installation of the machine.
The cost of the consultations 100
After the completion of the installation the mine invited its most important customers
to a function to commission the asset. The cost of the function 50
During the function, the machine was switched on for the first time to sink the first
mineshaft. Management will use the first shaft as an opportunity to establish whether
the machine operates as intended. It will require approximately 2 years to complete
the shaft before it can be utilised. The shaft will be used for 20 years for mining
operations. The cost to the mine of the first shaft 2 000
The shaft will cost the mine approximately R600 000 more than the normal costs for
other shafts, due to technical reasons.
continued
The cost of the machine will be determined as follows in terms of IAS 16:
R’000
Cost paid to supplier to deliver machine to harbour of destination 5 000
Import taxes on the import of machine at the harbour 450
Cost paid to the transport company to transport the asset from harbour to mine 250
Cost of the employees during installation
Cost per employee for 2 months: R90 000 × 2/12 = R15 000
Cost included in cost of machine: 15 000 × 20 = R300 000 300
General operating costs are excluded from the cost of the asset (IAS 16.19(d)) –
Professional fees of technician 100
The cost of the commissioning does not form part of the cost of the asset (IAS 16.19(b)). –
The initial operating loss of R600 000 is excluded from the cost of the machine
in terms of IAS 16.20(b). –
Total cost of the machine 6 100
Comment
¾ The question to be raised concerning the cost incurred on the first-time use is whether these
costs are really expenses for testing, or rather expenses to operate the machine. In this
example, the first shaft served as a test to establish whether the machine functions as intended
but is also used to sink a shaft to be used on completion. This indicates that the R2 000 000 to
sink the shaft is an operating expense, rather than a testing expense. The costs are therefore
not included in the cost of the machine. If the test costs could be identified separately from
operating costs, they would be capitalised. If it is assumed that they amount to 10% of the
operating costs, namely R200 000, the total cost of the machine would then have been
R6 300 000 (R200 000 will thus be included in the cost of the asset).
9.5.2 Asset dismantling, removal and restoration costs

IAS 16.16(c) states that the initial estimate of the costs of dismantling and removing the PPE
item and restoring the site on which it is located will form part of the cost of the asset. The
obligations for costs accounted for are recognised and measured in accordance with IAS 37
Provisions, Contingent Liabilities and Contingent Assets. The annual interest/finance cost on
the provision is accounted for by crediting the provision and debiting finance cost in the
profit or loss. This interest is not cost relating to borrowing of funds and may not be
capitalised to the asset in terms of IAS 23 Borrowing costs.
An entity applies IAS 2 to costs resulting from obligations for the dismantling and removing
of an item of PPE (as well as for the restoring of the site on which the asset is situated), if
the costs were incurred during a specific period in which the item of PPE was used to
produce inventory. This implies that these costs will be capitalised to inventory and not to
the item of PPE.
Example 9.6
9.6 Dismantling and removing costs
A Ltd acquired an office building. R

Cost of construction at 1 July 20.12 1 090 000
Expected dismantling and removal costs at end of useful life of asset 120 000
Applicable discount rate after tax (28%) 6,48%
Useful life of office building 24 years
If it is assumed that the building is erected on rented premises and that the rental agreement
requires dismantling of the building at the end of its useful life, the cost of the asset on
1 July 20.12 will be the following:
R
Cost of construction 1 090 000
Expected dismantling and removal costs discounted to present value
FV = R120 000; n = 24; i = 6,48/0,72 = 9; PV = ?* (See IAS 37) 15 169
Cost price of building 1 105 169
continued
Journal entries for dismantling and removal costs Dr Cr

Year 1 R R
Office building (SFP) 15 169
Provision for dismantling and removal costs (SFP) 15 169
Recognition of dismantling provision
Finance cost (P/L) (15 169 × 9%) 1 365
Recognition of finance cost for year 1
Year 2
Finance cost (P/L) [(15 169 + 1 365) × 9%] 1 488
Year 3 to 23
Entries similar to Year 2 for Years 3 to 23
Year 24
Finance cost (P/L) (110 092 × 9%) 9 908
Bank (SFP) (110 092 + 9 908) 120 000
Payment of dismantling of building
Amortisation table
Interest Balance
R R
Year 1 1 365 16 534
Year 2 1 488 18 022
Year 24 9 908 120 000
If the dismantling costs are revised at a later stage, IFRIC 1 Changes in Existing
Decommissioning, Restoration and Similar Liabilities (refer to chaper 15) deals with the
accounting treatment of these changes in estimates.
Under the cost model:,
If the related liability reduces (i.e. the liability is debited), this amount (the reduction)
will be offset against the asset but cannot create a net credit balance on the item of PPE.
Any excess beyond the carrying amount of the affected asset shall be recognised
immediately in the profit or loss section of the statement of profit or loss and other
If the related liability increases (i.e. the liability is credited), the carrying amount of
the item of PPE will increase. However, under these circumstances, an entity must
consider whether the increased carrying amount will be recoverable in full and
consequently, the asset must be subjected to impairment testing. The increase in the
carrying amount of the asset does not go hand-in-hand with an increase in expected
economic benefits from the asset and consequently, recovery of the carrying amount of
the asset could be problematic.
These adjustments are accounted for and disclosed as changes in estimate from the date
that the estimate is revised.
Under the revaluation model
A decrease in the related liability (i.e. liability is debited) will be credited to other
comprehensive income (that will not be reclassified to profit or loss) in the statement of
profit or loss and other comprehensive income and accumulated in the revaluation
surplus unless it reverses a debit taken to the profit or loss section of the statement of
profit or loss and other comprehensive income previously, in which case the profit or loss
section of the statement of profit or loss and other comprehensive income is credited.
An increase in the related liability (i.e. the liability is credited) will be debited as
other comprehensive income in the statement of profit or loss and other comprehensive
income and will therefore reduce the revaluation surplus related to the specific asset,
and any excess will be debited to the profit or loss section of the statement of profit or
loss and other comprehensive income.
If a decrease in the related liability exceeds the carrying amount of the asset that would
have been recognised had the asset been recognised at the cost model, the excess
must be recognised in the profit or loss section of the statement of profit or loss and
other comprehensive income. This would imply that the gain would be the same as the
gain that would have arisen under the cost model.
Increases in the revaluation surplus (and decreases in the provision) are limited to the
carrying amount of the relevant assets as determined according to the cost model.
When the revaluation model is used, a change in the provision might indicate that the asset
should be revalued. When revaluing an asset that has to be dismantled, the net replacement
cost should include a pro rata amount (depreciated value of the dismantling cost) related to
the dismantling cost.
Example 9.7
9.7 Changes in dismantling costs
H Ltd erected an asset during 20.12 and completed it on 31 December 20.12 The asset must be
dismantled after 20 years.
On 31 December 20.12, the company estimated the dismantling costs at an amount of R150 000.
Assume a fair discount rate of 5% before tax.
The following amounts related to dismantling costs are therefore included in the cost of the asset
on initial recognition:
FV = 150 000; PMT = nil; i = 5% (note 1); n = 20 years
Therefore PV = 56 533
The dismantling costs are reassessed on 1 January 20.15 and are estimated at R250 000
The provision for dismantling costs will change as follows:
Balance of the provision for dismantling costs (before change in estimate) R62 328
Balance after reassessment of dismantling costs in the future:
FV = 250 000; PMT = nil; i = 5%; n = 18 years (remaining)
An upward adjustment of R41 552 (R103 880 – R62 328) must be made to the provision.
If the company accounts for the asset in terms of the cost model, the adjustment will be treated
as follows:
Dr Cr
R R
Asset (cost) (SFP) 41 552
Provision for dismantling costs (SFP) 41 552
Reassessment of dismantling provision
IFRIC 1.5(c) determines that where the carrying amount increases, as above, the entity should
assess whether there is an indication of impairment of the asset.
continued
If the company accounts for the asset in terms of the revaluation model, the adjustment will be
treated as follows:
Assume a revaluation surplus of R30 000 before the adjustment. Ignore taxation.
The revaluation surplus is reduced to Rnil. Thereafter any excess is recognised in profit or loss if
the adjustment exceeds the balance of the revaluation surplus.
Dr Cr
R R
Increase in dismantling costs (P/L) (41 552 – 30 000) 11 552
Provision for dismantling costs (SFP) 41 552
Reassessment of dismantling provision
Note: A pre-tax discount rate is used because the carrying amount of the provision for dismantling
costs is a pre-tax amount.
9.5.3 Deferred beyond normal credit terms

When payment for an item of PPE is deferred beyond normal credit terms, its cost is the
cash price equivalent of the amount actually paid. This treatment is required because the
consideration is receivable in cash in the future, resulting in a lower present value than the
actual face value of the consideration. The difference between this amount and the total
amount paid is recognised as a finance cost over the period of credit, unless it is capitalised
in accordance with IAS 23 Borrowing Costs as borrowing costs. The whole deferred
settlement period will represent the abnormal credit term. This treatment is in line with
IFRS 9 as it suggests that the granting of abnormal credit terms will result in the effect of
discounting being material. For instance, if the normal credit term is 30 days and the entity
will only have to pay after six months, the cash price equivalent of the asset will be
calculated as the total amount payable, reduced by the interest for the whole six-month
period. This is necessary since the creditor must be initially accounted for at its fair value.
Fair value is calculated by discounting all future cash flows, at a market-related interest rate,
back to transaction date.
Example 9.8 Abnormal credit terms
On 1 February 20.12, a company purchases an industrial stand at a cost of R15 000 000, of which
R3 000 000 is attributable to the land and R12 000 000 to the factory building. The latter has a useful
life of 20 years. The transfer of ownership takes place on 30 June 20.12. The seller is willing to defer
payment of the purchase price until 31 December 20.12, whilst the normal credit terms would be two
months from date of transfer. On 31 December 20.12, the company obtains a long-term loan of
R15 000 000 at an interest rate of 18% per annum and settles the purchase price. Interest is
compounded annually in arrears. On 1 July 20.12, the property is available for use and
commissioned. The property is not considered to be an investment property.
In this case, it is normal practice for the purchase to take place when ownership is transferred, but
payment is only made six months later. To determine the cost of the asset, the cash price
equivalent therefore has to be determined on 30 June 20.12.
Note that IAS 23 specifies that interest cannot be capitalised once a property has already been
brought into use and thus the property is not a qualifying asset in terms of IAS 23.
Calculation of cost of the fixed property:
R
Cash price 15 000 000
Interest (18% × 6/12 = 9%; 9/109 × 15 000 000) (1 238 532)
Cash price equivalent or (FV = 15 000 000; n = 1; i = 18/2 = 9; PV = ?) 13 761 468
continued
The journal entries will be as follows:

30 June 20.12
Dr Cr
R R
Land (SFP) (3/15 × 13 761 468) 2 752 294
Buildings (SFP) (12/15 × 13 761 468) 11 009 174
Creditors/Payables (SFP) 13 761 468
Acquisition of land and buildings on credit
31 December 20.12
Bank (SFP) 15 000 000
Long-term liability (SFP) 15 000 000
Recognition of long-term loan
Creditors (SFP) 13 761 468
Finance cost (P/L) 1 238 532
Bank (SFP) 15 000 000
Recognition of payment of creditor
Depreciation (P/L) (11 009 174/20 years × 6/12) 275 229
Accumulated depreciation – buildings (SFP) 275 229
Current year depreciation charge
9.5.4 Exchange of property, plant and equipment items

When PPE items are acquired in exchange for other assets, whether monetary, non-monetary
or a combination of the two, the cost price of the item acquired is measured at fair value.
When the fair values of both assets (acquired and given up) can be determined
reliably, the fair value of the asset given up will be used (this is therefore the rule),
unless the fair value of the asset acquired is more evident, in which case that value may be
used. A gain or loss is recognised as the difference between the fair value and the carrying
amount of the asset given up, where applicable.
There are, however, two exceptions to the general rule that assets that were acquired in
exchange transactions should be measured at fair value:
The first exception is where the exchange transaction lacks commercial substance.
The second occurs where the fair values of both the asset that is acquired and the asset
that is given up cannot be estimated reliably.
In both these cases, the asset that is acquired is measured at the carrying amount of the
asset given up, and no gain or loss is recognised.
The reference to commercial substance is explained in IAS 16.25. In this regard, it is
necessary to consider the definition of the entity-specific value of an asset. The entity-
specific value is the present value of the cash flows that an entity expects from the
continued use of the asset, plus the present value of its disposal at the end of its useful life.
Note that the entity-specific value of an asset refers to after-tax cash flows, and any tax
allowances on these assets should be included in the calculation.
An entity determines whether an exchange transaction has commercial substance by
considering the extent to which its future cash flows are expected to change as a result of
the transaction. An exchange transaction has commercial substance if:
the configuration (risk, timing and amount) of the cash flows of the asset received differs
from the configuration of the cash flows of the asset transferred; or
the entity-specific value of the portion of the entity’s operations affected by the
transaction changes as a result of the exchange; and
the difference in the above is significant relative to the fair value of the assets
exchanged.
Example 9.9
9.9 Exchange of assets
Echo Ltd entered into the following exchange of assets transactions during the year ended
31 December 20.13:
Transaction 1
A motor vehicle, with a carrying amount of R120 000 in the records of Echo Ltd and a fair value of
R140 000, was exchanged for a delivery vehicle of Delta Ltd, with a fair value of R142 000. The
fair value of both vehicles can be readily determined, since an active market for similar used
vehicles exists.
Transaction 2
A machine with a carrying amount of R150 000 owned by Echo Ltd is exchanged for another
machine, which is carried at R145 000 in the records of Beta Ltd. The fair values of the two
machines cannot readily be ascertained.
Transaction 3
A computer system with a carrying amount of R220 000 in the books of Echo Ltd is exchanged for
a manufacturing plant with a carrying amount of R225 000 in the records of Charlie Ltd. The fair
value of the computer system is virtually impossible to determine, as these items are seldom sold,
but the following can be estimated reliably:
Probability Fair value
R
Possibility 1 30% 200 000
2 10% 250 000
3 20% 230 000
4 40% 210 000
The fair value of the manufacturing plant is R222 000 and is readily determinable since an active
market for these used assets exists.
Transaction 4
Echo Ltd exchanges a machine with a carrying amount of R1 700 000 for a similar machine of the
same age and condition. The existing machine that is painted red is exchanged for the other
machine that is painted blue, as the managing director likes blue machines. The fair values of the
two machines are R1 720 000 (red) and R1 750 000 (blue) respectively. Since the blue machines
are more popular, they have a higher fair value. Both machines’ residual values are immaterial.
In each of the abovementioned transactions, determine the amount at which the new asset
acquired in the exchange should be measured in the financial statements of Echo Ltd.
Transaction 1
The delivery vehicle will be measured at R140 000. Refer to IAS 16.26.
Transaction 2
The machine acquired in the exchange transaction will be measured at R150 000 which is the
carrying amount of the machine given up. Refer to IAS 16.24.
Transaction 3
The estimated fair value of the computer system given up is the following:
([200 000 × 30%] + [250 000 × 10%] + [230 000 × 20%] + [210 000 × 40%]) = R215 000.
Refer to the first part of IAS 16.26.
The fair value of the item that is acquired is R222 000.
The manufacturing plant should be measured at R222 000 (its fair value) since it is more readily
determinable than the fair value of the asset given up. Refer to the last part of IAS 16.26.
Transaction 4
This is an example of a transaction without commercial substance as described in IAS 16.24. The
transaction does not comply with any of the requirements of commercial substance, as specified in
IAS 16.25. Consequently, the acquired blue machine will be reflected at R1 700 000 in the records of
Echo Ltd – that is, at the carrying amount of the red machine given up.
9.5.5 Subsequent measurement

An entity will, after initial recognition, make a choice between the cost model (IAS 16.30) and
the revaluation model (IAS 16.31). In terms of the cost model, an item of PPE will, after
initial recognition as an asset, be carried at its cost less any accumulated depreciation and
accumulated impairment losses.
In terms of the revaluation model, an item of PPE will, after initial recognition, be carried at
the revalued amount, provided its fair value can be measured reliably. The revalued amount
referred to is the fair value on the date of revaluation less any accumulated depreciation and
accumulated impairment losses since the revaluation date. Revaluations must be done on a
regular basis to ensure that the carrying amount of the asset at end of the reporting period
does not differ substantially from the fair value at end of the reporting period.
PPE is therefore disclosed at cost/revalued amount less accumulated depreciation and
impairment losses. The same model must however, be used for all items of PPE in a
specific class.
9.6 Depreciation
IAS 16.6 and .50 state that depreciation is the systematic allocation of the depreciable
amount of an asset over its useful life.
9.6.1 Depreciable amount

Depreciable amount refers to the cost of an asset or another amount that replaces cost,
less residual value. The residual value of an asset is the estimated amount that the entity
would currently obtain from the disposal of the asset, after deducting the estimated costs of
disposal, if the asset were already of the age and in the condition expected at the end of its
useful life.
The aim is therefore to allocate the depreciable amount (original cost less the residual
value) of an asset over its useful life (the period during which the depreciable asset will be
used) to income generated by the asset. Consequently, the depreciable amount is
recovered through use, and the residual value is recovered through sale.
In order to decide on the amount of depreciation that should be allocated, three aspects
should be considered, namely:
the useful life;
the expected residual value; and
the method of depreciation.
9.6.2 Useful life

The following factors are considered in determining the useful life of an asset:
the expected use of the asset by the entity, determined by referring to the asset’s
expected capacity or physical production;
the expected physical wear-and-tear, dependent on operating factors such as the
number of shifts and the repairs and maintenance programme, as well as repairs and
maintenance while not in use;
the technical or commercial obsolescence resulting from changes and improvements in
production or a change in the demand for the product or service output of the asset; and
legal and similar limitations on the use of the asset, such as maturity dates of related
leases (normally finance leases).
The useful life of an asset is defined in terms of the asset’s expected utility to the entity,
while the economic life of an asset refers to the total life of an asset while in the possession
of one or more owners. The asset management policy of an entity may involve the disposal
of assets:
after a specified period; or
after the consumption of a certain portion of the economic benefits embodied in the asset
prior to the asset reaching the end of its economic life.
The useful life of the asset may therefore be shorter than its economic life.
The estimate of the useful life of PPE is a matter of judgement based on the entity’s
experience with similar assets. IAS 16.51 requires that the useful life should be reviewed
annually. If, prior to the expiry of the useful life of an asset, it becomes apparent that the
original estimate was incorrect, in that the useful life is longer or shorter than originally
estimated, an adjustment to the incorrect estimate must be made. This adjustment is not a
correction of an error, as estimates are an integral part of accrual accounting and may, by
their very nature, be inaccurate. Adjustments to such estimates form part of the normal
operating expense items, and may, at most, be disclosed separately in terms of IAS 8
Accounting Policies, Changes in Accounting Estimates and Errors, if size or nature warrants
such treatment. Changes in accounting estimates are not adjusted retrospectively, but
only in the current year and future periods. This rule also applies to subsequent expenditure
on an asset; or a change in the maintenance policy that results in a lengthening of the useful
life; or if changes in technology or market affect the demand for the products and the useful
life.
Example 9.10
9.10 Change in estimate of useful life
Assume the following details for equipment of A Ltd on 31 December 20.12:

R
Cost (5-year useful life) 450 000
Accumulated depreciation (450 000/5 × 2) (180 000)
Carrying amount 270 000
At the end of 20.13, the remaining useful life of the equipment was estimated at 3 years. It is
anticipated that neither the useful life nor the residual value of the asset of Rnil will change.
Taking the above into account, the depreciation for 20.12 to 20.14 will be as follows:
20.12: R450 000/5 = R90 000 (no restatement of comparatives).
20.13: R270 000/(3 + 1) = R67 500 (change applied from the beginning of the year)
Change in estimate for 20.13 (R67 500 (new) – R90 000 (old) = R22 500 decrease in
depreciation for the current year).
The cumulative future effect of the change in estimate is an increase in depreciation of
R25 000, as the total future depreciation is now R202 500 (R67 500 × 3), whereas it would
have been R180 000 (R90 000 × 2) before the change.
20.14: Depreciation of R67 500 per annum will now be recognised.
9.6.3 Useful life of land and buildings

Land and buildings are divisible assets that should be treated separately for accounting
purposes, even if they were acquired as a unit. These items are separated as land usually
has an infinite useful life and is therefore not depreciated, while buildings have a finite useful
life and are therefore depreciable assets. An increase in the value of the land on which a
building was erected does not affect the useful life of the building.
Depreciation may be provided on land if it is subject to the exploration of minerals or a
decrease in value due to other circumstances. For example, a dumping site that can only be
utilised for a limited number of years will be subject to depreciation. If the cost of land
includes restoration costs, a portion of the cost will have to be depreciated over the
period of expected benefits. The value of land may also be affected adversely by
considerations such as its location. In the latter circumstances, it may be necessary to write
the value of the land down to recognise the decline in value – this would represent an
impairment loss.
9.6.4 Residual value

In terms of IAS 16.6, the residual value of an asset is the estimated amount that the entity
would currently obtain from the disposal of the asset, after deducting the estimated costs of
disposal, if the asset were already of the age and in the condition expected at the end of its
useful life. Therefore, the residual value of an asset is the current value which ignores the
effect of future inflation.
Depreciation must be provided on any asset with a limited useful life, even if the fair value
of such an asset exceeds its carrying amount, provided the residual value does not exceed
the carrying amount. However, if the residual value of an asset is equal to or exceeds its
carrying amount at any time, no depreciation will be provided for on that asset, unless and
until the residual value declines below the carrying amount of the asset.
In practice, the residual value is normally not significant and will therefore not be material in
the calculation of the depreciable amount.
In terms of IAS 16, the residual value of any asset must be reviewed at least at the end of
each financial year. The change in the residual value will be accounted for as a normal
change in accounting estimate. Consequently, the depreciation for the current and
future years will be recalculated. In view of this, depreciation amounts may vary on an
annual basis. This rule applies to both the cost model and the revaluation model.
Example 9.11
9.11 Reviewing of residual value
Foxtrot Ltd acquired an asset with a useful life of 5 years on 1 January 20.10 for an amount of
R1 200 000. The estimated residual value of the asset was R100 000 on the date of acquisition.
The annual review of the residual value of the asset under discussion during the past 3 years
produced the following residual values:
R
31 December 20.10 100 000
31 December 20.11 50 000
31 December 20.12 120 000
The depreciable amount of the asset (taking into account the annual review of the residual value)
for 20.10 to 20.12, and the depreciation amount for 20.10 (current year) and future years, will be the
following:
Depreciable Depreciation
Year Calculation Current Future
amount
R R R
20.10 Depreciable amount (1 200 000 – 100 000) 1 100 000 – –
Depreciation (1 100 000/5) 220 000 220 000
20.11 Depreciable amount 930 000 – –
(1 200 000 – 220 000 – 50 000)
Depreciation (930 000/4) 232 500 232 500
20.12 Depreciable amount 627 500 – –
(1 200 000 – 220 000 – 232 500 – 120 000)
Depreciation (627 500/3) – 209 167 209 167
continued
Comment
¾ Although the residual value was revised at the end of each year, the revised residual value is
taken into account from the beginning of the respective year for the purposes of calculating
depreciation.
¾ In terms of IAS 8, the nature of the change, the amount, and the effect on future periods should
be disclosed, if significant. The effect of the changes in estimate is as follows:
20.11: Current year: increase in depreciation of R12 500 (232 500 – 220 000)
Cumulative future effect: increase in depreciation of
R37 500 [(232 500 × 3) – (220 000 × 3)]
20.12: Current year: decrease in depreciation of R23 333 (209 167 – 232 500)
Cumulative future effect: decrease in depreciation of
R46 666 [(209 167 × 2) – (232 500 × 2)]
9.6.5 Depreciation methods

Depreciation is allocated from the date on which the asset is available for use (in the
location and condition necessary for it to be capable of operating in the manner intended by
management), rather than when it is commissioned or brought into use. It is therefore
possible that depreciation on an asset could commence before it is physically brought into
use, because it was available for use before the date on which it was commissioned.
Depreciation on an asset should cease only when the asset is derecognised in terms of
IAS 16 or when it is classified as held for sale in terms of the strict criteria of IFRS 5 (see
chapter 19). An asset is only derecognised when it is disposed of or when no further
economic benefits are expected from the asset, either from its use or disposal. Depreciation
does not cease when an asset becomes temporarily idle or even if it is retired from active
use, unless the depreciable amount has been written-off in total or will not deliver future
economic benefits. However, if the unit-of-production method (a usage method) is used to
determine depreciation, depreciation may sometimes be zero. In addition, an interruption in
the use of an asset will lead to a lower depreciation charge, as no units will be produced
during the period it was idle.
Because of the view that depreciation is the allocation of the depreciable amount of an asset
to income over its useful life, it follows that the allocation should reflect the pattern in which
the asset’s future economic benefits are expected to be consumed by the entity. For
example, if the asset will generate more units at the beginning of its useful life than at the
end thereof, a depreciation method should be selected that will result in larger write-downs
in the beginning and smaller write-downs at the end of its useful life.
Revenue-based methods to calculate depreciation are not allowed. This is because a
revenue-based method reflects a pattern of economic benefits being generated from the
asset, rather than the expected pattern of consumption of the future economic benefits
embodied in the asset.
Depreciation may be calculated using a variety of methods, for example:
the straight-line method; or
the diminishing balance method (also known as reducing balance method); or
the sum-of-digits method; or
the units of production method.
9.6.5.1 Straight-line method
The allocation of depreciation in fixed instalments is usually adopted where the income
produced by the asset or part of the asset is a function of time rather than of usage, and
where the repair and maintenance charges and benefits are fairly constant.
9.6.5.2 Diminishing balance method

This method of depreciation, where the amount allocated declines on an annual basis, is
used where there is uncertainty about the amount of income that will be derived from the
asset. It is also appropriate where the effectiveness of the asset is expected to decline
gradually. It is often argued that the cost related to repairs and maintenance increases as an
asset ages, and that depreciation in declining instalments results in the total debit for the
cost of using the asset remaining fairly constant. When applying the diminishing balance
method, information about the technical or commerical obsolescence of the product is
relevant for estimating both the pattern of consumption of future economic benefits and the
useful life of the asset. The sum-of-digits method is also a reducing balance method.
9.6.5.3 Units of production method
The units of production method results in a charge based on the expected use or output of
the assets, called production units. The units of production method probably provide the
best approximation of the consumption of economic benefits contained in an asset. It has
the added advantage that it will prevent the depreciation of assets before they have been
brought into use, as the depreciation charge will only arise when the asset is used to
produce units.
Example 9.12
9.12 Depreciation methods
Alpha Ltd has the following equipment:

Cost of equipment (1 January 20.10) R310 000
Residual value (unchanged over useful life) R10 000
Useful life 5 years
Year end 31 December
The asset was available for use as intended by management on 1 January 20.10.
Using the allowed depreciation methods, the depreciation charge for Years 1 to 3 will be
calculated as follows:
Straight-line method: (310 000 – 10 000)/5 = R60 000 annually
Diminishing balance method: Assume a depreciation rate of 25%. R
Year 1: (310 000 – 10 000) × 25% = 75 000
Year 2: (310 000 – 10 000) × 75% × 25% = 56 250
Year 3: (310 000 – 10 000) × 75% × 75% × 25% = 42 188
Sum-of-digits: (1 + 2 + 3 + 4 + 5 = 15)
Year 1: (310 000 – 10 000) × 5/15 = 100 000
Year 2: (310 000 – 10 000) × 4/15 = 80 000
Year 3: (310 000 – 10 000) × 3/15 = 60 000
Units of production method: Assume the number of units per year = 8 000 (Year 1) + 6 000
(Year 2) + 3 000 (Year 3) + 2 000 (Year 4) + 1 000 (Year 5) = 20 000 units over the useful life of
the asset.
R
Year 1: 8/20 × (310 000 – 10 000) = 120 000
Year 2: 6/20 × (310 000 – 10 000) = 90 000
Year 3: 3/20 × (310 000 – 10 000) = 45 000
Comment
¾ If the estimated residual value of the above equipment changes to R15 000, the original
residual value of R10 000 will change to R15 000 in the calculation of depreciation, resulting in
a change in depreciation in the current and future periods.
¾ The depreciation method used must be reviewed annually and, where the expectation varies
significantly from the previous estimates, it must be recognised as a change in accounting
estimate.
9.6.6 Accounting treatment

Although depreciation is normally recognised as an expense in the profit or loss section of
the statement of profit or loss and other comprehensive income, it may be capitalised as
part of the cost of another asset. Examples of this treatment can be found in IAS 2
Inventory, (where inventory is manufactured); IAS 16 Property, Plant and Equipment (where
assets are self-constructed), and IAS 38 Intangible Assets (where intangible assets may be
developed).
In all the above cases, the useful life, residual value and depreciation method are reviewed
at least at each financial year end. If expectations differ from previous estimates, the
changes shall be accounted for as a change in an accounting estimate. A change in the
useful life, depreciation method or residual value will thus result in a change in the
depreciation charge for the current year and future periods. Disclosure of the nature and
amount of the change in estimate (if material), as well as the effect on the current and
future periods, is required in terms of IAS 8.39 and .40.
Example 9.13
9.13 Change in depreciation methods
A company that operates a bus service determined on 1 January 20.12 that the appropriate
depreciation method for a specific bus is the production unit method.
The bus was acquired for R750 000. The originally estimated useful life was 150 000 kilometres.
During the first year of use, depreciation of R200 000 was recognised. The bus therefore had a
carrying amount of R550 000 at the end of the first year of use.
In the second year of use, management decided that, due to safety requirements, the bus can
only be used for a total term of 3 years, irrespective of the number of kilometres travelled. The
appropriate depreciation method therefore changes to the straight-line method.
Carrying amount at the end of Year 1 R550 000
Remaining useful life 2 years
Depreciation per annum on the straight-line method (550 000/2) R275 000
Comment
¾ The change in the depreciation method is treated and disclosed as a change in estimate (if
material). The effect of the change in estimate is as follows:
Current year: Increase in depreciation of R75 000 (275 000 – 200 000)
Cumulative future effect: Decrease in depreciation of R75 000
[(750 000 – (200 000 × 2 years)) – 275 000].
9.7 Revaluation
All PPE is initially measured at cost. On subsequent measurement, the entity may, however,
choose to use either the cost model or the revaluation model. The revaluation model may,
however, only be chosen for subsequent measurement of an item of PPE if the fair value of
the asset can be measured reliably. If the fair value of the item under review cannot be
measured reliably, the asset will be measured using the cost model.
The frequency of revaluations depends upon the change in fair value of the items of PPE.
Revaluations should be made with sufficient regularity to ensure that the carrying amount
does not differ materially from the fair value at the end of the reporting period.
9.7.1 Fair value

The fair value of items of PPE subsequently measured under the revaluation model should
be determined according to the requirements of IFRS 13 (refer to chapter 21). According to
IFRS 13.27, a fair value measurement of a non-financial asset takes into account the market
participant’s ability to generate economic benefits by using the asset in its highest and best
use. According to IFRS 13.62, there are three widely used valuation techniques to
determine fair value. The three valuation techniques are as follows:
the market approach;
the cost approach; and
the income approach.
The fair value of property is quite often determined using the market value, if it is assumed
that the same type of business will be continued on the premises. Usually these values are
obtained from independent professional valuators.
9.7.2 Non-depreciable assets: subsequent revaluations and devaluations

If a specific asset’s carrying amount decreases as a result of a revaluation, this decrease
must first be debited against a credit in the revaluation surplus related to that specific asset,
via other comprehensive income, in the statement of profit or loss and other comprehensive
income. Any excess of the write-down over the existing revaluation credit must be written-off
immediately to the profit or loss section of the statement of profit or loss and other
comprehensive income. With a subsequent increase in the value of the specific asset, the
profit or loss section of the statement of profit or loss and other comprehensive income
should first be credited, but the amount credited to the profit or loss section should be limited
to the amount of the previous write-down debited to this section. Thereafter, the remaining
amount is credited to the revaluation surplus via other comprehensive income in the
statement of profit or loss and other comprehensive income. Deficits of one item cannot be
set-off against surpluses of another, even if such items are from the same class. The
revaluation surplus may subsequently be used to absorb subsequent revaluation deficits or
impairment losses.
Example 9.14
9.14 Non-
Non-depreciable asset: revaluation movements
Brit Ltd is the owner of a plot. The plot is not depreciated and does not meet the requirements of
investment property. The plot is valued according to the revaluation model.
R
1 January 20.9 Carrying amount 150 000
1 January 20.10 Revalued amount 125 000
Journal entries
Dr Cr
R R
1 January 20.10
Revaluation deficit (P/L) 25 000
Land (SFP) 25 000
1 January 20.11
Land (SFP) 10 000
Revaluation surplus (P/L) 10 000
1 January 20.12
Land (SFP) 25 000
Revaluation surplus (P/L) 15 000
1 January 20.13
Revaluation deficit (P/L) 5 000
Land (SFP) 15 000
continued
The statement of profit or loss and other comprehensive income will contain the following:
20.13 20.12 20.11 20.10
R R R R
(Profit or loss section)
Other (expenses)/income (5 000) 15 000 10 000 (25 000)
(Other comprehensive income section)
(Loss)/Gain on revaluation (10 000) 10 000 – –
The statement of changes in equity will contain
the following:
Revaluation surplus
Balance at beginning of year 10 000 – – –
Other comprehensive income (10 000) 10 000 – –
Balance at end of year – 10 000 – –
9.7.3 Non-depreciable assets: realisation of revaluation surplus

On revaluation, the difference between the revalued amount and the carrying amount is
recognised in the revaluation surplus via other comprehensive income if an upwards
revaluation occurred. The revaluation surplus is never subsequently reclassified to profit or
loss, but an entity may realise the revaluation surplus by making a direct transfer to retained
earnings through the statement of changes in equity. The revaluation surplus of non-
depreciable assets are realised when the asset is retired or disposed of. The amount
transferred from the revaluation surplus should be net of tax.
Example 9.1
9.15 Non-
Non-depreciable asset: realisation of revaluation surplus
P Ltd adopted a policy to revalue land. The company owns a piece of land acquired at a cost of
R1 500 000 on 1 January 20.11. The year end of the company is 31 December. Ignore taxation.
The company revalued the building to a market value of R2 000 000 on 31 December 20.13.
The revaluation surplus that will be created is calculated as follows:
R
Carrying amount of the building on 31 December 20.13 1 500 000
Market value 2 000 000
When the land is finally derecognised, the revaluation surplus will be transferred to retained
earnings. The journal entry will be as follows:
Dr Cr
R R
Revaluation surplus (Equity) 500 000
Retained earnings (Equity) 500 000
Realisation of revaluation surplus
9.8 Impairment losses and compensation for loss

The carrying amount of an item of PPE is usually recovered on a systematic basis over the
useful life of the asset through usage. If the use of an item or a group of similar items is
impaired by (e.g.) damage or technological obsolescence or other economic factors, the
recoverable amount of the asset may be less than its carrying amount. Should this be the
case, the carrying amount of the asset is written down to its recoverable amount.
To determine whether there has been a decline in the value of an item of PPE, an entity
applies IAS 36. This Standard explains how an entity should review the carrying amount of
its assets; how the recoverable amount is determined, and when and how an impairment
loss is recognised or reversed (refer to chapter 14).
IAS 16.65 and .66 provide guidance on how to account for the monetary or non-monetary
compensation that an entity may receive from third parties for the impairment or loss of
items of PPE. Often the monetary compensation received has to be used for economic
reasons to restore impaired assets or to purchase or construct new assets in order to
replace the assets lost or given up. Examples of these may include:
reimbursement by insurance companies after an impairment or loss of items of PPE, for
example due to natural disasters, theft or mishandling;
compensation by the government for items of PPE that are expropriated;
compensation related to the involuntary conversion of items of PPE, for example
relocation of facilities from a designated urban area to a non-urban area in accordance
with a national land policy; or
physical replacement in whole or in part of an impaired or lost asset.
The specific guidance on how to account for the abovementioned situations, deals with the
following:
impairments or losses of items of PPE;
related compensation from third parties; and
subsequent purchase or construction of assets.
The above-mentioned instances are separate economic events and are accounted for as
follows:
impairments of items of PPE must be recognised and measured in terms of the Standard
on impairment of assets, (IAS 36);
the retirement or disposal of items of PPE must be recognised in terms of IAS 16;
monetary or non-monetary compensation received from third parties for items of PPE
that were impaired, lost or given up must be included in profit or loss when receivable;
and
the cost of assets restored, purchased, or constructed as a replacement must be
accounted for in terms of IAS 16.
Example 9.1
9.16 Compensation for the loss of PPE
On 1 January 20.12, a motor vehicle with a carrying amount of R150 000 was stolen. The
company, Alpha Ltd, was fully insured. The insurance company paid out R160 000 (in cash) on
31 January 20.12. On 1 February 20.12, a new vehicle was purchased for R160 000 to replace
the stolen one. The financial year ends on 31 December. Assume all amounts are material.
The above information will be disclosed as follows in the notes of Alpha Ltd for the year ended
31 December 20.12.
Profit before tax
R
Income
Compensation received from insurance claim 160 000
Expenses
Loss of motor vehicle due to theft 150 000
Comment
¾ In terms of IAS 16.65 and .66, the insurance proceeds received when an asset is impaired, the
loss of the asset, and the purchase of a replacement asset, are all separate transactions and
must be disclosed as such.
9.9 Derecognition
An item of PPE is derecognised in the statement of financial position:
on disposal; or
The above two criteria preclude the derecognition of an asset by mere withdrawal from use,
unless the withdrawn asset can no longer be used or sold to produce any further economic
benefits.
The gain or loss arising from the derecognition of an item of PPE shall be determined as the
difference between the net disposal proceeds (if any) and the carrying amount of the item on
the date of disposal. This gain or loss shall be recognised in the profit or loss section
of the statement of profit or loss and other comprehensive income (unless IFRS 16
Leases, requires otherwise on a sale and leaseback transaction where it is deferred). A gain
is not classified as revenue. However the date of disposal will be date the buyer obtains
control of the asset in terms of IFRS 15 (refer chapter 22).
Depreciation on an item of PPE ceases at the earlier of the date on which the asset is
classified as held for sale (or included in a disposal group that is classified as held for sale),
or the date the asset is derecognised.
Example 9.17
9.17 Disposal and withdrawal of assets
Lima Ltd entered into the following two transactions relating to items of PPE during the year ended
31 December 20.12:
Asset A, with a carrying amount of R210 000 on 1 January 20.12 and an original cost of
R400 000, was sold for R220 000 on 30 June 20.12. The payment will only be received on
30 June 20.13.
Asset B, with a carrying amount of R400 000 on 1 January 20.12 and original cost of R800 000,
was withdrawn from use on 30 September 20.12 after environmental inspectors certified that the
asset could no longer be used. The asset cannot be altered to secure further use, which makes
sale thereof unlikely. The scrap value of the asset is negligible.
Both these assets are depreciated at 20% per annum on a straight-line basis and the current
interest rate on asset financing is 10% per annum. Assume that the revenue recognition criteria
have been adhered to in the case of Asset A and that the disposal was therefore recognised on
30 June 20.12.
The profit or loss arising on derecognition of the two assets, as well as any other relevant profit or
loss items, is as follows:
Asset A
R
Proceeds on disposal (See IAS 16.72) 200 000
(n = 1; FV = 220 000; i = 10%; Compute PV = 200 000)
Carrying amount at disposal (210 000 – (400 000 × 20% × 6/12)) (170 000)
Profit on sale of Asset A in profit or loss section of the statement of profit or loss
and other comprehensive income 30 000
Interest received (200 000 × 10% × 6/12) 10 000
Asset B
R
Proceeds on withdrawal from use –
Carrying amount at withdrawal (400 000 – (800 000 × 20% × 9/12)) (280 000)
Loss on withdrawal to profit or loss section of the statement of profit or loss
and other comprehensive income (280 000)
Comment
¾ IFRS 5 requires specific disclosure of non-current assets (including PPE) that have been
earmarked for disposal within 12 months after taking the decision to dispose of the asset.
9.10 Deferred tax implications

From an accounting perspective, depreciation methods, depreciation rates and residual values
are based on criteria such as the useful life of the asset to the entity, rather than its
economic life.
Deferred tax implications may therefore arise because of differences in:
the dates from which depreciation and wear-and-tear are calculated (date ready for
intended use versus date brought into use);
the use of different methods and rates to calculate depreciation, wear-and-tear and building
allowances, and the effect of subsequent changes due to the annual reassessment of
accounting allocations;
the use of residual values and subsequent changes (e.g. revaluations) to the values
which are not recognised for taxation purposes;
depreciation allowances that are calculated proportionately while wear-and-tear allowances
(e.g. in section 12C) are claimed for the full year; and
idle and damaged PPE, where depreciation and impairment adjustments are made for
accounting purposes that are not recognised for income tax purposes.
Revaluations may have an impact on the deferred tax balance. When an asset is revalued,
the carrying amount of the asset increases/decreases but the tax base of the asset remains
the same.
9.10.1 Manner of recovery

In terms of IAS 12.51 Income Taxes, the measurement of deferred tax liabilities and assets
must reflect the tax consequences that would follow from the manner in which the entity
expects, at the end of the reporting period, to recover or settle the carrying amounts of its
assets or liabilities.
IAS 12.51B furthermore states that the deferred tax asset or liability that arises when using
the revaluation model in IAS 16 on non-depreciable assets should reflect the tax
consequences of recovering the carrying amount of the asset through sale.
The carrying amount of depreciable PPE can be separated into a residual value and a
depreciable amount. In determining the residual value, an entity is effectively affirming that it
expects to recover the depreciable amount of an asset through use, and its residual value
through sale.
An item of depreciable PPE will only be recovered through sale when it is classified as held
for sale in terms of IFRS 5.
9.10.2 Deferred tax implications of cost model

Deferred tax on PPE is calculated on the difference between the historical cost carrying
amount and the tax base of an asset. This is regarded as a temporary difference that will
result in either a deferred tax liability (based on a taxable temporary difference) or a deferred
tax asset (based on a deductible temporary difference).
The carrying amount of a non-depreciable asset, such as land that has an unlimted life, will
be recovered only through sale. Because the asset is not depreciated, no part of its carrying
amount is expected to be recoverd through use.
Example 9.18
9.18 Non-depreciable asset
Mpho Ltd acquired land at a cost of R1 000 000 on 1 January 20.13. The year end of the company
is 31 December. Normal income tax is provided for at 28%.
Temporary difference on land on 31 December 20.13:
Carrying Temporary Deferred tax
Tax base
amount difference asset/(liability)
R R R R
Land 1 000 000 1 000 000 – –
Comment
¾ Please refer to IAS 12 BC6 regarding the manner of recovery of a non-depreciable asset.
When an item of PPE is depreciated but no tax deduction is allowed, no deferred tax is
recognised, because the temporary differences are part of the temporary differences that
arose on initial recognition (IAS 12.22(c)).
Example 9.19
9.19 Depreciation of non-tax-deductible PPE
Ndlovu Ltd acquired a building, which they intend to use for 20 years, with no residual value, on
1 April 20.12 for R1 000 000. The year end of the company is 31 March. No tax deductions are
available for the building. Normal income tax is provided for at 28%.
Temporary difference on the building on 31 March 20.13:
Tax base
R R R R
Building 950 000 – 950 000 Exempt
(IAS 12.22(c))
Comment
¾ No deferred tax is recognised on the current temporary difference of R950 000, because it is
part of the temporary differences arising on initial recognition (IAS 12.22(c)). The depreciation
of R50 000 is a non-deductible item in the taxable income calculation.
The example below illustrates the treatment of temporary differences when the item of PPE
is depreciated and tax deductions are allowed.
Example 9.2
9.20 Temporary differences on PPE
Zet Ltd acquired a machine at a cost of R100 000 on 1 July 20.12. The year end of the company is
31 December.
The company estimates the useful life of the machine as 5 years at initial recognition.
The machine is used in a process of manufacture; consequently, the South African Revenue
Service (SARS) allows a wear-and-tear allowance, not apportioned for part of a year, of 40% in
the first year in which the machine is brought into use and 20% in the three following years in
terms of section 12C of the Income Tax Act.
On 31 December 20.12, the relevant amounts for the machine are as follows:
Accounting depreciation: R100 000/5 × 6/12 = R10 000
Therefore, the carrying amount of the machine is R90 000 on 31 December 20.12.
Wear-and-tear allowances for tax purposes: R100 000 × 40% = R40 000
Therefore, the tax base of the machine is R60 000 on 31 December 20.12.
Normal income tax is provided for at a rate of 28%.
continued
Temporary difference on the machine on 31 December 20.12:

Tax base
R R R R
Machine 90 000 60 000 30 000 (8 400)
Comment
¾ The carrying amount of the machine represents the future economic benefits arising from the
use of the asset that will be included in taxable income in future. The tax base represents the
future tax deductions. Therefore, R90 000 will be included in future taxable income and
R60 000 will be allowed as a deduction. A future tax liability of R8 400 (30 000 × 28%) will
arise.
When a depreciable PPE item has a residual value and the residual value exceeds the
carrying amount, the PPE item is recovered through sale only. For example, if the carrying
amount of the asset is R50 000 and the residual value is R55 000 the total carrying amount
of R50 000 will be recovered through sale.
9.10.3 Non-depreciable assets: deferred tax implications of revaluation model

SARS does not recognise revaluations when determining the tax base of an asset. SARS
normally uses only historical cost as the point of departure. As a result, the tax base of an
asset will remain unchanged at revaluation, but the carrying amount of the asset will change.
The deferred tax on the revaluation of an item of PPE must be recognised against the
revaluation surplus via other comprehensive income, as the underlying reason for the
temporary difference (the increase in the carrying amount of the asset) is recognised in
other comprehensive income. IAS 12.61A and .62(a) require deferred tax to be recognised
in other comprehensive income if the tax relates to an item that was recognised in other
If a non-depreciable asset (e.g. land) is revalued in terms of IAS 16, the manner of recovery
of a revalued non-depreciable asset is through sale. When the assumption is that the
asset will be recovered through sale, the tax base of the asset will be equal to its base
cost (as the base cost will be allowed as a deduction against the proceeds to determine the
capital gain when the asset is sold).
Example 9.2
9.21 Revaluation of a non-depreciable asset
Metsi Ltd acquired land at a cost of R1 000 000 on 1 January 20.12. The land is revalued to
R1 500 000 on 31 December 20.12. Assume a normal income tax rate of 28% and an 80% capital
gains tax inclusion rate. Metsi Ltd presents other comprehensive income before related tax effects
and the tax effects are shown in aggregate.
Temporary difference on the machine on 31 December 20.12:
Deferred tax
Carrying Temporary
Tax base @ CGT rate*
amount difference
asset/(liability)
R R R R
Land 1 500 000 1 000 000 500 000 (112 000)
* Assume the asset was acquired after 1 October 2001.
Comment
¾ The carrying amount of the revalued asset has increased, but the tax base remains at
R1 000 000. As a result, the temporary difference increased by R500 000, which is equal to the
amount of the revaluation surplus on the asset. Since the asset is non-depreciable, deferred tax
should be raised on the revaluation surplus at the tax rate that would apply when the asset is
sold – in South Africa, Capital Gains Tax (CGT) will arise at 80% × normal income tax rate.
The deferred tax on the revaluation of an item of PPE is recognised against the revaluation
surplus via other comprehensive income.
continued
The journal entries will be as follows:

Dr Cr
R R
1 January 20.12
Land (SFP) 1 000 000
Bank (SFP) 1 000 000
Acquisition of land
31 December 20.12
Land (SFP) 500 000
Revaluation of land to its fair value
Deferred tax on revaluation surplus
Extract from statement of profit or loss and other comprehensive income
R
Other comprehensive income:
Gain on revaluation 500 000
Income tax relating to items that will not be reclassified to profit or loss (112 000)
Extract from statement of changes in equity for the year ended 31 December 20.12
Revaluation Retained
surplus earnings
R R
Balance at 1 January 20.12 – xxx
Profit for the year – xxx
Other comprehensive income for the year 388 000 –
Balance at 31 December 20.12 388 000 xxx
9.10.4 Capital Gains Tax

In terms of the latest tax legislation, capital gains on the sale of capital assets will be subject
to Capital Gains Tax (CGT) from 1 October 2001 unless ‘roll-over’ relief is applicable.
The capital gain is calculated as the difference between the proceeds on disposal of an
asset and the ‘base cost’ of the asset as defined in the Income Tax Act.
CGT is only applicable to assets sold after 1 October 2001. For assets acquired before
1 October 2001, only the part of the gain that arises after 1 October 2001 will be subject to
CGT. The base cost of the asset at 1 October 2001 must thus be determined and will serve as
the tax base of the asset under these specific circumstances. Currently the capital gains tax
inclusion rate for companies is 80%. Example 9.22 illustrates the current tax calculation of
capital gains on the sale of capital assets.
Example 9.2
9.22 Capital Gains Tax
The following items were included in the profit before tax of R550 000 of Alpha Ltd. Assume that
there were no other non-taxable/non-deductible items or temporary differences for the year. The
normal income tax rate is 28%.
R
Land sold for capital gain:
The accounting profit on the sale of land 200 000
The following information relates to land:
Proceeds 1 100 000
Revalued carrying amount on date of sale 900 000
Base cost (CGT purposes) 800 000
The current tax will be calculated as follows:
Non-taxable and non-deductible items:
Accounting profit not taxable (200 000 × 20%) (40 000)
Taxable profit before temporary differences 510 000
Movement in temporary differences# 80 000
Taxable profit 590 000
#
(900 000 – 800 000 = 100 000 × 80% = 80 000) – (Rnil) = 80 000
(reversal of taxable temporary differences)
South African normal tax
Current tax (Current year) 165 200
Deferred tax
Movement in temporary differences (80 000 × 28%) (22 400)
142 800
Tax rate reconciliation
Tax at 28% 154 000
Non-taxable/non-deductible items
Profit on sale of land not taxable (40 000 × 28%) (11 200)
Land sold for capital loss:
The accounting loss on the sale of land 200 000
The following information relates to land:
Proceeds 700 000
Revalued carrying amount on date of sale 900 000
Base cost (CGT purposes) 800 000
Assume future capital gains are probable in the future.
continued
The current tax will be calculated as follows:

R
Non-taxable and non-deductible items:
Accounting loss not deductible (200 000 × 20%) 40 000
Taxable profit before temporary differences 590 000
Movement in temporary differences# 80 000
Movement in temporary differences (unused capital loss) (100 000 × 80%) 80 000
Taxable profit 750 000
#
(900 000 – 800 000 = 100 000 × 80% = 80 000) – (Rnil) = 80 000
(reversal of taxable temporary differences)
SA Normal tax
Current tax (Current year) 210 000
Deferred tax
Movement in temporary differences (80 000 × 28%) (22 400)
Unused capital loss created (80 000 × 28%) (22 400)
165 200
Tax at 28% 154 000
Non-taxable/non-deductible items
Accounting loss on sale of land not deductible (40 000 × 28%) 11 200
Tax expense 165 200
9.11 Disclosure
In terms of IAS 16, the following information on PPE must be disclosed:
Accounting policy:
– For each class of PPE, the measurement basis used in establishing the gross carrying
amount;
– the depreciation methods for each class of asset; and
– the useful lives or depreciation rates for each class of PPE.
Statement of profit or loss and other comprehensive income and notes for each
class of asset:
– The depreciation recognised as an expense or shown as a part of the cost of other
assets during a period should be disclosed in terms of IAS 1 Presentation of Financial
Statements. A breakdown between the different classes of assets is not required. The
depreciation charge need not be split between amounts related to historical cost and
revaluation amounts;
– the effect of significant changes on the estimate of:
* useful lives;
* residual values;
* dismantling, removal or restoration costs; and
* depreciation method; and
– the amount of compensation received from third parties for the impairment, giving up
or loss of items of PPE, must be disclosed in a note if not presented on the face of the
statement of profit or loss and other comprehensive income.
Statement of financial position and notes:
– For each class of asset, the gross carrying amount and accumulated depreciation
(including impairment losses) at the beginning and the end of the period; and
– for each class of asset, a detailed reconciliation (refer to # below) of movements in the
carrying amount (refer to $ immediately below) at the beginning and end of the period
(lay out illustrated below).
$ The carrying amount is the amount at which an asset is recognised in the statement of
financial position after deducting the accumulated depreciation and impairment losses. This
implies that accumulated depreciation and impairment losses must be combined when
disclosing the opening and closing carrying amounts.
# The abovementioned reconciliation must contain the following:
• the carrying amount at the beginning and the end of the period;
• additions;
• assets classified as held for sale or included in a disposal group classified as held for sale
in terms of IFRS 5 and other disposals;
• acquisitions through business combinations;
• increases or decreases in value arising from revaluations;
• impairments, as well as reversals of impairment losses;
• depreciation;
• net exchange differences due to the translation of the financial statements of a foreign
operation from functional to presentation currency (if different), including translation of a
foreign operation into presentation currency of the reporting entity; and
• other changes.
Comparative amounts in respect of the reconciliation are required.
The amount incurred on PPE still under construction (in other words, on which no
depreciation has been provided).
A statement that PPE serves as security for liabilities, showing:
– the details and amount of restrictions on title; and
– the existence and amount of PPE pledged as security.
The following carrying amounts of PPE can also be disclosed voluntarily:
– temporarily idle items;
– items retired from active use and not classified as held for sale in terms of IFRS 5; and
– where the cost model is used, the fair value of each class of PPE if it differs materially
from the carrying amount.
The following additional information regarding assets that have been revalued must be
disclosed in terms of IAS 16:
– the disclosure required by IFRS 13 relating to assets measured at fair value;
– the effective date of the most recent revaluations;
– whether the revaluation was done independently;
– the carrying amount of each class of revalued PPE, if the cost model was used; and
– the revaluation surplus, including the change for the period and limitations on
distributions to shareholders (in other words, whether it is viewed as non-distributable).
Example 9.2
9.23 Disclosure of accounting policy and notes
Notes to the consolidated financial statements

1. Accounting policies
Plant and equipment are stated at cost, excluding the costs of day-to-day servicing, less
accumulated depreciation and accumulated impairment in value. Such costs include the cost of
replacing part of such plant and equipment when that cost is incurred when the recognition criteria
are met. Land is measured at fair value less impairment charged subsequent to the date of the
revaluation. Depreciation is calculated on a straight-line basis over the useful life of the assets.
The useful life of the assets is estimated as follows:
20.13 20.12
Plant and equipment 5 to 15 years 5 to 15 years
The carrying amounts of plant and equipment are reviewed for impairment when events or
changes in circumstances indicate that the carrying amount may not be recoverable.
Following initial recognition at cost, the land is carried at a revalued amount, which is the fair value
at the date of the revaluation less any accumulated impairment losses.
Valuations are performed frequently enough to ensure that the fair value of a revalued asset does
not differ materially from its carrying amount.
Any revaluation surplus is credited to the asset revaluation surplus included in the equity section of
the statement of financial position via other comprehensive income, except to the extent that it
reverses a revaluation decrease of the same asset previously recognised in profit or loss, in which
case the increase is recognised in profit or loss. A revaluation deficit is recognised in profit or loss,
except that a deficit directly offsetting a previous surplus on the same asset is offset against the
surplus in the asset revaluation reserve via other comprehensive income.
Upon disposal, any revaluation reserve relating to the particular asset being sold is transferred to
retained earnings.
An item of PPE is derecognised upon disposal or when no future economic benefits are expected
from its use or disposal. Any gain or loss arising on derecognition of the asset (calculated as the
difference between the net disposal proceeds and the carrying amount of the asset) is included in
the profit or loss section of the statement of profit or loss and other comprehensive income in the
year the asset is derecognised.
The asset’s residual value, useful life and depreciation method are reviewed, and adjusted if
appropriate, at each financial year end.
When each major inspection is performed, its cost is recognised in the carrying amount of the
plant and equipment as a replacement, if the recognition criteria are satisfied.
continued

Plant and
Land Total
equipment
R’000 R’000 R’000
31 December 20.13
Carrying amount at beginning of year 9 933 15 878 25 811
Cost 9 933 30 814 42 197
Accumulated depreciation and impairment losses – (14 936) (16 386)
Additions 1 612 6 043 7 655
Assets included in discontinued operation
and other disposals (2 674) (3 193) (5 867)
Revaluation surplus 846 – 846
Acquisition of a subsidiary 2 897 4 145 7 042
Impairment losses (187) (161) (348)
Depreciation for the year – (3 357) (3 857)
Exchange adjustment 10 119 129
Carrying amount at end of year 12 437 19 474 31 411
Cost or revalued amount 12 624 32 193 44 817
Accumulated depreciation and impairment losses (187) (12 719) (13 406)

This impairment loss relates to the assets attributable to a discontinued operation and has been
recognised in the profit or loss section of the statement of profit or loss and other
comprehensive income in the line item ‘Loss for the year from a discontinued operation’.
Impairment of property, plant and equipment
Immediately before its classification as a discontinued operation of Hose Ltd on 31 December 20.13,
a recoverable amount was estimated for certain items of PPE. An impairment loss totalling
R348 000 was recognised to reduce the carrying amount of certain of those assets to the
recoverable amount. The recoverable amount estimation was based on fair value less costs of
disposal and was determined at the cash-generating unit level consisting of the Euro land-based
assets of Hose Ltd relating to the reportable rubber equipment segment. An independent valuation
was obtained to determine fair value, which was based on recent transactions for similar assets
within the same industry.
Plant and
Land Total
equipment
R’000 R’000 R’000
31 December 20.12
Carrying amount at beginning of year 10 783 12 747 23 530
Cost 10 783 24 654 39 541
Movements for the year:
Additions 1 587 6 235 7 822
Disposals (2 032) – (2 032)
Impairmentʌ – (301) (301)
Depreciation for the year – (2 728) (3 082)
Exchange adjustment (405) (75) (126)
Carrying amount at end of year 9 933 15 878 25 811
Cost 9 933 30 814 42 197
ʌ
The R301 000 impairment loss represents the write-down of certain PPE in the fire prevention
segment to the recoverable amount. This has been recognised in the profit or loss section of the
statement of profit or loss and other comprehensive income in the line item “Cost of sales”.
The recoverable amount was based on value in use and was determined at the cash generating
unit level. The cash generating unit consists of the Euro land-based assets of Sprinklers Ltd
and Showers Ltd, a subsidiary and a jointly-controlled entity of the Group respectively. In
determining value in use for the cash generating unit, the cash flows were discounted at a rate
of 12,8% on a pre-tax basis.
continued
Revaluation of land
The group engaged Chartered Surveyors & Co, an accredited independent valuer, to determine
the fair value of its land. The date of the revaluation was 30 November 20.13.
If the land and buildings were measured using the cost model, the carrying amounts would be as
follows:
20.13 20.12
R’000 R’000
Cost 11 778 9 933
Accumulated impairment losses (187) –
Net carrying amount 11 591 9 933
Land with a carrying amount of R4 805 000 (20.12: R305 000) is subject to a first charge to secure
two of the Group’s bank loans.
9.12 Comprehensive example of cost model

The following is an extract from the fixed asset register of Impala Ltd on 31 December 20.12:
Accumulated Wear-and-tear
Asset type Date of purchase Cost Useful life
depreciation allowance
R R
Land 1 January 20.12 1 800 000 – – –
Buildings 1 January 20.12 2 500 000 125 000 20 years 2% straight-line
Vehicles 1 January 20.12 1 600 000 200 000 8 years 20% straight-line
Impala Ltd concluded the following asset transactions during the year:
Land with a cost of R400 000 was sold unexpectedly on 1 March 20.13 for R325 000.
A stand was purchased for R350 000. The stand is used as an owner-occupied property.
Improvements amounting to R135 000 were effected to buildings on 1 January 20.13.
A vehicle (original cost R160 000) was sold unexpectedly on 30 June 20.13 for R115 000.
The assets under consideration have no residual value and this situation will remain unchanged
until the end of the useful lives of the assets.
The manner in which assets are recovered is not expected to change.
On 1 January 20.13, Impala Ltd determined that the remaining useful life of the buildings was
25 years.
Assume a normal income tax rate of 28%.
Impala Ltd
Extract of Statement of financial position as at 31 December 20.13
Note R
Assets
Non-current assets
Deferred tax 4 94 836
Impala Ltd
Property, plant and equipment are shown at historical cost.
No depreciation is provided for on land.
Buildings and vehicles are depreciated according to the straight-line basis over their expected
remaining useful lives:
Buildings – 24 years
Vehicles – 6 years
Rates are considered appropriate to reduce carrying amounts of the assets to estimated residual
values (Rnil) over their expected useful lives.
Profit before tax is stated after taking the following items into account:
Expenses:
R
Loss on disposal of land (400 000 – 325 000) 75 000
Loss on disposal of vehicles 15 000
Depreciation 290 400
During the year, the remaining useful life of the buildings was revised. This resulted in a decrease
in depreciation in the current year of R31 705 and an increase in depreciation in the future of
R31 705.
Land Buildings Vehicles Total
R R R R
Carrying amount beginning of year 1 800 000 2 375 000 1 400 000 5 575 000
Cost 1 800 000 2 500 000 1 600 000 5 900 000
Accumulated depreciation – (125 000) (200 000) (325 000)
Movements for the year:
Disposals (400 000) – (130 000) (530 000)
Additions 350 000 135 000 – 485 000
Depreciation for the year – (100 400) (190 000) (290 400)
Carrying amount end of year 1 750 000 2 409 600 1 080 000 5 239 600
Cost 1 750 000 2 635 000 1 440 000 5 825 000
Accumulated depreciation – (225 400) (360 000) (585 400)
4. Deferred tax
R
Accelerated wear-and-tear for tax purposes [(122 700 × 28%) + (216 000 × 28%)] 94 836
Calculations
Historical Tax Temporary
cost base difference
R R R
Buildings
Cost 2 500 000 2 500 000 –
Accumulated depreciation/wear-and-tear (125 000) (50 000) (75 000)
Carrying amount 31 December 20.12 2 375 000 2 450 000 (75 000)
Additions 135 000 135 000 –
2 510 000 2 585 000 (75 000)
Depreciation/wear-and-tear 31 December 20.13
(2 510/25)/[(2 500 + 135) × 2%] (100 400) (52 700) (47 700)
Carrying amount 31 December 20.13 2 409 600 2 532 300 (122 700)
Vehicles
Cost 1 600 000 1 600 000 –
Accumulated depreciation/wear-and-tear (200 000) (320 000) 120 000
Carrying amount 31 December 20.12 1 400 000 1 280 000 120 000
Depreciation/wear-and-tear 30 June 20.13 (100 000) (160 000) 60 000
Carrying amount 30 June 20.13 1 300 000 1 120 000 180 000
Disposals (160/8 × 6,5); [160 – (160 × 20% × 1,5)] (130 000) (112 000) (18 000)
Depreciation/wear-and-tear 31 December 20.13 (90 000) (144 000) 54 000
Carrying amount 31 December 20.13 1 080 000 864 000 216 000
Depreciation – change in accounting estimate

Old method [(2 375 000 + 135 000)/19] = 132 105
New method = 100 400
Difference (132 105 – 100 400) = 31 705
CHAPTER
10
Employee benefits
(IAS 19; IFRIC 14 and FRG 3)
Contents
10.1 Overview of IAS 19 Employee Benefits ............................................................. 250
10.2 Background ....................................................................................................... 250
10.3 Short-term employee benefits ........................................................................... 251
10.3.1 Recognition and measurement ........................................................... 251
10.3.2 Disclosure ............................................................................................ 261
10.4 Post-employment benefits ................................................................................. 261
10.4.1 Types of post-employment benefit plans ............................................. 261
10.4.2 Defined contribution plans ................................................................... 261
10.4.3 Defined benefit plans ........................................................................... 262
10.4.4 Classification of post-employment benefit plans ................................. 262
10.4.5 Accounting for post-employment benefit plans ................................... 263
10.5 Other long-term employee benefits (IAS 19.153 to .158) .................................. 265
10.5.1 Recognition, measurement and disclosure ......................................... 266
10.6 Termination benefits (IAS 19.159 to .171)......................................................... 266
10.6.1 Recognition ......................................................................................... 266
10.6.2 Measurement ...................................................................................... 267
10.6.3 Disclosure ............................................................................................ 267
10.6.4 Tax implications ................................................................................... 267
10.7 Equity compensation benefits ........................................................................... 269
249
10.1 Overview of IAS 19 Employee Benefits

The following is a broad summary of IAS 19:
Employee benefits
Short-term Post- Other long-term Termination

employee employment employee benefits before
benefits benefits benefits retirement
Payable Benefits
Payable after Benefits at
within after
12 months termination
12 months retirement
Salaries and A: Defined Long-term Redundancy

wages, contribution jubilee benefits, payments
compensated plans absences,
absences, (provident funds) bonuses,
bonuses, P/L: In respect disability
other non-cash of employer’s benefits, etc P/L and SFP
benefits contribution. (liability if unpaid):
SFP: Liability if Payable within
contributions 12 months –
not paid apply
requirements
of short-term
B: Defined benefit employee
plans benefits.
(pension funds) Payable after
Not covered, refer 12 months –
to IAS 19) apply
requirements of
other long-term
employee
benefits
10.2 Background
Benefits provided in exchange for services rendered by employees whilst employed, as well
as benefits provided subsequent to employment, can take on many forms. Some
employment benefits even include benefits paid to either employees or their dependants. In
terms of IAS 19, these employee benefits can be classified into the following main categories:
short-term employee benefits;
post-employment benefits;
other long-term employee benefits; and
termination benefits.
Note that equity compensation benefits are dealt with in IFRS 2.
Because each category of employee benefit identified in terms of IAS 19 has different
characteristics, the Standard establishes separate requirements and accounting treatments
for each category. Consequently, the different categories are dealt with on an individual
basis in this chapter.
Employee benefits 251
10.3 Short-term employee benefits

Short-term employee benefits are employee benefits (other than termination benefits) that are
expected to be settled wholly within twelve months after the end of the annual reporting
period in which the employees rendered the related service, and include items, for example:
wages, salaries and social security contributions;
paid annual leave and paid sick leave;
profit-sharing and bonuses; and
non-monetary benefits (e.g. medical care, housing, cars and free or subsidised goods or
services) for employees currently employed by the entity.
The definition of short-term employee benefits requires that only benefits expected to be
settled wholly within twelve months after the end of the annual reporting period be classified
as such. The Standard does not specify what is meant by the term ‘wholly’, i.e whether it
applies to an individual employee or to the the total benefit for all employees. The authors
are of the opinion that it should reflect the characteristics of the benefits, therefore
classifying the benefit as a whole.
An entity does not need to reclassify short-term employee benefits if the timing of the
settlement of the benefits changes temporarily. However, if the characteristics of the
benefits change or the change in the expected timing of the settlement of the benefits is not
temporary, the entity must consider whether the benefits still meet the definition of short-
term benefits. They will most probably be classified as ‘other long-term benefits’. Refer to
section 10.6 for a discussion of other long-term employee benefits.
Accounting for short-term employee benefits is generally straightforward because no actuarial
assumptions are required to measure the obligation or the cost and there is no possibility of
any actuarial gain or loss. In addition, short-term employee benefits are measured on an
undiscounted basis.
10.3.1 Recognition and measurement

10.3.1.1 All short-term employee benefits
When an employee has rendered services to an entity during an accounting period (e.g. in
exchange for a salary), the entity must recognise the undiscounted amount of short-term
employee benefits expected to be paid in exchange for those services by raising an expense
together with a corresponding decrease in an asset or increase in a liability (accrued
expense). Therefore normal accrual accounting applies. An expense should be raised
unless another Standard requires or permits the inclusion of the benefits in the cost of the
asset – see, for example, IAS 2 Inventories, paragraphs 10 to 22 and IAS 16 Property, Plant
and Equipment, paragraphs 15 to 28.
Example 10.
10.1 Salary and the employee’s cost to company
Mr Salary is an employee in the employ of Entity X. The following is the salary slip of Mr Salary for
July 20.13:
R
Gross salary 10 000
Provident fund contribution (750)
Medical aid fund contribution (900)
Unemployment insurance fund contribution (100)
Employee tax (2 000)
Net salary paid over to Mr Salary 6 250
continued
Entity X contributes the same amount as the employee to the provident fund, medical aid fund and
unemployment insurance fund.
R
Contributions by Entity X
Provident fund contribution 750
Medical aid fund contribution 900
Unemployment insurance fund contribution 100
The journal entry to account for the salary of Mr Salary and the payment thereof is the following:
Dr Cr
R R
Short-term employee benefit cost (P/L) 10 000
Provident fund – payable (SFP) 750
Medical aid fund – payable (SFP) 900
SARS – payable (SFP) 2 000
Unemployment insurance fund – payable (SFP) 100
Salary due to employee (SFP) 6 250
Create obligations for amounts deducted from gross salary by Entity X,
before the net salary is paid to Mr Salary
Short-term employee benefit cost (P/L) 1 750
Provident fund – payable (SFP) 750
Medical aid fund – payable (SFP) 900
Recognise employer’s contributions in respect of sundry items
of Mr Salary for the month
Provident fund – payable (SFP) 1 500
Medical aid fund – payable (SFP) 1 800
SARS – payable (SFP) 2 000
Salary due to employee (SFP) 6 250
Bank (SFP) 11 750
Pay salary and deductions and contributions by employer over to relevant
creditors
For Entity X, the total cost to have Mr Salary in its employment for the above month would be
R
Gross salary (includes net salary and all deductions) 10 000
Contributions by Entity X
Medical aid fund contribution 900
Provident fund contribution 750
Unemployment insurance fund contribution 100
Employee benefit cost for company 11 750
Comment
¾ Several methods exist to account for the above, but only one is illustrated here.
¾ The fact that Mr Salary’s salary is utilised to pay contributions to funds and tax will not change
the fact that Entity X still pays him a gross salary of R10 000. The deductions funded by the
employee therefore do not influence Mr Salary’s gross salary.
¾ The employer’s contributions to the respective funds increase the total cost related to the
services of the employee to above his gross salary – the R11 750 is often referred to as ‘cost to
company’.
Example 10.
10.2 Short-term employee benefits
Wimble Ltd pays over salaries to employees on the first working day of each calendar month. The
company’s reporting period ends on 31 December. The total salary bill for December 20.13
amounted to R100 000, and this amount will be paid over on 2 January 20.14. The journal entry as
at 31 December 20.13, to account for the above, will be as follows:
Dr Cr
R R
31 December 20.13
Short-term employee benefit costs (P/L)# 100 000
Accrued expenses (SFP) 100 000
Accrual of salary cost at year end
If, for some reason, say R20 000 of the R100 000 was paid over on 30 December 20.13 (i.e.
before 31 December 20.13), the journal entries up to 31 December 20.13 would be as follows:
Dr Cr
R R
31 December 20.13
Short-term employee benefit costs (P/L)# 20 000
Bank (SFP) 20 000
Payment of salary cost
Dr Cr
R R
Short-term employee benefit costs (P/L) 80 000
Accrued expenses (SFP) *80 000
Accrual of salary cost at year end
In the case of accrued salary expenses, the expense will be allowed for tax purposes in terms of
section 11(a) of the Income Tax Act 58 of 1962, because the expenditure is actually incurred and
the entity has an obligation to pay the salaries. The deferred tax on the accrued expense will thus
be Rnil. This is calculated by comparing the carrying amount of the accrued expense, amounting
to R100 000, with the tax base of the liability, being R100 000. The tax base is calculated as
follows: Carrying amount R100 000 – Rnil (nothing will be deductible in future).
* (100 000 – 20 000 already paid).
#
Note that this amount need not necessarily be expensed, but can also be capitalised to the cost
of an asset, provided that this is required or permitted in terms of International Financial
Reporting Standards (e.g. IAS 2 and IAS 16).
The issue of recognising non-monetary benefits such as the use of a motor vehicle is
problematic. The question is whether the related costs if the underlying asset should be
treated as employee benefits or as expenses by nature such as depreciation, maintenance,
insurance and fuel. There is a strong argument that when sush a vehicle is used for private
use of an employee that portion of the expenses should rather be recognised as employee
benefits.
In the event of short-term compensated absences, profit-sharing and bonus plans, the basic
rules on short-term employee benefits may require slight modifications to ensure proper
application.
10.3.1.2 Short-term compensated absences
Short-term compensated absences refer to annual or other leave and can be classified as
either:
accumulating compensated absences (leave); or
non-accumulating compensated absences (leave).
Accumulating compensated absences are compensated absences that can be carried for-
ward to future periods if the entitlement of the current period is not used in full. For example,
ten days’ paid annual leave (accumulating) not utilised in full in the current year can be carried
forward to the next year and utilised then.
Non-accumulating compensated absences do not carry forward, and on the basis of the
information in the above example, it means that the 10 days accumulated annual leave from
the current year will lapse at the end of the current year and cannot be utilised in the follow-
ing year.
Accumulating compensated absences may be classified as vesting and non-vesting. Vesting
benefits are benefits where employees are entitled to a cash payment upon leaving the entity.
Non-vesting benefits are benefits where employees are not entitled to a cash payment upon
leaving the entity.
When accounting for accumulating compensated absences (leave), the expected cost of the
benefit should be recognised when the employees render service that increases their entitle-
ment to future compensated absences. The amount is measured as the additional amount
an entity expects to pay as a result of the unused entitlement that has accumulated at the
reporting date. The basic formula to calculate this would be:
Amount = Expected number of days’ leave that might be taken/paid

out in future years × tariff per day
Note that the basic formula presented above distinguishes between days’ leave to be taken
and days’ leave to be paid out. Depending on which of the two options the employer believes
would arise, the tariff used to measure the leave pay accrual would differ. A combination of
the two options would also be possible.
If the employer expects employees to have all accumulated leave paid out in cash, the
employer will use a tariff based on the gross basic salary of these employees to measure
the leave pay accrual (unless in rare circumstances the leave conditions specify something
else). However, if the employees are expected to be absent during the leave days (i.e.
take leave/take time off), the tariff used to measure the leave pay accrual will be based on
the cost to company amount for employees – this would be the basic gross salary plus the
additional contributions paid by the employer. This is the case because the employer will still
be required to make contributions to the pension fund, medical aid fund, etc during the
absence of the employees.
Example 10.
10.3 Recognition and utilisation of leave
Bat Ltd, with a year end of 31 December 20.14, has an employee that earns R240 000 per annum
(R20 000 per month). The employee is entitled to one calendar month’s leave. Assume that the
employee will take leave for the the whole of December 20.14.
The journal entry for each month from January to November 20.14 will be as follows:
Dr Cr
R R
January to November 20.14
Short term employee benefits expense (P/L) (240 000/11) 21 818
Leave pay accrual (SFP) 1 818
Bank/Liabilty (SFP) 20 000
Recognition of employee benefits with leave accrual for each month.
December 20.14
Bank/Liability (SFP) 20 000
Recognition of salary while on leave
continued
The leave pay accrual is recognised while the employee delivers services to the entity. Therefore
R1 818 is recognised as an expense on a monthly basis. When leave is taken in December 20.14
the salary will be debited to leave pay accrual and not expenses, as the employee did not deliver
any services in December 20.14.
It should be noted that in most instances in practice, the leave pay accrual is only adjusted at year
end and not on a monthly basis.
Example 10.
10.4 Vesting short-term accumulated compensated absences
At the beginning of 20.13, Entity X permanently employed one employee, namely Mr Y. Mr Y

received a gross salary of R295 000 per year (cost to company is R350 000), and is entitled to
20 working days’ leave a year. This leave benefit can be carried forward to the next year if not
utilised in the current year, but any untaken leave must be paid out in cash if Mr Y leaves the
employment of the entity. Assume that there are 261 working days in a year and that the company
expects Mr Y to take all leave days due in the following year. All leave payments are therefore
correctly classified as short-term employee benefits.
Since Mr Y’s leave can be carried forward to the next year, it is accumulating in nature. The fact that
it must be paid out when he leaves the employ of Entity X illustrates the fact that the leave vests.
Case 1: Mr Y takes no holiday leave for the year ended 31 December 20.13
Mr Y will receive his full gross salary and the employer contributions will continue during his
absence. The aggregated journal entry to account for this would be the following:
Dr Cr
R R

Bank (SFP) 350 000
Recognise the total salary cost of Mr Y as an expense for the year
Should the company expect Mr Y to utilise his accumulated leave in 20.14.
The fact that Mr Y did not utilise his leave during 20.13, but plans to take it in 20.14, means that an
accrual for leave pay should be created for the leave to be carried forward to the next year
(20.14). Since it is expected that Mr Y will take all his leave, his cost to company amount
(R380 550 – assume a salary increase of 8,7286% for 20.14) should be used to determine the
tariff to accrue leave pay. The journal entry to create the accrual is the following:
Dr Cr
R R
Accrual for leave pay (SFP) (380 550/261 × 20) 29 161
Recognise the accrued leave pay of Mr Y for the year
The effect of the second journal entry is that the employee benefit cost of 20.14 would increase, as
Mr Y did not use his annual leave but earned it through service. It is therefore carried forward to
the next year.
Comment
Comment
¾ From an accounting perspective, the additional expense relates to the additional revenue
generated by the fact that Mr Y did not take his leave in 20.13, and therefore worked during the
time when he should have taken leave.
¾ Mr Y’s gross annual salary is based on the assumption that he should only be present at work
for 241 of the 261 working days in a year. The accrued expense increases the employee benefit
cost, as Mr Y was present at work for 261 working days.
¾ When the leave of both the previous year and the current year (or part of it) is taken in a
following year (say 20.14), Mr Y will be present at work for less than 241 working days. The
accrued expense will reverse, as leave is taken, and the employee benefit cost for the year will
be reduced accordingly. The accrued leave pay that would arise during 20.14 will increase the
employee benefit cost in respect of the period of leave not taken by the employee.
continued
Should the company expect Mr Y to have all accumulated leave days paid out in cash:
A tariff based on the gross basic salary of Mr Y should be used to measure the leave pay
accrual (unless in rare circumstances the leave conditions specify something else). The journals
should be as follows.
Dr Cr
R R
Bank (SFP) 350 000
Recognise the total salary cost of Mr Y as expense for the year
– similar to Case 1.
Accrual for leave pay (SFP) (295 000/261 × 20) 22 605
Recognise the accrued leave pay of Mr Y for the year – Gross salary
should be used as discussed to calculate the leave pay provision.
Case 2: Continue to assume that the salary increase for 20.14 is 8,7286%. 50% of the
accumulated leave for 20.14, as well as the full amount of annual leave accumulated during
20.13, is taken in 20.14.
Assume, in this case, that Mr Y takes his full accumulated leave of 20.13 as well as 50% of his
leave for the current year in the 20.14 financial year. It is company policy to first use the accrued
leave pay from the previous year before utilising the accrued leave pay for the current year (FIFO).
The aggregated journal entry to account for the above is as follows:
Dr Cr
R R
Bank (SFP) 380 550
Recognise the gross salary cost of Mr Y as an expense for the year
Assuming the company expects a salary increase of 10% in 20.15 (R418 605 = 380 550 × 1,1),
the closing balance of the accrued leave pay that arose in 20.14 will therefore amount to R16 039
[418 605/261 × 10] at the end of 20.14, and the whole accrued leave pay expense of 20.13 will
reverse.
Dr Cr
R R
Accrual for leave pay (SFP) 29 161
Write back leave pay accrual for 20.13 in 20.14
Short-term employee benefit costs (P/L)
[418 605/261 × 20] × 50% 16 039
Accrual for leave pay (SFP) 16 039
Recognise the remaining accrued leave pay of Mr Y for 20.14
not utilised in the current year (20.14)
Comment
¾ The total employee benefit cost for 20.14 would be R367 428 , namely R380 550 – R29 161 +
R16 039
In the case of vesting benefits, the total amount of the benefits should generally be raised as
a liability. The fact that accumulating compensated absences may be non-vesting does not
affect the recognition of the related obligation, but measurement of the obligation should
also take into account the possibility that employees could leave before using an
accumulated non-vesting entitlement.
The above is presented as follows:

Short-term compensated absences
Accumulating short-term Non-accumulating short-term

compensated absences compensated absences
Employee not entitled

Vesting Non-vesting to cash payment on
leaving the entity
Employee Employee not Recognise only if

entitled to cash entitled to cash leave will be taken
payment upon payment upon in current leave
leaving the entity leaving the entity cycle
Raise amount
Raise entire that will probably
liability be ‘paid’ if leave
is taken
Since, per definition, the liability amount for accumulating short-term compensated absences
is due for settlement within 12 months after the end of the annual reporting period in which
the services were rendered, it is always classified as a current liability.
Example10
Example10.
10.5 Non-vesting paid annual leave and related liabilities
Strike Ltd has 50 employees, who are each entitled to 10 working days’ non-vesting paid annual
leave for each completed year of service. Unused paid annual leave may be carried forward for
one calendar year. Paid annual leave is first taken out of the previous year’s entitlement, and then
out of the current year’s entitlement (first-in, first-out-basis). At 31 December 20.13, the average
unused entitlement is four days per employee. Based on past experience, the entity expects that
41 employees will take 10 days’ paid annual leave in 20.14, and that the remaining nine
employees will each take an average of 14 days’ paid leave each. Assume the average daily pay
rate per employee to be used in the calculation is R60, and that 10% (i.e. 4) of the 41 employees
will resign during 20.14 before taking their leave.
Depending on the circumstances, the above case will lead to the following liabilities being raised
(see journals) at 31 December 20.13 if FIFO or LIFO principles are applied:
FIFO: As 90% of the 41 and 100% of the nine employees are expected to utilise (using FIFO)
the four days’ entitlement per employee as at 31 December 20.13, the following leave pay
liability should be raised:
4 days × R60/day × (41 – 4 (10%) + 9) employees = R11 040
Dr Cr
R R
Accrued leave pay (SFP) 11 040
Accrual for leave pay using FIFO principles
continued
LIFO: If paid annual leave was taken first from the current year’s (20.14) entitlement (LIFO
utilisation), the liability to be raised will be much less, as only employees taking more leave
than the current year’s allocation will give rise to a liability in respect of paid annual leave. The
following leave pay liability would then be raised:
4 days × R60/day × 9 employees = R2 160.
Dr Cr
R R
Accrual for leave pay using LIFO principles
If the unused leave pay can be carried forward indefinitely with a cash payment on resignation
for any unused days (a vesting benefit),the liability raised would be the following:
(41 + 9) × R60/day × 4 days = R12 000.
Dr Cr
R R
Accrual for leave pay – vesting benefit
Non-accumulating compensated absences do not carry forward, but lapse if not utilised in
the current year. These benefits do not entitle employees to a cash payment upon leaving the
entity. Common examples of these compensated absences include maternity leave, paternity
leave and compensated absences for military service. An entity recognises no liability or
expense until the time of such absence, as employee service does not increase the amount
of the benefit.
10.3.1.3 Profit-sharing and bonus plans
Although the recognition of the expected cost of profit-sharing and bonus payments is
similar to that associated with other short-term employee benefits, IAS 19.19 introduces two
additional criteria that should be met before recognition may take place, namely:
the entity should have a present legal or constructive obligation to make such payments
as a result of past events; and
a reliable estimate of the obligations should be possible.
The difference between a legal and a constructive obligation may be illustrated by using a
bonus payment to illustrate both instances. Should an employee be entitled to a thirteenth
cheque in terms of his contract of employment, this would constitute a legal obligation.
However, should the contract of employment not mention a thirteenth cheque, but the entity has
an established practice of paying thirteenth cheques over several years in the past, the latter
would constitute a constructive obligation. The entity has no realistic alternative but to make
the payment.
A reliable estimate of the expense associated with the legal or constructive obligation under a
profit-sharing or bonus plan can be made, when and only when:
the formal terms of the plan contain a formula for determining the amount of the benefit;
and
the entity determines the amounts to be paid before the financial statements are authorised
for issue; or
past practice gives clear evidence of the amount of the entity’s constructive obligation.
Some profit-sharing plans require employees to remain in the entity’s service for a specified
period in order to receive a share of the profit. Such plans result in a constructive obligation,
as employees render service that increases the amount payable if they remain in service
until the end of the specified period.
If profit-sharing and bonus plans are not wholly payable within twelve months after the
end of the annual reporting period during which the employees render the related service,
the amounts are classified as other long-term employee benefits.
Should profit-sharing and bonus payments meet the definition of ‘share-based payments’ (i.e.
be paid by issuing shares or amounts determined by reference to share prices), they should
be accounted for in terms of IFRS 2 (refer to chapter 18).
Both other long-term employee benefits and equity compensation benefits are discussed in
detail later in this chapter.
Example 10.
10.6 Short-term employee benefits and bonus plans
Shoppers Ltd is a supermarket in Pretoria with a 31 December 20.13 reporting date. The company
currently has 30 staff members of whom 18 are packers/cleaners, 10 are administrative and sales
personnel, and two are managers.
The basic salaries (excluding the bonuses) of the employees are as follows:
Basic salary per employee
Type of work
per year
R
Packers/cleaners 70 000
Administrative and sales personnel 120 000
Managers 220 000
Assume there are no increases expected in 20.14
The packers/cleaners and administrative personnel are each entitled to 20 working days’ paid
holiday leave per year, of which five days may be transferred to the next year. The leave carried
forward is not paid out if the employee leaves or retires. The managers are entitled to 25 working
days’ paid holiday leave per year, with no limit on transferring leave to subsequent years, which is
payable on resignation or retirement. All employees are entitled to 10 working days’ paid sick
leave per year that expires if not taken.
Experience (also i.r.o. 20.13) has indicated that packers/cleaners take, on average, 18 days of
ordinary leave per year; the administrative personnel take 14 days each, while the managers take
17 days each. On average, employees take four days of sick leave per year. Because of work
pressure, employees are expected to use only 60% of leave carried forward. Leave is taken on a
FIFO basis and it is assumed that leave will be taken within twelve months after the end of the
annual reporting period during which the employees rendered the related service.
Bonuses (cash) are paid at the end of December, and are calculated on the number of service
years per employee as follows:
Service years Benefit
1 to 5 years 100% of monthly basic salary
6 to 10 years 120% of monthly basic salary
More than 10 years 150% of monthly basic salary
The service years of the employees are as follows:
Packers/ Administrative and
Service years Managers
cleaners sales personnel
#
1 to 5 years *5 3 none
6 to 10 years 8 3 none
More than 10 years 5 4 2
18 10 2
* Including two workers who started working on 1 July 20.13, who are entitled to 50% of a year’s
allocation.
#
Including one worker who started working on 1 December 20.13, and is entitled to one twelfth of
a year’s allocation.
continued
Bonuses are thus paid pro rata if an employee has worked for less than a year. The three
employees who were employed during the current year took their full pro rata leave benefits.
Assume that a calendar year consists of 266 working days.
The short-term employee benefits of Shoppers Ltd for the year ended 31 December 20.13 are
Basic salaries R
Packers/cleaners: (16 × 70 000) + (2 × 70 000 × 6/12) 1 190 000
Administrative staff: (9 × 120 000) + (1 × 120 000 × 1/12) 1 090 000
Managers: (2 × 220 000) 440 000
2 720 000
Cumulative journal for 20.13
Dr Cr
R R
Short-term employee benefit costs (P/L) 2 720 000
Bank (SFP) 2 720 000
Payment of salaries and deductios
Bonuses
Packers/cleaners: (70 000/12 × 3) + (70 000/12 × 2 × 6/12) +
(70 000/12 × 1,2 × 8) + (70 000/12 × 1,5 × 5) 123 083
Administrative staff: (120 000/12 × 2) + (120 000/12 × 1/12 × 1) +
(120 000/12 × 1,2 × 3) + (120 000/12 × 1,5 × 4) 116 833
Managers: (220 000/12 × 1,5 × 2) 55 000
294 916
Journal raised at 31 December 20.13

Dr Cr
R R
Bank (SFP) (paid at the end of Dec) 294 916
Payment of bonuses
R
Leave (compensated absences)
Packers/cleaners: (70 000/266 × 2* × 16) × 60% 5 053
Administrative staff: (120 000/266 × 5# × 9) × 60% 12 180
Managers: (220 000/266 × 8$ × 2) 13 233
30 466
Journal raised at 31 December 20.13
Dr Cr
R R
Accrual for leave pay
* (20 – 18)
#
(20 – 14), but limited to 5
$
(25 – 17), but not limited
Comment
¾ Note that the managers’ leave pay accrual is based on their basic salary – this supports the
assumption that it will be paid out in total. However, if it is anticipated that only 50% will be paid
out and the rest will be taken as days absent, the calculation will be based partly on basic
salary and partly on basic salary plus employer’s contribution (refer to section 10.3.1.2).
10.3.2 Disclosure
IAS 19.25 does not require specific disclosures in respect of short-term employee benefits.
However, other Standards, for example IAS 1, do require the following specific disclosures:
IAS 1.104 requires the total amount of employee benefit expense to be disclosed either
on the face of the profit or loss section of the statement of profit or loss and other
comprehensive income, or in the notes to the financial statements. Presumably all short-
term employee benefits will form part of the aggregate amount for employee benefit
expense.
IAS 24 Related Party Disclosures requires the disclosure of employee benefits for key
management personnel.
10.4 Post-employment benefits

Post-employment benefits are employee benefits that are payable after the completion of
employment. These benefits can take many forms, but can broadly be classified into two
main categories, namely:
retirement benefits, for example pensions and payments from provident funds; and
other post-employment benefits, for example post-employment life insurance and
medical care.
10.4.1 Types of post-employment benefit plans
There are two categories of post-employment benefit plan alternatives that employers may
use, namely:
defined contribution plans (e.g. provident plans); and
defined benefit plans (e.g. pension plans).
The Pension Funds Act 24 of 1956 (as amended) (the Pension Funds Act), which regulates
most of these plans, provides for minimum funding requirements for these plans, and
prescribes the valuation methods and the frequency of valuation. Defined contribution plans
are discussed below, while defined benefit plans are discussed in section 10.4.3.
10.4.2 Defined contribution plans

10.4.2.1 Background
Defined contribution plans are post-employment benefit plans under which amounts to be
paid to employees as retirement benefits are determined by reference to cumulative total
contributions to a fund (by both employer and employee) together with investment earnings
thereon. The liability (legal or constructive obligation) of the employer is limited to the agreed
amount (contributions) to be paid to the separate fund (funded plan) to provide for the
payment of post-employment benefits to employees. Most provident funds fall into this category.
A record is maintained by the fund of the contributions (by employee and employer) each
member makes to the fund, as well as the investment earnings thereon. The ultimate
benefits payable to the members will not exceed the contributions made by and on behalf of
the members and the investment earnings generated by these contributions.
10.4.2.2 Risk
In view of the above, the risk that benefits will be less than expected (actuarial risk) and the
risk that the assets invested in will be insufficient to meet expected benefits (investment risk)
fall on the employee.
10.4.2.3 Premiums on an insurance policy
Note that where premiums on an insurance policy are paid to fund a post-employment
benefit obligation, such a plan will generally represent a defined contribution plan (refer to
IAS 19.46).
Contributions to an insurance policy in the name of a specific employee or group of

employees, in accordance with which the insurer has to pay certain benefits to employees,
also represent defined contributions. If, in rare circumstances, the employer retains an
additional legal or constructive obligation, such a plan shall be treated as a defined benefit
plan (see section 10.4.3. below).
10.4.3 Defined benefit plans

10.4.3.1 Background
Defined benefit plans are post-employment benefit plans under which amounts to be paid as
retirement benefits to current and retired employees are determined using a formula usually
based on employees’ remuneration and/or years of service. This implies that a benefit that is
to be paid to an employee is determined before the employee retires – the employer promises
a benefit based on a formula. For instance, a pension (defined benefit plan) is promised to
an employee based on the employee’s future salary at retirement date, as well as the
number of years in the employment of the employer. Another example is the promise to pay
medical aid contributions on behalf of the employee after retirement.
An entity should account for both its legal obligation under the formal terms of a defined
benefit plan, and its constructive obligation resulting from its past practices.
The obligation of the entity is to provide agreed benefits to its current and former
employees once they retire. Given the number of variables impacting on the final or average
remuneration of an employee – inflation, salary increases, working life, promotions, timing of
promotions, etc. – it is obvious that it will prove quite difficult to determine such an
obligation.
To finance and fund the benefits agreed upon, the entity uses assets set aside for this
purpose from contributions by the employer and employees, plus the investment returns on
those accumulated contributions (in aggregate called plan assets). These plan assets do
not stand to the ‘credit’ of any specific member of the plan (unlike defined contribution
plans), and the benefits that a member receives are also not related to these contributions.
Pension funds generally fall into this category.
10.4.3.2 Components of a defined benefit plan
As can be seen from the above discussion, a defined benefit plan comprises:
a defined benefit obligation (promised benefit owing); and
plan assets (assets used to service or fund the above obligation).
Note that the fair value of the plan assets theoretically represents the present value of the
expected future benefits from these assets. By contrast, the obligation to pay benefits in the
future represents a future obligation. To ensure that these two amounts are comparable, the
future obligation is discounted to present value.
This present value of the obligation arising from the future expected retirement benefits is
determined actuarially on a periodic basis. Actuarial valuations are also used to determine
future contribution levels. Any actuarial variances are accounted for in other comprehensive
income.
10.4.3.3 Risk
Both the risk that benefits will cost more than expected (actuarial risk) and the risk that assets
invested will be insufficient to meet expected benefits (investment risk) fall on the employer.
This is the opposite of a defined contribution plan (refer to section 10.4.2.2 above).
10.4.4 Classification of post-employment benefit plans

In practice, the classification of post-employment benefit plans can be difficult. For example,
the plan may prescribe the extent of contributions on which retirement benefits are based,
while the entity may still be liable for a minimum level of retirement benefits. Such a
retirement benefit plan has characteristics of both a defined contribution plan and a defined
benefit plan. The deciding factor for classification as a defined contribution plan is that the
employer only has an obligation to make a contribution to the plan, while, in the case of a
defined benefit plan, the employer has an obligation to provide a certain benefit to the
pensioner.
In IAS 19.32 to .45, the distinction between defined contribution plans and defined benefit
plans (in the context of multi-employer plans, state plans and insured benefits) is discussed
at some length.
Classification should be effected using the principle of substance over form. The
substance of the retirement plan is established by reference to the main terms and
contingents. In the main, it is necessary to determine whether the entity has an obligation in
terms of formal or informal arrangements to provide retirement benefits. Should an
obligation exist, the plan is classified as a defined benefit plan. If the obligation of the entity
is limited to specified contributions to the plan, it is a defined contribution plan.
10.4.5 Accounting for post-employment benefit plans

10.4.5.1 Defined contribution plans
Accounting for defined contribution plans is straight forward, as the obligation of the
reporting entity for each period is determined by the amounts to be contributed for that
period. No actuarial valuation of the obligation or the associated expense is necessary, and
the obligations are accounted for on an undiscounted basis, unless they do not fall due
within twelve months after the end of the annual reporting period during which the
employees render the service involved.
Recognition and measurement

Should an employee have rendered a service to an entity during a specific period, the entity
should recognise the contribution payable to the defined contribution fund in exchange for
the service as follows:
A liability (accrued expense) should be raised after deducting any contribution already paid,
and at the same time a corresponding expense should be raised. Note that the expense will
only represent the employer’s contribution to the defined contribution plan. Under certain
circumstances, the expense could be capitalised to the cost of an asset, provided this is
permitted or required in terms of another accounting standard. Note that, should the
contribution paid exceed the contribution due for services rendered at the reporting date,
the excess should be recognised as a pre-paid expense. Normal accrual accounting is
therefore applied.
Should contributions to a defined contribution plan not fall due wholly within twelve months
after the end of the annual reporting period during which the service was rendered, the
contributions should be discounted to present value using the discount rate discussed later
on in this chapter (refer to IAS 19.83).
Disclosure
An entity shall disclose the amount recognised as an expense for defined contribution
plans in the note on profit before tax.
Where required in terms of IAS 24 Related Party Disclosures an entity discloses
information on contributions to defined contribution plans made for key management
personnel.
Example 10.
10.7 Defined contribution plans
Bledo Ltd paid the following in respect of staff costs during the year ended 31 December 20.13:
R
Salaries (gross) 11 000 000
Wages (gross) 9 000 000
Contributions to defined contribution plan paid over 2 500 000
The rules of the defined contribution plan determine the following in respect of contributions:
Contribution by employer = 10% of total remuneration paid to employees.
Contribution by employee* = 9% of total remuneration paid to employees.
* The employer and employee usually make the same contribution, but this may not necessarily
be the case in practice.
The disclosure resulting from the above will be as follows:
2 Profit before tax
R
Employee benefit expense: 22 000 000
Short-term employee benefit costs: Salaries and wages# 20 000 000
Defined contribution plan expense *2 000 000
#
The employee’s contribution forms part of the gross salary expense, as it is paid over by the
employer on behalf of the employee.
* R(11 000 000 + 9 000 000) × 10% = R2 000 000.
Journal entries
Dr Cr
1 January to 31 December 20.13 R R
Short-term employee benefit costs (P/L) 20 000 000
Bank (SFP) (net of deduction for employee contributions at 9%) 18 200 000
Accrued expenses – contributions to plan (SFP) 1 800 000
Accrued contribution of the employees
Defined contribution plan expense (P/L) (employer) 2 000 000
Accrued expenses – contributions to plan (SFP) 2 000 000
Accrued contribution of the employer
Accrued expenses (SFP) 2 500 000
Bank (SFP) 2 500 000
Contributions paid over to the plan during the year
10 January 20.14
Accrued expenses (SFP)# 1 300 000
Bank (SFP) 1 300 000
Balance of the accrued contributions paid over to the plan
# Note that of the total amount of R1 300 000 paid over to the fund on 10 January 20.14, is
calculated as follows: 1 800 000 + 2 000 000 – 2 500 000 = R1 300 000. This amount would be
reflected as a liability in the statement of financial position at 31 December 20.13.
10.4.5.2 Defined benefit plans

Recognition, measurement and disclosure
The recognition, measurement and disclosure of defined benefit plans are not covered in
this text book. Refer to IAS 19 for further detail.
10.4.5.3 Tax implications of post-employment benefit plans

An employer may, in terms of section 11(l) of the Income Tax Act (as amended), deduct
contributions made for the benefit of employees to pension, provident and benefit funds,
subject to the following provisos:
If the contribution is a lump-sum payment, the South African Revenue Services (SARS)
may allow the deduction in annual instalments in the proportion he deems acceptable.
If the contributions (including any lump sum) per employee exceed 10% of the approved
remuneration (for remuneration SARS considers to be fair and reasonable in relation to
the value of the employee’s services), SARS may disallow the excess above the 10%
mentioned earlier. Any disallowed excess will fall away, but the SARS must allow at least
10% of the approved remuneration and has the discretion to allow more than 10%.
In practice, SARS allows the employer a deduction of up to 20% of the approved
remuneration of the employee.
Section 11(l) of the Income Tax Act does not cover an employer’s contributions to a
retirement annuity fund on behalf of his employees, but will enable an employer to
determine the amounts deductible in future (tax base) for a defined benefit plan, provided
certain significant assumptions are made.
In terms of section 11(m) of the Income Tax Act, annuities paid to former employees,
dependants of former employees and former partners on retirement may be deducted for tax
purposes, subject to certain provisos and limits.
Generally speaking, an employer who pays a termination lump sum (a lump sum at
retirement) to a retiring employee will be allowed a tax deduction if all requirements of
section 11(a) of the Income Tax Act are met.
Great care should be exercised when making such termination lump-sum payments, as the
reason for the payment may affect the deductibility thereof. In short, three possible
situations exist in respect of termination lump sums:
If the lump sum is paid in terms of a service contract, it will be allowed as a deduction.
If the lump sum paid acts as an incentive for current staff, it will probably be allowed as a
deduction, following the principles laid down in Provider v COT 1950 (4) SA 289 (SR).
If the lump sum is paid in respect of past services (where the two situations mentioned
above are not applicable), the amount will not be allowed as a deduction, following the
principles expounded in WF Johnstone & Co Ltd v CIR 1951 (2) SA 283 (AD).
Defined contribution plans will generally not have deferred tax implications for the employer.
However, if certain amounts are not allowed as a tax deduction, but are allowed for
accounting purposes, non-deductible expenses may arise.
10.5 Other long-term employee benefits (IAS 19.153 to .158)

Other long-term employee benefits (other than post-employment benefits and termination
benefits) are employee benefits that are expected not to be settled wholly within twelve
months after the end of the annual reporting period during which the employees render the
related service. Post-employment benefits, termination benefits and equity compensation
benefits are excluded.
Examples of other long-term employee benefits are the following:
long-term compensated absences, for example long-service or sabbatical leave;
jubilee or other long-service benefits;
long-term disability benefits;
profit-sharing and bonuses; and
deferred compensation.
Due to the nature of other long-term employee benefits, measurement of these benefits is not
usually subject to the same degree of uncertainty as the measurement of post-employment
benefits. For these reasons, IAS 19 requires a simplified method of accounting for other
long-term employee benefits.
10.5.1 Recognition, measurement and disclosure

The recognition, measurement and disclosure of other long-term employee benefits are not
covered in this text book. Refer to IAS 19 for further detail.
10.6 Termination benefits (IAS 19.159 to .171)

Termination benefits are employee benefits payable as a result of either:
an entity’s decision to terminate an employee’s or group of employees’ employment
before normal retirement age; or
an employee’s decision to accept voluntary redundancy in exchange for those benefits.
Payments (or other benefits) made to employees when their employment is terminated may
result from legislation, contractual or other agreements with employees or their representatives,
or a constructive obligation based on past business practice, custom or a desire to act
equitably. Such termination benefits are typically lump-sum payments, but sometimes also
include:
enhancements of retirement benefits or other post-employment benefits, either directly or
indirectly through an employee benefit plan; and
salaries until the end of a specified notice period, if the employees render no further
service that provides economic benefits to the entity.
Benefits paid (or other benefits provided) to employees, regardless of the reason for the
employee’s departure, are not termination benefits. These benefits are post-employment
benefits, and, although payment of such benefits is certain, the timing of their payment is
uncertain.
IAS 19 deals with termination benefits separately from other employee benefits, as the event
which gives rise to an obligation here is the termination, rather than employee service.
10.6.1 Recognition
An entity shall, in terms of IAS 19.165, recognise termination benefits as a liability and a
corresponding expense at the earlier of the following dates:
when the entity can no longer withdraw the offer of those benefits; or
when the entity recognises costs for a restructuring that is within the scope of IAS 37
Provisions, Contingent Liabilities and Contingent Assets and involves the payment of
termination benefits.
An entity can no longer withdraw an offer for termination benefits at the earlier of the date on
which the employees accept the offer, or when a restriction (legal, regulatory or contractual)
on the entity’s ability to withdraw the offer takes effect. If an entity decides to terminate
employees’ employment, the entity can no longer withdraw its offer for termination benefits
when the entity has communicated its termination plan to all affected employees. This
termination plan must meet the following criteria:
the actions required to complete the plan must indicate that it is unlikely that significant
changes to the plan will be made;
the plan must indicate the following:
– the number of employees whose services are to be terminated;
– their job classifications or functions; and
– their locations (each individual affected does not need to be identified in the plan);
the time at which the plan will be implemented; and

the termination benefits that employees will receive in sufficient detail that employees are
able to determine the type and amount of benefits they will receive when the
employment is terminated.
Due to the nature and origin of termination benefits, an entity may have to account for a plan
amendment or curtailment of other employee benefits at the same time.
10.6.2 Measurement
Termination benefits are measured on initial recognition and if they are expected to be
wholly settled within twelve months after the end of the annual reporting period in which they
are recognised, the requirements for short-term employee benefits must be applied. If the
benefit is expected not to be settled wholly within twelve months after the end of the annual
reporting period in which it is recognised, the requirements for other long-term employee
benefits must be applied.
In the case of an offer made to encourage voluntary redundancy, the measurement of
termination benefits shall be based on the number of employees expected to accept the
offer. Where there is uncertainty about the number of employees who will accept an offer of
termination benefits, a contingent liability exists.
10.6.3 Disclosure
No specific disclosure is required by IAS 19 itself, although the requirements of certain
other Standards may be applicable.
A contingency exists where there is uncertainty about the number of employees who will
accept an offer of termination benefits. As required by IAS 37 Provisions, Contingent
Liabilities and Contingent Assets, an entity discloses information about the contingency
unless the possibility of a loss is remote.
Termination benefits may result in an expense requiring disclosure as a separately
disclosable item in terms of IAS 1.86. This will be the case where the size, nature or
incidence of an expense is such that its disclosure is relevant to an explanation of the
performance of the entity for the period.
Where required by IAS 24 Related Party Disclosures, an entity discloses information
about termination benefits for key management personnel.
10.6.4 Tax implications

Termination benefits are deductible as expenses for accounting purposes, and it is probable
that SARS will be prepared to allow such payments for tax purposes, provided that the
retrenchment package complies with labour law/legislation. The fact that these expenses
may sometimes not be deductible for tax purposes arises, as it may be doubtful whether
such payments are incurred in the production of income.
It is useful to clarify the retrenchment packages with SARS beforehand. SARS will also
allow a deduction if benefits are paid in terms of a service contract, as such payments will
fall under section 11(a) of the Income Tax Act.
Example 10.
10.8 Tax implications of termination benefits
Termo Ltd decided in December 20.13 to restructure its workforce (which was immediately
communicated) in such a way that all employees of the age of 55, but below the age of 60 at the
reporting date, could retire immediately should they choose to do so. Employees of 60 years and
older, up to the age of 65 at the statement of financial position date, will be forced to retire
immediately, but will receive the post-employment benefits they would have been entitled to had
they retired at the age of 65. A directive on the matter was obtained from SARS beforehand, and
amounts will therefore be allowed for tax purposes. Assume a tax rate of 28%. Payment of any
benefits associated with early or voluntary retirement will take place one week after the statement
of financial position date (end of the reporting period). The following information relates:
Employees between 55 years and 59 years and 364 days:
Total number of employees in age bracket 40
Average payment per employee to encourage retirement R20 000
Percentage of employees expected to take advantage of the offer 60%
Employees with ages between 60 and 64 years and 364 days:
Total number of employees 20
Additional contribution to defined contribution fund made on 7 January 20.14 to ensure
promised post-employment benefits as at 65 years of age R600 000
Journal entries
Dr Cr
R R
31 December 20.13
Termination benefits (P/L) (60% × 40 × R20 000) 480 000
Accrued termination benefits (SFP) 480 000
Accrual for expected number of employees taking voluntary packages
Termination benefits (P/L) 600 000
Defined contribution plan obligation(SFP) 600 000
Additional obligation in respect of defined contribution plan to account
for promised benefits
Provision for deferred tax at 28% of R1 080 000
Payment takes place on 7 January 20.14, and only 50% of the targeted employees
(between 55 years and 59 years and 364 days) decided to take voluntary retirement.
Dr Cr
R R
7 January 20.14
Accrued termination benefits (SFP) 480 000
Bank (40 × 50% × R20 000) 400 000
Termination benefits overprovided (P/L) 80 000
Payment of voluntary redundancy packages
Defined contribution plan obligation (SFP) 600 000
Bank (SFP) 600 000
Payment of additional contributions to defined contribution fund
continued
Disclosure at 31 December 20.13

The Standard does not require any specific disclosures, but if it is assumed that the total amount
paid/accrued in respect of termination benefits is material, classification and disclosure as a
separately disclosable item is necessary (provide nature and amount).
Profit before tax R
Employee benefit cost
Termination benefits 1 080 000
10.7 Equity compensation benefits

This matter is dealt with under IFRS 2, in chapter 18.
CHAPTER
11
The effects of changes in foreign
exchange rates
(IAS 21)
Content
11.1 Overview of IAS 21 The Effects of Changes in Foreign Exchange Rates......... 272
11.2 Background ....................................................................................................... 272
11.3 Exchange rate ................................................................................................... 272
11.4 Accounting implications ..................................................................................... 273
11.4.1 Presentation currency ....................................................................... 274
11.4.2 Functional currency ........................................................................... 274
11.5 Reporting foreign currency transactions in functional currency......................... 275
11.5.1 Monetary and non-monetary items ................................................... 275
11.5.2 Uncovered transactions .................................................................... 276
11.5.3 Tax implications of foreign currency transactions ............................. 282
11.6 Translation of financial statements into presentation currency ......................... 283
11.7 Foreign operations ............................................................................................ 283
11.7.1 Translation of a foreign operation for inclusion in the financial
statements of the reporting entity ...................................................... 283
11.7.2 Intragroup monetary items ................................................................ 285
11.7.3 Non-coterminous financial periods .................................................... 286
11.7.4 Revaluation of assets ........................................................................ 286
11.7.5 Goodwill............................................................................................. 287
11.7.6 Foreign exchange differences on a net investment in a foreign
operation ........................................................................................... 290
11.7.7 Disposal or partial disposal of a foreign operation ............................ 293
11.8 Disclosure .......................................................................................................... 296
271
11.1 Overview of IAS 21 The Effects of Changes in Foreign Exchange

Rates
Foreign exchange activities
Foreign currency transactions Translation of financial statements and

(IAS 21.20 to .34) foreign operations
(IAS 21.38 to .49)
Hedging of foreign Hedge of a net investment in a

currency transactions foreign operation
(IFRS 9.6.1 to .6.6) (IFRS 9.6.5.13 to .6.5.14 and IFRIC 16)
11.2 Background
The volatility in foreign currency exchange movements is a fairly general phenomenon in the
world economy. Changes in the value of currencies have specific accounting implications,
which are addressed in IAS 21 The Effects of Changes in Foreign Exchange Rates, and
other accounting standards. IAS 21 provides guidance on the translation of transactions in
foreign currencies and the presenting of financial statements in a foreign currency.
In South Africa, the South African Reserve Bank controls all foreign transactions. The
movement of foreign exchange to and from the country is subject to the regulations issued
periodically by the Reserve Bank.
11.3 Exchange rate

In terms of IAS 21.8, the functional currency is the currency of the primary economic
environment in which the entity operates. A foreign currency is a currency other than the
functional currency of the entity. The exchange rate is the ratio at which the currencies of
two countries are exchanged. This rate is quoted by commercial banks and can be one of
several rates, depending on the nature of the foreign currency transaction. For example, if
foreign currency is required to pay for an import, the foreign currency must be bought from a
bank. In these circumstances, the bank acts as the seller of foreign currency and therefore
the selling rate will be quoted. By contrast, if goods are exported and foreign currency is
received for the export, the bank acts as the buyer of foreign currency and the appropriate
rate of exchange quoted by the bank will be the buying rate.
The spot exchange rate is the exchange rate for immediate delivery of currencies to be
exchanged at a particular time. The closing rate is the spot exchange rate at the end of the
reporting period. (IAS 21.8) The forward rate is the exchange rate for the exchange of two
currencies at a future agreed date.
A hedge against unfavourable exchange rate fluctuations can be obtained by, inter alia,
concluding an agreement, called a forward exchange contract, with a bank, in which the
bank undertakes to supply the foreign exchange at a predetermined rate when the currency
is required. This rate is the forward rate, which is calculated by reference to the spot
exchange rate ruling at the time the forward exchange contract is entered into and the
interest rate differential existing between the two countries whose currencies are being
exchanged. The currency of the country having a lower interest rate will trade at a premium
while the currency of the country having a higher interest rate will trade at a discount. The
forward rate is therefore quoted as a premium or a discount to the spot exchange rate. For
example, if the USA dollar is quoted at a premium to the rand, it implies that the dollar is
more highly regarded by investors than the rand.
The effects of changes in foreign exchange rates 273
Example 11.1 Calculating the forward rate
Importer Ltd has an obligation to pay a USA debt after two months. The spot exchange rate is
US$1 = R7,00. The forward rate for two months is quoted at a premium of 60 points per month.
The forward rate is calculated as follows:
R
Spot exchange rate: 7,000
Add: Premium (two months) (60 points per month) (2 × 0,0060) 0,012
Forward rate 7,012
It is therefore determined that the exchange in two months’ time will take place at a rate of
US$1 = R7,012, regardless of the actual spot exchange rate at the end of two months. As a result,
both the risk of unfavourable exchange fluctuations and the possible benefit of favourable
exchange fluctuations have been eliminated for the entity.
Example 11.2 Calculating the forward rate
Assume that a local manufacturer needs US$500 000 in six months’ time to pay a USA debt. The
manufacturer wishes to protect itself against unfavourable exchange rate fluctuations, and
therefore requests a foreign exchange dealer to quote a forward rate for six months. The spot
exchange rate on the date of the request is US$1 = R7,00.
The foreign exchange dealer, who trades daily on foreign exchange markets, assesses (in terms
of the interest parity theory) the interest rate in the USA, with a view to finding the amount that
should be invested immediately in order to render, together with interest, US$500 000 in six
months’ time.
If the interest rate in the USA is 7,5% per annum, it can be calculated that US$481 928 at 7,5%
per annum will render US$500 000 after six months. When converted at the spot exchange rate of
US$1 = R7,00, US$481 928 × 7 = R3 373 496 is therefore required. If the South African interest
rate is 13% per annum, it means that (R3 373 496 × 13/100 × ½) + R3 373 496 = R3 592 773 will
be payable by the manufacturer after six months. The forward rate that will be quoted by the
foreign exchange dealer will be US$1 = R7,1855 (3 592 773/500 000).
Exchange rates can be quoted directly or indirectly. With the direct method the exchange
rate shows how much of the local currency has to be exchanged for one unit of the foreign
currency. For example, if one has to pay R12,50 to obtain one US dollar, the direct quotation
is $1 = R12,50. With the indirect method the exchange rate is expressed as the amount of
foreign currency that is required to purchase one unit of the domestic currency. In this
example the indirect quotation is thus R1 = $0,080.
11.4 Accounting implications

An entity can enter into foreign denominated activities in one of two ways:
By entering into foreign currency transactions directly. (In such a case, the foreign
currency transactions need to be converted to the functional currency of the entity); or
by conducting its foreign activities through a foreign operation, for example a subsidiary,
associate, joint arrangement or branch of the reporting entity. (In such a case, the foreign
operation will keep accounting records in its own functional currency, which, if different
from the presentation currency of the reporting entity, must be translated to the
presentation currency of the reporting entity.)
IAS 21 addresses the abovementioned situations, namely conversion of foreign currency
transactions to an entity’s functional currency and translation of the financial statements of a
foreign operation of an entity to the presentation currency of the reporting entity.
IAS 21 does not address the hedging of foreign currency transactions or the hedge of a net
investment in a foreign operation. These situations are addressed in IFRS 9, Financial
Instruments, and are dealt with in chapter 20.
SIC 7, Introduction of the Euro, addresses the introduction of the euro (̀ሻ and the change
from the use of national currencies by participating member states of the European Union,
and therefore does not apply to most South African companies.
11.4.1 Presentation currency

An entity’s presentation currency is the currency in which the financial statements are
presented (IAS 21.8). An entity may present its financial statements in any currency or
currencies (presentation currency) (IAS 21.19). For example, a South African company with
a primary listing on the JSE Limited and a secondary listing on the New York Stock
Exchange may present its financial statements in South African rand and USA dollar.
11.4.2 Functional currency

Functional currency is defined as the currency of the primary economic environment in
which an entity operates (IAS 21.8). An entity does not have a free choice of functional
currency, meaning that an entity has to determine its functional currency by applying the
principles in IAS 21.9 to .13.
IAS 21.9 lists primary indicators, while IAS 21.10 and .11 list secondary indicators that must
be considered in determining an entity’s functional currency. The primary indicators are
linked to the primary economic environment of the entity, while the secondary indicators
provide additional supporting evidence to determine an entity’s functional currency
(IAS 21.BC9). If it is evident from the primary indicators what an entity’s functional currency
is, there is no need to consider the secondary factors.
The primary economic environment in which an entity operates is normally the one in which
it primarily generates and expends cash. The following primary factors are considered when
determining the functional currency of an entity (IAS 21.9):
the currency that mainly influences sales prices for goods or services (normally the
currency in which the sales price for goods or services is denominated and settled);
the currency of the country whose competitive forces and regulations mainly determine
the sales price of its goods and services; and
the currency that mainly influences labour, material and other costs of providing goods or
services (normally the currency in which such costs are denominated and settled).
The following secondary factors may also provide evidence of an entity’s functional currency
(IAS 21.10):
the currency in which funds from financing activities, such as issuing debt and equity
instruments, are generated; and
the currency in which receipts from operating activities are usually retained.
In certain instances, determining the functional currency of an entity may be straightforward,
while in other instances judgement may be required to determine the functional currency
that most faithfully represents the economic effects of the underlying transactions, events
and conditions (IAS 21.12).
For example, a gold mining company will recognise all its sales in USA dollar, as gold is
denominated in international trade in USA dollar. The competitive forces of a single country
will also not necessarily influence the sales price of gold. If this company is in South Africa,
a significant part of its labour cost will be rand-based. Therefore, based on the primary
indicators alone it might be difficult to determine the functional currency. One will then also
need to consider the secondary indicators, for example whether the gold mining company
uses foreign financing and in which country its bank accounts are.
In a group context, IAS 21.17 determines that each entity in the group will determine its own
functional currency, based on the indicators in IAS 21.9 to .14 and considering the facts and
circumstances that are relevant to that individual entity. This process may result in an entity
in the group having a different functional currency to the reporting entity, or a functional
currency that is the same as that of the reporting entity. As a result, IAS 21 defines a foreign
operation as an entity that is a subsidiary, associate, joint arrangement or branch of a
reporting entity, the activities of which are based or conducted in a country or currency other
than those of the reporting entity.
In addition to the primary and secondary indicators discussed above, IAS 21.11 lists further
secondary indicators that must be considered in determining the functional currency of a
foreign operation, namely:
whether the activities of the foreign operation are carried out as an extension of the
reporting entity, rather than being carried out with a significant degree of autonomy;
whether transactions with the reporting entity are a high or low proportion of the foreign
operation’s activities;
whether cash flows from activities of the foreign operation directly affect the cash flows of
the reporting entity and are readily available for remittance to it; and
whether cash flows from the activities of the foreign operation are sufficient to service
existing and normally expected debt obligations without funds being made available by
Where a foreign operation carries on business as if it were an extension of the reporting
entity’s operations, the functional currency of the foreign operation will always be the same
as that of the reporting entity, as it will be contradictory in such a case if the two entities
were to operate in different primary economic environments (IAS 21.BC6).
It follows that it is not necessary to translate the results and financial position of a foreign
operation that has the same functional currency as the parent, as the transactions will
already be measured in the parent’s functional currency.
Once an entity has determined its functional currency, it is not changed unless there is a
change in the primary economic environment in which the entity operates its business
(IAS 21.13).
11.5 Reporting foreign currency transactions in functional currency

11.5.1 Monetary and non-monetary items
Monetary and non-monetary items must be clearly distinguished. A monetary item is defined
as units of currency held and assets and liabilities to be received or paid in a fixed or
determinable number of units of currency. The essential feature being a right to receive (or
an obligation to deliver) a fixed or determinable number of units of currency, All other assets
and liabilities are non-monetary items. The essential feauture in this case is the absence of
a right to receive (or an obligation to deliver) a fixed or determinable number of units of
currency.
The following are examples of monetary and non-monetary items (IAS 21.16):
Monetary items Non-monetary items
Pensions and other employee benefits to be Amounts prepaid for goods or services
paid in cash Goodwill
Provisions that are to be settled in cash Intangible assets
Lease liabilities Inventories
Cash dividends that are recognised as a liability Property, plant and equipment
A contract to receive (or deliver) a variable Right-of-use assets
number of the entity’s own equity instruments in Provisions that are to be settled by the
which the fair value to be received (or delivered) delivery of a non-monetary asset
equals a fixed number of units of currency
11.5.2 Uncovered transactions

A foreign currency transaction is a transaction that has been concluded or has to be settled
in a foreign currency. Examples of unhedged foreign currency transactions include the
following (IAS 21.20):
buying and selling of goods and services in a foreign currency;
borrowing and lending of funds in a foreign currency; and
the acquisition and disposal of assets and the incurring and settling of liabilities in a
foreign currency.
Uncovered foreign currency transactions are recorded on initial recognition in the functional
currency using the spot exchange rate ruling at the transaction date.
Two questions arise from the above:
which exchange rate must be used; and
what is the transaction date?
11.5.2.1 The exchange rate
Where foreign debt must be paid, currency must be purchased to repay such debt and the
selling rate of the bank applies. By contrast, where foreign currency will be collected, it must
be sold for South African currency and the buyer’s rate of the bank applies. The appropriate
exchange rate for accounting for such transactions must thus be determined from the
perspective of the bank. For practical reasons an average rate is usually applied. The spot
exchange rate is the rate specified at close of business on the transaction date and is
normally used. The closing rate is the spot exchange rate at close of business on the last
day of the financial year.
11.5.2.2 Transaction date
The date of the transaction is the date on which the transaction first qualifies for recognition
in terms of the accounting standards (IAS 21.22).
Where goods are delivered free on board (FOB) from the port of departure, the significant
risks and rewards associated with ownership are transferred to the buyer on delivery to the
port of departure. The purchaser pays for the shipping costs and insurance as well as the
price of the purchased items calculated according to the FOB price. If goods are dispatched
on a cost, insurance, freight (CIF) basis, the risks and rewards associated with ownership
still pass at the port of departure, but the seller arranges for the shipping of the items
involved. Although the terminology used differs, the risks and rewards associated with
ownership are transferred at point of shipment for both FOB and CIF sales. Should other
shipping terms be used, the transaction date may differ from the date of shipment. However,
the transaction date will still be the date on which the risks and rewards of ownership are
transferred to the purchaser.
From a practical viewpoint, an approximate rate for a specific date or an average rate for a
week, month or even a longer period may be used as a substitute for the actual rate, as long
as the exchange rate does not fluctuate significantly (IAS 21.22).
Once a non-monetary item has been recorded at a particular amount, the amount will not
subsequently change due to currency fluctuations, unless the non-monetary item is one that
is measured at fair value in terms of IFRS 13, Fair Value Measurement, after the date of
acquisition (IAS 21.23(c)). Then the date of valuation becomes the new transaction date.
If a foreign non-monetary item must be written down to net realisable value in terms of IAS 2
Inventories, or recoverable amount in terms of IAS 36 Impairment of Assets, the carrying
amount is determined by comparing:
the cost or carrying amount translated at the spot exchange rate on the transaction or
valuation date; and
the net realisable or recoverable amount translated at the spot exchange rate on the
reporting date when the value was determined (IAS 21.25).
The difference between the amounts is written-off in the functional currency. The effect of
this comparison may be that an impairment loss is recognised in the functional currency but
would not be recognised in the foreign currency, or vice versa.
Example
Example 11.3 Impairment of non-monetary foreign currency asset
On 15 June 20.13, a company acquired inventory for US$1 000. On that date, the exchange rate
was US$1 = R12,48. On 31 December 20.13, none of the inventory was sold but the net realisable
value was US$960.
On 31 December 20.13, the exchange rate was US$1 = R13,00.
The write-down to net realisable value is calculated as follows:
R
Net realisable value (US$960 × 13,00) 12 480
Carrying amount (US$1 000 × 12,48) (12 480)
Write-down to realisable value –
Therefore, even though a write-down to net realisable value of US$40 (US$1 000 – US$960)
exists in the foreign currency, such a write-down is not recognised in the functional currency as a
result of the impact of the foreign exchange rate.
11.5.2.3 Exchange rate differences

Where a foreign monetary item has not been paid at the reporting date, it will be converted
at the closing rate ruling on that date, and any differences are taken to the profit or loss
section of the statement of profit or loss and other comprehensive income (IAS 21.28).
Currency fluctuations after the reporting date are accounted for in accordance with IAS 10
Events after the Reporting Period.
If a foreign monetary item is settled prior to the reporting date, any difference that may arise
is taken to the profit or loss section of the statement of profit or loss and other
comprehensive income (IAS 21.28).
IAS 23.6 Borrowing Costs allows, under certain conditions, the capitalisation of foreign
exchange differences to the extent that it is regarded as an adjustment to interest costs
(refer to chapter 12).
Example 11
11.4 Foreign currency transaction – creditor
RSA Ltd, a company conducting business in South Africa, purchased inventory from an overseas
supplier for FC200 000 on 30 September 20.11, when R1 = FC1. The supplier will only be paid on
31 December 20.13. No forward cover was taken out for the transaction. The exchange rates were
as follows:
31 December 20.11 R1 = FC0,80
31 December 20.12 R1 = FC1,00
31 December 20.13 R1 = FC1,25
RSA Ltd uses a perpetual inventory system to account for its inventories and has a 31 December
year end.
The inventory was sold as follows:
20.11: 75%
20.12: 25%
The selling price is cost plus 100%.
continued
Journal entries
Dr Cr
R R
30 September 20.11
Inventory (SFP) 200 000
Creditors (SFP) (FC200 000 × R1) 200 000
31 December 20.11
Receivables (SFP) 300 000
Sales (P/L) (R200 000 × 75% × 200/100) 300 000
Inventory (SFP) (R200 000 × 75%) 150 000
Foreign exchange difference (P/L) 50 000
Creditors (SFP) (FC200 000/0,8 – R200 000) 50 000
31 December 20.12
Receivables (SFP) 100 000
Sales (P/L) (R200 000 × 200% × 25%) 100 000
Inventory (SFP) (R200 000 × 25%) 50 000
Creditors (SFP) 50 000
Foreign exchange difference (P/L)
((FC200 000/1,00) – (FC200 000/0,8)) 50 000
31 December 20.13
((FC200 000/1,25) – (FC200 000/1,00))
Bank (SFP) (FC200 000/1,25) 160 000
Comment
¾ It is clear that when the rand deteriorates, it is to the disadvantage of the South African
creditor. The opposite is obviously also true.
Example 11.5 Foreign exchange transaction – sales and a debtor
Kappa Ltd, operating in South Africa, entered into a sales transaction with a foreign company on
30 September 20.11. Since Kappa Ltd anticipated that the rand would deteriorate in the
foreseeable future, the transaction was denominated in FC. In terms of this transaction, Kappa Ltd
delivered inventory valued at FC200 000 to the foreign company on 30 September 20.11 when the
exchange rate was R1 = FC1. The foreign company will settle the amount outstanding in respect
of the inventory sold to them on 31 December 20.13. No forward cover was taken out. Kappa Ltd
has a 31 December year end. The relevant exchange rates are as follows:
31 December 20.11 R1 = FC0,80 or FC1 = R1,25
continued
The journal entries in the records of Kappa Ltd will be as follows:

Dr Cr
30 September 20.11 R R
Debtor (SFP) (FC200 000/FC1 or × R1) 200 000
Sales (P/L) 200 000
Recognise sales on transaction date
31 December 20.11
Debtor (SFP) ((FC200 000/FC0,8 or × R1,25) – R200 000) 50 000
Adjust balance of debtor to closing rate at year end
31 December 20.12
Debtor (SFP) (R250 000 – (FC200 000/FC1,00 or × R1,00)) 50 000
Adjust balance of debtor to closing rate at year end
31 December 20.13
Bank (SFP) (FC200 000/FC1,25 or × R0,80) 160 000
Foreign exchange difference (P/L) (FC200 000 × (1,00 – 0,80)) 40 000
Debtor (SFP) 200 000
Adjust balance of debtor to closing rate at year end and account for
settlement by debtor
OR
Foreign exchange difference (P/L) (FC200 000 × (1,00 – 0,80)) 40 000
Debtor (SFP) 40 000
Restate debtor to rand amount before settlement
Bank (SFP) 160 000
Debtor (SFP) 160 000
Settlement of outstanding debt by debtor
Comment
¾ It is clear that it is to the advantage of the seller (Kappa Ltd) if the rand deteriorates – it will
receive more rand per FC.
¾ By contrast, it is to the disadvantage of Kappa Ltd should the rand appreciate, as it would then
receive fewer rand per FC.
¾ Also note the difference in notation of the rand versus the foreign currency as provided in this
question, namely R1 = FC or FC1 = R. The notation has an impact on the technique of
translation: when using R1 = FC, division is used and for FC1 = R, multiplication is used.
Example 11.6 Loan denominated in foreign currency
A South African company with a financial year end of 31 December borrows FC3 000 on
30 June 20.11 and receives R3 300. Interest on the loan is repayable in arrears at 10% per
annum. The capital is repayable on 30 June 20.13. The exchange rates are as follows:
30 June 31 December
FC1 = R FC1 = R
20.11 1,100 1,087
20.12 1,053 1,010
20.13 1,136 1,099
continued
The foreign exchange differences arising on the capital will be calculated as follows:
Date FC Rate R
30.06.20.11 Receive 3 000 1,100 3 300
31.12.20.11 Foreign exchange difference (balancing amount) (39)
31.12.20.11 Balance 3 000 1,087 3 261
31.12.20.12 Balance 3 000 1,010 3 030
30.06.20.13 Payment (3 000) 1,136 (3 408)
30.06.20.13 Foreign exchange difference (balancing amount) 378
30.06.20.13 Balance – 1,136 –
The loan represents a financial liability in terms of IFRS 9 Financial Instruments, which will initially
be measured at fair value and subsequently be measured at amortised cost. Assuming the 10%
interest rate is market-related, the amortised cost balance would be equal to the capital
outstanding as indicated in the table above. The amortised cost method requires that interest must
be recognised on a time-apportioned basis. Consequently, interest will be accrued on a day-to-day
basis and as IAS 21 requires transactions to be measured at the spot exchange rate applicable
on the transaction date, an average exchange rate must be used to translate the finance
charges. The accrued interest represents a monetary liability that must be remeasured to the spot
exchange rate at the reporting date.
The following finance charges and foreign exchange differences will arise:
Date FC Rate R
31.12.20.11 Interest expense 1501 1,09352 164
31.12.20.11 Balance 150 1,087 163
30.06.20.12 Interest paid (300) 1,053 (316)
30.06.20.12 Foreign exchange difference (163 + 161 – 316) (8)
31.12.20.12 Balance 150 1,010 152
30.06.20.13 Interest paid (300) 1,136 (341)
30.06.20.13 Foreign exchange difference (152 + 161 – 341) 28
30.06.20.13 Balance – 1,136 –
1. 3 000 × 10% × 6/12 = 150

2. (1,100 + 1,087)/2 = 1,0935 (average rate for 30 June 20.11 to 31 December 20.11)
3. (1,087 + 1,053)/2 = 1,07 (average rate for 1 January 20.12 to 30 June 20.12)
4. (1,053 + 1,010)/2 = 1,0315 (average rate for 1 July 20.12 to 31 December 20.12)
5. (1,010 + 1,136)/2 = 1,073 (average rate for 1 January 20.13 to 30 June 20.13)
The entries for the loan will be as follows:
Dr Cr
R R
30 June 20.11
Bank (SFP) 3 300
Loan (SFP) 3 300
31 December 20.11
Loan (SFP) 39
Foreign exchange difference (P/L) 39
Finance charges (P/L) 164
Interest accrued (SFP) 164
continued
Dr Cr
R R
30 June 20.12
Interest accrued (SFP) (164 – 1 + 161) 324
Bank (SFP) 316
31 December 20.12
Loan (SFP) 231
30 June 20.13
Loan (SFP) 378
Loan (SFP) 3 408
Bank (SFP) 3 408
Interest accrued (SFP) (155 – 3 + 161) 313
Bank (SFP) 341
If a gain or loss on a non-monetary item is recognised in other comprehensive income, then

IAS 21 requires the foreign exchange difference also to be recognised in other
comprehensive income (IAS 21.30). It follows that the treatment of foreign exchange
differences corresponds with the treatment of the gain or loss of the underlying non-
monetary item. This principle also applies to deferred tax (IAS 12).
Example 11
11.7 Profit or loss on foreign shares presented in other comprehensive income
in terms of IFRS 9
Euro Ltd purchases 100 000 ordinary shares in a USA company on 1 December 20.12 at US$14
per share. The entity has elected to present gains and losses on the investment in other
comprehensive income in terms of IFRS 9, since these shares are an equity investment that it
intends to keep as a long-term investment. The year end of the entity is 31 December.
The market price of the shares on 31 December 20.12 and 31 December 20.13 amounted to
US$17 and US$20 respectively. The following represents the appropriate rand/dollar spot
exchange rates.
US$1 = R
1 December 20.12 5,50
31 December 20.12 6,20
31 December 20.13 5,80
continued
The fair values of the investment on the above dates, in rand, are calculated as follows:
US$ R
1 December 20.12 (100 000 × US$14); (US$1 400 000 × R5,50) 1 400 000 7 700 000
31 December 20.12 (100 000 × US$17); (US$1 700 000 × R6,20) 1 700 000 10 540 000
31 December 20.13 (100 000 × US$20); (US$2 000 000 × R5,80) 2 000 000 11 600 000
From the above, it is clear that the change in the fair value of the shares would represent a
combination of the change in the rand/dollar exchange rate component and a change in the dollar
market price component.
The journal entries to account for the changes in fair value on 31 December 20.12 and 31 December
20.13 are as follows:
Dr Cr
Foreign share investment (asset) (SFP) (10 540 000 – 7 700 000) 2 840 000
Mark-to-market reserve (OCI) 2 840 000
Recognise the fair value adjustment of the financial asset
at year end
31 December 20.13
Foreign share investment (asset) (SFP) (11 600 000 – 10 540 000) 1 060 000
Mark-to-market reserve (OCI) 1 060 000
Recognise the fair value adjustment of the financial asset
at year end
Comment
¾ A financial assets measured at fair value through other comprehensive income (elected
classification) is not a monetary item (IFRS 9.B5.7.3). When accounting for fair value
adjustments for a non-monetary asset, no distinction is made between the pure fair value
adjustment in the foreign currency and the foreign exchange differences that arise from the
translation to the functional currency (IAS 21.52(a)).
¾ A financial assets measured at fair value through other comprehensive income (mandatory
classification) is treated as a monetary item (IFRS 9.B5.7.2A). Accordingly, such a financial
asset is treated as an asset measured at amortised cost in the foreign currency and exchange
differences on the amortised cost are recognised in profit or loss.
11.5.3 Tax implications of foreign currency transactions

The tax position of foreign currency transactions is too complex to discuss in detail here.
Accordingly, only the most important rules applicable in most circumstances are addressed.
The deferred tax consequences of each case will need to be assessed on the facts and
circumstances applicable to the specific scenario.
Unhedged transactions
Section 25D of the Income Tax Act 58 of 1962 (the Income Tax Act) states that a company
must convert foreign amounts by applying the spot exchange rate on the date of receipt or
accrual, or when an expenditure or loss was incurred, subject to certain exceptions in
section 25D(2)–(7). Thus, the accounting treatment and the tax treatment will be the same
under normal circumstances. Foreign exchange gains and losses are dealt with in section
24I of the Income Tax Act. The treatment of foreign exchange gains and losses is similar for
accounting and tax.
Temporary differences may, however, arise in certain circumstances. For example, where
the transaction is related to a loan, an advance or a debt used to acquire an asset on which
a wear-and-tear allowance is claimed (a so-called section 24I(7)(a) asset) and the asset is
not brought into use in the period in which it was acquired. Any foreign exchange differences
arising from the conversion of such a loan, advance or debt will be transferred to the period
in which the asset is brought into use for tax purposes. For accounting purposes, the foreign
exchange differences are recognised in the period of acquisition.
11.6 Translation of financial statements into presentation currency

The purpose with the translation of financial statements of an entity is to preserve as far as
possible the results of the interrelationships of amounts appearing in the financial
statements in the functional currency to the presentation currency. If an entity’s functional
currency differs from its presentation currency, the results and financial position of an entity
is translated using the closing rate method (IAS 21.39 to .41):
assets and liabilities for each statement of financial position presented (including
comparatives) are translated at the closing rate at the date of that statement of financial
position;
income and expenses for each statement of profit or loss and other comprehensive
income (including comparatives) are translated at exchange rates at the dates of the
transactions (for practical reasons, a rate that approximates the exchange rates at
transaction dates may be used, if exchange rates do not fluctuate significantly); and
all resulting foreign exchange differences are recognised in other comprehensive income
as a separate component of equity, normally called the foreign currency translation
reserve (FCTR) (the exchange differences result from translating income and expenses
at the exchange rates at the dates of the transactions, and assets and liabilities at the
closing rate, as well as translating the opening net assets at a closing rate that differs
from the previous closing rate).
IAS 21.55 is clear that when an entity presents its financial statements in a currency that is
different from its functional currency, it may not claim compliance with IFRS, unless those
financial statements have been translated in terms of the abovementioned principles. If any
other translation method is used, the financial statements must be clearly identified as
supplementary information to distinguish this information from information that complies with
IFRS (IAS 21.57(a)).
11.7 Foreign operations

11.7.1 Translation of a foreign operation for inclusion in the financial statements
of the reporting entity
IAS 21 requires each individual entity within a group of companies to determine its functional
currency and measure its results and financial position in that currency. The determination
of each entity’s functional currency must be performed on a stand-alone basis, as the group
does not have a functional currency. An entity may present its financial statements in any
currency. For example, when a group consists of individual entities with different functional
currencies, the results and financial position of each entity are expressed in a common
currency (the presentation currency of the parent) so that consolidated financial statements
may be presented.
The translation of the financial statements of a foreign operation with a functional currency
that differs from that of the reporting entity takes place directly into the currency in which the
financial statements (consolidated or separate, in the case of a branch) of the reporting entity
are presented. In other words, the financial statements of the foreign operation are not first
translated into the functional currency of the reporting entity and then into the presentation
currency, but are translated directly into the presentation currency (IAS 21.BC18).
The translation of the financial statements of a foreign operation into the presentation
currency of the reporting entity for inclusion in the separate financial statements of the
reporting entity (in the case of a branch), or consolidated financial statements of the
reporting entity (in the case of an associate, joint venture or subsidiary) is exactly the same
as discussed in section 11.6 above.
IAS 21.41 further requires that when the foreign operation is consolidated, a portion of the
foreign currency translation reserve (FCTR) is allocated to the non-controlling interests.
Example 11.8 Foreign currency – translation of a branch
The head office of Epsilon Co, with a functional and presentation currency of rand, made a loan of
FC20 800 to its newly formed foreign branch, Zeta, on 1 January 20.12 The foreign branch earned
profit of FC25 800 for the year ended 31 December 20.12.
On 1 January 20.12, the exchange rate was FC1 = R2,00, and on 31 December 20.12, it was
FC1 = R2,40. The weighted average exchange rate for 20.12 was FC1 = R1,95.
If the functional currency of the branch is FC and there were no other transactions between the
branch and head office, the trial balance of the branch on 31 December 20.12 will be as follows:
Dr Cr
FC FC
Loan from head office – 20 800
Profit for the year – 25 800
Property, plant and equipment 40 000 –
Receivables 3 000 –
Cash 3 600 –
46 600 46 600
The translation of the trial balance using the closing rate will be as follows:
FC Rate R
Credits
Loan from head office 20 800 2,40 49 920
Profit for the year 25 800 1,95 50 310
FCTR (balancing amount) 11 610
111 840
Debits
Property, plant and equipment 40 000 2,40 96 000
Receivables 3 000 2,40 7 200
Cash 3 600 2,40 8 640
111 840
If the branch earns a profit of FC30 000 in 20.13, the average exchange rate for 20.13 is
FC1 = R2,20 and the rate on 31 December 20.13 is FC1 = R2,40 once again, the trial balance of
the branch on 31 December 20.13 will be as follows:
Dr Cr
FC FC
Loan from head office 46 600
Opening balance 20 800
Retained earnings 20.12 25 800
Property, plant and equipment 50 000 –
Receivables 10 000 –
Cash 16 600 –
76 600 76 600
continued
Using the closing rate the translated trial balance will be as follows:
FC Rate R
Credits
Loan from head office 46 600 2,40 111 840
Profit for the year 30 000 2,20 66 000
FCTR (balancing amount) 6 000
183 840
Debits
Property, plant and equipment 50 000 2,40 120 000
Receivables 10 000 2,40 24 000
Cash 16 600 2,40 39 840
183 840
The decrease in the FCTR for 20.13 is R11 610 – R6 000 = R5 610 and is recognised in equity via
The FCTR will be disclosed as follows in the financial statements:
Epsilon Co
20.13 20.12
R R
Profit for the year xxx xxx
Gain/(loss) on translation of foreign operation (5 610) 11 610
Total comprehensive income for the year (xxx – 5 610); (xxx + 11 610) xxx xxx
Epsilon Co
Extract from the statement of changes in equity for the year ended 31 December 20.13
Foreign
currency
translation
reserve
R
Balance at 1 January 20.12 –
Total comprehensive income
Profit for the year –
Other comprehensive income 11 610
Total comprehensive income
Other comprehensive income (5 610)
11.7.2 Intragroup monetary items

Once the financial statements of the foreign operation have been translated to the
presentation currency of the reporting entity, the incorporation of the results and financial
position of the foreign operation into those of the reporting entity follows normal
consolidation procedures, such as the elimination of intragroup balances and intragroup
transactions of a subsidiary (IAS 21.45).
An intragroup monetary asset or liability cannot be eliminated against the corresponding

intragroup liability or asset without showing the results of currency fluctuations in the
consolidated financial statements (IAS 21.45).
Example 11.9 Intragroup monetary balances
A parent, with the South African rand as its functional and presentation currency, made a loan of
FC1 000 to its foreign subsidiary, with the FC as its functional currency, when the exchange rate
was FC1 = R4,00.
On the reporting date, the full loan is still outstanding. The exchange rate is FC1 = R4,20.
In its separate financial statements, the parent will remeasure the monetary item to R4 200 and
recognise a foreign exchange gain in the ‘profit or loss’ section of the statement of profit or loss
and other comprehensive income of R200.
The subsidiary will carry the loan in its separate financial statements at FC1 000. In order to
prepare consolidated financial statements, the liabilities of the subsidiary will be translated at
closing rate, meaning that the liability will be translated to R4 200.
The intragroup balance of R4 200 will be eliminated on consolidation, but the exchange gain of R200
will not be eliminated and will be shown in the consolidated profit or loss section of the statement of
profit or loss and other comprehensive income.
11.7.3 Non-coterminous financial periods

When the financial statements of a foreign operation are as of a date different from those of
the reporting entity, the foreign operation prepares additional statements as of the same
date as the reporting entity’s financial statements. When additional statements cannot be
prepared, IFRS 10 allows the use of a different reporting date, provided that the difference is
no greater than three months and adjustments are made for the effects of any significant
transactions or other events that occur between different dates. In such a case, the assets
and liabilities of the foreign operation are translated at the exchange rate on the reporting
date of the foreign operation. Adjustments are made for significant changes in exchange
rates up to the reporting date of the reporting entity. The same approach is applied to
associates and joint ventures (IAS 21.46).
11.7.4 Revaluation of assets

IAS 21.47 determines that any fair value adjustments to the carrying amount of assets and
liabilities arising on the acquisition of that foreign operation shall be treated as assets and
liabilities of the foreign operation. The fair value adjustments clearly relate to the identifiable
assets and liabilities of the acquired entity and must therefore be translated at closing rate
(IAS 21.BC28).
When assets are revalued in a foreign subsidiary after the date of acquisition, the method of
translation will impact on the rand amount of the revaluation surplus. This is explained in the
following example.
Example 11.10 Subsequent revaluation of assets
Echo Ltd acquired a 65% interest in Kilo Ltd on 1 January 20.10. On 1 January 20.12, Kilo Ltd
acquired a property for FC500 000. The property was revalued to FC1 000 000 on
1 January 20.13. The year end of the group is 31 December.
The following exchange rates apply:
FC1 = R
1 January 20.10 R0,80
31 December 20.11 R0,90
31 December 20.12 R1,00
31 December 20.13 R1,30
continued
The historical cost and the revalued amount of the property are translated at the exchange rate
ruling at the date of revaluation. The revaluation surplus is R500 000 ((FC1 000 000 × R1,00) –
(FC500 000 × R1,00)). On 31 December 20.13, the property is stated at R1 300 000 (FC1 000 000
× R1,30 (closing rate)). The revaluation surplus remains unchanged at R500 000, but the FCTR
increases by R150 000 (FC500 000 × (R1,30 – R1,00)).
11.7.5 Goodwill
Goodwill arising on the acquisition of a foreign operation must be treated as an asset of the
foreign operation, as opposed to an asset of the acquirer. The goodwill will therefore be
expressed in the functional currency of the foreign operation and be translated at the closing
rate (IAS 21.47). When the non-controlling interests are measured at the proportionate
share of the foreign operation’s net identifiable assets, the non-controlling interests will not
share in the foreign currency translation reserve (FCTR) on goodwill, because the non-
controlling interests do not contribute to goodwill. However, when the non-controlling
interests are measured at fair value, both the acquirer and the non-controlling interests will
contribute to goodwill. Therefore, the non-controlling interests will have a share in the
foreign currency translation reserve (FCTR) on goodwill. The share is based on the profit-
sharing ratio.
Example 11.11 Foreign currency translation of a subsidiary (including goodwill)
The following is an extract of the abridged trial balances of Lima Ltd and its foreign subsidiary,
Oscar Ltd, for the year ended 31 December 20.13:
Lima Ltd
Functional currency (non-hyperinflationary)
R
Retained earnings – beginning of year 20 000
115 000
Investment in Oscar Ltd 45 600
Current assets 64 400
115 000
Oscar Ltd
Functional currency (non-hyperinflationary)
FC
Retained earnings – beginning of year –
100 000

100 000
continued
Lima Ltd acquired a 65% controlling interest in Oscar Ltd on 1 January 20.13 (incorporation date).
Non-controlling interests in the foreign operation are measured as the non-controlling interests’
proportionate share of the foreign operation’s net identifiable assets.
Applicable exchange rates are as follows:
BV = R
1 January 20.13 R0,80
31 December 20.13 R0,90
20.13 Average R0,85
The presentation currency of Lima Ltd is rand (ZAR).
The functional currency of Oscar Ltd differs from the presentation currency of Lima Ltd. The
assets and liabilities of Oscar Ltd should be translated using the closing rate.
Using the closing rate, the translated trial balance and eventual consolidation will be as follows:
20.13
FC Rate R
Share capital 80 000 0,80 64 000
Profit after tax 14 000 0,85 11 900
Profit before tax 20 000 0,85 17 000
Income tax expense (6 000) 0,85 (5 100)
FCTR balancing 8 700
94 000 84 600
Current assets 94 000 0,90 84 600
94 000 0,90 84 600
Analysis of owners’ interest of Oscar Ltd

31 December 20.13
Lima Ltd Lima Ltd Non-
At Since controlling
Total
Total Rate acquisition acquisition interests
100%
65% 65% 35%
FC R R R R
At acquisition
Share capital 80 000 0,80 64 000 41 600 22 400
Goodwill 5 000 0,80 4 000 4 000 –
Investment in Oscar Ltd 85 000 68 000 45 600 22 400
Since acquisition
Profit after tax 14 000 0,85 11 900 7 735 4 165
FCTR (excluding 8 700 5 655 3 045
goodwill)
FCTR (goodwill only) 500 500 –
99 000 0,90 89 100 13 890 29 610
continued
Comment
¾ As the non-controlling interests in the foreign operation are measured as the non-controlling
interests’ proportionate share of the foreign operation’s net identifiable assets, the goodwill will
only relate to the acquirer. The goodwill is calculated in rand (R) and then translated into
foreign currency (FC):
R
Consideration 45 600
68 000
Net identifiable assets 64 000
Goodwill 4 000
Goodwill in FC = 4 000/0,80 = 5 000

¾ The FCTR on goodwill will only relate to the acquirer and will be calculated as follows:
(5 000 × 0,90) (closing) – 4 000 (at acquisition) = 500
¾ The FCTR (excluding goodwill) equals the amount calculated in the translated trial balance
above. As goodwill is not included in the translated trial balance, an additional consolidation
journal entry is required to account for the FCTR on goodwill:
Dr Cr
R R
Goodwill (SFP) 500
Foreign currency translation reserve (OCI) 500
¾ The foreign currency translation difference that is attributable to the non-controlling interests is
included as part of the non-controlling interests in the statement of financial position.
¾ If the non-controlling interests were measured at fair value, both the acquirer and the
non-controlling interests would contribute to goodwill. The non-controlling interests would share
in the FCTR on goodwill calculated by using the profit-sharing ratio.
Lima Ltd Group
R
Profit before tax (15 000 + 17 000) 32 000
Income tax expense (5 000 + 5 100) (10 100)
Exchange rate differences on translation of foreign operations (8 700 + 500) 9 200
Owners of the parent (15 000 – 5 000 + 7 735) or (21 900 – 4 165) 17 735
Non-controlling interests (as per analysis) 4 165
21 900
Owners of the parent (17 735 + 5 655 + 500) or (31 100 – 7 210) 23 890
Non-controlling interests (4 165 + 3 045) 7 210
31 100
continued
Lima Ltd Group

R
Assets
Non-current assets
Goodwill (4 000 + 500) or (5 000 x 0,90) 4 500
Current assets (64 400 + 84 600) 149 000
Total assets 153 500
Retained earnings (20 000 + 17 735) 37 735
Other components of equity
Foreign currency translation reserve (5 655 + 500) 6 155
123 890
Non-controlling interests (as per analysis) 29 610
11.7.6 Foreign exchange differences on a net investment in a foreign operation

A net investment in a foreign operation is the amount of the reporting entity’s interest in the
net assets of that operation (IAS 21.08). In other words, if a foreign operation has equity of
FC1 000 at the reporting date and an investor holds an 80% interest in that foreign
operation, the investor’s net investment in the foreign operation will be FC800. This will also
be the amount of the foreign operation that is effectively included in the consolidated
financial statements of the investor.
An entity may, however, have a monetary item that is receivable from or payable to a
foreign operation. An item for which settlement is neither planned nor likely to occur in
the foreseeable future is, in substance, part of the entity’s net investment in that foreign
operation. Such monetary items may include long-term receivables or loans. They do not
include trade receivables and trade payables (IAS 21.15).
IAS 21 requires that foreign exchange differences arising on such monetary items that in
essence form part of a reporting entity’s net investment in a foreign operation, be recognised
in the profit or loss section of the statement of profit or loss and other comprehensive
income in the separate financial statements of the reporting entity or the individual financial
statements of the foreign operation, as the case may be (IAS 21.32).
If an item that is considered to be part of the net investment is denominated in the functional
currency of the reporting entity, a foreign exchange difference arises in the individual
financial statements of the foreign operation. The opposite happens where the relevant item
is denominated in the functional currency of the foreign operation – in this instance, the
exchange rate difference will arise in the separate financial statements of the parent.
In the consolidated financial statements (statements including both the reporting entity as
well as the foreign operation), such exchange rate differences are reclassified to a separate
category of equity (normally the foreign currency translation reserve (FCTR)) through other
comprehensive income in the statement of profit or loss and other comprehensive income
(IAS 21.32). This is done by transferring the exchange rate difference under discussion to
the foreign currency translation reserve (FCTR) by way of a pro forma consolidation journal
entry. The effect of this transfer is that this type of monetary item is now treated in exactly
the same way for accounting purposes in the consolidated financial statements as an equity
interest would be. For purposes of this principle, consolidated financial statements include
consolidation and equity accounting.
If the net investment is sold at a later date, the accumulated foreign exchange differences in
the foreign currency translation reserve (FCTR) that ended up in equity via other
comprehensive income are reclassified to the statement of profit or loss and other
comprehensive income (IAS 21.32) as a reclassification adjustment.
Example 11
11.12 Net investment in foreign operation – monetary item
Bravo Ltd is the parent of Europe Inc, a wholly-owned subsidiary (100% interest). Both entities
have 31 December year ends. Bravo Ltd purchased all the shares of Europe Inc on
1 January 20.13. On this date, Bravo Ltd granted a loan to Europe Inc.
No repayment terms have been agreed on, and Bravo Ltd will not require settlement of the loan in
the foreseeable future.
The loan is thus a monetary item forming part of the net investment of Bravo Ltd in Europe Inc.
The respective functional currencies of Bravo Ltd and Europe Inc are the SA rand (R) and the
euro (̀). The presentation currency of the Group is the SA rand (R).
The following are the relevant ̀:R exchange rates:
̀1:R
1 January 20.13 8,20
Average rate (rate changes evenly over time): 1 January 20.13 – 31 December 20.13 8,50
31 December 20.13 8,80
Case 1: Loan in the functional currency of the subsidiary
Assume that the loan granted on 1 January 20.13 amounted to ̀200 000.
The journal entry required to initially account for the loan in the separate financial statements of
Bravo Ltd, is the following:
Dr Cr
R R
1 January 20.13
Loan to subsidiary (̀200 000 × R8,20) 1 640 000
Bank 1 640 000
Recognise loan granted to subsidiary denominated in euro
The journal entry that would appear in the separate financial statements of Bravo Ltd at year end
is the following:
Dr Cr
R R
31 December 20.13
Loan to subsidiary (̀200 000 × (R8,80 – R8,20)) 120 000
Recognise foreign exchange difference on the loan to subsidiary
denominated in euro (̀)
Comment
¾ Since a monetary item denominated in a foreign currency appears in the separate financial
statements of Bravo Ltd, a foreign exchange difference will arise in the separate financial
statements of Bravo Ltd, provided fluctuations in exchange rates took place during the year.
¾ In terms of IAS 21.28, these foreign exchange differences are recognised in the profit or loss
section of the statement of profit or loss and other comprehensive income.
¾ Consequently, no foreign exchange difference will be recognised in the separate financial
statements of Europe Inc, since the loan is denominated in the functional currency of
Europe Inc, namely euro (̀ሻ.
continued
On consolidation, the trial balance of Europe Inc will be translated using the closing rate method.
The effect of this is that the loan (creditor) translated to rand in the records of Europe Inc, will be
shown as follows:
Exchange
̀ R
rate
Loan (creditor) 200 000 8,80 1 760 000
The credit loan included in the consolidated financial statements amounts to R1 760 000. The debit
loan included in the consolidated financial statements, also amounts to R1 760 000 (1 640 000 +
120 000). These items are intra group items and must be eliminated on consolidation.
IAS 21.32 requires that a foreign exchange difference on a monetary item forming part of the net
investment in a subsidiary and recognised in the separate financial statements in the profit or loss
section of the statement of profit or loss and other comprehensive income must be transferred to
the FCTR (part of equity) on consolidation, via other comprehensive income.
The pro forma consolidation journal entry to give effect to IAS 21.32 is as follows:
Dr Cr
R R
31 December 20.13
Foreign currency translation reserve (OCI) 120 000
Transfer foreign exchange difference on monetary item that forms
part of the net investment in a subsidiary, to equity
Case 2: Loan in the functional currency of the parent

Assume that the amount of the loan granted on 1 January 20.13, amounts to R1 640 000.
The journal entry in the separate financial statements of Europe Inc, at initial recognition, is as follows:
Dr Cr
̀ ̀
1 January 20.13
Bank 200 000
Loan from parent (R1 640 000/8,20) 200 000
Recognise loan denominated in rand received from parent
The journal entry in the separate financial statements of Europe Inc at year end is as follows:
Dr Cr
̀ ̀
31 December 20.13
Loan from parent ((R1 640 000/8,80) – ̀200 000) 13 636
Recognise foreign exchange difference on loan received from
parent denominated in rand
Comment
¾ Since a monetary item denominated in a foreign currency appears in the separate financial
statements of Europe Inc, a foreign exchange difference will arise in the separate financial
statements of Europe Inc, provided fluctuations in exchange rates took place during the year.
¾ In terms of IAS 21.28, these foreign exchange differences are recognised in the profit or loss
¾ Consequently, no foreign exchange differences will be recognised in the separate financial
statements of Bravo Ltd, since the loan is denominated in the functional currency of Bravo Ltd,
namely rand.
continued
On consolidation, the trial balance of Europe Inc will be translated using the closing rate method.
When the loan (creditor) and the foreign exchange difference in the records of Europe Inc are
translated to rand, they would appear as follows:
Exchange
̀ R
rate
Loan (creditor) (R1 640 000/8,80) 186 364 8,80 1 640 000
Foreign exchange difference (P/L) 13 636 8,50 115 906
The credit loan included in the consolidated financial statements amounts to R1 640 000. The
debit loan included in the consolidated financial statements, also amounts to R1 640 000. These
items are intragroup items that can now be eliminated.
As in Case 1 above, IAS 21.32 requires that a foreign exchange difference on a monetary item
forming part of the net investment in a subsidiary and recognised in the separate financial
statements in the profit or loss section of the statement of profit or loss and other comprehensive
income, must be transferred to the FCTR (part of equity) on consolidation, via other
comprehensive income in the statement of profit or loss and other comprehensive income.
The pro forma consolidation journal entry to give effect to IAS 21.32, is as follows:
Dr Cr
R R
31 December 20.13
Foreign currency translation reserve (OCI) 115 906
Transfer foreign exchange difference on monetary item forming part
of the net investment in subsidiary to equity
Comment
¾ At the translation of the assets, liabilities, income and expenses of a foreign subsidiary with a
functional currency that differs from that of the parent, a foreign exchange difference will arise
that will be recognised in the FCTR.
¾ Part of the income items mentioned above, is the foreign exchange difference of ̀13 636 that
will be translated to rand at an average exchange rate of ̀1 = R8,50 and that will eventually,
due to the translation technique as prescribed in IAS 21, be adjusted to a closing rate of
̀1 = R8,80.
¾ The difference between the translation of the ̀13 636 at ̀1 = R8,50 and ̀1 = R8,80, is R4 094
(rounded up) and together with the original R115 906 transferred to the FCTR via the
consolidation journal, this would equal the R120 000 that appears in the FCTR in Case 1.
The above discussion deals with the case where the specific monetary item is denominated
in the functional currency of either the reporting entity or the foreign operation. It is also
possible for the relevant item to be denominated in a foreign currency other than the
functional currency of the reporting entity or the foreign operation. For instance, the
monetary item is denominated in euro, but the functional and presentation currency of the
reporting entity is rand and that of the foreign operation is USA dollar. Under such
circumstances, exchange rate differences will arise in both the separate financial statements
of the reporting entity as well as in the individual financial statements of the foreign
operation. In the consolidated financial statements, these exchange rate differences are also
transferred to the foreign currency translation reserve (FCTR) (IAS 21.33).
11.7.7 Disposal or partial disposal of a foreign operation

On the disposal of a foreign operation, the cumulative amount of the exchange differences
relating to that foreign operation, recognised in other comprehensive income and
accumulated in the separate component of equity (FCTR), shall be reclassified from equity
to profit or loss as a reclassification adjustment when the gain or loss on disposal is
recognised.
The following are considered to be disposals:
• disposal of an entity’s entire interest;
• partial disposal which results in the loss of control of a foreign subsidiary; and
• partial disposal of a joint arrangement or an associate where the remaining interest is a
financial asset (loss of significant influence or joint control).
The cumulative amount of the exchange differences relating to the foreign operation that
has been attributed to the non-controlling interests will be derecognised, but will not be
reclassified to profit or loss.
On the partial disposal of a subsidiary that includes a foreign operation, the entity will
reattribute the proportionate share of the cumulative amount of the exchange differences
recognised in other comprehensive income to the non-controlling interests. In any other
partial disposals disposal of a foreign operation the entity shall reclassify to profit or loss
only the proportionate share of the cumulative amount of the exchange differences
recognised in other comprehensive income. Partial disposals are any reductions in
ownership interests except those seen as disposals above. Therefore a partial disposal will
occur when an entity disposes of an interest in its foreign operation without losing control,
significant influence or joint control.
Example 11.13 Disposal of a foreign operation
Able Ltd owns a foreign subsidiary, Barter Ltd. Barter Ltd has a functional currency that differs
from that of Able Ltd. Able Ltd acquired an 80% controlling interest in Barter Ltd on
1 January 20.11 for R80 000 and no goodwill arose at acquisition date. The non-controlling
interests are measured at their proportionate share of the net identifiable assets of the subsidiary.
Able Ltd sells its entire interest in Barter Ltd for R800 000 on 31 December 20.13.
The equity of Barter Ltd (translated to rand for consolidation purposes) at 31 December 20.13 is as
follows:
R
Equity at acquisition: 100 000
Equity since acquisition: 850 000
Retained earnings 1 January 20.13 500 000
Profit for the year 20.13 100 000
FCTR balance 1 January 20.13 200 000
FCTR movement for the year 20.13 50 000
Total equity 950 000

The retained earnings of Able Ltd on 31 December 20.13 is made up as follows:
Retained earnings 1 January 20.13 2 000 000
Profit for the year 20.13 800 000
Analysis of owner’s interest of Barter Ltd – 31 December 20.13
Able Ltd (80% – 0%)
Non-
At Since
Total controlling
acquisition acquisition
interests
R R R R
At acquisition
Share capital 10 000 8 000 2 000
Retained earnings 90 000 72 000 18 000
Investment in Barter Ltd 100 000 80 000 20 000
continued
Able Ltd (80% – 0%)

Non-
At Since
Total controlling
acquisition acquisition
interests
R R R R
Since acquisition
To beginning of current year
Retained earnings 500 000 400 000 100 000
FCTR 200 000 160 000 40 000
Current year
FCTR 50 000 40 000 10 000
950 000 680 000 190 000
Dispose of entire interest (950 000) (80 000) (680 000) (190 000)
– – –
The consolidated profit at disposal of the investment in Barter Ltd is calculated as follows:
R
Derecognise assets and liabilities (950 000)
Derecognise non-controlling interests 190 000
Proceeds on disposal 800 000
Profit on disposal (excluding reclassification of FCTR) 40 000
Comment
¾ IAS 21.48 determines that the FCTR accumulated in the separate component of equity is
reclassified to the statement of profit or loss and other comprehensive income (profit or loss
section) on disposal of an interest in a foreign operation. The FCTR (reserve in equity) of
R200 000 (160 000 + 40 000) must thus be reclassified to the statement of profit or loss and
other comprehensive income (profit and loss section). This is done by reducing the relevant line
item in the other comprehensive income section of the statement of profit or loss and other
comprehensive income (refer to 1 below) and increasing an appropriate line item in the profit or
loss section (refer to 2 below).
R
Profit for the year (800 000 + 100 000 + 40 000 + 200 0002) 1 140 000
Other comprehensive income for the year:
Exchange difference on translating foreign operation 50 000
Reclassification adjustment of FCTR due to the disposal of a foreign operation (200 000)1
Other comprehensive income for the year (150 000)
Owners of the parent (800 000 + 80 000 + 40 000 + 200 000) 1 120 000
1 140 000
Owners of the parent (1 120 000 + 40 000 – 200 000) 960 000
Non-controlling interests (20 000 + 10 000) 30 000
990 000
continued

Foreign
Non-
Retained currency
controlling
earnings translation
interests
reserve
R R R
Balance at 1 January 20.13
(2 000 000 + 400 000) 2 400 000 160 000 160 000
Total comprehensive income 1 120 000 (160 000) 30 000
Profit for the year 1 120 000 20 000
Other comprehensive income (160 000) 10 000
Disposal of interest in foreign operation (190 000)
Balance at 31 December 20.13 3 520 000 – –
Comment
¾ The above R200 000 included in the profit for the year represents the FCTR realised on
disposal and transferred to the profit and loss section of the statement of profit or loss and other
comprehensive income. The FCTR attributed to the non-controlling interests will be
derecognised, but will not be reclassified to profit or loss.
¾ The R40 000 included in profit for the year represents the consolidated gain on the disposal of
the entire interest in the subsidiary (excluding the FCTR reclassification).
¾ The closing retained earnings balance of R3 520 000 is made up of the closing retained
earnings of Able Ltd of R2 800 000 (R2 000 000 + R800 000) and the since acquisition
reserves of Barter Ltd of R680 000 and the group profit on disposal of Barter Ltd of R40 000
(R2 800 000 + R680 000 + R40 000 = R3 520 000).
11.8 Disclosure
IAS 21.51 to .57 requires the following disclosure:
The amount of foreign exchange differences recognised in the profit or loss section of
the statement of profit or loss and other comprehensive income. Foreign exchange
differences recognised in the profit or loss section of the statement of profit or loss and
other comprehensive income as part of fair value adjustments on financial instruments at
fair value through profit or loss in terms of IFRS 9, Financial Instruments, need not be
identified separately.
The net foreign exchange differences recognised in other comprehensive income and
accumulated as a separate component of equity and reconciliation between the opening
and closing balances.
When the presentation currency is different from the functional currency, the following
must be disclosed:
– that fact;
– the functional currency; and
– the reason for using a different presentation currency.
When the entity translates its financial statements using a method which is not in line
with IAS 21:
– the information must be identified as supplementary information;
– the presentation currency of the supplementary information must be disclosed;
– the functional currency of the entity must be disclosed; and
– the method of translation used to determine the supplementary information must be
disclosed.
Example 11.14 Disclosure of accounting policies and notes

Foreign currency transactions
(i) Functional and presentation currency
Items included in the financial statements of each of the group’s entities are measured using the
currency of the primary economic environment in which the entity operates (‘the functional
currency’). The consolidated financial statements are presented in rand, which is Plantkor Ltd’s
functional and presentation currency.
(ii) Transactions and balances
Foreign currency transactions are translated into the functional currency using the exchange rates
at the dates of the transactions. Foreign exchange differences resulting from the settlement of
such transactions and from the translation of monetary assets and liabilities denominated in foreign
currencies at year end exchange rates are generally recognised in profit or loss. The portion of the
gain or loss on qualifying cash flow hedges and net investment hedges that is determined to be an
effective hedge is recognised in other comprehensive income. Foreign exchange differences that
relate to borrowings are presented in the statement of profit or loss, within finance costs. All other
foreign exchange differences are presented in the statement of profit or loss within other income or
other expenses.
Non-monetary items that are measured at fair value in a foreign currency are translated using the
exchange rates at the date when the fair value was determined. Translation differences on assets
and liabilities carried at fair value are reported as part of the fair value gain or loss. For example,
translation differences on non-monetary assets such as financial assets measured at fair value
through other comprehensive income (elected classification) are recognised in other
(iii) Group companies
The results and financial position of foreign operations that have a functional currency different
from the presentation currency are translated into the presentation currency as follows:
assets and liabilities for each balance sheet presented are translated at the closing rate at the
date of that balance sheet;
income and expenses for each statement of profit or loss and statement of comprehensive
income are translated at average exchange rates; and
all resulting exchange differences are recognised in other comprehensive income.
On consolidation, exchange differences arising from the translation of any net investment in foreign
entities are recognised in other comprehensive income. When a foreign operation is sold the
associated exchange differences are reclassified to profit or loss, as part of the gain or loss on
sale.
Goodwill and fair value adjustments arising on the acquisition of a foreign operation are treated as
assets and liabilities of the foreign operation and translated at the closing rate.
CHAPTER
12
Borrowing costs
(IAS 23)
Contents
12.1 Overview of IAS 23 Borrowing Costs ................................................................ 300
12.2 Background ....................................................................................................... 300
12.3 Accounting treatment ........................................................................................ 300
12.4 Rules of capitalisation ....................................................................................... 301
12.4.1 Qualifying assets ................................................................................. 301
12.4.2 Borrowing costs ................................................................................... 301
12.4.3 Commencement of capitalisation ........................................................ 301
12.4.4 Suspension of capitalisation ................................................................ 303
12.4.5 Cessation of capitalisation ................................................................... 303
12.4.6 Limit on capitalisation .......................................................................... 303
12.4.7 Total cost of the qualifying asset exceeds the recoverable amount .... 304
12.5 Capitalisation procedures .................................................................................. 304
12.5.1 Weighted average expenditure ........................................................... 305
12.5.2 Specific financing ................................................................................ 305
12.5.3 General pool of funds .......................................................................... 306
12.5.4 Combination – specific and general loans ........................................... 306
12.5.5 Group statements ................................................................................ 306
12.5.6 Foreign exchange differences ............................................................ 307
12.6 Tax implications ................................................................................................. 308
12.7 Disclosure .......................................................................................................... 310
299
12.1 Overview of IAS 23 Borrowing Costs
Borrowing costs.
Definitions
Qualifying asset.
Capitalise borrowing costs directly attributable to the

production, construction or acquisition of qualifying
asset.
Commence when expenditure for the asset and
borrowing costs are being incurred and activities
Recognition necessary to prepare asset are undertaken.
Suspend when active development of qualifying asset is
interrupted for extended periods.
Cease when substantially all the activities necessary to
prepare qualifying asset for intended use or sale are
complete.
Specific funds: actual borrowing costs incurred, less any

Borrowing costs
investment income from surplus funds invested.
eligible for
General funds: weighted average rate of borrowing
capitalisation
costs. Limited to actual borrowing costs incurred.
12.2 Background
Previously, the accounting standard on borrowing costs, IAS 23, allowed two accounting
treatments for borrowing costs on the acquisition, erection or production of qualifying assets.
Borrowing costs could be capitalised against the cost of the asset or recognised as an
expense. However, the revised edition of IAS 23 that appeared in March 2007 forces entities
to capitalise borrowing costs against such qualifying assets. Consequently, the policy choice
to expense borrowing costs on qualifying assets is removed. The elimination of a choice of
accounting policy has improved comparability between the financial statements of entities
and aligned the accounting standards issued by the IASB and FASB (issuing US GAAP).
12.3 Accounting treatment

IAS 23 regulates the circumstances under which borrowing costs shall be capitalised.
According to IAS 23, if borrowing costs are directly related to the acquisition, construction or
production of a qualifying asset, they must be capitalised in terms of IAS 23.1. Other
borrowing costs are recognised as an expense. Entities are not required to apply IAS 23 to a
qualifying asset carried at fair value (e.g. biological assets) or inventory manufactured
or produced in large quantities on a repetitive basis.
Where borrowing costs are capitalised, the recognition criteria for assets must be met. In
other words, it must be relevant and faithfully represented. The cost of calculating the
borrowing costs to be capitalised should not exceed the benefits of the information.
Capitalisation must be applied consistently to the borrowing costs of all qualifying assets,
and the accounting policy must be disclosed in the financial statements.
IAS 23 does not deal with the actual or deemed cost of equity or preferred share capital
classified as equity.
Borrowing costs 301
12.4 Rules of capitalisation

There are certain requirements, for example when capitalisation shall commence, when it
shall be suspended temporarily, and when it shall cease. In addition, a limit is placed on the
extent of the borrowing costs to be capitalised, and on the treatment where the total cost,
including the capitalised borrowing costs exceeds the recoverable or realisable value of the
asset.
Borrowing costs that are directly related to the acquisition, construction or production of
qualifying assets are capitalised. Capitalisation shall proceed even if the carrying amount of
the asset exceeds the recoverable or net realisable amount. An appropriate impairment to
recoverable amount or net realisable value write-down would then be recognised.
12.4.1 Qualifying assets

Capitalisation of borrowing costs can only take place for qualifying assets. A qualifying
asset is an asset that necessarily takes a substantial time to get ready for its intended
use or sale. Assets that are ready for intended use or sale at acquisition are therefore not
qualifying assets.
Qualifying assets include assets manufactured for own use to produce future revenue, as
well as manufacturing plants, intangible assets, power-generation facilities, properties that
will become self-constructed investment properties once completed, and investment
properties measured at cost that are being developed. Routinely-produced inventories are
excluded, but inventory with long production processes, for example ships and good wines,
may qualify for capitalisation. Financial assets are also excluded.
A qualifying asset must take a substantial period of time to complete. However, IAS 23
provides no guidance on the length of the period, and therefore judgement is required.
12.4.2 Borrowing costs

The general rule is that borrowing costs must be directly attributable to a qualifying
asset and that they would have been avoided if the expenditure on the qualifying asset had
not been incurred.
Borrowing costs are interest and other costs incurred by an entity in connection with the
borrowing of funds. They include:
interest on borrowed funds, for example bank overdrafts and short- and long-term
borrowings using the effective interest method in terms of IFRS 9;
foreign exchange gains and losses arising from foreign currency borrowings to the extent
that they are regarded as an adjustment to interest costs; and
interest in respect of lease liabilities recognised in accordance with IFRS 16.
12.4.3 Commencement of capitalisation

The capitalisation of borrowing costs as part of the cost of a qualifying asset should
commence when:
borrowing costs are incurred;
expenditure on the asset are incurred; and
activities that are necessary to prepare the asset for its intended use or sale are in
progress.
12.4.3.1 Borrowing costs are being incurred
Borrowing costs are usually incurred when the entity obtains interest-bearing external
finance, for example overdrafts, and short- or long-term borrowings to finance the
completion of the qualifying assets.
The borrowing costs may arise from loans made specifically for the purpose of completing
the qualifying asset (hence specific loans), or the entity may have a general pool of loans,
or a centralised policy for raising and co-ordinating finance where it is not possible to link
loans directly to qualifying assets and an exercise of judgement is required (hence general
loans). The nature of the funding will determine when the borrowing costs will be incurred:
specific loan: borrowing costs will be incurred from the date that the loan funds are
advanced to the entity;
bank overdraft: borrowing costs will be incurred from the date that the overdraft facility
is used by the entity; and
mortgage loan: borrowing costs will be incurred from the date that the entity actually
draws down on the loan facility (note that the borrowing costs are only incurred on the
loan draw-downs and not on the total bond amount registered).
IAS 23 does not address the issue of interest-free loans or instances of deferred terms of
payment beyond normal market credit terms. It may be appropriate to calculate market-
related deemed interest in such cases. Such interest will qualify as borrowing costs in terms
of this Standard, as borrowing costs include the interest expense calculated using the
effective interest method as described in the relevant Standard dealing with financial
instruments.
For compound financial instruments, for example convertible or redeemable instruments, the
requirements of the Standard dealing with financial instruments are followed and the interest
element (in terms of substance over form) may also qualify for capitalisation.
12.4.3.2 Expenditure is being incurred
Expenditure is being incurred on a qualifying asset if the payment of cash, or the transfer of
ownership of assets, or the receipt of interest-bearing liabilities has taken place. Expenditure
is reduced by any progress payments and grants (including government grants) received on
qualifying assets. The conclusion of a loan agreement in anticipation of the construction of
an asset does not necessarily give rise to ‘expenditure’.
The average carrying amount of an asset during a period, including borrowing costs
capitalised earlier, shall be used when the capitalisation rate for a period is applied to the
carrying amount of an asset. This will be the case where borrowing costs and expenditure
are funded out of a pool of funds (general loans) and interest is not funded out of other
surplus cash resources (i.e., interest is funded out of the pool of funds).
12.4.3.3 Activities necessary to prepare the asset for its intended use or sale
are in progress
‘Activities’ is used in a broad context, and includes more than just the physical
construction of the asset. It also includes technical and administrative work prior to the
commencement of the physical construction, for example obtaining permits or council
approval prior to construction. If the asset is merely ‘owned’ and no construction or
development is taking place, the requirement is deemed not to have been met. For example,
borrowing costs incurred while land is under development are capitalised during the
period in which activities related to the development are undertaken. However, borrowing
costs incurred while land acquired for development is held without any associated
development activity, do not qualify for capitalisation.
Example 12.1 Date of commencement of capitalisation of borrowing cost
Loaner Limited decides on 1 January 20.12 to erect a building. The current cash position of the
entity is not sufficient to erect the building without securing additional borrowed funds.
On 1 February 20.12, a loan is approved by NBF Bank and an amount of R10 000 000 is paid over
to Loaner Ltd on 30 April 20.12 in terms of the loan agreement. The loan bears interest at a
market-related interest rate of 12% per annum.
continued
Borrowing costs 303
On 1 March 20.12, the entity obtains approval from the metro council to erect a building on the
relevant plot, and on 2 March 20.12, the architects commence planning the building. On
1 April 2012, planning has advanced to such an extent that site preparation takes effect. The entity
and the architects, as well as the site preparation personnel, agreed that the first payment would
be made on 30 April 20.12 – the date on which the additional funding is received.
In terms of IAS 23.17, capitalisation must commence as soon as the entity has incurred borrowing
costs as well as expenditures for the asset, and the activities necessary to prepare the asset for its
intended use (or sale) have commenced.
On 1 March 20.12, as soon as the entity had obtained permission to erect the building, the
activities necessary to prepare the asset for its intended use had commenced. Expenditures are
incurred from 2 March 20.12, when the architects and site preparation personnel commence with
their activities. From 30 April 20.12, interest (borrowing costs) will be incurred. On 30 April 20.12, all
the conditions of IAS 23.17 are met, and therefore borrowing costs will be capitalised from that date.
12.4.4 Suspension of capitalisation

Where the active development of qualifying assets is interrupted for extended periods,
the capitalisation of borrowing costs is suspended until the active development resumes.
Capitalisation of borrowing costs is not normally suspended during a period when
substantial technical and administrative work is carried out. The capitalisation is also not
suspended for short interruptions in activities due to external factors, for example ongoing
bad weather and delays inherent in the acquisition process of an asset. If it is necessary to
age inventory, capitalisation will continue.
A measure of judgement is often required, as IAS 23 does not explain terms such as
‘extended period’ and ‘active development’. A general rule of thumb is to consider whether
the events causing the interruption are under the control of management. Events beyond the
control of management do not normally lead to the suspension of capitalisation, whereas
events caused by incorrect planning and other management inefficiencies may indicate that
capitalisation should be suspended.
12.4.5 Cessation of capitalisation

The capitalisation of borrowing costs ceases when substantially all activities necessary to
prepare the qualifying asset for its intended use or sale are complete. Even though
routine administrative work may still continue, capitalisation will cease once substantially all
activities are completed, usually when physical construction is complete. Note that the
cessation of capitalisation is linked to completeness and readiness, rather than the actual
dates when the asset is brought into use or is sold.
When the construction of an asset is completed on a piecemeal basis, it is possible that one
part may be completed for its intended use while construction continues on the other parts.
In this instance, capitalisation is ceased on the part that is completed. Where all parts need
to be completed before any part can be used or sold, capitalisation continues until the
construction as a whole is substantially complete. An example of the above is a production
plant in which production takes place in a specific sequence in different sections of the plant
and where the product is only complete once it has passed through all the sections.
12.4.6 Limit on capitalisation

A limit is placed on the capitalisation of borrowing costs for general loans, in that the amount
of borrowing costs capitalised during a period must not exceed the total amount of
borrowing costs incurred during that period. This limit may arise because of the
weighted average capitalisation rates and averaged expenditure used in the calculation. In
consolidated financial statements, the limit is established with reference to the consolidated
amount of borrowing costs.
This does not imply, however, that all borrowing costs may be capitalised. Only the
borrowing costs that are directly attributable to the acquisition, construction or production of
a qualifying asset or that would have been avoided if the expenditure on the qualifying asset
had not been incurred but rather utilised to redeem existing loans, qualify for capitalisation.
On some projects, the financing arrangements for specific loans are such that the entity has
to pay borrowing costs on the full amount of the loan from the date specified in the
agreement. Surplus funds that are not utilised immediately are then invested temporarily
until required. Such investment income must be offset against the actual borrowing costs
incurred, in order to determine the amount of borrowing costs to be capitalised. If the
borrowed funds are paid into a bank overdraft on a temporary basis, the interest saved shall
theoretically also qualify as ‘investment income’ for these purposes.
12.4.7 Total cost of the qualifying asset exceeds the recoverable amount
Capitalisation may result in the carrying amount or the expected ultimate cost of a qualifying
asset exceeding its recoverable amount or net realisable value. In this case, capitalisation
continues. If the carrying amount exceeds the recoverable amount or net realisable amount,
the impairment or write-down is treated in accordance with IAS 36 or IAS 2. Such
impairment or write-down may subsequently be reversed in accordance with these Standards.
Where assets are revalued, the historical cost and capitalised borrowing costs are replaced
by the revalued amount.
12.5 Capitalisation procedures

The principle applied in IAS 23 is that the part of borrowing costs that must be capitalised is
that part which would have been avoided if the company had not incurred the expenditure
on that particular qualifying asset. Any technique that complies with this principle is
acceptable. Where specific loans were incurred in order to construct the asset, it is fairly
easy to identify the borrowing costs. By contrast, where a company or group with a complex
financing structure is involved in the construction of a qualifying asset, it becomes
progressively more difficult to determine the amount of borrowing costs that must be
capitalised. In these circumstances, it is important that the technique used to determine the
borrowing costs is the one that best meets the abovementioned principle.
The procedures for the calculation of the borrowing costs to be capitalised can usually be
carried out as follows:
Specific financing related to the project
Specific loan:
– calculate the interest on the total loan amount from the date that the loan was
advanced;
– determine the utilisation of the loan funds for the expenses incurred on the project;
– calculate the surplus funds and the interest income;
– deduct the interest income from the interest cost; and
– capitalise this net interest cost to the qualifying asset.
Bank overdraft and mortgage loan:
– determine the utilisation of the overdraft facility/mortgage for the expenses incurred on
the project (this represents the borrowing amount);
– calculate the interest on this borrowing amount (note that no interest income can be
earned on a bank overdraft/mortgage loan, since no surplus funds are invested); and
– capitalise this interest cost to the qualifying asset.
General pool of funds
determine the borrowing costs on loans/bank overdrafts/mortgage loans included in the
pool of funds;
Borrowing costs 305
determine the weighted average capitalisation rate of general loans;

determine the expenditure incurred on the qualifying asset not funded out of specific
funding or surplus cash funds that may be available since interest will not be incurred;
apply the capitalisation rate to the (weighted) expenditure of the qualifying asset to
calculate the borrowing costs that can be capitalised; and
check that this borrowing cost amount does not exceed the amount of actual borrowing
costs incurred.
Because the borrowing costs that may be capitalised are those that could have been
avoided had the company not incurred expenditure on the particular asset, notional
borrowing costs (income lost due to funds that could have been invested productively being
used for construction purposes) are not capitalised. It is also inappropriate to merely use the
market-related interest rate, which may not approximate the actual rate paid. It is however,
acceptable that the ratio of total borrowing costs to the total outstanding loans be used to
calculate a weighted average rate. Actual rates or a weighted rate, or a combination thereof,
may therefore be used. The terms of the loan agreement determine whether compound or
simple interest is calculated, and over what periods interest is payable.
12.5.1 Weighted average expenditure

It is important to consider when the expenditure on the qualifying assets was incurred. It
may be incurred at the beginning, or evenly throughout the period, or at the end of the
period. When expenses were incurred evenly through a period, a weighted average of
expenditure for the period under discussion is calculated.
12.5.2 Specific financing
Example 12.2 Specific loan: elementary application
The following information is presented:

R
Budgeted cost of the project to construct plant 4 000 000
Expenses incurred evenly during the year ended 30 June 20.12 2 400 000
A loan of R4 000 000 was obtained to finance the project on 1 July 20.11 at an interest rate of
20% per annum. This loan was negotiated specifically for this project. Interest on any surplus
funds invested is earned at 16% per annum. Interest of R800 000 and R448 000 respectively were
paid and received on 30 June 20.12. The year end of the company is 30 June. The loan capital is
repayable after 10 years. The amount that must be capitalised for a specific loan is the actual
borrowing cost incurred, less investment income earned from the temporary investment of the
surplus cash funds of the specific loan
The borrowing costs that must be capitalised to the plant for the year ended 30 June 20.12 are as
follows:
R
Borrowing costs incurred for the year 800 000
Interest received on surplus funds invested (448 000)
Borrowing costs capitalised 352 000
Journal entry:
Dr Cr
R R
Property, plant and equipment (SFP) 352 000
Interest paid (P/L) 352 000
Borrowing costs capitalised
12.5.3 General pool of funds

Where general loans are raised that are used for a variety of purposes (including the
construction of a qualifying asset), the capitalisation rate is the weighted average of the
borrowing rates applicable to the outstanding loans of the entity during the period. The
borrowing costs on specific loans used to construct a qualifying asset are excluded from this
calculation, as these are capitalised fully in any event.
During October 2015, the International Accounting Standards Board (IASB) agreed to clarify
the wording in IAS 23 to include funds specifically borrowed to finance the construction of a
qualifying asset, the construction of which has been completed, to be included as part of the
general borrowings for the purposes of determining the capitalisation rate of the entity’s
general borrowings.
Example 12.3 Pool of funds: elementary application
Assume the same information as in example 12.2 above

Apart from the loan of R4 000 000 the entity also has another loan of R2 000 000 at an interest
rate of 16% per annum. Neither of the loans were specifically obtained for the project to construct
the plant.
First a weighted average interest rate is calculated;
Interest
R R
First loan 4 000 000 800 000 (4 000 000 × 20%)
Second loan 2 000 000 320 000 (2 000 000 × 16%)
Total 6 000 000 1 120 000
R
Weighted average interest rae 18,67% (1 120 000/6 000 000 × 100/1)
Borrowing costs capitalised:
Borrowing costs based on expenses incurred (2 400 000/2 × 18.67%) 224 040
Journal entry:
Dr Cr
R R
Borrowing costs capitalised
12.5.4 Combination – specific and general loans

Where a specific loan is raised for a particular project, but the loan is insufficient to finance
the full project, general loans on which borrowing costs are payable may also be used. The
specific loans are utilised first to cover the expenditure of the asset, and the balance of
expenditure is attributed to general loans.
12.5.5 Group statements

In group financial statements, several problems may exist regarding the identification of the
loans on which the capitalisation rate will be determined. These problems arise in complex
circumstances, where different companies in the group borrow money in different markets
and lend these monies to companies within the group on different bases. Usually, each
subsidiary uses the rates applicable to its loans. In consolidated financial statements, the
borrowing rates of the loans made to the group by third parties are used. The difference
between the borrowing cost reognised by individual companies and what it should be for
consolidated financial statments should be reversed upon consolidation.
Borrowing costs 307
Example 12.4 Capitalising borrowing costs in groups
Assume that the interest capitalised in the subsidiary’s separate financial statements is R831 000
and in the consolidated financial statements it should have been R763 000 due to the lower
weighted average interest rates of the group.
Consolidation journal entry
Dr Dr
R R
Capital expenditure (SFP) 68 000
Adjustment of borrowing costs capitalised
Recorded by subsidiary 831 000
Required in consolidated financial statements 763 000
Reversal of entry 68 000
12.5.6 Foreign exchange differences

In IAS 23.6(e), borrowing costs may include exchange differences arising from foreign
currency borrowings, to the extent that they are regarded as adjustments to interest costs.
Consequently, not all exchange differences qualify for capitalisation. In general, the interest
on a foreign currency loan that is directly attributable to a qualifying asset must be converted
to the functional currency, and qualifies for capitalisation as borrowing costs. The treatment
of exchange differences arising on the principal amount of the loan is less clear. If it is
assumed that exchange rates are usually a function of the differential interest rate between
different countries, it may be argued that the full amount of exchange differences qualify for
capitalisation, yet market volatility indicates that market sentiment and other factors also
influence exchange rates, and these elements of exchange differences do not qualify for
capitalisation in terms of IAS 23. Consequently, how an entity applies IAS 23 to foreign
currency borrowings is a matter of accounting policy, requiring the exercise of judgement.
It is therefore prudent to limit the exchange differences on the capital amount of borrowings
that qualifies for capitalisation to the amount of borrowing costs that would have been
incurred on the functional currency equivalent borrowings in the functional currency. The
next example explains this interpretation.
Example 12.5 Treatment of foreign exchange differences
Alpha Ltd, a company with a financial year ending on 31 December, conducts business in South
Africa. On 1 January 20.12, the company borrows FC1 000 000 to finance the development of a
qualifying asset of R2 000 000 in South Africa. Interest on the foreign loan is payable at 8% per
annum in arrears, while the equivalent interest rate on such a loan in South Africa is 12% per
annum in arrears. It is the policy of Alpha Ltd to include the foreign exchange gains or losses on
the principal amount of the loan and interest expense accrual (if any) in borrowing cost. It is also
the policy of Alpha Ltd to limit the borrowing costs capitalised to the amount of borrowing costs
that would have been incurred on equivalent borrowings in the functional currency. The exchange
rates are as follows:
FC1 = R
1 January 20.12 2,00
31 December 20.12 3,00
Average for the year 2,50
The actual interest payable (8% × FC1 000 000) FC80 000
Translated at 2,50 R200 000
If the loan had been incurred in South Africa:
Equivalent of FC1 000 000 on 1 January 20.12 @ 2,00 R2 000 000
Interest (12% × R2 000 000) R240 000
Restatement of principal amount:
1 January 20.12 (FC1 000 000 × 2,00) R2 000 000
31 December 20.12 (FC1 000 000 × 3,00) R3 000 000
Exchange difference on principal amount R1 000 000
Total amount of borrowing costs capitalised are limited to R240 000
Where a foreign loan is hedged by a forward exchange contract (FEC), the exchange
differences are not treated as borrowing costs for capitalisation, as this will disturb the
matching of the income and expenses of the hedged relationship. The FEC is accounted for
in accordance with IFRS 9.
12.6 Tax implications

As a result of differences between the income tax and accountancy treatment of pre-pro-
duction interest, temporary differences may arise. The Income Tax Act 58 of 1962 allows a
deduction for pre-trade expenses in terms of section 11A. Section 11A allows for a
deduction of qualifying expenditure and losses incurred before the commencement of that
trade once a trade is carried on.
If a taxpayer already carries on a trade, the pre-production expenses may be deducted in
terms of the general deduction formula (section 11(a)) or may be regarded to be of a capital
nature and form part of the base cost of the asset.
Example 12.6 Deferred tax on borrowing costs and pre-trade expenditure
Alpha Ltd has a qualifying asset of which the borrowing costs are capitalised. The following
expenses were incurred at the beginning of each year on the qualifying asset:
R
Year 1 80 000
Year 2 150 000
Year 3 200 000
Year 4 120 000
550 000
continued
Borrowing costs 309
Alpha Ltd started trading at the beginning of Year 5 and the asset is depreciated at 15% per
annum on a straight-line basis. South African Revenue Service (SARS) allows a wear-and-tear
allowance at 20% on cost, and the normal income tax rate is 28%. The borrowing cost is allowed
as a pre-trade expenditure in terms of section 11A. The following borrowing costs on the asset were
capitalised:
R
Year 1 12 000
Year 2 24 000
Year 3 30 000
Year 4 16 800
82 800
Deferred tax
Carrying Temporary
Tax base
amount difference
R R R
Year 5 *537 880 **440 000 97 880
Deferred tax liability (97 880 × 28%) 27 406
* Carrying amount
Cost 550 000
Capitalised (interest) 82 800
632 800
Depreciation (632 800 × 15%) (94 920)
537 880
** Tax base
Cost (excluding borrowing costs capitalised) 550 000
Wear-and-tear (550 000 × 20%) (110 000)
440 000
Comment
¾ The taxable temporary difference arose as follows:
R
Depreciation 94 920
Wear-and-tear (110 000)
Pre-trade interest (borrowing costs capitalised) (82 800)
(97 880)
¾ If the asset is depreciated for accounting purposes, but no wear-and-tear allowance is allowed
for tax purposes, the temporary difference that arises between the carrying amount and the tax
base, excluding the element of borrowing cost, will be exempt from deferred tax. However, the
temporary difference arising from the capitalised borrowing cost and the pre-trade interest will
result in a deferred tax liability. The current tax calculation will be as follows:
R
Profit before tax xxx
Non-deductible expenses 82 500
Depreciation (550 000 × 15%) 82 500
Movement in temporary differences (70 380)
The movement in temporary differences may be broken down as follows:
Depreciation on borrowing cost component (82 800 × 15%) 12 420
Pre-trade interest (82 800)
Taxable income xxx

Example 12.7 Deferred tax on borrowing costs
The following are the details of a plant that is used in the production of income on which SARS
grants a section 12C (40:20:20:20) deduction on 31 December 20.12.
R
Cost 1 495 400
Capitalised borrowing cost 275 000
1 770 400
Depreciation at 10% per annum on cost (1 770 400 × 10% × 6/12) (88 520)
Carrying amount 1 681 880
The plant was available for use and was brought into use on 30 June 20.12. The plant is used to
expand an existing business. The normal income tax rate is 28% and the borrowing costs were
deducted for tax purposes in terms of the general deduction formula.
Deferred tax is calculated as follows:
Borrowing
Cost
Total cost
element
element
R R R
Cost 1 770 400 1 495 400 275 000
Depreciation (88 250) (74 770) (13 750)
Carrying amount 1 681 880 1 420 630 261 250
Tax base (1 495 400 – 598 160 (1 495 400 ×40%) 897 240 897 240 –
Temporary difference 784 640 523 390 261 250
Deferred tax at 28% 219 699 146 549 73 150
12.7 Disclosure
The following aspects must be disclosed separately:
the policy regarding the capitalisation of borrowing costs;
the capitalisation rate used to determine the amount of borrowing costs of general loans
to be capitalised (IAS 23.26(b)); and
the amount of borrowing costs capitalised during the period (IAS 23.26(a)).
Example 12.8 Disclosure of borrowing costs capitalised
Entity A erected a plant on which borrowing costs are capitalised at 12,5% per annum during the
year ended 30 June 20.12. The carrying amount of the asset, including borrowing costs of
R125 000 (interest expense of R150 000 minus investment income earned of R25 000), amounts
to R1 125 000. The total finance costs incurred for the year amount to R200 000.
The above facts will be disclosed as follows in the notes to the financial statements for the year
ending 30 June 20.12:
1 Accounting policy
1.1 Borrowing costs
Borrowing costs incurred on qualifying assets in terms of the requirements of IAS 23 are
capitalised from the date on which the borrowing costs, as well as expenditures for the asset, are
incurred. In addition, the activities necessary to prepare the asset for its intended use or sale must
have commenced. Capitalisation ceases as soon as the activities necessary to prepare the asset
for its intended use are completed.
continued
Borrowing costs 311
10 Finance costs
R
Borrowing costs incurred (Disclosure not required by standard) 200 000
Borrowing costs capitalised (125 000)
(Disclosure not required by standard) 75 000
During the year, the entity capitalised borrowing costs at a rate of 12,5% per annum.
16 Property, plant and equipment
(Extract from this note if it is assumed that the entity owns only this plant and that the plant was
available for use as intended by management only on the last day of the financial year – therefore
no depreciation is written-off).
Plant
R
Carrying amount on 1 July 20.11 –
Cost –
Accumulated depreciation –
Movements during the year 1 125 000
Additions (1 125 000 – 125 000 (borrowing costs)) 1 000 000
Borrowing cost capitalised 125 000
Carrying amount on 30 June 20.12 1 125 000
Cost 1 125 000

Accumulated depreciation –
CHAPTER
13
Related party disclosures
(IAS 24)
Contents
13.1 Overview of IAS 24 Related Party Disclosure ................................................... 314
13.2 Background ..................................................................................................... 314
13.3 Identifying related parties ................................................................................ 315
13.3.1 A person or close family member .................................................... 316
13.3.2 Entities controlled, jointly controlled or significantly influenced
by certain related individuals ........................................................... 316
13.3.3 Key management personnel ............................................................ 316
13.3.4 The entity and the reporting entity are members of the same
group................................................................................................ 317
13.3.5 Parties with significant influence ...................................................... 317
13.3.6 Parties with joint arrangements ....................................................... 318
13.3.7 Related parties (subsidiaries, associates and joint ventures) .......... 319
13.3.8 Post-employment benefit plan ......................................................... 320
13.3.9 Entities deemed not to be related parties ........................................ 321
13.4 Related party transactions .............................................................................. 322
13.5 Disclosure........................................................................................................ 323
13.5.1 Disclosure of related party relationships .......................................... 323
13.5.2 Disclosure of key management personnel compensation ............... 324
13.5.3 Disclosure of related party transactions .......................................... 324
13.5.4 Government-related entities ............................................................ 325
13.5.5 Suggested format for disclosure of related party transactions ........ 326
13.6 Materiality ........................................................................................................ 326
13.7 Comprehensive example ................................................................................ 327
313
13.1 Overview of IAS 24 Related Party Disclosure
IAS 24
Related party Disclosure
KMP
Persons Entities Relationships Transactions
compensation
Persons who Parent, Show Show total In respect of

control, jointly Subsidiaries, relationship compensation various
control and Fellow with: under categories,
influence subsidiaries, Parent following disclose the
significantly Joint ventures, categories: following:
Subsidiaries
Persons who Associates, Short-term, Relationship
Benefit plans, Fellow other long-
are key subsidiaries Nature
management Ventures; and term,
Entities which post- Amount
personnel
(KMP) of the influence employment, Amounts
entity or its significantly. termination outstanding
parent Entities benefits Allowance for
controlled or Share-based credit losses
jointly payments Credit losses
controlled by
written off
persons who
are related.
Entities
that are
significantly
influenced by
persons who
control or
jointly control
the entity or
identified KMP
13.2 Background
The qualitative characteristic of financial reports known as faithful representation, implies,
inter alia, that the information contained in the reports faithfully represents that which it
purports to represent. It means that the financial reports represent the result of transactions
between independent parties on a normal arm’s length basis, unless the opposite is
stated. If transactions take place other than on a normal arm’s length basis, this should be
disclosed in the financial statements. Related party transactions are sometimes not at arm’s
length and are transactions that involve the transfer of resources, services or obligations
between related parties, regardless of whether a price is charged (IAS 24.9).
The closing of transactions on terms different to those normally applicable in the market
often occurs between parties that are ‘related’. As reporting for accounting purposes is
usually based on the values agreed upon by the parties to the transaction, which are not
necessarily the values determined in the free market, the financial statements of entities with
Related party disclosures 315
material related party transactions may not be comparable with the statements of entities
without these types of transactions. A related party relationship could also have a significant
influence on the financial position and operating results of the reporting entity, as these
parties are often involved in transactions that unrelated parties would not enter into. Even
the mere existence of such a relationship without any transactions may be sufficient to affect
the transactions of the reporting entity with other parties.
For these reasons, knowledge of related party transactions, outstanding balances and
relationships may affect assessments of an entity’s operations by users of financial
statements, including assessments of the risks and opportunities facing the entity.
The objective of IAS 24 is therefore to ensure that an entity’s financial statements contain
the disclosures necessary to draw attention to the possibility that its financial position and
profit or loss may have been affected by the existence of related parties and by transactions
with, and outstanding balances of, such parties (IAS 24.1).
Unusual transactions, for example mass sales, the exchange of assets, transactions of a
non-recurring nature and transactions where the risks of ownership do not pass to the
buyer, are often indicative of the existence of related party relationships. Sometimes,
transactions between related parties, for example free management services or an
advertising campaign that benefits several companies in a group, where the costs are borne
by one company, are not recorded.
The Standard is applied in (IAS 24.2):
identifying related party relationships and transactions;
identifying outstanding balances (including commitments) between an entity and its
related parties;
identifying the circumstances in which disclosure of related party relationships,
transactions and outstanding balances between an entity and its related parties is
required; and
determining the disclosure requirements of these items as above.
The Standard also requires that related party transactions and outstanding balances between
related parties should be disclosed in the consolidated and separate financial statements
of a parent or investors with joint control of, or significant influence over an investee
(IAS 24.3) presented in terms of IFRS 10 Consolidated Financial Statements and IAS 27
Separate Financial Statements. This Standard also applies to individual financial statements.
Since intragroup-related party transactions and outstanding balances are eliminated in the
consolidated financial statements of a group, such transactions and balances are only
disclosed in the entity’s own financial statements (IAS 24.4).
13.3 Identifying related parties

A related party is a person or entity that is related to the entity that is preparing its
financial statements (referred to as the ‘reporting entity’).
A person or close member of that person’s family is related to a reporting entity if that
person (IAS 24.9(a)):
has control or joint control over the reporting entity; or
has significant influence over the reporting entity; or
is a member of the key management personnel of the reporting entity or its parent.
An entity is related to a reporting entity if any of the following conditions apply (IAS 24.9(b)):
the entity and the reporting entity are members of the same group; or
one entity is an associate or joint venture of the other entity; or
both entities are joint ventures of the same third entity; or
one entity is a joint venture of a third entity and the other entity is an associate of the
third entity; or
the entity is a post-employment benefit plan for the benefit of employees of either the
reporting entity or an entity related to the reporting entity. If the reporting entity is itself
such a benefit plan, the sponsoring employers are also related to the reporting entity; or
the entity is controlled or jointly controlled by a person identified in paragraph 9(a) of
IAS 24 as discussed above; or
a person who has control or joint control over the reporting entity has significant
influence over the entity or is a member of the key management personnel of the entity
(or of a parent of the entity).
the entity, or any member of a group of which it is a part, provides key management
personnel services to the reporting entity or to the parent of the reporting entity.
In considering each possible related party relationship, attention is directed to the
substance of the relationship and not merely its legal form (IAS 24.10). Elements of the
definition of a related party are discussed in more detail below.
13.3.1 A person or close family member

Close members of the family of a person are those family members who may be expected to
influence or to be influenced by that person in their dealings with the entity. These close
members of the family of a person include:
that person’s children and spouse or domestic partner;
children of that person’s spouse or domestic partner; and
dependants of that person or that person’s spouse or domestic partner (IAS 24.9).
In other words, they are close members of a family of individuals who have control,
significant influence or joint control over the entity or key management personnel.
The intention of this component of the definition of a related party is to prevent entities from
transacting with close members of family rather than with individuals in order to avoid the
disclosure required by the Standard.
13.3.2 Entities controlled, jointly controlled or significantly influenced

by certain related individuals
Entities are related if they are:
controlled or jointly controlled by persons identified in IAS 24.9(a); or
significantly influenced by persons controlling or jointly controlling the reporting entity; or
by key management personnel of the reporting entity or its parent.
This part of the definition is intended to prevent entities from avoiding the disclosure
requirements of the Standard by transacting with entities that are controlled, jointly
controlled or significantly influenced by the individuals, instead of transacting with the
individuals themselves.
13.3.3 Key management personnel

‘Key management personnel’ is defined as those persons having authority and responsibility
for planning, directing and controlling the activities of the entity, directly or indirectly,
including any director (whether executive or otherwise) of that entity (IAS 24.9).
Any executive or non-executive director of an entity will be a related party of that entity.
Other individuals that are not directors could also be a related party of the entity if they have
the authority and responsibility for planning, directing and controlling the activities of the
entity.
Example 13.1 Related individuals
Mr A is a non-executive director of Entity B. He owns 100% of the issued share capital of Entity C.
The related parties of Entity B are:
Mr A is a related party of Entity B as he is a member of key management personnel (non-
executive director).
Entity C is a related party of Entity B, as Entity C is controlled by a member of the key
management personnel of Entity B (Mr A owns 100% of Entity C).
Entity B will have to disclose transactions with Mr A and Entity C.
Both Mr A and Entity B are also related parties of Entity C. Mr A controls Entity C (IAS 24.9(a)(i)).
Since he controls Entity C and is also a member of the key management personnel of Entity B
(IAS 24.9(b)(vii), Entity B is also a related party of Entity C.
Entity C will have to disclose transactions with Mr A and Entity B.
13.3.4 The entity and the reporting entity are members of the same group
The entity and the reporting entity are members of the same group which means that each
parent, subsidiary and fellow subsidiary within a group is related to the other entities within
the group.
A party is thus related to a reporting entity if it is controlled by the reporting entity. The
definition of control of an investee as per IFRS 10 Consolidated Financial Statements is as
follows:
An investor has power over the investee; and
an investor is exposed, or has rights, to variable returns from its involvement with the
investee; and
the investor has the ability to affect those returns through its power over the investee.
Example 13.2 Members of the same group
Parent A has control over subsidiary B and subsidiary C.

In the separate financial statements of parent A, both subsidiary companies B and C will be
disclosed as related parties to the parent as they are controlled by the parent.
In the separate financial statements of subsidiary B:
Parent A will be disclosed as a related party, as the parent A controls subsidiary B.
Subsidiary C will be disclosed as a related party as it is under common control, that is, both
subsidiary B and subsidiary C are controlled by the same entity.
On similar grounds, parent A and subsidiary B will be disclosed as related parties in the separate
financial statements of subsidiary C.
It should however be noted that the reference to ‘a party’ in this context is not limited to corporate
entities only, as individuals are also able to control an entity.
13.3.5 Parties with significant influence

‘Significant influence’ means the power to participate in the financial and operating policy
decisions of the other party, but not to control or have joint control of those policies. This
significant influence may be gained by share ownership, statute or agreement.
The discussion of significant influence contained in IAS 28 Investments in Associates and
Joint Ventures states that if an entity holds, either directly or indirectly (e.g. through
subsidiaries), 20% or more of the voting power of the investee, it is normally presumed to
have significant influence (IAS 28.5).
It should be noted that investments held by venture capital organisations or mutual funds,
unit trusts and similar entities that are not equity-accounted under IAS 28, are also included
in this definition of significant influence.
13.3.5.1 Reporting entity is an associate
A party is related to an entity if the party holds an interest in the reporting entity and
exercises significant influence over that entity (an associate).
An associate is defined by IAS 28 Investments in Associates and Joint Ventures as an entity
over which the investor has significant influence.
Example 13.3 Significant influence over associate
Entity A has a 30% interest, constituting significant influence, in Entity B.

Entity B must disclose in its financial statements that Entity A is a related party.
13.3.5.2 Reporting entity is an investor

A party is related to an entity if the party is an associate of the reporting entity (IAS 24.9(b)(ii)).
Example 13.4 Investor with significant influence
Entity A has a 30% interest, constituting significant influence, in Entity B.

In Entity A’s financial statements, Entity B will be disclosed as a related party.
13.3.6 Parties with joint arrangements

A joint arrangement is an arrangement in which two or more parties have joint control
(IFRS 11.4 Joint Arrangements).
Joint control is defined as the contractually agreed sharing of control of an arrangement,
which exists only when decisions about the relevant activities require the unanimous
consent of the parties sharing control (IFRS 11.7).
13.3.6.1 Reporting entity is the joint venture
A party is related to a reporting entity if it has joint control over the reporting entity.
Example 13.5 Entity is jointly controlled
Entity A has a 45% interest in Entity B and exercises joint control over Entity B in terms of a
contractual arrangement with another party.
In Entity B’s financial statements, Entity A will be disclosed as a related party.
13.3.6.2 Reporting entity has joint control

An entity is related to a reporting entity if one entity is a joint venture of the other entity
(IAS 24.9(b)(ii)).
Example 13.6 Entity has joint control
Entity A has a 45% interest in Entity B and exercises joint control over Entity B in terms of a
contractual arrangement with another party.
In Entity A’s financial statements, Entity B will be a related party.
13.3.7 Related parties (subsidiaries, associates and joint ventures)

In the definition of a related party:
an associate includes subsidiaries of the associate; and
a joint venture includes subsidiaries of the joint venture.
Therefore, an associate’s subsidiary and the investor that has significant influence over the
associate, are related to each other.
Two or more venturers are not related parties simply because they share joint control over a
joint venture (IAS 24.11(b).
Relationships between a parent and its subsidiaries must be disclosed irrespective of
whether there have been transactions between them.
Example 13.7 Associates and joint ventures of the same third party
The following entities are part of the Entity A Group:

Entity A
45% 35%
Entity B Entity C
(joint venture) (associate)
The following related parties are identified and disclosed in the separate financial statements of
each entity within the group:
Entity A’s (separate) financial statements
Entity B (joint venture) and Entity C (associate) are related parties of Entity A.
Entity B’s financial statements
Entity A and Entity C are related parties of Entity B.
Entity C’s financial statements
Entity A and Entity B are related parties of Entity C.
Comment
¾ An entity is a related party of the reporting entity if one of the entities is a joint venture of a third
party and the other entity is an associate of the third party.
¾ The parties Entity B (joint venture) and Entity C (associate) are related according to
paragraph 9(b)(iv) of the related party definition. If both Entity B and Entity C had been
associates, then these two entities would not have been related parties.
Example 13.8 Subsidiaries, associates and joint ventures
The following entities are part of the Entity A Group:

Entity A
(parent)
80% 65% 35% 45%

Entity B Entity C Entity D Entity E
(subsidiary) (subsidiary) (associate) (joint venture)
25%
Entity F
(associate)
continued
The following related parties are identified and disclosed in the separate financial statements of
each entity within the group:
Entity A’s (parent) separate financial statements
Entity B (subsidiary), Entity C (subsidiary), Entity D (associate), Entity E (joint venture) and
Entity F (associate of Entity B) are related parties. (Refer to IAS 24, paragraph 9(b)(i) and (ii)).
Entity A’s consolidated financial statements
In the consolidated financial statements of A, only Entity D, E and F are related parties to the
group, as they are regarded as one reporting entity (and all the intragroup transactions between
Entity A (parent) and Entity B and C (subsidiaries) are eliminated).
Entity D is a related party of Entity A, as it is an associate of Entity A.
Entity E is also a related party of Entity A, as it is a joint venture of Entity A.
Entity F is a related party of Entity A, as it is an associate of Entity B which is a subsidiary of
Entity A.
Entity B’s financial statements
The parent, Entity A, Entity C (subsidiary of Entity A), Entity D (associate of Entity A) and Entity E
(joint venture of Entity A) and Entity F (associate of Entity B) are related parties (refer to IAS 24,
paragraph 9(b)(i) and (ii)).
Entity C’s financial statements
The parent, Entity A, Entity B (subsidiary of Entity A), Entity D (associate of Entity A) and Entity E
(joint venture of Entity A) and Entity F (associate of Entity B) are related parties (refer to IAS 24,
paragraph 9(b)(i) and (ii)).
Entity D’s financial statements
Entity A is a related party of Entity D as it exercises significant influence over Entity D.
Entity E is a related party of Entity D as it is a joint venture of Entity A (IAS 24(b)(iv).
Entity A is a related party of Entity D (IAS 24(b)(ii) and as a result Entity B and Entity C are related
parties of Entity D as they are all members of the Entity A group.
Entities F is not a related party of Entity D as none of the components of the definition of a related
party are applicable (also refer IAS 24.IE7).
Entity E’s financial statements
Entity A is a related party of Entity E as it exercises joint control over Entity E.
Entity D is a related party of Entity E as it is an associate of Entity A (IAS 24(b)(iv).
Entity A is a related party of Entity E and as a result Entity B and Entity C are related parties of Entity
E as they are all members of the Entity A group (IAS 24(b)(ii).
Entities F is not a related party of Entity E as none of the components of the definition of a related
party are applicable.
Entity F’s financial statements
Entity B is a related party of Entity F as it exercises significant influence over Entity F.
Entity A is a related party of Entity F as it controls Entity B.
Entity C is a related party of Entity F as Entity F is an associate of Entity B which is in the same group
of Entities as Entity C.
Entities D and E are not related parties as none of the components of the definition of a related party
are applicable.
13.3.8 Post-employment benefit plan

A party is related to an entity if the party is a post-employment benefit plan for the benefit of
the employees of either the reporting entity, or of an entity that is a related party to the
reporting entity. If the reporting entity is itself a plan, the sponsoring employers are also
related to the reporting entity (refer to IAS 24.9(b)(v)).
Example 13.9 Post-employment plan
Fund A has been created for the benefit of the employees of Entity A and Fund B has been
created for the benefit of the employees of Entity B, which is a subsidiary of Entity A.
Fund A and Fund B are related parties of Entity A.
13.3.9 Entities deemed not to be related parties

IAS 24.11 determines that the following are not necessarily related parties:
two entities, simply because they have a director or other member of key management
personnel in common, or because a member of key management personnel of one entity
has significant influence over the other entity; or
two joint venturers, simply because they share joint control over a joint venture; or
providers of finance, trade unions, public utilities and government departments and
agencies, simply by virtue of their normal dealings with an entity (even though they may
affect the freedom of action of an entity or participate in its decision-making process); or
a customer, supplier, franchisor, distributor or general agent with whom an entity
transacts a significant volume of business, merely by virtue of the resulting economic
dependence.
The use of the words ‘simply’ and ‘merely’ in the above context are extremely important, as
it indicates that other factors could result in the parties being related.
Example 13.10 Identifying related parties
The following figure shows the related parties of the# reporting entity, A Ltd. Related parties are
identified by*, while unrelated parties are identified by .
Example 1 Z Ltd*
Parent
Y Ltd*
A Ltd
Fellow subsidiary
Control Joint control Significant

influence
W Ltd* X Ltd* B Ltd* C Ltd* Jointly- D Ltd*
Subsidiary Associate Subsidiary controlled entity Associate
Significant
influence
E Ltd* F Ltd* M Ltd#

Subsidiary Associate Associate
K Ltd* L Ltd*
Subsidiary Associate
continued
Comment
¾ It can be argued that M Ltd (Example 1 above) does not qualify as a related party as A Ltd
exercises only significant influence over D Ltd and does not, as a result, exercise significant
influence over M Ltd. In each instance, one should consider the underlying circumstances and
the economic reality. If A Ltd should have significant influence over M Ltd, it is recognised as a
related party. If no such influence exists, M Ltd does not qualify as a related party.
Example 2
Q Ltd* Mr Y*
Parent CEO of Q Ltd
Significant S Ltd* Private company

influence Mr Y holds 100% of the shares
Control
R Ltd*
Associate
P Ltd#
A Ltd
Joint venturer
Joint control Joint control
Significant influence
H Ltd* G Ltd*
Associate Joint venture
Control
J Ltd*
Subsidiary
Comment
¾ When determining whether parties are related or not, the economic substance rather than the
legal form of the relationship should be considered. The aim of the disclosure of transactions with
related parties is to provide users of the financial statements with information on the risk profile of
¾ Where transactions are eliminated on consolidation, these transactions need not be disclosed.
The relationship between parents and subsidiaries should, however, still be disclosed.
¾ Where equity accounting results in the partial elimination of transactions, only the transactions
that are not eliminated should be disclosed. Examples include transactions with associates and
with jointly controlled entities.
13.4 Related party transactions

A related party transaction is a transfer of resources, services or obligations between a
reporting entity and a related party, regardless of whether a price is charged (IAS 24.9).
This definition therefore includes all transactions with related parties, irrespective of whether
they took place on an arm’s length basis or not. Relations with related parties may result in
substantial changes to the financial statements without any transactions being entered into.
A subsidiary may be prevented by its parent from conducting any research. IAS 24 does not
require that the effect of such influences, which do not lead to transactions, be determined,
and deals only with the disclosure of actual transactions.
IAS 24 provides the following examples of situations where transactions between related
parties should be disclosed by the reporting entity (IAS 24.21):
purchases or sales of goods (finished or unfinished);
purchases or sales of property and other assets;

rendering or receiving of services;
leases;
transfers of research and development;
transfers under license agreements;
transfers under finance agreements, including loans and equity contributions in cash or
in kind;
provision of guarantees or collaterals;
commitments to do something if a particular event occurs or does not occur in the future,
including recognised and unrecognised executory contracts (contracts under which neither
party has performed any of its obligations or both parties have partially performed their
obligations to an equal extent (IAS 37 Provisions, Contingent Liabilities and Contingent
Assets); and
settlement of liabilities on behalf of the entity or by the entity on behalf of that related party.
Related parties have a degree of flexibility in the price-setting process that is not present in
transactions between unrelated parties. IAS 24 does not require that the methods used for
transfer pricing between related parties should be disclosed.
The Standard states that disclosures that related party transactions were made on terms
equivalent to those that prevail in arm’s length transactions are made only if such terms can
be substantiated (IAS 24.23).
13.5 Disclosure
The disclosure requirements of IAS 24 address the following:
disclosure of related party relationships;
disclosure of key management personnel compensation; and
disclosure of other related party transactions.
13.5.1 Disclosure of related party relationships

All entities:
Relationships between a parent and its subsidiaries must be disclosed irrespective of
whether there were transactions between them (IAS 24.13).
An entity must disclose the name of its parent and, if different, the name of the ultimate
controlling party (IAS 24.13).
If neither the entity’s parent nor the ultimate controlling party produces consolidated
financial statements available for public use, the name of the next most senior parent
(the first parent in the group above the immediate parent that produces consolidated
financial statements available for public use (IAS 24.16)) that does so shall be disclosed
(IAS 24.13).
To enable users of financial statements to establish a view about the effects that related
party relationships have on an entity, it is appropriate to disclose the related party
relationship when control exists, irrespective of whether there have been transactions
between the related parties.
The requirement to disclose related party relationships between a parent and its subsidiaries
is in addition to the disclosure requirements in IAS 27 Separate Financial Statements and
IFRS 12 Disclosure of Interests in Other Entities.
13.5.2 Disclosure of key management personnel compensation

For this purpose, compensation includes all employee benefits as defined in IAS 19,
Employee Benefits, including share-based payments within the scope of IFRS 2,
Share-based Payment. Employee benefits are all forms of consideration paid in exchange
for services rendered to the entity. It also includes considerations paid on behalf of a parent
in respect of the entity.
IAS 24.17 requires disclosure of key management personnel compensation in total and for
each of the following categories:
short-term employee benefits, for example wages, salaries and social security
contributions, paid annual leave and paid sick leave, profit-sharing and bonuses (if
payable within twelve months of the end of the period) and non-monetary benefits for
example medical care, housing, cars and free or subsidised goods or services;
post-employment benefits, for example pensions, other retirement benefits, post-
employment life insurance and post-employment medical care;
other long-term benefits, for example long service leave or sabbatical leave, jubilee or
other long-service benefits, long-term disability benefits and, if they are not payable wholly
within twelve months after the end of the period, profit-sharing, bonuses and deferred
compensation;
termination benefits; and
share-based payments.
Amounts incurred by the entity for the provision of key management personnel services that
are provided by a separate management entity shall be disclosed, however the entity is not
required to apply the requirements in IAS 24.17 to the compensation paid or payable by the
management entity to the management entity’s employees or directors.
13.5.3 Disclosure of related party transactions

In terms of IAS 24, information about related party transactions and outstanding balances
necessary for an understanding of the potential effect of the relationship on the financial
statements should be disclosed.
At a minimum, disclosure must include (IAS 24.18):
the nature of the related party relationships;
the amount of the transactions;
the amount of outstanding balances, including commitments (distinguished between
payable to and receivable from) and
– their terms and conditions, including whether they are secured, and the nature of the
consideration to be provided in settlement; and
– details of any guarantees given or received;
provisions for doubtful debts related to the amount of outstanding balances, and
the expense recognised during the period in respect of bad or doubtful debts due from
related parties.
The abovementioned required disclosure must be presented for each of the following
categories (IAS 24.19):
the parent;
entities with joint control or significant influence over the entity;
subsidiaries;
associates;
joint ventures in which the entity is a venturer;

key management personnel of the entity or its parent; and
other related parties.
IAS 24 provides guidelines for the disclosure of transactions with related parties, but does
not require a specific format of presentation. Items of a similar nature may be disclosed in
aggregate, except when separate disclosure is necessary for an understanding of the
effects of related party transactions on the financial statements of the entity (IAS 24.24).
Professional judgement is required when deciding on the presentation of the disclosure of
transactions with related parties.
As the transactions between related parties that are equity-accounted are not normally
eliminated on consolidation, these related party transactions should be disclosed. The same
rule applies to joint ventures that are also accounted for under the equity method in terms of
IFRS 11 Joint Arrangements.
13.5.4 Government-related entities

A government-related entity is exempt from the disclosure requirements in relation to:
related party transactions and outstanding balances, including commitments, with a
government that has control, joint control or significant influence over the reporting entity;
and
transactions with another entity that is a related party because the same government has
control, joint control or significant influence over both the reporting entity and the other
entity (IAS 24.25).
If the exemption in IAS 24.25 is applied, the entity must disclose the following about the
transactions and related outstanding balances referred to above:
the name of the government and the nature of its relationship with the reporting entity
(i.e. control, joint control or significant influence);
the following information in sufficient detail to enable users of the entity’s financial
statements to understand the effect of related party transactions on its financial
statements:
– the nature and amount of each individually significant transaction; and
– for other transactions that are collectively, but not individually, significant, a qualitative
or quantitative indication of their extent (IAS 24.26).
In determining the level of detail to be disclosed, judgement should be applied. The
reporting entity will consider the closeness of the related party relationship and other factors
relevant in establishing the level of significance of the transaction. Factors to consider are
whether the transaction is:
significant in terms of size;
carried out on non-market terms;
outside normal day-to-day business operations, for example the purchase and sale of a
business;
disclosed to regulatory or supervisory authorities;
reported to senior management; and
subject to shareholder approval.
13.5.5 Suggested format for disclosure of related party transactions
The following diagram could serve as a useful aid in the disclosure of related party transactions:
Joint control,
Key
Joint significant
Parent Subsidiary Associate Other management
venture influence over
personnel
reporting entity
Transaction
amount
Outstanding
balance
Terms
Guarantees
Allowance
account for
credit losses
Bad debts
(SAICA)
13.6 Materiality
IAS 1.31 Presentation of Financial Statements determines that applying the concept of
materiality means that a specific disclosure requirement in a Standard need not be satisfied
if the information is not material. This by implication means that, if related party information
is not material, an entity need not comply with IAS 24 for that information.
IAS 1 Presentation of Financial Statements defines ‘material’ as (IAS 1.7):
omissions or misstatements of items;
if they could, individually or collectively;
influence the economic decisions of users taken on the basis of the financial statements.
Materiality depends on the size and nature of the omission or misstatement judged in the
surrounding circumstances. The size or nature of the item, or a combination of both, could
be the determining factor.
In the context of related party disclosures, size is not of primary importance, as IAS 24.9
defines a related party transaction as a transfer of resources, services or obligations
between related parties, regardless of whether a price is charged. If judged on size
alone, a transaction for which no price is charged may be considered to be immaterial as it
has no value. The Standard gives ample examples of the qualitative importance of related
party disclosures, including:
that related parties will enter into transactions that unrelated parties would not;
the profit or loss and financial position of an entity may be affected by a related party
relationship even if related party transactions do not occur; and
knowledge of related party transactions may affect assessments of an entity’s operations
(IAS 24.6 to .8).
Based on this, companies will have to prove that related party disclosures are qualitatively
not material in order to make use of IAS 1.31. Given the qualitative importance placed on
related party disclosures by IAS 24, this may be difficult to do.

Kingfisher Ltd is a diversified retail group that operates speciality stores. The group structure is as
follows:
Kingfisher Ltd has a wholly-owned subsidiary, A Ltd, which in turn owns a 60% subsidiary, B Ltd.
Kingfisher Ltd has a 30% interest in C Ltd (significant influence) which in turn has a 40% interest in
D Ltd.
Mrs Weaver has significant influence over Kingfisher Ltd.
The group structure can schematically be presented schematically as follows:
(30% interest) (20% interest)
Kingfisher Ltd Mrs Weaver
(100%)
(Subsidiary)
C Ltd A Ltd
(40% interest) (60% interest)
D Ltd B Ltd
Kingfisher Ltd is considering whether or not the following transactions constitute related party
transactions for the year ended 31 December 20.13:
1. Bateleur Ltd is responsible for certain administration and investment services of Kingfisher
Ltd. Mr Bird, a non-executive director of Kingfisher Ltd, is also a director of Bateleur Ltd.
In terms of IAS 24, a non-executive director is included in the definition of key management
personnel; therefore Mr Bird is a related party.
IAS 24.11 determines that two entities are not related parties simply because they have a
director or other member of key management personnel in common. Bateleur Ltd is therefore not
a related party of Kingfisher Ltd based solely on the fact that Mr Bird is a director of both
companies. Other facts may, however, indicate that the two parties are related.
2. Kingfisher Ltd provides a range of administrative, technical-advisory and other services to
its associate (C Ltd) in accordance with its needs, and subject to various agreements drawn
up under normal commercial terms and conditions. In return, the associate pays a fee and
reimburses Kingfisher Ltd for costs it incurs. During the year, fees amounted to R560 000
and an amount of R49 000 was reimbursed.
Associates are related parties; therefore disclosure should be as follows:
The company provides a range of administrative, technical-advisory and other services to its
associate, in accordance with its needs and subject to various agreements drawn up under normal
commercial terms and conditions. In return, the associate pays a fee and reimburses the company
for costs it incurs.
Information relating to the associate is as follows:
R
Fees 560 000
Amounts reimbursed 49 000
No balances were outstanding on 31 December 20.13
Other information relating to the associate can be found in note x.
3. Mr Quail, the managing director of Kingfisher Ltd, engaged the services of his daughter (a
design student) to select and hang new curtains in the company’s new office. An amount of
R12 000 was paid to Miss Quail and R170 000 to Deco Ltd. There is no connection between
Deco Ltd and Kingfisher Ltd.
Miss Quail is a close family member of a director of the company.
This is therefore a related party relationship and disclosure should be made of the transaction as
follows:
Miss Quail, a daughter of Mr Quail, provided certain once-off consulting services to the company
during the year. A market-related amount of R12 000 was paid to her. No amounts are outstanding
on 31 December 20.13.
4. Kingfisher Ltd made sales in the ordinary course of business of R56 000 to B Ltd, of which
R23 000 was outstanding at the year end.
Kingfisher Ltd and B Ltd are related parties, as Kingfisher Ltd exercises control over B Ltd.
However, no disclosure of this transaction is required in the consolidated financial statements, as
these intra-group transactions are eliminated.
The related party relationship will have to be disclosed as follows:
A related party relationship exists between Kingfisher Ltd and B Ltd by virtue of a 100% holding in
A Ltd, and A Ltd's 60% holding in B Ltd.
This information will normally be disclosed in the notes dealing with investments and the note on
related parties will refer to the investment note in this regard.
5. Mrs Weaver, who has a 20% shareholding in Kingfisher Ltd, made a loan of R250 000 on
1 January 20.13 to Kingfisher Ltd. Interest is payable at 20% per annum.
Mrs Weaver has significant influence over the reporting entity. There is thus a related party
relationship between Mrs Weaver and Kingfisher Ltd, requiring disclosure as follows:
A non-controlling shareholder, Mrs Weaver, has made a loan of R250 000 to the company. Interest
of R50 000 for the year, representing a rate of 20%, was charged on this loan. The terms and
conditions of the settlement and the nature of the settlement should also be disclosed.
6. Kingfisher Ltd purchases all its health products from Health Ltd. During the current year,
purchases from Health Ltd amounted to R110 million.
No related party relationship exists, as a relationship resulting from economic dependence in itself
is not deemed to be a related party relationship.
7. During the year, D Ltd sold a building to Kingfisher Ltd at its market value of R2,5 million.
No related party relationship exists as C Ltd does not have control over D Ltd. IAS 24.12 states that
an investor will also be related to subsidiaries of an associate. In this case D Ltd is not a subsidiary
of C Ltd.
8. Mrs Nest, a junior employee of Kingfisher Ltd, received a loan of R85 000 from
Kingfisher Ltd at a commercial rate of interest for the purchase of a new car during the year.
Interest amounted to R6 500.
There is no related party relationship between Mrs Nest and Kingfisher Ltd as she does not have
any significant influence over the reporting entity and is not part of key management personnel.
CHAPTER
14
Impairment of assets
(IAS 36)
Contents
14.1 Overview of IAS 36 Impairment of Assets ......................................................... 330
14.2 Identifying impairment ....................................................................................... 331
14.3 Measurement of recoverable amount and recognition of impairment loss ........ 332
14.3.1 Fair value less costs of disposal......................................................... 333
14.3.2 Value in use........................................................................................ 333
14.3.3 Recognition of impairment loss .......................................................... 336
14.3.4 Measuring recoverable amount for an intangible asset
with an indefinite useful life ................................................................ 336
14.4 Reversal of impairment loss .............................................................................. 337
14.5 Cash-generating units ....................................................................................... 339
14.5.1 Identification of cash-generating units ................................................ 339
14.5.2 Recoverable amount and carrying amount of a
cash-generating unit ........................................................................... 341
14.5.3 Allocating goodwill to cash-generating units ...................................... 342
14.5.4 Corporate assets ................................................................................ 345
14.5.5 Recognition of an impairment loss for a cash-generating unit
and the allocation thereof ................................................................... 345
14.5.6 Timing of impairment test for a cash-generating unit ......................... 347
14.5.7 Non-controlling interests..................................................................... 349
14.5.8 Reversal of impairment losses for cash-generating units .................. 352
14.6 Disclosure .......................................................................................................... 354
14.6.1 Statement of profit or loss and other comprehensive income:
Profit or loss section ........................................................................... 354
Other comprehensive income section ................................................ 354
14.6.3 Notes to the financial statements ....................................................... 355
14.7 Tax implications ................................................................................................. 357
329
14.1 Overview of IAS 36 Impairment of Assets
DEFINITIONS IDENTIFYING AN ASSET THAT MAY

Recoverable amount – higher of an BE IMPAIRED
asset’s fair value less costs of disposal External sources of information
and its value in use. Significant decline in asset’s value.
Value in use – present value of future Significant changes in technological,
cash flows expected to be derived from market, economic or legal environment.
an asset or CGU. These cash flows will Market interest rates/other market rates of
include both those from the continuing
return on investments increased and
use of the asset and from its disposal at
the end of its useful life. decrease the asset’s recoverable amount
materially.
Fair value – IFRS 13 Fair value
measurement. Carrying amount of net assets is more than
its market capitalisation.
Costs of disposal – incremental costs
directly attributable to disposal of the Internal sources of information
asset (excluding finance costs and Evidence of obsolescence or physical
income tax expenses). damage to an asset.
Including: legal costs, stamp duty, Significant changes to extent to which
transaction taxes, the cost of removing asset is used (e.g. asset becoming idle,
the assets. plans to discontinue/restructure operations,
Excluding: termination benefits, plans to dispose of asset and reassessing
reorganisation costs. the useful life of an asset as finite rather
Impairment loss – amount by which the than indefinite).
carrying amount of an asset or CGU Evidence that economic performance of an
exceeds its recoverable amount. asset is/will be worse than expected.
Cash-generating unit (CGU) – smallest Test for impairment
identifiable group of assets that generates End of each reporting period, if indication
cash inflows that are largely independent of impairment.
of the cash flows from other assets or Intangible asset with indefinite useful life/
groups of assets. intangible asset not yet available for use –
Including: assets that can be attributed test annually.
directly or allocated on a reasonable and Goodwill – annually.
consistent basis (such as goodwill and
corporate assets in some cases).
Excluding: carrying amount of recognised
liabilities, unless the recoverable amount
of the CGU cannot be determined without
the liability.
RECOGNISING AND MEASURING AN IMPAIRMENT LOSS
Individual asset Cash-generating unit

Cost model – recognise in profit/loss Allocate first to goodwill.
(P/L). Pro rata to other assets of CGU.
Revaluation model – account for as Limit – carrying amount of asset not
revaluation decrease. reduced below higher of:
– fair value less disposal costs;
– value in use;
– Rnil.
Reversing Reversing
Cost model – recognise in profit/loss Loss on goodwill may not be reversed.
(P/L). Allocate reversal pro rata to other assets of
Revaluation model – account for as CGU.
revaluation increase. Limit carrying amount of individual asset to
Limit – increased carrying amount may lower of:
not exceed what carrying amount would – recoverable amount; or
have been if no impairment. – what carrying amount would have
been if no impairment.
Impairment of assets 331
14.2 Identifying impairment

IAS 36 applies mainly to:
tangible and intangible assets;
investments in subsidiaries;
joint arrangements; and
associates,
although the last three items are financial assets.
IAS 36 is not applicable to assets such as:
inventories;
construction contracts;
deferred tax assets;
employee benefits;
investment property measured at fair value;
biological assets from agricultural activity carried at fair value less estimated point-of-sale
costs;
deferred acquisition costs;
intangible assets arising from IFRS 4, non-current assets classified as held for sale
under IFRS 5; and
financial assets within the scope of IAS 39, which are excluded as the recoverability of
these items is dealt with in the relevant Standards.
IAS 36 contains a number of definitions, which are essential in explaining the
impairment approach:
Recoverable amount is the higher of an asset’s or CGU’s fair value less costs of
disposal and its value in use.
Value in use is the present value of future cash flows expected to be derived from an
asset or CGU. These cash flows will include both those from the continuing use of the
asset and from its disposal at the end of its useful life.
Fair value is the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the measurement date (refer to
IFRS 13, Fair value measurement).
Carrying amount is the amount at which an asset is recognised (in the statement of
financial position) after deducting any accumulated depreciation or amortisation and
accumulated impairment losses thereon.
Impairment loss is the amount by which the carrying amount of an asset or CGU
exceeds its recoverable amount.
A cash-generating unit (CGU) is the smallest identifiable group of assets that
generates cash inflows that are largely independent of the cash flows from other assets
or groups of assets.
An entity shall at each reporting date (presumably year end and interim dates) assess
whether there are indications that assets may be impaired. If such indications exist, the
entity must calculate the recoverable amounts of the particular assets, provided the impact
thereof is material.
Irrespective of whether there is any indication of impairment and whether it is
material, an entity shall also annually test the following assets for impairment:
an intangible asset with an indefinite useful life;
an intangible asset not yet available for use;

goodwill acquired in a business combination (IAS 36.80 to .99).
The impairment test may be conducted at any time during the year, provided it is performed
at the same time every year. However, if such an intangible asset is recognised initially
during the current annual period, it must be tested for impairment before the end of the
current annual period.
Note that the materiality of an item will not play a role when conducting the compulsory
impairment tests, but it will play a role when examining normal indications of impairment.
A entity must, as a minimum, consider the following indicators in assessing whether
assets are likely to be impaired (IAS 36.12):
External sources of information
There are observable indications that the asset’s value has declined significantly, that is,
more than would be expected as a result of the passage of time or normal use during the
period.
Significant changes with an adverse effect on the entity have taken place during the
period, or will take place in the near future, in the technological, market, economic or
legal environment in which the entity operates or in the market to which the products of
an asset are dedicated.
Market interest rates or other market rates of return on investments have increased
during the period, and those increases are likely to affect the discount rate used in
calculating an asset’s value in use, and decrease the asset’s recoverable amount
materially.
The carrying amount of the net assets of the reporting entity is more than its market
capitalisation (i.e. number of shares × quoted market price).
Internal sources of information
Evidence is available of obsolescence of, or physical damage to, an asset.
Significant changes with an adverse effect on the entity have taken place during the
period, or are expected to take place in the near future, to the extent to which, or manner
in which, an asset is used or is expected to be used. These changes include the asset
becoming idle, plans to discontinue or restructure the operation to which an asset
belongs, plans to dispose of an asset before the previously expected date, and
reassessing the useful life of an asset as finite rather than indefinite.
Evidence is available from internal reporting that indicates that the economic
performance of an asset is, or will be, worse than expected.
If previous analyses have shown that the carrying amount of the asset is not sensitive to the
above indicators, it is not necessary to calculate the recoverable amount of the asset. Once
there is an indication that an asset may be impaired, the remaining useful life estimate,
depreciation method or residual value of the asset may also be affected. These must
therefore be reviewed and adjusted, even if no impairment loss is recognised.
14.3 Measurement of recoverable amount and recognition of impairment

loss
An asset is impaired when its carrying amount is larger than its recoverable amount. The
recoverable amount is the higher of an asset’s fair value less costs of disposal and its value
in use.
If the carrying amount of the asset is written-down to its recoverable amount, an impairment
loss should be recognised:
in the profit or loss section in the statement of profit or loss and other comprehensive
income; or
in the revaluation surplus via the other comprehensive income section in the statement
of profit or loss and other comprehensive income for any revalued assets if there is a
revaluation surplus for that specific asset.
14.3.1 Fair value less costs of disposal

Fair value is the price that would be received to sell an asset or paid to transfer a liability in
an orderly transaction between market participants at the measurement date (refer to
IFRS 13 Fair Value Measurement).
The costs of disposal are the incremental costs that are directly attributable to the disposal
of the asset (excluding, finance costs and income tax expenses):
include costs such as legal costs, stamp duty, transaction taxes, the cost of removing the
assets, and any direct incremental costs incurred to bring the asset into a condition for
sale. It excludes expenses for which provision has already been made;
exclude termination benefits and costs associated with reducing or re-organising the
entity as a result of the sale of the asset.
Example 14.1
14.1 Fair value less costs of disposal
At 31 December 20.14, Quantum Ltd owns a machine with a carrying amount of R106 666 for
which there is an active market. The machine can at this stage be disposed of to a knowledgeable,
willing buyer for R108 500.
This machine initially cost R200 000 and is depreciated on a straight-line basis over 7,5 years. A
total of 3,5 years of the useful life of the machine have already expired as at 31 December 20.14.
Any broker involved in such transaction will charge a fee of R2 000 and the cost to dismantle and
remove the asset will be R3 000. No provision for this cost of R3 000 has been recognised in terms
of IAS 37. Before considering the recoverable amount of the asset, the asset was serviced to ensure
that it is in good working order. The technician charged R1 500 for the service.
To determine the fair value less costs of disposal of this asset the following calculation is made:
R
Selling price in an active market 108 500
Less: Brokerage (2 000)
Cost of service – bringing asset into condition for its sale (1 500)
Cost of dismantling/removing the asset (3 000)
Fair value less costs of disposal 102 000
14.3.2 Value in use

The steps required to establish value in use are the following:
estimate the future cash inflows and outflows to be derived from the continued use and
eventual disposal of the asset; and
apply an appropriate discount rate to the future cash flows.
The value in use calculation should reflect the following elements:
an estimate of the future cash flows the entity expects to derive from the asset;
expectations about possible variations in the amount or timing of those future cash flows;
the time value of money, represented by the current market risk-free rate of interest;
the price for bearing the uncertainty inherent in the asset;
other factors, such as illiquidity, that market participants would reflect in pricing the future
cash flows the entity expects to derive from the asset.
14.3.2.1 Cash flow projections

IAS 36.33 requires that cash flow projections:
be based on reasonable and supportable assumptions, based on management’s best
estimate of the economic conditions that will exist over the remaining useful life of the
asset;
be based on the most recent financial budgets or forecasts that have been approved by
management. These projections must cover a maximum of five years unless a longer
period is justified, and must exclude estimated future cash inflows or outflows expected
to arise from future restructurings or from improving or enhancing the performance of the
asset; and
beyond the period in budgets or forecasts are estimated by extrapolating the projections
based on the budgets/forecasts with a steady or declining growth rate, unless an
increasing rate can be justified. The growth rate must not exceed the long-term growth
rate of the products/industry/country.
Cash flows projections should include:
cash inflows from the continuing use of the asset;
cash outflows incurred to generate the cash inflows (including outflows that can be
directly attributed or allocated on a reasonable basis, such as the day-to-day servicing of
the asset); and
net cash inflows on the disposal of the asset at the end of its useful life.
The cash flows from the disposal of the asset at the end of its useful life is the amount that
the entity expects to obtain from the disposal of the asset in an arm’s length transaction
between knowledgeable and willing parties, after deducting the estimated costs of disposal.
The cash flows from disposal are based on prices prevailing at the estimate date for similar
assets at the end of their useful life which are adjusted for the effect of future price increases
(due to general inflation or specific price increases).
Future cash flows must be estimated for the asset in its current condition, excluding:
future cash inflows or outflows from the future restructuring of the entity to which the
entity is not yet committed; or
future capital expenditure that will enhance or improve the performance of the asset.
Future cash flows shall include future cash outflows necessary to maintain the level of
economic benefits expected to arise from the asset in its current condition – that is, day-to-
day servicing. When a CGU comprises assets with different useful lives, and all these
assets are essential to the ongoing operation of the unit, the replacement of assets in the
unit is deemed to be part of the day-to-day servicing of the unit when estimating cash flows
associated with the unit. The same principle would apply when an asset comprises
components with different useful lives.
Fair value differs from value in use. Fair value reflects the assumptions market
participants would use when pricing the asset. In contrast, value in use reflects the effects of
factors that may be specific to the entity and not applicable to entities in general.
Fair value does not reflect any of the following factors to the extent that they would not be
generally available to market participants (IAS 36.53A):
additional value derived from the grouping of assets;
synergies between the asset being measured and other assets;
legal rights or legal restrictions that are specific only to the current owner of the asset; or
tax benefits or tax burdens that are specific to the current owner of the asset.
14.3.2.2 Discount rate

The required discount rate, which is a pre-tax current market rate, is independent of the
entity’s capital structure. The rate includes the time value of money and a provision for the
particular type of risk to which the asset in question is exposed. To avoid double counting,
the discount rate must not reflect risks for which the future cash flow estimates have already
been adjusted, and vice versa. Therefore, if the discount rate accommodates the effect of
price increases due to inflation, cash flows will be measured in nominal terms (i.e. be
increased for inflation). However, if the discount rate excludes the effect of inflation, the cash
flows to be discounted must be measured in real terms (i.e. not increased for inflation). In all
material respects, this asset-specific rate corresponds to the one used in the investment
decision, except that a pre-tax rate is required to determine impairment.
When an asset-specific rate is not available from the market, the entity uses the entity’s
weighted average cost of capital, its incremental borrowing rate and other market borrowing
rates as a starting point to develop an appropriate rate. These rates are adjusted to reflect
the specific risks of the projected cash flows and to exclude risks not relevant to the
projected cash flows, or risks for which cash flows have been adjusted. These risks include
country risk, currency risk, price risk and cash flow risk. This pre-tax rate is then applied to
discount the expected cash flows from using the asset to establish its value in use.
Example 14.2
14.2 Recoverable amount
The asset mentioned in Example 14.1 has a remaining useful life of four years from
31 December 20.12. Quantum Ltd is of the opinion that this asset will generate cash inflows of
R60 000 per year and directly associated necessary cash outflows of R20 000 per year over the
next four years. This was confirmed in management’s most recent cash flow budget. The asset will
be disposed of at a net amount of R4 000 at the end of its useful life.
An appropriate after-tax discount for this type of asset is 15,84% per annum. The tax rate is 28%.
Assume all amounts are material.
The value in use of this asset will be determined as follows:
Net cash inflows per annum (60 000 – 20 000) R40 000
Period over which inflows will occur 4 years
Expected net cash inflow at disposal R4 000
Pre-tax discount rate (15,84%/72%) 22%
Present value of cash generated via usage and disposal:
PMT = R40 000; n = 4 years; i = 22%; FV = R4 000; PV = R101 552
If the asset is impaired, the impairment loss that is recognised in the profit or loss section of the
statement of profit or loss and other comprehensive income will be calculated as follows:
(The recoverable amount is the higher of the fair value less costs of disposal and the value in use
of the asset under consideration).
R
Fair value less costs of disposal (from the previous example) 102 000
Value in use 101 552
Therefore, the recoverable amount will be the higher amount 102 000
The impairment loss will be determined as the difference between the recoverable amount and the
carrying amount.
Therefore, the impairment loss is:
R
Recoverable amount (102 000)
Impairment loss to be recognised 4 666
The depreciation charge for the year ended 31 December 20.14 is: R200 000/7,5 = R26 667
The depreciation charge for subsequent years is: R102 000*/4 = R25 500
* New carrying amount
14.3.2.3 Value in use where the entity is committed to restructuring

Although it was stated in section 2.2 that a future restructuring to which an entity is not yet
committed must not impact on cash flows when calculating value in use, the situation
changes when an entity becomes committed to a restructuring.
Once an entity is committed to the restructuring, its estimates of future cash inflows and
cash outflows for the purpose of determining value in use shall reflect the cost savings and
other benefits from restructuring resulting from the most recent budgets/forecasts approved
by management. Furthermore, estimates of future cash outflows for restructuring are
included in a restructuring provision in terms of IAS 37.
Example
Example 14.3
14.3 Value in use - entity committed to a restructuring
A Ltd uses a manufacturing machine to manufacture product X that generates net cash flows of
R1 000 000 per annum. This machine is currently operated by two full-time employees. However,
product X’ performance is not as good as initially expected and management is considering a
restructuring plan in terms of which the machine will be used to manufacture product Y instead.
This will increase the annual cash flows of the machine by R800 000 per annum.
However, one of the employees will be retrenched. In terms of the service termination agreement
entered into with the employee, the entity will make a termination payment of R100 000 to the
employee.
The expected costs to adjust the machine to manufacture product Y, is R120 000.
Before management is committed to the restructuring, the value in use will be calculated with
reference to annual net cash flows of R1 000 000.
Once management is committed to the restructuring, the annual cash flows for the value in use
calculation will be R1 680 000 (1 000 000 + 800 000 – 120 000).
The termination costs of R100 000 will be raised as a provision, since there is a legal present
obligation to make the payment and should be ignored when calculating the value in use.
Comment
¾ In terms of IAS 36.44(b), any cash flows resulting from future improvements to the asset
must be ignored when calculating the value in use.
14.3.3 Recognition of impairment loss

If the impaired asset (other than goodwill) is accounted for on the cost basis, the
impairment loss is recognised in the profit or loss section in the statement of profit or loss
and other comprehensive income.
The impairment losses for assets (other than goodwill) that are revalued are treated as
decreases of the revaluation surplus in the other comprehensive income section of the
statement of profit or loss and other comprehensive income. Should the impairment loss
exceed the revaluation surplus, the excess is recognised as an expense in the profit or loss
section of the statement of profit or loss and other comprehensive income. However, note
that the impairment loss of one revalued asset may not be adjusted against the revaluation
surplus of another revalued asset, as surpluses and deficits are offset on an item-for-item
basis.
The depreciation charge in respect of an asset subject to impairment shall be adjusted for
future periods to allocate the asset’s revised carrying amount (net of the impairment loss)
less its residual value, on a systematic basis over its useful life.
14.3.4 Measuring recoverable amount for an intangible asset with an indefinite

useful life
It was noted earlier that some assets must be tested for impairment annually, irrespective of
whether there are indications of impairment. An intangible asset with an indefinite useful life
is an example of such an asset. Due to the practical implications of testing for impairment on
an annual basis, IAS 36 allows an entity to use the most recent detailed calculation of such
an asset’s recoverable amount made in a preceding period to test for impairment in the
current period, provided all the following criteria are met (IAS 36.24):
If this intangible asset forms part of a CGU, the assets and liabilities of the unit must
have remained mostly unchanged since the previous calculation of recoverable amount.
The most recent recoverable amount calculation must have resulted in a recoverable
amount that exceeded the carrying amount of the asset now tested for impairment, by a
wide margin.
Based on an analysis of the circumstances surrounding the most recent recoverable
amount calculation, the likelihood that the current recoverable amount determination
would be less than the asset’s carrying amount must be remote.
14.4 Reversal of impairment loss

An entity must at each reporting date assess whether there are indications that earlier
impairment losses recognised for assets other than goodwill, may have decreased or no
longer exist. This does not imply that the recoverable amounts must automatically be
calculated on all previously impaired assets. The objective of IAS 36 is rather to look for
indications that these impairments may have reversed wholly or partially. The recoverable
amounts are calculated only on those assets where there are indications that the impairment
losses may have reversed.
The following are indications (similar to those indicating original impairment, but the
inverse thereof) that must be considered as a minimum:
External sources of information
There are observable indications that the asset’s value has increased significantly during
the period.
Significant changes with a favourable effect on the entity have taken place during the
period, or will take place in the near future, in the technological, market, economic or
legal environment in which the entity operates, or in the market to which the asset is
dedicated.
Market interest rates or other market rates of return on investments have decreased
during the period, and those decreases are likely to affect the discount rate used in
calculating the asset’s value in use, and increase the asset’s recoverable amount
materially.
Internal sources of information
Significant changes with a favourable effect on the entity have taken place during the
period, or are expected to take place in the near future, to the extent to which, or manner
in which, the asset is used or is expected to be used. These changes include capital
expenditure that has been incurred during the period to improve or enhance an asset’s
performance or restructure the operation to which the asset belongs.
Evidence is available from internal reporting that indicates that the economic
performance of the asset is, or will be, better than expected.
If the recoverable amount of an identified impaired asset (other than goodwill) is
recalculated and it now exceeds the carrying amount of the asset, the carrying amount of
the asset is increased to the new recoverable amount (subject to a calculated maximum –
see next paragraph). This is a reversal of impairment losses which reflects, in essence, that
due to a change in circumstances the estimated service potential through sale or use of the
asset has increased since the date (mostly in prior periods) on which the asset became
impaired. The reversal of an impairment loss may also indicate that the remaining useful life,
depreciation method and residual value of the particular asset must also be reviewed.
Examples of changes in estimates that cause an increase in service potential include:

a change in the basis for determining the recoverable amount (say from fair value less
costs of disposal to value in use);
where the recoverable amount was based on value in use, a change in the amount or
timing of estimated future cash flows or the discount rate; or
if the recoverable amount was based on fair value less costs of disposal, a change in
estimate of the components of fair value less costs of disposal.
The impairment loss is reversed only to the extent that it does not exceed the carrying
amount (net of depreciation or amortisation) that would have been determined for the asset
(other than goodwill) in prior years, if there had been no impairment loss. An impairment
loss is not reversed because of unwinding of the discount rate used in the calculation of
value in use, as the service potential of the asset has not increased.
A reversal of an impairment loss is recognised as follows:
if the asset (other than goodwill) is accounted for on the cost basis: the reversal of an
impairment loss is recognised in the profit or loss section of the statement of profit or loss
and other comprehensive income;
if the asset is revalued: the reversal of the impairment loss is treated as an increase in
the revaluation surplus directly in other comprehensive income in the statement of profit
or loss and other comprehensive income. In instances where the whole or part of the
impairment loss of an asset was recognised as an expense in the profit or loss in the
statement of profit or loss and other comprehensive income in prior periods, a reversal
for that impairment loss (or part thereof) is first recognised as income in profit or loss in
the statement of profit or loss and other comprehensive income, until all prior recognised
impairment losses have been reversed, whereafter this remainder is shown as an increase
of the revaluation surplus through other comprehensive income in the statement of profit
or loss and other comprehensive income. Such revaluations would only be recognised if
this is within the revaluation cycle of the asset and all assets in the same class of asset
are also revalued.
Example 14.4
14.4 Reversal of impairment loss – individual asset
The carrying amount of a machine of Cheers Ltd on the date of the statement of financial position,
30 June 20.15, is as follows:
R
Cost 50 000
Accumulated depreciation
(calculated at 10% per annum, straight-line, assuming no residual value) (25 000)
Carrying amount at the end of Year 5 25 000
The fair value less costs of disposal the asset under consideration is R20 000. The present value
of the expected return from the use of the asset over its useful life amounts to R15 000. The value
in use for this item is therefore R15 000. Ignore taxation.
The recoverable amount, being the higher of fair value less costs of disposal (R20 000) and
value in use (R15 000), is therefore R20 000. The carrying amount (R25 000) must therefore be
written-down to the recoverable amount (R20 000) by R5 000. This amount will be recognised as
an impairment loss of R5 000, with a depreciation charge of R5 000 in the profit or loss section in
the statement of profit or loss and other comprehensive income of the current year.
Assume that the recoverable amount for the machine is re-estimated on 30 June 20.17 as follows:
R
Fair value less costs of disposal 14 000
Value in use 18 000
The revised recoverable amount is therefore R18 000 (the higher).
continued
The recoverable amount has increased, thereby reversing a part of the impairment loss
recognised in prior years. The maximum increase in the recoverable amount allowed is calculated
as follows:
Depreciation for Year 20.16 and 20.17:
Recoverable amount end of Year 20.15 R20 000
Remaining useful life 5 years
Depreciation R4 000 per annum
Depreciation for Year 20.16 and 20.17:
The carrying amount at the end of 20.17:
R
(50 000 – 25 000 – 5 000 (impairment loss) – 4 000 (depreciation) – 4 000 (depreciation)) 12 000
Increase in recoverable amount/reversal of impairment loss (15 000 – 12 000) 3 000
New carrying amount 15 000 *
* The new carrying amount is limited to what the carrying amount would have been, had no
impairment loss been recognised for the asset in prior years (20.15). The recoverable amount of
R18 000 is thus ignored if the historical cost-carrying amount is lower.
Calculation of limitation on increased carrying amount:
R
Carrying amount had impairment not been recognised 15 000
Cost price (before recognition of impairment) 50 000
Accumulated depreciation at 30 June 20.17 (5 000 × 7) (35 000)
Comment
Comment
¾ The reversal of the impairment loss to the amount of R3 000 is credited to profit or loss in the
statement of profit or loss and other comprehensive income, as the machine is measured on
the cost method in this example.
¾ The carrying amount after reversal of impairment loss (12 000 + 3 000) is R15 000. The
increased carrying amount is equal to what the carrying amount would have been, had
depreciation on historical cost been allocated normally over the years without taking impairment
into account, namely R50 000 – (7 × 5 000) = R15 000.
14.5 Cash-generating units
14.5.1 Identification of cash-generating units

IAS 36 requires the recoverable amount of an asset to be estimated when an asset is
impaired. Where the future cash flows cannot be attributed to a single asset to establish the
recoverable amount on a reasonable basis, it is necessary to identify the smallest
cash-generating unit (CGU) to which such cash flows can be attributed. A CGU is therefore
the smallest identifiable group of assets that generates cash inflows that are largely
independent of the cash inflows from other assets or groups of assets.
Assume that a small-scale diamond mining operation runs a shaft, a railway line and a
locomotive with two coaches to transport the diamond-bearing gravel to a diamond washing
plant. Under these circumstances, it would be highly unlikely that any of the individual
assets could generate independent cash flows without the co-operation of the other three
assets. Consequently, the four assets would be combined to form a CGU.
In recognising CGUs, the lowest aggregation of assets that generate independent cash
flows is recognised. Normally the cash inflows from the continuing use of the asset or group
of assets refer to the cash and cash equivalents received from parties outside the reporting
entity. These cash flows must be independent of the cash flows of other assets or CGUs.
To establish the independence of these cash flows, consideration is given to factors such
as:
how management monitors and controls operations (i.e. by product line, businesses,
locations); or
how management makes decisions to continue to sell parts of the entity’s assets or
operations.
In certain instances, CGUs may be identified where all or a portion of the cash flows are
from internal sources. Internal cash flows refer to cash flows within the entity’s operation
itself, for example the transfer of products between departments, branches and businesses.
These cash flows qualify for the recognition of CGUs only if active markets exist for the
output. When calculating the recoverable amount for these CGUs, management must use
its best estimate of future arm’s length prices for the output, as the actual transfer prices
used for internal transfers may not be market-related. These arm’s-length transaction prices
must be used in estimating:
the future cash inflows used to determine the CGUs value in use; and
the future cash outflows used to determine the value in use of any other assets or
CGUs that are affected by internal transfer pricing.
Example 14.5
14.5 Cash-generating unit
Delta Ltd produces a single product and owns plants A, B and C. Each plant is located on a
different continent. A produces a component that is assembled in either B or C. The combined
capacity of B and C is not fully utilised. Delta’s products are sold worldwide from either B or C. For
example, B’s production can be sold on C’s continent if the products can be delivered faster from
B than from C. Utilisation levels of B and C depend on the allocation of sales between the two
sites.
Identify the CGUs for A, B and C in each of the following cases:
Case 1: There is an active market for A’s products.
Case 2: There is no active market for A’s products.
Case 1
It is likely that A is a separate CGU because there is an active market for its products, although all
of its cash flows are generated internally.
Although there is an active market for the products assembled by B and C, cash inflows for B and
C depend on the allocation of production across the two sites. It is unlikely that the future cash
inflows for B and C can be determined individually. Therefore, it is likely that B and C together
constitute the smallest identifiable group of assets that generates cash inflows that are largely
independent.
In determining the value in use of A and B plus C, Delta adjusts financial budgets/forecasts to
reflect its best estimate of future prices for A’s products achieved in arm’s length transactions.
Case 2
It is likely that the recoverable amount of each plant cannot be assessed independently because:
there is no active market for A’s products. Therefore, A’s cash inflows depend on sales of the
final product by B and C; and
although there is an active market for the products assembled by B and C, cash inflows for B
and C depend on the allocation of production across the two sites. It is unlikely that the future
cash inflows for B and C can be determined individually.
As a consequence, it is likely that A, B and C together (i.e. Delta as a whole) is the smallest
identifiable group of assets that generates cash inflows that are largely independent.
Example 14.6
14.6 Internal cash flows when identifying CGUs
H Ltd manufactures a chemical product XHO. Raw material X is converted into XH during the
manufacturing process. XH is then further processed into XHO.
The entity is divided into two sections for management purposes. Section A converts raw material
X to XH and Section B processed XH to XHO.
Section A purchases raw material X at a cost of R 9 000 per kilogram and incurs conversion costs
of R1 500 per kilogram. Section A charges a transfer price of R15 000 per kilogram of XH
transferred to Section B. If XH is not transferred to Section B it can be sold in the market at
R20 000 per kilogram.
Since there is an active market for the output of Section A, Section A can be regarded as a CGU,
even though all the output is internally transferred to Section B.
The following is an estimate of the kilograms of XH that will be produced by Section A (assume
that the section will use the current assets for a further 4 years):
20.11 – 200 kg; 20.12 – 180 kg; 20.13 – 160 kg; 20.14 – 150 kg
The expected cash flow per kilogram is R9 500 (R20 000 – (9 000 + 1 500)).
The value in use is as follows, assuming a fair rate of return of 10% per annum:
R
20.11 (CF1) 200 × 9 500 1 900 000
20.12 (CF2) 180 × 9 500 1 710 000
20.13 (CF3) 160 × 9 500 1 520 000
20.14 (CF4) 150 × 9 500 1 425 000
Present value (NPV) (discounted at 10%) 5 255 789
The value in use of Section A for impairment purposes is thus R5 255 789.
14.5.2 Recoverable amount and carrying amount of a cash-generating unit

As with individual assets, the recoverable amount of a CGU is the higher of its fair value less
costs of disposal and value in use. The same rules apply to the calculation of the
recoverable amounts of individual assets and CGUs. There are however a number of
problems which arise specifically in calculating recoverable amounts for CGUs that are
addressed in IAS 36.
When establishing whether a CGU is impaired, the first step is to calculate its carrying
amount. The general rule is that the manner in which the carrying amount of the CGU is
determined shall be consistent with that of the recoverable amount of the CGU – meaning
that the same items must be included. If the recoverable amount is lower than the carrying
amount of the CGU, an impairment loss is recognised in respect of that CGU.
The carrying amount of a cash-generating unit:
includes those assets that can be attributed directly or allocated on a reasonable and
consistent basis (such as goodwill and corporate assets in some cases) and that will
generate future cash inflows used in determining the value in use of the CGU;
excludes the carrying amount of recognised liabilities, unless the recoverable amount of
the CGU cannot be determined without the liability (where the purchaser of a unit is
required to take over the liability);
excludes assets that cannot be allocated on a reasonable basis such as goodwill and
corporate assets in some cases; and
excludes assets that will not produce the estimated future cash inflows.
Where assets are grouped together to determine their recoverability, all assets that generate
or are used to generate the relevant stream of cash inflows should be included in the
specific CGU. If this is not done, it may appear that the CGU is fully recoverable, when in
fact an impairment loss has occurred.
In some cases, certain assets such as goodwill or corporate assets (e.g. a head office
building) may contribute to the estimated future cash flows of a CGU, but these assets
cannot be allocated to the CGU on a reasonable and consistent basis.
Sometimes the recoverable amount of a CGU may include some recognised liabilities where
such liabilities are directly associated with the CGU. To perform a meaningful comparison
between the carrying and recoverable amounts of a CGU, the carrying amount of the liability
must be deducted when calculating both the value in use and fair value less costs of
disposal of the CGU. An example of such a liability would be an obligation to restore a site
to its original pristine condition once manufacturing activities on it have ceased. If this site is
sold, the liability in respect of the restoration will attach to the site and if its recoverable
amount is to be determined, this liability will be included in the calculation.
14.5.3 Allocating goodwill to cash-generating units

For the purpose of performing impairment tests, goodwill acquired in a business
combination shall, from the acquisition date, be allocated to each of the acquirer’s CGUs
(or groups of CGUs) that are expected to benefit from the synergies of the business
combination. This is done irrespective of whether the acquirer allocates other assets of the
acquiree to those CGUs or groups of CGUs. Each such CGU to which the goodwill is
allocated shall:
represent the lowest level within the entity at which goodwill is monitored for internal
management purposes; and
not be larger than a primary or secondary segment in accordance with IAS 14.
Goodwill will not usually generate cash flows independently of other assets or groups of
assets, and often contributes to the cash flows of several CGUs. Consequently, it may
sometimes not be possible to reasonably and on a consistent basis allocate goodwill to
individual CGUs, but it may be possible to allocate the goodwill to groups of CGUs.
If the initial allocation of goodwill acquired in a business combination cannot be completed
before the end of the annual period in which the business combination is effected, that initial
allocation shall be completed before the end of the first annual period beginning after the
acquisition date. For example, goodwill was acquired in a business combination on
30 June 20.13, while the year end of the entity is 31 December 20.13. Due to several
uncertainties, the initial accounting of the business combination cannot be completed by
31 December 20.13. Consequently, the allocation of goodwill to the CGUs also cannot be
completed. Under these circumstances, the allocation of goodwill must thus be completed
by 31 December 20.14.
If goodwill has been allocated to a CGU and the entity disposes of a portion of that
CGU, the goodwill associated with the portion of the CGU disposed of, shall be:
included in the carrying amount of the operation disposed of when determining the gain
or loss on disposal; and
measured on the basis of the split between the relative values of the operation disposed
of and the portion of the CGU retained. This basis is used, unless another method better
reflects the goodwill associated with the operation disposed of.
Example 14.7
14. Cash-generating unit and goodwill
B Ltd sells an operation forming part of a CGU to which goodwill was allocated, for R200 000. The
total goodwill (R160 000) allocated to the CGU cannot be allocated to this smaller part of the CGU
on a reasonable and consistent basis. The portion of the CGU not disposed of has a recoverable
amount of R600 000.
Because the goodwill allocated to the complete CGU cannot be allocated to the portion disposed
of on a non-arbitrary basis, the goodwill disposed of, with the portion of the CGU for R200 000, will
amount to 25% (R40 000) (200/(200 + 600) × 160 000) of the total goodwill allocated to the CGU.
The portion of goodwill retained in the CGU will amount to 75% (R120 000) of the total goodwill.
The relative value approach will be used unless some other method better reflects the goodwill
associated with the part of the CGU disposed of.
The principle applied when disposing of a portion of a CGU will also be applied when an
entity re-organises its reporting structure to change the composition of one or more CGUs to
which goodwill has been allocated. The goodwill shall thus be reallocated to the CGUs
affected. The reallocation will take place on the same basis as that used when disposing of
part of a CGU.
14.5.3.1 Cash-generating units with no goodwill allocated to them
As already stated, goodwill can sometimes not be allocated to a CGU on a reasonable and
consistent basis, even though goodwill relates to such a CGU. Goodwill will under these
circumstances be allocated to a group of CGUs which contains, amongst others, the CGU
to which the goodwill could not be allocated.
For these smaller CGUs (not including allocated goodwill), testing for impairment will only
take place whenever there is an indication that the CGU may be impaired, by comparing
its carrying amount (excluding goodwill) with its recoverable amount. Any impairment loss
will be allocated to the assets of this smaller CGU pro rata, based on the carrying amounts
of the assets in the CGU. Note that since there is no goodwill in the CGU, the impairment
loss need not first be allocated to the goodwill contained in the CGU.
Example 14.8
14. Cash-generating unit - no goodwill allocated
X Ltd acquired a 100% interest in Z Ltd on 1 January 20.11 for R58 000. Z Ltd consists of three
CGUs, namely A, B and C. The fair values of the net assets of CGUs A, B and C were R25 000,
R15 000 and R10 000 respectively at date of acquisition. The following now relates to CGUs A, B
and C:
A B C Total
R R R R
31 December 20.11
Net carrying amount (excluding goodwill) 31 000 12 000 9 000 52 000
Recoverable amount (including effect of goodwill) 33 000 15 000 8 100 56 100
The impairment loss(es) for the CGUs at 31 December, assuming indications of impairment, if
goodwill cannot be allocated to any of the CGUs on a reasonable and consistent basis, will be as
follows:
A B C Total
R R R R
Net carrying amounts of assets 31 000 12 000 9 000 52 000
Recoverable amounts 33 000 15 000 8 100 –
Impairment loss on individual CGU – – 900 * (900)
Net carrying amount for total CGUs with no goodwill
allocated to any individual CGU 51 100
* Impairment loss will be allocated to the individual assets of CGU C, based on their carrying
amounts.
14.5.3.2 Cash-generating units to which goodwill has been allocated

A CGU to which goodwill has been allocated (it may comprise several smaller CGUs to
which goodwill could not be allocated on a reasonable and consistent bases) shall be
tested for impairment annually and also whenever there is an indication that the CGU
may be impaired. The impairment testing is done by comparing the carrying amount of the
CGU, including goodwill, with the recoverable amount of the unit. This matter is discussed in
detail in section 3.5; however, the basic principles are explained briefly below:
If the recoverable amount of the CGU exceeds the carrying amount, the CGU and the
goodwill allocated to it shall be regarded as not being impaired.
If the carrying amount of the CGU exceeds the recoverable amount, the CGU and the
goodwill allocated to it shall be regarded as impaired. Consequently, the entity shall
recognise the resulting impairment loss in the following manner:
firstly against the goodwill allocated to the CGU; and
secondly to the other assets in the CGU pro rata on the basis of the carrying amount of
each asset.
The following example will illustrate the situation if the goodwill can be allocated to individual
CGUs based on a reasonable and consistent basis:
Example 14.9
14.9 Cash-generating unit – goodwill allocated
Use the same information as in the previous example, but assume that goodwill can be allocated
to the individual CGUs based on the fair values of the assets in the individual CGUs. The following
will relate to CGUs A, B and C:
A B C Total
31 December 20.11 R R R R
Net carrying amount excluding goodwill 31 000 12 000 9 000 52 000
Goodwill allocated based on fair values at date of
acquisition: (25 000 + 15 000 + 10 000 = 50 000)
A (25/50 × (58 000 – 50 000) 4 000 4 000
B (15/50 × (58 000 – 50 000) 2 400 2 400
C (10/50 × (58 000 – 50 000)) 1 600 1 600
35 000 14 400 10 600 60 000
Recoverable amounts (33 000) (15 000) (8 100) (56 100)
# $
Impairment losses *2 000 – 2 500 3 900
* The R2 000 impairment loss will be off-set against the R4 000 goodwill allocated to CGU A,
leaving R2 000 of goodwill in the CGU.
#
The R2 500 impairment loss will wipe out the allocated goodwill of R1 600 in CGU C. The
remainder of the impairment loss (R900) will be allocated to the individual assets in the CGU,
based on their carrying amounts.
$
The impairment loss of R3 900 determined by using the total figures of R60 000 and R56 100 is
not relevant, as goodwill has been allocated to the individual CGUs.
When both tests are required, the CGU without the allocation of goodwill (the smaller CGU)
will be tested for impairment first, provided there is an indication of impairment. The carrying
amounts of the assets in the smaller CGU are adjusted for impairment and included in the
bigger CGU (including allocated goodwill). This CGU is then tested for impairment.
Example 14.10
14.10 Cash-generating unit included in bigger cash-generating unit
Use the same information as in Example 14.11 in respect of X Ltd and Z Ltd (and ignore
Example 14.12). Take into account that an impairment loss of R900 occurred in CGU C, but not in
A or B, and that goodwill is only allocated to the larger CGU ABC (comprising CGUs A, B and C).
The following is applicable:
CGU
ABC
R
31 December 20.11
Newly-calculated carrying amount after impairment loss in CGU C (52 000 – 900) 51 100
Goodwill allocated to CGU ABC (58 000 – 50 000) 8 000
Carrying amount of CGU ABC including allocated goodwill 59 100
Recoverable amount CGU ABC (given) (56 100)
Impairment loss for CGU ABC 3 000
The impairment loss of R3 000 will be set off against the goodwill of R8 000, leaving a remainder of
R5 000, and other net assets with a combined carrying amount of R56 100 (51 100 + 8 000 – 3 000).
14.5.4 Corporate assets

The principles governing the calculation of impairment losses for corporate assets are very
similar to those used for the calculation of impairment losses for goodwill. IAS 36.102
clarifies the matter and provides a summary of the calculation of impairment losses on
goodwill that is also applied to corporate assets. IAS 36 provides a detailed example of the
treatment of corporate assets in its Illustrative Example 8.
14.5.5 Recognition of an impairment loss for a cash-generating unit and the

allocation thereof
As for an individual asset, an impairment loss for a CGU to which goodwill (or a corporate
asset, if applicable) has been allocated will arise when the carrying amount of the CGU
exceeds its recoverable amount or, put differently, if the recoverable amount is less than the
carrying amount of the CGU (or group of CGUs).
The impairment loss identified will be allocated to reduce the carrying amounts of the assets
in the CGU in the following order:
firstly, to reduce the amount of goodwill allocated to the CGU (or group of units); and
secondly to other assets of the unit (or group of units) pro rata on the basis of the
carrying amount of each asset in the unit (or group of units).
The above reductions in carrying amounts will be treated as impairment losses on individual
assets and recognised in the profit or loss section or the other comprehensive income
section of the statement of profit or loss and other comprehensive income for revalued
assets that have a balance on the revaluation surplus attributable to that specific asset.
Example 14.11
14. Allocation of impairment loss
A Ltd acquired B Ltd on 1 January 20.10 for R30 million. B Ltd has two operations, one in Namibia
and one in Botswana, and each operation is a CGU. At the acquisition date, the purchase price of
the operation in Namibia comprised the following:
R’000
Fair value of identifiable assets 8 000
Goodwill 2 400
Purchase price – total 10 400
continued
Depreciation is provided for on a straight-line basis over 10 years, while goodwill is not amortised,
but is tested for impairment on an annual basis. There are no residual values at any time during
the useful life of these assets.
On 31 December 20.11, the government of Namibia announced export restrictions on local
production, resulting in a reduction of production of 50% in B Ltd’s operations in Namibia. The fair
value less costs of disposal for the operation cannot be determined and its value in use is
R4,8 million.
The impairment loss for the Namibian operation is calculated and allocated as follows:
Identi-
Good-
fiable Total
will
assets
R’000 R’000 R’000
Cost 2 400 8 000 10 400
Accumulated depreciation – (1 600) (1 600)
Carrying amounts 2 400 6 400 8 800
Impairment loss (2 400) (1 600) (4 000)
Recoverable amount (value in use) – 4 800 4 800
Comment
¾ The impairment loss of the CGU is allocated first to goodwill (until goodwill is nil) and then to
other assets.
Once an impairment loss has been allocated, it is necessary to test that the carrying amount
of any individual asset in the CGU is not reduced to below the highest of:
its fair value less costs of disposal;
its value in use (if applicable); and
nil.
If the allocation of an impairment loss results in the carrying amount of an individual asset in
the CGU being reduced below any of the above limits, the excess must be reallocated to the
other assets in the CGU or group of CGUs on a pro rata basis. This is best explained in an
example.
Example 14.12
14.12 Limitation on allocation of impairment loss
Bravo Africa Ltd has a business that manufactures and sells compact discs (CDs) of the
performances of famous artists in South Africa. The assets used in the business qualify as a CGU.
The carrying amounts of the assets in the CGU as at 31 December 20.14 are as follows:
R
Equipment 30 000
Machinery 28 000
Furniture 42 000
Goodwill 25 000
125 000
The following information regarding the recoverable amount of the CGU is available:
Fair value less costs of disposal R70 000
Value in use R82 000
The effect of the impairment of the unit must still be recorded. The only fair value less costs of
disposal available for individual assets is for furniture, for which there is an active market. This fair
value less costs of disposal amounts to R38 000.
continued
The recoverable amount of the CGU is the higher of the fair value less costs of disposal and value
in use, thus R82 000. The carrying amount of the unit of R125 000 exceeds the recoverable amount;
therefore the CGU is impaired, and an impairment loss of R43 000 (R125 000 – 82 000) is recognised.
The impairment loss is allocated first to goodwill (utilising goodwill of R25 000) and the remaining
R18 000 on a pro rata basis to the remaining assets in the unit.
The allocation to the individual assets in the above journal entry is calculated as follows:
Old New Fair value less
Impairment
carrying carrying costs of
loss
amount amount disposal
R R R R
Equipment (30/100 × 18 000) (5 400) 30 000 24 600 Not available
Machinery (28/100 × 18 000) (5 040) 28 000 22 960 Not available
Furniture (42/100 × 18 000) (7 560) 42 000 34 440 38 000
(43 000 – 25 000) (18 000) 100 000 82 000
As the impairment loss on furniture results in a carrying amount (R34 440) which is less than the
higher of R38 000 and nil, the amount of R3 560 (R38 000 – 34 440) must be allocated to the
other two assets on a pro rata basis.
R
Equipment ((30/(28 + 30)) × 3 560) 1 841
Machinery ((28/(28 + 30)) × 3 560) 1 719
3 560
The journal entry for Bravo Africa Ltd is as follows:
Dr Cr
R R
Impairment loss in CGU (P/L) 43 000
Goodwill (allocated first) (SFP) 25 000
Equipment (5 400 + 1 841) (SFP)* 7 241
Machinery (5 040 + 1 719) (SFP)* 6 759
Furniture (7 560 – 3 560) (SFP)* 4 000
*Accumulated depreciation
14.5.6 Timing of impairment test for a cash-generating unit

The timing of impairment tests for cash-generating units are the following:
The annual impairment test for a CGU to which goodwill has been allocated may be
performed at any time during the annual period, provided the test is performed at the
same time every year. This means that if the yearend of a CGU falls on 31 December,
the impairment test related to this CGU need not be performed on 31 December, but
may be performed at any other time during the year (say 31 May). However, if it is
decided to perform the impairment test for this CGU on 31 May, the test must be
performed consistently on 31 May every year.
Different CGUs may be tested at different times in the year, for instance some CGUs
may be tested on 31 March, some on 31 May and some on 31 August, although all these
CGUs may be part of the same group of companies.
If some or all of the goodwill allocated to a CGU was acquired in a business combination
during the current financial year, that CGU shall be tested for impairment before the end
of the current financial year. For instance, if the CGU was acquired on 31 October 20.14
and the company has a year end of 31 December 20.14, the CGU must be tested for
impairment for the first time on 31 December 20.14.
If the individual assets constituting a CGU to which goodwill has been allocated are tested
for impairment because there are indications of impairment for those individual assets, and
at the same time the unit containing the goodwill is tested for impairment, the individual
assets shall be tested for impairment before the CGU containing the goodwill is tested. This
obviously implies that the carrying amounts of the individual assets are reduced by their
related impairment losses before calculating the impairment loss of the CGU.
Example 14.13
14.13 Individual assets and cash-generating units
X Ltd acquired a 100% interest in Z Ltd on 1 January 20.14. Z Ltd owns only three assets, namely
D, E and F. Goodwill of R10 000 is applicable to the subsidiary (CGU) as a whole. The following
relates to assets D, E and F:
31 December 20.14
D E F
R R R
Net carrying amounts (not goodwill) 31 000 12 000 9 000
Recoverable amounts 33 000 15 000 8 100
The impairment loss(es) on the individual assets (these are tested first) at 31 December 20.14, if
indications of impairment are assumed, will be:
31 December 20.14
D E F
R R R
Carrying amount of asset 31 000 12 000 9 000
Recoverable amount 33 000 15 000 8 100
Impairment loss on Asset F – – * 900
If the whole CGU (Z Ltd) is subject to impairment, the CGU as a whole (including Assets D, E and
F, and goodwill) is tested for impairment. This is done after the individual assets have been tested
for impairment – Asset F was impaired. The recoverable amount of the total CGU (including
goodwill) is R60 100; consequently the impairment loss for the CGU (including goodwill) is
Carrying amount
R
Asset D 31000
Asset E 12 000
Asset F (net of impairment loss) (9 000 – 900*) 8 100
Goodwill 10 000
Total carrying amount of CGU 61 100
Recoverable amount 60 100
Impairment loss on CGU 1 000
Comment
¾ The impairment loss on Asset F was set off against this asset first, before the CGU was tested
for impairment, while the impairment loss of R1 000 in respect of the CGU (Z Ltd) as a whole is
then set-off against the goodwill in the CGU.
¾ Similarly, if the CGUs (not containing goodwill) constituting a group of CGUs to which goodwill
has been allocated, are tested for impairment at the same time as the group of CGUs
(containing the goodwill), the individual CGUs shall be tested for impairment first, that is, before
testing the group of CGUs containing the goodwill.
In the annual impairment test of a cash-generating unit to which goodwill has been
allocated, the most recent detailed calculation made in a preceding period of the
recoverable amount could be used, provided all of the following criteria are met:
the assets and liabilities making up the unit have not changes significantly since the most
recent recoverable amount calculation;
the most recent recoverable amount calculation resulted in an amount that exceeded the
carrying amount of the unit by a substantial margin;
based on an analysis of events that have occurred and circumstances that have changed
since the most recent recoverable amount calculation; the likelihood that a current
recoverable amount determination would be less that the current carrying amount of the
unit is remote.
14.5.7 Non-controlling interests

In terms of IFRS 3.32, goodwill on acquisition date is calculated as the difference between
the sum of the following:
the consideration transferred in the business combination measured at fair value at
acquisition date;
the amount of the non-controlling interests in the acquiree measured either at fair value
or the non-controlling interests’ proportionate share of the acquiree’s net assets (an
entity can select either of these per business combination and it would normally not form
part of the general accounting policy of a group);
where a business combination is achieved in stages, the acquisition-date fair value of the
acquirer’s previously held equity interest in the acquiree; and
the identifiable assets acquired and liabilities assumed at acquisition date.
The above confirms that there are two measurement options in the case of non-controlling
interests and that these form part of the goodwill calculation; consequently, the amount
of goodwill attributable to a business combination would vary, depending on how
non-controlling interests are measured.
14.5.7.1 Non-controlling interests measured at fair value
Assume that an 80% interest in a subsidiary is acquired by a parent for R1 000 000, when
the total identifiable net assets of the subsidiary amounts to R900 000. The non-controlling
interests have a fair value at date of acquisition of R240 000.
Where non-controlling interests are measured at fair value, total goodwill attributed to a
subsidiary in the consolidated financial statements will be calculated as follows: R340 000
goodwill = (R1 000 000 + 240 000 + 0) – 900 000). This total goodwill figure comprises two
components:
The first component of goodwill is generated by measuring the non-controlling interests
(20%) at fair value (R240 000) and comparing this fair value to the non-controlling
interests’ portion of the identifiable net assets of the subsidiary of R180 000 (900 000
× 20%). Goodwill included as part of the fair value of the non-controlling interests would
therefore be R60 000.
The second component of goodwill would be the goodwill generated by the controlling
interest (parent) (80%) when purchasing the interest in the subsidiary. This amount is
determined by reducing the total goodwill of R340 000 (calculated above) by the goodwill
generated by the fair value of the non-controlling interests of R60 000 (see first
component). This would be R280 000 (340 000 – 60 000).
Since both the non-controlling interests and the controlling interest contributed to the total
goodwill figure, the amount of goodwill included in the carrying amount of a subsidiary on
consolidation would be represent 100% of the goodwill attributed to the subsidiary (parent
and non-controlling interests).
Testing for the impairment of goodwill annually in terms of IAS 36 involves comparing the
entire carrying amount of a CGU with its entire recoverable amount.
Impairment testing will not create a problem where the non-controlling interests are
measured at fair value, since the goodwill attributable to both controlling (parent) (80%) and
non-controlling interests (20%) would form part of the carrying amount of the subsidiary and
also its recoverable amount.
Example 14.14
14.14 Non-controlling interests and impairment – measurement at fair value
The fair value of the total identifiable net assets of a subsidiary is R1 500 and a parent acquires an
80% interest in those items for R1 600. The NCI’s proportionate share of the identifiable net assets
of the subsidiary amounted to R300 (1 500 × 20%). The NCI is measured at its fair value of R350.
Applying the normal principles contained in IFRS 3. 32 to calculate goodwill, the sum of
R1 600 + R350, namely R1 950, will be compared to the total identifiable net assets of the
subsidiary, namely R1 500, to determine goodwill of R450. The goodwill contributed by the NCI
amounts to R50 (350 – 1 500 × 20%), while the goodwill contributed by the parent amounts to
R400 (450 – 50) and relates to the parent’s 80% interest in the subsidiary (total being parent’s and
NCI’s). The portion of goodwill attributed to the NCI is recognised in the consolidated financial
statements under this measurement basis and total goodwill of R450 will appear in the
consolidated financial statements.
Using the above information, if there is an NCI component in a CGU (the CGU is a subsidiary not
wholly-owned by the parent to which goodwill has been allocated), the carrying amount of the
CGU (subsidiary) in the consolidated financial statements will include allocated goodwill of R450
as well as both the parent’s and the NCI’s interest in the identifiable net assets of the subsidiary
(R1 500). This results in a total carrying amount of R1 950.
This amount of R1 950 includes the goodwill of the NCI of R50.
Note that in terms of IAS 36.C4, the recoverable amount of the CGU (subsidiary) will be
determined for the CGU as a whole.
Following the basic principle that the carrying amount of the CGU and its recoverable amount
should be symmetrical (compare apples with apples) when testing for impairment, the carrying
amount of the CGU to be compared to the recoverable amount of the CGU, should be R1 950.
If the recoverable amount of the entire subsidiary amounts to R1 450, an impairment loss of R500
(1 950 – 1 450) will be identified.
Applying the basic principle of IAS 36.104 in respect of the allocation of the impairment loss of a
CGU, the impairment loss of R500 should first be allocated to goodwill recognised (R450) in the
consolidated financial statements and the remaining R50 should then be allocated to the other
assets in the CGU.
Comment
¾ In profit or loss, the impairment loss is allocated between the parent and the NCI in the
profit-sharing ratio.
¾ R450 goodwill (parent and NCI) currently forms part of the carrying amount of the CGU.
¾ The possible impairment loss of R500 would be allocated to goodwill of the CGU until it wipes
out the total goodwill recognised (R450). The remainder of R50 (500 – 450) of the impairment
loss will be allocated to other assets in the CGU pro rata using their carrying amounts as basis.
¾ Detailed examples in this regard are presented in Illustrative Examples 7A to 7C of IAS 36.
14.5.7.2 Non-controlling interests is measured at the proportionate share

of the acquiree’s identifiable net assets
Where non-controlling interests are measured at the proportionate share of the acquiree’s
identifiable net assets, the total goodwill attributed to a subsidiary will comprise only one
component (nothing contributed by non-controlling interests not measured at fair value):
Compare the sum of the consideration transferred# (R1 000 000), the non-controlling
interests measured at their proportionate share of the identifiable net assets$ (R180 000)
(900 000 × 20%) and, if applicable, the fair value of the previously-held equity interest in
the subsidiary& (nil) to the net assets of the subsidiary (R900 000). Goodwill would thus
be R280 000 (1 000 000 + 900 000 × 20%) – 900 000 (net assets)). Clearly no
component of the goodwill amount of the subsidiary is contributed by the non-controlling
interests as they are measured at their proportionate share of identifiable net assets of
the subsidiary, not fair value. This implies that the total amount of goodwill included in
the carrying amount of the subsidiary (R280 000), would represent the goodwill of the
subsidiary contributed by the parent who holds 80% of the shares. The non-controlling
interests would contribute nothing.
Testing for the impairment of goodwill on an annual basis in terms of IAS 36 involves
comparing the entire carrying amount of a CGU with its entire recoverable amount.
Where non-controlling interests are measured at their proportionate share of the identifiable
net assets of the subsidiary, the carrying amount of the subsidiary will only include goodwill
related to the controlling interest of 80% (parent) and nothing in respect of the non-
controlling interests. By contrast, the recoverable amount of the subsidiary would include
goodwill related to both the parent and the non-controlling interests. Clearly this would lead
to a situation where like is not compared with like; therefore the carrying amount of the
subsidiary should be grossed up to include the unrecognised portion of goodwill.
Example 14.15
14.15 Non-controlling interests and impairment – measurement at proportionate
share of identifiable net assets
The fair value of the total identifiable net assets of a subsidiary is R1 500. A parent acquires an
80% interest in those items for R1 600. The non-controlling interests (NCI) are measured at their
proportionate share of the net assets of the subsidiary and amount to R300 (1 500 × 20%).
Applying the normal principles contained in IFRS 3.32 to calculate goodwill, the sum of
R1 600 + (20% × R1 500), namely R1 900, will be compared to the total identifiable net assets of
the subsidiary, namely R1 500, to determine goodwill of R400. The goodwill of R400 relates to the
parent’s 80% interest in the subsidiary and therefore represents only 80% of the total goodwill
(total being parent’s and non-controlling interests’ goodwill) that can be associated with the
subsidiary as a whole. The portion of goodwill attributed to the NCI is not recognised in the
consolidated financial statements under this measurement basis.
To determine the grossed-up goodwill for the subsidiary as a whole of R500 (400/80%), notional
goodwill of R100 (500 – 400) (which has not been recognised in the consolidated financial
statements) should be added to the original R400.
Using the above information, if there is an NCI component in a CGU (the CGU is a subsidiary not
wholly-owned by the parent to which goodwill has been allocated), the carrying amount of the
CGU (subsidiary) in the consolidated financial statements will include allocated goodwill of R400,
as well as both the parent’s and the NCI’s interest in the identifiable net assets of the subsidiary
(R1 500). This will give a total carrying amount of R1 900.
This amount of R1 900 does not include the notional goodwill of the NCI of R100. If that were
included, the carrying amount of the CGU would have been R2 000 (1 900 + 100).
Note that in terms of IAS 36.C4, the recoverable amount of the CGU (subsidiary) will be
determined for the CGU as a whole.
Following the basic principle that the carrying amount of the CGU and its recoverable amount
should be symmetrical (compare apples with apples) when testing for impairment, the carrying
amount of the CGU to be compared to the recoverable amount of the CGU should be R2 000. This
will be achieved if the actual recognised carrying amount of the CGU is adjusted notionally by
R100 (500 × 20%) for the calculation of the impairment loss on the CGU.
If the recoverable amount of the entire subsidiary amounts to R1 450, an impairment loss of R550
(2 000 – 1 450) will be identified. Note that this amount assumes that the R100 goodwill
attributable to the NCI is also available for the impairment loss to be offset, but this is not the case.
Consequently, the impairment loss should be reduced by the R100 in respect of notional goodwill
that does not form part of the carrying amount of the subsidiary that was tested for impairment.
continued
Applying the basic principle of IAS 36.104 in respect of the allocation of the impairment loss of a
CGU, the (net) impairment loss of R450 (550 – 100) should first be allocated to goodwill
recognised (R400) in the consolidated financial statements. The remainder of R50 should then be
allocated to the other assets in the CGU.
Comment
¾ In profit or loss, the impairment loss is allocated between the parent and the NCI in the
profit-sharing ratio.
¾ R400 goodwill currently forms part of the carrying amount of the CGU.
¾ The possible impairment loss of R550 that could have been allocated to goodwill if the parent
owned a 100% of the CGU needs to be reduced by R100 to R450, to align it with the goodwill
recognised of R400. The remainder of R50 (450 – 400) of the impairment loss will be allocated
to other assets in the CGU pro rata using their carrying amounts as basis.
¾ If the impairment loss amounted to only R360 instead of R450, the total impairment loss would
be allocated to goodwill and the goodwill balance will be reduced to R40 (400 – 360).
¾ Detailed examples in this regard are presented in Illustrative Examples 7A to 7C of IAS 36.
14.5.8 Reversal of impairment losses for cash-generating units

The reversal of impairment losses for CGUs is similar to that of individual assets
(IAS 36.122 to .124).
When the impairment loss of a CGU is reversed, the reversal must be allocated to the
carrying amounts of the assets in the unit, except for goodwill, as follows:
assets other than goodwill are increased on a pro rata basis, based on their carrying
amounts in the unit; and
goodwill that is allocated to the unit, is never reinstated. This is to avoid recognising
internally-generated goodwill, which is prohibited by IAS 38.
When the reversal of an impairment loss for a CGU is allocated to the assets in the unit, the
carrying amounts of the assets must not increase above the lower of:
its recoverable amount; and
the carrying amount that would have been determined had no impairment loss been
recognised in prior periods.
If the carrying amount of individual assets increases above the amount stated above, the
residual is allocated to the remaining assets (except for goodwill) in the unit on a pro rata
basis.
Note that where goodwill has been written-down to the recoverable amount in the interim
financial statements, the amount may not be reversed in the second part of the financial
year.
Example 14.16
14.16 Reversal of impairment in the case of a cash-generating unit
On 1 January 20.14, a CGU consists of the following assets:

R
Goodwill 100 000
Machine (useful life 10 years) 500 000
Building (useful life 50 years) 1 000 000
Land (indefinite useful life) 570 000
continued
On 31 December 20.14, the CGU was impaired. The following is applicable:

R
Carrying amount of CGU:
Goodwill 100 000
Machine (500 000 × 9/10) 450 000
Building (1 000 000 × 49/50) 980 000
Land 570 000
2 100 000
Value in use 1 000 000
Fair value less costs of disposal of CGU 900 000
Recoverable amount of CGU = R1 000 000
Impairment loss: R2 100 000 – R1 000 000 = R1 100 000
It is impossible to determine the value in use less costs to sell of the assets separately.
The impairment loss allocated as follows:
Goodwill Machine Building Land Total
R R R R R
Carrying amount 100 000 450 000 980 000 570 000 2 100 000
Impairment loss
allocated to goodwill (100 000) (100 000)
Carrying amount – 450 000 980 000 570 000 2 000 000
The remaining
impairment loss of
R1 000 000
(1 100 000 – 100 000)
must be allocated to
the other assets on a
pro rata basis – *(225 000) *(490 000) *(285 000) (1 000 000)
Carrying amount after
impairment loss – 225 000 490 000 285 000 1 100 000
Depreciation for the
year ended
31 December 20.15 – (25 000) (10 000) – (35 000)
Carrying amount
31 December 20.15 – 200 000 480 000 285 000 965 000
* (450 000/2 000 000 × 1 000 000); (980 000/2 000 000 × 1 000 000); (570 000/2 000 000 × 1 000 000)
On 31 December 20.15, there was an improvement in the circumstances resulting in the
impairment. The recoverable amount of the CGU is calculated as R2 200 000.
In terms of IAS 36.123, the reversal must be allocated pro rata to all the assets, except goodwill.
The reversal is as follows:
R
Carrying amount of CGU on 31 December 20.15 965 000
Recoverable amount 2 200 000
Maximum reversal 1 235 000
On 31 December 20.15, the recoverable amount of the land is R500 000.
continued
In terms of IAS 36.123, the reversal must not be more than the lowest of the carrying amount, if no
impairment loss was recognised, or the recoverable amount of the asset. The carrying amount of
the assets would be as follows if no impairment loss was recognised previously:
Machine Building Land Total
R R R R
Carrying amount 31 December 20.15
(no impairment loss *400 000 *960 000 570 000
Recoverable amount – – 500 000
Limit on carrying amount after reversal 400 000 960 000 500 000
Carrying amount before reversal 200 000 480 000 285 000
Maximum reversal on asset 200 000 480 000 215 000 895 000
* (500 000/10 × 8); (1 000 000/50 × 48)
The reversal of impairment loss must be allocated as follows:

Goodwill Machine Building Land Total
R R R R R
Carrying amount
31 December 20.15 – 200 000 480 000 285 000 965 000
Reversal
Maximum reversal – 200 000 480 000 215 000 895 000
Pro rata allocation of
R1 235 000 – no limit – * 255 959 * 614 301 * 364 740 1 235
000
Unused reversal – (55 959) (134 301) (149 740) (340 000)
Carrying amount after

reversal – 400 000 960 000 500 000 1 860
000
* (200 000/965 000 × 1 235 000); (480 000/965 000 × 1 235 000); (285 000/965 000 × 1 235 000)
14.6 Disclosure
In the financial statements of an entity, the following must be disclosed for each class of
assets (a class is a grouping of assets of similar nature and use):

Profit or loss section
The amount of impairment losses recognised in the profit or loss section in the statement
of profit or loss and other comprehensive income during the period, and the line item(s)
of the statement of profit or loss and other comprehensive income in which those
impairment losses are included.
The amount of reversals of impairment losses recognised in the profit or loss section in
the statement of profit or loss and other comprehensive income during the period, and
the line item(s) of the statement of profit or loss and other comprehensive income in
which those impairment losses are reversed.

Other comprehensive income section
The amount of impairment losses recognised in other comprehensive income during the
period.
The amount of reversals of impairment losses recognised in other comprehensive
income during the period.
14.6.3 Notes to the financial statements

If the impairment loss recognised or reversed on an individual asset or CGU is material, the
following additional information is provided for an individual asset or a CGU, including
goodwill:
A description of the events and circumstances that led to the recognition or reversal of
the impairment loss.
The amount of the impairment loss recognised or reversed.
For an individual asset:
– the nature of the asset; and
– the reportable segment to which the asset belongs.
For a CGU:
– a description of the CGU (whether it is a product line, a plant, a business operation, a
geographical area, or a reportable segment);
– the amount of the impairment loss recognised or reversed by class of assets and by
reportable primary segment; and
– if the aggregation of assets for identifying the CGU has changed since the previous
estimate of the CGU’s recoverable amount (if any), a description of the current and
former way of aggregating assets and the reasons for changing the way the CGU is
identified.
Whether the recoverable amount of the asset or CGU is its fair value less costs of
disposal or its value in use.
If the recoverable amount is fair value less costs of disposal, the basis used to determine
fair value less costs of disposal.
If the recoverable amount is value in use, the discount rate(s) used in the current
estimate and previous estimate (if any) of value in use.
If impairment losses recognised (reversed) during the period are not individually material
to the financial statements of the reporting entity as a whole, an entity must disclose for the
aggregate impairment losses and reversals thereof, a brief description of the following:
The main classes of assets affected by impairment losses (reversals of impairment
losses) for which no information is disclosed in terms of the above.
The main events and circumstances that led to the recognition (reversal) of these
impairment losses for which no information is disclosed in terms of the above.
An entity is encouraged to disclose the assumptions used to determine the recoverable
amount of assets/CGUs in the period.
If, at the initial allocation of goodwill as discussed in IAS 36.84, any portion of goodwill
has not been allocated to a CGU or group of CGUs at the reporting date, the amount of
unallocated goodwill shall be disclosed, with reasons why the amount remains
unallocated.
An entity shall disclose the information required below for each CGU (group of CGUs) for
which the carrying amount of goodwill or intangible assets with indefinite useful lives
allocated to that CGU (group of CGUs) is significant in comparison with the entity’s total
carrying amount of goodwill or intangible assets with indefinite useful lives:
the carrying amount of goodwill allocated to the CGU (group of CGUs);
the carrying amount of intangible assets with indefinite useful lives allocated to the CGU
(group of CGUs);
the basis on which the CGU’s (group of CGUs’) recoverable amount has been
determined (i.e. value in use or fair value less costs of disposal);
if the CGU’s (group of CGUs’) recoverable amount is based on value in use:

– each key assumption on which management has based its cash flow projections for
the period covered by the most recent budgets/forecasts. Key assumptions are those
to which the CGU’s (group of CGUs’) recoverable amount is most sensitive;
– a description of management’s approach to determining the value(s) assigned to each
key assumption, whether those values reflect past experience or, if appropriate, are
consistent with external sources of information, and, if not, how and why they differ
from past experience or external sources of information;
– the period over which management has projected cash flows based on financial
budgets/forecasts approved by management and, when a period greater than five
years is used for a CGU (group of CGUs), an explanation of why that longer period is
justified;
– the growth rate used to extrapolate cash flow projections beyond the period covered
by the most recent budgets/forecasts, and the justification for using any growth rate
that exceeds the long-term average growth rate for the products, industries, or country
or countries in which the entity operates, or for the market to which the CGU (group of
CGUs) is dedicated; and
– the discount rate(s) applied to the cash flow projections;
if the CGU’s (group of CGUs’) recoverable amount is based on fair value less costs of
disposal, the valuation techniques used to measure fair value less costs of disposal. An
entity is not required to provide the disclosure required by IFRS 13. If fair value less
costs to sell is not measured using a quoted price for an identical CGU (group of CGUs),
the following information shall also be disclosed:
– each key assumption on which management has based its determination of fair value
less costs of disposal;
– a description of management’s approach to determining the value(s) assigned to each
key assumption, whether those values reflect past experience or, if appropriate, are
consistent with external sources of information, and, if not, how and why they differ
from past experience or external sources of information;
– the level of the fair value hierarchy (refer to IFRS 13) within which the fair value
measurement is categorised in its entirety (without giving regard to the observability of
costs of disposal); and
– if there has been a change in valuation technique, the change and the reasons for
making it; and
if a reasonably possible change in a key assumption on which management has based
its determination of the CGU’s (group of CGUs’) recoverable amount would cause the
unit’s (group of units’) carrying amount to exceeds its recoverable amount:
– the amount by which the CGU’s (group of CGUs’) recoverable amount exceeds its
carrying amount;
– the value assigned to the key assumption; and
– the amount by which the value assigned to the key assumption must change, after
incorporating any consequential effects of that change on the other variables used to
measure the recoverable amount, in order for the CGU’s (group of CGUs’)
recoverable amount to be equal to its carrying amount.
If some or all of the carrying amount of goodwill or intangible assets with indefinite useful
lives is allocated across multiple CGUs (groups of CGUs), and the amount so allocated to
each CGU (group of CGUs) is not significant in comparison with the entity’s total carrying
amount of goodwill or intangible assets with indefinite useful lives, that fact shall be
disclosed, as well as the aggregate carrying amount of goodwill or intangible assets with
indefinite useful lives allocated to those CGUs (groups of CGUs).
In addition, if the recoverable amounts of any of those CGUs (groups of CGUs) are based
on the same key assumption(s) and the aggregate carrying amount of goodwill or intangible
assets with indefinite useful lives allocated to them is significant in comparison to the
entity’s total carrying amount of goodwill or intangible assets with indefinite useful lives, an
entity shall disclose that fact, together with:
the aggregate carrying amount of goodwill allocated to those CGUs (groups of CGUs);
the aggregate carrying amount of intangible assets with indefinite useful lives allocated
to those CGUs (groups of CGUs);
a description of the key assumption(s);
a description of management’s approach to determining the value(s) assigned to the key
assumption, whether those values reflect past experience or, if appropriate, are
consistent with external sources of information, and, if not, how and why they differ from
past experience or external sources of information; and
if a reasonably possible change in the key assumption(s) would cause the aggregate of
the CGU’s (group of CGUs’) carrying amounts to exceed the aggregate of their
recoverable amounts:
– the amount by which the aggregate of the CGU’s (group of CGUs’) recoverable
amount exceeds the aggregate of their carrying amounts;
– the value(s) assigned to the key assumption(s); and
– the amount by which the value(s) assigned to the key assumption(s) must change,
after incorporating any consequential effects of the change on the other variables
used to measure the recoverable amount, in order for the aggregate of the CGU’s
(group of CGUs’) recoverable amounts to equal the aggregate of their carrying
amounts.

The impairment losses recognised on individual assets or CGUs are not recognised as tax
deductions in terms of the Income Tax Act 58 of 1962. Consequently, temporary differences,
and therefore deferred tax, arise when an impairment loss is recognised or reversed. (Refer
to the comprehensive example).

On 1 January 20.12 Bird Ltd had the following balances with regard to property, plant and equipment:
Accumulated
Cost
depreciation
R’000 R’000
Land 300 –
Buildings 4 000 400
Plant 4 000 1 600
All the above assets were acquired 1 January 20.10. Buildings and plant are depreciated on the
straight-line basis over 20 years and 5 years respectively and are carried at cost less accumulated
depreciation. Residual values are Rnil. Land, buildings and the plant are accounted for in accordance
with the cost model. Land is a non-depreciable asset.
On 30 June 20.12 a machine (with an original cost of R700 000 and a useful life of 5 years), which is
an integral part of the above plant, was destroyed by a fire and replaced with a similar one for
R800 000. Bird Ltd received an insurance claim of R210 000.
During the 20.12 financial year the market values of properties to drop sharply. On 31 December 20.12
the value in use and the fair value less cost of disposal of land and buildings was R2 000 000 and
R2 400 000 respectively. It was estimated that the market value of the land is 10% of the market value
of the total property. The fair values of the land and buildings at 31 December 20.12 were R130 000
and R1 900 000 respectively.
The following notes to the financial statements of Bird Ltd for the year ended 31 December 20.12
would be disclosed:
Land Buildings Plant Total
R’000 R’000 R’000 R’000
Carrying amount at beginning of year 300 3 600 2 400 6 300
Gross carrying amount or cost 300 4 000 4 000 8 300
Accumulated depreciation – (400) (1 600) (2 000)
Impairment losses through profit or loss
(included in other expenses) (C1) (60) (1 240) (350) (1 650)
Additions – – 800 800
Depreciation for the year (C2) – (200) (810) (1 010)
Carrying amount at end of year 240 2 160 2 040 4 440
Gross carrying amount or cost 300 4 000 4 100 8 400
Accumulated depreciation and impairment losses (60) (1 840) (2 060) (3 960)

The following items are included: R’000
Income
Compensation from insurer for impairment loss on property, plant and equipment
(IAS 16.65) 210
Expenses
Impairment losses individually regarded as material (IAS 36.130): (1 650)
Machine destroyed by fire (350)
Land and buildings: Adverse economic climate (1 240 + 60) (1 300)
Depreciation on property, plant and equipment (1 035)
Calculations
C1. Machine destroyed
R
Cost 700
Depreciation
20.10 – 20.11 (700/5 × 2) (280)
20.12 (700/5 × 6/12) (70)
Carrying amount 30 June 20.12 350
Impairment loss (350 – 0 = 350)
Property B – Impairment loss
Land Buildings
R’000 R’000
Carrying amount (4 000 – (4 000/20 × 2) – (4 000/20) = 3 400) 300 3 400
Recoverable amount (2 400 × 10%=240; 2 400 × 90% = 2 160) 240 2 160
Impairment loss 60 1 240
C2. Depreciation
R
Buildings (4 000/20) 200
Plant 70
Machine destroyed [C1] 80
New machine (800/5 × 6/12) 660
Rest ((4 000 – 700)/5) 810
C3. Reversal of impairment loss

Land Buildings
R’000 R’000
Carrying amount (2 160 – (2 160/17)) 240 2 033
Recoverable amount (400 and 5 000) limited to (IAS 36.117) 300 3 200
(4 000 – (4 000/20 × 4) = 3 200) 60 1 167
CHAPTER
15
Provisions, contingent liabilities
and contingent assets
(IAS 37; IFRIC 1, 5, 6 and 21)
Contents
15.1 Overview of IAS 37 Provisions, Contingent Liabilities and
Contingent Assets ........................................................................................... 362
15.2 Background ..................................................................................................... 363
15.3 Relationship between provisions and contingent liabilities ............................. 363
15.4 Provisions ........................................................................................................ 365
15.4.1 Recognition ...................................................................................... 365
15.4.2 Measurement ................................................................................... 367
15.4.3 Disclosure ........................................................................................ 369
15.4.4 Onerous contract ............................................................................. 370
15.4.5 Restructuring ................................................................................... 371
15.4.6 Additional matters surrounding provisions ....................................... 373
15.5 Contingent liabilities ........................................................................................ 374
15.5.1 Measurement ................................................................................... 375
15.5.2 Disclosure ........................................................................................ 375
15.5.3 Contingent liabilities recognised at business combinations ............. 376
15.6 Contingent assets............................................................................................ 376
15.6.1 Disclosure ........................................................................................ 377
15.7 Tax implications............................................................................................... 378
15.8 Changes in existing decommissioning, restoration and similar liabilities
(IFRIC 1).......................................................................................................... 379
15.8.1 Deferred tax consequences of decommissioning, restoration
and similar liabilities ......................................................................... 380
15.9 Rights to interests arising from decommissioning, restoration
sand environmental rehabilitation funds (IFRIC 5) .......................................... 381
15.9.1 Background...................................................................................... 381
15.9.2 Accounting for the interest in a fund ................................................ 381
15.9.3 Obligations to make additional contributions to the fund ................. 382
15.9.4 Disclosure ........................................................................................ 382
15.10 Liabilities arising from participating in a specific market –
waste electrical and electronic equipment (IFRIC 6) ....................................... 382
15.11 Levies (IFRIC 21) ............................................................................................ 383
361
15.1 Overview of IAS 37 Provisions, Contingent Liabilities

and Contingent Assets
Provisions
and
Start
contingent
liabilities
Present No No
Is there a
obligation
possible
as a result of
obligation?
obligating event?
Yes Yes
Is there a No Is the outflow Yes

probable of resources
outflow? remote?
Yes
Is there a No No
reliable (rare)
estimate?
Yes
Can obligation No
IAS 37
exist
independently
from entity’s
future actions?
Yes
Disclose a
Create
contingent liability Do nothing
a provision
in a note
Possible asset, No
existence
Contingent
confirmed
assets
by uncertain
future event
Yes
Is there a No
probable inflow?
Yes
Disclose a
contingent asset
in a note
Provisions, contingent liabilities and contingent assets 363
15.2 Background
IAS 37 deals with the accounting recognition and disclosure of provisions, contingent
liabilities and contingent assets in financial statements. This means that it is often required
that factual knowledge that only became available after the end of the reporting period be
considered.
IAS 37 is not applicable to provisions, contingent liabilities and contingent assets of:
executory contracts, except where the contract is onerous; and
items covered by other IFRSs such as:
– financial instruments that are within the scope of IFRS 9 Financial Instruments;
– the rights and obligations arising from contracts with customers within the scope of
IFRS 15 Revenue from Contracts with Customers. However, as IFRS 15 contains no
specific requirements to address contracts that are or have become onerous, IAS 37
will apply to such cases; and
– leases addressed in IFRS 16 Leases. However, IAS 37 applies to any lease that
becomes onerous before commencement date, short-term leases and leases which
the underlying asset is accounted for as low value.
The 2018 Conceptual Framework for Financial Reporting defines a liability as a present
obligation of the entity to transfer an economic resource as a result of past events. However,
no changes have been made to the definition of a liability in IAS 37, the IASB preserved the
reference to the definition of a liability in the 2001 Conceptual Framework. The reference to
a liability in IAS 37, refer to the definition of a liability as a present obligation of the entity
arising from past events, the settlement of which is expected to result in an outflow from the
entity of resources embodying economic benefits.
15.3 Relationship between provisions and contingent liabilities

The accounting process is, inter alia, concerned with the identification, recognition and
disclosure of elements of financial statements:
Identification refers to the assessment of a particular item with a view to determining
whether it fulfils the definition of the element concerned.
Recognition comprises two facets: timing and measurement. This means at what point in
time and at what value the element must be recognised.
As soon as the element is recognised, it is disclosed appropriately. The disclosure may
be qualitative (description) or quantitative (figures) or both.
The above may be represented schematically as follows:
Recognition may possibly take place after

Identification Disclosure
identification. Two aspects are considered:
Whether Timing Measurement How
The characteristics of When there is sufficient How much is the It is disclosed:
elements in terms of the probability that there will amount that must qualitatively,
2001 Conceptual be an outflow of be disclosed? quantitatively,
Framework are resources. or both?
displayed.
The fundamental difference between contingent liabilities and provisions is in the degree of
fulfilment of the requirements of identification. In the case of a provision, no doubt exists
regarding identification: a provision is a liability, because it has the characteristics of a
liability, as stated in the 2001 Conceptual Framework.
In the case of a contingent liability, there is a greater measure of uncertainty about the
fulfilment of the requirements of identification than for a provision: the uncertainty may
already exist at identification, because the contingent liability is described as a possible
obligation that arises from past events and whose existence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future events not wholly within the
control of the entity. A contingent liability may also take the form of a real present
obligation (not only a possible obligation) – but one that may however not be recognised,
because either the ‘when’ (timing) or the ‘how much’ (measurement) is not known.
Example 15.1 Contrasting a provision and contingent liability
Guests were catered for by a restaurant and after the reception, twelve people died as a result of
food poisoning contracted at the function. On 31 October 20.14, the relatives of the deceased
instituted a claim of R6 million against the entity. The year end of the company is 31 December.
The following two possibilities exist as at 31 December 20.14 in respect of the accounting
treatment of the claim:
Option 1: Provision
Should the legal advisors of the restaurant be of the opinion that the claim will probably be
successful and that the amount of R6 million represents a reasonable estimate of the amount to be
paid, the entity will recognise a liability, that is, a provision. A provision, as defined, is a liability of
uncertain timing or amount. In this case, uncertainty as to when the amount will be paid exists, but
sufficient certainty exists about the fact that there is a liability as well as the approximate amount
that should be paid.
Option 2: Contingent liability
If the legal advisors are of the opinion that it is merely possible that the claim may be successful, but
not probable, the matter will be disclosed as a contingent liability. It will thus not be recognised in the
financial statements, but will only be disclosed in the notes to the financial statements. In terms of the
definition of a contingent liability, the possible obligation arises from past events (the reception with
the contaminated food) and the existence of the obligation will only be confirmed at the occurrence
(judgment against the entity) or non-occurrence (judgment in favour of the entity) of uncertain future
events.
Example 15.2 Progression from a contingent liability to a provision
Suppose that Alfa Ltd provides and installs a factory plant for a customer and guarantees that
80% capacity will be achieved within three months of the commencement of production. If this
target is not achieved, Alfa is liable for damages to the extent of the lost production. Initially,
there is a small possibility that Alfa will have to perform, and therefore no accounting recognition
is required. After two weeks, it would appear that a liability may indeed materialise, but as it is
uncertain whether an outflow of resources will occur, as well as what the amount of such an
outflow will be, no liability is recognised, but the situation is explained by way of a note. This
treatment stays unchanged as long as the outflow of resources, or the amount of such an
outflow, remains uncertain. As soon as there is reasonable certainty of the fact that there will
indeed be an outflow of resources, as well as about the amount of such an outflow, a provision
is created and a liability is recognised in the financial statements.
The following summary is provided in the Implementation Guidance to IAS 37 to illustrate

the relationship between provisions and contingent liabilities:
Where, as a result of past events, there may be an outflow of resources embodying future
economic benefits in settlement of: (a) a present obligation, or (b) a possible obligation
whose existence will be confirmed only by the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control of the entity.
There is a possible obligation There is a possible
There is a present
or a present obligation that obligation or a present
obligation that probably
may, but probably will not, obligation where the
requires an outflow
require an outflow likelihood of an outflow of
of resources.
of resources. resources is remote.
A provision is recognised. No provision is recognised. No provision is recognised.
Disclosure is required Disclosure is required for the
No disclosure is required.
for the provision. contingent liability.
Example 15.3 Application of above table
Alfa Ltd is sued for R1 million for damages caused by a defective product that has been
manufactured and sold. The following two situations represent possible outcomes to the claim:
(a) Alfa Ltd’s legal advisors are of the opinion that the claim will probably succeed.
A present obligation exists as a result of a past obligating event (sale of a defective product). An
outflow of resources embodying future economic benefits is probable. A provision must be
recognised for the best estimate of the amount (R1 million) to settle the obligation.
(b) Alfa Ltd’s legal advisors are of the opinion that it is unlikely that Alfa Ltd will be found
liable.
Based on the opinion of Alfa Ltd’s legal advisors, a present obligation does not exist, but it is
possible that the entity may still have to pay. No provision is recognised. A contingent liability
must be disclosed, unless the possibility of an outflow of resources embodying economic benefits
is remote.
15.4 Provisions
A provision is defined in IAS 37.10 as a liability of which the amount or timing is uncertain.
15.4.1 Recognition
Provisions are not a separate element of financial statements, but form part of liabilities.
They are, however, distinguished from other liabilities, for example trade payables and
accrued amounts, by the element of uncertainty associated with them. This uncertainty
takes the form of uncertainty about either the timing or the amount at which it is recognised.
As indicated above, ‘timing’ refers to the moment when there will be reasonable certainty
about the resources that the entity must transfer to another party. Provisions are not
recognised as an element of financial statements until reasonable certainty exists.
In terms of IAS 37.14, a provision is only recognised when when all three of the below
criteria are met:
the entity has a present legal or constructive obligation to forfeit economic benefits as a
result of events in the past (‘whether it complies’);
it is probable that an outflow of resources embodying economic benefits will be required
to settle the obligation (‘when’); and
a reliable estimate of the obligation can be made (‘how much’).
Two types of obligations can thus exist in terms of a provision, namely:

a legal obligation; or
a constructive obligation.
A legal obligation is an obligation that derives from a contract (explicit or implicit terms);
legislation or other operation of law.
A constructive obligation is an obligation that is not legally enforceable, but arises as a
result of management policy and decisions that create a valid expectation with third parties
that the entity will act in a certain manner.
A past event that gives rise to a present obligation is called an obligating event. It is
necessary for an event to leave the entity with no realistic alternative to settle the obligation
for that event to be an obligating event. This is the case only where the settlement of the
obligating event is enforced by law or in the case of a constructive obligation.
In rare cases, it is not clear that there is a present obligation. In these cases, a past event is
deemed to give rise to a present obligation if, taking account of all available evidence, it is
more likely than not that a present obligation exists at the end of the reporting period.
Example 15.4
15.4 Meeting the requirements for recognising a provision
All three of the abovementioned recognition requirements must be met before a provision can be
recognised.
When an entity delivers assurance-type warranties to its clients, the following requirements
must be met before a provision is created:
An entity is normally liable for complying with the terms of the warranty contract. The warranty
contract creates a legal obligation for the entity to perform in terms of the contract if the client
claims in terms of the warranty. These contracts are concluded at a date in the past, i.e. the date
of the delivery of goods or services.
When the probability of the client claiming in terms of the warranty contract is assessed, one
must have reasonable certainty that the client will exercise his/her rights, if required.
The estimate of the number of clients likely to claim against warranty contracts will influence the
reliability of the estimate of the provision. It should be possible, based on historical information
and the costs related to performing on a warranty, to arrive at a reliable estimate of the
expected future outflows related to the warranty.
An assurance-type warranty contract should, because of the above reasons, thus result in a
provision in terms of IAS 37.
Example 15.
15.5 Legal versus constructive obligations
Gamma Ltd has retail outlets for electrical appliances in three different countries:
Finland: In Finland, legislation requires retailers of electrical appliances to provide a one-year
standard warranty that specifies the appliances will comply with agreed-upon
specifications.
South South Africa has no legislation in this regard, but most retailers selling electrical
Africa: appliances usually provide a one-year standard warranty that specifies the appliances
will comply with agreed-upon specifications. However, Gamma Ltd did not follow this
custom. In view of the company’s attitude, customers boycotted the company for two
months. Subsequently, management issued a press release to the effect that it would
also in future provide a one-year standard warranty.
Cambodia: Cambodia has no legislation in this regard, although the management of Gamma Ltd
is considering the introduction of a standard warranty. However, no announcement to
this effect has been made.
continued
The question is when a provision for the warranties should be raised in each of the above cases.
In general, a provision is recognised when there is a present obligation as a result of past events.
The past events in this case are the sales of electrical appliances, and to incur a present
obligation, the company must have either a legal or a constructive obligation to accept returned
goods.
Finland: A legal obligation arises immediately after a sale, as a law governs the matter.
Consequently, a provision for returns must be recognised.
South A constructive obligation exists as a valid expectation arose with customers after
Africa: the company’s public announcement to this effect. A provision must thus be
recognised.
Cambodia: As Cambodia has no legislation in this regard and customers are not aware of the
company’s intentions, no legal or constructive obligation exists. No provision must
be recognised in this case.
It is also important to take note that only those obligations that can exist independently of
an entity’s future actions (in other words, the future conduct of its business) are
recognised as provisions (IAS 37.19). If an obligation can be avoided by way of future
action, the entity still has a realistic alternative to settling the obligation. An example of this
principle would be the obligation to replace the lining of a grain silo in future due to an Act
requiring grain silo linings to be replaced on a regular basis. Should the entity decide to
rather utilise the silo for other purposes, for example storing sugar rather than storing grain,
the replacement of the lining becomes unnecessary. This obligation is thus dependent on
the fact that the entity who owns the grain silo will still utilise the silo in exactly the same
manner as currently. Therefore the obligation does not exist independently from the entity’s
future actions, and may not be recognised as provision.
15.4.2 Measurement
In accordance with IAS 37.36, a provision is measured in terms of the amount that
represents the best estimate of the amount required to settle the obligation at the end of
the reporting period.
When a single obligation is being measured, the individual most likely estimate is used as
the best estimate of the liability. The entity will however also consider other possible
outcomes. Where the other possible outcomes are either mostly higher or mostly lower than
the most likely outcome, the best estimate will be a higher or lower amount.
Where there is a continuous range of possible outcomes, and each point in that range is as
likely as any other point, the mid-point of the range is used.
IAS 37.45 states that if the effect of discounting is material, the provision must be
measured at the present value of the expected future outflow of resources. This applies to
the liabilities that have an effect over the long term, as often occurs in the case of
environmental costs, for example rehabilitation of disturbed land in the mining industry.
Because the expenses in these cases may occur over a very long period or may only be
incurred after a long period has lapsed, it can present an unrealistic impression if the
expected expenses over these long periods are not discounted to present values for the
purposes of the provision. The discount rate and the cash flows must both be expressed in
either nominal terms (including the effect of inflation) or in real terms (excluding the effect of
inflation) and on a before-tax basis. The discount rate must recognise current market
evaluations of the time value of money as well as the risks that are associated with the
particular obligation. Although the Standard is not clear, an entity’s own credit risk is
currently not regarded in practice as a risk that is associated with the liability and is therefore
not included in the discount rate. The discount rate must not reflect risks for which future
cash flow estimates have been adjusted, and may be revised if changed circumstances
warrant it.
When discounting is used in the measurement of a provision, the carrying amount will
increase on an annual basis over time. The debit leg of the increase in the provision is
recognised as finance costs in the profit or loss section of the statement of profit or loss
Example 15.
15.6 Provisions and the time value of money
Charlie Ltd is a manufacturing company with a 31 December year end. The company’s
manufacturing plant releases toxic substances that will contaminate the land surrounding the plant
unless they are collected and stored safely. The local authorities approved the erection of the
plant, provided the entity undertakes to build safe storage tanks for the toxic substances and to
remove these after a period of 20 years and restore the environment to its original condition.
On 1 January 20.13 (the day on which the plant was commisioned), it was determined that it would
cost approximately R20 million at future prices to remove the tanks and restore the environment
after 20 years have expired. It is expected that the cost involved would be tax deductable (at
normal income tax rate of 28%) and a nominal before-tax discount rate amounts to 15%. The
actual cost of decontamination in 20.32 amounted to R21 million.
The journal entries for 20.13, 20.14 and settlement in 20.32 are as follows:
Dr Cr
R R
1 January 20.13
Asset (refer to IAS 16.16(c)) (SFP) 1 222 006
Provision for environmental costs (SFP)
[20 000 000 × 1/(1,15)20] 1 222 006
Initial recognition of discounted environmental costs
31 December 20.13
Finance costs [(1 222 006 × 1,15) – 1 222 006] (P/L) 183 301
Provision for environmental costs (SFP) 183 301
Accounting for the increase in the provision as a result
of the time value of money
31 December 20.14
Finance costs [(1 222 006 + 183 301) × 15%] (P/L) 210 796
Provision for environmental costs (SFP) 210 796
Accounting for increase in provision due to time value of money
31 December 20.32
Provision for environmental costs (SFP) 20 000 000
Environmental costs (P/L) 1 000 000
Bank (SFP) 21 000 000
Accounting for the actual environmental costs at the end
of 20 years
The following amounts will appear in the statements of financial position at the end of 20.13 and
20.14:
R
20.13
Provision [20 000 000 × 1/(1,15)19] or [1 222 006 + 183 301] 1 405 307
20.14
Provision [20 000 000 × 1/(1,15)18] or [1 405 307 + 210 796] 1 616 103
Future events that are expected to have an effect on the amount that the entity will
eventually need to settle the provision may be taken into account in the measurement
process. In IAS 37.49, the example is used of new technology that may become available
later and may influence the rehabilitation of contaminated land. It would be acceptable to
include the appropriate cost reductions that are expected as a result of the application of the
new technology in the calculation of the provision, and therefore to measure the provision at
an appropriately lower value.
The technique of calculating an expected value may also be applied to determine an
appropriate amount at which to measure a provision.
Example 15.
15.7 Measurement of a provision using expected values
The Truth, a newspaper with a daily circulation of 500 000 copies, publishes an article in which it is
alleged that a prominent politician is having an improper extramarital affair with the wife of an
opposition politician. The owner of the company, Truth Media Ltd, is summonsed for alleged
defamation amounting to R5 million. The company’s legal advisors assessed the possible
outcomes of the case as follows:
Probabilities:
15% that the claim will fail;
20% that an amount of R1 million will be granted;
25% that an amount of R1,5 million will be granted;
20% that an amount of R1,8 million will be granted; or
20% that an amount of R2 million will be granted.
The amount at which the provision will be measured is calculated as follows: R
15% × 0 –
20% × R1 million 200 000
25% × R1,5 million 375 000
20% × R1,8 million 360 000
20% × R2 million 400 000
Expected value 1 335 000
15.4.3 Disclosure
Provisions are disclosed as a separate line item on the face of the statement of financial
position.
No detailed disclosure is required in the extremely rare cases where the disclosure of
information, as stated below, may prejudice the position of the entity in negotiations (in
respect of a dispute) with other parties in respect of the matter for which the provision is
required. Such instances are, in general, extremely rare. This does not, however, imply that
the provision cannot be created: it is still done, but only its general nature and the reason
why it is not disclosed more comprehensively are stated. An example of required disclosure
in this regard appears in Example 3 of disclosure examples of IAS 37.
The following must be disclosed for each category of provision:
a brief description of the nature of the obligation and the expected timing of any outflow
of economic benefits associated there with;
any significant uncertainty about the amount or timing of the expense must be stated.
Where it is necessary for a better understanding of the financial statements, the main
assumptions about future events must be disclosed. Such future events may, for
example, be related to proposed legislation, technological development, etc.;
where there is an anticipated reimbursement of a provision, the amount of the expected
recovery must be stated, as well as the amount of any asset that has been recognised in
respect of it;
the carrying amount at the beginning and the end of the period;
movements in each category of provisions must be reflected separately, with an

indication of:
– additional provisions made in the period and increases in existing provisions;
– amounts incurred (utilised) and offset against the provision during the period;
– amounts reversed during the period for being superfluous; and
– the increase in the amount of the provision during the period due to the passage of
time, or a change in the discount rate; and
should an entity commence the implementation of a restructuring plan after the end of
the reporting period or disclose the main features of such a plan to affected parties after
the end of the reporting period, disclosure in terms of IAS 10 (refer to chapter 7) is
required. This is the case provided the restructuring is material and that non-disclosure
would impact on economic decisions of users.
Comparative information is not required.
15.4.4 Onerous contracts

An onerous contract is a contract in which the unavoidable costs of meeting the obligations
under the contract exceed the economic benefits expected to be received under it. The
present obligation as a result of a past obligating event is the signing of the onerous
contract, which gives rise to a legal obligation. When the contract becomes onerous, an
outflow of resources embodying economic benefits becomes probable. As a result the
present obligation in terms of onerous contracts is recognised in the financial statements as
a provision. This provision is the smaller of:
the loss that would be incurred by specific fulfilment of the contract; and
the loss incurred if the contract were to be cancelled and the payment of fines associated
with the cancellation enforced.
Probable impairment losses relating to assets under such a contract must be recognised
separately in terms of IAS 36 (refer to chapter 14), and do not normally lead to any
obligations.
Example 15.8 Onerous lease contract
On 1 January 20.11, Zanzi Ltd entered into a lease contract for computers. The computers were
determined as low value assets in accordance with paragraph 6 of IFRS 16. The lease is to run for
a period of three years (contract expires on 31 December 20.13). As a result of several factors, the
board of directors decided on 31 October 20.12 to enter a new lease agreement with a different
supplier for computers, with commencement date 1 January 20.13. However, the lease contract
determines the following:
R
Lease payments per year (no escalation) 100 000
Fine payable on early cancellation of the contract 150 000
The computers cannot be sub-let
The company’s year end is 31 December.
The decision of the board of directors on 31 October 20.12 resulted in an onerous contract.
Assume that the time value of money does not play a material role here. Since the contract
represents a present legal obligation, a provision needs to be raised for the smaller of:
R
Remaining lease payments from 1 January 20.13 100 000
Fine payable on cancellation 150 000
continued
Consequently, a provision of R100 000 (the smaller figure) is accounted for on 31 December 20.12
as follows:
Dr Cr
R R
Fine at cancellation of lease contract (P/L) 100 000
Provision for onerous contract (SFP) 100 000
Recognise provision for an onerous contract
Onerous contracts may therefore, in some cases, be regarded as an exception to the

principle that future losses may not be provided for. Losses from future activities are
normally not provided for before such activities have indeed occurred. However, in the case
of a contractual obligation which is in the form of an onerous contract, such an obligation is
accounted for immediately.
Executory contracts are contracts in terms of which not one of the parties involved has
performed, or both have performed to an equal extent. An example would be a normal order
placed for generally available inventories – an order that can be cancelled at any time.
IAS 37 does not deal with executory contracts, unless they are onerous (IAS 37.3).
15.4.5 Restructuring
A specific form of provision, discussed in IAS 37, is where a plan for restructuring is put into
operation. Restructuring is defined in IAS 37.10 as a programme that is planned and
controlled by management and that brings about material change to either:
the extent of the entity’s operations; or
the way in which business is done.
The provision that is established in this way must be:
necessitated by the restructuring; and
must not form part of the normal ongoing operations of the entity.
An example of restructuring is when a large supermarket chain closes certain branches and
converts some of them into smaller specialty shops. Other examples include the closing
down of branches in a particular area and the opening of branches in other areas, changes
in the management structure and a reorganisation that has a major influence on the nature
and focus of the activities of the entity.
A restructuring may or may not take the form of a discontinued operation as described in
IFRS 5, depending on whether a component of an entity is closed down or not (refer to
chapter 19).
An obligation for restructuring only arises when all the following conditions are met
(IAS 37.72):
A detailed plan, identifying at least the following, must exist:
– the part of the business that is to be restructured;
– the principal areas that are affected;
– the location, function and approximate number of employees that will be compensated
for terminating their services;
– the expenditure that will be undertaken; and
– when the plan will be implemented.
A valid expectation must have been raised in those affected that the entity will carry out
the restructuring by starting to implement the plan or announcing its main features to
those affected by it. In the latter case, restructuring must indeed commence shortly, as a
long delay could give rise to the expectation that it will no longer be implemented and a
constructive obligation would thus not exist.
Whether a constructive obligation indeed exists at the end of the reporting period when
management or the directors have taken a decision before the end of the reporting
period, and whether a provision must thus be raised, will depend on whether the entity,
before the end of the reporting period:
started to implement the restructuring plan; or
announced the main features of the restructuring plan in such a way that the affected
parties have a valid expectation that the restructuring will take place.
The circumstances of each case will be decisive. Negotiations with labour unions and
prospective buyers will be indicative of the existence, or otherwise, of the constructive
obligation.
An obligation for the sale of an operation does not arise before a binding sales agreement
is concluded (IAS 37.78). In this case, professional judgement is not applicable – even if
announcements have already been made, the obligation only arises when the relevant
contract is concluded, because the management of the entity may still change its mind. This
is therefore not a constructive obligation, but a legal one. Should a sale form part of a
restructuring, the related assets must be reviewed for impairment in terms of IAS 36 (refer to
chapter 14). If a sale forms part of a restructuring, a constructive obligation for other parts
of the restructuring may arise before a binding sales agreement is entered into.
If financial reporting should occur before the restructuring process has been completed, and
there is therefore still uncertainty about the extent of the amounts involved, such expenses
will be estimated and provided for. The expenses that are therefore directly involved in
the restructuring will appear as a provision on the statement of financial position – this
provision includes expenses that are both essential to the restructuring and that do not
relate to the continuing operations of the entity. Examples of such direct expenses include
severance packages of members of staff, fines for the cancellation of contracts, costs of
dissolution, costs of discontinuation of renting, and retention payments made to key staff.
Costs for the retraining or relocation of continuing staff, marketing or investment in new
systems and distribution networks are not included in the provision, as these relate to the
future operations of the entity and do not constitute an obligation for the restructuring of the
business at the end of the reporting period. Also, future operating losses are not provided
for, unless they originate from an onerous contract. Profits on the expected sale of assets
are never taken into account in measuring a provision, as it would be tantamount to the
premature recognition of income (IAS 37.51).
Example 15.9 Timing of raising restructuring provisions
No implementation of closure of division before end of the reporting period

On 15 June 20.14, the board of an entity decided to close down a division. The decision was not
communicated to any of those affected before the end of the reporting period (30 June 20.14), and
no other steps were taken to implement the decision.
As there has been no obligating event, there is no obligation. No provision is thus recognised on
30 June 20.14.
Communication/implementation of closure before end of the reporting period
On 15 June 20.14, the board of an entity decided to close down a division manufacturing a
particular product. On 22 June 20.14, a detailed plan for closing down the division was approved
by the board; letters were sent to customers advising them to seek an alternative source of supply,
and redundancy notices were sent to the staff of the division.
The obligating event is the existence of a detailed plan and the communication of the decision to
the customers and employees, which gives rise to a constructive obligation from that date as a
valid expectation that the division will be closed, has been raised.
An outflow of resources embodying economic benefits in settlement is probable.
A provision will be recognised on 30 June 20.14 for the best estimate of the costs of closing the
division.
Provisions must not be recognised for future operating losses. The possible incurrence of future
operating losses is an indication that certain assets may be impaired.
15.4.6 Additional matters surrounding provisions

IAS 37.53 states that where an entity has a right of recovery against a third party in
respect of a provision or a part of a provision, the part that can be recovered from the third
party must be recognised as a separate asset if it is virtually certain that the amount will be
received. The related provision and asset in the statement of financial position will thus
each be shown separately and will not be offset against each other. In the statement of profit
or loss and other comprehensive income, however, the expense leg of the provision and
the income leg of the related reimbursement may be offset against each other. The amount to
be recognised for the reimbursement of the provision is limited to the amount of the provision
to which it is related, and an asset in respect of the recovery may only be raised when it is
virtually certain that the amount will be received. The following summary is provided in the
Implementation Guide to IAS 37 to explain these matters:
Some or all of the expenditure required to settle a provision is expected to be reimbursed

by another party.
The entity has no The obligation for the amount expected The obligation for the amount
obligation for the part of to be reimbursed remains with the expected to be reimbursed
the expenditure to be entity and it is virtually certain that remains with the entity and the
reimbursed by the other reimbursement will be received if the reimbursement is not virtually
party. entity settles the provision. certain if the entity settles the
provision.
The entity has no The reimbursement is recognised as a The expected reimbursement
liability for the amount separate asset in the statement of is not recognised as an asset.
to be reimbursed by the financial position and may be offset
other party. against the expense in the statement of
profit or loss and other comprehensive
income. The amount recognised for the
expected reimbursement does not
exceed the liability.
No disclosure is The reimbursement is disclosed The expected reimbursement
required. together with the amount recognised is disclosed as a contingent
for the reimbursement. asset.
Example 15.10 Right of recovery in respect of provisions
A retailer sells electrical appliances subject to a two-year warranty (assurance-type). Given the
above information, the following situations, inter alia, are possible:
Case 1
The manufacturer of the electrical appliances does not provide a warranty on the items sold.
In this case, the retailer will have to provide for the total warranty provision and the amount (say
R100 000) involved will be raised as a liability and a corresponding expense. The journal entry in
the retailer’s records will be as follows:
Dr Cr
R R
Warranty expense (P/L) 100 000
Warranty provision (SFP) 100 000
Accounting for warranty provision
Case 2
The retailer provides the warranty which is backed up fully by the manufacturer on a rand-for-rand
basis.
continued
In this case, the retailer will raise a warranty provision with a corresponding warranty expense.
Since the manufacturer is prepared to accept responsibility for the warranty offered by the retailer,
the retailer may raise a corresponding asset in respect of the anticipated reimbursement, provided
the retailer is virtually certain the manufacturer will and can fulfil its undertaking to back the
retailer’s guarantee. The journal entries in the retailer’s records will be as follows (assuming an
amount of R100 000):
Dr Cr
R R
#
Warranty expense (P/L) 100 000
Warranty provision (SFP)* 100 000
Accounting for the warranty provision
Reimbursement on warranty (SFP)* 100 000
#
Warranty reimbursement (income) (P/L) 100 000
Accounting for reimbursement asset on warranty
# These two amounts may be offset in the statement of profit or loss and other comprehensive
income.
* The asset and liability may not be offset in the statement of financial position.
Comment
¾ If the reimbursement is not virtually certain, the reimbursement will be disclosed as a contingent
asset in a note.
Gains that may arise on the future sale of assets are not provided for, as doing this would
amount to the premature recognition of income. Losses on the sale of assets, for example
as a result of restructuring, could however be recognised in terms of IAS 36 (the recoverable
amount may change to fair value less cost to sell due to the restructuring, and thus an
impairment may be required). Future operating losses are not provided for, as this would
amount to the premature recognition of losses.
As in the case of all elements of financial statements, provisions, like liabilities, must be
assessed continually to ensure that the amount against which they are measured is still
acceptable in the light of the normal measurement principles. If an adjustment is required, it
is made through the profit or loss section of the statement of profit or loss and other
Naturally, provisions may only be used for the purposes for which they were originally
created.
If an entity is jointly and severally liable for an obligation, the obligation is disclosed as a
contingent liability to the extent that it is expected that other parties will settle the liability.
The total obligation will thus be carried partly as a liability and partly as a contingent liability.
15.5 Contingent liabilities

A contingent liability is a condition or circumstance at the end of the reporting period of
which the eventual result (beneficial or prejudicial) will only be confirmed upon the
occurrence or non-occurrence of one or more uncertain future events that are beyond the
control of the entity.
A contingent liability may take the form of either a possible obligation or an actual present
obligation.
In the form of a possible obligation, there is uncertainty about whether the obligation
indeed exists – such uncertainty will later be removed by the occurrence or non-
occurrence of future events that are not completely under the control of the entity.
In the form of an actual present obligation, the uncertainty manifests itself either in the
fact that it may be improbable that resources will be utilised to settle the obligation, or
because the amount cannot be measured reliably.
To distinguish between a possible oligation and a present obligation of which the outflow of
benefits is not probable may prove to be difficult in many cases.
Contingent liabilities are never recognised as an element of financial statements, although
they are usually disclosed by way of a note. The reason for this is that the recognition
criteria for elements (the ‘when’ and/or the ‘how much’) are not sufficiently met.
15.5.1 Measurement
Contingent liabilities are measured at the best estimate of the amount that will be required to
settle the liability at the end of the reporting period, should it indeed materialise. The risks
and uncertainties that are associated with the contingent liability are taken into consideration
during the estimation process. For example, should the effect of the time value of money be
material, for example because the contingent liability would only be settled after a long
period has lapsed, the expected expense is discounted to its present value. The discount
rate is a pre-tax rate that would reflect the risks associated with the particular contingent
liability.
The same rules that apply to the measurement of provisions also apply to contingent
liabilities, but obviously the associated finance cost is not recognised in the profit or loss
15.5.2 Disclosure
The following disclosure requirements apply in the case of contingent liabilities:
for each class of contingent liability, a brief description of its nature is given, as well as,
where practicable:
– an estimate of its financial effect;
– an indication of the uncertainties relating to the amount or timing of any outflow; and
– the possibility of any reimbursement;
where a provison and a contingent liability relate to the same set of circumstances, the
disclosure for the contingent liability is cross-referenced to the disclosure for the
provision to clearly illustrate the relationship; and
where the disclosure of the above information does not take place as it would be
impracticable and is not disclosed for this reason, that fact must be stated.
The above disclosure requirements do not apply when the possibility of any outflow of
resources is remote – then no disclosure is required.
No specific disclosure is required in cases in which the disclosure of information, as set out
above, may prejudice the position of the entity in negotiations (in respect of a dispute) with
other parties with regard to the matter to which the contingency relates. IAS 37.92 does,
however, indicate that these circumstances are extremely rare. The general nature of the
circumstances and the fact that the information is not disclosed, as well as the reason why it
is not disclosed, must be stated. Refer to Example 3 of Appendix D to IAS 37 for an
example on this matter.
Example 15.11 Contingent liability – measurement and disclosure
Delta Limited has established that it has a contingent liability in respect of a summons and related
court case for breach of contract amounting to R2 million at 31 December 20.14 (the year end).
The court case will, due to the backlog in court cases currently evident in the justice system, only
be finalised in three years’ time. An appropriate pre-tax discount rate associated with this company
would be 12%. Disclosure will be as follows:
Delta Ltd
11. Contingent liability
A court case in respect of a claim for breach of contract to the amount of R2 million has been
instituted against the company. Since the trial will only be finalised in three years’ time due to a
backlog in the allocation of cases, the estimated present value of the anticipated payment that may
be required is calculated as R1 423 561 (2 000 000 × 1/(1,12)³). There is no possibility of claiming
this amount from a third party resulting in reimbursement.
15.5.3 Contingent liabilities recognised at business combinations

In terms of IAS 37, contingent liabilities must be disclosed by way of a note, and must not be
recognised as a liability. However, in terms of IFRS 3 (refer to chapter 26), some contingent
liabilities of the acquiree are raised as liabilities when accounting for a business combination
under the acquisition method. Contingent liabilities assumed in a business combination must
only be recognised if it is a present obligation that arises from past events and its fair value
can be measured reliably. A contingent liability that is only a possible obligation may,
however, not be recognised in such a business combination as it does not meet the
definition of a liability.
The reason for recognising contingent liabilities when accounting for the business
combination is that the acquirer in a business combination would factor the existence of a
contingent liability into his price when making an offer for the purchase of another company –
this fact would reduce the purchase price offered. If the net assets of the acquiree therefore do
not take into account the contingent liability (reducing net assets), goodwill arising on the
business combination may be understated, or the gain from the bargain purchase that arose will
be overstated.
15.6 Contingent assets

A contingent asset is a possible asset that arises from past events, the existence of which
will be confirmed only by the occurrence or non-occurrence of one or more uncertain future
events not wholly within the control of the entity (IAS 37.10).
A contingent asset may, for example, be associated with a claim instituted by the entity that
may lead to the realisation of income for the entity. However, contingent assets are not
recognised in financial statements, since this may result in the recognition of income
that may never be realised. Hence, the recognition of income is usually postponed until
its realisation is virtually certain. When its realisation is virtually certain, such income is
no longer merely a contingency and it is appropriate to recognise the income and related
asset.
The following summary is provided in the Implementation Guidance to IAS 37 to explain the
accounting treatment of contingent assets:
Where, as a result of past events, there is a possible asset whose existence will be confirmed
only by the occurrence or non-occurrence of one or more uncertain future events not wholly
within the control of the entity, the following apply:
The inflow of economic
The inflow of economic The inflow is not
benefits is probable, but not
benefits is virtually certain. probable.
virtually certain.
The asset is not contingent No asset is recognised. No asset is recognised.

and is recognised. Disclosure is required in a note. No disclosure is required.
Example 15.12 Accounting treatment – contingent and other assets
Delta Ltd summonsed Echo Ltd on 30 April 20.14 for breach of copyright. The court case is in
progress at the moment, and the lawyers of Delta Ltd expect that the court will award an amount of
R900 000 to the company. Echo Ltd is a financially sound company and will be able to pay the
R900 000. Delta Ltd’s year end is 30 June.
In view of the above information, there are two possibilities with regard to the accounting treatment
on 30 June 20.14 of the income that would accrue to Delta Ltd should the case be decided in the
company’s favour:
On 30 June 20.14, the outcome of the court case is uncertain, but it is probable that
Delta Ltd will win the case:
Delta Ltd does not recognise the expected income of R900 000, but discloses a contingent asset by
way of a note.
On 30 June 20.14, it is virtually certain that Delta Ltd will receive R900 000 in damages for
breach of copyright:
Delta Ltd recognises an asset and the related income of R900 000 in the statement of financial
position and statement of profit or loss and other comprehensive income respectively. The
statement of profit or loss and other comprehensive income item will, in all probability, be disclosed
in the notes to the financial statements.
15.6.1 Disclosure
Should an inflow of economic benefits be probable, the following disclosure requirements
apply to contingent assets:
a brief description of the nature of the contingent asset;
an estimate of the financial effect of the contingent asset, measured in accordance with
the same principles that apply to provisions and contingent liabilities, provided it is
practicable to obtain this information;
where the disclosure of the above information does not take place as it would be
impracticable and is not disclosed for this reason, that fact must be disclosed; and
no specific disclosure is required in cases in which the disclosure of information, as set
out above, may prejudice the position of the entity in negotiations with other parties in
respect of the matter to which the contingency relates. IAS 37.92 does, however,
indicate that these circumstances are extremely rare. The general nature of the
circumstances and the fact that the information is not disclosed, as well as the reason
why it is not disclosed, must be stated.

This part of the chapter is not meant to provide detailed guidance on the tax implications of
provisions, and merely gives an overview of some aspects of tax related to provisions.
In terms of the general prohibition contained in section 23(e) of the Income Tax Act 58 of
1962, a taxpayer may not claim a deduction when determining taxable income, should this
deduction originate from a reserve transfer or any other capitalisation of income (raising of a
provision). This section supports the principle contained in the general deduction formula in
section 11(a). Section 11(a) determines that expenses may only be deducted when
incurred, unless the Income Tax Act provides specifically for the deduction of expenses not yet
incurred when taxable income is determined. The expense resulting from provisions may
either be deductible for tax purposes when the provision is raised, deductible in the
future when the provision is settled or not deductible at any stage.
Example 15.13 Deferred tax on provisions – deductible in current year
Assume Echo Ltd raised a provision to the amount of R100 000 during 20.14 (the current year).
Assume the SARS allows the R100 000 as a tax deduction in the current year. Normal income tax
rate of 28%.
Deferred tax for 20.14 resulting from the above, is the following:
Carrying Tax Temporary Deferred tax
amount base difference @ 28%
R R R R
Provision for warranty claims (100 000) (100 000)* – –
* The tax base of the provision is the carrying amount (R100 000) less the amount that will be
deductable for tax purposes in the future (zero).
The following example illustrates the difference in treatment of a provision depending on

whether the related expense is deductiblein the future or not deductible.
Example 15.14 Deferred tax on provisions – deductible in the future or non-deductible

for tax purposes
Foxtrot Ltd became the defendant in two court cases during the year ended 31 December 20.14. It
appears probable that the company will have to pay damages to both claimants. An amount of
R800 000 is claimed for infringement on a patent (capital of nature), while R1 000 000 is claimed
for damages caused by products sold by Foxtrot Ltd. The claim will be deductible for tax purposes
when it is actually settled. Both these amounts were raised as provisions at year end. The
deferred tax resulting from the above information is the following:
Infringement on a patent
20.14
R R R R
Provision for damages in respect
of infringement on patent (800 000) (800 000) – –
Comment
Comment
¾ Since nothing will be deductible for tax purposes in future due to the capital nature of the claim,
the carrying amount of the provision will be equal to its tax base and the resultant deferred tax
will be Rnil.
continued
Damages caused by Foxtrot Ltd’s products

20.14
R R R R
Provision for damages from use
of products (1 000 000) – (1 000 000) 280 000
Comment
¾ The claim will be deductible for tax purposes when settled. As the carrying amount of the provision
less the amount that will be deductible in future is equal to Rnil, the deductible temporary difference
is R1 000 000 and a debit of R280 000 is raised in the deferred tax account.
15.8 Changes in existing decommissioning, restoration and similar

liabilities (IFRIC 1)
The elements of cost of property, plant and equipment as listed in IAS 16.16 include an
initial estimate of the cost of dismantling and removing the item and restoring the site on
which it is located, provided these costs were raised via an associated provision. The
obligation related to the provision could arise either when the item is acquired or as a
consequence of having used the item during a particular period for purposes other than
producing inventories during that period. If the item is used to manufacture inventories, the
cost leg of the provision entry will be capitalised as part of the cost of inventories.
Although IAS 16 was clear on what to do at initial recognition with such costs and the related
provision, there was a lack of guidance as to what would happen if the amount of the initial
estimate included in the cost of the PPE item were to change at a later stage when the
estimate is revised.
IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities deals only
with the accounting treatment relating to changes in the measurement of any
decommissioning, restoration or similar liabilities that form part of both PPE and provisions.
Since the provisions associated with the abovementioned costs generally relate to amounts
to be paid at some date in the future, these items are mostly discounted to present value at
date of recognition. The subsequent unwinding of the discount factor would result in an
increase in the related provision and a debit against finance cost in the statement of profit or
loss and other comprehensive income as is the case with any provision where the time value
of money plays a role (refer to section 15.4.2). IFRIC 1.8 prohibits the capitalisation of finance
costs arising from this source and the unwinding of the discount rate does not constitute a
change in accounting estimate.
Changes in the measurement of an existing decommissioning, restoration or similar liability
arise from:
a change in the estimated cash flows required to settle the obligation;
a change in the current market-based discount rate used to calculate the present value
of the obligation; and
an increase that reflects the passage of time (unwinding of discount rate).
Since the unwinding of the discount rate does not represent a change in accounting
estimate, IFRIC 1 only covers the impact of the first two items listed above.
The accounting treatment differs, depending on whether the cost or revaluation model is
used to account for PPE. Changing the carrying amount of a property, plant and equipment
item (for both the cost and revaluation models) will also change the depreciable amount of
the asset involved. This adjusted depreciable amount will be depreciated over the asset’s
remaining useful life. Once the related asset has reached the end of its useful life, all
subsequent changes in the value of the liability will be recognised in the profit or loss section
of the statement of profit or loss and other comprehensive income as they occur. Refer to
chapter 9 example 9.7 for an example on changes in dismantling costs.
15.8.1 Deferred tax consequences of decommissioning, restoration and similar

liabilities
A temporary difference that arises from the amount of the asset and liability recognised at
initial recognition of a decommissioning, restoration and similar liability or on subsequent
revisions of estimates, is generally viewed as being within the scope of the ‘initial recognition
exemption’ in IAS 12, paragraph 15 or 24. This is because the temporary difference that
arises at the initial recognition of the asset and liability does not affect accounting profit or
taxable profit. The amount of accretion in the provision from unwinding of the discount does,
however, give rise to a temporary difference subsequent to initial recognition. A similar issue
arises at the initial recognition of a right-of-use asset and lease liability. In practice diversity,
does exist in the application of the initial recognition exemption for leases. Accordingly,
some entities might take an alternative view that the initial recognition exemption should not
be applied for leases and therefore not to decommissioning, restoration or similar liabilities.
However, a consistent policy should be adopted for deferred tax accounting for leases and
decommission, restoration and similar liabilities (IAS 8.13).
Example 15.15
.15 Deferred tax on decommissioning liability
Excom has an item of plant and a related decommissioning provision. The item of plant was
available for use on 1 January 20.14, and has a useful life of 40 years. Its initial cost was
R60 million, which included R5 million for decommissioning costs in terms of IAS 16.16(c). The
R5 million was calculated by discounting cash outflows in respect of decommissioning costs of
R108,623 million over 40 years using an appropriate discount rate of 8%. The entity’s year end is
31 December. The South African Receiver of Revenue (SARS) grants a section 12C allowance of
25% per annum on the cost of the plant, excluding the decommissioning cost. On
31 December 20.14, the decommissioning liability was increased by R8 million due to a change in
estimate. The decommissioning costs will only be allowed as a deduction for tax purposes when
the costs are incurred. Excom deems the initial recognition exemption to apply to
decommissioning liabilities. The deferred tax resulting from the above information is the following:
Carrying Tax Temporary Deferred

1 January 20.14
amount base difference tax @ 28%
R R R R
Plant
– Purchase price 55 000 000 55 000 000 – –
– Decomissioning cost 5 000 000 – 5 000 000 Exempt
Decommissioning provision
– Cost (5 000 000) – (5 000 000) Exempt
31 December 20. 14
Plant
– Purchase price 55 000 000 55 000 000 – –
– Decomissioning cost 13 000 000 – 13 000 000 Exempt
– Accumulated depreciation (1 700 000) (13 750 000) 12 050 000 (3 374 000)
Decommissioning provision
– Cost (13 000 000) – (13 000 000) Exempt
– Unwinding of discount (400 000) – (400 000) 112 000
(5 000 000 × 8%)
Comment
¾ In the event that Excom did not deem the initial recognition exemption to apply to the
decommissioning liability, deferred tax will be recognised on all the temporary differences
marked as ‘Exempt’ in the solution above. The net impact on the deferred tax calculation will
however be Rnil.
15.9 Rights to interests arising from decommissioning, restoration

and environmental rehabilitation funds (IFRIC 5)
15.9.1 Background
IFRIC 5 Rights to Interests Arising from Decommissioning, Restoration and Environmental
Rehabilitation Funds is an interpretation of how to account for decommissioning, restoration
and environmental rehabilitation funds, sometimes called ‘decommissioning funds’ or just
‘funds’.
An entity may, on its own or in collaboration with other entities, decide to set aside funds for
the ultimate decommissioning of plant (e.g. a nuclear plant) or certain equipment (e.g. cars),
or for the purposes of environmental rehabilitation (e.g. the restoration of mined land). Such
funds are often administered separately by independent trustees and the contributions of the
entities (contributors) are invested in a range of assets that may include debt and/or equity
investments, which are utilised to help defray the contributors’ decommissioning costs.
When contributors eventually become liable for decommissioning costs, they are able to
institute a claim on the fund for an amount up to the lower of the decommissioning costs
incurred and the entity’s share of assets of the fund. The contributors may be required to
structure their contributions based on its current activity, while any benefits could be based
on its past activity. This may lead to a mismatch in contributions made and the value of the
claim from the fund.
The fund operates separately from any of the contributors and is governed, in accordance
with its founding documents, by a board of trustees. Any access by contributors to any
surplus assets over those used to meet decommissioning costs is either restricted or
prohibited. Contributors may be entitled to reimbursement for decommissioning expenses to
the extent of their fund contributions plus any actual earnings on those contributions less
their share of the costs of administering the fund. Contributors may also be obliged to make
additional contributions, for example if one of the contributors went bankrupt.
The accounting issues that arise from these arrangements include how a contributor must
account for its interest in a fund, as well as how an obligation arising from a requirement to
make additional contributions (e.g., in the event of the bankruptcy of another contributor),
must be accounted for.
IFRIC 5 applies to the accounting in the financial statements of a contributor to a
decommissioning fund where the assets of the fund are administered separately (i.e. either
in a separate legal entity or as segregated assets within another entity) where the
contributor’s right to access the assets is restricted. Where residual funds remain after the
completion of decommissioning and such funds may be distributed to contributors, IFRS 9
applies.
15.9.2 Accounting for the interest in a fund

The obligation to pay decommissioning costs and its interest in a fund as described above
are recognised separately in the financial statements of the contributor, unless the
contributor is not liable to pay decommissioning costs, even if the fund fails to pay.
The contributor has to determine whether it has control, joint control or significant influence
over the fund and account for its interest in accordance with IFRS 10, IFRS 11 or IAS 28.
Where interest in funds is not within the scope of the above Standards, the possibilities that
such interest gives rise to either both an asset (the right to receive assets from the fund) and
a liability (the decommissioning obligation), or only a net asset or liability (the net
decommissioning obligation relative to attributable fund assets), were considered by the
IFRIC. Since the contributor remains liable for the decommissioning costs when a fund does
not relieve the contributor of its obligation to pay such costs, it was concluded that both an
asset and a liability exist in such circumstances. Therefore, in circumstances where
IFRS 10, IFRS 11 or IAS 28 do not apply, and the fund does not relieve the contributor of its
obligation to pay decommissioning costs, the principles set out in IAS 37 must be applied.
IAS 37 provides that when an entity remains liable for expenditure, a provision must be
recognised even where reimbursement is available, and if the reimbursement is virtually
certain to be received when the obligation is settled, then it must be treated as a separate
asset. It therefore follows that an asset, that is, the right to receive reimbursement from the
fund, must be raised, measured at the lower of the amount of the decommissioning
obligation and the entity’s share of the fair value of the net assets of the fund adjusted for
actual or expected factors that affect the entity’s ability to access these assets. The carrying
amount of this asset must be reviewed regularly and any changes recognised in the profit or
loss section of the statement of profit or loss and other comprehensive income. A liability
must also be raised for the amount of the decommissioning obligation.
15.9.3 Obligations to make additional contributions to the fund

The mere fact of participating in a fund, may result in a contributor finding itself in the
position of a guarantor of the contributions of the other contributors, and therefore becoming
jointly and severally liable for the obligations of other contributors. Also, the value of the
investment assets of the fund may decrease in such a manner that they are rendered
insufficient to fulfil the fund’s obligations. The principles described in IAS 37 are appropriate
for such circumstances, since IAS 37.29 states that ‘where an entity is jointly and severally
liable for an obligation, the part of the obligation that is expected to be met by other parties
is treated as a contingent liability.’ However, when it is probable that additional contributions
will indeed be made, a liability is recognised (IFRIC 5.10).
15.9.4 Disclosure
The following disclosure requirements are applicable:
When control, joint control or significant influence exists and the interest in the fund is
accounted for in accordance with the relevant Standard, the disclosure requirements of
the particular Standard (refer to IFRS 12) are followed.
Where the accounting treatment of IAS 37 on provisions, contingent liabilities and
contingent assets is applied, the contributor discloses its interest in the fund in
accordance with this Standard.
When a contributor has an obligation to make potential additional contributions, for
example in the event of the bankruptcy of another contributor, and such an obligation is
not recognised as a liability in terms of IAS 37, a brief description of the nature of the
contingent liability must be provided, unless the possibility of any outflow in settlement is
remote. Where practicable, the following must also be disclosed:
– an estimate of its financial effect;
– an indication of the uncertainties relating to the amount or timing of any outflow; and
– the possibility of any reimbursement.
The nature of the entity’s interest and any restrictions on access to the assets in the fund
must also be disclosed.
15.10 Liabilities arising from participating in a specific market

– waste electrical and electronic equipment (IFRIC 6)
IFRIC 6 Liabilities arising from Participating in a Specific Market – Waste Electrical and
Electronic Equipment deals with the liabilities that arise under the EU Directive on Waste
Electrical and Electronic Equipment (WE&EE). More specifically, it deals with when the
liability arising from the decommissioning of WE&EE must be recognised by producers of
that type of equipment. Since this is an EU matter, it is unlikely that many companies in
South Africa will have to apply this IFRIC, unless parent companies have subsidiaries that
were incorporated in the EU.
Example 15.16 Provision for waste management costs
Electro Ltd, an entity which sold electronic equipment to private households during 20.12, has a
market share of 5% in 20.12. It subsequently discontinues its operations and by 20.16, that is the
year serving as the ‘measurement period’ for the specific EU state in which it used to operate, the
company has no market share. The total waste management costs of €30 000 000 associated with
selling electrical and electronic equipment for private households in the member states are
allocated to those entities with a market share in the 20.16 calendar year – the latter year being
the measurement period.
Since Electro Ltd is no longer operational in 20.16 and consequently has a market share of €nil,
the company has no obligation to provide for any of the waste management costs of ̀30 000 000.
However, if another entity, Equiplec Ltd, enters the market for electronic equipment in 20.16 and
achieves a market share of 4%, that company will be held responsible for the costs of waste
management for periods before 20.16, and will incur a liability and raise a provision for €1 200 000
(€30 000 000 × 4%). This is so, even though Equiplec Ltd was not operational during the years
when the waste management costs arose and had not produced any products for which waste
management costs are allocated in 20.16.
15.11 Levies (IFRIC 21)

An IFRS Interpretations Committee project examined whether IFRIC 6 should also be
applied to other levies charged for participation in a market on a specified date, in order to
identify the event giving rise to a liability. The project’s scope was subsequently widened to
consider a broader range of levies, rather than focusing on levies charged to participate in a
specific market. A government may impose a levy on an entity (e.g. the United Kingdom
bank levy, railway tax in France and fees paid to the Federal Government by pharmaceutical
manufacturers in the US). IFRIC 21 provides guidance regarding when a liability to pay a
levy, accounted for in terms of IAS 37, should be recognised by the entity paying the levy.
Example 15.17
.17 Recognition of a liability for a levy
FB Ltd is company that needs to pay a number of levies in accordance with legislation. FB Ltd’s
current reporting period ends on 31 December 20.14. The following levies are applicable to
FB Ltd:
Levy 1: 1,5% of current year revenue is payable as it is generated.
Levy 1 is triggered progressively as FB Ltd earns revenue; therefore, the liability will be
recognised progressively over the period that revenue is generated (i.e. progressively over
20.14). The obligating event is the generation of revenue during 20.14.
Levy 2: 1,5% of the previous year’s (20.13) revenue is payable as soon as FB Ltd generates
revenue in 20.11. FB Ltd started to generate revenue in the current year on 4 January 20.11.
Levy 2 is triggered as soon as FB Ltd earns revenue in 20.11. Therefore, the liability will be
recognised in full on 4 January 20.14 since the obligating event is the first generation of revenue
in 20.14. The amount of the levy will be determined by the amount of revenue generated in
20.13. It is important to note that the generation of revenue in 20.13 does not give rise to an
obligation to pay the levy.
Levy 3: A levy is payable if FB Ltd earns revenue above R20 million in the current year (20.14).
The levy is structured as follows: 0% is payable for the first R20 million, and 2% is payable for
revenue earned above R20 million. FB Ltd reached the R20 million revenue threshold on
5 June 20.14.
Levy 3 is triggered on 5 June 20.14, when FB Ltd reaches the R20 million revenue threshold.
The obligating event is the revenue earned after the threshold is reached. The liability will be
recognised between 5 June 20.14 and 31 December 20.14, and the amount of the liability will be
based on the amount of revenue earned above R20 million.
CHAPTER
16
Intangible assets
(IAS 38, SIC 32 and IFRIC 12)
Contents
16.1 Overview of IAS 38 Intangible Assets............................................................. 386
16.2 Nature of intangible assets .............................................................................. 387
16.3 Recognition and initial measurement .............................................................. 388
16.3.1 Recognition ...................................................................................... 388
16.3.2 Separate acquisitions ...................................................................... 389
16.3.3 Acquisition as part of a business combination ................................. 390
16.3.4 Exchanges of intangible assets ....................................................... 391
16.3.5 Acquisition by way of government grant .......................................... 392
16.3.6 Service concession arrangements .................................................. 392
16.4 Internally generated intangible assets ............................................................. 393
16.4.1 Internally generated goodwill ........................................................... 393
16.4.2 Other internally generated intangible assets ................................... 393
16.4.3 Website costs .................................................................................. 397
16.5 Subsequent measurement .............................................................................. 401
16.5.1 Cost model....................................................................................... 401
16.5.2 Revaluation model ........................................................................... 402
16.5.3 Intangible assets with a finite useful life .......................................... 403
16.5.4 Intangible assets with indefinite useful lives .................................... 405
16.6 Impairment ...................................................................................................... 406
16.7 Derecognition .................................................................................................. 406
16.8 Disclosure........................................................................................................ 407
16.10 Comprehensive example ................................................................................ 411
385
16.1 Overview of IAS 38 Intangible Assets
DEFINITIONS An asset meets the identifiability criterion

Intangible assets are assets: when it:
without physical substance; is separable, capable of being separated
that are identifiable; and or divided from the entity and sold,
transferred, licensed, rented or
that are non-monetary. exchanged; or
An asset is a resource: arises from contractual or other legal
controlled by an entity as a result of past rights, regardless of whether those rights
events; and are transferable or separable from the
from which future economic benefits are entity or from other rights and obligations.
expected to flow to the entity.
RECOGNITION INITIAL MEASUREMENT

probable that future economic benefits Separate acquisitions.
will flow to the entity; and Acquisition part of business combination.
costs of the intangible asset can be Exchanges of intangible assets.
measured reliably. Acquisition by way of government grant.
INTERNALLY GENERATED INTANGIBLE SUBSEQUENT MEASUREMENT

ASSETS Cost model
Internally generated goodwill Cost less any accumulated amortisation and
Written off in period incurred. impairment losses.
Research costs Revaluation model
Written off in period incurred. Fair value on the date of revaluation less any
Development costs subsequent accumulated amortisation and
Capitalised if criteria are met (IAS 38.57). impairment losses.
Website costs Intangible assets with finite useful life
Website that arises from development is Amortised over useful life, from date the
recognised as an intangible asset (SIC 32). asset is available for use.
If solely or primarily for promoting and Amortisation ceases at the earlier of: the
advertising – expenses written off. date the asset is classified as held for
sale in terms of IFRS 5; or the date on
which the asset is derecognised; or the
date on which the asset is fully amortised.
Residual value deemed to be nil, unless
there is a commitment by a third party to
purchase the asset at the end of its useful
life, or there is an active market (which
will still exist at end of the useful life).
Change in residual value, amortisation
method or period is a change in
accounting estimate.
Intangible assets with indefinite useful
lives
Not amortised, but tested for impairment
annually (more often than annually where
indication of impairment).
Review useful life annually.
Intangible assets 387
16.2 Nature of intangible assets

IAS 38 Intangible Assets provides criteria for the identification of intangible assets and
provides guidance on the recognition, measurement and disclosure of these assets.
IAS 38 does not apply to:
intangible assets that are within the scope of another Standard, namely:
– intangible assets held by an entity for sale in the ordinary course of business (IAS 2,
Inventories);
– deferred tax assets (IAS 12 Income Taxes);
– leases of intangible assets accounted for in accordance with IFRS 16 Leases;
– assets arising from employee benefits (IAS 19 Employee Benefits);
– goodwill acquired in a business combination (IFRS 3 Business Combinations);
– deferred acquisition costs and intangible assets arising from an insurer’s contractual
rights under insurance contracts (IFRS 4 Insurance Contracts);
– non-current intangible assets classified as held for sale (IFRS 5 Non-current Assets
Held for Sale and Discontinued Operations);
– assets arising from contracts with customers that are recognised in accordance with
IFRS 15 Revenue from Contracts with Customers;
– financial assets as defined in IAS 32 Financial Instruments: Presentation; and
mineral rights and expenditure on the exploration for, or development and extraction of,
minerals, oil, natural gas and similar non-regenerative resources.
Rights held by a lessee under licensing agreements for items such as motion picture films,
video recordings, plays, manuscripts, patents and copyrights are within the scope of IAS 38
and are excluded from the scope of IFRS 16.
The definition of an asset in this Standard was not revised following the revision of the
definition of an asset in the Conceptual Framework for Financial Reporting issued in 2018
(refer to chapter 2).
IAS 38 defines intangible assets as:
being without physical substance;
being identifiable;
being non-monetary.
An asset is a resource:
controlled by an entity as a result of past events; and
something from which future economic benefits are expected to flow to the entity.
When an entity controls an asset, it has the power to obtain the future economic benefits
flowing from the underlying resource, and can also restrict the access of others to those
benefits. The capacity to exercise control over intangible assets usually arises from a legal
right. To illustrate: an entity may only control the technical knowledge used to ensure future
economic benefits for the company if it is protected through copyright, a restraint of trade
agreement or a legal duty of employees to maintain confidentiality. However, an entity does
not usually have sufficient control over a team of skilled staff to recognise them as intangible
assets.
The future economic benefits expected to flow to the entity from the intangible asset
include revenue from the sale of goods and services, as well as cost savings and other
benefits resulting from the use of the asset. Knowledge about the efficient structuring of
production facilities may, for example, result in cost savings rather than in an increase in
revenue.
An intangible asset may sometimes be contained in a physical substance, for example a

compact disc for software, a legal document for patents, or film. This definition may
therefore result in confusion about what asset or part of an asset is tangible and must be
treated in accordance with IAS 16 Property, Plant and Equipment and what asset or part of
an asset is intangible, and must thus be treated in accordance with IAS 38. In such
instances, professional judgement is required, and the relationships between assets and the
outcome of processes must be considered in order to determine which element is the most
significant (IAS 38.4).
The operating system of a computer, for example Windows, forms an integral part of the
hardware and must, for accounting purposes, be treated as property, plant and equipment.
Other software applications and packages, for example MS Office, however, qualify as
intangible assets. In the case of research and development activities, the development of a
prototype is the result of a process through which knowledge is created and therefore both
the process and prototype must be treated as intangible assets.
The identifiability requirement of the definition is used to distinguish goodwill from
intangible assets. Goodwill is a payment made by an acquirer in a business combination, in
anticipation of future economic benefits from assets that cannot be individually identified. It
represents future economic benefits arising from the synergy between identifiable assets or
from intangible assets that do not meet the criteria for recognition as an intangible asset.
An asset meets the identifiability criterion when it:
is separable (it is capable of being separated or divided from the entity and sold,
transferred, licensed, rented or exchanged, either individually or together with a related
contract, asset or liability); or
arises from contractual or other legal rights, regardless of whether those rights are
transferable or separable from the entity or from other rights and obligations.
Examples of intangible assets include:
Computer software Patents Copyrights Motion picture films
Customer lists Mortgage servicing Fishing licenses Import quotas
rights
Franchises Customer or supplier Customer loyalty Market share
relationships
Marketing rights Trademarks Other licenses Publishers’ titles
Production quotas Models Prototypes Recipes and
formulae
Each group of intangible assets with a similar nature and use in the entity is identified as a
class of intangible assets that is disclosed separately in the financial statements.
16.3 Recognition and initial measurement
16.3.1 Recognition
An intangible asset shall be measured initially at cost (IAS 38.24). An item should be
recognised as an intangible asset, if:
the item meets the definition of an intangible asset; as well as
the recognition criteria for an intangible asset, namely:
– it must be probable that future economic benefits specifically attributable to the asset,
will flow to the entity. The determination of the probability of future economic benefits
is based on professional judgement, using reasonable and supportable assumptions.
These represent management’s best estimate of the probable economic conditions
that will exist over the useful life of the asset. Evidence supporting the probability of
receiving future economic benefits includes market research, feasibility studies,
comprehensive business plans and the like; and
– the costs of the intangible asset can be measured reliably.
This requirement applies to costs incurred initially to acquire or internally generate, and
those incurred subsequently to add to, replace part of, or service it.
Costs incurred to acquire or generate an intangible item that were initially recognised as an
expense by the reporting entity must not be reinstated once recognition criteria are met as
part of the cost of an intangible asset at a later date.
Generally speaking, subsequent expenditure in the case of intangible assets will be incurred
to maintain expected future economic benefits embodied in such an asset. Consequently,
such expenditure will be expensed. Furthermore, consistent with IAS 38.63, subsequent
expenditure on brands, mastheads and similar items, whether externally acquired or
internally generated, will also be expensed in the profit or loss section of the statement of
16.3.2 Separate acquisitions

When an intangible asset is acquired, the cost of the asset can usually be measured
reliably, and consists of the following:
the purchase price, including import duties and non-refundable purchase taxes, after
deducting trade discounts and rebates; and
any costs directly attributable to preparing the asset for its intended use.
Examples of directly attributable costs:
the cost of employee benefits arising directly from bringing the asset to its working
condition;
professional fees arising directly from bringing the asset to its working condition; and
the costs of testing whether the asset is functioning properly.
Examples of costs that are excluded:
the costs of introducing a new product or service (including the cost of advertising and
promotional activities);
the costs of conducting business in a new location or with a new class of customer
(including costs of staff training); and
administration and other general overhead costs.
The recognition of costs in the carrying amount of an intangible asset ceases when the
asset is in a condition necessary for it to be capable of operating in the manner intended by
management. Therefore, costs associated with redeploying an intangible asset are not
included in the carrying amount of the asset, for example:
costs incurred while an asset capable of being operated as management intended has
not been brought into use; and
initial operating losses, for example those incurred while demand for the asset’s output builds
up.
Incidental operations are not necessary to bring an asset to the condition necessary for it to
be capable of operating in the manner intended by management; therefore the income and
related expenses of incidental operations are recognised immediately in profit or loss, and
included in their respective classifications of income and expense.
If the payment for the intangible asset is deferred beyond normal credit terms, its cost is
deemed to be the cash price equivalent, with the ‘interest expense’ being recognised over
the full period of the credit terms.
Example 16.
16.1 Cost of a separately acquired intangible asset
Delta Ltd acquired a broadcasting licence for a local radio station. The following additional costs
were incurred in connection with this acquisition:
R
Fees of professional broadcasting consultant (including VAT) 11 400
Legal fees (including VAT) 5 700
Allocation of cost of time spent by management (employee benefit costs) 30 000
It was agreed that the purchase price would be settled by issuing 200 000 shares in Delta Ltd,
and the shares were trading at R2,00 per share when settlement was effected.
Taking the above into account, and assuming that Delta Ltd is a registered VAT vendor, the
broadcasting licence must be capitalised at an amount calculated as follows:
R
Fair value of shares at settlement date (200 000 × R2) 400 000
Professional fees (11 400 × 100/114) 10 000
Legal fees (5 700 × 100/114) 5 000
Management salaries allocated 30 000
Broadcasting licence capitalised/recognised at 445 000
16.3.3 Acquisition as part of a business combination

Intangible assets acquired in a business combination require specific attention, especially
where the cost of the business combination is allocated to identifiable assets.
In accordance with IFRS 3 Business Combinations an intangible asset acquired in a
business combination may only be recognised if its fair value can be measured reliably. In
terms of IAS 38.33, this second recognition criterion, in respect of the probability of future
economic benefits flowing to the entity, is always considered to be satisfied in the case of
intangible assets acquired in a business combination. Furthermore, it is assumed that the fair
value of an intangible asset acquired in a business combination will reflect market
participants’ expectations at the acquisition date in respect of the probability of future
economic benefits to be derived from the asset.
In view of the above, an acquirer will recognise an intangible asset separately from goodwill,
provided its fair value can be determined reliably, irrespective of whether the asset had been
recognised by the acquiree before the business combination. Consequently, intangibles that
are not normally recognised, for example research and development projects of the
acquiree or the acquisition of a masthead, will be recognised as intangible assets in a
business combination, provided the asset meets the definition of an intangible asset and its
fair value can be determined reliably.
The only circumstances where it may not be possible to determine the fair value of an
intangible asset acquired in a business combination occurs when the intangible asset arises
from legal or other contractual rights and either:
is not separable; or
is separable, but there is no history of exchange transactions for the same or similar
assets and otherwise estimating the fair value is not possible due to immeasurable
variables.
Apart from the above, the measurement of the fair value of intangible assets acquired in a
business combination will be determined using the normal principles associated with
measuring fair value (IFRS 13 Fair Value Measurement).
Example 16.2 Intangible asset acquired in a business combination
On 1 March 20.14, A Ltd obtained control over Z Ltd. The transaction qualifies as a business
combination as defined in IFRS 3. On 1 March 20.14, Z Ltd had two intangible assets:
A patent recognised already in terms of IAS 38 with a carrying amount of R120 000 (measured
using the cost model). The fair value of the asset is R150 000.
Research costs incurred by Z Ltd. The research costs do not qualify in terms of IAS 38 for
recognition as development costs. The amount incurred on research was R250 000. The fair value
of the asset is R100 000.
In terms of IFRS 3, the acquirer must recognise any intangible asset in a business combination if
the fair value of the intangible asset can be measured reliably, irrespective of whether the intangible
assets is recognised by the acquiree or not.
Assume a tax rate of 28%
The intangible assets will be recognised on the acquisition of the subsidiary by means of the
following pro-forma consolidation journal entries:
Dr Cr
R R
Intangible asset – Patent (150 000 – 120 000) 30 000
Revaluation surplus (equity on acquisition of subsidiary) (OCI) 30 000
Recognise intangible asset on business combination
Retained earnings (on acquisition) 8 400
Deferred taxation (SFP) (30 000 × 28%) 8 400
Recognise deferred tax on intangible asset
Intangible asset – Research cost 100 000
Revaluation surplus (equity on acquisition of subsidiary) (OCI) 100 000
Recognise intangible asset on business combination
Retained earnings (on acquisition) 28 000
Deferred taxation (SFP) (100 000 × 28%) 28 000
Recognise deferred tax on intangible asset
16.3.4 Exchanges of intangible assets

The accounting treatment for exchanges of intangible assets is exactly the same as for
property, plant and equipment (refer to chapter 9).
Example 16.
16.3 Intangible asset acquired in an exchange transaction
A Ltd is the manufacturer of specialised machinery. B Ltd is, however, the registered owner of the
only two licences to produce product Z, the product that is manufactured by the machinery
produced by A Ltd. B Ltd does not have the expertise or capacity to manufacture the specialised
machinery to produce product Z.
A Ltd and B Ltd enter into the following agreement that benefits both parties:
A Ltd will deliver two of the specialised machines to B Ltd in exchange for one of B Ltd’s licences.
The licence is valid for a term of 5 years, whereafter it can be renewed at a significant cost.
Assume the fair value of the licence is available – the value is R500 000. The fair value of a
machine is estimated at R300 000. The cost to A Ltd to manufacture one machine is R200 000.
In this instance, the transaction has commercial substance and the fair value of the asset acquired
can be determined. The licence will be recognised in the records of A Ltd at R600 000 in terms of
IAS 38.45.
continued
The transaction will be accounted for as follows in the records of A Ltd:

Dr Cr
R R
Intangible asset – Licence (300 000 × 2) 600 000
Revenue 600 000
Initial recognition of license
Cost of sales (200 000 × 2) 400 000
Inventories 400 000
Exchange of machines for license
Comment
¾ If the fair value of neither the licence nor the machinery can be determined, IAS 38.45
determines that the asset that will be acquired is recognised at the carrying value of the asset
that is given up. In this instance, the license would be recognised at R400 000
(R200 000 × 2).
16.3.5 Acquisition by way of government grant

Where an intangible asset is acquired free of charge or for a nominal consideration by way
of a government grant, an entity may choose to recognise both the grant and the intangible
asset at fair value or at a nominal amount (i.e. a minimal amount). If the asset is recognised
at a nominal value, the expenditure directly attributable to preparing the asset for its
intended use is capitalised. If the asset is recognised at fair value, the expenditure will not
be capitalised, because the resultant carrying amount will exceed its fair value.
16.3.6 Service concession arrangements

IFRIC 12 deals with specialised transactions where a concession operator (a private sector
entity) enters into an agreement with a concession provider (a public sector body or non-
government organisation (NGO)) to render services that will provide the public with access
to infrastructure, for example roads, car parks, bridges, hospitals and airports. In exchange
for the development, upgrading and maintenance of the infrastructure, the concession
operator receives the right to use specified tangible, intangible or financial assets. An
example is the building of toll roads, where the concession provider has the obligation to
build, upgrade and maintain the roads and obtains the right to charge the public a toll in
order to use the road.
IFRIC 12 only applies if the concession provider (grantor) controls what services the
operator must provide with the infrastructure, to whom and at what price; and the grantor
controls any significant residual interest in the infrastructure at the end of the term of the
arrangement.
The question arises whether the concession operator must recognise the infrastructure as
property, plant or equipment or rather as a right received from the concession provider. The
Interpretation suggests that the latter is the appropriate accounting treatment and states that
the right received may be either:
a financial asset; or
an intangible asset.
If the right is an intangible asset, it is accounted for in accordance with IAS 38 and
recognised at cost. Any obligations to construct or enhance infrastructure are included in the
cost of the intangible asset. Other obligations, for example maintenance, are recognised in
accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Service
concessions are disclosed in accordance with SIC 29 Service Concession Arrangments:
Disclosures (SIC 29.5 and .6).
16.4 Internally generated intangible assets

16.4.1 Internally generated goodwill
Internally generated goodwill does not meet the definition of an asset nor the recognition
criteria, as it is not a source that is controlled by the entity that will generate specific future
economic benefits and it cannot be measured reliably.
Internally generated goodwill may not be recognised as an asset, as it does not meet the
identifiability requirements as it is not separable nor does it arise from contractual or other
legal rights.
It may be argued that the difference between the carrying amount of the net identifiable
assets of an entity and the entity’s market value represents internally generated goodwill. This
difference may arise from a wide range of factors, and may therefore not be deemed to
represent the cost of an intangible asset controlled by the entity.
16.4.2 Other internally generated intangible assets

It is sometimes difficult to establish whether other internally generated intangible assets
comply with the definition of an intangible asset and the recognition criteria. The difficulties
with the recognition criteria specifically arise from problems in:
identifying whether and when there is an identifiable asset that will generate expected
future economic benefits; and
determining the cost of the internally generated intangible asset reliably.
Internally generated brands, newspaper mastheads, publishing titles, customer lists and
items similar in substance are not recognised as other internally generated intangible
assets, but rather form part of internally generated goodwill. This is because the cost of
these items cannot be distinguished from the cost of developing the business as a whole.
16.4.2.1 Research and development costs
IAS 38 identifies two phases in the development of internally generated intangible assets,
namely a research phase and a development phase. This is done in an attempt to
alleviate the problems associated with internally generated intangibles other than internally
generated goodwill.
Research is the original and planned investigation undertaken with the prospect of gaining
new scientific or technical knowledge. Examples of research activities include:
activities to gain new knowledge;
the search for, selection and application of, research findings;
the search for alternatives; and
the formulation, design, evaluation and selection of alternatives for materials, devices,
products, processes, systems or services.
The nature of research is such that there is a low level of certainty that future economic
benefits will flow to the entity. Consequently, IAS 38 requires that research costs are written
off in the period incurred.
Development is the application of research findings or other knowledge through the
development of a plan or design aimed at the production of new or improved materials,
devices, products, processes, systems or services, prior to the commencement of
commercial production. Examples of development activities include:
the design, construction and testing of pre-production prototypes, and models;
the design of tools, jigs, moulds and dies;
the design, construction and operation of a pilot plant; and
the design, construction and testing of a selected alternative for materials, devices,
products, processes, systems or services.
Development activities indicate that the internal project has advanced beyond the
research phase and that the entity may already be able to estimate the future economic
benefits. Therefore, development costs must be capitalised when the following criteria,
over and above the normal recognition criteria, are met (IAS 38.57):
The technical feasibility of completing the intangible asset is of such a nature that it will
be available for use or sale.
The entity has the intention to complete the intangible asset, and use or sell it.
The entity has the ability to use or sell the intangible asset.
The entity can establish how the intangible asset will generate probable future economic
benefits. The entity must 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. An entity assesses the future economic benefits to be
obtained from an asset, using the principles contained in IAS 36 on impairment of
assets, including the principles associated with cash generating units.
The entity has adequate technical, financial and other resources to complete the
development, and to use or sell the intangible asset. This is proven by a business plan
showing the resources required and the entity’s ability to secure those resources.
The entity can reliably measure the expenditure attributable to the intangible asset during
its development.
When uncertainty exists about the economic benefits that may be expected from the
development activities, these costs will be written-off as they are incurred, as with research
costs. If an intangible asset has been raised that is not yet in use, the carrying amount of the
intangible asset must be tested for impairment at least annually (IAS 38.108), and where
applicable, written-off to recoverable amount.
If an entity cannot distinguish between the research and the development phases of a
project, the Standard requires that all the expenditure be allocated to the research phase
and be written-off as incurred.
16.4.2.2 Costs of internally generated intangible assets
The costs forming part of internally generated intangible assets recognised as assets are
those costs which are directly attributable, or that can be allocated on a reasonable basis,
related to the creation, production and preparation of the asset for its intended use. Only
costs related to development may qualify for capitalisation. The costing system of the entity is
usually capable of measuring the costs of internally generated intangible assets reliably. The
cost of these assets is the total expenditure incurred from the date the asset first met the
recognition criteria. Costs incurred before that point are expensed.
Examples of directly attributable costs: raw materials and service costs, costs of employee
benefits, legal costs incurred to register legal rights, depreciation on equipment, and the
amortisation of patents and licenses.
The following do not qualify as costs of internally generated intangible assets: selling
expenses, general administrative expenses, inefficiencies, initial operating losses, and
training expenses.
Costs that were initially written off as expenses in the profit or loss section of the statement
of profit or loss and other comprehensive income cannot subsequently be reinstated and
recognised as an asset. Consequently, the initial carrying amount of such an intangible
asset is the sum of the costs incurred from the date on which the asset qualified as an asset
for the first time. Internally generated intangible assets are only amortised from the date on
which the asset is available for use as intended by management.
Example 16.
16.4 Research and development costs
Alpha Ltd, a motor vehicle manufacturer, has a research division that worked on the following
projects during the year:
Project I – The design of a steering mechanism that does not operate like the conventional
steering wheel, but reacts to impulses from the driver’s fingers. Vehicle
manufacturers are very sceptical about this project.
Project II – The design of a welding apparatus that is controlled electronically rather than
mechanically. Several large plants have enquired about this development and are
very enthusiastic. This project meets all the recognition criteria for intangible assets
since the beginning of this year.
The following is a summary of the expenses of the different departments:
General Project I Project II
R’000 R’000 R’000
Material and services 128 935 620
Labour
Direct labour – 630 320
Departmental head 400 – –
Administrative personnel 725 – –
Overheads
Direct – 340 410
Indirect 270 110 60
The departmental head spent 15% of his time on Project I and 10% on Project II.
The capitalisation of development costs for the financial year is as follows:
R’000
Project I: The activity is classified as research and all costs are recognised as expenses –
Project II: (620 + 320 + (10% × 400) + 410 + 60) 1 450
1 450
Comment
¾ Assume that in respect of Project II, an amount of R200 000 was written off in the previous year
(or interim period) because the development costs did not qualify for recognition as an asset
before the beginning of the current year. This amount cannot be reinstated as part of the cost of
development in the current year or later. Only costs from the date on which the intangible first
qualified as an asset in terms of the recognition criteria for intangible assets may be capitalised
as internally generated intangibles.
The amortisation of an internally generated intangible asset is recognised on a systematic

basis in order to reflect the pattern in which the related economic benefits are recognised.
Amortisation commences once the intangible asset is available for use and not when it is
put into use. The amortisation period is often limited as a result of technological and
economic ageing and the uncertainties inherent in estimating future costs and expenses. As
with depreciation, the amortisation of the internally generated intangible assets can be
allocated to another asset account, from where it will be written off with the other
components of that asset.
At the end of each financial year, the expected future economic benefits of the asset as
compared to the asset carrying amount must be assessed. Internally generated intangible
assets that are not yet available for use are compared to their recoverable amounts at least
annually, even if no indication of impairment exists. If any of the abovementioned criteria for
the capitalisation of development costs no longer apply, the balance on the account must be
written off immediately. Where, however, such an asset has been written down and there is
subsequently persuasive evidence that the circumstances that resulted in the write-down no
longer exist, the asset may be reinstated. The reinstatement takes into account the
amortisation in accordance with the original plan of amortisation for the period of the write-
down. The reinstatement is recognised and disclosed in accordance with IAS 36 Impairment
of Assets.
Example 16.
16.5 Development costs and impairment
Beta Ltd incurred development costs of R2 400 000 that may be capitalised to 31 March 20.12.
The asset was available for use on 1 May 20.12 and the marketing division completed the
following estimates of future sales for the years ended 31 December:
20.12 – 2 800 000 (production commenced on 30 June 20.12)
20.13 – 3 600 000
20.14 – 3 300 000
20.15 – 2 000 000
20.16 – 1 800 000 (production ceased and asset derecognised on 30 June 20.16)
The estimated average gross profit mark-up on sales is 25%, while the associated sales and
administrative expenses amount to 6% of the selling price. The fair pre-tax discount rate for
Beta Ltd is 10% and cash flows are deemed to have taken place on the last day of the financial
year. The fair value less costs of disposal of the asset is R1 300 000, at 31 December 20.13.
The company plans to amortise the development costs over a period of 48 months (the estimated
market life) but a technical problem caused production to cease temporarily between
1 January 20.13 and 31 May 20.13. The total development costs were written off during the year
ended 31 December 20.12, as the technical feasibility of the product was questioned at that stage,
and thus an impairment loss was recognised.
Further development costs amounting to R390 000 were incurred between January and
May 20.13. However, the problem with technical feasibility was solved in the interim, and
production recommenced on 1 June 20.13, thus leading to a reversal of the impairment loss. The
actual sales figure for 20.13 was R2 800 000, while the estimates for 20.14 and thereafter
increased by 20% as a result of an unexpected increase in demand for the now improved product.
The estimated market life still expires on 30 June 20.16.
The development costs will be accounted for as follows in the profit or loss section of the
statement of profit or loss and other comprehensive income for the year ended
31 December 20.12:
Amortisation of asset (from date available for use) (2 400 000 × 8/48) = R400 000
Development costs written off at year end – impairment loss
(2 400 000 – 400 000) = R2 000 000
The development costs will be treated as follows for accounting purposes during the year
Development costs (impairment loss) written back on 1 June 20.13 in profit of loss
The remaining market life from 1 June 20.13 to 30 June 20.16 = 37 months
The amount written back as a credit in profit or loss (37/48 × 2 400 000) = 1 850 000
Carrying amount of capitalised development costs in the statement of financial position
R
Capitalised during 20.13 to solve technical problems 390 000
Impairment loss written back 1 850 000
2 240 000
Amortised during 20.13 from 1 June 20.13 (2 240 000/37 × 7) (423 784)
Carrying amount 1 816 216
continued
If there are indications of impairment again, a test must be performed to determine whether the
carrying amount of the asset does not exceed its recoverable amount. The recoverable amount at
31 December 20.13 is established as follows:
20.14 20.15 20.16
R’000 R’000 R’000
Future sales (20% up) 3 960 2 400 2 160
Estimated gross profit (25%) 990 600 540
Estimated marketing costs (6%) (237,6) (144) (129,6)
Estimated future economic benefits 752,4 456 410,4
Discounted value at 10% 684,00 376,86 308,34
Value in use (684 000 + 376 860 + 308 340) R1 369 200
Fair value less costs of disposal R1 300 000
Comment
¾ The carrying amount will therefore be reduced by an amount of R447 016
(1 816 216 – 1 369 200) that will result in R870 800 (423 784 + 447 016) being expensed
in 20.13.
16.4.3 Website costs

16.4.3.1 Background
SIC 32 was issued to address the issue of internal expenditure being incurred on the
development and operation of a website for internal or external access. A website designed
for internal access may be used to store information on company policies, customer details
and search for relevant information. A website designed for external access may be used
for various purposes, for example to promote and advertise an entity’s own products and
services, and sell products and services.
The stages of development related to a website in short comprise the following: planning,
application and infrastructure development, graphic design development, and content
development. Once the development stage of a website has been completed, the operating
stage begins. The operating stage comprises maintaining and enhancing applications,
infrastructure, graphical design and the content of the website.
This Interpretation does not apply to expenditure on the purchasing, developing and
operating of hardware (e.g. web, production servers and internet connections) of a website,
as these are accounted for under IAS 16 Property, Plant and Equipment.
In addition, where an entity incurs expenditure on an internet service provider hosting the
entity’s website, these expenditures are recognised as an expense when the services are
received.
IAS 38 does not apply to intangible assets held for resale or leases of intangible assets
accounted for in accordance with IFRS 16. Accordingly, the interpretation also does not
apply to websites developed or operated for resale or that are accounted for in accordance
with IFRS 16.
16.4.3.2 Consensus on website costs
An entity’s own website that arises from development and for which the purpose is internal or
external access, is an internally generated intangible asset that is subject to the
requirements of IAS 38.
A website arising from development must be recognised as an intangible asset if the entity
can satisfy the requirements in IAS 38.57 in addition to the general requirements for
recognition and measurement in IAS 38. An entity must be able to satisfy the requirement to
demonstrate how its website will generate probable future economic benefits, including the
direct income resulting from the placement of orders.
An entity is not able to demonstrate how a website developed solely or primarily for
promoting and advertising its own products and services will generate probable future
economic benefits, and consequently all expenditure on developing such a website must be
recognised as an expense when incurred.
Any internal expenditure on the development and operation of an entity’s own website
must be accounted for in accordance with IAS 38. The nature of each activity for which
expenditure is incurred (e.g. training employees and maintaining the website) and the
website’s stage of development or post-development must be evaluated to determine the
appropriate accounting treatment.
The following must be considered:
The planning stage:
– is similar in nature to the research phase in IAS 38.54 to .56;
– the expenditure incurred in this stage must be recognised as an expense when it is
incurred.
The application and infrastructure development stage, and the graphical design stage
and the content development stage:
– are similar in nature to the development phase in IAS 38.57 to .64 (to the extent that
content is developed for purposes other than to advertise and promote an entity’s own
products and services);
– expenditure incurred in these stages must be included in the cost of a website
recognised as an intangible asset (capitalised) when the expenditure can be directly
attributed, or allocated on a reasonable and consistent basis, to preparing the website
for its intended use.
For example, expenditure on purchasing or creating content (other than content that
advertises and promotes an entity’s own products and services) specifically for a
website, or expenditure to enable use of the content (e.g. a fee for acquiring a licence to
reproduce) on the website, must be included in the cost of development when this
condition is met.
However, in accordance with IAS 38, expenditure on an intangible item that was initially
recognised as an expense in previous financial statements must not be recognised as
part of the cost of an intangible asset at a later date (e.g. when the costs of a copyright
have been fully amortised, and the content is subsequently provided on a website).
Expenditure incurred in the content development stage:
– to the extent that content is developed to advertise and promote an entity’s own
products and services (e.g. digital photographs of products);
– must be recognised as an expense when incurred.
For example, when accounting for expenditure on professional services for taking digital
photographs of an entity’s own products and for enhancing their display, expenditure
must be recognised as an expense, as the professional services are received during the
process, not when the digital photographs are displayed on the website.
The operating stage begins once development of a website is complete. Expenditure
incurred in this stage must be recognised as an expense when it is incurred, unless it
meets the recognition criteria for intangible assets.
A website that is recognised as an intangible asset under SIC 32 must be measured later
(after initial recognition) by applying the requirements of IAS 38.72 to .87 in respect of the
cost model and revaluation model. The best estimate of a website’s useful life should be
short.
16.4.3.3 Expenditure incurred in the different stages of a website’s development
Stage/Nature of expenditure Accounting treatment

Planning Expensed when incurred since similar to
Undertaking feasibility studies. research phase.
Defining hardware and software specifications.
Evaluating alternative products and suppliers.
Selecting preferences.
Application and infrastructure development Apply the requirements of IAS 16.
Purchasing/developing hardware. Expensed when incurred, unless the
Obtaining a domain name. expenditure is directly attributed, or
Developing operating software allocated on a reasonable and consistent
(e.g. operating system and server software). basis, to preparing the website for its
Developing code for the application. intended use, and the website meets the
Installing developed applications on the web recognition criteria to be recognised as an
server. intangible asset. If the expense relates to
Stress testing. promotional and advertising activities of the
entity’s own products and services, it must
always be expensed.
Graphical design development Expensed when incurred, unless the
Designing the appearance (e.g. layout and expenditure is directly attributed, or
colour) of web pages. allocated on a reasonable and consistent
basis, to preparing the website for its
intended use, and the website meets the
recognition criteria to be recognised as an
intangible asset. However, if it relates to
promotional and advertising activities of the
entity’s own products and services, it must
always be expensed.
Content development Expensed when incurred to the extent that
Creating, purchasing, preparing (e.g. creating content is developed to advertise and
links and identifying tags), and uploading promote an enterprise’s own products and
information, either textual or graphical in services (e.g. digital photographs of
nature, on the website before the completion of products).
the website’s development. Examples of Otherwise, expensed when incurred, unless
content include information about an the expenditure is directly attributed, or
enterprise, products or services offered for allocated on a reasonable and consistent
sale, and topics that subscribers access. basis, to preparing the website for its
intended use, and the website meets the
recognition criteria to be recognised as an
intangible asset.
Operating Expensed when incurred, unless in rare
Updating graphics and revising content. circumstances it meets the criteria that
Adding new functions, features and content. would justify capitalisation, in which case
Registering the website with search engines. the expenditure is included in the cost of
Backing up data. the website.
Reviewing security access.
Analysing usage of the website.
continued
Stage/Nature of Expenditure Accounting treatment

Other Expensed when incurred as it does not
Selling, administrative and other general form part of the cost of an internally
overhead expenditure, unless it can be directly generated intangible asset.
attributed to preparing the website for use.
Clearly identified inefficiencies and initial
operating losses incurred before the website
achieves planned performance (e.g. false start
testing).
Training employees to operate the website.
Example 16.
16.6 Website costs
Beta Ltd is a large listed company selling Cetabs. Management decided to develop a website that
would enable customers to order the company’s products online, instead of having to place an
order telephonically or by mail.
Since the company had never operated a website previously, it was decided to first undertake a
feasibility study and if successful, define hardware and software specifications, evaluate
alternative products and suppliers and then select preferences. These steps were executed and
eventually expenses of R60 000 were incurred in this regard.
During the feasibility study, it also came to light that the customers were very much in favour of the
website and that sales were expected to increase by 15% as a result of the introduction of the
website.
In the next stage of the project, hardware was purchased, a domain name was obtained and
operating software was developed. These developed applications were installed on the web server
and the total cost incurred in this stage amounted to R220 000, of which the hardware comprised
R80 000, the software R100 000 and the remainder was spent on obtaining the domain name.
Once the above had been completed, the appearance of the web pages was designed. A graphic
designer rendered an account of R18 000, which was paid in cash immediately.
The content of the website was then developed. This dealt with products offered for sale and other
information in respect of the company that the users of the website could access. The cost
involved in this development amounted to R25 000. This amount is still outstanding, although
management was completely satisfied with the work done by the consultant.
The website was taken into use on 1 July 20.14 (year end 31 December 20.14). During the
6 months following on it being commissioned, graphics were updated, the website was registered
with a few new search engines and the usage of the website was analysed to establish the
effectiveness thereof as a marketing tool. The costs amounted to R20 000.
Do not provide for depreciation or amortisation.
The allocation of the costs incurred will be the following:
Capitalised Expensed
R R
Planning stage – 60 000
Application and infrastructure development stage:
Hardware (per IAS 16) 80 000
Software and domain (per IAS 38) (220 000 – 80 000) 140 000
Graphical design development stage 18 000
Content development stage 25 000
Operating stage – 20 000
Total 263 000 80 000
continued
Comment
¾ Since the criteria for the recognition of an internally generated intangible asset have all been
met and the majority of the costs are directly associated with preparing the website for its
intended use, the majority of the costs can be capitalised. Note that the planning stage is the
equivalent of the research phase in terms of IAS 38 and will always be expensed, while the
expenses incurred in respect of the operating stage would generally also be expensed.
¾ If the website will be used solely for promotional and advertising activities, all expenses
incurred in respect of the website, except for the hardware, will be expensed. The hardware
purchased will be capitalised and accounted for in terms of IAS 16 Property, Plant and Equipment.
16.5 Subsequent measurement

IAS 38 allows the following two accounting policies for measuring intangible assets
subsequent to initial recognition:
cost model; and
revaluation model.
16.5.1 Cost model

The cost model allows an entity to carry the asset at its cost (after initial recognition) less
any accumulated amortisation and impairment losses.
Example 16.
16.7 Amortisation of an intangible asset with impairment
H Ltd developed a new product and capitalised an amount of R150 000 as development costs
between 31 July 20.12 and 31 December 20.12. On 1 January 20.13, the useful life of the
development cost is estimated at five years as the expected useful life of the product arising from
the development costs is expected to be five years.
The journal entries for the development costs will be as follows:
Dr Cr
31 July 20.12 – 31 December 20.12 R R
Intangible asset – Development costs 150 000
Bank 150 000
Recognise development cost as an intangible asset
31 December 20.13
Amortisation (P/L)* 30 000
Accumulated amortisation 30 000
Amortisation of development costs for 20.13 (150 000/5)
* The amortisation of the development costs can also be debited to the cost of inventories (SFP)
and subsequently, on sale of the inventories, debited to the line item cost of sales (P/L) since it
relates to the manufacturing of the new product.
On 31 December 20.14, a competitor introduced a new product that will shortly overtake the
market held by the product of H Ltd. On 31 December 20.14, the management of the entity
estimates that the remaining life of their market is six months before it will be taken over by the
product of the competitor. On 31 December 20.14, the recoverable amount of the asset is only
R20 000.
continued
The accounting treatment for the year ended 31 December 20.14 will be as follows:
Dr Cr
Amortisation (P/L)* 30 000
Recognise the amortisation for 20.14 (150 000/5)
Recognise impairment as a result of the loss of market share
Calculation of impairment loss
R
Carrying amount (150 000 – 30 000 – 30 000) 90 000
Recoverable amount (given) 20 000
Impairment loss 70 000
16.5.2 Revaluation model

The revaluation model allows an entity to revalue the asset to fair value. The carrying
amount of the revalued asset is therefore the fair value on the date of revaluation less any
subsequent accumulated amortisation and impairment losses.
An intangible asset can only be revalued if the fair value can be measured reliably. Fair
value can usually only be measured reliably if an active market in that type of intangible
asset exists. As active markets will not exist for customised and unique intangible assets,
intangible assets, for example trademarks, brands, newspaper mastheads, music and film
publishing rights and patents cannot be revalued. Active markets may however exist for
certain types of licences and quotas.
When intangible assets are revalued, revaluation must take place at regular intervals so that
the carrying amount does not differ substantially from the fair value. Certain intangible
assets whose fair values are volatile or fluctuate substantially must be revalued more
regularly, probably annually. In contrast, intangible assets with relatively stable fair values
can be revalued on a less frequent basis.
The change from cost to revaluation method entails a change in accounting policy which
must be treated and disclosed in accordance with the requirements of IAS 8 Accounting
Policies, Changes in Accounting Estimates and Errors – which states that the change is
merely treated as a revaluation rather than a change in accounting policy (IAS 8.17).
The revaluation model does not allow:
the revaluation of intangible assets where intangible assets have not previously been
recognised as assets; and
the initial recognition of intangible assets at amounts other than cost.
If only part of the cost of an intangible asset was capitalised or the asset was received by
means of a government grant and is carried at a nominal value, the revaluation alternative
may be applied to the whole asset. This pragmatic approach prevents the revaluation of only
portions of intangible assets.
When intangible assets are revalued, a whole class of assets must be revalued so that no
category consists of assets stated both at cost and at revalued amount. Sometimes, an
asset with a reliable fair value in one period does not enjoy an active market in a
subsequent period, and consequently the asset cannot be revalued. In these cases, the
carrying amount of the intangible asset is the revaluation amount on the date of the last
revaluation less any subsequent accumulated amortisation and impairment losses. If the fair
value can be measured reliably once again in a subsequent year, the intangible asset is
again revalued. This accounting treatment does not constitute a change in accounting
policy. It is recommended, however, that such circumstances be disclosed in the financial
statements. The fact that the active market no longer exists may also indicate that the asset
is impaired.
Refer to chapter 9 for examples on the accounting treatment of revaluations and subsequent
revaluations and devaluations.
16.5.3 Intangible assets with a finite useful life

Assets with finite useful lives shall be amortised over their useful lives. Amortisation is the
systematic allocation of the depreciable amount of an intangible asset over the best
estimate of its useful life. The depreciable amount is the cost of the asset or other amount
substituted for cost less the residual value, and amortisation commences as soon as the
asset is available for use (when the asset is in the location and condition necessary for it to
be capable of operating in the manner intended by management).
16.5.3.1 Useful life
Several factors may influence the useful lives of intangible assets, including the following
(IAS 38.90):
the expected use;
the useful life of similar assets;
technological or other types of obsolescence;
maintenance expenditure;
actions by competitors;
legal or similar contractual limits on the use of the asset;
whether the useful life is dependent on the useful life of other assets;
the stability of the industry in which the asset operates; and
changes in market demand for services or products generated by the intangible asset.
IAS 38 further notes that due to rapid changes in technology, computer software and other
similar intangible assets will have fairly short useful lives.
In instances where the useful life of an intangible asset arises through legal rights granted
for a finite period, the useful life of the intangible assets must not exceed the period granted
by the legal rights unless renewal of the rights can be supported by evidence and will not
lead to significant costs for the entity. If the cost of renewal is significant, the ‘renewal cost’
will represent the cost of a new intangible asset at renewal date.
IAS 38.96 contains a list of factors that would indicate that rights can be renewed without
significant cost.
16.5.3.2 Amortisation method
The amortisation method selected will reflect the pattern in which the asset’s economic
benefits are expected to be consumed by the entity. Paragraph 98A of IAS 38 introduces a
rebuttable presumption that an amortisation method that is based on the revenue generated
by an activity that includes the use of an intangible asset is inappropriate.
The rebuttable presumption can be overcome in two limited circumstances when:
the intangible asset is expressed as a measure of revenue; or
it can be demonstrated that revenue and the consumption of economic benefits of the
intangible asset are highly correlated.
In these circumstances, revenue expected to be generated from the intangible asset might
be an appropriate basis for amortisation.
Amortisation methods that can be used in terms of IAS 38 include the straight-line method,
reducing balance method and unit of production method. Where the pattern is not clearly
discernible, the straight-line method is used.
Amortisation commences from the date on which the asset is available for use and is
applied consistently, unless a change in the expected pattern of use is recognised.
Amortisation ceases at the earlier of:
the date on which the asset is classified as held for sale in terms of IFRS 5; or
the date on which the asset is derecognised; or
the date on which the asset is fully amortised.
The fact that an asset is no longer used does not cause amortisation to cease.
Note that amortisation based on units of production will only commence once production has
started, even though the intangible asset may be available for use before then as no
production will, mathematically, result in a Rnil amortisation. The normal rule is however still
applied to get to this calculation result.
The amount of amortisation for the period is an expense that is usually written off in the
profit or loss section of the statement of profit or loss and other comprehensive income. In
certain instances, the amortisation amount may form part of the cost of other assets, for
example inventories or construction contracts.
16.5.3.3 Residual value
The residual values of intangible assets with a finite useful life are deemed to be Rnil;
unless
there is a commitment by a third party to purchase the asset at the end of its useful life;
or
there is an active market (as defined by IFRS 13 Fair Value Measurement) for the asset
which will probably still exist at the end of the asset’s useful life.
The residual value can be determined reliably in these instances.
A residual value larger than Rnil indicates that the entity intends to dispose of the intangible
asset before the end of its economic life.
An estimate of an asset’s residual value is based on the amount that can currently be
obtained from disposal of a similar asset at the end of its useful life that had been operated
under similar conditions as the asset under review. Residual value is reviewed at least
annually. A change in residual value is a change in accounting estimate and must be
accounted for in terms of IAS 8.
The residual value of an intangible asset may sometimes increase to an amount equal to or
greater than the carrying amount. Should this happen, the amortisation charge would be Rnil,
until the residual value subsequently decreases to below the asset’s carrying amount, in
which case amortisation will once again commence.
Both the amortisation period and the amortisation method of an asset with a finite useful
life must be reassessed at the end of each reporting period. When the expected useful lives
of intangible assets change substantially as a result of (for example) the incurring of
subsequent costs which increase the useful life, the amortisation period is adjusted
accordingly. The pattern of expected future economic benefits resulting from the use of an
asset may also change, and another amortisation method may thus be more appropriate to
use. In both instances, the change in the amortisation method and period is a change in
accounting estimate, which is adjusted prospectively in the current and future periods in
terms of IAS 8.
Example 16.
16.8 Intangible asset with a residual value
On 1 January 20.13, A Ltd acquired a licence to use computer software to manage inventories at a
cost of R27 000. The licence has no time limit. It is however the policy of the entity to upgrade
computer systems every 3 years with the latest available software. Assume that there is an active
market for these types of second-hand software licences. The estimated current residual value to
sell the licence second-hand amounts to R6 000.
The amortisation for the first year of use is calculated as follows:
R
Estimated residual value (6 000)
Amount to be amortised 21 000
Useful life 3 years
Amortisation (21 000/3) 7 000
During 20.14 there were significant increases in the price of second-hand software.
The residual value of the software licence was revised to R11 000.
The amortisation for the second year of use of the licence will be as follows:
R
Carrying amount (27 000 – 7 000) 20 000
Estimated residual value (11 000)
Amount to be amortised 9 000
Useful life (remaining) 2 years
Amortisation (9 000/2) 4 500
16.5.4 Intangible assets with indefinite useful lives

Assets are regarded as having an indefinite useful life when there is no foreseeable limit to
the period over which the asset will generate net cash inflows for the entity. However,
indefinite does not have the same meaning as infinite. When an asset has an infinite useful
life, there is no end to the flow of future economic benefits. Where with an indefinite useful
life the end of the flow of future economic benefits cannot be determined as the flow will not
cease for the foreseeable future.
Assets with indefinite useful lives are not amortised, but:
are tested for impairment annually in terms of IAS 36 Impairment of Assets by comparing
their carrying amounts with their recoverable amounts on an annual basis; and
are tested more often than annually where there is an indication that the intangible asset
may be impaired.
For an intangible asset with an indefinite useful life, an annual review must be conducted to
determine whether events and circumstances still continue to support an indefinite useful life
assessment for the asset. Should an indefinite useful life no longer be appropriate and the
useful life of the asset changes to finite, this will be accounted for as a change in accounting
estimate in terms of IAS 8. Changing the useful life of an asset from indefinite to finite could
be an indication of impairment.
Example 16.9 Intangible asset with an indefinite useful life
A Ltd developed a new innovative product, Product P. The entity incurred development costs of
R500 000 equally during 20.13. The development process is completed on 31 December 20.13.
On this date, there was no limit to the expected future cash flows that the development would
generate to the entity, as the product was the only of its kind in the market and there was no
indication of competition.
On 1 January 20.14, the development costs had an indefinite useful life.
IAS 38.109 requires that where the useful life is indefinite, that it must be assessed on an annual
basis.
If a competitor were to enter the market two years after A Ltd incurred the development costs, it
might cause the nature of the useful life of the asset to change from an indefinite useful life to a
finite useful life and the development costs will be amortised. IAS 38 states that this change may
also be an indication of a possible impairment of the asset.
16.6 Impairment
IAS 36, which deals with impairment, is used as the basis for writing down intangible assets
to a recoverable amount. The recoverable amount is the higher of:
fair value less costs of disposal; and
value in use.
The following specific impairment testing is applicable to intangible assets:
an intangible asset with an indefinite useful life is tested for impairment annually and
whenever there is an indication of impairment;
an intangible asset not yet available for use is tested for impairment at least annually;
and
all other intangible assets are assessed at reporting date to determine if there is an
indication of impairment.
The carrying amount of an intangible asset is usually recovered on a systematic basis over
the useful life of the asset. If the usefulness of the item declines as a result of damage,
technical obsolescence or other economic factors, the recoverable amount can be lower
than the carrying amount of the asset. In such circumstances a write-down of carrying
amount to recoverable amount is required (impairment loss). For a comprehensive
discussion on impairment, refer to chapter 14.
16.7 Derecognition
An intangible asset is removed from the statement of financial position (i.e. derecognised)
when:
it is sold (disposed) of; or
Gains and losses from the derecognition of intangible assets:
are determined as the difference between the net proceeds from disposal and the
carrying amount on the date of disposal; and
this difference is recognised in profit or loss in the statement of profit or loss and other
comprehensive income as a gain or a loss.
When an intangible asset is retired from use, it will still be amortised, unless the retirement
can be equated to derecognition, as discussed above. For a detailed discussion on this
matter, refer to chapter 9.
Example 16.
16.10 Retirement of an intangible asset
Lima Ltd holds a patent with a carrying amount of R2 000 000 as at 31 December 20.12. The
patent was acquired four years ago at a cost of R4 000 000 and a useful life of 8 years was
estimated at that point. On 1 September 20.13, the production process in respect of which the
patent was required was terminated, and it was consequently decided to retire the patent from
active use. At 31 December 20.13, the year end, there were internal indications of impairment and
it was established that the value in use of this patent was Rnil, while it could be disposed of for
R1 200 000 (gross) provided selling costs of R100 000 were incurred. Disposal is not planned at
this stage as the asset may perhaps be modified for other use.
The above scenario would be accounted for as follows in the financial statements for the year
Amortisation for 20.13 of retired asset (not to be derecognised)
R’000
Cost at initial recognition 4 000
Amortisation per annum (4 000 000/8) 500
Amortisation on this asset for the whole year (4 000 000/8) 500
Carrying amount of patent on 31 December 20.13
Cost (given) 4 000
Accumulated amortisation until 31 December 20.13 (R500 000 × 5 years) (2 500)
Carrying amount as at 31 December 20.13 1 500
Carrying amount and impairment loss on 31 December 20.13
Carrying amount on 31 December 20.13 before impairment testing 1 500
Recoverable amount and carrying amount at year end
(Higher of Rnil and R1 100 000 (1 200 000 – 100 000)) 1 100
Impairment loss recognised in 20.13 400
Comment
¾ Amortisation will continue, since the asset has not met the criteria for derecognition.
¾ The impairment loss is recognised in profit or loss in the statement of profit or loss and other
comprehensive income for 20.13, and amortisation for 20.14 onwards will change to
R1 100 000/(8 – 5 years) = R366 667 per year.
16.8 Disclosure
In terms of IAS 38, the following information concerning internally generated intangible assets
and purchased intangible assets must be disclosed in the financial statements:
Accounting policy:
the accounting policy used for recognising intangible assets, namely the cost model, or
the revaluation model;
amortisation methods used for each class of intangible assets with finite useful lives;
whether the useful lives are indefinite or finite; and
if useful lives are finite, the useful life or amortisation rates for each class of such
intangible assets.
Statement of profit or loss and other comprehensive income and notes:
the total amortisation charge in the profit or loss section of the statement of profit or loss
and other comprehensive income in terms of IAS 1 Presentation of Financial Statements;
the line item in the statement of profit or loss and other comprehensive income in which
amortisation of intangible assets is included;
the effect of significant changes in accounting estimate in terms of IAS 8 Accounting

Policies, Changes in Accounting Estimates and Errors regarding the following:
– useful life;
– residual value; and
– amortisation method; and
costs recognised as expenses in the profit or loss section of the statement of profit or
loss and other comprehensive income for the following categories:
– research; and
– development.
Statement of financial position and notes:
for each class (examples of separate classes in IAS 38.119) of purchased and internally
generated intangible assets, the gross carrying amount and accumulated amortisation
(including accumulated impairment losses) at the beginning and end of the reporting
period;
for each class of purchased and internally generated intangible assets, a reconciliation of
the carrying amount at the beginning and end of the reporting period. The reconciliation
consists of:
– carrying amounts at the beginning and end of the reporting period;
– additions, indicating separately additions through business combinations, separate
acquisitions and internal development;
– the removal of assets (or assets that form part of a disposal group) classified as held
for sale (refer to IFRS 5 and other disposals);
– increases and decreases resulting from revaluations and from impairment losses
recognised or reversed in equity via other comprehensive income;
– impairment losses recognised in profit or loss in the statement of profit or loss and
other comprehensive income;
– impairment losses reversed in profit or loss in the statement of profit or loss and other
comprehensive income;
– amortisation recognised during the period;
– net exchange differences arising on the translation of financial statements of a foreign
operation to presentation currency of the entity, or translating the financial statements
of an entity from functional currency to a different presentation currency;
– other movements in carrying amounts during the period under review; and
– comparatives to the reconciliation are required;
for an asset with an indefinite useful life, the carrying amount of such an asset and the
facts supporting the assessment of an indefinite useful life;
also supply (with the above reasons) the factors that proved significant in the
determination that the asset has an indefinite useful life;
a description, the carrying amount and remaining amortisation period of any individual
intangible asset whose carrying amount is material to the entity;
the existence and the amounts of intangible assets whose titles are restricted and the
carrying amounts of intangible assets pledged as security for liabilities; and
the amount of contractual commitments for the acquisition of intangible assets.
In those exceptional instances where purchased and internally generated intangible assets
are revalued, the following additional information must be disclosed:
for each class of intangible assets, the effective date of revaluation;
for each class of intangible assets, the carrying amount of revalued intangible assets;
for each class of intangible assets, the carrying amount if the assets are accounted for
using the cost model; and
the amount of the revaluation surplus that relates to intangible assets at the beginning
and end of the period, showing the movement for the period and any restrictions on the
distribution of the balance to shareholders.
It is also recommended that the following be disclosed:
a brief description of significant intangible assets that did not meet the recognition criteria
for intangible assets in terms of IAS 38.128(b); and
a description of fully amortised intangible assets still in use.
Research and development expenditure:
An entity shall disclose the aggregate amount of research and development expenditure
(all expenditure that is directly attributable to research or development activities
(IAS 38.66 and.67)) recognised as an expense during the period.
Further disclosure includes the following:
the disclosure requirements of IAS 36 Impairment of Assets;
for intangible assets acquired via a government grant and initially recognised at fair
value:
– the fair value at initial recognition;
– the carrying amount; and
– whether the cost model or the revaluation model for subsequent periods was used.
Example 16.
16.11 Disclosure
Accounting policy
Intangible assets
Intangible assets acquired separately are measured on initial recognition at cost. The cost of
intangible assets acquired in a business combination is the fair value at the date of acquisition.
Following initial recognition, intangible assets are carried at cost less any accumulated
amortisation and any accumulated impairment losses. Internally generated intangible assets,
excluding capitalised development costs, are not capitalised and expenditure is charged against
profits in the year in which expenditure is incurred.
Intangible assets with finite lives are amortised over their useful economic lives and assessed
for impairment whenever there is an indication that the intangible asset may be impaired. The
amortisation period and the amortisation method for an intangible asset with a finite useful life are
reviewed at least at each financial year end. Changes in the expected useful life or the expected
pattern of consumption of future economic benefits embodied in the asset are accounted for by
changing the amortisation period or method, as appropriate and are treated as changes in
accounting estimates. The amortisation expense on intangible assets with finite lives is recognised
in the profit or loss section of the statement of profit or loss and other comprehensive income in the
expense category consistent with the function of the intangible asset.
Intangible assets with indefinite useful lives are tested for impairment annually either
individually or at the cash generating unit (CGU) level. Such intangibles are not amortised. The
useful life of an intangible asset with an indefinite life is reviewed annually to determine whether
the indefinite life assessment continues to be supportable. If not, the change in the useful life
assessment from indefinite to finite is made on a prospective basis.
continued
Research and development costs

Research costs are expensed as incurred. An intangible asset arising from development
expenditure on an individual project is recognised only when the group can demonstrate the
technical feasibility of completing the intangible asset so that it will be available for use or sale; by
its intention to complete and its ability to use or sell the asset; by how the asset will generate future
economic benefits; by having resources to complete; and by the availability to measure reliably the
expenditure during the development. Following the initial recognition of the development
expenditure, the cost model is applied, requiring the asset to be carried at cost less any
accumulated amortisation and accumulated losses. Any expenditure capitalised is amortised from
the related project over the period of expected future sales.
The carrying amount of development costs is reviewed for impairment annually when the asset is
not yet in use, or more frequently when an indication of impairment arises during the reporting year.
A summary of the policies applied to the group’s intangible assets is as follows:
Patents and licence Development costs
Useful lives Indefinite (20.14: Finite) Finite (20.14: Finite).
Method used No amortisation Amortised over the period of expected future
(20.14: 10 years) sales from the related project on a straight-line
basis (20.14: Amortised over the period of
expected future sales from the related project on a
straight-line basis).
Internally generated Acquired Internally generated.
or acquired
Impairment Annually and more Annually for assets not yet in use and more
testing/recoverable frequently when an frequently when an indication of impairment
amount testing indication of impairment exists. The amortisation method is reviewed at
exists each reporting date.
The patents have been granted for a minimum of 10 years by the relevant government agency with
the option of renewal at the end of this period, based on whether the group meets certain
predetermined targets. The fact that previous licences acquired had been renewed previously, for an
indefinite period, has allowed the group to determine that these assets have an indefinite useful life.
Gains or losses arising from derecognition of an intangible asset are measured as the difference
between the net disposal proceeds and the carrying amount of the asset and are recognised in the
statement of profit or loss and other comprehensive income when the asset is derecognised.
Intangible assets
Internally Purchased
generated
Total
development Patents and Goodwill
costs licences
R’000 R’000 R’000 R’000
Cost at 1 January 20.15, net of
accumulated amortisation and
impairment 1 686 525 200 2 411
Additions – internal development 587 – – 587
Acquisition of a subsidiary – 1 200 1 500 2 700
Attributable to a discontinued –
operation/classified as held for sale (128) – (128)
Impairment – (7) – (7)
Amortisation (125) – – (125)
31 December 20.15 2 148 1 590 1 700 5 438
continued
Internally Purchased
generated
Total
development Patents and Goodwill
costs licences
1 January 20.15 R’000 R’000 R’000 R’000
Cost (gross carrying amount)
as previously stated 1 975 635 250 2 860
Elimination of accumulated
amortisation – – (50) (50)
1 975 635 200 2 810
Accumulated amortisation and
impairment as previously stated (289) (110) (50) (449)
Elimination of accumulated
amortisation – – 50 50
Net carrying amount 1 686 525 200 2 411
31 December 20.15
Cost (gross carrying amount) 2 562 1 707 1 700 5 969
Accumulated amortisation and
impairment (414) (117) – (531)
Net carrying amount 2 148 1 590 1 700 5 438
The development costs are amortised using the straight-line method over a period of 15 years. If
an impairment indication arises, the recoverable amount is estimated and an impairment loss is
recognised if the recoverable amount is lower than the carrying amount.
Due to the change in the estimate of the useful life of patents and licences in the current year
resulting in indefinite lives, the cost at 1 January 20.15 is no longer amortised.
Acquisition during the year
Patents and licences include intangible assets acquired through business combinations. These
intangibles were determined to have indefinite lives and the cost model was utilised for their
measurement. These patents have been granted for a minimum of 10 years by the relevant
government agency with the option of renewal at the end of this period, based on whether the
group meets certain predetermined targets. This acquisition, coupled with the fact that licences
acquired in the past had previously been renewed for an indefinite period, had allowed the group
to determine that these assets have an indefinite useful life. At 31 December 20.15, these assets
were tested for impairment.

The Income Tax Act deals with intangible assets in several sections of the Act. For example,
section 11D deals specifically with scientific and technological research and section 11(gC)
deals with the acquisition of intellectual property other than trademarks. As a result of
differences between the income tax and accounting treatment of intangibles, temporary
differences may arise. These can give rise to deferred tax in terms of IAS 12.

Quatro Ltd is a company that holds several intangible assets as its main business. The following
information in respect of these intangible assets on 31 December 20.14 is available:
(a) Patents with a cost of R6 000 000 were purchased on 1 January 20.12. The expected useful life of
the patents was established as 30 years on the date of acquisition. Patents are amortised on a
straight-line basis over their useful life with residual values that are negligible. Residual values will
not change during the useful life of the assets.
(b) Copyright of several publications was acquired on 1 July 20.14 for R9 800 000. Legal costs and
other professional costs to complete the transaction amounted to R200 000. On 1 July 20.14, it
was estimated that the copyright will have a useful life of 20 years. The assets were amortised
over that period on a straight-line basis. Residual value is negligible and did not change during the
useful life of the assets.
The following additional information is available:
1. During January 20.14, new information suggested that the remaining useful life of the
abovementioned patents was 16 years.
On 31 December 20.14, there was an indication of impairment because the estimated revenue that
will be earned over the remaining period of the patent is significantly lower than was originally
expected. The following information was collected:
– The market value of the patents, if sold, would be R4 000 000. Brokers indicated that a fee of
2,5% would be charged on such sales transactions.
– The patents are expected to generate royalties of R1 100 000 cash per annum over their
remaining useful life. The related costs are expected to be R100 000 cash per annum.
– An after-tax rate of return of 14,4% is viewed as reasonable.
2. Assume a normal income tax rate of 28%. 5% of the expenditure on qualifying inventions, patents,
copyrights and other similar items will be allowed by SARS as a deduction in each year of
assessment. The allowance is not apportioned for part of a year.
3. The current tax of the company is calculated at R600 000 before taking into account the above.
Apart from the above, no other temporary differences will arise.
4. The deferred tax liability from other sources, both at the beginning and end of 20.14, amounted to
R1 000 000.
Round amounts to the nearest R1 000.
The financial statements of Quatro Ltd for the year ended 31 December 20.14, drafted in
accordance with IFRS, will be as follows:
Quatro Ltd
Statement of financial position as at 31 December 20.14
R’000
Assets
Non-current assets
Intangible assets 14 425
Deferred tax (R1 000 000 + R70 000 (calc 3) – R119 000 (calc 3)) 951
Quatro Ltd
1.1 Intangible assets
Intangible assets are shown at cost less accumulated amortisation and impairment losses. The
amortisation methods are as follows:
Patents – Straight-line at 6,25% (350/5 600) per annum (useful lives may also be provided here
– i.e. 15 years)
Copyrights – Straight-line at 5% (500/10 000) per annum (useful lives may also be provided
here – i.e. 20 years)
2. Intangible assets
Other intangible assets
Copyrights Patents Total
R’000 R’000 R’000
Carrying amount at 31 December 20.13 – 5 600 5 600
Cost – 6 000 6 000
Accumulated amortisation (1) – (400) (400)
Additions (2) 10 000 – 10 000
Amortisation (3, 4) (250) (350) (600)
Impairment loss recognised in (P/L)
(included in other expenses) (5) – (575) (575)
Carrying amount 31 December 20.14 9 750 4 675 14 425
Cost 10 000 6 000 16 000
Accumulated amortisation and impairment (6) (250) (1 325) (1 575)
Remaining useful life at 31 December 20.14 19,5 years 15 years

Total useful life
(1) 6 000 000/30 = R200 000 per annum × 2 years = R400 000
(2) 9 800 000 + 200 000 = R10 000 000
(3) 10 000 000/20 × 6/12 = R250 000
(4) 5 600 000/16 = R350 000
(5) Refer to calculation 1
(6) 400 000 + 350 000 + 575 000 = R1 325 000
Profit before tax is calculated after the following:
Expenses R
Amortisation (250 000 + 350 000) (included in other expenses) 600 000
Change in estimate: the remaining useful life of the patents
was revised. This resulted in an increase in the amortisation
expense of R150 000 (350 000 – 200 000) in the current year
and a decrease in the cumulative amortisation expense of
R150 000 in the future.
Impairment loss on patents (included in other expenses) 575 000
The impairment loss arose due to the estimated revenue that will be earned over the future use of
the patent being significantly lower than was originally expected.
The recoverable amount is based on the value in use and the discount rate is 20% per annum.
R
Main components of income tax expense:
Current tax expense (calc 2) 376 000
Deferred tax expense (calc 3) (105 000)
271 000
Calculations
1. Patent – Testing for impairment
Fair value less costs of disposal
R
Market value 4 000 000
Selling costs (4 000 000 × 2,5%) (100 000)
3 900 000
Value in use: PMT = 1 000 000 (1 100 000 – 100 000); n = 15; i = 20 (14,4%/0,72);
PV = R4 675 473
Recoverable amount is the greater of R3 900 000 (fair value) and R4 675 473 (value in use),
therefore R4 675 473.
Impairment loss
R
Carrying amount of patents 31 December 20.14
(6 000 000 × 28/30 – 350 000) or (6 000 000 – 400 000 – 350 000) 5 250 000
Recoverable amount (4 675 473)
Impairment 574 527
Rounded amount 575 000
2. Current tax
Taxable profit (600 000/28%) 2 142 857
Less: Deductions
Patents (6 000 000 × 5%) (300 000)
Copyright (10 000 000 × 5%) (500 000)
Taxable profit 1 342 857
Current tax @ 28% 376 000
3. Deferred tax
Deferred
Carrying Tax Temporary tax (28%)
amount base difference asset /
(liability)
R’000 R’000 R’000 R’000
Copyright
Carrying amount 31 December 20.13 – – – –
Carrying amount 31 December 20.14 9 750 9 500* 250 (70)
* 10 000 000 – 500 000 (calc 2) = R9 500 000
Patent
Carrying amount 31 December 20.13 5 600 5 400# 200 (56)
$
Carrying amount 31 December 20.14 4 675 5 100 (425) 119
#
6 000 000 – (5% × 2 × 6 000 000) = 5 400 000
$
5 400 000 – (6 000 000 × 5%) = 5 100 000
Dr/(Cr)
R
Total deferred tax balance
Balance: 20.13 (56 000)
20.14 (119 000 – 70 000) 49 000
Thus the movement in 20.14 in profit or loss will be a credit of 105 000 (49 000 + 56 000) – see
note 4.
CHAPTER
17
Investment property
(IAS 40)
Contents
17.1 Overview of IAS 40 Investment Property .................................................. 416
17.2 Nature of investment property................................................................... 417
17.3 Recognition and initial measurement ........................................................ 418
17.3.1 Recognition ...................................................................................... 418
17.3.2 Initial measurement ......................................................................... 418
17.4 Subsequent measurement ........................................................................ 419
17.4.1 Fair value model .............................................................................. 419
17.4.2 Cost model....................................................................................... 422
17.4.3 Subsequent expenditure .................................................................. 423
17.4.4 Derecognition................................................................................... 423
17.4.5 Transfers.......................................................................................... 425
17.5 Intragroup investment property ....................................................................... 427
17.6 Disclosure ................................................................................................. 427
17.7 Tax implications ........................................................................................ 430
17.7.1 Cost model....................................................................................... 430
17.7.2 Fair value model .............................................................................. 430
17.8 Comprehensive example .......................................................................... 433
415
17.1 Overview of IAS 40 Investment Property

DEFINITIONS EXAMPLES
Investment property is property (land and Investment property
buildings, or part of a building, or both) that Land held for long-term capital
is held: appreciation;
to earn rentals; or land held for a currently undetermined
for capital appreciation; or future use;
both. building leased out under an operating
lease;
Owner occupied property is held for use in
the production or supply of goods or services building that is vacant but is held with the
or for administrative purposes. intention of letting it under an operating lease;
property being constructed or developed
for future use as investment property.
RECOGNITION INITIAL MEASUREMENT

It is probable that future economic Cost (including transaction costs);
benefits will flow to the entity; and including: any directly attributable
the cost of the investment property can expenditure such as legal services,
be measured reliably. property transfer taxes and other
transaction costs;
excluding: start-up costs, initial operating
losses, wasted material, or unproductive
labour costs.
SUBSEQUENT MEASUREMENT Subsequent expenditure

Fair value model Only capitalised when it meets the
All investment property valued at fair requirements for subsequent recognition as
value. an asset.
Fair value adjustments recognised in Derecognition
profit or loss (no depreciation). On disposal, or on entering into a finance
Cost model lease, or when the property is permanently
All investment property measured using withdrawn from use and no further economic
the cost model in IAS 16 on property, benefits are expected at disposal.
plant and equipment. Transfers
Investment property carried at cost less Transfers between investment property and
accumulated depreciation and impairment other asset categories shall only be made
losses. when there is a change in use.
A change in use is evidenced by:
commencement of owner-occupation
(transfer from investment property to
PPE);
commencement of development with a
view to sell (transfer from investment
property to inventories);
end of owner-occupation (transfer from
owner-occupied to investment property);
or
commencement of an operating lease to
another party (from inventories to
Investment property 417
17.2 Nature of investment property

IAS 40 does not deal with:
forests and similar regenerative natural resources (biological assets); and
mineral rights, the exploration for and extraction of, minerals, oil, natural gas and similar
non-regenerative natural resources.
Investment property is property that is held:
to earn rentals; or
for capital appreciation; or
both.
Property includes land and buildings, or part of a building, or both. Undeveloped land may
also meet the definition of investment property. Investment property is therefore not property
held for use in the production or supply of goods or services or for administrative purposes,
nor is it property held for sale in the ordinary course of business. Owner-occupied property
does not qualify as investment property.
In practice, the classification of property into either owner-occupied property or
investment property may be problematic. A property may, for example, be used for dual
purposes, namely to earn rentals and to serve as an administrative head office.
The basic guideline to use in the classification is that an investment property must generate
cash flows that are largely independent of the other assets held by the entity. If the property
is used for dual purposes, the issue to consider is whether these portions can be sold
separately or be leased as a right-to-use asset. If the answer is affirmative, the entity
accounts for the portions separately as investment property and owner-occupied property.
The intention is that the asset must only be split into two classification categories if the
portions of the asset can be sold or leased separately. If the property cannot be sold
separately, it is only classified as an investment property if an insignificant portion is used for
production, or supply of goods or services, or for administrative purposes, either by the
owner or the lessee. What constitutes an insignificant portion is left to the discretion of
management.
IAS 40.14 notes that judgement is required to determine whether a property qualifies as
investment property. It is suggested that entities must develop their own criteria to ensure
that the exercise of judgement in classification between investment and owner-occupied
properties is consistent. Where classification is particularly difficult, disclosure of the criteria is
required.
In some instances, the classification of a property as either investment property or owner-
occupied property is further complicated in lease agreements by ancillary services that the
lessor company may provide to the lessee or occupants. The significance of such ancillary
services to the arrangement determines whether the property qualifies as an investment
property. If the lessor provides security and maintenance services (for example) it may be
insignificant to the lease arrangement as a whole. The property would then qualify as an
investment property. If the services comprise a more significant component, such as where
the company manages a hotel and provides extensive services to guests, the property
qualifies as an owner-occupied property.
Example 17.
17.1 Classification
Alpha Ltd owns an office block with 50 offices. Five of the offices are occupied by the entity, while
45 offices are occupied by tenants.
A: Offices can be sold separately
As the offices can be sold separately, the five offices occupied by Alpha Ltd should be accounted
for as owner-occupied (in terms of IAS 16), while the 45 offices that are leased out should be
accounted for as investment property (in terms of IAS 40).
B Offices cannot be sold separately
The offices cannot be sold separately, as certain facilities are shared.
As the offices cannot be sold separately, it is not possible to account for the portions of the office
block separately.
The entire office block should be accounted for as either owner-occupied property or investment
property. Alpha Ltd uses 10% of the offices for its own purposes, which may be regarded as
insignificant. As a result, the entire office block should be accounted for as an investment property.
IAS 40 provides a number of examples of investment property:

land held for long-term capital appreciation;
land held for a currently undetermined future use;
a building (owned by the entity or a right-of-use asset) leased out under operating
leases;
a building that is vacant but is held with the intention of letting it under an operating
lease; and
property being constructed or developed for future use as investment property.
The following are examples of items that are not investment property:
property held for sale in the ordinary course of business, or in the construction or
development for such sale (refer to IAS 2);
owner-occupied property, including property held for future use or held for future
development and subsequent use as owner-occupied property;
property occupied by employees (regardless of whether the employees pay market-
related rentals);
owner-occupied property awaiting disposal (refer to IAS 16); and
property leased out to another entity in terms of a finance lease agreement.
17.3 Recognition and initial measurement
17.3.1 Recognition
An owned investment property is recognised when the usual recognition criteria of the
Conceptual Framework are met, namely:
it is probable that future economic benefits will flow to the entity; and
the cost of the investment property can be measured reliably.
An investment property held by a lessee as a right-to-use asset is recognised in accordance
with IFRS 16 (IAS 40.19A).

On initial recognition, the owned investment property is measured as follows:
cost (including transaction costs);
including: any directly attributable expenditure such as legal services, property transfer
taxes and other transaction costs; but
excluding: start-up costs, initial operating losses, wasted material, or unproductive labour
costs.
Start-up costs may only be capitalised if they are necessary to bring the property to its
working condition in order to be operated in the manner intended by management. The cost
of self-constructed investment property is the cost incurred by the company to the date on
which the construction or development is substantially completed.
If payment for an investment property is deferred, its cost is the cash price equivalent. This
is determined in exactly the same way as for property, plant and equipment (refer to IAS
16). The difference between cost and the proceeds is recognised as interest over the period
of credit.
The initial measurement of investment properties acquired in terms of an exchange
transaction is also exactly the same as that used for property, plant and equipment.
17.4 Subsequent measurement

All investment properties, subsequent to initial measurement, are measured using
either:
the cost model; or
the fair value model.
A change from the cost model to the fair value model constitutes a change in accounting
policy in terms of IAS 8. IAS 40 mentions, however, that it is unlikely that a change from the
fair value model to the cost model will result in a more appropriate presentation of events (a
specific requirement in IAS 8). Such a change in accounting policy is, in effect, discouraged,
if not prohibited.
Two exceptions to the general rule are however referred to in paragraphs 32A and 34. An
entity may choose either the fair value model or the cost model for all investment property
backing liabilities that pay a return linked directly to the fair value of, or returns from,
specified assets, including the investment property, regardless of the model chosen for other
investment property. This means that the model used for the pool of other investment
properties may differ from the model selected for this pool of investment properties. This
exception is likely to apply to insurers and other entities with internal property funds. The
second exception (paragraph 34) arises where a property is held by a lessee under an
operating lease that must be stated at fair value.
17.4.1 Fair value model

If an entity chooses to adopt the fair value model, all of its investment property shall be
valued at fair value. The gains and losses from changes in the fair value of the investment
property are recognised in the profit and loss section of the statement of profit or loss and to
other comprehensive income in the period in which they arise.
17.4.1.1 Fair value

Fair value is defined as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date (refer
to IFRS 13 Fair value measurement).
The fair value reflects, in terms of IAS 40.40:
rental income from current leases; and
other assumptions that market participants would use when pricing the investment
property under current market conditions.
When a lessee uses the fair value model to measure an investment property that is held as
a right-of-use asset, that asset, and not the underlying property, is measured at fair value.
In measuring fair value, assets or liabilities that are recognised as separate assets or
liabilities should not be reflected in the fair value measurement, as this may result in double
accounting, for example:
equipment such as lifts or air-conditioning is often an integral part of a building and is
generally included in the fair value of the investment property, rather than recognised
separately as property, plant and equipment;
if an office is leased on a furnished basis, the fair value of the office generally includes
the fair value of the furniture, because the rental income relates to the furnished office –
therefore the entity does not recognise the fair value of the furniture as a separate asset;
the fair value of investment property excludes prepaid or accrued operating lease
income, because the entity recognises it as a separate liability or asset; and
the fair value of investment property held by a lessee as a right-to-use asset reflects
expected cash flows (including variable lease payments expected to be payable). It will
be necessary to add back any recognised lease liability to arrive at the fair value of the
Example 17.
17.2a Fair value model for measuring investment property
Chelsea Ltd owns an office building that is let to Z Ltd under an operating lease agreement. As the
building is used to generate rental income, it can be classified as an investment property in terms
of IAS 40.
Chelsea Ltd has adopted the fair value model as its accounting policy for measuring investment
property. The building has a useful life of 40 years.
The following fair values apply:
R
1 January 20.12 (Cost) 400 000
31 December 20.12 600 000
31 December 20.13 500 000
On 31 December 20.12, Chelsea Ltd had to remeasure the building at fair value. The
remeasurement is recognised in the profit or loss section of the statement of profit or loss and
Dr Cr
R R
31 December 20.12
Investment property (600 000 – 400 000) (SFP) 200 000
Fair value adjustment (P/L) 200 000
Remeasurement investment property at fair value
No depreciation is provided on investment property measured at fair value.
On 31 December 20.13, Chelsea Ltd once again remeasured the investment property to fair value,
with the loss being recognised in the profit or loss section of the statement of profit or loss and
Dr Cr
R R
31 December 20.13
Fair value adjustment (P/L) (500 000 – 600 000) 100 000
Investment property (SFP) 100 000
Remeasurement investment property to fair value
Example 17.2b Fair value model and accrued lease income
Xena Ltd rented out a vacant land (investment property) from 1 January 20.13 in terms of an
operating lease. The operating lease term is 4 years and instalments are payable at the end of
each year (year 1: R100 000; year 2: R110 000; year 3: R121 000; year 4: R133 100). It is Xena
Ltd’s accounting policy to account for investment property using the fair value model. The fair
value of the property was R1 000 000 on 1 January 20.13 and R1 150 000 on 31 December
20.13.
The following journal entries are required:
Dr Cr
R R
31 December 20.13
Bank (SFP) 100 000
Operating lease income (P/L) 116 025
(100 000+110 000+121 000+133 100=464 100/4)
Accrued operating lease income 16 025
Recognition of lease income
Fair value adjustment (P/L) (1 150 000 – 1 000 000 – 16 025) 133 975
17.4.1.2 Investment property held as a right-of-use asset

If a lessee leases a property and earns rental income by leasing the property to another
lessee (sublease), the resulting right-of-use asset should be accounted for as an investment
property. The asset accounted for as an investment property is not the physical property, but
the right-of-use asset (the lease interest in the property). The physical property will still be
accounted for as an asset in the owner’s financial statements. If the fair value model is
applied, the right-of-use asset should be measured at fair value and not the underlying
property.
Example 17.3 Right-of-use asset
Chelsea Ltd leases land with a fair value R1 000 000 for a period of 3 years at an annual market-
related rental of R100 000 (payable in arrears). The land was the leased to Alpha Ltd for the same
period under an operating lease at R125 000 per annum (payable in arrears). Both lease
agreements were entered into on 1 January 20.13. Chelsea Ltd accounts for the lease liability by
using an incremental borrowing rate of 6% per annum. Assume a fair discount rate of 4% on
31 December 20.13.
The following journal entries are required:
Dr Cr
R R
1 January 20.13
Finance lease liability (SFP) 267 301
(PMT=100 000; n=3; i=6; PV=267 301)
Recognition of investment property
31 December 20.13
Finance lease liability (SFP) (100 000 – 16 038) 83 962
Interest paid (P/L) (267 301 x 6%) 16 038
Bank (SFP) 100 000
Payment of instalment
continued
Dr Cr
R R
Bank (SFP) 125 000
Rental income (P/L) 125 000
Receipt of instalment
(PMT=125 000; n=2; i=4; PV=235 762)
17.4.1.3 Inability to measure fair value

There is a rebuttable presumption that an entity can reliably measure the fair value of
investment property on a continuing basis.
In exceptional circumstances, there might be clear evidence when the property is first
acquired that the entity will not be able to reliably measure the fair value of the investment
property on a continuing basis. This arises only when the market for comparable properties
is inactive (e.g. there are few recent transactions, price quotations are not current or
observed transaction prices indicate that the seller was forced to sell) and alternative
reliable measurements of fair value, such as discounted cash flow projections, are not
available. The entity measures that investment property using the cost model in IAS 16 for
owned investment property or in accordance with IFRS 16 for investment property held by a
lessee as a right-to-use asset until its disposal date. The residual value of such an
investment property is assumed to be Rnil. All other investment property is measured at fair
value. (IAS 40.53).
If an entity determines that the fair value of an investment property under construction is
not reliably measurable, but expects the fair value of the property to be reliably measurable
when construction is complete, the investment property under construction should be
measured at cost until either its fair value becomes reliably measurable or construction is
completed (whichever is earlier).
The exemption only applies to investment property when it is first acquired or is first
classified as investment property. If a company has previously measured an investment
property at fair value, it shall be consistent and continue to measure such a property at fair
value, even if the market becomes less active and market prices are not readily available
(IAS 40.55).
Example 17.
17.4 Investment property under construction
Chelsea Ltd acquired a fixed property on 1 January 20.13 at a cost of R100 000, with the intention
to develop the property. At 31 December 20.13 (year end) construction of the property was not
completed, and construction costs incurred amounted to R450 000. If the fair value of the
investment property under construction could not be reliably measured at year end, the property
should be reflected at its cost of R550 000 (100 000 + 450 000). If the fair value of the fixed
property was R575 000 at 31 December 20.13, Chelsea Ltd should recognise a fair value
adjustment (gain) of R25 000 (575 000 – 100 000 – 450 000) in profit or loss in order to reflect the
investment property at its fair value of R575 000.
17.4.2 Cost model

If the cost model is used, the investment property is measured as follows after initial
recognition (IAS 40.56):
in accordance with IFRS 5 if it meets the criteria to be classified as held for sale;
in accordance with IFRS 16 if it is held by a lessee as a right-of-use asset;
in accordance with IAS 16 (cost model) in all other cases.
Example 17.
17.5 Cost model for measuring investment property
Shivas Ltd commenced erecting a building on 1 January 20.16. It is the intention of the entity to
rent the building to third parties on completion. The following erection costs were incurred:
R
Material 300 000
Labour 200 000
Other professional services 50 000
Total cost 550 000
The building was completed on 30 June 20.17.
Shivas Ltd adopted an accounting policy to measure investment property using the cost model.
The useful life of the building is 55 years from date of completion.
On 31 December 20.16, Shivas Ltd will disclose the cost incurred to date in the PPE note as
property under construction. The property is not depreciated as it is not ready for its intended use.
When the property is completed on 30 June 20.17, it is transferred to investment property. From
1 July 20.17, when the asset was ready for intended use, it will be depreciated. On
31 December 20.17, the market value of the property is R800 000.
The following journal entries are required for the year ended 31 December 20.17:
Dr Cr
R R
31 December 20.16
Bank (SFP) 550 000
Recognise investment property
31 December 20.17
Depreciation (P/L) (550 000/55 × 6/12) 5 000
Provide depreciation on investment property
17.4.3 Subsequent expenditure

Subsequent expenditure incurred in relation to recognised investment property is only
capitalised when it meets the requirements for subsequent recognition as contained in
IAS 16.16 and IAS 40.16. If subsequent expenditure does not meet these criteria, these
expenses are recognised as repairs and maintenance in the profit or loss section of the
statement of profit or loss and other comprehensive income. This treatment is similar to that
followed for property, plant and equipment in IAS 16. Subsequent expenditure that is
incurred to bring the asset to its working condition after purchase, for example the
renovation of a building, is also capitalised, provided it meets the recognition criteria of the
Conceptual Framework.
17.4.4 Derecognition
The derecognition of investment property takes place on disposal, or when the property is
permanently withdrawn from use and no further economic benefits are expected at disposal.
The difference between the net disposal proceeds and the carrying amount of the asset is
recognised in the profit or loss section of the statement of profit or loss and other
comprehensive income as a profit or a loss, and losses arising from a sale and leaseback
agreement are treated in accordance with IFRS 16.
Example 17.
17.6 Disposal of investment property
Xena Ltd acquired a property with a building on it on 1 July 20.14 at a cost of R500 000. The
building was used to earn income and was therefore classified as an investment property. It is the
accounting policy of Xena Ltd to account for investment property using the fair value model. The
year end of the entity is 30 June.
On 30 June 20.16, the fair value of the property was R800 000.
The asset was sold on 31 July 20.16 for R1 000 000 (assume that the building generated income
until this date and that the asset didn’t meet the requirements to be classified as held for sale in
terms of IFRS 5).
The building was used as a factory, qualifying for a deduction of 5% per year, not apportioned for
part of a year. Assume a normal income tax rate of 28%. Capital gains tax (CGT) is provided for at
80% of the capital profit.
The deferred tax for the property was as follows:
30 June 20.16 Carrying Tax Temporary Deferred tax
Investment property R R R R
Cost (50 000 x 28%) 500 000 450 000 50 000 14 000
Fair value adjustment 300 000 – 300 000 67 200
(300 000 × 28% × 80%)
800 000 450 000 350 000 81 200
30 July 20.16 Carrying Tax Temporary Deferred

amount base difference tax
Investment property R R R R
Cost (75 000 × 28%) 500 000 425 000 75 000 21 000
Fair value adjustment 300 000 – 300 000 67 200
(300 000 × 28% × 80%)
800 000 425 000 375 000 88 200
Tax base of the property: [500 000 – (500 000 × 5% × 2 years)] = 450 000
(Refer to point 21.6 for the tax implications of investment properties)
The accounting entry recording the sale of the asset will be as follows:
Dr Cr
31 July 20.16 R R
Bank (SFP) 1 000 000
Fair value adjustment (P/L) (1 000 000 – 800 000) 200 000
Derecognition of asset
The following amount will be included in the current tax for the year ended 30 June 20.17:
R R
Recovery in terms of section 8(4)(a) 21 000
(500 000 – 425 000) × 28%
Capital Gains Tax (500 000 × 28% × 80%) 112 000
Total tax payable 133 000
continued
The following entries are required to record firstly the current tax, and secondly the reversal of the
deferred tax to ensure that the asset is no longer recognised in the records of Xena Ltd:
Dr Cr
31 July 20.16 R R
Recognise the current tax liability as a result of the sale of the
asset
Write deferred tax back once asset is de-recognised
17.4.5 Transfers
Transfers between investment property and other asset categories shall only be made when
there is a change in use.
A change in use is evidenced by the following (IAS 40.57):
the commencement of owner-occupation (transfer from investment property to PPE);
the commencement of development with a view to sell (transfer from investment property
to inventories);
the end of owner-occupation (transfer from owner-occupied to investment property); or
the commencement of an operating lease to another party (from inventories to
When an entity uses the cost model to account for an investment property, the carrying
amount does not change for transfers between the investment property, owner-occupied
property and inventories.
For transfers from investment property measured at fair value to inventories or owner-
occupied property, the fair value on the date of change is deemed to be the cost of the latter
two assets. An owner-occupied property (IAS 16 – owned property and IFRS 16 – right-to-
use asset) that becomes an investment property to be carried at fair value must be revalued
in accordance with the requirements of IAS 16 at the date of transfer. For a transfer of
inventories to investment property to be carried at fair value, the difference between the
carrying amount and the fair value on the date of transfer is recognised in the profit or loss
section of the statement of profit or loss and other comprehensive income. On completion of
the construction of an investment property to be carried at fair value, the difference between
the carrying amount and the fair value on the date of transfer is also recognised in the profit
or loss section of the statement of profit or loss and other comprehensive income.
The accounting treatment of transfers may be summarised as follows:
Accounting model Transfers

Accounting treatment
for investment
From To of difference in value
property
Cost model Investment property Inventories,
owner-occupied –
property
Inventories,
owner-occupied / Investment property –
self-constructed
property
continued
Accounting model Transfers

Accounting treatment
for investment
From To of difference in value
property
Fair value model Investment property Inventories, Fair value now deemed
owner-occupied cost
property
Owner-occupied Asset revalued,
property Investment property revaluation gain/loss
treated in terms of IAS 16
(revaluation surplus).
Difference recognised in
Inventories Investment property the profit or loss section
of the statement of
Example 17.
17.7 Transfer between investment property at fair value and owner
occupied property
Assume for the following two cases that the reporting entity follows an accounting policy to
measure investment property using the fair value model.
Case 1: Owner-occupied property becomes an investment property
Mishka Ltd has used a building as its administrative head office for the past few years. During the
year ended 31 December 20.12, the entity acquired a new office building. From 1 January 20.13,
the new building will be used as the head office. The previous head office building will be retained
for capital growth.
On 1 January 20.13, the carrying amount in terms of IAS 16 is R500 000 (while the initial cost was
R800 000). The fair value was R700 000 at this date. The remaining useful life of the asset on
1 January 20.13 is 13 years. On 31 December 20.13, the fair value was R950 000.
The general journal entries for the year ended 31 December 20.13 are as follows:
Journal entries for the year ending 31 December 20.13:
Dr Cr
1 January 20.13 R R
Property at cost (OCI) 800 000
Revaluation surplus (OCI) (700 000 – 500 000) 200 000
Transfer of owner occupied property to investment property
31 December 20.13
Investment property (SFP) (950 000 – 700 000) 250 000
Remeasurement of investment property to fair value
Case 2: Investment property becomes owner-occupied property
Noela Ltd leased a building to third parties until 31 December 20.12. The property was therefore
classified as investment property. On 31 December 20.12, the fair value of the building was
R300 000.
On 1 January 20.13, the intention of the entity regarding the use of the building changed, and from
this date Noela Ltd used the building as a factory. The entity accounts for PPE using the cost
model. The remaining useful life on this date is 10 years.
continued
Journal entries for the year ended 31 December 20.3:

Dr Cr
R R
1 January 20.13
Transfer from investment property to owner-occupied property
31 December 20.13
Depreciation (P/L) (300 000/10) 30 000
Provide for depreciation for the year
17.5 Intragroup investment property

If a company in a group owns a property that is leased to or occupied by a parent or a
subsidiary, the property may qualify as an investment property from the perspective of the
reporting company. However, from the perspective of the group as a whole, the property will
be owner-occupied. Appropriate consolidation journal entries will be required to reflect the
economic reality of the different reporting entities.
Example 17.
17.8 Intragroup investment property
Alpha Ltd has a 80% interest in Beta Ltd. On 1 July 20.13 Alpha Ltd acquired a building with a
useful life of 25 years at a cost of R750 000 and immediately leased the buiding to Beta Ltd in
terms of an operating lease. Alpha Ltd classified the building as investment property (fair value at
year end amounted to R790 000). Investment property is accounted for by using the fair value
model and owner-occupied property in terms of the cost model.
The following pro forma consolidation journals are required:
Dr Cr
R R
Reversal of fair value adjustment
Reclassification of investment property as owner-occupied property
Depreciation (P/L) (750 000/25 × 6/12) 15 000
Provide depreciation for the year
17.6 Disclosure
In terms of IAS 40.74 to .79, the following information on investment property shall be
disclosed:
whether the entity applies the fair value or cost model;
criteria developed to distinguish investment property from other asset classes when
classification is difficult;
the extent to which the fair value of investment property has been measured by an
independent valuer with the necessary qualifications and recent experience, and where
no such valuation was done, a statement to that effect;
the existence and amounts of restrictions on the realisability of investment property or

the remittance of income and proceeds of disposal; and
material contractual obligations to purchase, construct or develop investment property or
for repairs or enhancement to the property.
In the profit or loss section of the statement of profit or loss and other comprehensive
income, the following amounts must be disclosed:
rental income;
direct operating expenses applicable to investment property that generated rental
income;
direct operating expenses applicable to investment property that did not generate rental
income; and
the cumulative change in fair value where an investment property is sold from a portfolio
where the cost model is used to a portfolio where the fair value model is used.
Where an entity adopts the fair value model, a reconciliation of the carrying amount
of investment property at the beginning and end of the period, showing the following:
additions resulting from acquisitions or from capitalised subsequent expenditure;
additions resulting from acquisitions through business combinations;
disposals and assets classified as held for sale in terms of IFRS 5;
net gains or losses from fair value adjustments;
the net exchange differences arising on the translation of foreign entities;
transfers to and from inventories and owner-occupied property; and
other movements.
Example 17.
17.9 Disclosure of the fair value model
Notes to the financial statements

1.1 Investment properties
Investment properties are measured initially at cost, including transaction costs. The carrying
amount includes the cost of replacing part of an existing investment property at the time that cost
is incurred if the recognition criteria are met, and excludes the costs of day-to-day servicing of an
investment property. Subsequent to the initial recognition, investment properties are stated at fair
value, which reflects market conditions at the end of the reporting period. Gains or losses arising
from changes in the fair values on investment properties are included in the profit or loss section of
the statement of profit or loss and other comprehensive income in the year in which they arise.
Investment properties are derecognised when they have either been disposed of or when the
investment property is permanently withdrawn from use and no future economic benefit is expected
from its disposal. Any gains or losses on the retirement or disposal of an investment property are
recognised in the statement of profit or loss and other comprehensive income in the year of
retirement or disposal.
Transfers are made to investment property when, and only when, there is a change in use,
evidenced by the end of owner-occupation, commencement of an operating lease to another
party, or ending of construction or development. Transfers are made from investment property
when, and only when, there is a change in use, evidenced by commencement of owner-
occupation or commencement of development with a view to sale.
continued
For a transfer from investment property to owner-occupied property or inventories, the deemed cost
of property for subsequent accounting is its fair value on the date of change in use. If the property
occupied by the group as an owner-occupied property becomes an investment property, the group
accounts for such property in accordance with the policy stated under PPE up to the date of change
in use. For a transfer from inventories to investment property, the difference between the fair value of
the property on that date and its previous carrying amount is recognised in the profit or loss section of
the statement of profit or loss and other comprehensive income. When the group completes the
construction or development of a self-constructed investment property, the difference between the
fair value of the property on that date and its previous carrying amount is recognised in the profit or
loss section of the statement of profit or loss and other comprehensive income.
2. Investment property
Land and buildings
20.15 20.14
R’000 R’000
Opening balance at 1 January at fair value 7 983 7 091
Additions: – acquisitions 1 216
– subsequent expenditure capitalised 1 192
Net loss from a fair value adjustment (306) (300)
Closing balance at 31 December at fair value 8 893 7 983
Investment properties are stated at fair values, which have been determined based on valuations
performed by Qualified Surveyors & Co at 31 December 20.15 and 31 December 20.14 for the
current and previous years respectively. Qualified Surveyors & Co is an industry specialist in
valuing these types of investment properties. The fair value represents the amount at which the
assets could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing
seller in an arm’s length transaction at the date of valuation, in accordance with international
standards.
If, in exceptional circumstances, the entity is unable to establish a reliable fair value for an
investment property, a separate reconciliation of that investment property’s carrying amount
shall be prepared, in addition to disclosing the following:
a description of the investment property;
an explanation of why fair value cannot be measured reliably;
if possible, the range of estimates of fair value; and
on disposal of such investment property:
– the fact that the asset that was not carried at fair value was disposed of;
– the carrying amount at time of sale; and
– the gain or loss recognised.
Where a company adopts the cost model, the following information, similar to that
required in IAS 16, shall be disclosed:
the depreciation methods;
the useful lives or depreciation rates;
the gross carrying amount and accumulated depreciation at the beginning and end of the
period; and
a reconciliation of the carrying amount of investment property at the beginning and end
of the period, showing:
– additions resulting from acquisitions and from capitalised subsequent expenditure;
– additions resulting from acquisitions;
– disposals and assets classified as held for sale in terms of IFRS 5;
– depreciation;
– amounts of impairment losses recognised or reversed;
– the net exchange differences arising from the translation of foreign entities;
– transfers to and from inventories and owner-occupied property; and
– other movements.

The provision for deferred tax on investment property is influenced by the manner in which
the entity expects to recover the asset. The provision for deferred tax is also influenced by
whether the entity uses the cost model or fair value model to measure investment property.
17.7.1 Cost model

When the cost model is used for investment properties, the tax implications are the same as
when the cost model is used for PPE in terms of IAS 16.
17.7.2 Fair value model

When the fair value model is used for investment property, the property is actually revalued
on an annual basis. The application of the fair value model will result in no further
depreciation on investment property being written off. This discontinuance of depreciation
only applies to depreciable assets and thus not to land (IAS 12.51, .51C and 51D).
If a deferred tax liability or asset arises from investment property that is measured using the
fair value model, there is a rebuttable presumption that the carrying amount of the
investment property will be recovered through sale. Accordingly, unless the presumption is
rebutted, the measurement of the deferred tax liability or deferred tax asset shall reflect the
tax consequences of recovering the carrying amount of the investment property entirely
through sale. This presumption is rebutted if the investment property is:
depreciable; and
is held within a business model whose objective is to consume substantially all of the
economic benefits embodied in the investment property over time, rather than through
sale.
The tax implications can be summarised as follows:
NON-DEPRECIABLE ASSETS
Presumption – recovery always through sale
Temporary difference Tax rate
Carrying amount (CA) – Cost Capital gains tax rate (CGT) (28% × 80%)
Below cost 0%
DEPRECIABLE ASSETS
Presumption – recovery through sale
Tax deductions allowed No tax deductions allowed
(e.g. factory building) (e.g. admin building)
Temporary Temporary
Tax rate Tax rate
difference difference
CA – Cost CGT (28% × 80%) CA – Cost CGT (28% × 80%)
Cost – Tax base Normal income tax Below cost 0%
rate (28%)
continued
Presumption – recovery through sale rebutted

Tax allowances granted No tax allowances granted
(e.g. factory building) (e.g. admin building)
Temporary Tax rate Temporary Tax rate
difference difference
CA – Tax base Normal tax rate (28%) CA – Cost Normal income tax
Below cost rate (28%)
0%
Example 17.
17.10 Deferred tax based on manner of recovery of factory buildings
Beta Ltd has a factory building with a carrying amount of R1 000 000 as an investment property.
(Ignore the implications of land for the purposes of this example). The original cost price is
R500 000 and the tax base is R300 000. The entity uses the fair value model for investment
property. Assume a normal income tax rate of 28%.
R
Presumption of recovery through sale
[(1 000 000 – 500 000) × 28% × 80%] + [(500 000 – 300 000) × 28%] 168 000
Presumption of recovery through sale is rebutted
[(1 000 000 – 300 000) × 28%] 196 000
Example 17.
17.11 Deferred tax on property and office building
Beta Ltd owns an investment property measured using the fair value model with a carrying amount
of R5 000 000 on 31 December 20.13 (the year end), of which 30% relates to land and the
remainder to the office building on the premises. The initial cost price of the property was
R2 000 000. On the purchase date, the land component amounted to R800 000 and the building
component to R1 200 000. Assume a normal income tax rate of 28% and a capital gains tax
inclusion rate of 80%. No tax deductions are allowed on the office building.
The deferred tax on the fair value adjustments going through the profit and loss section of the
statement of profit or loss and other comprehensive income will be determined as follows:
Land
[((5 000 000 × 30%) – 800 000) × 28% × 80%] R156 800
Office building
[((5 000 000 × 70%) – 1 200 000) × 28% x 80%] R515 200
Presumption of recovery through sale is rebutted
[((5 000 000 × 70%) – 1 200 000) × 28%] R644 000
Comment
¾ The land had always been non-depreciable in terms of IAS 16. Consequently, deferred tax on
the fair value adjustment was provided at the rate that would apply when the item was sold (in
SA at the CGT rate of 28% × 80%). By implication, the carrying amount of the land will only be
recovered through sale and the CGT rate is appropriate.
An illustration of the deferred tax implications that will arise at the transfer of an item from
another class of asset to investment property now follows.
Example 17.
17.12 Transfer of property classified as PPE to investment property
On 1 July 20.11, Beta Ltd moved its manufacturing operations to new premises and let its existing
premises to another manufacturing company. The company uses the fair value model in respect of
investment properties and has a December year end. Assume a normal income tax rate of 28%.
Details in respect of this property are as follows:
Cost R
Land 1 000 000
Buildings 1 000 000
Accumulated depreciation – buildings (1 January 20.11) 200 000
Tax base: buildings (1 January 20.11) 500 000
Depreciation: buildings per annum 20 000
Building allowance for tax purposes per annum 50 000
Deferred tax provided on this property at 1 January 20.11 at 28% 84 000
Fair value on 1 July 20.11
Land 1 100 000
Buildings 1 300 000
Fair value on 31 December 20.11
Land 1 150 000
Buildings 1 350 000
The tax base for purposes of CGT was as follows:
Land R1 125 000
Buildings R1 000 000
Journal entries
Dr Cr
R R
1 July 20.11
Depreciation (P/L) 10 000
Depreciation for the year (20 000 × 6/12)
Investment property (SFP) (1 100 000 + 1 300 000) 2 400 000
Accumulated depreciation (SFP) (200 000 + 10 000) 210 000
Land (SFP) 1 000 000
Buildings (SFP) 1 000 000
Revaluation surplus (OCI) (2 400 000 – 2 000 000 + 210 000) 610 000
Transfer to investment property
Revaluation surplus (OCI) –
Deferred taxation (SFP) –
Deferred tax on the revaluation of land does not arise, as the tax base
for CGT purposes is higher than the revalued amount
Deferred taxation (SFP) 142 800
Provide for deferred taxation on revaluation of building
((610 000 – 100 000) × 28%)
Adjustment to deferred tax on fair value adjustment above cost because
of reclassification to investment property
(510 000 × 28%) – [(1 300 000 – 1 000 000) × 28% × 80%] +
[(1 000 000 – 790 000) × 28%]
continued
Dr Cr
Taxation (P/L) 11 200
Buildings allowance 20.11 R50 000
Depreciation (10 000)
R40 000 × 28% = R11 200

Fair value adjustment (P/L) (1 150 000 + 1 350 000 – 2 400 000) 100 000
Fair value adjustment on 31 December 20.11
Taxation (P/L) 16 800
Provide for deferred tax on fair value adjustment
Buildings (1 350 000 – 1 300 000) × 28% x 80% = R11 200
Land (1 150 000 – 1 125 000) × 80% × 28% = 5 600
R16 800
The balance on the deferred tax account after the above entries will be R238 000, namely:
(84 000 + 142 800 – 16 800 + 11 200 + 16 800).
Proof
Total
Land Buildings deferred
tax
R R R
The carrying amount of the asset 1 150 000 1 350 000
The tax base of the asset 1 125 000 450 000
Temporary difference 25 000 900 000
[(1 350 000 – 1 000 000) × 28% × 80%] +
[(1 000 000 – 450 000) × 28%] – 232 400
(25 000 × 28% × 80%) 5 600 –
5 600 232 400 238 000

An extract from the financial records of Alpha Candles Ltd, a company that manufactures candles,
contains the following information:
Property R
1. Land: Stand 152 Garsfontein 500 000
Building thereon (acquired 1 January 20.13) 1 250 000
(The property is used to house the manufacturer’s operations and was available
for use as intended by management immediately.)
2. Land: Stand 181 Hatfield 800 000
Buildings thereon (acquired 30 June 20.13 and available for use as intended
by management immediately.) 2 100 000
Improvements to the building to extend rented floor capacity
(completed on 31 December 20.13.) 400 000
Repairs and maintenance to investment property for the year 50 000
(The property is used as the administrative head office of the company
(approximately 6% of the floor space). The remainder of the building is leased out
under operating leases. The company provides lessees with security services.)
continued
The company values investment property using the fair value model. Owner-occupied property is
valued at cost in terms of IAS 16 and the building is depreciated at 5% per annum on the straight-line
basis.
On 31 December 20.13 (the financial year end of Alpha Candles Ltd), Mr Matchbox (a sworn appraiser)
valued the two properties based on market evidence at the following fair values:
Property 1
Land R500 000
Property 2
Land R1 000 000
Properties 1 and 2 can only be sold as two complete units. Any decline in the value of Property 1 is
attributable to the building and is deemed to be an impairment loss. Alpha Candles Ltd received rental
for Property 2 amounting to R160 000. Assume all amounts are material.
Calculations
Property, plant and equipment (IAS 16) R
Buildings at cost (given) 1 250 000
Depreciation (20.13) (1 250 000 × 5%) (62 500)
Carrying amount of buildings at 31 December 20.13 1 187 500
Market value (given) (1 100 000)
Impairment loss 31 December 20.13 87 500
Land at cost (given) 500 000
Land at market value 31 December 20.13 (given) (500 000)
Impairment loss –
Investment property (IAS 40)
Land at cost (given) 800 000
Buildings at cost (given) 2 100 000
Subsequent expenditure (given) 400 000
Carrying amount of land and buildings at 31 December 20.13 3 300 000
Fair value on 31 December 20.13 (given) (1 000 000 + 2 600 000) 3 600 000
Fair value adjustment (gain) at 31 December 20.13 300 000
Disclosure
Alpha Candles Ltd
Statement of financial position as at 31 December 20.13
Notes R
Assets
Non-current assets 5 200 000
Property, plant and equipment (500 000 + 1 100 000) 3 1 600 000
Investment property (1 000 000 + 2 600 000) 4 3 600 000

Profit before tax is stated after:
R
Income
Rent income from investment property 160 000
Fair value adjustment (gain) – investment property 300 000
Expenses
Depreciation 62 500
Impairment loss – building (included in line item ‘Other expenses’) 87 500
Direct operating expenses – investment property earning rental income 50 000
Also disclose information about the impairment loss in terms of IAS 36.130 and .131.
continued
Land Buildings
R R
Carrying amount beginning of year – –
Cost – –
Accumulated depreciation – –
Movements during year 500 000 1 100 000
Additions 500 000 1 250 000
Depreciation – (62 500)
Impairment loss – (87 500)
Carrying amount end of year 500 000 1 100 000
Cost 500 000 1250 000

Accumulated depreciation (62 500 + 87 500) – (150 000)
4. Investment property
Land and
buildings
R
Carrying amount beginning of year –
Movements during year 3 600 000
Additions – cost on acquisition (800 000 + 2 100 000) 2 900 000
Additions – subsequent expenditure capitalised 400 000
Fair value adjustment 300 000
Carrying amount end of year 3 600 000

The fair value was determined by an independent sworn appraiser using current market values on
31 December 20.13. The appraiser holds a recognised and relevant professional qualification and has
recent experience in the location and category of the investment property being valued.
CHAPTER
18
Share-based payment
(IFRS 2 and FRG 2)
Contents
18.1 Overview of IFRS 2 Share-based Payment .................................................... 438
18.2 Introduction...................................................................................................... 441
18.2.1 Date when transactions are recognised ............................................... 442
18.3 Equity-settled share-based payment transactions .......................................... 443
18.3.1 Fair value of goods/services received or equity instruments
granted............................................................................................. 443
18.3.2 Vesting ............................................................................................. 443
18.3.3 Fair value ......................................................................................... 450
18.3.4 Modification to terms and conditions of equity instruments
granted............................................................................................. 451
18.4 Cash-settled share-based payment transactions ............................................ 456
18.5 Modification of a share-based payment transaction that changes
its classification from cash-settled to equity-settled ........................................ 460
18.6 Share-based payment transactions with cash alternatives ............................. 460
18.6.1 Share-based payment transactions in which the counterparty
has the choice of settlement ............................................................ 460
18.6.2 Share-based payment transactions where the entity
has the choice of settlement ............................................................ 463
18.6.3 Share-based payment transactions with a net settlement
feature for withholding tax obligations ............................................. 464
18.7 Group share-based payment transactions ..................................................... 465
18.8 Disclosure........................................................................................................ 468
18.8.1 IFRS 2 disclosures........................................................................... 468
18.8.2 JSE Listing Requirements ............................................................... 470
18.9 Accounting for Black Economic Empowerment transactions (FRG 2) ............ 472
18.9.1 Background...................................................................................... 472
18.9.2 Scope............................................................................................... 472
18.9.3 Consensus ....................................................................................... 472
437
18.1 Overview of IFRS 2 Share-based Payment

Share-based payment transactions
Choice between
Equity-settled share-
Cash-settled share-based cash-based and equity-settled
based payment
payment transactions share-based payment
transactions
transactions
Entity receives goods /

Entity receives goods/services
Entity receives services and entity/supplier
by incurring liabilities based on
goods/services and chooses whether transaction
the price of an entity’s shares
issues equity is settled in cash
and uses cash to settle the
instruments to settle (linked to share price)
amount of the liability
or by issuing equity instruments
SHARE BASED PAYMENT
SCOPE RECOGNITION
IFRS 2.2–.6A IFRS 2.7–.9
EQUITY-SETTLED CASH-SETTLED CHOICE OF SETTLEMENT

IFRS 2.10–.29 IFRS 2.30–.33 IFRS 2.34
IFRS 2 IG Example 1A–.11 IFRS 2 IG Example 12 & 12A IFRS 2 IG Example 13
MEASUREMENT MEASUREMENT MEASUREMENT
Counter parties Employees Both: Choice of

• Goods and services received
Directly: Fair value of goods/ Indirectly: Fair value of equity • Liabilit Counter party (CP) Entity
services received else Indirectly instruments granted At the fair value of the liability
IFRS 2.10 & .13 IFRS 2.11–.12 IFRS 2.30 IFRS 2.35–.40 IFRS 2.41–.43
Unable to use fair value, use intrinsic value Compound financial Equity Cash
IFRS 2.24–.25 instrument settled settled
Measurement date Measurement date

Date which goods / Date which equity Grant date
services are received instruments are granted Restate at:
IFRS 2.13 IFRS 2.16 • Reporting date & If no liability If liability
• Settlement date Debt Equity has been has been
VESTING IFRS 2.33 incurred incurred
Refer Table 1
IFRS 2.19–.23 VESTING CP’s right to CP’s right to demand
Refer Table 1 demand payment payment in equity instruments
MODIFICATIONS IFRS 2.32 in cash rather than in cash
including cancellations and settlements
IFRS 2.26–.29
Beneficial Non-beneficial
AMONG GROUP ENTITIES DISCLOSURE BEE

IFRS 2.43A–.43D IFRS 2.44–.52 FRG 2
IFRS 2 IG Example 14
continued
Share-based payment 439
Table 1
VESTING
Refer IFRS 2 IG4A and IG24
Non-vesting condition
applicable Vest immediately Vesting conditions applicable
IFRS 2.21A
Service conditions Performance conditions
Market condition Non-market condition

E.g. share price E.g. turnover
Recognised as an Recognised as an Recognised as an

expense expense expense in Profit or Loss
in Profit or Loss in Profit or Loss over
IMMEDIATELY over VESTING PERIOD
VESTING PERIOD
Taken into account when Taken into account

estimating the when estimating the
fair value of |the fair value
equity instrument of the equity instrument
Change in performance conditions
Beneficial Not beneficial

18.2 Introduction
Entities often use shares or share options to pay employees, and even other parties, for
goods delivered and/or services rendered.
IFRS 2 covers all share-based payment transactions, including transactions in which shares
or other equity instruments are granted to employees, as well as transactions with parties
other than employees where goods or services are received by an entity in exchange for its
equity instruments. In addition, IFRS 2 also covers payments in cash where the amount is
determined by reference to the price of an entity’s shares or other equity instruments –
hence these payments are also share-based.
The IASB has updated the definitions of elements of the financial statements in IFRS 2 to
the definitions of the Conceptual Framework of Financial Reporting issued in 2018 (refer to
chapter 2).
IFRS 2 does not apply to the following:
Transactions with employees (or other parties) that hold equity instruments in their
capacity as owners (e.g. a rights issue at less than fair value).
Goods or other non-financial assets acquired as part of net assets acquired in a
business combination in terms of IFRS 3.
Goods acquired as part of net assets in a combination of entities under common control,
or the contribution of a business on formation of a joint venture.
Goods or services received/acquired pursuant to certain contracts contained in IAS 32
and IFRS 9 regarding financial instruments.
The following definitions are applicable:
A share-based payment transaction is defined as a transaction in which the entity
receives goods or services as consideration for equity instruments of the entity (including
shares or share options); or
acquires goods or services by incurring liabilities to the supplier of these goods or services
for amounts that are based on the price of an entity’s shares or other equity instruments.
This definition is further illuminated by splitting the definition into the two possible types of
share-based payment transactions as follows:
Cash-settled share-based payment transactions are share-based payment
transactions in which an entity acquires goods or services by incurring a liability to
transfer cash or other assets to the supplier of those goods or services for amounts that
are based on the price (or value) of the entity’s shares or other equity instruments. Cash-
share appreciation rights, where a cash payment is made based on the increase in the
market value of the entity’s shares are an example of the type of instrument used for
these transactions.
Equity-settled share-based payment transactions are share-based payment
transactions in which the entity receives goods or services as consideration for equity
instruments of the entity (including shares or share options). For example, a lawyer
renders certain professional services to an entity and is paid for those services by the
entity issuing shares of an equivalent value to him.
It is also possible to enter into share-based payment transactions in which the entity or the
counterparty has the choice of the form of settlement – it can elect to have the transaction
settled either by using a cash-settled share-based payment or an equity-settled share-based
payment.
The grant date in respect of a share-based payment arrangement is the date on which the
entity and the other party (including an employee) agree to such an arrangement. At this
point, both the entity and the counterparty have a shared understanding of the terms and
conditions of such an arrangement. At grant date, the entity confers on the counterparty the
right to cash, other assets, or equity instruments of the entity, provided the specified vesting
conditions, if any, are met. If that agreement is subject to an approval process, the grant
date is the date when that approval is obtained.
The measurement date is the date on which the fair value of the equity instruments granted
is measured. For transactions with employees, the measurement date is the grant date. For
transactions with parties other than employees, the measurement date is the date the entity
obtains the goods or when the counterparty renders the service.
Vesting conditions refer to the conditions that must be satisfied for a counterparty in a
share-based payment arrangement to become entitled to receive cash, other assets or
equity instruments of the entity. This will include service conditions (completing a specified
period of service) and performance conditions (meeting a specific target, e.g. a specified
increase in profit).
A market condition is a condition upon which the exercise price, vesting or exercisability of
an equity instrument depends, and is related to the market price of the entity’s equity
instruments, for example attaining a specified share price (or a specified amount of intrinsic
value of a share option), or achieving a specified target that is based on the market price of
the entity’s equity instruments relative to an index of market prices of equity instruments of
other entities.
The vesting period is the period during which all the specified vesting conditions of a
share-based payment arrangement are to be satisfied.
The intrinsic value of an equity instrument (usually a share option) is the difference
between the fair value of the shares to which the counterparty has the right to subscribe and
the price the counterparty is (or will be) required to pay for those shares. For example, a
share option with an exercise price of R15, on a share with a fair value of R20, has an
intrinsic value of R5.
18.2.1 Date when transactions are recognised

Goods or services received/acquired in a share-based payment transaction should be
recognised on the date that the goods are obtained or the services are received.
A corresponding increase in equity will be recognised in an equity-settled share-based
payment transaction (through the statement of changes in equity), while a corresponding
increase in liabilities will be recognised in a cash-settled share-based payment transaction.
The goods or services received or acquired in a share-based payment can either be
capitalised or expensed depending if it is an asset or not.
Example 18.
18.1 Initial recognition
Thandi Ltd entered into the following transactions during the 20.12 financial year ending on
31 December:
Professional services with a fair value of R60 000 were rendered by a lawyer on
31 March 20.12. The entity will pay the lawyer for these services by issuing 20 000 ordinary
shares to him.
Manufacturing plant with a fair value of R200 000 was delivered by a supplier on 30 April 20.12.
The entity will pay the supplier by issuing 80 000 ordinary shares to it.
5 000 phantom shares (the right to receive a cash payment on 1 January 20.14 equal to the
value of 5 000 shares) are issued to the managing director of the company at year end 20.12.
There are no vesting conditions and the share price at year end is R3,00 per share.
continued
The journal entries associated with the initial recognition of these transactions are the following:
Dr Cr
R R
31 March 20.12
Legal fees (P/L) 60 000
Equity-settled share-based payment
30 April 20.12
Manufacturing plant (SFP) 200 000
Equity-settled share-based payment
31 December 20.12
Employee benefit costs (P/L) 15 000
Liability (SFP)(5 000 × R3) 15 000
Cash-settled share-based payment
18.3 Equity-settled share-based payment transactions
18.3.1 Fair value of goods/services received or equity instruments granted

IFRS 2 states that the goods or services received and the corresponding increase in equity
should be measured directly, at the fair value of the goods or services received, provided
that the fair value of these goods or services can be estimated reliably. Otherwise the goods
or services and the corresponding increase in equity should be measured indirectly, by
reference to the fair value of the equity instruments granted.
IFRS 2 continues by stating that the determination of fair value will also be affected by
whether the equity-settled share-based payment transaction was entered into with
employees or other counterparties.
If such a transaction is entered into with parties other than employees, there is a rebuttable
presumption that the fair value of the goods or services can be estimated reliably. (This is
because established market prices usually exist for these goods and services.) The fair
value of these goods/services is measured at the date that the entity obtains the goods or
services. However, if this fair value cannot be estimated reliably, the goods or services
and the increase in equity are measured by reference to the fair value of the equity
instruments granted, which is also determined at the date on which the goods or services
are obtained.
By contrast, for transactions with employees, the entity will measure the employee services
received by reference to the fair value of equity instruments granted, as one has to
assume that the fair value of services rendered by employees cannot be estimated reliably.
The justification for this is that options and shares issued to employees are sometimes part
of a bonus arrangement or an effort to retain the services of a specific employee.
Establishing the fair values of such amounts is bound to be very difficult and therefore the
fair value of the equity instruments issued may be more readily determinable than the fair
value of the services. It is however, important to note that in respect of transactions with
employees, the fair value of the equity instruments is measured at grant date.
18.3.2 Vesting
Equity instruments granted as part of an equity-settled share-based payment transaction in
which services are received can vest either immediately or during a vesting period after
certain vesting conditions have been satisfied. Vesting conditions relate to share-based
payment transactions with employees and are service conditions and performance
conditions only. The latter must require, either explicitly or implicitly, services to be
rendered by the employee. Other features of a share-based payment are not vesting
conditions, and should be factored into the fair value of the equity instruments. A typical
example of vesting and the issues associated with vesting would be when an entity grants
an employee the right to specific equity instruments on joining the entity that will vest only
after three years of service have been completed by the affected employee (service
condition). This means that the employee will receive the equity instruments only once he or
she has been in the employ of the entity for three years (the vesting period).
By contrast, if the entity should grant the equity instruments to the employee at
commencement of employment (without any conditions), the instruments vest immediately
and there is no vesting period. In this case, the entity shall recognise the services rendered
in full, on the grant date, with a corresponding increase in equity.
If a vesting period is applicable, the entity will assume that the employee renders the
services necessary to earn the equity instruments during the vesting period. The entity shall
thus account for the services when they are rendered by the employee during the vesting
period (spread over time), with corresponding increases in equity.
Example 18.
18.2 Vesting period
Nick Ltd granted its management team share options with a fair value of R900 000 on
30 June 20.13, without any vesting conditions attached. It is expected that the entire management
team will remain with the company until at least 30 June 20.16 and that they will exercise all the
options granted. The year end of the company is 31 December.
As the management team immediately becomes entitled to the options, the following journal entry
will be passed:
Dr Cr
R R
30 June 20.13
Management remuneration (P/L) 900 000
Share-based payment reserve (Equity SCE) 900 000
Expense for 20.13
If, however, the management team will become entitled to the options only if they are still
employed on 30 June 20.16, the management remuneration incurred during the vesting period
should be calculated and accounted for as follows:
The fair value of the equity instruments at grant date is R900 000, which equals the fair value of
the services Nick Ltd expects to receive from the employees during the vesting period of three years.
This fair value is to be allocated over the vesting period, resulting in an expense of R25 000 per
month (900 000/(3 × 12 months)).
The journal entries from 30 June 20.13 to 30 June 20.16 will be the following:
Dr Cr
R R
20.13
Management remuneration (P/L)(R25 000 × 6) 150 000
Expense for 20.13
20.14 and 20.15
Expense for 20.14 and 20.15
20.16
Expense for 20.16
continued
Comment
¾ This is a very simplistic example that does not take into account the fact that some members of
the management team may resign during the three-year vesting period.
¾ The fair value of the equity instruments (options) was determined using the principles
prescribed by IFRS 2, but this valuation is not illustrated here.
¾ The reallocation of the equity component upon exercising the options is not illustrated here.
¾ Once the services have been received and the corresponding increase in equity has been fully
recognised (i.e. 30 June 20.16), no subsequent adjustment to total equity shall be made by an entity
(apart from a possible transfer from one component of equity to another). This is so irrespective of
whether instruments granted are later forfeited or whether options are later exercised.
The following is a more complex example (taken from IFRS 2 and adapted) illustrating the
same principles:
Example 18.
18.3 Vesting period and resignation of employees
Mark Ltd grants 100 options to each of its 500 employees on 2 January 20.12. Each grant is
conditional upon the employee working for the company for the next three years. Using an
appropriate option pricing model and taking into account the relevant facts, it is estimated that the
fair value of each option is R15 at grant date. Using a weighted average probability, the entity
estimates that 20% of the 500 employees will resign and consequently forfeit their rights to the
options during the three-year vesting period.
Taking the above information into account, as well as the fact that the options are granted to
employees, the total fair value of the options granted is 500 employees × 100 options × R15 ×
80% of employees remaining = R600 000. Therefore, if everything turns out exactly as expected,
an amount of R200 000 (600 000/3) will have to be recognised every year (from 20.12 to 20.14) as
an expense and an increase in equity. If the actual outcome, however, differs from what was
expected, the necessary adjustments will have to be made. This is illustrated by the following:
Use the same information as in the above example, except that during 20.12 only 20 employees
leave. As a result, the estimate of total employee departures over the three-year period is revised
at the end of 20.12 from 20% to 15%. During 20.13, a further 22 employees leave and once again
the estimate is adjusted – this time from 15% to 12%. The actual number of employees that left
during 20.14 was 15. The journal entries from 20.12 to 20.14 to account for this are as follows
(assuming a 31 December year-end):
Dr Cr
R R
31 December 20.12
Expense for 20.12
Working
Estimate 31 December 20.12 (500 employees × 100 options
× R15 × 85% employees remaining × 1/3 of vesting period)
31 December 20.13
Expense for 20.13
Working
Estimate (500 × 100 × R15 × 88% × 2/3) 440 000
Previous estimate 212 500
Increase 227 500
continued
Dr Cr
R R
31 December 20.14
Expense for 20.14
Working
Actual outcome 31 December 20.14
[(500 – 20 – 22 – 15) × 100 × R15] 664 500
Increase 224 500
Comment
¾ The estimate at the end of each period should be based on the information available at the end
of that period.
¾ As the vesting period covers three years, one third of the total expected expense is recognised
per annum.
No further adjustments are made after vesting date. If, for example, the options are not exercised
by the employees after vesting date, the amount recognised as an expense should not be
reversed. It is, however, acceptable to make a transfer from one component of equity to another
after vesting date, for example, from the share-based payment reserve to share capital, if the
options are exercised, or to retained earnings if the options are not exercised. Assume, for
example, that 200 of the qualifying employees exercised their options at 31 December 20.15 at an
exercise price of R10 per share, while the remaining 243 employees indicate that they will not take
up any shares. The journal entries are as follows:
Dr Cr
R R
31 December 20.15
Bank (200 × 100 × R10) 200 000
Share-based payment reserve (Equity SCE) (443 × 100 × R15) 664 500
Share capital (200 × 100 × R10) + (664 500 × 200/443) 500 000
Retained earnings (664 500 × 243/443) 364 500
Exercising of options in 20.15
A vesting period may be either fixed (services to be rendered for a fixed number of years)
or variable (services to be rendered until a performance condition is satisfied). A
performance condition is a vesting condition based on performance. This performance
may relate to either the performance of the market price of the entity’s equity instruments
(called a market condition) or, alternatively, it may relate to other performance measures,
for example turnover, earnings, etc. (not a market condition).
If the vesting period is variable, an initial estimate of its length should be made at grant
date, based on the most likely outcome of the performance condition. If the performance
condition is a market condition (e.g. attainment of a specified share price) the estimated
length of the vesting period is not revised subsequently. If the performance condition is not
a market condition (e.g. attainment of a specified turnover figure) the length of the vesting
period should be revised in subsequent periods if necessary. This latter case is illustrated
by the following example:
Example 18.
18.4 Variable vesting period
On 1 January 20.11, John Ltd grants 50 shares each to 200 employees, conditional upon the
employees remaining in its employ during a vesting period. The shares will vest at the end of
20.11 if John Ltd’s earnings increase by more than 10% during 20.11, at the end of 20.12 if they
increase by more than an average of 8% per annum over the two-year period, and at the end of
20.13 if they increase by more than 6% per annum over the three-year period. The shares have a
fair value of R20 each at 1 January 20.11.
By the end of 20.11, John Ltd’s earnings have increased by 9% and 5 employees have left. At this
date it is expected that earnings will continue to increase at a similar rate, and that a further
6 employees will leave during the next year.
At the end of 20.12, John Ltd’s earnings have increased, on average, by only 7% per annum over
the last two years and 4 employees have left during 20.12. At this date it is expected that earnings
will continue to increase at a similar rate, and that a further 3 employees will leave during the next
year (20.13).
At the end of 20.13, John Ltd’s earnings have increased, on average, by 6,5% per annum over the
last three years and only 1 employee has left during the year.
From the information provided, it is clear that expectations at the end of 20.11 were that the shares
will vest at the end of 20.12, as the expected increase in earnings was 9% (resulting in a two-year
vesting period). It was also expected that 189 (200 – 5 (actual) – 6 (estimate)) employees will
qualify for shares on the vesting date.
At the end of 20.12, the expected increase in earnings was only 7%; therefore the expected vesting
date changed from the end of 20.12 to the end of 20.13 (resulting in a three-year vesting period).
The estimate of the number of employees that will qualify for shares on the vesting date changed
to 188 (200 – 5 (actual) – 4 (actual) – 3 (estimate)).
The performance condition related to vesting is not a market condition (does not relate to the
share price); therefore the length of the vesting period will be adjusted if necessary.
The journal entries to account for the share-based payment are as follows:
Dr Cr
R R
31 December 20.11
Expense for 20.11
Working
(assuming a 2-year vesting period and 189 qualifying employees):
Estimate
31 December 20.11
(189 employees × 50 shares × R20 × 1/2 of vesting period)
31 December 20.12
Expense for 20.12
Working
(assuming a 3-year vesting period and 188 qualifying employees):
Estimate
31 December 20.12 (188 × 50 × R20 × 2/3) 125 333
Increase 30 833
continued
Dr Cr
R R
31 December 20.13
Expense for 20.13
Working
(3-year vesting period and 190 (200 – 5 – 4 – 1)
qualifying employees):
Actual outcome 31 December 20.13 (190 × 50 × R20) 190 000
Increase 64 667
In the above example, the vesting condition affected the length of the vesting period.
Vesting conditions may, however, also affect the number of shares/options to be issued and
whether shares/options are indeed issued. When dealing with vesting conditions, it is (once
again) important to determine whether these conditions may be classified as market
conditions or not.
Vesting conditions that are classified as market conditions are taken into account at
measurement date when estimating the fair value of the equity instruments granted, but are
not taken into account subsequently upon re-measurement of the transaction. This will result
in recognition of the goods or services received, irrespective of whether the market condition
is satisfied.
Vesting conditions, other than market conditions, are not taken into account at
measurement date when estimating the fair value of the equity instruments granted, but are
taken into account subsequently upon re-measurement of the transaction. This will result in
the amount recognised for the goods or services being based on the number of equity
instruments that eventually vest. Hence, on a cumulative basis, no amount is recognised for
the goods or services if the vesting condition is not satisfied. Refer to the table in IFRS 2
IG24 categorising various vesting and non-vesting conditions. The accounting treatment of
vesting conditions other than market conditions is illustrated by the following example.
Example 18.
18.5 Performance condition other than a market condition
At the beginning of 20.11, Theta Ltd grants 20 share options to each of its 100 employees. These
options will vest at the end of 20.12, provided that the employees remain in Theta Ltd’s service,
and provided that revenue increases by at least 6% per annum. If revenue increases by at least
8% per annum, an additional 5 share options will be granted to each employee.
At grant date, the fair value of each option is R8 (not taking into account vesting conditions on
determining fair value). At this date, it is estimated that revenue will increase by 7% per annum
over the next two years and that 2 employees will resign during the two-year period.
By the end of 20.11, it is determined that revenue has increased by 10% during the year. At this
date, the increase for the next year is estimated at 9%. Two employees left during 20.11 and it is
expected that another employee will leave during 20.12.
continued
At the end of 20.12, the average increase in turnover over the last two years amounted to only
6,5% per annum, due to unexpected actions from competitors. No employees left during 20.12.
The journal entries to account for this will be as follows:
Dr Cr
R R
31 December 20.11
Expense for 20.11
Working
Estimate: 31 December 20.11 ((100 – 2 – 1) × (20 + 5) × R8 × 1/2)
Comment
¾ At the end of 20.11 it is expected that 3 employees will resign during the two-year period;
therefore the calculation is based on 97 employees. In addition, the average increase in
revenue is expected to be between 9% and 10%, resulting in each employee receiving 25
share options instead of only 20. The vesting period is two years and, as a result, only one half
of the expected expense is recognised in 20.11.
Dr Cr
R R
31 December 20.12
Share-based payment reserve (Equity) 5 980
Expense for 20.12
Working
Actual outcome 31 December 20.12 (100 – 2) × 20 × R8 15 680
Increase 5 980
Example 18.
18.6 Performance condition is a market conditions
If the same information as in the previous example is used, but instead of an increase in revenue,
the granting of the share options is conditional upon an increase in Theta Ltd’s share price, the
solution would change, as the vesting condition is now a market condition. The fair value of the
options will change, as this fair value should now take into account the possibility that the share
price will increase by less than 6%, by between 6% and 8% and by more than 8% – assume an
adjusted fair value of R7. However, the estimate of the number of options to be issued will not be
revised during the vesting period, irrespective of what the actual increase in the share price is.
The journal entries will therefore be as follows, assuming the same information as in the previous
example, but replacing all references to ‘revenue’ with ‘share price’:
Dr Cr
R R
31 December 20.11
Expense for 20.11
Working:
Estimate: 31 December 20.11 (100 – 2 – 1) × 20 × R7 × 1/2
continued
Comment
¾ The calculation is based on the number of options (at grant date) expected to be issued. This is
not revised subsequently, even though the increase in share price is expected to be more than
8% at the end of 20.11, resulting in each employee qualifying for 25 options. The only change
relates to the number of employees that will qualify, as their continued service is a service
condition and not a market condition.
Dr Cr
R R
31 December 20.12
Expense for 20.12
Working:
Actual outcome (100 – 2) × 20 × R7 13 720
Increase 6 930
Comment
¾ Even if the share price eventually increased by less than 6% (resulting in no options being
granted) the above journal entry will not change, as the amounts to be recognised are not
affected by the eventual outcome of the market condition. (The fair value of the share options
has already taken the possibility that the increase in share price would not be achieved into
account.)
18.3.3 Fair value

Fair value plays a major part in the measurement of equity-settled share-based payment
transactions. The general rule is that an entity should measure the fair value of equity
instruments granted by using the market price of such shares, if available, as the point of
departure. These market prices should be adjusted for the impact of the terms and
conditions under which those equity instruments were issued.
The fair value of shares granted is measured at the market price (or estimated market price
if shares are not publicly traded) of the issuing entity’s shares, adjusted to take into account
the terms and conditions upon which those shares are granted (except for vesting conditions
that are excluded from the measurement of fair value). For example, if the shares are not
entitled to dividends for, say, three years after being taken up, the fair value of such shares
should be reduced accordingly.
The fair value of options granted is measured at the market price of equivalent traded
options with similar terms and conditions. In many cases, however, equivalent traded
options do not exist, as the options granted are subject to terms and conditions that do not
apply to traded options. For instance, traded options would generally be transferable, while
employee options granted may be subject to transfer restrictions.
If traded options with similar terms and conditions do not exist, the fair value of options
granted shall be estimated by applying an option pricing model. IFRS 2 is not prescriptive as
to which option pricing model should be used, but supplies two examples, namely the Black-
Scholes model and the binomial model.
The following factors should be taken into account (irrespective of which model is
used):
exercise price of the option;
life of the option;
the current price of the underlying shares;

the expected volatility of the share price;
the dividends expected on the shares, if appropriate (dividends or dividend equivalents
could be deferred for a specified period before the employee becomes entitled to them);
and
the risk-free interest rate for the life of the option.
If the fair value of equity instruments cannot be estimated reliably, it should be measured at
the intrinsic value of the instruments.
18.3.4 Modification to terms and conditions of equity instruments granted

An entity may modify the terms and conditions on which equity instruments were granted.
Amongst others, an entity could reduce the exercise price of options granted to employees,
thereby repricing the options – this would lead to an increase in the value of the options.
These modifications may either increase the benefits to be received by the employee
(beneficial) or alternatively decrease these benefits (not beneficial), thereby necessitating
different accounting treatments. As a minimum, an entity should recognise the services
received measured at the grant date fair value of the equity instruments, unless those equity
instruments do not vest because of failure to satisfy a vesting condition (other than a market
condition) that was specified at grant date. A decrease in benefits is therefore ignored,
resulting in the original transaction being accounted for as if no modifications took place. An
increase in benefits is, however, recognised over the remaining vesting period.
18.3.4.1 Beneficial modifications
If the modification to the terms/conditions increases the fair value of the equity instruments
granted measured immediately before and after the modification (e.g., by reducing the
exercise price), the entity shall include the incremental fair value granted in the
measurement of the amount recognised for services received. (The incremental fair value
granted is the difference between the fair value of the modified equity instrument and that of
the original equity instrument, both estimated at the date of the modification). If the
modification occurs during the vesting period, this incremental fair value is recognised over
the period from the modification date until the date when the modified equity instruments
vest (in addition to the amount based on the grant date fair value of the original equity
instruments, which is recognised over the remainder of the original vesting period). If the
modification occurs after vesting date, the incremental fair value is recognised immediately,
or over the vesting period if the employee is required to complete an additional period of
service before becoming unconditionally entitled to those modified equity instruments. The
same principle applies if the modification increases the number of equity instruments
granted instead of their fair value.
If the entity modifies the vesting conditions in any other manner that is beneficial to the
employee, for example, by reducing the vesting period or by modifying or eliminating a
performance condition (other than a market condition, which is accounted for in accordance
with the above paragraph) the entity shall take these modified vesting conditions into account
when recognising the transaction.
Example 18.
18.7 Repricing during the vesting period
At the beginning of Year 1, an entity grants 100 share options to each of its 500 employees. Each
grant is conditional upon the employee remaining in service over the next three years. The entity
estimates that the fair value of each option is R15 at this date. On the basis of a weighted average
probability, the entity estimates that 100 employees will leave during the three-year period and
therefore forfeit their rights to the share options.
Suppose that 40 employees leave during Year 1. Also suppose that by the end of Year 1, the
entity’s share price has dropped, and the entity reprices its share options, but that the repriced
share options still vest at the end of Year 3. The entity estimates that a further 70 employees will
leave during Years 2 and 3; therefore the total number of expected employee departures over the
three-year vesting period is 110.
During Year 2, a further 35 employees leave, and the entity estimates that a further 30 employees
will leave during Year 3, to bring the total number of expected employee departures over the
three-year vesting period to 105.
During Year 3, a total of 28 employees leave; therefore a total of 103 employees ceased
employment during the vesting period. For the remaining 397 employees, the share options vested
at the end of Year 3.
The entity estimates that, at the date of repricing, the fair value of each of the original share
options granted (i.e. before taking into account the repricing) is R5 and that the fair value of each
repriced share option is R8. Therefore, the incremental fair value granted is R3.
The incremental fair value recognised over the remaining vesting period is R59 250 in year 2 and
the total incremental fair value granted due to the beneficial modification of the terms and
conditions of the share options is R119 100.
The journal entries to account for this transaction over the three-year period are as follows:
Dr Cr
R R
Year 1
Expense for Year 1
Working
Estimate end of Year 1 (500 – 40 – 70) × 100 × R15 × 1/3
Year 2
Expense for Year 2
Working:
Estimate end of Year 2:
Original (500 – 40 – 35 – 30) × 100 × R15 × 2/3 395 000
Modification (500 – 40 – 35 – 30) × 100 × R3 × 1/2 59 250
454 250
Increase 259 250
Comment
¾ The incremental value is R3 per share option (R8 – R5) and the repricing occurs during the
vesting period. This amount is recognised over the remaining two years of the vesting period,
along with the remuneration expense based on the original vesting period and option value of
R15.
continued
Dr Cr
R R
Year 3
Employee benefit costs (P/L) R260 350
Share-based payment reserve (Equity SCE) R260 350
Expense for Year 3
Working
Actual outcome end of Year 3:
Original (397 × 100 × 15) 595 500
Modification (397 × 100 × R3) 119 100
714 600
Increase 260 350
18.3.4.2 Modifications that are not beneficial

If the entity modifies the terms or conditions of the equity instruments granted in a manner
that reduces the total fair value of the share-based payment arrangement, or is not
otherwise beneficial to the employee, the entity shall nevertheless continue to account for
the services received as consideration for the equity instruments granted as if that
modification had not occurred (other than a cancellation of some or all of the equity
instruments granted, which will be discussed later in this section).
Therefore, if the modification reduces the fair value of the equity instruments granted,
measured immediately before and after the modification, the entity shall not take that
decrease in fair value into account and shall continue to measure the amount recognised for
services received as consideration for the equity instruments, based on the grant date fair
value of the equity instruments granted.
If the modification reduces the number of equity instruments granted to an employee,
that reduction shall be accounted for as a cancellation of that portion of the grant (refer to
the discussion on cancellation of grants that follows later in this section).
If the entity modifies the vesting conditions in any other manner that is not beneficial to the
employee, for example, by increasing the vesting period or by modifying or adding a
performance condition (other than a market condition), the entity shall not take the modified
vesting conditions into account when recognising the transaction.
Example
Example 18.8 Non-beneficial modification
At the beginning of Year 1, the entity grants 1 000 share options to each member of its sales team
(12 employees), conditional upon the employees remaining in the entity’s employ for three years,
and the team selling more than 50 000 units of a particular product over the three-year period. The
fair value of the share options is R15 per option at the date of grant.
During Year 2, the entity increases the sales target to 100 000 units. By the end of Year 3, the
entity has only sold 55 000 units; therefore the share options are forfeited. Twelve members of the
sales team have remained in service for the three-year period.
The modification to the performance condition made it less likely that the share options would vest
(it is more difficult to sell 100 000 units than 50 000 units). Because this was not beneficial to the
employees, the entity takes no account of the modified performance condition when recognising
the services received. Instead, it continues to recognise the services received over the three-year
period based on the original vesting conditions. Hence, the entity ultimately recognises cumulative
remuneration expenses of R180 000 over the three-year period (12 employees × 1 000 options
× R15), resulting in an expense of R60 000 per annum.
continued
The same result would have occurred if, instead of modifying the performance target, the entity
had increased the number of years of service required for the share options to vest from three
years to ten years. Because such a modification would make it less likely that the options will vest
(more employees may leave in a ten-year period than in a three-year period), which would not be
beneficial to the employees, the entity would take no account of the modified service condition
when recognising the services received. Instead, it would recognise the services received from the
twelve employees who remained in service over the original three-year vesting period at R60 000
per annum.
18.3.4.3 Cancellations
Under IFRS 2, a failure to meet a condition, other than a vesting condition, is treated as a
cancellation.
If an entity decides to modify the terms and conditions on which equity instruments were
granted by cancelling or settling the shares or options during the vesting period (other than a
grant cancelled by forfeiture if vesting conditions are not satisfied), the accounting treatment
is as follows:
The cancellation or settlement is accounted for as an acceleration of vesting, by
immediately recognising the amount that would have been deferred over the remainder
of the vesting period.
Any payment made to the employee on cancellation or settlement of such a grant will
be accounted for as the repurchase of an equity interest. A repurchase of an interest is
accounted for as a deduction from equity, unless the payment on repurchase exceeds
the fair value of shares or options granted, measured at repurchase date. Such an
excess will be treated as an expense.
If new equity instruments are granted to an employee and on the date of the granting
of the new equity instruments, these are identified as replacement equity instruments for
the cancelled instruments, these replacement instruments should be accounted for in the
same manner as for other changes in terms and conditions for shares and options granted.
Under these circumstances, the incremental value granted is the difference between the
fair value of the replacement equity instruments and the net fair value of the cancelled
equity instruments determined at the date the replacement options are granted.
Net fair value of the cancelled equity instruments is their fair value immediately before
the cancellation, less the amount of any payment made to the employee on cancellation
of the original equity instruments that is accounted for as a deduction from equity.
If the entity does not identify new equity instruments granted as being instruments
replacing the cancelled instruments, the entity shall account for the new instruments as a
new grant.
Example 18.
18.9 Cancellation of shares during vesting period
Jake Ltd granted 10 shares to each of its 200 employees, provided that they remain in Jake Ltd’s
employment for five years. The shares will vest at the end of Year 5. On grant date, the fair value of
the shares amounted to R15 each. At the end of the third year, this arrangement is cancelled by
Jake Ltd in return for the payment of an amount of R20 per share to each employee. The fair value of
the shares amounted to R18 at that date.
The journal entries to account for this will be as follows:
Dr Cr
Years 1 and 2 R R
Expense for Year 1
Working
200 × 10 × R15 × 1/5 = 6 000
continued
Year 3 Dr Cr
R R
R R
Expense for Year 3
Share-based payment reserve (Equity SCE) (R6 000 × 2) 12 000
Accelerated vesting in respect of Year 4 and Year 5 done at end of
Year 3
Retained earnings (200 × 10 × (R18 – R15)) 6 000
Share-based payment reserve (Equity SCE) (200 × 10 × R15) 30 000
Employee benefit costs (P/L) (200 × 10 × (R20 – R18)) 4 000
Bank (200 × 10 × R20) 40 000
Repurchase of equity interest
Comment
¾ Since the payment on repurchase exceeds the fair value of the shares (as measured at
repurchase date) the excess is recognised as an expense.
The previous example deals with variations in the terms and conditions on which equity
instruments were granted, and relates to cancellation of such equity instruments before
vesting. Entities could, however, merely repurchase equity instruments after they have
vested. If this is the case, the payment made to the counterparty will be deducted directly
from equity, except to the extent that the payment made on repurchase exceeds the fair
value of equity instruments repurchased as determined on repurchase date. Such an excess
payment will be accounted for as an expense.
Example 18.
18.10 Repurchase of equity instruments
Assume Terg Ltd has 1 000 000 shares in issue at R10 per share. Twenty percent of these shares
were issued to employees as part of a share-based payment transaction. Terg Ltd now decides to
repurchase 100 000 shares from employees at R10,50 per share, that is, at 20 cents above the
current fair value. The journal entry is as follows:
Dr Cr
R R
Share capital (100 000 × R10,00) 1 000 000
Retained earnings (100 000 × (R10,50 – R0,20 – R10,00)) 30 000
Employee benefit costs (P/L)(R0,20 × 100 000) 20 000
Bank (100 000 × R10,50) 1 050 000
Repurchase of vested shares
Comment
¾ Note that the amount set off against equity is limited to the fair value determined on repurchase
date. The excess above repurchase date is an expense.
An entity should take into account all the non-vesting conditions when estimating the fair
value of equity instruments. If either the entity or the counterparty may choose to meet a
non-vesting condition, the entity will account for the failure of a non-vesting condition by
either the entity or the counterparty as a cancellation. Refer to IFRS 6.IG15A and
Example 9A.
18.4 Cash-settled share-based payment transactions

In a cash-settled share-based payment transaction, an entity acquires goods or services by
incurring a liability to the supplier of those goods or services for amounts that are based on
the price (or value) of the entity’s shares. This means that the goods or services will be paid
for in cash, but that the amount of the cash payment depends on the price of the entity’s
shares. An example of instruments that represent cash-settled share-based payment
transactions is share appreciation rights (SARs) granted to employees as part of their
remuneration package. In terms of such an instrument, the employees become entitled to a
future cash payment rather than an equity instrument. This future cash payment is based on
an increase in the entity’s share price from a specified level over a specified period of time.
Another example could be where an entity grants the right to shares that are redeemable,
either mandatorily or at the employee’s option, to employees.
To account for a cash-settled share-based payment transaction, an entity shall
measure both the goods or services acquired and the liability incurred at the fair
value of the liability. Furthermore, until the liability is settled, the entity shall remeasure the
liability to fair value at each reporting date and at the date of settlement, and any changes in
fair value shall go to profit or loss.
Fair value is determined using an option pricing model as discussed under equity-settled
share-based payment transactions, taking into account the terms and conditions on which
the specific rights were granted, and also the extent to which employees have rendered
service to date.
Vesting conditions (service and non-market performance conditions), upon which
satisfaction of a cash-settled share-based payment transaction is conditional, are not taken
into account when estimating the fair value of the cash-settled share-based payment at
measurement date. Instead these are taken into account by adjusting the number of awards
included in the measurement of the liability. Market and non-vesting conditions are taken
into account when estimating the fair value of the cash-settled share-based payment
granted. These are also taken into account when re-measuring the fair value at the end of
each reporting period and at date of settlement. The cumulative amount ultimately
recognised for goods or services received, as consideration for the cash-settled share-
based payment, is equal to the cash that is paid.
The goods or services received/acquired are recognised when the goods are obtained or
as the services are rendered. In the case of services rendered, it is necessary to take into
account any vesting conditions relating to the relevant equity instrument. For example,
where share appreciation rights vest immediately (i.e. the employees are not required to
complete a specified period of service to become entitled to the cash payment), the entity
shall recognise the services received and the liability to pay for them immediately. However,
it should be remembered that the fair value of the share appreciation rights should be
remeasured at the end of each financial period. Any difference in fair value should go to
profit or loss, and at the same time a corresponding adjustment should be made against the
related liability.
Example 18.
18.11 Share appreciation rights vest immediately
Bella Ltd issued 1 000 unconditional share appreciation rights (SARs) that vest immediately to its
managing director on 1 January 20.11. At that date it is estimated, using an option pricing model,
that the fair value of a share appreciation right is R12. The managing director is entitled to exercise
the share appreciation rights at any time up to 31 December 20.13, at which date they must be
exercised. The fair values of the share appreciation rights increased over time as follows:
R
31 December 20.11 12,50
31 December 20.12 12,90
31 December 20.13 13,80
The journal entries related to this transaction will be the following if it is assumed that all such
rights are exercised at fair value on 31 December 20.13.
Dr Cr
R R
1 January 20.11
Employee benefit costs (P/L) (1 000 × R12) 12 000
Cash-settled share-based liability (SFP) 12 000
Initial recognition of liability and share-based payment expense
31 December 20.11
Employee benefit costs (P/L) (1 000 × (R12,50 – R12,00)) 500
Cash-settled share-based liability (SFP) 500
Subsequent remeasurement of liability for 20.11
31 December 20.12
31 December 20.13
Bank (1 000 × R13,80) 13 800
Settlement of liability at 31 December 20.13 at fair value
Comment
¾ It should be noted that if this example dealt with the acquisition of an asset, for example inventory,
then the cost of the inventory would not be adjusted for the effects of the liability re-measurement
(i.e. the cost would remain at R12 000). The fair value adjustments on the liability will still occur
and will be taken to profit and loss.
If share appreciation rights do not vest immediately but vest only after the employees have
completed a specified period of service, the entity shall recognise the services received and
the corresponding liability to pay for them as employees render services during the vesting
period.
Example 18.
18.12 Share appreciation rights do not vest immediately
A more complex example of share appreciation rights is now presented (based on the example in
the Implementation Guidance of IFRS 2):
Illus Ltd grants 100 cash-share appreciation rights (SARs) to each of its 500 employees at the
beginning of 20.11, on condition that the employees remain in its employ for the next three years.
During 20.11, 35 employees leave. Illus Ltd estimates that a further 60 will leave during 20.12 and
20.13. During 20.12, 40 employees leave and it is estimated that a further 25 will leave during
20.13. During 20.13, 22 employees leave. At the end of 20.13, 150 employees exercise their
SARs, another 140 employees exercise their SARs at the end of 20.14 and the remaining
113 employees exercise their SARs at the end of 20.15.
Using an option-pricing model as discussed earlier, Illus Ltd estimates the fair value of the SARs at
the end of each year of the existence of the liability. The intrinsic values at the date of exercise
(equal to cash paid out) are also presented.
Fair Intrinsic
value value
R R
20.11 14,40 –
20.12 15,50 –
20.13 18,20 15,00
20.14 21,40 20,00
20.15 – 25,00
Using the theory discussed earlier and the information in this example, the following amounts
would be raised as expenses and liabilities:
Dr Cr
R R
20.11
Share-based payment expense and related liability adjustment
for 20.11
Working
Liability end 20.12
[(500 – 35 – 60) × 100 × R14,40 × 1/3] 194 400
Comment
¾ As the employees have to remain in Illus Ltd’s employ for three years, only one third of the
expense is recognised per annum. The liability is calculated by multiplying the SARs granted to
those employees who are expected to remain in employment for three years by the fair value
per SAR at year end. The amount thus calculated is multiplied by 1/3 or 2/3 or 3/3, depending
on the completed years of service.
Dr Cr
R R
20.12
Share-based payment expense and related liability adjustment for 20.12
Working
Liability end 20.12 413 333
[(500 – 35 – 40 – 25) × 100 × R15,50 × 2/3]
Liability end 20.11 (194 400)
Increase 218 933
continued
Dr Cr
R R
20.13
Share-based payment expense and adjustment for 20.13 related liability
Working
Liability end 20.13
SARs not exercised
[(500 – 35 – 40 – 22 – 150) × 100 × R18,20 × 3/3] 460 460
SARs exercised (150 × 100 × R15) 225 000
685 460
Increase 272 127

Bank (150 × 100 × R15) 225 000
Cash settlement of SARs exercised
Comment
¾ The SARs exercised during the year should be remeasured to the fair value at the date of settlement
(cash paid out) and not to the fair value at year end.
Dr Cr
R R
20.14
Share-based payment expense and related liability adjustment for 20.14
Working
Liability end 20.13
SARs not exercised
[(500 – 35 – 40 – 22 – 150 – 140) × 100 × R21,40] 241 820
SARs exercised (150 × 100 × R15) 280 000
521 820
Increase 61 360

Bank (140 × 100 × R20) 280 000
20.15
Share-based payment expense for 20.15
Working
SARs not exercised –
SARs exercised (113 × 100 × R25) 282 500
282 500
Increase 40 680

Bank (113 × 100 × R25) 282 500
18.5 Modification of a share-based payment transaction that changes its

classification from cash-settled to equity-settled
If the terms and conditions of a cash-settled share-based payment transaction are modified
and results in it becoming an equity-settled share-based payment transaction, the
transaction is accounted for as equity-settled share-based payment transaction from the
date of modification.
The equity-settled share-based payment transaction is measured at the fair value of the
equity instrument granted at modification date and is recognised in equity, to the extend to
which goods or services have been received.
The liability for the cash-settled share-based payment transaction as at date of modification
is derecognised in profit or loss. Refer to IFRS 2.IG 9B and Example 12C.
18.6 Share-based payment transactions with cash alternatives

Up to now, share-based payment transactions could be classified as either equity-settled or
cash-settled transactions. However, it is quite common for entities to enter into share-based
payment transactions where either the entity or a counterparty may elect whether the entity
should settle the transaction in cash or by issuing equity instruments.
Should a share-based payment transaction fall within the ambit of the above two types of
transactions, it may represent a compound instrument – one component being a cash-
settled share-based payment transaction and the other being an equity-settled share-
based payment transaction. Alternatively, the entire instrument could be classified as being
either cash-settled or equity-settled. The entity will account for a transaction or component
of a transaction as a cash-settled share-based payment transaction if the entity incurred a
liability to settle in cash or other assets. By contrast, it would account for a transaction or
component of a transaction as an equity-settled share-based payment transaction if no such
liability has been incurred.
The component approach is followed where the counterparty has the choice of manner of
settlement, while the approach where the entire instrument is classified as being either
cash-settled or equity-settled, is followed where the entity chooses.
18.6.1 Share-based payment transactions in which the counterparty has the

choice of settlement
If the entity has granted the counterparty the right to choose whether a share-based
payment transaction is to be settled in cash or by issuing equity instruments, this comprises
a compound financial instrument with a debt component and an equity component.
The debt component represents the counterparty’s right to demand payment in cash; the
equity component represents the counterparty’s right to demand settlement in equity
instruments rather than in cash.
For transactions with parties other than employees and in which the fair value of the goods
or services received by the entity can be measured directly, the equity component of such
an instrument will be measured as the difference between the fair value of goods or services
received and the fair value of the debt component. These values will be established on the
day the goods or services are received.
The entity shall account separately for goods or services received or acquired in respect of
each component of a compound instrument. For instance, for the debt component, the entity
shall recognise the goods or services acquired together with a corresponding liability to pay
for the goods or services, just as would be the case for any cash-settled share-based
payment transaction. For the equity component (if any arises), the entity shall recognise
goods or services received and a corresponding increase in equity – this will be similar to
what is done for equity-settled share-based payment transactions.
Example 18.
18.13 Counterparty (other than employee) has choice of settlement
Counter Ltd purchased machinery with a fair value of R500 000 two weeks before year end from
Cash Ltd in terms of a share-based payment transaction. This share-based payment transaction
allows Cash Ltd (the counterparty) to choose, on settlement date, whether it wants to have the
purchase price settled in cash or by having shares in Counter Ltd issued to it. The cash payment
will be based on the fair value of 10 000 shares at settlement date. If the share alternative is
chosen, 10 500 shares will be issued to Cash Ltd. Since the counterparty may choose the manner
of settlement, this is a compound instrument (refer to above discussion).
If it is established that the fair value of one Counter Ltd share amounts to R48 at the date the
machinery is received, then the debt component of the compound instrument will amount to
R480 000 (10 000 × 48). The equity component will be R20 000. This R20 000 is the difference
between the fair value of the goods received (R500 000) and the debt component (R480 000) at
the date on which the goods are received.
The journal entry to account for the acquisition of the machinery will be as follows:
Dr Cr
R R
Machinery (SFP) 500 000
Acquisition of machine
If the fair value of a Counter Ltd share increased to R51 at year end and settlement has not yet
occurred, the liability should be remeasured as follows:
Loss on remeasurement of share-based liability (P/L) 30 000
Cash-settled share-based liability (SFP) [(R51 – R48) × 10 000] 30 000
Remeasurement of liability at year end
At settlement date, the liability should be remeasured to its fair value. Should an entity issue
equity instruments on settlement rather than paying cash, the liability shall be transferred
directly to equity as consideration for the equity instruments issued.
Should the entity pay cash on settlement rather than issuing equity instruments, the cash
payment shall be applied to settle the liability in full. Any equity component previously
carried in equity will remain within equity. An entity may, however, make a transfer from one
component of equity to another.
Example 18.
18.14 Settlement (counterparty has choice of settlement)
Use the same information as in the previous example and assume that the fair value of a
Counter Ltd share increased to R52 at settlement date. The first two journals will be the same as
in the previous example. The journal entries on settlement date will be as follows:
Dr Cr
R R
If equity instruments are issued
Remeasurement of liability at settlement date
Share-based payment reserve 20 000
Equity issued
continued
Dr Cr
R R
If cash settlement is opted for
Remeasurement of liability at settlement date
Cash-settled share-based liability (SFP) (10 000 × R52) 520 000
Bank 520 000
Settlement of liability
For other transactions where the fair value of goods or services cannot be measured
directly, for example transactions with employees, the entity shall measure the fair value of
the compound financial instrument at the measurement date, taking into account the terms
and conditions on which the rights to cash or equity instruments were granted. This is done
as follows:
First, measure the fair value of the debt component.
Then, measure the fair value of the equity component, taking into account the fact that
the counterparty must forfeit its right to cash if it elects to receive the equity instrument.
The fair value of the compound instrument is the sum of the fair value of the debt
component and equity component.
Note that share-based payment transactions in which the counterparty has the choice of
settlement are often structured so that the fair values of the two choices are the same.
When this happens, the equity component will have a value of Rnil, hence the total value of
the compound instrument will be equal to the debt component.
Example 18.
18.15 Counterparty (employee) has choice of settlement
On 1 January 20.11, Komp Ltd grants to an employee the right to choose either 800 phantom shares
(i.e. the right to a cash payment equal to the value of 800 shares), or 900 actual shares. The grant is
conditional upon the completion of two years’ service. If the employee chooses the actual share
alternative, the shares must be held for two years after vesting date. On 1 January 20.11,
Komp Ltd’s share price is R20 per share. (This share price amounts to R22 and R23 on
31 December 20.11 and 20.12 respectively.) The fair value of the shares to be issued to the
employee, however, amounts to only R19 on 1 January 20.11, due to the post-vesting transfer
restrictions.
The first step is to determine the fair value of the debt component. This amounts to R16 000 (800 × 20).
Second, the fair value of the equity component should be determined, by reference to the fair value
of the equity and cash alternatives. The fair value of the equity alternative is R17 100 (900 × 19), while
the fair value of the cash alternative is R16 000 (800 × 20). Therefore, the fair value of the equity
component of the compound instrument is R1 100 (17 100 – 16 000).
The journal entries to account for this transaction will be as follows:
Dr Cr
R R
31 December 20.11
Cash-settled share-based liability (SFP) (800 × R22 × 1/2) 8 800
Share-based payment reserve (Equity SCE) (R1 100/2) 550
Accounting for employee benefit costs in 1st year of vesting period
continued
Dr Cr
R R
31 December 20.12
Cash-settled share-based liability (SFP) [(800 × R23) – 8 800] 9 600
Share-based payment reserve (Equity SCE) (R1 100/2) 550
Accounting for employee benefit costs in 2nd year of vesting period
If the employee chooses cash settlement on 31 December 20.12, the following journal entry will be
passed upon settlement:
(800 × R23) or (R8 800 + R9 600)
Bank 18 400
Alternatively, if the employee chooses the shares, the journal entry upon settlement will be as
follows:
18.6.2 Share-based payment transactions where the entity has the choice
of settlement
If an entity enters into a share-based payment transaction in which the entity may choose
whether to settle in cash or by issuing equity instruments, the entity shall determine whether
it has a present obligation to settle in cash. If such an obligation exists, the transaction
should be accounted for as a cash-settled share-based payment transaction. The entity has
a present obligation to settle in cash if the choice of settlement in equity instruments has no
commercial substance (e.g., because the entity is legally prohibited from issuing shares), or
the entity has a past practice or a stated policy of settling in cash, or generally settles in
cash whenever the counterparty asks for cash settlement.
If the entity has no such obligation, the transaction shall be accounted for in the same way
as an equity-settled share-based payment transaction. In the case of an equity-settled
share-based payment transaction classification, the manner of eventual settlement will,
however, influence the accounting treatment:
If the entity elects to settle in cash, the cash payment shall be accounted for as the
repurchase of an equity interest, that is, a reduction in equity. There is one exception to
this rule, which is discussed below.*
If the entity elects to settle by issuing equity instruments, no further accounting is
required, apart from transforming one component of equity to another, if necessary.
There is also one exception to this rule; it too, is discussed below.*
* Exception: If an entity elects the settlement alternative with the higher fair value as at
date of settlement, it shall recognise an additional expense for the excess value given,
that is, the difference between cash paid and the fair value of the equity instruments that
would otherwise have been issued, or the difference between the fair value of the equity
instruments issued and the amount of cash that would otherwise have been paid.
Example 18.
18.16 Entity has choice of settlement
On 1 January 20.11, Ponent Ltd grants the right to receive either a cash payment equal to the
value of 800 shares or 900 actual shares to an employee. The terms of the arrangement provide
Ponent Ltd with the choice of settlement. The grant is conditional upon the completion of two
years’ service. If shares are issued, the shares must be held for two years after vesting date. On
1 January 20.11, Ponent Ltd’s share price is R20 per share. (This price amounts to R22 and R23
on 31 December 20.11 and 20.12 respectively.) The fair value of the shares to be issued to the
employee, however, amounts to only R19 on 1 January 20.11 (R21 on 31 December 20.12), due
to the post-vesting transfer restrictions. Ponent Ltd does not have a present obligation to settle in
cash.
The journal entries to account for this transaction will be as follows:
Dr Cr
R R
31 December 20.11
Share-based payment reserve (Equity SCE)
[(900 × R19) × 1/2] 8 550
Accounting for employee benefit costs in 1st year of vesting period
31 December 20.12
Share-based payment reserve (Equity SCE)
[(900 × R19 × 1/2)] 8 550
Accounting for employee benefit costs in 2nd year of vesting period
If Ponent Ltd decides to opt for cash settlement, the following journal entry needs to be passed
upon settlement:
Bank (800 × R23) 18 400
Comment
¾ The fair value of the cash settlement amounts to R18 400 (800 × R23), while the fair value of
the equity instruments amounts to R18 900 (900 × R21). As the settlement alternative with the
lower fair value is chosen, no additional expense need be recognised.
If Ponent Ltd decides to opt for settlement in shares (not in cash), no further accounting entries
would have been required if the share alternative had the lower fair value. However, as the fair
value of the share alternative (R18 900) exceeds the fair value of the cash alternative (R18 400),
the following additional entry should be passed upon settlement:
Dr Cr
R R
Employee benefit costs (P/L) 500
Share-based payment reserve (Equity SCE) (R18 900 – R18 400) 500
Share-based payment reserve (Equity SCE) (R17 100 + R500) 17 600
18.6.3 Share-based payment transactions with a net settlement feature

for withholding tax obligations
In some jurisdictions tax authorities may require the entity to withheld an amount for the tax
obligations relating to the share-based payment transaction and to transfer the amount in
cash to the tax authorities on behalf of the employee. To fulfil this obligation, the terms of the
share-based payment arrangement may permit the entity to withhld the number of equity
instruments equal to the cash value of the tax obligation from the total number of equity
instruments granted to the employee. This share-based payment arrangement contains a
net settlement feature. Such a transaction will be classified in its entirety as equity-settled
share-based payment transaction.
The cash payment to the tax authority is treated as a deduction from equity, except to the
extent the cash payment exceeds the fair value at the date of the net settlement. Refer to
IFRS 2.IG 19A and Example 12B.
18.7 Group share-based payment transactions

IFRS 2 includes the accounting treatment for group cash-settled share-based payment
transactions, in the separate financial statements of the entity receiving the goods or
services, when the entity has no obligation to settle the share-based payment transaction.
The following important principles should be noted:
A distinction is made between the ‘receiving entity’ and the ‘settling entity’. The receiving
entity receives the goods or services in a share-based payment transaction and the settling
entity has the obligation to settle the share-based payment transaction.
The receiving entity shall measure the goods or services received as an equity-settled
share-based payment transaction, when:
the awards granted are the entity’s own equity instruments; or
the entity has no obligation to settle the share-based payment transaction.
In all other circumstances, the receiving entity should measure the goods or services
received as a cash-settled share-based payment transaction.
If the receiving entity has no obligation to settle the share-based payment transaction, the
transaction should be treated as an equity contribution from the settling entity.
The settling entity should recognise the transaction as equity-settled only if it will be settled
in that entity’s own equity instruments. In all other circumstances, the entity should
recognise the transaction as cash-settled.
In some instances, the receiving entity may refund the settling entity for the making of the
share-based payments, also referred to as repayment arrangements. This would not impact
the initial classification as discussed above. Repayment arrangements may however give
rise to assets and liabilities covered by other Standards.
Example 18.
18.17 Parent entity grants own instruments to subsidiary’s employees
H Ltd grants 100 share options to acquire shares in H Ltd to 50 employees of S Ltd, a subsidiary of
H Ltd. The fair value of a share option on grant date is R20 each. The options vests immediately.
S Ltd (as the receiving entity) has no obligation to settle the payment. S Ltd therefore classifies the
transaction as equity-settled.
Dr Cr
R R
S Ltd
Employee benefits (P/L) 100 000
Equity (Contribution from parent) (50 × 100 × R20) 100 000
continued
H Ltd (as the settling entity) has the obligation to settle the payment in own equity instruments.
H Ltd therefore classifies the transaction as equity-settled.
Dr Cr
R R
H Ltd
Investment in subsidiary (SFP) 100 000
Share-based payment reserve (Equity) 100 000
In H Ltd’s consolidated financial statements, the transaction would also be classified as equity-
settled. The following consolidation journal will be required:
Dr Cr
R R
Equity (Contribution from parent) 100 000
Example 18.
18.18 Subsidiary grants parent’s instruments to own employees
S Ltd grants 100 share options in H Ltd, S Ltd’s parent company, to 50 of S Ltd’s employees. The
fair value of a share option on grant date is R20 each. The options vest immediately.
S Ltd (as the receiving entity) has an obligation to settle the payment. S Ltd therefore classifies the
transaction as cash-settled and recognises a liability.
Dr Cr
R R
S Ltd
Cash-settled share-based liability (SFP) (50 × 100 × R20) 100 000
Note that the liability would be remeasured to fair value on each reporting date if the options did
not vest immediately.
H Ltd will not recognise the transaction in its separate financial statements. However, from a group
perspective, the transaction is equity-settled and the journals in S Ltd will have to be reversed on
consolidation, and equity-settled journals prepared.
Assume the following: The options did not vest immediately but only after a year, with an exercise
price of R50 per share. At the end of the vesting period, all the options were exercised. S Ltd
bought the shares in the open market at R80 per share. The fair value of the options was R25 at
the end of the year and R30 on exercise date.
Dr Cr
R R
S Ltd
Year end
Cash-settled share-based payment expense
Exercise date
Cash-settled share-based liability (SFP)
[(50 × 100 × R30) – R125 000] 25 000
Remeasurement of share-based payment liability
Investment in shares (SFP) 400 000
Bank (SFP) (50 × 100 × R80) 400 000
Purchase shares to settle obligation
Bank (SFP) (50 × 100 × R50) 250 000
Cash-settled share-based liability (SFP) (R125 000 + R25 000) 150 000
Investment in shares (SFP) 400 000
Settlement of cash-settled share-based payment
Example 18.
18.19 Parent entity grants cash payments to subsidiary’s employees
H Ltd grants 100 phantom shares to 50 employees of S Ltd, a subsidiary of H Ltd. The shares are
conditional upon two years’ service. The fair value of a phantom share on grant date and at year
end is R20 and R25 respectively.
S Ltd (as the receiving entity) has no obligation to settle the payment. S Ltd therefore classifies the
transaction as equity-settled.
Dr Cr
R R
S Ltd
Equity (Contribution from parent) (50 × 100 × R20 × 1/2) 50 000
H Ltd (as the settling entity) has the obligation to settle the payment in cash. H Ltd therefore
classifies the transaction as cash-settled. H Ltd will remeasure the cash-settled liability to fair value
at year end.
Dr Cr
R R
H Ltd
Share-based payment liability (SFP) 50 000
Share-based payment liability (SFP)
[(100 × 50 × R25) × 1/2) – R50 000] 62 500
In H Ltd’s consolidated financial statements, the transaction would also be classified as cash-
settled. The following consolidation journal will be required:
Dr Cr
R R
Equity (Contribution from parent) 50 000
Example 18.
18.20 Subsidiary grants cash payment, based on parent’s instruments to own
employees
S Ltd grants 100 phantom shares in H Ltd, S Ltd’s parent company, to 50 employees of S Ltd. The
fair value of a phantom share on grant date is R20 each. The shares vest immediately.
S Ltd (as the receiving entity) has an obligation to settle the payment. S Ltd therefore classifies the
transaction as cash-settled and recognises a liability.
Dr Cr
R R
S Ltd
Note that the liability would be remeasured to fair value on each reporting date if the options did
not vest immediately.
H Ltd will not recognise the transaction in its separate financial statements. In H Ltd’s consolidated
financial statements, the transaction would also be classified as cash-settled; therefore no
consolidation journals will be required.
Example 18.
18.21 Transfer of employees within the group
H Ltd grants 10 000 share options in H Ltd to an S Ltd employee, Mr A. S Ltd is a subsidiary of
H Ltd. The employee has to complete one year’s service within the group to qualify for the options.
The fair value of a share option on grant date is R20 each. After six months, Mr A transfers
employment from S Ltd to SS Ltd, also a subsidiary of H Ltd.
Each of the two subsidiaries will account for their portion of the equity-settled share payment.
Dr Cr
R R
S Ltd
Equity (Contribution from parent) (100 × R20 × 6/12) 10 000
SS Ltd
Equity (Contribution from parent) (100 × R20 × 6/12) 10 000
If the subsidiary had an obligation to settle the share-based payment with H Ltd’s equity
instruments, the transaction would be classified as cash-settled. The share-based payment liability
would be remeasured to fair value on each reporting date if the options did not vest immediately.
If Mr A did not satisfy the vesting condition of one year’s service, S Ltd and SS Ltd would reverse
the expense previously recognised.
18.8 Disclosure
18.8.1 IFRS 2 disclosures

An entity shall disclose information that enables users of the financial statements to
understand the nature and extent of share-based payment arrangements that existed
during the period. (Refer to# at the end of disclosures).
To give effect to the principle above, the entity shall disclose at least the following:
– a description of each type of share-based payment arrangement that existed at any
time during the period, including the general terms and conditions of each
arrangement, for example:
* vesting requirements;
* the maximum term of options granted; and
* the method of settlement (e.g., whether cash or equity);
– the number and weighted average exercise prices of options for each of the following
groups:
* outstanding at the beginning of the period;
* granted during the period;
* forfeited during the period;
* exercised during the period;
* expired during the period;
* outstanding at the end of the period; and
* exercisable at the end of the period;
– for options exercised during the period, the weighted average share price at the date
of exercise; and
– for options outstanding at the end of the period, the range of exercise prices and
weighted average remaining contractual life. If the range of exercise prices is wide,
the outstanding options shall be divided into range-groups that are meaningful for
assessing the number and timing of additional shares that may be issued and the
cash that may be received upon exercise of those options.
An entity shall disclose information to enable users of the financial statements to
understand how the fair value of the goods or services received, or the fair value of the
equity instruments granted, during the period was determined.# (Refer to# at end of
disclosures.)
If the entity has measured the fair value of goods or services received as consideration
for equity instruments of the entity indirectly, by reference to the fair value of the equity
instruments granted, the entity shall disclose at least the following in order to give effect
to the principle above:
– for options granted during the period, the weighted average fair value of those options
at the measurement date and information on how that fair value was measured,
including:
* the option-pricing model used and the inputs to that model, including the weighted
average share price, exercise price, expected volatility, option life, expected
dividends, the risk-free interest rate and any other inputs to the model;
* how expected volatility was determined, including an explanation of the extent to
which expected volatility was based on historical volatility; and
* whether and how any other features of the option grant were incorporated into the
measurement of fair value, for example a market condition;
– for other equity instruments (not options) granted during the period, the number and
weighted average fair value of those equity instruments at the measurement date, and
information on how that fair value was measured, including:
* if fair value was not measured on the basis of an observable market price, how it
was determined;
* whether and how expected dividends were incorporated into the measurement of
fair value; and
* whether and how any other features of the equity instruments granted were
incorporated into the measurement of fair value; and
– for share-based payment arrangements that were modified during the period:
* an explanation of those modifications;
* the incremental fair value granted (as a result of those modifications); and
* information on how the incremental fair value granted was measured.
If an entity has measured the fair value of goods or services received during the period
directly, the entity shall disclose how that fair value was determined, for example
whether fair value was measured at an established market price for those goods or
services.
If an entity has rebutted the presumption that the fair value of goods/services can be
estimated reliably (in respect of parties other than employees), it shall disclose that fact
and give an explanation of why the presumption was rebutted.
An entity shall disclose information that enables users of the financial statements to
understand the effect of share-based payment transactions on both the entity’s profit or
loss for the period and its financial position.#
To give effect to the principle above, the entity shall disclose at least the following:
– the total expense recognised for the period arising from share-based payment
transactions in which the goods or services received did not qualify for recognition as
assets and hence were recognised immediately as an expense, including that portion
of the total expense that arises from transactions accounted for as equity-settled
share-based payment transactions; and
– for liabilities arising from share-based payment transactions:

* the total carrying amount at the end of the period; and
* the total intrinsic value at the end of the period of liabilities for which the
counterparty’s right to cash or other assets had vested by the end of the period.
If the information required to be disclosed by this statement does not satisfy the
principles in paragraphs marked with#, the entity shall disclose such additional
information as is necessary to satisfy them.
18.8.2 JSE Listing Requirements

The JSE Listing Requirements require the following disclosures in respect of share-based
payment transactions:
Share incentive schemes:
– A listed company must, in respect of its own or its subsidiary companies’ share
incentive schemes, summarise:
* the details and terms of options in issue at the beginning of the financial period;
* the number of securities that may be utilised for purposes of the scheme at the
beginning of the financial period;
* changes in such number during the financial period; and
* the number of securities available for utilisation for purposes of the scheme at the
end of the financial period.
Directors’ emoluments related to share-based payments:
– In respect of share options which have or had any other right given which has had the
same or a similar effect in respect of providing a right to subscribe for shares (‘share
options’), disclose:
* the opening balance of share options, including the number of share options at
each different strike price;
* the number of share options awarded and their strike prices;
* the strike dates of differing lots of options awarded;
* the number of share options exercised and at what prices; and
* the closing balance of share options, including the number of share options at each
different strike price.
– In respect of any shares issued and allotted in terms of a share purchase/option
scheme for employees (or other scheme/structure effected outside of the issuer which
achieves substantially the same objectives as a share purchase/option scheme),
usually held as a pledge against an outstanding loan to an employee in a share-
purchase scheme trust, which have not been fully paid for, disclose:
* provide the number so issued and allotted;
* the price of issue and allotment;
* the release periods applicable to such shares; and
* any other relevant information.
Example 18.
18.22 Disclosure
The following example illustrates the disclosure requirements of IFRS 2:

Extract from the notes of Company Z for the year ended 31 December 20.15
Share-based payment
During the period ended 31 December 20.15, the company had four share-based payment
arrangements, which are described below:
Senior
Senior
General management
Type of management Executive
employee share share
arrangement share share plan
option plan appreciation
option plan
cash plan
Date of grant 1 January 20.14 1 January 20.15 1 January 20.15 1 July 20.15
Number granted 50 000 75 000 50 000 25 000
Contractual life 10 years 10 years N/A 10 years
Vesting conditions One and a half Three years’ Three years’ Three years’
years’ service service. service and service and
and achievement achievement of achievement of
of a share price a target growth a target increase
target, which in earnings per in market share.
was achieved. share.
The estimated fair value of each share option granted in the general employee share option plan is
R23,60. This was calculated by applying a binomial option-pricing model. The model inputs were the
share price of R50 at grant date, the exercise price of R50, the expected volatility of 30%, no
expected dividends, a contractual life of ten years, and a risk-free interest rate of 5%. To allow for the
effects of early exercise, it was assumed that the employees would exercise the options after vesting
date, when the share price was twice the exercise price. Historical volatility was 40%, which includes
the early years of the company’s life. The company expects the volatility of its share price to
reduce as it matures.
The estimated fair value of each share granted in the executive share plan is R50,00, which is
equal to the share price at the date of grant.
Further details of the two share option plans are as follows:
20.15 20.14
Number of Weighted average Number of Weighted average
options exercise price options exercise price
Outstanding at start of year 45 000 R40 – –
Granted 75 000 R50 50 000 R40
Forfeited (8 000) R46 (5 000) R40
Exercised (4 000) R40 – –
Outstanding at end of year 108 000 R46 45 000 R40
Exercisable at end of year 38 000 R40 – R40
The weighted average share price at the date of exercise for share options exercised during the
period was R52. The options outstanding at 31 December 20.15 had exercise prices of R40 and
R50, and a weighted average remaining contractual life of 8,64 years.
20.15 20.14
R R
Expense arising from share-based payment transactions 1 105 867 495 000
Expense arising from share and share option plans 1 007 000 495 000
Closing balance of liability for cash-share appreciation plan 98 867 –
Expense arising from increase in fair value of liability
for cash-share appreciation plan 9 200 –
18.9 Accounting for Black Economic Empowerment transactions (FRG 2)

18.9.1 Background
Financial Reporting Guide (FRG) 2 is a South African Interpretation which was issued by the
APB during March 2006. The Interpretation is effective for annual periods beginning on or
after 1 March 2006.
In the context of empowerment of black people through meaningful participation in the South
African economy, entities may issue equity instruments to black people or entities controlled
by black people at a discount on fair value. Such transactions are known as Black Economic
Empowerment (BEE) transactions.
IFRS 2 applies to the accounting for BEE transactions where the fair value of cash and other
assets received is less than the fair value of equity instruments granted. FRG 2 addresses
issues specific to BEE transactions.
18.9.2 Scope
The Interpretation includes only those BEE transactions where the entity grants equity
instruments to black people (directly or indirectly) and the fair value of the cash and other
assets received (or to be received) is less than the fair value of the equity instruments
granted. It does not apply to transactions where the BEE partner is issued with equity
instruments for transactions that are unrelated to the entity obtaining BEE equity credentials
(IFRS 2 applies to these transactions).
The equity instruments may take many forms, for example ordinary shares, deferred
ordinary shares, share options and convertible preference shares or debentures.
The types of structures that are considered to be within the scope of this Interpretation
include, amongst others, the following:
leveraged buy-out structures where equity is issued to an empowerment partner and the
issuer of the equity (or a related party) provides or guarantees the borrowings required to
purchase the equity;
structures where equity is issued at a nominal amount by a new entity to all participants
so that the entity can obtain BEE equity credentials;
transactions between shareholders of an entity that enable the entity to obtain BEE
equity credentials;
transactions that facilitate BEE through a special purpose entity for obtaining BEE equity
credentials; and
business combinations between BEE businesses in order that at least one entity obtains
further BEE equity credentials.
18.9.3 Consensus
The difference between the fair value of the equity instruments granted and the fair value
of the cash and other assets received, namely the BEE equity credentials, represents an
intangible item that does not meet the definition of an intangible asset and, therefore,
does not qualify for recognition as an intangible asset. The difference should be expensed.
If the cost of the BEE equity credentials is directly attributable to the acquisition of
another intangible asset, that intangible asset should be valued at its fair value and any
additional equity credential costs expensed.
Where BEE equity credentials are obtained as part of the net assets acquired in a
business combination, the equity credentials do not qualify for recognition as an
intangible asset and will form part of goodwill. If the business combination element is
insignificant or contrived, the transaction should be accounted for as two separate
transactions; namely the BEE transaction in terms of IFRS 2, and the business
combination in terms of IFRS 3.
If the BEE transaction contains service conditions, the fair value of the equity instruments
should be measured at grant date and the expense recognised over the service
condition period (vesting condition). If the BEE transaction does not include service
conditions, the expense should be recognised immediately on grant date.
Where market performance conditions exist, tthey should be taken into account when
estimating the fair value of the equity instruments granted. Where non-market
performance conditions exist, the fair value of the equity instruments granted is not
adjusted, but the number of equity instruments that will ultimately vest is used to
calculate the cumulative amount recognised for goods or services received.
A post-vesting restriction on the transfer of the equity instruments is not a vesting
condition, but should be taken into account in determining the fair value of the equity
instruments granted. Restrictions on transfer, or other restrictions that exist during the
vesting period, should not be taken into account when estimating the fair value on grant
date, but should be considered as part of the vesting conditions (if any existed).
Example 18.
18.23 BEE transactions
Transaction 1
A BEE partner is paid commission, through the issue of equity instruments, on the basis of profits
received from contracts he obtained on behalf of the entity. The fair value of the service received
by the entity is equal to the fair value of the equity instruments.
The recognition of the commission and the equity instruments issued is not within the scope of
FRG 2, because there is no BEE equity credential element in the transaction.
Transaction 2
An entity issued equity instruments to a BEE partner for the purpose of acquiring a building. The
fair value of the building acquired is lower than the fair value of the equity instruments given up.
The building is identifiable through its fair value. Assuming that there are no other clearly
identifiable goods or services, the difference between the fair value of the building and the fair
value of the equity instruments is attributable to BEE equity credentials, and is therefore within the
scope of FRG 2.
Example 18.
18.24 BEE transaction with vesting conditions
A Ltd granted options to its black directors for which the black directors are required to remain in
the company’s employ for three years. The number of options that will vest depends on profit
growth over the next five years. Therefore, the actual number of options to be delivered will not be
finalised until the end of Year 5. However, if the black directors left the employment of A Ltd in
Year 4, they would still be entitled to exercise the options that vest on the basis of profit
performance at the end of Year 5.
The service received in relation to the share-based payment that does not vest immediately should
be recognised as an expense over the vesting period. The black directors are required to be in the
employment of A Ltd for three years in order to be entitled to a certain number of options, which
will be determined only at the end of Year 5, and therefore the expense should be recognised over
the three-year service period. However, all vesting conditions are not satisfied until the end of
Year 5 and therefore the amount expensed in the first three years should be corrected up until the
end of the five-year vesting period for the number of options that are expected to vest and that
ultimately do vest.
CHAPTER
19
Non-current assets held for sale,
and discontinued operations
(IFRS 5)
Contents
19.1 Overview of IFRS 5 Non-current Assets Held for Sale and Discontinued
Operations ....................................................................................................... 477
Part 1: Non-current assets held for sale
19.2 Introduction...................................................................................................... 478
19.3 Classification of a non-current asset (or disposal group) as held for sale....... 478
19.3.1 Criteria to qualify as held for sale .................................................... 478
19.3.2 Other matters to consider with regard to classification
as held for sale ................................................................................ 479
19.3.3 Extension of the period required to complete a sale ....................... 479
19.3.4 Meeting the criteria after reporting date ........................................... 480
19.3.5 Non-current assets held for distribution to owners .......................... 480
19.4 Accounting treatment ...................................................................................... 480
19.4.1 Measurement requirements ............................................................. 480
19.4.2 Assets excluded from the measurement requirements ................... 482
19.4.3 A disposal group containing both items included and excluded
from the measurement requirements .............................................. 482
19.5 Measurement of an individual non-current asset ............................................ 482
19.5.1 Assets falling within the scope for measurement requirements ...... 482
19.5.2 Assets falling outside the scope for measurement
requirements .................................................................................... 485
19.6 Measurement of a disposal group ................................................................... 486
19.6.1 Disposal group within the scope for measurement
requirements .................................................................................... 486
19.6.2 Disposal group outside the scope for measurement
requirements .................................................................................... 492
19.6.3 Newly acquired asset (or disposal group) ....................................... 494
19.6.4 Costs to sell ..................................................................................... 494
19.7 Recognition of gains and losses at date of sale of a non-current asset .......... 495
19.8 Non-current assets to be abandoned .............................................................. 496
19.9 Changes to a plan of sale ............................................................................... 496
19.9.1 General ............................................................................................ 496
19.9.2 Individual assets no longer classified as held for sale ..................... 496
19.9.3 Individual item that is part of disposal group no longer classified
as held for sale ................................................................................ 498
475

19.10.1 Deferred tax on an individual asset measured at cost classified
as held for sale ................................................................................ 499
19.10.2 Deferred tax on an individual asset measured at revaluation
classified as held for sale ................................................................ 501
19.10.3 Deferred tax on disposal group held for sale ................................... 504
19.11 Disclosure of a non-current asset or disposal group classified
as held for sale ................................................................................................ 504
Part 2: Discontinued operations
19.12 Introduction...................................................................................................... 508
19.13 Presenting discontinued operations ................................................................ 508
19.13.1 A newly identified discontinued operation ....................................... 508
19.13.2 Discontinued operations that arose in previous years ..................... 511
19.13.3 Classification as a discontinued operation ceases
since no longer classified as held for sale ....................................... 511
19.14 Measuring and presenting subsidiaries meeting the criteria
to be classified as held for sale at acquisition ................................................. 511
Non-current assets held for sale, and discontinued operations 477
19.1 Overview of IFRS 5 Non-current assets held for sale

and discontinued operations
DEFINITIONS MEASUREMENT
Disposal group – group of assets (both Assets within measurement scope
non-current and current) to be disposed of by Immediately before classification – measure
sale or otherwise, together as a group in a asset in terms of relevant Standard.
single transaction. Liabilities associated with Immediately after classification – measure asset
those assets will also be included in the at lower of carrying amount and fair value less
transaction. costs to sell:
CLASSIFICATION – recognise impairment loss in profit/loss.
Carrying amount will be recovered through At reporting date – measure asset at lower of
sale transaction rather than through carrying amount and fair value less costs to sell:
continuing use. Asset must be available for – recognise impairment loss in profit/loss; and
immediate sale in present condition and sale – recognise reversal of impairment loss in
must be highly probable. profit/loss (limited to prior impairment
Management committed to a plan to sell the losses).
asset, and an active program to locate a Assets outside measurement scope
buyer and complete the plan initiated. Immediately before classification – measure
Asset actively marketed for sale. asset in terms of relevant Standard.
Sale expected to qualify for recognition At reporting date – measure asset in terms of
within one year. relevant Standard.
Unlikely that significant changes to the plan Assets excluded:
will be made or that plan will be withdrawn. deferred tax assets;
Asset to be abandoned – cannot be classified employee benefits assets;
as held for sale. financial assets within the scope of IFRS 9;
investment property at fair value; and
contractual rights under insurance contracts.
MEASUREMENT CHANGES TO A PLAN OF SALE

Disposal group within measurement scope Reclassify asset.
Immediately before classification – measure Measure asset at reclassification at lower of:
all assets and liabilities in terms of relevant – carrying amount (if asset was never
Standards. classified as held for sale); and
Immediately after classification – measure – recoverable amount on date of decision not
disposal group at lower of carrying amount to sell asset.
and fair value less costs to sell:
– recognise impairment loss in profit/loss,
allocate: DISCONTINUED OPERATIONS
• first to goodwill; Discontinued operation – component of an
• then pro-rata to other non-current assets entity that has been disposed of or is classified
within measurement scope. as held for sale and:
At reporting date – measure disposal group at – represents a separate major line of business
lower of carrying amount and fair value less or geographical area of operations; and
costs to sell (first measure all assets and – is part of a single co-ordinated plan to
liabilities outside measurement scope in terms dispose of a separate major line of business
of their relevant Standards): or geographical area of operations; or
– recognise impairment loss in profit/loss, – is a subsidiary acquired exclusively with a
allocate: view to resale.
• first to goodwill; Classify discontinued operation at earliest date
• then pro-rata to other non-current assets of: sale, classification as held for sale,
within measurement scope; and abandonment.
– recognise reversal of impairment loss in Disclose single amount in statement of profit or
profit/loss (limited to prior impairment loss and other comprehensive income.
losses) and allocate pro-rata to other Presentation and disclosure (IFRS 5.33 to .36).
non-current assets within measurement
scope.
Disposal group outside measurement scope
Immediately before classification – measure
all assets and liabilities in terms of their relevant
Standards.
At reporting date – measure all assets and
liabilities in terms of their relevant Standards.
Part 1: Non-current assets held for sale

19.2 Introduction
In terms of IAS 1, assets and liabilities must be classified as current and non-current. This
classification endeavours to provide users with information about the timing and amount of
cash flows associated with these items. IFRS 5 is applied to all non-current assets that are
reclassified as current assets when they are held for sale. In IFRS 5, the accounting
treatment, presentation and disclosure of non-current assets (both individual assets and
disposal groups) and discontinued operations are addressed. IFRS 5 attempts to do this by
stating that such assets and the associated liabilities that will be recovered and settled
through sale will be remeasured to the lower of the carrying amount and fair value less costs
to sell, and will be presented as separate current items on the statement of financial
position.
On the date on which a decision is taken to sell a particular non-current asset, the asset is
reclassified if the criteria specified in IFRS 5 are met. IAS 16 no longer applies, while IFRS 5
becomes applicable.
The following definitions are applicable:
A disposal group is a group of assets (both non-current and current) to be disposed of by
sale or otherwise, together as a group in a single transaction. The liabilities associated with
those assets will also be included in the transaction. The disposal group will include goodwill
acquired in a business combination if the group is a cash-generating unit (CGU) to which
goodwill has been allocated when assets are impaired, or can be an operation within such a
CGU, with or without acquired goodwill.
A discontinued operation is a component of an entity that has been disposed of or is
classified as held for sale and:
represents a separate major line of business or geographical area of operations (i.e. a
segment/s or part of a segment); and
is part of a single co-ordinated plan to dispose of a separate major line of business or
geographical area of operations; or
is a subsidiary acquired exclusively with a view to resale.
It is important to note that the discontinued operation is a component of an entity. A
component of an entity is where operations and cash flows are clearly distinguished –
operationally and for financial reporting purposes – from the rest of the entity and may
include divisions, branches, separate companies and segments.
19.3 Classification of a non-current asset (or disposal group) as held for

sale
The general rule is that an entity shall classify a non-current asset (or disposal group) as
held for sale if its carrying amount will be recovered principally through a sale transaction
rather than through continuing use.
19.3.1 Criteria to qualify as held for sale

IFRS 5 requires non-current assets that are to be disposed of to be reclassified from
non-current to current. Items must be classified as held for sale only once they have met
all the following criteria (IFRS 5.6 to .12):
A non-current asset (or disposal group) must be classified as held for sale if its carrying
amount will be recovered principally through a sale transaction rather than through
continuing use. The asset (or disposal group) must be available for immediate sale in
its present condition, subject only to terms that are usual and customary for sales of
such assets (or disposal groups) and its sale must be highly probable.
For the sale to be highly probable, the appropriate level of management must be
committed to a plan to sell the asset (or disposal group), and an active program to
locate a buyer and complete the plan must have been initiated.
The asset (or disposal group) must be actively marketed for sale at a price that is
reasonable in relation to its current fair value.
The sale must be expected to qualify for recognition as a completed sale within one
year from the date of classification, except if there are acceptable grounds for extension
of the sales period beyond one year as permitted by IFRS 5.9 (refer to section 19.3.3).
Actions required to complete the plan must indicate that it is unlikely that significant
changes to the plan will be made or that the plan will be withdrawn.
19.3.2 Other matters to consider with regard to classification as held for sale
Sales transactions for purposes of classifying a non-current asset as a current asset held for
sale include exchanges of non-current assets for other non-current assets when the
exchange has commercial substance as defined in IAS 16 Property, plant and equipment.
When an entity acquires a non-current asset (or disposal group) exclusively with a view to
its subsequent disposal, it will classify the non-current asset (or disposal group) as held for
sale on the acquisition date, only if the one year (refer to section 19.3.3) or the permitted
extended period requirement is met and it is highly probable that any other criteria in
section 19.3.1 (apart from the one-year period) that are not met at acquisition date will be
met within a short period (usually limited to three months) following the acquisition.
19.3.3 Extension of the period required to complete a sale

As noted in section 19.3.1, an extension of the period required to complete a sale beyond
one year does not preclude an asset (or disposal group) from being classified as held for
sale if (IFRS 5.9):
the delay is caused by events or circumstances beyond the entity’s control; and
there is sufficient evidence that the entity remains committed to its plan to sell the asset
(or disposal group).
An exception to the one-year requirement mentioned in section 19.3.1 shall therefore apply
in the following situations (contained in IFRS 5 Appendix B) in which such events or
circumstances arise:
on the date an entity commits itself to a plan to sell a non-current asset (or disposal
group) it reasonably expects that others (not a buyer) will impose conditions on the
transfer of the asset (or disposal group) that will extend the period required to complete
the sale; and:
– actions necessary to respond to those conditions cannot be initiated until after a firm
purchase commitment is obtained; and
– a firm purchase commitment is highly probable within one year, OR
an entity obtains a firm purchase commitment and, as a result, a buyer or others
unexpectedly impose conditions on the transfer of a non-current asset (or disposal
group) previously classified as held for sale that will extend the period required to
complete the sale; and:
– timely actions necessary to respond to the conditions have been taken; and
– a favourable resolution of the delaying factors is expected, OR
during the initial one-year period, circumstances arise that were previously considered
unlikely and, as a result, a non-current asset (or disposal group) previously classified as
held for sale is not sold by the end of that period; and:
– during the initial one-year period, the entity took the action necessary to respond to
the change in circumstances;
– the non-current asset (or disposal group) is being actively marketed at a price that is
reasonable, given the change in circumstances; and
– the criteria in section 19.3.1 are met.
A firm purchase commitment is an agreement with an unrelated party that is binding on
both parties. It is usually legally enforceable, and specifies all significant terms, including the
price and timing of the transaction; and includes a disincentive for non-performance that is
sufficiently large to make performance highly probable.
19.3.4 Meeting the criteria after reporting date

If the criteria in section 19.3.1 are met only after the reporting date, an entity shall not
classify a non-current asset (or disposal group) as held for sale in those financial statements
when issued. However, when the criteria in section 19.3.1 are met after the reporting date,
but before the authorisation of the financial statements for issue, the entity shall disclose the
following information by way of a note:
a description of the non-current asset (or disposal group);
a description of the facts and circumstances of the sale, or leading to the expected
disposal, and the expected manner and timing of that disposal; and
if applicable, the segment in which the non-current asset (or disposal group) is
presented, in accordance with IAS 14 on segment reporting.
19.3.5 Non-current assets held for distribution to owners

Assets other than cash could be distributed as dividends to the owners of an entity. A non-
current asset (or disposal group) is classified as held for distribution to owners when the
entity is committed to distributing the asset (or disposal group). The following criteria are
applicable:
the asset must be available for immediate distribution in its present condition;
the distribution must be highly probable;
actions to complete the distribution must have been initiated;
actions to complete the distribution are expected to be completed within one year from
the date of classification; and
actions required to complete the distribution must indicate that it is unlikely that
significant changes to the distribution will be made or that the distribution will be
withdrawn.
19.4.1 Measurement requirements

All assets (or disposal groups) that are to be reclassified as held for sale are measured in
terms of the Standards normally applicable to them immediately before their initial
classification as held for sale (IFRS 5.18).
For instance, if an item of property, plant and equipment carried at cost is to be sold, the
carrying amount of the asset immediately before the initial classification as held for sale
must be determined. This means that depreciation on the asset involved, right up to the
point of reclassification, must be written off to determine its carrying amount in terms of
IAS 16 (the applicable Standard). When an investment property carried at fair value is
earmarked for disposal within the next year, it must be measured at its ruling fair value
immediately before its initial classification as held for sale in terms of this rule. This implies
that the fair value of the investment property is determined by applying the principles of the
fair value model contained in IAS 40.
Non-current assets (or disposal groups) classified as held for sale are measured at the
lower of their carrying amount and fair value less costs to sell (IFRS 5.15).
Fair value is the price that would be received to sell an asset or paid to transfer a liability in
an orderly transaction between market participants at the measurement date (IFRS 13 Fair
Value Measurement). Costs to sell are the incremental costs directly attributable to the
disposal of an asset or disposal group excluding finance costs and income tax expense.
Example 19.1
19.1 Basic principles
A Ltd holds an item of property, plant and equipment (PPE) with a carrying amount of R100 000 on
31 December 20.11 that is accounted for on the cost model. On that date, management decides to
sell the asset for R101 000 (fair value) by 31 March 20.12 and concludes a valid non-cancellable
sales contract (using fair values) to this effect with a buyer. Costs to sell the asset will amount to
R6 000. Assume all amounts involved are material and that the criteria for classification as held for
sale had been met on 31 December 20.11.
Applying IFRS 5 will have the following effect:
The carrying amount of the PPE item on 31 December 20.11 must be determined
Before the reclassification from non-current assets to current assets, an asset must be
measured in terms of the applicable Standards.
Since the decision to sell was taken at year end, the carrying amount is R100 000.
Next, the fair value less costs to sell of the PPE item must be determined
Fair value is R101 000 and costs to sell R6 000. Consequently, the fair value less costs to sell is
R95 000.
The PPE item initially classified as held for sale must be transferred from non-current
assets to current assets and then be measured at the lower of its carrying amount and
fair value less costs to sell
The PPE item with a carrying amount of R100 000 shall then be transferred from non-current
assets to current assets on the face of the statement of financial position and be described as
held for sale. This held for sale asset shall then be written down from R100 000 to R95 000 and
an impairment loss of R5 000 shall be recognised in the profit or loss section of the statement of
profit or loss and other comprehensive income of 20.11.
Example 19.2
19.2 Disposal groups
An entity may decide to sell any of the following:

A factory comprising three manufacturing plants (carrying amounts R100 000, R200 000 and
R300 000 respectively) representing a group of three CGUs, OR
only one of the three manufacturing plants representing a single CGU, for example, the plant with
a carrying amount of R100 000, OR
two machines (carrying amount R40 000) forming part of one manufacturing plant may be sold
and replaced by two more modern machines.
Each of the above alternatives will represent a disposal group.
19.4.2 Assets excluded from the measurement requirements

The measurement requirements do not apply to the following assets (either as individual
assets or as part of a disposal group):
deferred tax assets from IAS 12 Income Taxes;
assets arising from employee benefits in terms of IAS 19 Employee Benefits;
financial assets within the scope of IFRS 9 Financial Instruments;
non-current assets that have been accounted for using the fair value model in IAS 40
Investment Property;
non-current assets that have been measured at fair value less costs to sell in
accordance with IAS 41 Agriculture;
contractual rights under insurance contracts as defined in IFRS 4 Insurance Contracts.
Since these items are excluded from the scope of IFRS 5 in respect of measurement
requirements, the items will not be carried at the lower of the carrying amount and fair value
less costs to sell, but at the values determined by applying the applicable Standards.
19.4.3 A disposal group containing both items included and excluded

from the measurement requirements
A disposal group may include any assets and any liabilities of an entity – therefore current
and non-current assets and liabilities as well as some assets that are excluded from the
measurement requirements of IFRS 5 can form part of a disposal group.
Example 19.3
19.3 A disposal group
A disposal group can consist of the following items:

Land: Cost R100 000
Factory building: Carrying amount R400 000
Plant: Carrying amount R210 000
Inventories: Carrying amount R60 000
Payables associated with the plant, inventory and factory building R30 000
Share investment: Fair value R100 000
The first three items listed above would be non-current assets included in the scope of
measurement requirements of IFRS 5, that would be measured at the lower of the carrying amount
and fair value less costs to sell. The next item (Inventories) is a current asset being disposed of as
part of the disposal group. The payables represent an associated liability, while the share
investment represents a non-current asset excluded from the scope of the measurement
requirements of IFRS 5. Irrespective of the diverse nature of the items in the disposal group, the
items involved still comprise a single disposal group since the disposal group includes at least one
item that falls within the IFRS 5 measurement scope. The disposal group will be measured at the
lower of its carrying amount and the fair value less costs to sell in terms of IFRS 5.
19.5 Measurement of an individual non-current asset

19.5.1 Assets falling within the scope for measurement requirements
19.5.1.1 Measurement immediately before initial classification as held for sale
Immediately before the initial classification of an existing non-current asset as held for sale,
the asset should be measured in accordance with the applicable IFRSs. Assets included
within the scope of IFRS 5 will not be depreciated (or amortised) further (where applicable)
once classified as held for sale.
The measurement requirements of IFRS 5 in respect of a non-current asset classified as

held for sale require that the asset shall then be restated to the lower of its carrying amount
at reclassification and fair value less costs to sell. This adjustment is an impairment loss.
19.5.1.2 Subsequent measurement
A non-current asset classified as held for sale should be remeasured (again) to the lower of
its carrying amount and fair value less costs to sell at year end.
19.5.1.3 Recognition of impairment losses
The classification and measurement of non-current assets in terms of IFRS 5.15 can lead to
an impairment loss when the carrying amount of the non-current asset exceeds its fair value
less costs to sell. This can be the case for both initial and subsequent measurement.
In the case of an individual non-current asset that has been classified as held for sale, the
impairment loss calculated will be treated in the same manner, regardless of whether the
assets are carried on the cost model or the revaluation model. The carrying amount of the
asset affected (using accumulated depreciation and impairment losses) will be credited and
the impairment loss will be debited in the profit or loss section of the statement of profit
or loss and other comprehensive income (not revaluation surplus).
19.5.1.4 Reversal of an impairment loss
In terms of IFRS 5.21, an entity shall recognise a gain for any subsequent increase in fair
value less costs to sell on an individual asset, but the gain cannot exceed (is limited to) the
cumulative impairment losses recognised in terms of IFRS 5 and previously under IAS 36.
Example 19.4
19.4 Individual asset carried at cost
C Ltd has plant with a cost of R200 000 and a carrying amount of R160 000 on 1 January 20.12
(beginning of the year). Plant is depreciated at 10% per annum on the straight-line basis.
On 30 June 20.12, management decides to dispose of the asset within the next year. All other
criteria to facilitate the classification of the asset as a non-current asset held for sale are met. The
plant’s fair value less costs to sell amounts to R135 000 on 30 June 20.12.
Applying the requirement in IFRS 5.18 that non-current assets to be reclassified as held for sale
need to have their carrying amounts measured in terms of the applicable Standards immediately
before initial classification as held for sale means that IAS 16 will be applied to determine the
carrying amount of the plant involved on 30 June 20.12. Consequently, the carrying amount of the
plant must be calculated as R150 000 (R160 000 – (R200 000 × 10% × 6/12)) raising a
depreciation expense of R10 000 in respect of this asset in 20.12 up to the point of initial
classification as held for sale.
In terms of IFRS 5.15, this newly determined carrying amount of R150 000 must be compared to
the plant’s fair value less costs to sell of R135 000, and be shown at the lower of the two. This will
result in an impairment loss of R15 000 in this case.
If the carrying amount at the initial classification as held for sale was not determined, and the
carrying amount at the beginning of the year was used in the calculation, any impairment loss
arising on reclassification of the asset as held for sale would be overstated by R10 000 –
amounting, in this case, to an impairment loss of R25 000.
Journal entries
30 June 20.12
Dr Cr
R R
continued
Dr Cr
R R
Accumulated depreciation (SFP) (40 000 + 10 000) 50 000
Plant – cost (SFP) 200 000
Asset held for sale – plant (SFP) 150 000
Comment
¾ Once the item has been classified as held for sale, no further depreciation is written-off on it.
Example 19.5
19.5 Reversal of an impairment loss (individual asset)
H Ltd has decided to dispose of an individual imported machine with a carrying amount on date of
classification as held for sale (30 September 20.13) of R100 000. The year end of the company is
31 December. The carrying amount comprises the cost of R200 000, accumulated depreciation of
R75 000 and earlier accumulated impairment losses of R25 000. All the criteria necessary to
classify the asset as held for sale were met initially. The machine’s fair value less costs to sell at
point of classification as held for sale amounted to R80 000.
On 31 December 20.13, the machine held for sale was remeasured and it was found that the fair
value of the asset less costs to sell had increased to R135 000 due to a severe deterioration in the
value of the Rand and an unprecedented demand for this type of machine.
On 30 September 20.13, the classification as held for sale will lead to an impairment loss
The asset must be measured to the lower of the carrying amount (R100 000) and fair value less
costs to sell (R80 000). The result is that an impairment loss of R20 000 (100 000 – 80 000) will be
recognised in the profit or loss section of the statement of profit or loss and other comprehensive
income of 20.13.
On 31 December 20.13, the held for sale machine will be remeasured (subsequent
remeasurement) and this will result in a gain
The asset is currently carried at R80 000. The new fair value less costs to sell on 31 December 20.13
will be R135 000. Potentially, a gain of R55 000 can be recognised. An additional impairment loss
could also have arisen at remeasurement, but in this case the fair value less costs to sell
increased.
However, in terms of IFRS 5.21, the gain on subsequent increase in fair value less costs to sell is
limited to the cumulative impairment losses that were recognised in respect of this asset in the
past in terms of IFRS 5 and IAS 36. The total impairment losses recognised in the past amounted
to R45 000#, being R25 000 (IAS 36 earlier) and R20 000 (IFRS 5 on 30 September 20.13).
Consequently, the total gain of R55 000 may not be recognised, as it is limited to R45 000. The
R45 000 is recognised as a gain on remeasurement of the machine held for sale in the profit or
loss section of the statement or comprehensive income.
The carrying amount of the machine held for sale on 31 December 20.13
The new carrying amount will be R125 000, namely R80 000 (no further depreciation written-off once
classified as held for sale) plus R45 000 (gain limited to total impairment losses recognised in the past).
Journal entries
30 September 20.13
Dr Cr
R R
Asset held for sale – machinery (SFP) 100 000
Accumulated depreciation – machinery (SFP) 100 000
Machinery – cost (SFP) 200 000
continued
Dr Cr
R R
31 December 20.13
Impairment loss reversal (P/L) 45 000
19.5.2 Assets falling outside the scope for measurement requirements

Immediately before the initial classification of an existing non-current asset as held for sale,
the asset should be measured in accordance with the applicable IFRSs.
If a non-current asset falls outside the scope of IFRS 5 in respect of measurement
requirements, the individual asset shall not be restated to the lower of carrying amount and
fair value less costs to sell, but will instead be carried at the value determined by applying
the relevant Standard relating to that asset.
A non-current asset that falls outside the scope of IFRS 5 in respect of the measurement
requirements should be remeasured at year end by applying the relevant Standard relating
to that asset.
Example 19.6
19.6 Individual asset carried at fair value
C Ltd owns an investment property carried at fair value of R2 000 000 on 1 January 20.12
(beginning of the year). The fair value of the investment property is R2 100 000 on 30 June 20.12,
while costs to sell on that date will amount to R150 000. Assume all amounts are material.
On 30 June 20.12, management decides to dispose of the investment property within the next
year. All other criteria to facilitate the classification of the asset as a non-current asset held for sale
have been met.
Applying the requirement in IFRS 5 that non-current assets to be classified as held for sale need to
have their carrying amounts measured in terms of applicable Standards immediately before
classification as held for sale means that IAS 40 would be applied to determine the carrying
amount of the investment property on 30 June 20.12.
However, investment property falls outside the scope of the measurement requirements of
the Standard in terms of IFRS 5.5 and must therefore be carried as a current asset at fair value
only (without deducting costs to sell) once classified as held for sale. Consequently, this newly
determined carrying amount of R2 100 000 (fair value) must not be compared to the fair value less
costs to sell of the item involved (i.e. R1 950 000 [R2 100 000 – R150 000]), as the exception to
measurement requirements applies. The investment property shall now be carried at its new fair
value of R2 100 000.
Journal entries
30 June 20.12
Dr Cr
R R
Asset held for sale – property (SFP) 2 100 000
Investment property (SFP) 2 100 000
19.6 Measurement of a disposal group

19.6.1 Disposal group within the scope for measurement requirements
An entity may dispose of a group of assets and possibly some directly associated liabilities
in a single transaction. If any of the non-current assets included in such a disposal group fall
within the scope of the measurement requirements of IFRS 5, the measurement
requirements of IFRS 5 will apply to the disposal group as a whole.
Immediately before the initial classification of a disposal group as a non-current asset held
for sale, all the assets and liabilities in the disposal group should be measured in
accordance with the applicable IFRSs (irrespective of whether any of the non-current assets
in the group are subject to the measurement requirements of IFRS 5).
The entire group should then be measured to the lower of the group’s carrying amount and
fair value less costs to sell.
On subsequent measurement of a disposal group that falls within the measurement
requirements of IFRS 5, any assets and liabilities that are not within the measurement
requirements of IFRS 5 (but are included in the disposal group), should be remeasured in
accordance with the applicable IFRSs.
The entire group should then be measured to the lower of the group’s carrying amount and
19.6.1.3 Recognition of impairment losses
Any impairment loss should be allocated only to those non-current assets that fall within the
measurement requirements of IFRS 5 (IFRS 5.23). The reduction shall be allocated to these
qualifying non-current assets in the same order (first against goodwill and the remainder
against other assets in proportion to their carrying amounts) as for a normal impairment loss
for a cash generating unit as set out in IAS 36.104(a) and (b) and .122. This means that
current assets forming part of the disposal group will not be reduced by the impairment loss.
19.6.1.4 Reversal of an impairment loss
In terms of IFRS 5.22, an entity shall recognise a gain for any subsequent increase in fair
value less costs to sell on a disposal group:
to the extent that it has not been recognised when restating the fair values of assets
falling outside the scope of the measurement requirements of IFRS 5.5 (share
investments, investment properties, etc.), but
not in excess of the cumulative impairment loss that has been recognised earlier, either
in accordance with IFRS 5 or previously in accordance with IAS 36, on the non-current
assets that are within the scope of the measurement requirements of this IFRS.
The gain recognised for the disposal group shall increase the carrying amounts of non-
current assets falling within the scope of the measurement requirements of IFRS 5 only
(IFRS 5.23). The gain will be allocated to the individual assets in the disposal group in the
same order as a normal impairment loss for a cash generating unit as set out in
IAS 36.104(a) and (b) and .122.
From this the following is derived: Although impairment losses will be allocated to goodwill
and individual non-current assets in the sequence first to goodwill and then to other assets,
IAS 36.122 ignores goodwill completely when allocating subsequent reversals of impairment
losses (i.e. subsequent gains). Reversals of impairment losses may therefore not be
allocated to goodwill at all, but will be allocated only to non-current assets falling within the
scope of the measurement requirements of IFRS 5.
Example 19.7
D Ltd (year end 31 December 20.14) decides on 30 September 20.14 to dispose of a disposal
group within the next year. All the requirements for classification as held for sale have been met;
consequently the disposal group can be classified as held for sale. The carrying amounts of the
items included in the disposal group are the following:
R
Land (on 1 January 20.14): Carrying amount 100 000
Factory building (on 1 January 20.14): Carrying amount
(Cost – R535 715; Accumulated depreciation – R35 715)
(Depreciation: reducing balance at 6,667% per annum) 500 000
Plant (on 1 January 20.14 – acquisition date): Cost
(Depreciation: reducing balance at 13,3333% per annum) 210 000
Inventories: Carrying amount R60 000 on 30 September 20.14
with a net realisable value (NRV) of 50 000
Creditors associated with the plant, inventories and factory building
(on 30 September 20.14) 30 000
Share investments: (assume fair value adjustment through profit or loss)
on 1 January 20.14 (fair value R100 000 on 30 September 20.14) 80 000
The fair value of the disposal group on 30 September 20.14, that is, the date of initial classification as
held for sale, amounted to R880 000, while costs associated with selling the disposal group
amounted to:
Commission on sale of all items in disposal group = R40 000
CGT on disposal of factory = R10 000
In this case, although the share investments fall outside the scope of IFRS 5 regarding
measurement requirements, the disposal group as a whole will be subject to the measurement
requirements, since other non-current assets within the measurement scope of IFRS 5 form part of
the group. The whole disposal group will thus be measured at the lower of carrying amount and
Assets marked with# fall within the scope of the measurement requirements of IFRS 5.
First, determine the carrying amount of all the individual assets in the disposal group at
30 September 20.14
R
#
Land at cost 100 000
#
Factory building [500 000 – (500 000 × 6,667% × 9/12)] (IAS 16 applicable) 475 000
#
Plant [210 000 – (210 000 × 13,3333% × 9/12)] (IAS 16 applicable) 189 000
Inventories – Use NRV since lower than cost (IAS 2 applicable) 50 000
Payables – cost (IFRS 9 applicable) (30 000)
Share investments – fair value (IFRS 9 applicable) 100 000
Total carrying amount 884 000
Second, determine the fair value less costs to sell of the disposal group
at 30 September 20.14
R
Fair value less costs to sell (880 000 – 40 000*) 840 000
* The CGT is excluded specifically per the definition of costs to sell.
continued
Determine the lower of the carrying amount and fair value less costs to sell
on 30 September 20.14
R
Measure the disposal group held for sale at the fair value less costs to sell,
as this is the lower of the two figures calculated 840 000
Calculate the impairment loss incurred on 30 September 20.14
Carrying amount less fair value less costs to sell (884 000 – 840 000) 44 000
Journal entries
30 September 20.14
Dr Cr
R R
Depreciation (P/L) (25 000 + 21 000) 46 000
Accumulated depreciation – factory building (SFP) 25 000
Accumulated depreciation – plant (SFP) 21 000
Write down to net realisable value (P/L) (60 000 – 50 000) 10 000
Share investments (SFP) (100 000 – 80 000) 20 000
Accumulated depreciation – factory building (SFP)
(35 715 + 25 000) 60 715
Accumulated depreciation – plant (SFP) 21 000
Factory building – cost (SFP) 535 715
Plant – cost (SFP) 210 000
Asset held for sale – factory building (SFP) 475 000
Asset held for sale – land (SFP) 100 000
Land (SFP) 100 000
Asset held for sale – inventories (SFP) 50 000
Asset held for sale (SFP) 100 000
Investments (SFP) 100 000
Liabilities associated with assets held for sale (SFP) 30 000
Comment
¾ All the assets and liabilities in the disposal group initially classified as held for sale will first be
measured to their carrying amounts by applying the IFRSs applicable to them. Note how the
specific values of the individual items are determined.
¾ The fair value less costs to sell of the whole disposal group is then determined. The calculation
of fair value less costs to sell is per definition.
¾ The disposal group will then be measured to the lower of its carrying amount and fair value less
costs to sell. This is done by allocating the impairment loss of R44 000 to non-current assets
within the scope of the measurement requirements of IFRS 5. Refer to the following example
for the allocation of the impairment loss and journal entries.
Example 19.8
19.8 Allocation of an impairment loss
The information in the previous example is used here to illustrate the accounting treatment of an
impairment loss. Assets marked with # will fall within the scope of the measurement requirements
of IFRS 5.
The impairment loss calculated amounted to R44 000 and the whole amount will appear in the
profit or loss section of the statement of profit or loss and other comprehensive income. Since the
total of non-current assets subject to impairment amounted to R764 000# = 100 000 + 475 000
+189 000, the allocation of the impairment loss to the individual assets will be as follows:
Carrying CA after
Impairment
amounts on impairment
loss allocated
classification loss
R R R
#
Land 100 000 (5 759) (1) 94 241
#
Factory building 475 000 (27 356) (2) 447 644
#
Plant 189 000 (10 885) (3) 178 115
Inventories 50 000 – (4) 50 000
Payables (30 000) – (5) (30 000)
Share investments 100 000 – (6) 100 000
Total carrying amount 884 000 (44 000) 840 000
(1) 44 000 × 100 000/764 000
(2) 44 000 × 475 000/764 000
(3) 44 000 × 189 000/764 000
(4) Asset already subjected to a net realisable value test in terms of IAS 2 – the equivalent of
impairment tests for current assets – and IFRS 5.23 specifically refers to only non-current
assets for allocation of impairment loss.
(5) Not an asset and not subject to impairment.
(6) Since IFRS 5.23 specifically states that only non-current assets that fall within the scope of
the measurement requirements of IFRS 5.5 must be reduced by the impairment loss for the
disposal group, and investments fall outside the scope of measurement requirements, no
portion of the impairment loss is allocated to the share investments. This will also be the case
if the share investments were an investment property carried under the fair value model.
Journal entries
30 September 20.14
Dr Cr
R R
Asset held for sale – factory building (SFP)
([465 000/(100 000 + 475 000 + 189 000)] × 44 000) 27 356
Asset held for sale – plant (SFP)
([189 000/(100 000 + 475 000 + 189 000)] × 44 000) 10 885
Asset held for sale – land (SFP)
([100 000/(100 000 + 475 000 + 189 000)] × 44 000) 5 759
Example 19.
19.9 Reversal of an impairment loss (disposal group)
D Ltd (year end 31 December 20.14) decided on 30 September 20.14 to dispose of a disposal
group within the next year. All the requirements for classification as held for sale have been met;
consequently the disposal group can be classified as held for sale on this date. The carrying
amounts of the items included in the disposal group on 30 September 20.14 (after initial
classification as held for sale and measurement resulting in an impairment loss of R44 000 being
recognised for the disposal group) and 31 December 20.14 (where applicable) are the following
(refer to previous example):
R
Land: Carrying amount (30 September 20.14) 94 241
Factory building: Carrying amount (30 September 20.14) 447 644
Depreciate using reducing balance at 6,667% per annum
Plant: Carrying amount (30 September 20.14)
Depreciate using reducing balance at 13,333% per annum 178 115
Inventories: Carrying amount (30/9/20.14) 50 000
(On 31 December 20.14 = R30 000 being the new net realisable value for
inventory and after selling some items between 30 September and
31 December 20.14)
Payables related to the plant, inventories and factory building
Carrying amount (30 September 20.14) 30 000
(On 31 December 20.14 – R15 000 as the rest paid off in the interim)
Share investments: Carrying amount (30 September 20.14) 100 000
(On 31 December 20.14 – R120 000 being the new fair value of the investment)
The fair value of the disposal group on 31 December 20.14, point of
remeasurement of the disposal group, amounted to R960 000, while costs
associated with the sale amounted to:
Commission on sale of investment, land, factory and plant 50 000
CGT on disposal of investment and plant 15 000
Finance costs 4 000
The amount of the gain (reversing an earlier impairment loss) on remeasurement that must be
reflected in the profit or loss section of the statement of profit or loss and other comprehensive
income will be the following, if no impairment loss other than the R44 000 has previously been
recognised:
The subsequent gain or reversal of impairment loss recognised at remeasurement of the disposal
group will increase the carrying amounts of only the non-current assets in the disposal group that
fall within the scope of the measurement requirements of IFRS 5.
Current assets and liabilities will not be affected by a subsequent gain or reversal in terms of
IFRS 5, as the measurement scope applies only to non-current assets. Changes to these balances
will affect the fair value less costs to sell of the disposal group as a whole and adjustments will
have to be made to these amounts to reflect the effect of selling inventory and settling creditors.
Furthermore, any increase in fair value of the share investments at date of remeasurement (falling
outside the measurement scope of IFRS 5) will be recognised in their carrying amounts, as this will
translate into an equivalent increase in the fair value of the disposal group as a whole. This means
that the increase in the fair value of share investments will be reflected in both the revised carrying
amount and fair value less costs to sell of the disposal group – thus having a nil effect.
continued
First, determine the revised carrying amounts (if applicable) of all the individual assets in
the disposal group on 31 December 20.14
R
Land (still the same as before as not depreciable) 94 241
Factory building (has not changed since no depreciation written off now) 447 644
Plant (has not changed since no depreciation written off now) 178 115
Inventories – at net realisable value since lower than cost (IAS 2) 30 000
Payables – at cost (IFRS 9) (15 000)
Share investments – revised fair value (IFRS 9) 120 000
on 31 December 20.14
*The CGT and finance cost are excluded specifically per the definition of costs to sell.
Calculate the impairment loss to be reversed on 31 December 20.14
Fair value less costs to sell at date of remeasurement 910 000
Carrying amount at date of r-measurement 855 000
Reversal of impairment loss recognised in terms of IFRS 5 55 000
Calculate limit on impairment loss to be reversed on 31 December 20.14

Cumulative impairment losses written off in the past 44 000
Reversal of impairment loss 55 000
Limited to R44 000, namely the earlier impairment losses written off 44 000
Allocation of reversal of impairment loss (effectively a gain) to individual non-current

assets on 31 December 20.14 within the measurement scope of IFRS 5
Land: [44 000 × 94 241/(94 241 + 447 644 + 178 115)] 5 759
Factory building: (44 000 × 447 644/720 000) 27 356
Plant: (44 000 × 178 115/720 000) 10 885
Journal entries
31 December 20.14
Dr Cr
R R
Asset held for sale – land (SFP) 5 759
Asset held for sale – factory building (SFP) 27 356
Reversal of impairment loss (P/L) 44 000
Comment
¾ As in the case of an impairment loss, the reversal of the impairment loss will be allocated to the
carrying amounts of the non-current assets originally affected by it on a pro rata basis, based
on their carrying amounts before allocating the reversal.
¾ Goodwill can, however, never be reinstated once written off and any reversal of an impairment
loss will thus be added back only to non-current assets falling within the scope of the
measurement requirements of IFRS 5 (excluding goodwill).
continued
New carrying amounts of items in the disposal group after reversing impairment loss on
31 December 20.14
R
Land (94 241 + 5 759)# 100 000
Factory building (447 644 + 27 356)# 475 000
Plant (178 115 + 10 885)# 189 000
Inventories – NRV since lower than cost (IAS 2) 30 000
Payables – cost (IAS 39/IFRS 9) (15 000)
Share investments – fair value (IAS 39/IFRS 9) 120 000
Total carrying amount after remeasurement* 899 000
* The new carrying amount of the disposal group after reversal of the impairment loss subject to
the R44 000 limit, is not R910 000, but only R899 000.
#
The non-current assets have been restated to their original carrying amounts before the
recognition of the original impairment loss of R44 000. Without the limit on the reversal of the
impairment loss, carrying amounts would have been higher than the original carrying amounts of
the asset.
Comment
¾ The assets in the disposal group classified as held for sale that are excluded from the scope of
measurement requirements will still be measured at their fair value.
¾ The inventories and payables in the disposal group have to be adjusted since some payables
have been paid and some inventory sold, but are not restated in terms of IFRS 5 as it applies
only to non-current assets.
¾ The non-current assets in the disposal group included in the measurement scope of IRFS 5 will
not be remeasured before determining the new fair value less costs to sell on remeasurement.
¾ The fair value less costs to sell of the whole disposal group is remeasured.
¾ The reversal of the impairment loss will be added to the non-current assets previously impaired
in the ratio of their carrying amounts before allocation of the reversal of the impairment loss.
19.6.2 Disposal group outside the scope for measurement requirements

Immediately before the initial classification of a disposal group as a non-current asset held
for sale, all the assets and liabilities in the disposal group should be measured in
accordance with the applicable IFRSs (irrespective of whether any of the non-current assets
in the group are subject to the measurement requirements of IFRS 5).
If none of the assets in a disposal group fall within the scope of the measurement
requirements of IFRS 5, no remeasurement will occur immediately after classification as
held for sale.
If none of the assets in a disposal group fall within the scope of the measurement
requirements of IFRS 5, then the measurement requirement of IFRS 5 will not be applicable to
the disposal group and the assets in the group will merely be carried at their values
determined by applying their applicable Standards.
Example 19.10
E Ltd (year end 31 December 20.14) decides on 30 June 20.14 to dispose of all its share
investments in one transaction at some point during the next year. The disposal group has met all
the requirements for classification as held for sale; consequently it can be classified as held for
sale. The carrying amounts of the items included in the disposal group are the following:
Speculative share investments at fair value on 1 January: R65 000; 30 June: R80 000
Long-term share investments at fair value (designated as fair value through profit or loss) on
1 January: R93 000; 30 June: R100 000
The fair value of the disposal group on 30 June 20.14 amounted to R180 000, while costs
associated with selling amounted to:
Commission on sale of both investments = R20 000 (assumed)
CGT on disposal of investments = R5 000 (assumed)
Share investments fall outside the scope of IFRS 5 regarding measurement requirements;
therefore the disposal group as a whole will be excluded from the second measurement
requirements of IFRS 5. As a result, the investments will be shown at fair value without deducting
costs to sell, instead of at the lower of carrying amount and fair value less costs to sell.
First, determine the carrying amount of the individual assets in the disposal group on
30 June 20.14
R
Speculative share investments – fair value (IFRS 9) 80 000
Other share investments – fair value (IFRS 9) 100 000
This calculation will not be necessary as the whole disposal group is excluded from the scope of
the measurement requirements of IFRS 5. The costs to sell will thus not be used.
Determine the lower of carrying amount and fair value less costs to sell
This calculation will not be necessary as the whole disposal group is excluded from the scope of
the measurement requirements of IFRS 5.
Calculate the impairment loss suffered on 30 June 20.14
Not applicable.
Comment
¾ The assets in the disposal group reclassified as held for sale will first be measured to their
carrying amounts at point of classification as held for sale by applying the IFRSs applicable to
them. In this case, the fair value adjustment to the investments will be R22 000 in total
(R180 000 – R158 000). This amount is taken to profit and loss.
¾ The fair value less costs to sell of the whole disposal group is not determined as all assets in
the disposal group fall outside the scope of the measurement rules of IFRS 5.
¾ The disposal group will still be measured at fair value determined at date of classification as
held for sale.
Journal entries
30 June 20.14
Dr Cr
R R
Speculative share investments (SFP) 15 000
Long-term share investments (SFP) 7 000
Assets held for sale – investments (SFP) 180 000
Speculative share investments (SFP) 80 000
Long-term share investments (SFP) 100 000
19.6.3 Newly acquired asset (or disposal group)

Although the measurement requirements in IFRS 5 generally would apply to assets that
have been in the possession of an entity for some time and are now up for sale/disposal,
non-current assets are sometimes acquired with a view to disposal in the short term.
Consequently, if a newly acquired asset (or disposal group) that is normally classified as
non-current (e.g. plant) meets the criteria to be classified as held for sale, applying the
measurement requirements of IFRS 5 will result in the asset (or disposal group) being
measured even on initial recognition at the lower of its carrying amount had it not been
classified as held for sale (normally its cost) and its fair value less costs to sell. It follows that
if the asset (or disposal group) is acquired as part of a business combination, it shall be
measured at acquisition at fair value less costs to sell.
Example 19.11
19.11 New asset initially classified as a non-current asset held for sale
B Ltd purchases plant with a cost price of R200 000 and a fair value of R210 000 for cash. Costs
to sell amount to R20 000. The plant was acquired with a view to dispose of it within the next six
months. All other criteria necessary for classification as a non-current asset held for sale have
been met.
Following the general principles discussed above, this plant will be measured at the lower of its
cost and fair value less costs to sell at initial recognition. This means that the plant will be
recognised at initial recognition at R190 000 (R210 000 – R20 000).
Journal entry
Date of purchase
Dr Cr
R R
Assets held for sale – plant (SFP) 190 000
Bank (SFP) 200 000
19.6.4 Costs to sell

When the sale of the non-current asset is expected to occur later than one year from date of
reclassification (the maximum selling period allowed) and provided the additional criteria
have been complied with, the entity shall measure the costs to sell at their present value.
Any increase in the present value of the costs to sell that arises from the passage of time
shall be presented in profit or loss as a financing cost.
Example 19.12
19.12 Costs to sell discounted
B Ltd decided at 30 June to sell plant with a carrying amount of R204 000 and a fair value of
R206 000, within the next 18 months. The costs to sell amounted to R5 000. Assume that these
estimates were unchanged at year end (31 December). All other criteria necessary for
classification as a non-current asset held for sale have been met and the extension of the period
beyond 12 months is acceptable. A fair discount rate is 12% per annum, compounded monthly.
As the sale is expected to occur beyond a year, the costs to sell should be discounted to a present
value.
30 June: R4 180 (n=18; i=1; FV=5 000)
31 December (year end): R4 437 (n=12; i=1; FV=5 000)
continued
Journal entries
Dr Cr
30 June R R
Assets held for sale – plant (SFP) (206 000 – 4 180) 201 820
Impairment loss (P/L) ((206 000 – 4 180) – 204 000) 2 180
Plant (SFP) 204 000
31 December
Finance cost (P/L) 257
Assets held for sale – plant (SFP) ((206 000 – 4 437) – 201 820)) 257
19.7 Recognition of gains and losses at date of sale of a non-current

asset
A gain or loss not already recognised at either initial classification or subsequent
remeasurement will, on the sale of a non-current asset (or disposal group), be recognised in
the profit or loss section of the statement of profit or loss and other comprehensive income
(and never in the revaluation reserve) on the date of derecognition. The requirements for
derecognition of non-current assets falling within the scope of IFRS 5 are contained in:
IAS 16.67 to .72 for PPE and IAS 38.112 to .117 for intangible assets (refer to chapters 9
and 20 for details). These derecognition requirements are:
The gain or loss arising from derecognition of an item of PPE/intangible asset shall be
included in the profit or loss section of the statement of profit or loss and other
comprehensive income when the item is derecognised (unless IAS 17 requires otherwise
on a sale and leaseback). Gains shall not be classified as revenue.
In determining the date of disposal of an item, an entity applies the criteria in IFRS 15 for
recognising revenue from the sale of goods – all the criteria must be met. IAS 17 applies
to disposal by a sale and leaseback.
The gain or loss arising from the derecognition of an item of property, plant and
equipment shall be determined as the difference between the net disposal proceeds, if
any, and the carrying amount of the item.
The consideration receivable on disposal of an item of property, plant and equipment is
recognised initially at its fair value. If payment for the item is deferred, the consideration
received is recognised initially at the cash price equivalent. The difference between the
nominal amount of the consideration and the cash price equivalent is recognised as
interest income under IFRS 15, and reflects the effective yield on the receivable.
Example 19.1
19.13 Derecognition of an asset classified as held for sale
G Ltd (year end 31 December 20.14) classified plant as held for sale on 30 June 20.14 after all the
criteria for classification had been met. An impairment loss of R20 000 was recognised in profit
and loss, resulting in a carrying amount of R840 000. On 31 December 20.14, the fair value less
costs to sell of plant was once again lower than its carrying amount on that date and the item was
subsequently remeasured at fair value less costs to sell of R800 000, with an impairment loss of
R40 000 recognised in profit or loss. The plant is finally disposed of for R810 000 on 30 April 20.14
after all the criteria for derecognition have been met.
continued
A summary of the effect of the above scenario on the profit or loss section of the statement of
profit or loss and other comprehensive income in 20.14 and 20.15 is the following:
In 20.14
An initial impairment loss of R20 000 was recognised at initial classification as held for sale on
30 June 20.14. A second impairment loss of R40 000 (840 000 – 800 000) was recognised at re-
measurement on 31 December 20.14.
In 20.15
A final gain of R10 000 (810 000 – 800 000) is recognised on derecognition of the plant on final
disposal.
19.8 Non-current assets to be abandoned

Although abandonment is a criterion for derecognition, the recovery of carrying amounts in
the case of abandonment and disposal is different.
This difference in treatment arises since the carrying amount of the abandoned asset (or
disposal group) will be recovered principally through continuing use, while that of an asset
(or disposal group) held for sale will be recovered through sale. Consequently, an entity shall
not classify as held for sale a non-current asset (or disposal group) that is to be abandoned.
Non-current assets (or disposal groups) to be abandoned include non-current assets (or
disposal groups) that are to be used to the end of their economic life, as well as non-current
assets (or disposal groups) that are to be closed down rather than sold.
However, if the disposal group to be abandoned meets the criteria for qualification as a
discontinued operation (dealt with later in this chapter), the entity shall present the results
and cash flows of the disposal group as a discontinued operation on the date on which it
ceases to be used.
An entity shall not account for a non-current asset that has been temporarily taken out of
use as if it had been abandoned. An asset removed from use temporarily will still be
depreciated as it is still available for use, as explained in chapter 9.
19.9 Changes to a plan of sale

19.9.1 General
If an entity has previously classified an asset (or disposal group) as held for sale, but the
criteria for classification as held for sale are no longer met, the entity shall cease to classify
the asset (or disposal group) as held for sale. Under these circumstances, the non-current
asset that ceases to be classified as held for sale (or ceases to be included in a disposal
group classified as held for sale) shall be measured at the lower of:
the carrying amount before the asset (or disposal group) was classified as held for sale,
adjusted for any depreciation, amortisation or revaluations that would have been
recognised had the asset (or disposal group) not been classified as held for sale; and
the recoverable amount on the date of the subsequent decision not to sell.
If the non-current asset is part of a cash generating unit, this recoverable amount is the
carrying amount that would have been recognised after the allocation of any impairment loss
arising on that cash generating unit in accordance with IAS 36.
19.9.2 Individual assets no longer classified as held for sale

Any required adjustment to the carrying amount of a non-current asset that ceases to be
classified as held for sale must be included in profit from continuing operations in the period
in which the criteria for classification as held for sale are no longer met.
The adjustment must be included in the profit or loss section of the statement of
comprehensive income when measuring an item that has been classified as held for sale
which is not a discontinued operation. The line item in which the adjustment is included must
be disclosed. If the asset under consideration is either an item of property, plant and
equipment or an intangible asset that has been carried under the revaluation model in terms
of IAS 16 or IAS 38, the adjustment shall be treated as a revaluation increase or decrease in
the other comprehensive income section of the statement of profit or loss and other
Example 19.1
19.14 Reclassification of an individual asset
M Ltd classified a broadcasting licence as held for sale on 30 June 20.14 (its year end) as it had
met all the criteria for classification as held for sale on that date. The licence had a carrying
amount of R3 600 000 at year end, an original cost of R6 000 000 and amortisation on the item is
written off at 20% per annum on the straight-line basis with no residual value anticipated at any
time in the future.
Due to a change in broadcasting legislation promulgated on 1 April 20.15, M Ltd decided not to
dispose of the broadcasting licence; consequently the asset had to be reclassified. The
recoverable amount of the asset under consideration amounted to R2 600 000 on 1 April 20.15
and its useful life on that date was 2,25 years.
The carrying amount at which the broadcasting licence must be reinstated on 1 April 20.15, due to
the decision to no longer sell it, is the adjusted carrying amount, as well as the applicable
amortisation for 20.15. Also state under which caption (line item) on the statement of profit or loss
and other comprehensive income the adjustment to the carrying amount must be reflected.
The asset no longer classified as held for sale must be reinstated at the lower of what its carrying
amount would have been had it never been classified as held for sale, and its recoverable amount.
Calculate what the carrying amount would have been on 1 April 20.15 if the intangible asset
had never been classified as held for sale
R
Carrying amount on 30 June 20.14 3 600 000
Amortisation from 1 July 20.14 to 31 March 20.15 (6 000 000 × 20% × 9/12) (900 000)
Carrying amount on 1 April 20.15 2 700 000
Recoverable amount on 1 April 20.15 2 600 000
The lower of the two is the recoverable amount of R2 600 000; therefore the asset must be
remeasured to this amount on 1 April 20.15.
Calculate the adjustment to the existing carrying amount on reclassification
R
Held for sale item carried at 3 600 000
Carrying amount on 1 April 20.15 once no longer held for sale 2 600 000
Adjustment to carrying amount – write-off 1 000 000
Amortisation during 20.15
The new carrying amount on 1 April 20.15 from the previous calculation is R2 600 000, while the
remaining useful life would be 2,25 years on that date. Since the residual value of the broadcasting
licence is Rnil, the amortisation for 20.15 will be R288 889 (R2 600 000/2,25 × 3/12).
Where on the statement of profit or loss and other comprehensive income must the adjustment on
restatement on 1 April 20.15 be disclosed?
continued
The adjustment of R1 000 000 must be disclosed as a deduction from other income or as part of
other expenses.
Journal entries
Dr Cr
R R
30 June 20.14
Asset held for sale (SFP) 3 600 000
Accumulated amortisation – Intangible asset (SFP) 2 400 000
Intangible asset (broadcasting licence) – Cost (SFP) 6 000 000
1 April 20.15
Fair value adjustment (P/L) 1 000 000
Intangible asset (broadcasting licence) (SFP) 2 600 000
30 June 20.15
Amortisation (P/L) 288 889
Accumulated amortisation – Intangible asset (SFP) 288 889
19.9.3 Individual item that is part of disposal group no longer classified

as held for sale
If an individual asset or liability is removed from a disposal group classified as held for sale,
the remaining assets and liabilities of the disposal group still to be sold will continue to be
measured as a disposal group only if the disposal group still meets the criteria in section 19.3.1.
Otherwise, the remaining non-current assets of the disposal group that individually still meet
the criteria to be classified as held for sale will be measured individually at the lower of their
carrying amounts and fair values less costs to sell at that date. Any non-current assets that no
longer meet the criteria shall cease to be classified as held for sale.
Example 19.1
19.15 Reclassification of an individual asset forming part of a disposal group
On 2 January 20.14, N Ltd (year end 31 December 20.13) classified the following group of assets
as a disposal group held for sale, having met all the criteria for classification as held for sale
required by IFRS 5. The effect of the classification as held for sale and measurement at initial
classification is set out in the table below:
Carrying
Impairment
amounts CA after
loss
before classification
allocated
classification
R R R
Land 100 000 5 759 94 241
Factory building (not occupied) 475 000 27 356 447 644
Widget plant# 189 000 10 885 178 115
Inventories 50 000 – 50 000
Payables (30 000) – (30 000)
Share investments 100 000 – 100 000
Total carrying amount 884 000 44 000 840 000
#
Depreciation provided for at 15% per annum, straight-line, based on a cost of R240 000 (no
residual value). The recoverable amount of the Widget plant based on value in use is R180 000
on 31 May 20.14, while the remaining useful life of the Widget plant on 31 May 20.14 is
five years and three months. The residual value of the asset has not changed and is still Rnil.
continued
On 31 May 20.14, the directors reconsidered the assets held for sale and decided not to dispose of
the Widget plant, as they had unexpectedly secured a large contract for the production of Widgets
for the next five years. Consequently, the Widget plant was removed from the disposal group. The
inventories retained their net realisable value determined on 2 January 20.14 and all payables
have been repaid since initial classification as held for sale. The fair value of the share investments
has not changed. The group still meets the criteria for classification as a disposal group after the
removal of the Widget plant.
Determine the carrying amount of the Widget plant after the decision to no longer sell it has been
made, the adjustment to the profit or loss section of the statement of profit or loss and other
comprehensive income due to the reclassification, the depreciation charge for 20.14, and the
carrying amount of the disposal group after the removal of the Widget plant.
Carrying amount of the Widget plant on removal from the disposal group on 31 May 20.14
R
Carrying amount as it would have been if the disposal group had never been classified
as held for sale [R189 000 – (240 000 × 15% × 5/12)] 174 000
Recoverable amount (given) 180 000
The lower of the two alternatives must be taken, thus R174 000.
Adjustment on the statement of profit or loss and other comprehensive income of 20.14 due
to reclassification
R
Carrying amount determined on 2 January 20.14 178 115
Carrying amount determined on 31 May 20.14 174 000
Adjustment on statement of profit or loss and other comprehensive income
– loss recognised 4 115
Comment
¾ The adjustment in respect of reclassification of the Widget plant would have been different if the
recoverable amount was (say) R160 000 (i.e. lower than the carrying amount on 31 May of
R174 000).
Depreciation charge for 20.14 on the Widget plant
Carrying amount on 31 May 20.14 174 000
Depreciation charge (174 000/5,25 × 7/12) 19 333
Carrying amount of disposal group after removal of the Widget plant on 31 May 20.14
R
Carrying amount including the Widget plant 840 000
Carrying amount excluding the Widget plant (840 000 – 178 115 + 30 000) 691 885

19.10.1 Deferred tax on an individual asset measured at cost classified as held
for sale
Deferred tax in the case of a non-current asset arises from recovering the carrying amount
of the asset either through use or sale – consequently realising taxable income (from an
income tax or a capital gains tax (CGT) perspective) in the process. The tax base of the
asset under discussion is then compared to its temporary difference carrying amount. If the
carrying amount exceeds the tax base, a taxable temporary difference will arise and a
deferred tax liability will result. If the tax base exceeds the carrying amount, a deductible
temporary difference will arise that will result in a deferred tax asset.
From the abovementioned, it seems that the deferred tax implications of classifying non-
current assets as held for sale will result from adjustments to the carrying amounts of the
assets involved, rather than from adjustments to the tax bases of the assets involved, and that
different tax rates may apply as assets are not recovered through use but through sale. The
treatment of deferred tax arising from an impairment loss resulting from initially classifying
an asset as held for sale (or later from subsequently remeasuring it), is thus similar to that of
a normal impairment loss.
Example 19.1
19.16 Deferred tax (individual asset at cost)
C Ltd has plant with a cost of R200 000 and a carrying amount of R160 000 (asset two years old)
on 1 January 20.12 (beginning of the year). Plant is depreciated at 10% per annum on the
straight-line basis. The South African Revenue Service (SARS) allows a tax allowance at 20% per
annum on cost, not apportioned for a part of a year. C Ltd’s year end is 31 December. Assume a normal
income tax rate of 28%.
On 30 June 20.12, management decides to dispose of the plant within the next year. All other
criteria to facilitate the initial classification of the asset as a non-current asset held for sale have
been met. The plant’s fair value less costs to sell amounts to R135 000 at that stage. On
31 December 20.12, when it is subsequently remeasured, the fair value less costs to sell have
changed to R125 000. The plant is finally sold on 31 March 20.13 (nine months after meeting the
criteria for classification as held for sale) for R120 000.
Applying the IFRS 5 principles to the plant makes it clear that the carrying amount of the PPE item
must be adjusted from R160 000 at the beginning of 20.12 to R150 000 (writing off depreciation of
R10 000) at initial classification as held for sale (30 June 20.12). Following that, the carrying
amount must be reduced to R135 000, being the fair value less costs to sell (lower than carrying
amount of R150 000) on 30 June 20.12. At the end of 20.12, as the plant has not yet been sold,
the fair value less costs to sell has dropped to R125 000. The carrying amount must thus be
reduced to R125 000. The plant is finally sold for R120 000 on 31 March 20.13. A Ltd continued to
use the plant after it had been classified as held for sale (it was still available for immediate sale).
From a tax perspective, the tax base of the plant will be reduced from R120 000 [R200 000 –
(R200 000 × 20% × 2 years)] at the beginning of the year to R80 000 (20% tax allowance on
R200 000 not apportioned for a part of a year) at initial classification as held for sale. The deferred
tax implications resulting from the classification as held for sale during the period 1 January 20.12
to 31 March 20.13 are illustrated in the table below:
Deferred tax
Deferred
Carrying Temporary
Tax base tax
amount difference
@ 28%
R R R R
1 January 20.12 Balance 160 000 120 000 40 000 11 200
#
Depreciation/Tax allowance to 30 June 20.12 (10 000) (40 000) 30 000 8 400
Held for sale balance 150 000 80 000 70 000 19 600
Impairment loss (15 000) – (15 000) (4 200)
30 June 20.12 Balance 135 000 80 000 55 000 15 400
Depreciation/Tax allowance to 31 Dec 20.12 – – – –
Impairment loss (10 000) – (10 000) (2 800)
31 December 20.12 Balance 125 000 80 000 45 000 12 600
#
Depreciation/Tax allowance to 31 March 20.13 – (40 000) 40 000 11 200
31 March 20.13 Balance 125 000 40 000 85 000 23 800
31 March 20.13 Sold (125 000) (40 000) (85 000) (23 800)
31 December 20.13 Balance – – – –
#
Not apportioned for a part of a year.
continued
Comment
¾ The initial impairment loss will result in a loss of R15 000 recognised in the profit or loss section
of the statement of profit or loss and other comprehensive income and a reduction of R4 200 in
the tax charge on the statement of profit or loss and other comprehensive income via deferred tax.
The impairment loss amounting to R10 000 on subsequent remeasurement will now result in a loss
of R10 000 and a reduction in the tax expense of R2 800 recognised in the profit or loss section of
the statement of profit or loss and other comprehensive income.
¾ The final loss recognised on disposal will be R5 000 (125 000 – 120 000). Deferred tax of
R23 800 associated with the derecognition of the asset will be reversed from the deferred tax
liability on the statement of financial position and will be credited in the tax expense in the profit
or loss section of the statement of profit or loss and other comprehensive income via deferred
tax. The current tax on the sale will be R22 400, based on the R80 000 recoupment, taxed at
28%. The difference between the R23 800 credit in deferred tax in the profit or loss section of
the statement of profit or loss and other comprehensive income and the current tax of R22 400
is a credit of R1 400, which represents the tax saving at 28% on the loss of R5 000 in respect of
the disposal of the asset at R120 000.
19.10.2 Deferred tax on an individual asset measured at revaluation classified as

held for sale
The same basic principles in respect of the recovery of the carrying amount of a non-current
asset will apply to an asset carried under the revaluation model as contained in IAS 16 and
IAS 38. Impairment losses on the revalued asset will be taken directly to the profit or loss
Example 19.1
19.17 Deferred tax (individual asset at revaluation)
D Ltd has a plant item with a cost of R200 000 and a revalued carrying amount of R240 000 (the
cost-carrying amount would have been R160 000) on 1 January 20.12 (beginning of the year) after
a revaluation on that date. Plant is depreciated on the straight-line basis and the remaining useful
life of the asset under consideration (eight years) has not changed. The SARS allows a tax
allowance at 20% per annum on cost, not apportioned for a part of a year. Assume a normal income
tax rate of 28% and a capital gains tax inclusion rate of 80%. Revaluation surpluses are realised
through use and any remaining balance on the revaluation surplus is transferred directly to
retained earnings on disposal.
On 30 June 20.12, management decides to dispose of this asset within the next year. All other
criteria to facilitate the classification of the asset as a non-current asset held for sale are met. The
fair value less costs to sell of the plant amounts to R215 000 at that stage, but on
31 December 20.12, when it is remeasured, the fair value less costs to sell changed to R205 000.
The asset is finally sold on 31 March 20.13 (9 months after meeting the criteria for classification as
held for sale) for R220 000.
It is clear that the carrying amount of the plant increased from R160 000 to R240 000 when the
revaluation took place. Applying the IFRS 5 principles to the plant, the R240 000 at the beginning
of 20.12 will be depreciated to R225 000 (writing off depreciation of R15 000, being R240 000/8
× 6/12) at initial classification as held for sale (30 June 20.12). Thereafter, the carrying amount
must be reduced to R215 000, being the fair value less costs to sell (lower than carrying amount of
R225 000) on 30 June 20.12. At the end of 20.12, the asset has not yet been sold and the fair
value less costs to sell has dropped to R205 000. The carrying amount must thus be reduced to
R205 000. The asset is finally sold for R220 000 on 31 March 20.13.
continued
From a tax perspective, the tax base of the asset will be reduced from R120 000
(R200 000 – (R200 000 × 20% × 2 years)) at the beginning of the year to R80 000 (20% tax
allowance on R200 000 not apportioned) at initial classification as held for sale. The deferred tax
implications resulting from the classification as held for sale during the period 1 January 20.12 to
31 March 20.13 are illustrated in the table below:
Carrying Carrying Temporary Deferred tax
Tax
amount amount @ 28% /
base difference
revaluation historical 28% × 80%
R R R R R
31 December 20.12 Balance 160 000 160 000 120 000 40 000 11 200
Revaluation surplus
1 January 20.12 80 000 – – 80 000 22 400
1 January 20.12 Balance 240 000 160 000 120 000 120 000 33 600
Depreciation /
Tax allowance to 30 June 20.12 (15 000) (10 000) (40 000) 25 000 7 000
Classified as held for sale 225 000 150 000 80 000 145 000 40 600
Excess deferred tax written
back to revaluation surplus
(refer to comment) – – – – (1 400)
225 000 150 000 80 000 145 000 39 200
Impairment loss (10 000) * – (10 000) (2 240)
30 June 20.12 Balance 215 000 80 000 135 000 36 960
Depreciation/Tax allowance
to 31 December 20.12 – * – – –
Impairment loss (10 000) * – (10 000) (2 240)
31 December 20.12 Balance 205 000 80 000 125 000 34 720
Depreciation /
Tax allowance 31 March 20.13 – * (40 000) 40 000 11 200
#
31 March 20.13 Balance 205 000 * 40 000 165 000 45 920
31 March 20.13 Sell (205 000) * (40 000) (165 000) (45 920)
* All these adjustments are at above original cost so do not impact on the cost calculations at all –
therefore there are no entries in this column.
#
Proof of the deferred tax balance:
R
Income tax on recoupment of R160 000 (200 000 – 40 000) at 28% 44 800
Capital gains tax on excess carrying amount above cost since intention of recovery
has changed to sale (205 000 – 200 000) at 28% × 80% 1 120
Total deferred tax balance on table 45 920
Comment
¾ Initially the intention was to recover the carrying amount of the revalued asset through use;
therefore deferred tax on total temporary differences was provided for at 28%.
¾ However, the fact that the asset under consideration had been classified as held for sale on
30 June 20.12, signifies a change in intention regarding the recovery of the carrying amount –
the asset will now no longer be recovered through use, but rather through sale.
continued
From a tax perspective, a total profit of R145 000 (R225 000 – R80 000) will be realised. Of this
profit, R120 000 (R200 000 (cost) – R80 000 (TB)) will constitute a recoupment of an earlier tax
allowance allowed – this would attract tax at 28%. The excess of tax profit above R200 000
(cost) namely R25 000, will, however, be subject to CGT (28% × 80%) if one assumes that the
cost and base cost of the asset are the same – consequently the R25 000 of the carrying
amount above base cost/cost must be taxed at 28% × 80% instead of 28% as it stands now.
This means that deferred tax on the R25 000 under the assumption of recovery through use will
have been provided for at 28%, while current tax on it will eventually be paid at only
28% × 80% – thus a reversal of excess deferred tax of R1 400 ((R25 000 × 28%) – (R25 000 ×
28% × 80%)) is necessary.
¾ The impairment losses at measurement and remeasurement of the carrying amount of the
asset held for sale will reduce the carrying amount of the asset by another R10 000 at each
point and these reductions of R10 000 each will potentially reduce the capital gain on the
disposal of the asset to R5 000. Consequently, the reversal of deferred tax in both cases will be
done at 28% × 80% as the excess deferred tax above cost is already carried at 28% × 80%.
The journal entries related to the above transactions (including deferred tax per the deferred tax
calculation but excluding current tax) will be the following:
Dr Cr
R R
Asset at revaluation (SFP) 240 000
Asset at cost (SFP) 200 000
Accounting for the initial revaluation of the asset
Revaluation surplus (OCI) (80 000 × 28%) 22 400
Accounting for deferred tax on the revaluation surplus
Providing depreciation until classification as held for sale
Deferred tax on depreciation in the statement of profit or loss
and other comprehensive income
Revaluation surplus (equity) (5 000 × 72%) 3 600
Retained earnings (equity) 3 600
After-tax transfer from revaluation surplus to retained
earnings through statement of changes in equity
Transfer of plant to asset held for sale
Correcting deferred tax from 28% to 28% × 80%
due to change in intention in respect of the recovery
of the carrying amount of the asset – previously use, now sale
Revaluation surplus (SCE) (80 000 – 22 400 – 3 600 + 1 400) 55 400
Equity associated with non-current asset held for sale (SCE) 55 400
Transfer of revaluation surplus to equity associated
with non-current asset held for sale
continued
Comment
¾ When the PPE item is classified as held for sale, the accumulated depreciation up to that point
will be eliminated against the asset at revaluation, as would be done for a normal revaluation
(refer to first journal). The net carrying amount is then transferred to assets held for sale.
¾ The impairment losses arising from measuring the asset under discussion at the lower of
carrying amount and fair value less costs to sell are set off directly against this net carrying
amount of the asset held for sale.
Dr Cr
R R
Deferred tax (SFP) (@28% × 80%) 2 240
Recognising impairment loss on classification as held for sale
as well as deferred tax – 30 June 20.12
Deferred tax (SFP) (@28% × 80%) 2 240
Recognising impairment loss on classification as held for sale
as well as deferred tax – 31 December 20.12
Deferred tax effect of writing off tax allowance and no longer
depreciating the asset as classified as held for sale
Bank/Receivables (SFP) 220 000
Gain on disposal (P/L) (220 000 – 205 000) 15 000
Derecognising the asset disposed of
Equity associated with non-current asset held for sale (equity)
(80 000 – 22 400 – 3 600 + 1 400) 55 400
Retained earnings (equity) 55 400
Derecognising deferred tax on asset disposed
of and transferring equity associated with non-current asset
held for sale realised to retained earnings
19.10.3 Deferred tax on disposal group held for sale

The calculation of deferred tax on the classification of a disposal group as held for sale is
similar to the deferred tax calculation in respect of individual assets. However, the difference
lies in the fact that each of the items in the disposal group will have to be assessed individually
– this makes the calculations more complex.
19.11 Disclosure of a non-current asset or disposal group classified as

held for sale
The objective of disclosure of non-current assets and disposal groups held for sale is to
ensure that an entity presents and discloses information that enables users of the financial
statements to evaluate the financial effects of disposals of non-current assets (or disposal
groups). These disclosures in respect of non-current assets held for sale are directly linked
to discontinued operations, and will also appear later in this chapter in respect of
discontinued operations.
Any gain or loss on the remeasurement of a non-current asset (or disposal group) classified
as held for sale that does not meet the definition of a discontinued operation will be included
in profit or loss from continuing operations.
The following must be disclosed:
A non-current asset classified as held for sale and the assets of a disposal group
classified as held for sale separately from other assets on the statement of financial
position – such assets will appear under current assets.
The liabilities of a disposal group classified as held for sale will be presented separately
from other liabilities on the statement of financial position – such liabilities will appear
under current liabilities.
The assets and liabilities in the above two headings will not be off-set and presented as
a single amount (this practice is in conflict with the normal off-setting rules).
The major classes of assets and liabilities classified as held for sale shall be separately
disclosed either on the face of the statement of financial position or in the notes. The
authors propose showing the major classes of assets in the notes to the financial
statements.
Present any cumulative income or expense recognised through other comprehensive
income separately on the statement of financial position relating to a non-current asset
(or disposal group) classified as held for sale – for example revaluation surpluses related
to non-current assets and the mark-to-market reserve of an available for sale financial
asset.
Notes
The following must be disclosed:
In the period in which a non-current asset (or disposal group) is classified either as held
for sale or sold:
– a description of the non-current asset (or disposal group);
– a description of the facts and circumstances of the sale, or leading to the expected
disposal, and the expected manner and timing of that disposal;
– the gain or loss recognised on initial or subsequent write-down or reversal (subject to
the limit) (refer to IFRS 5.20 to .22) and, if not separately presented on the face of the
statement of profit or loss and other comprehensive income, the caption (line item) on
the statement of profit or loss and other comprehensive income that includes that gain
or loss; and
– if applicable, the segment in which the non-current asset (or disposal group) is
presented in accordance with IAS 14 Segment Reporting.
If there is a change to the plan of sale, an entity must disclose, in the period of the
decision to change the plan to sell the non-current asset (or disposal group):
– a description of the facts and circumstances leading to the decision; and
– the effect of the decision on the results of operations for the period and any prior
periods presented.
The major classes of assets and liabilities classified as held for sale are disclosed separately,
either on the face of the statement of financial position or in the notes. The authors
propose showing the major classes of assets in the notes.
Comparatives are not restated.
Amounts for non-current assets or for the assets and liabilities of disposal groups
classified as held for sale on the statements of financial position cannot be reclassified or
represented for prior periods in order to reflect the classification on the statement of
financial position for the latest (current) period.
Example 19.1
19.18 Disclosure
In late December 20.15, Example Ltd decides to dispose of part of its assets (and directly
associated liabilities) as it wants to focus on its core products. The disposal groups identified will
generally form part of the manufacturing segment. It is anticipated that the actual sale of the assets
and settlement of liabilities will take place in March 20.16. The disposal, which meets the criteria to
be classified as held for sale, comprises two disposal groups. The amounts presented are carrying
amounts after classification as held for sale and related impairment losses:
Disposal Disposal
group I group II
R’000 R’000
Property, plant and equipment# 4 900 1 700
Available for sale financial asset* 1 400 –
Liabilities$ (2 400) (900)
Net carrying amount of disposal group 3 900 800
#
Impairment losses of R800 000 (R500 000 (Group I) and R300 000 (Group II)) were recognised
against plant, with R200 000 (R140 000 (Group I) and R60 000 (Group II)) recognised against
vehicles, in order to arrive at the carrying amounts reflected. The major classes of assets are
plant and vehicles, with their respective carrying amounts being R5 280 000 and R1 320 000
after allocating the impairment loss.
* An amount of R400 000 (after tax) in respect of this financial asset has been accounted for in
equity via other comprehensive income on restating the available-for-sale financial asset to fair
value.
$
The liabilities comprise deferred tax of R400 000 for each disposal group. The remainder
constitutes trade creditors.
The presentation in the entity’s statement of financial position of the disposal groups classified as
held for sale can be shown as follows:
Notes 20.15 20.14
R R
Assets
Current assets x x
Non-current assets classified as held for sale
(4 900 + 1 700 + 1 400) 10 8 000 –
Equity attributable to owners of the parent x x
Amounts recognised in other comprehensive income
and accumulated in equity relating to non-current assets
held for sale 10 400 –
Current liabilities x x
Liabilities directly associated with non-current
assets classified as held for sale (2 400 + 900 – 400 – 400) 10 2 500 –
continued
Comment
¾ The presentation requirements for assets (or disposal groups) classified as held for sale at the
end of the reporting period do not apply retrospectively. The comparative statements of financial
position for any previous periods are therefore not restated (IFRS 5 uses the term ‘represented’).
Example Ltd
Land Plant Vehicles Total
R’000 R’000 R’000 R’000
Carrying amount on 1 January 20.15 xx xx xx xxx
Cost xx xx xx xx
Accumulated depreciation – (x) (x) (x)
Depreciation for the year – (x) (x) (x)
Assets classified as held for sale and transferred
to current assets (refer to note 10) – (6 080)(1) (1 520)(2) (7 600)
Carrying amount on 31 December 20.15 xx xx xx xxx
Cost xx xx xx xx
Accumulated depreciation – (x) (x) (x)
(1) ([5 280 000 carrying amount after impairment loss + 800 000 impairment loss)]
(2) ([1 320 000 carrying amount after impairment loss + 200 000 impairment loss)]
10. Disposal group
A decision to dispose of two groups of assets and related liabilities was taken late in
December 20.15 with the objective of focusing on core products of the company to a larger extent.
It is expected that the assets under these disposal groups will be sold for cash and that the
disposal will be completed by the end of March 20.16. The disposal groups under discussion
comprise:
R’000
Assets
Plant (6 080 – 800) 5 280
Vehicles (1 520 – 200) 1 320
Share investment 1 400
8 000
Liabilities
Trade creditors (2 400 + 900 – 400 – 400) 2 500
A total impairment loss of R1 000 000 was recognised on initial classification of the disposal group
as held for sale. This amount was included under other expenses on the face of the statement of
The disposal groups form part of the manufacturing segment.
Part 2: Discontinued operations
19.12 Introduction
The definition of a discontinued operation refers to a component of an entity that has
either been disposed of, or is classified as held for sale. In terms of IFRS 5.31, a component
of an entity comprises operations and cash flows that can be clearly distinguished, operationally
and for financial reporting purposes, from the rest of the entity. By implication then, a component
of an entity may comprise a cash generating unit or a group of cash generating units (refer
to chapter 14 for discussions on cash generating units) while these were still held for use.
A discontinued operation is a component of an entity that has either been disposed
of or is classified as held for sale; and:
represents a separate major line of business or geographical area of operations;
is part of a single co-ordinated plan to dispose of a separate major line of business or
geographical area of operations; or
is a subsidiary acquired exclusively with a view to resale.
In order to determine whether the part of an entity disposed of or to be disposed of repre-
sents a discontinued operation, an entity must first establish whether it represents a
component. Once this has been established, it must secondly be established whether the
criteria listed under the definition of a discontinued operation have been met.
IFRS 5 deals with non-current assets held for sale as well as disposal groups held for sale,
and discontinued operations, as the disposal of assets could directly be associated with a
discontinued operation. The discontinuance of an operations will in most cases lead to the
disposal of a disposal group or at least an individual asset.
19.13 Presenting discontinued operations
19.13.1 A newly identified discontinued operation

In terms of IFRS 5, an entity shall disclose the following main matters:
A single amount on the face of the statement of profit or loss and other comprehensive
income, comprising a total of the following:
– the post-tax profit or loss of discontinued operations; and
– the post-tax gain or loss recognised on the measurement to fair value less costs to
sell of individual assets or disposal groups forming part of the discontinued operation,
or realised on the disposal of the assets or disposal groups constituting the
discontinued operation.
The single amount mentioned above shall be analysed into the following and be
presented on either the face of the statement of profit or loss and other comprehensive
income or in the notes:
– the revenue, expenses and pre-tax profit or loss of discontinued operations*;
– the related income tax expense as required by IAS 12.81(h)*;
– the gain or loss recognised on the measurement to fair value less costs to sell of
individual assets or disposal groups forming part of the discontinued operation or
realised on the disposal of the assets or disposal groups constituting the discontinued
operation*; and
– the related income tax expense as required by IAS 12.81(h)*.
Example 19.1
19.19 Presentation of discontinued operation
Single amount on the face of the statement of profit or loss and other comprehensive
income with analysis in notes
Wild Group
20.12 20.11
Notes R’000 R’000
Continuing operations
Revenue 2 000 1 800
Cost of sales (1 000) (900)
Other income 60 50
Administrative expenses (144) (120)
Finance costs (132) (110)
Share of profit of associates 24 20
Profit for the year from continuing operations 463 432
Discontinued operations
Profit for the year from discontinued operations 8 20 34
Attributable to:
Non-controlling interest 68 66
483 466
Wild Group
8. Discontinued operations
20.12 20.11
R’000 R’000
Revenue 96 125
Expenses* (50) (54)
Profit after tax 32 50
Loss after tax from remeasurement (12) (16)
Loss from re-measuring the disposal group to fair value less costs to sell (17) (23)
Profit from discontinuance per the statement of profit or loss

and other comprehensive income 20 34
* Since several of the expenses (onerous contract expenses, termination benefits, etc.) included
here can be material, disclosure in terms of IAS 1.86 is advisable.
continued
Analysis of required amount on the face of the statement of profit or loss and other
comprehensive income with no note
Wild Group
20.12 20.11
R’000 R’000
Continuing operations
Revenue 2 000 1 800
Cost of sales (1 000) (900)
Other income 60 50
Administrative expenses (144) (120)
Finance costs (132) (110)
Share of profit of associates 24 20
Profit for the year from continuing operations 463 432
Discontinued operations
Revenue 96 125
Expenses* (50) (54)
Profit after tax 32 50
Loss after tax from remeasurement (12) (16)
Loss from remeasurement of disposal group to fair value less costs to sell (17) (23)
Profit after tax from discontinued operations 20 34

Attributable to:
Continuing operations 395 366
Discontinued operations 20 34
Non-controlling interest 68 66
483 466
* Since several of the expenses (onerous contract expenses, termination benefits, etc.) included
here can be material, disclosure in terms of IAS 1.86 is advisable.
Comment
¾ The amounts in the above examples were assumed to illustrate the disclosure of discontinued
operations. They represent one possible format of the presentation of discontinued operations –
other formats representing the same information are also acceptable.
¾ The above analysis of the single amount associated with the discontinued operation need not
be disclosed for disposal groups that represent newly acquired subsidiaries that meet the
criteria to be classified as held for sale at acquisition.
¾ For net cash flows attributable to the operating, investing and financing activities of
discontinued operations, the disclosures are once again presented in either the notes or on the
face of the statement of cash flows. These disclosures need not be disclosed for disposal groups
that represent newly acquired subsidiaries that meet the criteria to be classified as held for sale on
acquisition.
An entity will re-present the disclosures discussed in section 19.13.1 for prior periods
presented, so that the disclosure relates to all operations that have been discontinued by the
reporting date at the end of the current year. This means that for the current year and any
previous years presented in the financial statements, these disclosures will be provided in
respect of all discontinued operations that occurred up to the end of the current year.
19.13.2 Discontinued operations that arose in previous years

Adjustments in the current year that arise from amounts previously presented as part of a
discontinued operation that are directly related to the disposal of a discontinued operation in
a prior period are classified separately in discontinued operations. The nature and amount of
such adjustments must be disclosed.
Such adjustments may arise under several circumstances, including:
the resolution of uncertainties that arise from the terms of the disposal transaction, for
example the resolution of purchase price adjustments and indemnification issues with the
purchaser;
the resolution of uncertainties that arise from and are directly related to the operations of
the component before its disposal, for example environmental and product warranty
obligations retained by the seller; and
the settlement of employee benefit plan obligations, provided the settlement is directly
related to the disposal transaction.
19.13.3 Classification as a discontinued operation ceases since no longer
classified as held for sale
If an entity ceases to classify a specific component of an entity as held for sale, the results
of the operations of the component previously considered and presented as a discontinued
operation are reclassified as part of continuing operations for all periods presented. If this
reclassification from discontinued operations to continued operations takes place, amounts
for prior periods that are re-presented are described as such.
19.14 Measuring and presenting subsidiaries meeting the criteria

to be classified as held for sale at acquisition
A subsidiary acquired with a view to sale, is not exempt from consolidation and is
treated in accordance with IFRS 5. However, such a consolidated subsidiary will be
classified as held for sale at the acquisition date only if the one-year requirement is met and
it is highly probable that any of the other required criteria will be met within three months
from the date of acquisition.
A newly acquired subsidiary that meets the required criteria to be classified as held for sale
is treated as a disposal group, but disclosure of the main classes of assets and liabilities, as
is required for a normal disposal group, is not required.
In addition, certain of the disclosures are not required:
The analysis of the single amount on the statement of profit or loss and other
comprehensive income associated with the discontinued operation need not be
disclosed for disposal groups that represent newly acquired subsidiaries that meet the
criteria to be classified as held for sale on acquisition.
Disclosures on net cash flows need not be disclosed for disposal groups that represent
newly acquired subsidiaries that meet the criteria to be classified as held for sale on
acquisition.
In terms of IFRS 5.BC55, to require the normal analyses in respect of the items on the face
of the statement of financial position and the statement of profit or loss and other
comprehensive income for newly acquired subsidiaries held with a view to disposal would
be very cumbersome; consequently the analyses are not required.
Example 13 of IFRS 5, Implementation Guidance, illustrates the matter clearly and is

presented here as Example 19.20:
Example 19.20
19.20 Newly acquired subsidiary held for sale
A Ltd acquires H Ltd, the parent of two subsidiaries, namely S1 Ltd and S2 Ltd. S2 Ltd was
acquired with a view to disposal within 12 months from acquisition date and meets all the criteria to
be classified as held for sale. In terms of IFRS 5.32(c), S2 Ltd is also a discontinued operation.
The estimated fair value less costs to sell of S2 Ltd is R135 000. A Ltd accounts for S2 Ltd as follows:
Initially, A Ltd measures the identifiable liabilities of S2 Ltd at fair value of R40 000 (assumption).
Furthermore, A Ltd initially measures the acquired assets of S2 Ltd at fair value less costs to sell
(R135 000) plus the fair value of the liabilities, namely R40 000. The total value of the assets of
S2 Ltd thus amounts to R175 000.
At reporting date, A Ltd remeasures the disposal group at the lower of cost and fair value less
costs to sell, namely R130 000 (assumption). The liabilities are remeasured to R35 000 in terms
of applicable IFRSs, while the total assets are measured at R165 000 (130 000 + 35 000).
At reporting date, A Ltd presents the assets (R165 000) and liabilities (R35 000) separate from
other assets and liabilities of the group on the statement of financial position. The assets held for
sale are shown as one line item under assets on the statement of financial position. The
liabilities held for sale are also shown as one line item, under liabilities on the statement of
financial position. Further analyses in respect of exactly which assets/liabilities comprise the
single line item are not required here.
On the statement of profit or loss and other comprehensive income, A Ltd presents the total
post-tax profit or loss of S2 Ltd and the post-tax gain or loss recognised at subsequent
measurement of S2 Ltd, namely R5 000. This is the result of the remeasurement of the disposal
group from R135 000 to R130 000. A further analysis of the change in the value of the disposal
group is not required.

In terms of section 11(a) of the Income Tax Act 58 of 1962, expenditure and losses (which
are not of a capital nature) are deductible from taxable income if they were incurred in the
production of income. There must be reasonable prospects that income will be earned from
the involvement in the trade.
Expenses directly related to the decision to discontinue the operations will not be allowed,
as they are not included in the production of income.
In terms of section 11(o), the remainder of the tax bases of assets that will be sold or
abandoned on the discontinuance of the business operations (also known as a scrapping
allowance) will be allowed as a deduction.
Other taxation implications of importance to discontinued operations are the following:
Operating profits or losses of the discontinued operation are usually included in the
taxable income to the date of disposal. This principle is applicable only where a section
of the entity is discontinued, for example if a branch or a division is closed. Where the
discontinued operation is itself a tax entity, for example in the case of a subsidiary of a
group, the tax loss of the subsidiary cannot be offset against the taxable income of the
group.
Tax allowances on non-current assets are calculated up to the date on which the asset is
no longer used in the business activities, or the date of disposal, whichever comes first.
The allowances given in terms of sections 12B, 12C, 12E and 13 are claimed in full
even if the asset was used for only a portion of the year, unlike section 11(e)
allowances, which need to be apportioned.
Tax allowances recouped on the disposal of assets are taxable.

80% of any capital gain is included in taxable income.
Example 19.2
19.21 Discontinued operation
Teba Ltd manufactures and sells water-sports equipment and has branches in Pretoria, Polokwane
and Durban. The Durban branch, whose results were previously reported in the KwaZulu-Natal
geographical segment, has incurred losses over the past two years. On 31 March 20.14, the board
of directors approved a detailed formal plan for the discontinuance of the branch and on the same
date made a public announcement. The approved formal agreement with regard to the piecemeal
sale of assets and redemption of liabilities was at a stage of completion on 30 September 20.14
that no realistic possibility of withdrawal existed, and all necessary criteria for classification as held
for sale were met. Sale agreements for all assets were concluded on this date. It is expected that
the plan for the discontinuance of the Durban branch will be finally completed on
28 February 20.15. The year end is 31 December.
The following information is presented to you on 31 December 20.14 (before taking any
adjustments due to the discontinuance into account):
Pretoria &
Durban
Polokwane
R R
Property, plant and equipment (refer to point 2) 200 000 1 000 000
Current assets (trade debtors) 40 000 200 000
Long-term liabilities (mortgage loans) 90 000 300 000
Current liabilities (trade creditors) 60 000 150 000
Additional information in respect of following periods:
Pretoria &
Pretoria Polokwane Durban Durban
Polokwane
1/1/20.14 1/1/20.14 1/1/20.14 1/4/20.14 1/10/20.14 1/1/20.13 1/1/20.13
to to to to to to to
31/12/20.14 31/12/20.14 31/3/20.14 30/9/20.14 31/12/20.14 31/12/20.13 31/12/20.13
R R R R R R R
Revenue 800 000 770 000 75 000 100 000 60 000 1 250 000 250 000
Cost of sales 350 000 355 000 60 000 70 000 45 000 500 000 200 000
Operating
expenses 325 000 297 000 20 000 30 000 20 000 515 000 60 000
Finance cost – 15 000 – – – 15 000 –
31/12/20.14 31/12/20.13
R R
Dividends paid 50 000 40 000
1. Information in respect of the Durban branch relating to its discontinuance:
1.1.20.15 to 31.03.20.14 to
28.02.20.15 31.12.20.14
(Estimated) (Actual)
R R
Direct costs of discontinuance (tax deductible) 3 000 4 500
Severance pay payable to employees (not tax deductible) 20 000
Fines (discontinuance of contracts) (not tax deductible) 2 000
Revenue 30 000
Cost of sales 25 000
Operating expenses 10 000
continued
2. On 30 September 20.14, information pertaining to the sale of assets and liabilities relating to
the discontinued operation was as follows:
Tax Carrying Contract Contract settlement
base amount price date
R R R
Fixed property – land 120 000 120 000 105 000 28 February 20.15
Plant 80 000 80 000 80 000 28 February 20.15
200 000 200 000 185 000
Current assets, long-term liabilities and current liabilities will be taken over at their carrying
amounts.
3. Assume a normal income tax rate of 28%. There are no non-deductible expenses or
temporary differences, other than those evident from the question. Assume that there are no
other potential capital gains. Assume further that there is sufficient other taxable income for
the recognition of deferred tax assets.
The presentation and disclosure related to Teba Ltd would be as follows:
Alternative 1: Presentation of discontinued operation as a single line item on face of the
statement of profit or loss and other comprehensive income with a note containing an
analysis of this amount
Teba Ltd
20.14 20.13
Notes
Continuing operations R R
Revenue (20.14: 800 000 + 770 000) 1 570 000 1 250 000
Cost of sales (20.14: 350 000 + 355 000) (705 000) (500 000)
Gross profit 865 000 750 000
Other expenses (20.14: 325 000 + 297 000) (622 000) (515 000)
Finance cost (given) (15 000) (15 000)
Income tax expense (C6) 4 (63 840) (61 600)
Profit for the year from continuing operations 164 160 158 400
Discontinued operation
Loss from discontinued operation 2 (49 600) (7 200)
Teba Ltd
2. Discontinued operation
Gross Tax Net
20.14
R R R
Revenue (C1) 235 000
Cost of sales (C2) (175 000)
Gross profit 60 000
Other expenses (C3) (99 500)
Loss from discontinued operation (39 500) 4 900 (34 600)
Loss on remeasurement of disposal group (C4) (15 000) – (15 000)
Total loss from discontinued operation (54 500) 4 900 (49 600)
continued
Gross Tax Net

20.13
R R R
Revenue 250 000
Gross profit 50 000
Loss from discontinued operation (10 000) 2 800 (7 200)
Note
IFRS 5.33(b)(i) requires that the ‘expenses’ be disclosed. Thus the amounts presented
separately in the above note for cost of sales and other expenses could alternatively be
presented as one amount of R274 500 (20.13: R260 000) as a single line item ‘Expenses’.
The loss on remeasurement must, however, be disclosed as a separate line item and may not
be included in the line item ‘Expenses’.
3. Non-current assets held for sale
On 30 September 20.14, the operations of the Durban branch were discontinued and sale
agreements were concluded for the sale of all the net assets as the branch has incurred
losses. The discontinuance will be completed on 28 February 20.15. The branch’s results
were previously reported in the KwaZulu-Natal geographical segment. An impairment loss of
R15 000 is included in the line item ‘Loss on remeasurement of disposal group.’
The assets and liabilities to be disposed of are as follows:
Assets R
Land 105 000
Plant 80 000
Trade debtors 40 000
Liabilities
Mortgage liability 90 000
Trade creditors 60 000
20.14 20.13
R R
Main components of income tax expense:
Current – current year (63 840 – 4 060)/(61 600 – 2 800) 59 780 58 800
Deferred – current year (840) –
Secondary tax on companies
Tax per the statement of profit or loss and other comprehensive
income 58 940 58 800
Accounting profit
20.14 (228 000 – 39 500 – 15 000)
20.13 (220 000 – 10 000) 173 500 210 000
Tax on profit at 28% 48 580 58 800
Non-deductible expenses:
Loss on discontinued operation relating to land (15 000 × 28%) 4 200 –
Fines for cancellation of contracts (2 000 × 28%) 560 –
Severance pay (20 000 × 28%) 5 600 –
continued
Alternative 2: Presentation of discontinued operation with the detailed analysis on face of

the statement of profit or loss and other comprehensive income
Teba Ltd
20.14 20.13
Notes
Continuing operations R R
Revenue (20.14: 800 000 + 770 000) 1 570 000 1 250 000
Cost of sales (20.14: 350 000 + 355 000) (705 000) (500 000)
Gross profit 865 000 750 000
Other expenses (20.14: 325 000 + 297 000) (622 000) (515 000)
Finance cost (given) (15 000) (15 000)
Income tax expense (C6) 4 (63 840) (61 600)
Profit for the year from continuing operations 164 160 158400
Discontinued operation
Revenue 235 000 250 000
Cost of sales (175 000) (200 000)
Gross profit 60 000 50 000
Other expenses (C3) (99 500) (60 000)
Loss before tax (39 500) (10 000)
Income tax expense 4 900 2 800
Loss from discontinued operation (34 600) (7 200)
Loss on remeasurement of disposal group (15 000) –
Loss on remeasurement before income tax (C4) (15 000) –
Income tax expense – –
Loss for the year from discontinued operation (49 600) (7 200)
Comment
¾ IFRS 5.33(b)(i) requires that the ‘expenses’ be disclosed. Therefore the amounts presented
separately in the above note for cost of sales and other expenses could alternatively be
presented as one amount of R274 500 (20.13: R260 000) as a single line item ‘Expenses’. The
loss on remeasurement must, however, be disclosed as a separate line item and may not be
included in the line item ‘Expenses’.
¾ Notes 1, 3 and 4 per Alternative 1 would also be provided here. Note 2, however, will no longer
be required here as the information is presented on the face of the financial statements.
Calculations
R
1. Revenue
75 000 + 100 000 + 60 000 235 000
2. Cost of sales
60 000 + 70 000 + 45 000 175 000
3. Other expenses
20 000 + 30 000 + 20 000 (incurred) 70 000
Direct costs of discontinuance (3 000 provided for + 4 500 incurred) 7 500
Severance pay payable to employees (provided for) 20 000
Fines for discontinuance of contracts (provided for) 2 000
99 500
continued
R
4. Impairment loss on fixed property – land
Carrying amount – land 120 000
Contract price (105 000)
15 000
5. Deferred tax – discontinued operation
20.13
Carrying Temporary Deferred
Tax base P or L
amount difference tax
(Dr)/Cr Dr/(Cr)
R R R R R
– –
20.14
Provision for direct costs (3 000) – (3 000) (840)
Provision for fines (2 000) 2 000 – –
Provision for severance pay (20 000) 20 000 – –
Mortgage liability (90 000) 90 000 – –
Trade payables (60 000) 60 000 – –
Trade receivables 40 000 40 000 – –
Land 105 000 – 105 000 Exempt
Plant 80 000 80 000 – –
(840) 840
6. Current tax – continuing operations
20.14 20.13
R R
Profit before tax (per statement of profit or loss and other
comprehensive income) 228 000 220 000
Temporary differences – –
Non-taxable/non-deductible differences – –
228 000 220 000
Income tax expense (28%) 63 840 61 600
Deferred tax – –
63 840 61 600
7. Taxation – discontinued operation
Loss (before tax and impairment losses) (39 500) (10 000)
Non-deductible items
Fines 2 000 –
Salaries 20 000 –
Temporary differences 3 000 –
Provision for direct costs of discontinuance 3 000 –
Tax loss (14 500) (10 000)

Current tax – tax saving (4 060) (2 800)
Deferred tax (C5) (840) –
CHAPTER
20
Financial instruments
(IAS 32; IFRS 7; IFRS 9 and IFRIC 19)
Contents
20.1 Introduction ........................................................................................................ 520
IAS 32 Financial Instruments: Presentation
20.2 Background ....................................................................................................... 520
20.3 Scope ................................................................................................................ 521
20.4 Definitions .......................................................................................................... 521
20.4.1 Financial instruments ......................................................................... 521
20.4.2 Financial asset ................................................................................... 521
20.4.3 Financial liability ................................................................................. 522
20.4.4 Equity instrument................................................................................ 522
20.5 Is it a financial liability or an equity instrument? ................................................ 522
20.5.1 Preference shares .............................................................................. 523
20.5.2 Contingent settlement provisions ....................................................... 524
20.5.3 Compound financial instruments ........................................................ 525
20.6 Treasury shares ................................................................................................ 527
20.7 Interest, dividends, losses and gains ................................................................ 527
20.8 Transaction costs on equity instruments ........................................................... 527
20.9 Offsetting ........................................................................................................... 527
IFRS 9 Financial Instruments
20.10 Initial recognition ............................................................................................... 528
20.10.1 General recognition criteria ................................................................ 528
20.10.2 Regular way contracts ........................................................................ 528
20.11 Classification of financial instruments ............................................................... 529
20.11.1 Financial assets.................................................................................. 529
20.11.2 Financial liabilities .............................................................................. 535
20.12 Measurement of financial instruments............................................................... 536
20.12.1 Initial measurement ............................................................................ 536
20.12.2 Subsequent measurement ................................................................. 538
20.13 Impairment ........................................................................................................ 546
20.13.1 Scope ................................................................................................. 546
20.13.2 Approaches to recognise expected credit losses ............................... 546
20.13.3 General approach............................................................................... 547
20.13.4 Purchased or originated credit-impaired financial assets ................... 559
20.13.5 Simplified approach ............................................................................ 559
20.13.6 Modification of contractual cash flows and the effect on credit risk ... 561
20.13.7 A summary of impairment .................................................................. 562
20.14 Reclassification ................................................................................................. 563
519
20.15 Derecognition .................................................................................................... 565

20.15.2 Financial liabilities .............................................................................. 565
20.16 Hedge accounting ............................................................................................. 567
20.16.1 What is hedge accounting? ................................................................ 567
20.17 Derivative financial instruments ......................................................................... 569
20.17.1 What is derivative financial instruments? ........................................... 569
IFRS 7 Financial Instruments: Disclosures
20.18 Disclosure .......................................................................................................... 571
20.18.1 Financial position and performance ................................................... 571
20.18.2 Risks ................................................................................................... 573
20.19 Deferred tax ....................................................................................................... 575
20.1 Introduction
Global financial markets worldwide have in recent times changed dramatically, and are still
continuing to experience rapid change. A range of larger and more sophisticated financial
instruments, used by all types of business entities, exists. Financial markets use a variety of
financial instruments that include primary instruments (e.g. shares) and derivative instru-
ments (e.g. options).
Banks and other financial institutions are no longer the sole participants in active trading of
financial instruments. Businesses are forced more and more to compete in international
market places, not only in respect of their primary operating activities, but also in terms of
their capital financing, investment and risk management activities. Consequently, a large
number of corporations are forming treasury divisions whose primary responsibility is the
management of these activities.
The rapid changes in the financial markets and the increased usage of financial instruments
have resulted in the development of accounting standards to govern the reporting of
financial instruments. The International Accounting Standards Board (IASB) accelerated its
improvement of these accounting standards in response to the global financial crisis. It
launched a project to replace IAS 39 Financial Instruments: Recognition and Measurement.
In July 2014, the IASB completed this project by issuing its final version of IFRS 9 Financial
Instruments. The three accounting standards that now govern the accounting treatment and
disclosure in respect of financial instruments are:
IAS 32 Financial Instruments: Presentation;
IFRS 7 Financial Instruments: Disclosures; and
IFRS 9 Financial Instruments.
IAS 32 Financial Instruments: Presentation
20.2 Background
The objective of IAS 32 is to prescribe the presentation of financial instruments in the
financial statements, specifically relating to the presentation as financial assets, financial
liabilities and equity instruments. IAS 32 also addresses the classification of interest,
dividends, gains and losses on financial instruments. The offsetting of financial assets and
financial liabilities are also dealt with in IAS 32.
Financial instruments 521
20.3 Scope
IAS 32 deals with the presentation of all financial instruments, except the following:
interests in subsidiaries, associates or joint ventures (IAS 27, IAS 28 and IFRS 10);
employers’ rights and obligations under employee benefit plans (IAS 19);
insurance contracts (IFRS 17); and
contracts and obligations under share-based payment transactions (IFRS 2) with
exception of those contracts that fall within the scope of IAS 32.8 to .10.
20.4 Definitions
20.4.1 Financial instruments
A financial instrument is any contract that gives rise to a financial asset for one party and
a financial liability or equity instrument of another entity. A contract is an agreement
between two or more parties with clear economic results. The parties have limited discretion
to avoid their contractual obligations and the contract is usually enforceable by law.
Example 20.1
20.1 Financial instruments
The first situation (financial asset and financial liability) is illustrated by using a debtor (receivable)
which is an example of a contract that will give rise to a financial asset in the books of one entity
(seller), while giving rise to a financial liability (payable) in the books of the other entity
(purchaser).
The second situation where a financial asset and a corresponding equity instrument are raised in
terms of a contract is illustrated by a share investment, where one entity takes up a share in the
other by contributing cash, and the other issues an equity instrument. The share investment in the
books of the entity taking up the share is a financial asset, while the share issued by the entity
receiving the cash represents an equity instrument.
20.4.2 Financial asset

A financial asset is any asset that is:
cash;
an equity instrument of another entity;
a contractual right:
– to receive cash or another financial asset from another entity; or
– to exchange financial assets or financial liabilities with another entity under conditions
that are potentially favourable to the entity; or
a contract that will or may be settled in the entity’s own equity instruments and is:
– a non-derivative for which the entity is or may be obliged to receive a variable
number of the entity’s own equity instruments; or
– a derivative that will or may be settled other than by the exchange of a fixed amount
of cash or another financial asset for a fixed number of the entity’s own equity
instruments.
Example 20.2
20.2 Financial asset
Company A holds 100 000 ordinary shares in Company B.

The investment in equity instruments (ordinary shares) of Company B is classified as a financial
asset in the statement of financial position of Company A.
Physical assets such as inventories, and intangible assets such as patents, are not financial
assets. Although these assets have the potential to produce economic benefits (economic
resource – refer to the Conceptual Framework for Financial Reporting (Conceptual
Framework)), they do not give rise to a contractual right to receive cash or other financial
assets.
20.4.3 Financial liability

A financial liability is any liability that is:
a contractual obligation:
– to deliver cash or another financial asset to another entity; or
– to exchange financial assets or financial liabilities with another entity under conditions
that are potentially unfavourable to the entity; or
a contract that will or may be settled in the entity’s own equity instruments and is:
– a non-derivative for which the entity is or may be obliged to deliver a variable
number of the entity’s own equity instruments; or
– a derivative that will or may be settled other than by the exchange of a fixed amount
of cash or another financial asset for a fixed number of the entity’s own equity
instruments.
Example 20.3
20.3 Financial liability
Company A borrowed R500 000 from Bank B. Interest is payable annually and the capital amount
is repayable after two years.
The loan represents a contractual obligation to pay cash and will be classified as a financial
liability in the statement of financial position of Company A.
Liabilities imposed by statutory requirements, such as income taxes, do not represent

financial liabilities, since such liabilities are not contractual in nature.
20.4.4 Equity instrument

An equity instrument is any contract that evidences a residual interest in the assets of an
entity after deducting all of its liabilities. In simple terms, an equity instrument represents an
owner’s interest or share of the net assets (i.e. assets minus liabilities) of a company.
Based on the definition of a financial liability (refer to section 20.4.3) it follows that a financial
instrument can only be an equity instrument if:
the instrument includes no contractual obligation to deliver cash or another financial
asset to another entity or to exchange financial assets or liabilities under unfavourable
conditions for the issuer; and
it is a contract that will or may be settled by exchanging a fixed number of the entity’s
own equity instruments for a fixed amount of cash or a financial asset.
Example 20.4
20.4 Equity instruments
Company A issues 100 000 ordinary shares. Consequently Company A’s own ordinary share
issue would be an equity instrument.
20.5 Is it a financial liability or an equity instrument?

The issuer of a financial instrument should classify an issued financial instrument on initial
recognition as either a financial liability, equity instrument or a compound financial
instrument (refer to section 20.5.3). It is however at times difficult to determine whether a

financial instrument should be classified as a financial liability or an equity instrument from
the issuer’s perspective. IAS 32 provides the following guidance in cases like these:
Does the financial instrument meet the definition of a financial liability from the issuer’s
perspective?
A financial liability is ‘the existence of a contractual obligation of one party to the
financial instrument (the issuer) to deliver cash or another financial asset to the other
party (the holder)’ (IAS 32.17). It is therefore important to examine whether the
contractual terms of an individual financial instrument establish a contractual obligation
to deliver cash or a financial asset. This is generally referred to as the critical feature
of a financial liability. If the issued financial instrument does not meet the critical feature
of a financial liability, then the substance of the arrangement should be considered.
What is the substance of the arrangement (IAS 32.15)?
In order to ensure the faithful presentation of a financial instrument, the substance of a
financial instrument, rather than its legal form, governs its classification in the issuer’s
statement of financial position (IAS 32.18).
An assessment of the substance of an agreement is necessary, for example where an
issuer will settle a financial instrument using its own equity instruments, since the
financial instrument will not meet the critical feature test to be classified as a financial
liability (the issuer will not have a contractual obligation to deliver cash or another
financial asset).
Where the arrangement is in substance a contract that will be settled by issuing a
variable number of the issuer’s equity instruments that equals an agreed value, the
contract should be classified as a financial liability even though it fails the critical feature
test (IAS 32.16). Therefore, a contract to pay a specified amount (rather than a
specified equity interest) is not an equity instrument but a financial liability.
On the other hand, a contract that does not meet the critical feature test and that will be
settled by the entity delivering a fixed number of its own equity instruments in
exchange for a fixed amount of cash or another financial asset is an equity instrument.
Example 20.5
20.5 Loan settled in a variable number of the issuer’s shares
Company A obtained a loan from Company B that provides that on settlement date, Company A
will deliver a number of its own equity instruments to Company B that are worth the outstanding
capital amount plus interest (i.e. a fixed amount).
Classification
The loan is a contract that will be settled by a variable number of Company A’s equity instruments
that are equal to a fixed amount. Therefore, even though the loan fails the critical feature test
(there is no contractual obligation to deliver cash to Company B), it should be classified as a
financial liability since it will be settled by Company A delivering a variable number of its own
equity instruments (IAS 32.AG27(d)).
20.5.1 Preference shares

One of the instances where the classification of issued financial instruments comes to the
fore is with the issue of preference shares.
The crux of the matter is that two separate cash flow streams are evident when dealing with
preference shares, namely the preference dividends, and the capital amount of preference
shares. These cash flow streams should be considered separately when determining
whether preference shares should be classified as a financial liability or equity. It is even
possible that preference shares can be viewed as a compound instrument (i.e. an
instrument with both an equity and a liability component).
Example 20.6
20.6 Redeemable preference shares
Company A issued preference shares of R1 000 000 that are redeemable in 20.18. The annual
preference dividend of R120 000 (R1 000 000 × 12%) is cumulative. All unpaid preference
dividends are accumulated for future declarations or until the redemption in 20.18.
Classification
The preference shares, although equity instruments (shares) in legal form, have the substance of a
debt instrument (loan). Company A has a contractual obligation to deliver cash in the form of
preference dividends and preference share capital. Company A does not have an unconditional
right to avoid paying the annual preference dividends and the preference share capital on the
specified future dates (IAS 32.18(a)). Therefore, the redeemable preference shares should be
classified as a financial liability by Company A.
Example 20.7
20.7 Non-redeemable preference shares
Company A issued non-redeemable preference share capital of R1 000 000. The annual
preference dividend of R120 000 (R1 000 000 × 12%) is cumulative and is payable at the full
discretion of Company A.
Classification
When preference shares are non-redeemable, the appropriate classification is determined by the
other rights that are attached to them (IAS 32.AG26). Company A is able to avoid paying the
annual preference dividends and the preference share capital in terms of the contractual terms
and conditions of the non-redeemable preference shares (IAS 32.19). Therefore the contract
cannot be classified as a financial liability. Also, when preference dividends on non-redeemable
preference shares, whether cumulative or non-cumulative, are at the discretion of the issuer, the
shares should be classified as equity instruments (IAS 32.AG26). Thus the non-redeemable
preference shares should be classified as an equity instrument by Company A.
20.5.2 Contingent settlement provisions

A contract that requires settlement by the issuer based on uncertain future events
contains a contingent settlement provision.
A contract that contains a contingent settlement provision that would be settled in the
future in such a way that the contract would be classified by the issuer as a financial
liability is only classified as a financial liability by the issuer if the uncertain future event is
beyond the control of both the issuer and the holder of that financial instrument.
In the following circumstances, the financial instrument containing the contingent
settlement provision may not be classified as a financial liability, but is instead classified
as an equity instrument:
– the contingent settlement provision is not genuine (extremely rare, highly abnormal or
highly unlikely to occur);
– settlement by the issuer is only required on liquidation; or
– the instrument is a puttable instrument.
Example 20.8
20.8 Contingent settlement provisions
Construct Ltd issues debentures that are convertible into ordinary shares after three years if the
revenue of Construct Ltd increases by more than 8% per annum. If the increase in revenue is less
than 8% per annum, Construct Ltd will redeem the debentures in cash. Based on historical figures
an 8% per annum increase in revenue is likely.
Classification
The increase in Construct Ltd’s revenue is beyond the control of both Construct Ltd and the
debenture holders. There is also no indication that an 8% per annum increase in revenue is
abnormal or unlikely. Hence Construct Ltd does not have an unconditional right to avoid the
redemption of the debentures in cash. In light of the above, the debentures should be classified as
a financial liability from Construct Ltd’s perspective.
20.5.3 Compound financial instruments

Where a financial instrument contains a liability and an equity component, such a
financial instrument is referred to as a compound financial instrument (IAS 32.28).
The components of a compound financial instrument should be separately classified.
This is generally referred to as ‘split accounting’.
When the initial carrying amount of a compound financial instrument is allocated to its
equity and liability components, the equity component is assigned the residual amount
after deducting the fair value of the liability component from the fair value of the
instrument as a whole (IAS 32.31). The reason for this is that equity instruments
resemble a residual interest in the assets of an entity after deducting all of its liabilities.
Transaction costs that relate to the issue of a compound financial instrument are
allocated to the liability and equity components of the instrument in proportion to the
allocation of proceeds to the liability and equity components (IAS 32.38).
Example 20.9
20.9 Accounting for compound financial instruments
Griffin Ltd issued 2 000 convertible bonds on 1 January 20.12. The bonds have a three-year term,
and are issued at fair value and a face value of R1 000 per bond, giving total proceeds of
R2 000 000. Interest is payable annually in arrears at a nominal interest rate of 6% per annum.
Each bond is convertible at the option of the holder into a fixed number of ordinary shares at any
time up to maturity. On 1 January 20.12, a market-related discount rate for a basic three-year debt
instrument for Griffin Ltd is 10% per annum. On 31 December 20.12, it seemed very likely that the
holder will exercise his right to convert the bonds into a fixed number of ordinary shares in the next
two months. However, by 31 December 20.14, the holder had not exercised this right and the
bonds were settled, at R1 000 per bond, in cash by Griffin Ltd.
Solution
Split accounting – 1 January 20.12
Component Calculation Amount
Financial liability (FV = 2 000 000; PMT = 120 000; n = 3; i = 10%;
component PV = ?) 1 801 052
Equity component Balancing figure 198 948
Total proceeds 2 000 000
continued
Amortisation schedule of financial liability component – 1 January 20.12

Cash Effective Capital Amortisation Amortised
Date
flow interest repayments of difference cost balance
1 January 20.12 – 1 801 052 1 801 052
31 December 20.12 120 000 180 105 60 105 1 861 157
31 December 20.13 120 000 186 116 66 116 1 927 273
31 December 20.14 2 120 000 192 727 – 2 000 000 72 727 –
Total 558 948 558 948 – 2 000 000 198 948
The journal entries to account for the convertible bonds in the financial statements of Griffin Ltd will
be as follows:
Dr Cr
R R
1 January 20.12
Cash (SFP) 2 000 000
Equity (SCE) 198 948
Financial liability at amortised cost: bonds (SFP) 1 801 052
Recognition of convertible bonds (split accounting)
31 December 20.12
Effective interest expense (P/L) (1 801 052 × 10%) 180 105
Financial liability at amortised cost: bonds (SFP) 60 105
Cash (SFP) (2 000 000 × 6%) 120 000
Subsequent measurement of bonds at amortised cost
31 December 20.13
Effective interest expense (P/L) ((1 801 052 + 60 105) × 10%) 186 116
Cash (SFP) (2 000 000 × 6%) 120 000
31 December 20.14
Effective interest expense (P/L) ((1 801 052 + 60 105 + 66 116) × 10%) 192 727
Cash (SFP) (2 000 000 × 6%) 120 000
Financial liability at amortised cost: bonds (SFP) 2 000 000
Cash (SFP) 2 000 000
Settlement of bonds
Comment
¾ It should be noted that classification of the liability and equity components of a convertible
instrument is not impacted by which party has the option to convert. The financial liability
component remains since the issuer’s obligation to make scheduled payments of interest and
principal to the holder exists as long as the instrument is not converted.
¾ The equity component is the value given to the conversion option attached to the
convertible instrument.
¾ The likelihood that the conversion option will be exercised does not impact on the
classification of the liability and equity component of the convertible instrument.
20.6 Treasury shares

If an entity reacquires its own equity instruments, those instruments are defined as treasury
shares. In such a case, the reacquired equity instruments (treasury shares) are cancelled as
issued share capital and restored to authorised share capital. This is accounted for by
deducting the treasury shares from equity. No gain or loss is recognised in profit or loss on
the reacquired equity instruments.
20.7 Interest, dividends, losses and gains

The statement of financial position classification of the financial instrument determines
whether the items mentioned above are included in profit or loss as income or expenses, or
charged directly to equity. For instance, dividends on shares classified as liabilities in terms
of IAS 32 would be classified as expenses in the same way as interest payments on a loan.
A further implication of this classification is that such dividends would need to be accrued
over time, by using the effective interest rate method, in the same manner as interest.
Interest, dividends, losses and gains should be reported in profit or loss as expenses or
income if they relate to a financial liability. Distributions to holders of a financial instrument
classified as an equity instrument should be debited directly to equity by the issuer.
Gains and losses (presumably premiums and discounts) on redemptions or refinancing of
instruments classified as liabilities are reported in the profit or loss section of the statement of
profit or loss and other comprehensive income, while the gains and losses on instruments
classified as equity of the issuer are reported as movements in equity via other
Example 20.10
20.10 Presentation
A Ltd issued 2 000 000 redeemable preference shares at R2 000 000 bearing a market-related
cumulative preference dividend of R0,08 per share per annum. This would give rise to annual
cumulative preference dividends of R160 000 per annum.
Presentation
Applying substance over form to these preference shares in terms of IAS 32 would result in the
preference shares being classified as a financial liability of R2 000 000. Consequently, the annual
dividend of R160 000 would be shown as finance cost (interest) in the statement of profit or loss
Since this preference dividend represents finance cost (interest) from an accounting perspective, it
would accrue on a daily basis, like any other interest expense.
20.8 Transaction costs on equity instruments

The transaction costs of an equity transaction shall be accounted for as a deduction from
equity, to the extent that they are incremental costs directly attributable to the equity
transaction that would otherwise have been avoided. These costs may include registration
and other regulatory fees, amounts paid to legal, accounting and other professional
advisers, printing costs and stamp duties.
The amount incurred in respect of transaction costs related to equity transactions and
associated taxation is disclosed separately in terms of IAS 1 as a deduction in the
statement of changes in equity.
20.9 Offsetting
IAS 32.42 states that a financial asset and a financial liability should only be offset and the
net amount reported in the statement of financial position when an entity:
currently has a legally enforceable right to set off the recognised amounts; and
intends to settle on a net basis, or to realise the asset and settle the liability
simultaneously.
If the conditions mentioned above are met, the liability would be deducted from the value of
the asset, and only the net asset would be disclosed in the statement of financial position.
This is appropriate, as only a single financial asset or liability exists in substance. Such
presentation would more appropriately reflect the amounts and timing of the expected future
cash flows, as well as the risks to which those cash flows are exposed.
IFRS 9 Financial Instruments
20.10 Initial recognition

20.10.1 General recognition criteria
Recognition generally refers to when items should be accounted for in the financial records,
therefore initial recognition specifically refers to the timing of the recognition of financial
instruments.
An entity recognises a financial asset or financial liability on its statement of financial position when,
and only when, it becomes a party to the contractual provisions of the instrument.
20.10.2 Regular way contracts

Specific recognition rules apply to regular way contracts.
A regular way purchase or sale is a purchase or sale of a financial asset under a contract whose
terms require delivery of the asset within the time-frame generally established by regulation or
convention in the market-place concerned.
An example of a regular way purchase contract is when an entity purchases a call option in a
public market. If an entity exercises its option, it may have, for instance, three days to settle the
transaction according to regulation. The settlement by delivery of the shares within three days is
therefore a regular way transaction because the settlement is governed by regulation in the
market-place.
Due to the period of time that would lapse in this type of transaction, there are two important
dates relevant to regular way contracts. These dates are the trade date – the date on which
the entity is committed to the purchase or sale of a financial asset, and the settlement date
– the date on which the financial asset will be delivered to the entity. Between these two
dates, a regular way contract is a derivative instrument (a contract to buy or sell a financial
instrument at a specific price on a specific date). However, because of the short duration
between the trade date and settlement date a derivative instrument is not recognised.
Instead, IFRS 9 allows for special accounting of regular way contracts.
A regular way purchase or sale of financial assets should be recognised using either:
trade date accounting: recognising the asset and liability on the date that the entity
commits to the purchase or sale of the asset; or
settlement date accounting: recognising the asset and liability on the date that the
asset is delivered to or by the entity.
There are thus two possible accounting policies when dealing with regular way contracts
and an entity should select one of these. The following table illustrates the difference:
Trade date Settlement date

PURCHASER PURCHASER
Recognise asset on trade date Only recognise asset at settlement
Recognise liability to pay on trade date Change in the fair value of the asset between
trade date and settlement date
– Recognise as for the underlying asset
Derecognise asset on trade date Derecognise asset on delivery
Recognise a receivable amount (debtor) on Then recognise gain or loss on disposal
trade date
Recognise a gain or loss on disposal on Do not recognise the change in the fair value
trade date of the assets (rights have expired)
Whichever method (accounting policy) is selected, it should be applied consistently for all
purchases and sales of financial assets that belong to the same category of financial asset.
For this purpose, assets that are mandatorily measured at fair value through profit or loss
are seen as a separate category from assets designated as measured at fair value through
profit or loss.
20.11 Classification of financial instruments

The classification referred to in IFRS 9 determines how financial instruments are accounted
for and measured in the financial statements. The following classification categories of
financial assets and financial liabilities are described in IFRS 9:
Financial assets measured at amortised cost
Financial assets Financial assets measured at fair value through profit or loss
Financial assets measured at fair value through other

comprehensive income (mandatory classification for certain
investments in debt instruments)
Financial liabilities measured at amortised cost
Financial
liabilities
Financial liabilities measured at fair value through profit or loss
The classification criteria for financial assets and financial liabilities are discussed in more
detail below:
20.11.1 Financial assets

Financial assets are classified into one of the above three measurement categories on initial
recognition of the financial asset. A financial asset may only be subsequently reclassified
into another measurement category in special circumstances (see paragraph 20.14).
The classification of financial assets is determined based on two assessments:

the entity’s business model for managing the financial assets; and
the contractual cash flow characteristics of the financial assets.
Based on the above classification criteria, an entity performs the business model
assessment first. If a financial asset is held within a business model to collect contractual
cash flows, then the contractual cash flow characteristics of the financial asset are
assessed. These two assessments will determine the classification category of a financial
asset as follows:
Financial assets at fair value Financial assets at

Financial assets at
through other comprehensive fair value through
amortised cost
income (OCI) profit or loss (P/L)
(a) Business model: (a) Business model: Those financial assets

To collect contractual To collect contractual that are not measured
cash flows from the cash flows and to sell at amortised cost or fair
financial asset. the financial asset. value through other
(b) Cash flow characteristics: (b) Cash flow comprehensive income
characteristics: are included in this
Solely payments of classification.
interest and principal on Solely payments of
specified dates. interest and principal on
specified dates.
The business model and cash flow characteristics assessment and their impact on the
classification of a financial asset are discussed below.
20.11.1.1 Business model assessment (how the financial assets are managed)
Financial assets are classified as financial assets at amortised cost or fair value based on
the entity’s business model for managing the financial assets. Business model objectives
can broadly be classified into three objectives:
an objective to collect contractual cash flows;
an objective to realise cash flows through the sale of the financial assets (realising fair
value gains); or
an objective consisting of a combination of the two objectives above.
The respective three objectives and how they impact upon the classification of financial
assets are outlined below.
Classification of
financial assets
Business model Description of the business model managed within
this business
model
1. To collect Financial assets managed within this business Financial assets
contractual cash model are held to collect particular contractual measured at
flows cash flows and not to realise fair value gains amortised cost
through selling the financial assets.
It is important to note that even when sales of
financial assets occur or are expected to occur in
the future, an entity’s business model can still be
to hold financial assets to collect contractual cash
flows. However, if sales occur frequently and those
sales are significant in value, an entity needs to
assess whether and how such sales are
consistent with a business model of collecting
contractual cash flows.
An investment in debt instruments typically
gives rise to contractual cash flows and may be
classified in this category.
2. To collect In this business model, the entity’s key manage- Financial assets
contractual cash ment personnel have made a decision that both measured at fair
flows and to sell collecting contractual cash flows and selling value through other
financial assets financial assets are integral to achieving the comprehensive
objective of the business model. This business income
model will typically involve greater frequency and
value of sales than in the business model above.
An investment in debt instruments can also be
classified into this category since it gives rise to
contractual cash flows and may also be sold to
realise fair value gains.
3. To realise cash In this business model, the financial assets are Financial assets
flows through the actively managed to realise cash flows through measured at fair
sale of the the sale of the financial assets. This may result in value through profit
financial assets active buying and selling of financial assets by the or loss
entity. Consequently, this category will include
financial assets that are held for trading and
financial assets managed on a fair value basis.
The business model of financial assets is determined by key management personnel and
is observed by the manner in which the business is managed. It is important to note that the
entity’s business model does not depend on management’s intentions for an individual
instrument but is assessed on a higher level of aggregation.
The following provide objective evidence of the type of business model in which financial
assets are managed:
how the performance of the financial assets within a business model is evaluated and
reported to the entity’s key management personnel;
the risks that affect the financial assets within a business model and how those risks are
managed; and
how the managers of the business are compensated.
In light of the above, the business model for managing financial assets is based on objective
evidence of particular activities of an entity and all relevant facts should be considered.
Example 20.1
20.11 Financial assets held to collect contractual cash flows
Construct Ltd acquired 10 000 10% R1 000 bonds as a means to generate steady cash flow
consisting of interest revenue on a monthly basis in order to help fund its operations. The bonds
will be redeemed within 5 years, at which time the principal amount will be paid to Construct Ltd.
The investment policy of the entity is established by key management personnel. The policy
indicates that if the Moody’s credit rating of a financial asset decreases to below A3, the risk of not
collecting the required cash flows becomes too high and the asset must be disposed of. At year
end, the bonds were rated Baa1, a rating below A3, and were disposed of.
Assessment of business model
Construct Ltd acquired the bonds within a business model whose objective is to hold financial
assets in order to collect contractual cash flows in order to fund its operations. The objective of an
entity’s business model may be to hold financial assets in order to collect contractual cash flows
even though it might not hold all of those instruments until maturity because, for example, the
financial asset no longer meets the entity’s investment policy (IFRS 9.B4.1.3). Therefore, the
disposal of the bonds at year end does not affect Construct Ltd’s business model to collect
contractual cash flows.
Example 20.1
20.12 Financial assets held to collect contractual cash flows and to sell the
financial assets
Construct Ltd acquired 10 000 10% R1 000 bonds as a means to generate steady cash flow
consisting of interest revenue on a monthly basis and by selling the bonds. If the bonds are not
sold, they will be redeemed within 5 years, at which time the principal amount will be paid to
Construct Ltd.
The investment policy of the entity is established by key management personnel. The policy
indicates that the entity will hold bonds to collect contractual cash flows and, when the opportunity
arises, it will sell the bonds to re-invest the cash in financial assets with higher returns.
The objective of Construct Ltd’s business model is achieved by collecting contractual cash flows
and selling the bonds. Since the selling of the bonds is integral to achieving this business model,
there will be a greater frequency and value of sales than in a business model with the objective of
only collecting contractual cash flows.
Example 20.1
20.13 Financial assets held for realising cash flows through the sale of the assets
Construct Ltd acquired 10 000 10% R1 000 bonds. The bonds will be allocated to a portfolio of
bonds that are managed together, with the objective of generating a profit from short-term
fluctuations in the market price of the bonds. The objective of the portfolios managed by Construct
Ltd is established by the key management personnel. At year end, Construct Ltd still held all of the
bonds.
continued

The bonds meet the definition of financial assets held for trading as, on initial recognition, they are
part of a portfolio of identified financial instruments that are managed together and for which there
is evidence of a recent actual pattern of short-term profit-taking (IFRS 9 Appendix A). Therefore,
even though the bonds will generate contractual cash flows (coupon interest income and
repayment of the principal amount), the bonds are not held within a business model to collect the
contractual cash flows (IFRS 9.B4.1.6). The fact that Construct Ltd still held all of the bonds at
year end does not negate the bonds meeting the held for trading definition.
20.11.1.2 Contractual cash flow assessment

Contractual cash flows are those cash flows specified in a contract between the parties. For
instance, a loan agreement between parties will specify the amount of interest payable, the
timing of the interest payments, the principal amount of the loan and the date of settlement.
The cash flow characteristics of such a contract is important since it will determine if the
investment in a debt instrument can be classified as measured at amortised cost or at fair
value through other comprehensive income.
Only a financial asset with contractual cash flows that are solely payments of principal and
interest on specified dates are eligible for classification as financial assets measured at
amortised cost or fair value through other comprehensive income.
In practice, an application issue may arise when determining if the cash flows on a financial
asset are exclusively interest and principal. Some financial assets are complex and may
include features or conditions that are not in line with the ‘solely payments of principal and
interest on specified dates’ criterion. It is therefore important to understand what the terms
‘interest’ and ‘principal’ mean according to IFRS 9.
Interest is the consideration for the following:

the time value of money; and
credit risk.
Interest can also include:
lending risks (such as liquidity risk);
lending costs (such as administration costs); and
a profit margin on the lending arrangement.
The principal amount is the fair value of a financial asset at initial recognition.
It is not a requirement that the principal amount should be repaid as a single amount. The principal
amount may be repaid as instalments.
The following features indicate that cash flows from a financial asset are not solely
payments of principal and interest on specified dates:
Contractual terms that expose the contractual cash flows to risks or volatility that is
unrelated to a basic lending arrangement (e.g. commodity price risk);
Leverage (leverage increases the variability of the contractual cash flows, with the result
that they do not have the economic characteristics of interest); or
Contractual features that are non-genuine (contractual cash flows that are contingent on
an extremely rare, highly abnormal or very unlikely event).
If the cash flows from a financial asset are not solely payments of principal and interest
on specified dates, such financial assets would fail the contractual cash flow test and
should be measured at fair value through profit or loss.
20.11.1.3 Fair value through profit or loss designation

Even if an investment in a debt instrument meets the criteria to be classified as
measured at amortised cost or fair value through other comprehensive income, an entity
may, upon initial recognition, designate the financial asset as measured at fair value
through profit or loss.
Designating a financial asset into the fair value through profit or loss category is only
allowed if it will eliminate or significantly reduce a measurement or recognition
inconsistency (‘accounting mismatch’) that would otherwise arise.
Such a designation must take place at initial recognition and is irrevocable.
Designation in the context of IFRS 9 means to elect or choose a specific classification category for
a financial instrument. This is only allowed when certain criteria are met (see paragraphs 20.11.1.3
and 20.11.1.4). It is important to note that designation, unlike accounting policy choice, is not
required to be applied consistently to all similar transactions.
20.11.1.4 Fair value through other comprehensive income designation

Even if an investment in an equity instrument meets the criteria to be classified as
measured at fair value through profit or loss, an entity may, on initial recognition, elect to
present all fair value changes in other comprehensive income instead of profit or loss.
This designation is only available for investments in equity instruments that are not
held for trading.
Such an election/designation must take place at initial recognition and is irrevocable.
Investments in equity instruments that are recognised as contingent consideration by an
acquirer in terms of IFRS 3 Business Combinations may not be designated as measured
at fair value through other comprehensive income.
Any dividends received on investments in equity instruments designated as measured at
fair value through other comprehensive income, remain to be recognised in profit or loss.
The fair value gains or losses recognised in other comprehensive income is not
subsequently reclassified to profit or loss. However, an entity may choose to transfer the
cumulative gain or loss within equity (e.g. transfer the cumulative gain or loss to retained
earnings).
20.11.1.5 A summary of the classification of financial assets

The following diagram summarises the process for determining the classification of
financial assets:
Business model
To collect
contractual
cash flows and
to sell financial Is it an
To collect assets? equity
contractual No instrument No
cash flows? held for
trading?
Yes Fair value

Classification: through other
Yes Yes Fair value comprehensive
through profit income elected
or loss
Cash flows are solely payments of

No No Yes
interest and principal?
Classification:
Fair value
Yes Yes through other
comprehensive
income
Fair value through profit or loss

Yes
option is elected?
No No
Classification:
Classification: Fair value
through other
Amortised cost
comprehensive
income
20.11.2 Financial liabilities

20.11.2.1 Financial liabilities at amortised cost
All financial liabilities are classified as measured at amortised cost, except the following:
financial liabilities held for trading (including derivatives);
financial liabilities designated to be measured at fair value through profit or loss;
contingent consideration recognised by the acquirer in terms of IFRS 3 Business
Combinations;
financial guarantee contracts; and

loan commitments to provide loans at below-market interest rates.
20.11.2.2 Financial liabilities at fair value through profit or loss
In light of the above exclusions from the classification category of amortised cost, financial
liabilities measured at fair value through profit or loss are those financial liabilities that:
meet the definition of held for trading. If the financial liability is part of a hedging
relationship, the principles regarding hedge accounting would have to be applied; and
are designated by the entity as measured at fair value through profit or loss.
Designating a financial liability into this category is allowed if it will result in more relevant
information, either by:
– eliminating or significantly reducing a measurement or recognition inconsistency
(‘accounting mismatch’) that would otherwise arise; or
– a portfolio of financial liabilities is evaluated on a fair value basis in terms of the
entity’s documented risk management or investment strategy and information about
the portfolio is provided internally to the key management personnel on that basis.
Designation must take place at initial recognition and the designation is irrevocable.
20.12 Measurement of financial instruments

All financial instruments, except trade receivables that do not have a significant
financing component, are initially measured at fair value. It should be noted that IFRS 13
Fair Value Measurement sets out the requirements for measuring the fair value of a financial
asset or a financial liability.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.
The fair value of an instrument would generally be considered to be its quoted price, but a
valuation technique, such as discounted cash flow, may be used to determine fair value if
the market for the instrument is not active. Fair value is measured with reference to:
transaction price (being the fair value of the consideration given or received);
quoted market price in an active market for an identical asset or liability;
estimated discounted value of all future cash payments or receipts; or
recent prices of similar instruments where there is no active market.
If there is a common valuation technique used by market participants where there is no
active market and it has provided reliable estimates of market prices, this technique should
be used.
(a) Transaction costs
Transaction costs can adjust the fair value of financial instruments on initial
measurement.
Transaction costs are incremental costs that are directly attributable to the acquisition, issue
or disposal of a financial asset or a financial liability. An incremental cost is one that would not
have been incurred if the entity had not acquired, issued or disposed of the financial instrument.
The classification of a financial instrument determines if the transaction costs adjust the
fair value of a financial instrument on initial measurement or not.
Transaction costs incurred in relation to all financial assets and financial liabilities
measured at fair value through profit or loss are accounted for as an expense.
Transaction costs incurred in relation to financial assets and financial liabilities measured
at amortised cost and financial assets measured at fair value through other
comprehensive income are capitalised against the carrying amount of the asset or
liability.
Transaction costs include fees and commissions paid to agents (including employees
acting as selling agents), advisors, brokers and dealers, levies by regulatory agencies
and securities exchanges, and transfer taxes and duties. Transaction costs do not
include debt premiums or discounts, financing costs or internal administrative or holding
costs.
In summary, transactions costs are accounted for as follows:
Classification of financial instrument Initial measurement
Financial assets/liabilities at fair value through At fair value (expense transaction costs)
profit or loss
Financial assets at fair value through other At fair value + transaction costs
Financial assets at amortised cost At fair value + transaction costs
Financial liabilities at amortised cost At fair value – transaction costs
(b) Day one gains or losses

The fair value of a financial instrument at initial recognition is generally considered to be the
transaction price. In some cases, however, the fair value might not equal the transaction
price (the consideration paid or received). In such cases a gain or loss arises on initial
measurement of the financial instrument. The difference between the fair value and the
transaction price is referred to as ‘day one gains or losses’. The treatment of day one gains
or losses is dependent on the valuation technique used to determine the fair value of the
financial instrument. In summary, the day one gains or losses are treated as follows:
Valuation technique Recognition of day one gains or losses
Fair value is determined with reference to Recognise immediately in profit or loss.
quoted market prices.
Fair value is determined using a valuation Recognise immediately in profit or loss.
technique with observable inputs.
Fair value is determined using a valuation Defer the day one gain or loss (it may be
technique with inputs that are not observable recognised in profit or loss at a later stage when
inputs. market-based information becomes available).
Example 20.1
20.14 Day one gains or losses (quoted market price)
Manufacta Ltd purchases 2 000 debentures from Brick Ltd at R200 per debenture on
1 January 20.14. On this day, Brick Ltd’s debentures are trading on the Bond Exchange of South
Africa at R210 per debenture. The debentures are classified by Manufacta Ltd as measured at fair
value through profit or loss, since they are held for trading.
Solution
The fair value of the debentures can be determined on initial recognition with reference to quoted
market prices for identical financial assets. However, the fair value of the debentures and the
transaction price are not equal, resulting in a day one gain or loss.
continued
The following journal accounts for the initial recognition of the debentures:
Dr Cr
1 January 20.14 R R
Financial assets at fair value through profit or loss: Debentures (SFP)
(2 000 × R210) 420 000
Day one gain on acquisition of debentures (P/L) 20 000
Cash (SFP) (2 000 × R200) 400 000
Initial recognition of investment in debentures at fair value
20.12.2 Subsequent measurement

The classification categories of financial instruments in terms of IFRS 9 are extremely
important, as they determine the subsequent measurement of financial instruments as well
as the applicable accounting treatment. The subsequent measurement provisions relating to
each classification category of financial assets and financial liabilities are discussed in more
detail below:
20.12.2.1 Financial assets and financial liabilities measured at amortised cost
The amortised cost of a financial asset or a financial liability is the amount at which a
financial instrument is measured at initial recognition (fair value plus/minus transaction
costs), minus principal repayments, plus or minus the cumulative amortisation using the
effective interest method and adjusted for any loss allowance for expected credit losses
(only applicable for financial assets). The calculation of amortised cost is illustrated as
follows:
Financial asset Financial liability
Amount initially recognised Amount initially recognised
(fair value + transactions costs) (fair value – transactions costs)
– Principal repayments – Principal repayments
+ Cumulative amortisation + Cumulative amortisation
= Gross carrying amount
– Loss allowance for expected credit losses
= Amortised cost = Amortised cost
In the case of a financial asset measured at amortised cost, the following is recognised in
profit or loss:
interest revenue using the effective interest method (see paragraph (a) below);
expected credit losses and reversals; and
foreign exchange gains or losses.
In the case of a financial liability measured at amortised cost the following are recognised
in profit or loss:
interest expense using the effective interest method (see paragraph (a) below); and
foreign exchange gains or losses.
(a) Effective interest rate
The effective interest rate is the rate that exactly discounts estimated future cash payments or
receipts through the expected life of the financial asset or financial liability to the gross carrying
amount of a financial asset or to the amortised cost of a financial liability.
When calculating the effective interest rate, an entity estimates the expected cash flows of
a financial instrument by considering all the contractual terms (expected credit losses are
not considered). The effective interest rate calculation also includes the following over the
life of the financial instrument:
fees paid between the parties;
transaction costs; and
premiums or discounts.
The interest revenue is calculated by applying the effective interest rate to the gross
carrying amount of the financial asset. The interest expense is calculated by applying the
effective interest rate to the amortised cost of the financial liability.
If a financial asset subsequently becomes credit impaired, the interest revenue is
calculated by applying the effective interest rate to the amortised cost of the financial
asset.
If a financial asset is purchased or originated credit-impaired, a credit-adjusted effective
interest rate is determined and applied to the amortised cost of the asset in order to
determine the interest revenue.
Purchased or originated credit-impaired financial assets are those financial assets that are credit
impaired on initial recognition due to their very high credit risk.
A credit-adjusted effective interest rate is calculated in a similar manner as the effective
interest rate as described above, but takes into account expected credit losses. The credit-
adjusted effective interest rate discounts the future cash flows to the amortised cost of a
financial asset.
Example 20.1
20.15 Calculating the effective interest and gross carrying amount
Seraphim Ltd acquired 1 000 R100 12% per annum corporate bonds on 1 January 20.12 at their
fair value of R98 000. Transaction costs of R500 were incurred. The bonds pay interest annually
on 31 December, and the capital is settled at nominal value on 31 December 20.14. Seraphim Ltd
has a financial year end of 31 December. The bonds are held within a business model to collect
contractual cash flows of interest and the principal amount and are therefore classified as
measured at amortised cost. The investment in corporate bonds is not credit impaired on purchase
or reporting date.
Solution
The expected cash flows arising from the bonds constitute the receipt of annual interest and the
capital amount on maturity. These cash flows are discounted over the expected life of the financial
asset. The transaction costs are included in the present value since they will be amortised over the
life of the bonds.
Effective interest rate
The effective interest rate for the bonds is determined as 12,631% per annum.
(PV = – 98 500 (98 000 + 500); PMT = 12 000; FV = 100 000; n = 3; i = ?)
Gross carrying amount as at 31 December 20.13
continued
The gross carrying amount of the bonds as at 31 December 20.13 amounts to R99 440. This is
evident from the following amortisation schedule:
Gross
Cash Effective Principal Cumulative
Date carrying
flow interest repayments amortisation
amount
1 January 20.12 – 98 500 98 500
31 December 20.12 12 000 12 442 442 98 942
31 December 20.13 12 000 12 498 498 99 440
31 December 20.14 112 000 12 560 – 100 000 560 –
Total 37 500 37 500 – 100 000 1 500
(b) Gains or losses

For those financial assets measured at amortised cost, a gain or loss is recognised in
profit or loss when the financial asset is derecognised, reclassified, or impaired, as well
as through the amortisation process.
For those financial liabilities measured at amortised cost, a gain or loss is recognised
in profit or loss when the financial liability is derecognised, as well as through the
amortisation process.
Example 20.1
20.16 Journal entries for a financial asset measured at amortised cost
Pharaoh Ltd acquired, for cash, 1 000 R100 12% per annum corporate bonds on 1 January 20.12
at their fair value of R98 000. Transaction costs of R500 were incurred and paid on the same day.
Pharaoh Ltd has a 31 December year end. The bonds pay interest annually on 31 December, and
the capital is settled at the nominal value on 31 December 20.14. The bonds are held within a
business model to collect contractual cash flows and are therefore classified as measured at
amortised cost. The effective interest rate for the bonds is 12,631% per annum (PV = – 98 500
(98 000 + 500); PMT = 12 000; FV = 100 000; n = 3; i = ?). The investment in corporate bonds is
not credit impaired on purchase or reporting date.
The amortisation schedule for these bonds can be illustrated as follows:
Gross
Cash Effective Principal Cumulative
Date carrying
flow interest repayments amortisation
amount
1 January 20.12 – 98 500 98 500
31 December 20.12 12 000 12 442 442 98 942
31 December 20.13 12 000 12 498 498 99 440
31 December 20.14 112 000 12 560 – 100 000 560 –
Total 37 500 37 500 – 100 000 1 500
The journal entries to account for the corporate bonds in the financial statements of Pharaoh Ltd
will be as follows:
Dr Cr
R R
1 January 20.12
Financial asset at amortised cost: corporate bonds (SFP) 98 000
Cash (SFP) 98 000
Recognition of 1 000 R100 12% corporate bonds at fair value
continued
Dr Cr
R R
Financial asset at amortised cost: corporate bonds (SFP) 500
Cash (SFP) 500
Recognition of transaction costs incurred
31 December 20.12
Cash (SFP) 12 000
Effective interest income (P/L) 12 442
Subsequent measurement of corporate bonds at amortised cost
31 December 20.13
Cash (SFP) 12 000
31 December 20.14
Cash (SFP) 12 000
31 December 20.14
Cash (SFP) 100 000
Settlement of corporate bonds at maturity date
(c) Modification of contractual cash flows

A modification of contractual cash flows occurs when the parties to a contract agree to
renegotiate the contractual cash flows of the contract.
If the contractual cash flows of a financial asset measured at amortised cost are
renegotiated or modified and this does not lead to the derecognition of the financial asset,
an entity has to recalculate the gross carrying amount of the financial asset and recognise
a modification gain or loss in profit or loss.
The modification gain or loss is the difference between the gross carrying amount of the
financial asset before modification and the present value of the modified contractual cash
flows discounted at the financial asset’s original effective interest rate. In the case of
purchased or originated credit-impaired financial assets, the original credit-adjusted effective
interest rate is used to discount the original and modified contractual cash flows.
Example 20.1
20.17 Modification of contractual cash flow
Caesar Ltd granted a loan of R98 500 to Roman Ltd on 1 January 20.12. The loan is repayable by
Roman Ltd in three equal annual instalments of R42 087 at the end of each year. The effective
interest rate for the loan is 13,522% per annum (PV = -98 500; PMT = 42 087; FV = 0; n = 3; i =
?). Caesar Ltd holds the loan within a business model to collect contractual cash flows and
therefore classifies the loan as a financial asset measured at amortised cost. The loan is not credit
impaired on purchase or reporting date.
continued
The amortisation schedule for the loan can be illustrated as follows:

Gross carrying
Cash Effective Principal
Date amount
flow interest repayments
(before modification)
1 January 20.12 – 98 500 98 500
31 December 20.12 42 087 13 319 – 28 768 69 732
31 December 20.13 42 087 9 429 – 32 658 37 074
31 December 20.14 42 087 5 013 – 37 074 –
Total 27 761 27 761 – 98 500
On 31 December 20.12, Roman Ltd renegotiated the terms of the loan payable to Caesar Ltd in
order to improve its net cash position for the next two years. The outstanding capital balance of
the loan on 31 December 20.12, namely, R69 732, will only be repaid at maturity on
31 December 20.14. Interest of 12% per annum on the outstanding capital will be paid annually
on 31 December. The modification does not result in a derecognition of the financial asset by
Caesar Ltd.
Solution
The present value of the modified cash flows, discounted at the original effective interest rate at
31 December 20.12 will be R67 974 (FV = 69 732; PMT = 8 368 (69 732 × 12%); n = 2;
i = 13,522%; PV = ?). The adjusted amortisation schedule of the loan will be as follows:
Gross carrying
Cash Effective Capital
Date amount
flow interest repayments
(after modification)
31 December 20.12 – 67 974 – 67 974
31 December 20.13 8 368 9 191 68 797
31 December 20.14 78 100 9 303 – 69 732 –
Total 18 494 18 494 – 69 732
The journal entry to account for the modification in the records of Caesar Ltd will be as follows:
Dr Cr
Loss from modification of loan (P/L) (69 732 – 67 974) 1 758
Financial asset at amortised cost: loan receivable (SFP) 1 758
Modification loss recognised on modification of contractual cash
flows of the loan receivable
If the contractual cash flows of a financial asset are substantially modified by the parties, this
may lead to the derecognition of the financial asset. In such a case, a new financial asset
should be recognised at its fair value. The derecognition of the original financial asset and
the recognition of the new financial asset at fair value will effectively result in a gain or loss.
20.12.2.2 Financial assets measured at fair value through profit or loss
All financial assets classified as measured at fair value through profit or loss are carried
at fair value subsequent to initial recognition.
Fair value gains or losses (realised and unrealised), calculated on the subsequent
measurement of these financial assets, are recorded directly in profit or loss.
20.12.2.3 Financial assets measured at fair value through other comprehensive

income – investment in debt instruments (mandatory classification)
All financial assets mandatorily measured at fair value through other comprehensive
income are carried at fair value subsequent to initial recognition. All fair value gains or
losses are taken to equity via other comprehensive income.
The cumulative fair value gain or loss recognised in equity via other comprehensive
income is reclassified to profit or loss (reclassification adjustment in terms of IAS 1)
when the financial asset is derecognised.
Impairment losses and foreign exchange differences on financial assets mandatorily
measured at fair value through other comprehensive income are recognised in profit or
loss and not in other comprehensive income.
Effective interest income on the gross carrying amount of the financial asset is
recognised in profit or loss.
The purpose of the above is to ensure that all the amounts recognised in profit or loss on
the financial asset measured at fair value through other comprehensive income are the
same as the amounts that would have been recognised in profit or loss if the
financial asset was measured at amortised cost.
Example 20.1
20.18 Financial assets measured at fair value through other comprehensive
income – investment in debt instruments (mandatory)
Construct Ltd acquired 10 000 bonds on 1 January 20.13 at a fair value of R3 per bond.
Transaction costs amounted to R1 500 and were paid by Construct Ltd. The coupon interest on
the bonds amounts to R12 000 per annum, receivable on 31 Desember. The effective interest on
the bonds amounted to R13 500 for 20.13. The entity holds the bonds to collect the contractual
cash flows and, when an opportunity arises, it will sell the bonds to re-invest the cash in other
financial assets with a higher return. Therefore both collecting contractual cash flows and selling
the bonds are integral in achieving the business model’s objective. The market value of the bonds
at year end (31 December 20.13) is R5,50 per bond. These bonds were sold on 2 January 20.14
at the fair value of R5,60 per bond for cash.
Journal entries
Dr Cr
1 January 20.13 R R
Financial asset at fair value through OCI: bonds (SFP) 31 500
Cash (SFP) [(10 000 × 3,00) + 1 500] 31 500
Initial recognition of bonds at fair value plus transaction costs
31 December 20.13
Cash (SFP) 12 000
Interest income (P/L) 13 500
Recognition of 20.13 interest income
Fair value gain (OCI) [(10 000 × 5,50) – 31 500 – 1 500] 22 000
Investment remeasured to fair value in other comprehensive income
2 January 20.14
Fair value gain (OCI) [(10 000 × 5,60) – 55 000] 1 000
Remeasure investment on date of derecognition to fair value
continued
Dr Cr
R R
Cash (SFP) 56 000
Sell investment for cash
Fair value gain (OCI) [22 000 + 1 000] 23 000
Fair value gain (reclassification gain) (P/L) 23 000
Reclassify the accumulated fair value gain reserve to profit or loss
20.12.2.4 Financial assets measured at fair value through other comprehensive

income – investment in equity instruments (designated classification)
All financial assets designated as measured at fair value through other comprehensive
income are carried at fair value subsequent to initial recognition. All fair value gains or
losses are taken to equity via other comprehensive income.
The cumulative fair value gain or loss recognised in equity via other comprehensive
income is never subsequently reclassified to profit or loss. The entity may, however,
transfer the cumulative fair value gain or loss directly within equity (i.e. transfer to
retained earnings).
Dividends received from financial assets designated as measured at fair value through
other comprehensive income (investments in equity instruments) are recognised in profit
or loss when the entity’s right to receive payment of the dividend is established.
Example 20.19 Financial assets measured at fair value through other comprehensive
income – investment in equity instruments (designated)
Company A acquired 10 000 ordinary shares in a listed company on 1 November 20.13. The
shares are not held for trading, but were acquired with a long-term view. The directors of the
company irrevocably elected, at initial recognition, to classify this investment as measured at fair
value through other comprehensive income. The shares were purchased at a fair value of R3,00
per share. Transaction costs amounted to R1 500 and were paid by the purchaser. The market
value of the shares at year end (31 December 20.13) is R5,50 per share. These shares are sold
on 2 January 20.14 at the fair value of R5,60 per share for cash. It is the accounting policy of the
company to transfer the cumulative balance gain or loss in the mark-to-market reserve to retained
earnings when the financial asset is derecognised.
Journal entries
Dr Cr
R R
1 November 20.13
Financial asset at fair value through OCI: shares (SFP) 31 500
Cash (SFP) [(10 000 × 3,00) + 1 500] 31 500
Initial recognition of investment at fair value
31 December 20.13
Mark-to-market reserve (OCI) [(10 000 × 5,50) – 31 500] 23 500
Investment remeasured to fair value in other comprehensive income
continued
Dr Cr
R R
2 January 20.14
Financial asset at fair value through OCI: shares (SFP)
[(10 000 × 5,60) – 55 000] 1 000
Mark-to-market reserve (OCI) 1 000
Remeasure investment on date of derecognition to fair value
Cash (SFP) 56 000
Sell share investment for cash
Mark-to-market reserve (SCE) 24 500
Retained earnings (SCE) 24 500
Transfer the accumulated fair value gain in the mark-to-market reserve to
retained earnings
20.12.2.5 Financial liabilities measured at fair value through profit or loss

For financial liabilities held as measured at fair value through profit or loss, all gains or losses
(realised and unrealised) calculated on the subsequent measurement of these
instruments are recorded directly in profit or loss.
For financial liabilities elected (designated) into the category as at fair value through
profit or loss, the subsequent changes in fair value must be separated between those
fair value changes that are due to changes in the credit risk of the issuer, and other
risks. Other risks include market condition risks such as interest rate, commodity price
and exchange rate risks.
Fair value changes due to the issuer’s own credit risk must be recognised in other
comprehensive income and accumulated in equity. The remaining amount of the fair
value change that is due to other risks must be recognised in profit or loss.
Separation is, however, not required if the separation would create or enlarge an
accounting mismatch in profit or loss or if the financial liability is a loan commitment or a
financial guarantee contract. Under these circumstances, all changes in fair value must
be recognised in profit or loss.
Example 20.2
20.20 Financial liability designated as measured at fair value through profit or loss
Caesar Ltd issued 1 000 R100 listed bonds on 1 January 20.13 at their fair value of R100 000.
Coupon interest is payable annually in arrears and is based on the repo rate plus 2% on the face
value of the bonds. The repo rate on 1 January 20.13 was 4,50% per annum and on
31 December 20.13 it was 5% per annum. The bonds are redeemable on 31 December 20.14 at a
premium of 5%. The internal rate of return on the bonds is determined as 9% per annum for the
year ended 31 December 20.13. Caesar Ltd designated the listed bonds as measured at fair value
The fair value of the listed bonds based on market prices was R96 000 on 31 December 20.13.
continued
Separation of the fair value on 31 December 20.13

The total fair value gain on the bonds is R4 000 (R100 000 – R96 000) on 31 December 20.13.
The fair value gain is separated into components related to credit risk and other risks as follows:
The internal rate of return on the bonds is given as 9% per annum. Since the observed interest
rate (repo rate) on 1 January 20.13 is 4,50%, the instrument-specific component of the internal
rate of return is 4,50% (9% less 4,50%) (IFRS 9.B5.7.18(a)).
The expected fair value of the listed bonds on 31 December 20.13 based on the discount rate of
9,50% (repo rate at 31 December 20.13 plus the 4,50% instrument-specific component) is
determined as R102 283 (FV = 105 000, PMT = 100 000 × (5% + 2%) = 7 000, n = 1, i = 9,50%,
PV = ?).
R
Fair value on 1 January 20.13 100 000
Expected fair value on 31 December 20.13 102 283
Fair value loss due to risks other than credit risk (P/L) (2 283)
Expected fair value on 31 December 20.13 102 283

Actual fair value on 31 December 20.13 96 000
Fair value gain due to credit risk (OCI) 6 283
20.13 Impairment
The impairment loss model in IAS 39 Financial Instruments: Recognition and Measurement
has been replaced by a new expected credit losses model contained in IFRS 9. The new
credit losses model is based on expected credit losses instead of incurred losses. The new
model is more forward looking in that it is not necessary for a credit event to have occurred
before credit losses (impairment) are recognised. Instead, an entity always accounts for
expected credit losses on financial assets that are within the scope of the impairment
provisions.
20.13.1 Scope
For the following financial assets, expected credit losses have to be estimated:
financial assets at amortised cost;
financial assets at fair value through other comprehensive income (mandatory);
lease receivables;
contract assets (IFRS 15 Revenue from Contracts with Customers); and
loan commitments and financial guarantee contracts.
The impairment model of IFRS 9 is not applied to investments in equity instruments or any
other financial asset measured as at fair value through profit or loss.
20.13.2 Approaches to recognise expected credit losses

IFRS 9 requires the recognition of expected credit losses on all those financial assets within
the scope of the impairment model. This is achieved by recognising the movement in the
expected credit loss in profit or loss and an allowance for the cumulative expected credit
losses in the statement of financial position.
A credit loss is the difference between all contractual cash flows of the financial asset due in
terms of the contract and all the expected cash flows of the financial asset discounted at the
original effective interest rate.
Expected credit losses are the weighted average of credit losses (based on the risk of default
occurring).
The approach to determine the loss allowance for expected credit losses for a financial
asset is dependent on the type of financial asset:
Type of financial asset Approach
Trade receivables, contract assets and lease Simplified approach (section 20.13.5)
receivables
Financial assets that are purchased or Lifetime expected credit loss approach (section
originated credit-impaired 20.13.4)
Other financial assets General approach (section 20.13.3)
20.13.3 General approach

Under the general approach, a financial instrument moves through three stages as its credit
risk deteriorates. Each stage determines how the loss allowance for expected credit losses
is measured and how the effective interest revenue on the financial asset is calculated. The
three stages of the expected credit loss model are as follows:
Stage 1
The credit risk of the financial instrument has not increased significantly
since initial recognition, or it is a financial instrument with a low credit risk at
reporting date.
The loss allowance recognised equals a 12-month expected credit loss.
Deterioration of credit risk

Effective interest is calculated on the gross carrying amount of the financial
asset.
Stage 2
The credit risk of the financial instrument has increased significantly since
initial recognition but there is no objective evidence of impairment. Financial
instruments with a low credit risk at reporting date remain in stage 1 even
though their credit risk may have increased significantly.
The loss allowance recognised equals lifetime expected credit losses.
Effective interest is calculated on the gross carrying amount of the financial
asset.
Stage 3
There is objective evidence that the financial instrument is credit impaired.

The loss allowance recognised equals lifetime expected credit losses.
Effective interest is calculated on the amortised cost of the financial asset (gross
carrying amount – loss allowance).
As can be seen from the above illustration, a financial asset moves from 12-month expected
credit losses to lifetime expected credit losses when the credit risk of the financial asset
increases significantly (i.e. the credit risk has deteriorated). When this credit risk
deterioration occurs, the loss allowance that was initially equal to the 12-month expected
credit losses should be remeasured to equal an amount of lifetime expected credit losses.
The terms ‘lifetime expected credit losses’ and ‘12-month expected credit losses’ are
important and are defined below.
The lifetime expected credit losses are the expected credit losses that result from all
possible default events over the expected life of a financial instrument. The amount
therefore represents an expected cash shortfall that is calculated as the difference
between the discounted cash flows that are due to the entity in terms of the contract and
the discounted cash flows that the entity expects to receive.
The 12-month expected credit losses are the portion of lifetime expected credit losses
that represent the expected credit losses that result from default events that are possible
within 12 months after the reporting date. The 12-month expected credit losses are
calculated by multiplying the probability of default occurring on the financial asset
within 12 months after reporting date by the lifetime expected credit losses. Therefore
the amount is not the expected cash shortfalls over the 12-month period but the entire
lifetime credit losses on a financial instrument weighted by the probability that the loss
will occur in the next 12 months.
Example
Example 20.2
20.21 Expected credit losses
Manufacta Ltd provided Brick Ltd with a loan of R1 000 000 at interest of 8% per annum. The
interest and loan are repayable after three years. Manufacta Ltd classifies the loan receivable as a
financial asset measured at amortised cost.
Manufacta Ltd estimates that the loan at initial recognition has a probability of default (PD) of 0,5%
over the next 12 months. At reporting date, Manufacta Ltd determines that there has not been a
significant increase in credit risk of the loan since initial recognition and that the PD remained
unchanged at 0,5%. Manufacta Ltd determines that 25% of the principal amount of the loan will be
lost if the loan defaults.
Loss allowance
On initial recognition, Manufacta Ltd measures the loss allowance at an amount equal to a
12-month expected credit losses using the 12-month probability of default of 0,5%. Implicit in that
calculation is the 99,5% probability that there will be no default. The lifetime expected credit loss on
the loan amounts to R250 000 (R1 000 000 × 25%). Therefore the loss allowance recognised for
the 12-month expected credit losses is R1 250 (0,5% × R250 000). Since there was no significant
increase in credit risk of the loan since initial recognition and the probability of default has
remained unchanged on reporting date, the loss allowance at reporting date remains equal to the
12-month expected credit losses of R1 250.
In determining the loss allowance for expected credit losses, it is evident that the following
are important:
determining if there was a significant increase in credit risk; and
measuring the expected credit losses.
The above two concepts are discussed below.
20.13.3.1 A significant increase in credit risk
A financial instrument transitions from stage 1 to stage 2 when there is a significant
increase in the credit risk of the financial asset since initial recognition.
A financial instrument transitions from stage 1 and stage 2 to stage 3 if there is a
significant increase in the credit risk of the financial asset and there is objective evidence
indicating that the financial asset is credit impaired.
The assessment of credit risk is one of the major areas of judgement for entities when
assessing whether the increase in credit risk is indeed significant.
IFRS 7 defines credit risk as the risk that one party to a financial instrument will cause a financial
loss for the other party by failing to discharge an obligation.
From stage 1 to stage 2

The following indicate that there may be an increase in the credit risk of a financial
instrument causing the financial asset to transition from stage 1 to stage 2:
changes in rates or terms (e.g. more stringent terms, increased guarantees);
existing or forecast adverse changes in business, financial or economic conditions that
cause a significant change in a borrower’s ability to pay;
adverse changes in the operating results of the borrower;
credit deterioration of other financial instruments held by the borrower;
adverse change in the quality of the guarantee/support by the parent of the borrower;
changes in the credit management approach (i.e. the financial instrument becoming
more active or closely monitored); and
past due information, including the rebuttable presumption (see below).
Two exceptions to the above assessment of the increase in credit risk exist:
(a) Low credit risk exception

It is important to note that a practical expedient applies where a financial asset is determined
to have a low credit risk at the reporting date. In such a case, an entity may assume that the
credit risk of the financial asset has not increased significantly since initial recognition of the
financial asset. This exception is applied by an entity to simplify the impairment requirements
of IFRS 9 for those financial assets identified by the entity as having a low credit risk. The
credit risk of a financial asset is considered low when:
there is a low risk of default;
the borrower has a strong capacity to meet its contractual cash flow obligations in the near
term; or
adverse changes in the economic and business conditions in the long term may, but will
not necessarily, reduce the borrower’s ability to meet its obligations.
(b) Rebuttable presumption

There is a rebuttable presumption that credit risk has increased significantly when
contractual payments are more than 30 days overdue. An entity can rebut this presumption
if it has information available that supports the belief that the credit risk has not increased
significantly even though the contractual payments are more than 30 days overdue.
However, when an entity determines that there has been a significant increase in credit risk
before contractual payments are more than 30 days past due, the rebuttable presumption
does not apply.
Stage 1 and 2 to stage 3 (credit impaired)

When the credit risk of a financial asset increases significantly and there is evidence that the
financial asset is credit impaired, the financial asset transitions to stage 3. The following lists
observable data that a financial asset is credit impaired:
significant financial difficulty of the issuer or the borrower;
a breach of contract, such as a default or past due event;
the lender(s), for economic or contractual reasons relating to the borrower’s financial
difficulty, having granted to the borrower a concession(s) that the lender(s) would not
otherwise consider;
it is becoming probable that the borrower will enter bankruptcy or other financial
reorganisation;
the disappearance of an active market for that financial asset because of financial
difficulties; or
the purchase or origination of a financial asset at a deep discount that reflects the
incurred credit losses.
Assessing credit risk
The entity may apply various methods when determining whether the credit risk has increased
significantly since initial recognition. The entity should however consider the characteristics
of the financial instrument (or group of financial instruments) and the default patterns in the
past for comparable financial instruments. The information does not need to flow through a
statistical model or a credit ratings process in order to determine whether there has been a
significant increase in the credit risk of the financial instrument. An entity may use qualitative
and non-statistical quantitative information to make this assessment. The assessment of
the credit risk should however consider the following factors:
a change in risk of default since initial recognition;
the expected life of the financial instrument; and
reasonable and supportable information that is available without undue cost or effort that
may affect credit risk.
The above factors are discussed in more detail below.
(a) Change in risk of default
To determine if there was a significant increase in credit risk, an entity compares the risk of
a default occurring on the financial instrument as at the reporting date with the risk of a
default occurring on the financial instrument at initial recognition. When considering the
magnitude of changes in credit risk, an entity should use probabilities of default rather
than the change in expected credit losses. The definition of default should be determined
by the entity’s internal credit risk management process for each financial instrument.
(b) Expected life of the financial instrument
There is a relationship between the expected life of a financial instrument and the risk of
defaulting. For instance, the risk of a default occurring over the expected life of a financial
instrument usually decreases as time passes and the financial instrument gets closer to
maturity, if the credit risk is unchanged. Conversely, for those financial assets that have a
significant payment on maturity date, the risk of default increases as they reach the maturity
date.
(c) Reasonable and supportable information
In determining the increase in credit risk of a financial instrument, an entity should use
forward-looking information if it is available without undue cost or effort. When forward-
looking information is too costly or too much effort to acquire, past information may be used
to determine the credit risk of a financial instrument.
Assessment level
The assessment of the increase in credit risk should be done on an individual instrument
level. If evidence of such significant increases in credit risk at the individual instrument level
is not available, the assessment should be done on a collective basis (for a group of
financial assets). An entity can group financial instruments on the basis of shared credit
risk characteristics. Examples of shared credit risk characteristics are:
instrument type;
credit risk ratings;
collateral type;
date of initial recognition;
remaining term to maturity;

industry; and
geographical location of the borrower.
20.13.3.2 Measurement of expected credit losses
In determining the amount of expected credit losses, IFRS 9 does not prescribe a specific
method but requires that the method adopted by the entity should be based on:
an unbiased and probability-weighted amount that is determined by evaluating a range of
possible outcomes;
the time value of money; and
reasonable and supportive information that is available without undue cost or effort about
past events, current conditions and forecasts of future economic conditions.
Credit losses are the present value of expected cash shortfalls. A cash shortfall is
determined as the difference between the contractual cash flows due to the entity in terms of
the contract and the expected cash flows. Hence the cash shortfalls take into account the
possibility of missed cash receipts and also the late recovery of missed receipts.
Example 20.2
20.22 Credit losses
Retail Ltd acquired 1 000 R100 12% per annum corporate bonds issued by Telecom Ltd on
1 January 20.15 at fair value. The bonds are redeemable by Telecom Ltd on 31 December 20.17
at a premium of 5%. Coupon interest is payable annually in arrears to Retail Ltd.
On 1 January 20.15, Retail Ltd estimates that if Telecom Ltd were to default, the expected cash
flows will be as follows:
Contractual Expected Cash shortfall
Date cash flow (A) cash flow (B) (A – B)
R R R
31 December 20.15 12 000 12 000 –
31 December 20.16 12 000 10 000 2 000
31 December 20.17 12 000 10 000 2 000
31 December 20.17 105 000 99 000 6 000
Determine the credit losses
All cash shortfalls expected over the life of the corporate bonds are included in the measurement
of the credit losses. Hence the total undiscounted credit losses on the corporate bonds amount to
R10 000 (R2 000 + R2 000 + R6 000).
The expected credit losses determined for a financial asset should be discounted to
reporting date since the expected credit losses have to reflect the time value of money. The
maximum period over which expected credit losses are discounted is the maximum
contractual period over which the entity is exposed to the credit risk.
Once the expected credit losses on a financial asset have been determined, the credit risk
of the financial asset has to be assessed. This assessment of the credit risk will determine if
the loss allowance account should equal the amount of the lifetime expected credit losses or
the 12-month expected credit losses. The following table summarises when lifetime
expected credit losses or 12-month expected credit losses are applied.
Loss allowance = Loss allowance =

Lifetime expected credit losses 12-month expected credit losses
Significant increase in the credit risk since initial No significant increase in the credit risk since
recognition of the financial asset. initial recognition of the financial asset.
The financial asset is credit impaired. Low credit risk financial asset.
It is important to note that a financial asset for which lifetime expected credit losses were
recognised may revert back to 12-month expected credit losses when the credit risk at
reporting date improves to a sufficient extent.
Example 20.23 Lifetime and 12-

12-month expected credit losses
1 January 20.15 at fair value. The bonds are redeemable by Telecom Ltd on 31 December 20.17
at a premium of 5%. Coupon interest is payable annually in arrears to Retail Ltd. The effective
interest rate on the corporate bonds is 13,4611% per annum. The reporting date is 31 December
20.15.
Contractual Expected
cash flow cash flow Cash shortfall
Date R R R
31 December 20.15 12 000 12 000 –
31 December 20.16 12 000 10 000 2 000
31 December 20.17 12 000 10 000 2 000
31 December 20.17 105 000 99 000 6 000
On 31 December 20.15, Retail Ltd determines that the probability that Telecom Ltd will default
within the next 12 months after reporting date is 2%.
Determining lifetime and 12-month expected credit losses
If the assessment of credit risk on 31 December 20.15 indicates that the credit risk of the
corporate bonds has increased significantly since initial recognition, the loss allowance will equal
the lifetime expected credit losses. The lifetime expected credit losses on 31 December 20.15
are determined as follows:
Present value of contractual cash flows
(FV = 105 000, PMT = 12 000, n = 2, i = 13,4611%, PV = ?) R101 461
Present value of expected cash flows
(FV = 99 000, PMT = 10 000, n = 2, i = 13,4611%, PV = ?) R93 484
Lifetime expected credit losses R7 977
If the assessment of credit risk on 31 December 20.15 indicates that the credit risk of the
corporate bonds has not increased significantly since initial recognition, the loss allowance will
equal the 12-month expected credit losses. The 12-month expected credit losses on
31 December 20.15 are determined as follows:
Discounted lifetime expected credit losses (calculated above) R7 977
Probability of default 2%
12-month expected credit losses (2% × R7 977) R160
20.13.3.3 Accounting for impairment under the general approach

Financial assets measured at amortised cost
A loss allowance account is recognised in the statement of financial position for those
financial assets measured at amortised cost. The movement in the loss allowance
account is accounted for in the profit or loss.
Interest revenue on the financial instrument is calculated using the effective interest
method on the financial asset’s gross carrying amount when the asset is not credit
impaired. If the financial asset is credit impaired the interest revenue is calculated using
the effective interest method on the financial asset’s amortised cost (gross carrying
amount minus the loss allowance).
Example 20.24 Financial asset at amortised cost - not credit impaired
1 January 20.15 at their fair value of R100 000. The bonds are redeemable by Telecom Ltd on
31 December 20.17 at a premium of 5%. Coupon interest is payable annually in arrears to Retail
Ltd. The effective interest rate on the corporate bonds is 13,4611% per annum. The reporting
date is 31 December 20.15. The bonds were classified as a financial asset measured at
amortised cost.
Cash shortfall
Date cash flow cash flow
R
R R
31 December 20.15 12 000 12 000 –
31 December 20.16 12 000 10 000 2 000
31 December 20.17 12 000 10 000 2 000
31 December 20.17 105 000 99 000 6 000
On 1 January 20.15, Retail Ltd determines the 12-month expected credit losses on the bonds as
R150. On 31 December 20.15 and 31 December 20.16 the credit risk had increased significantly
since initial recognition. However, the corporate bonds were not credit impaired on any of the
reporting dates. The lifetime expected credit losses amounted to the following:
Reporting date Lifetime expected credit losses
R
31 December 20.15 7 977
31 December 20.16 7 051
Assuming that all contractual cash flows for 31 December 20.15, 31 December 20.16 and
31 December 20.17 were received, the journals will be as follows:
Dr Cr
R R
1 January 20.15
Financial asset at amortised cost: bonds (SFP) 100 000
Cash (SFP) 100 000
Recognition of 1 000 R100 12% bonds at fair value
Expected credit loss (P/L) 150
Loss allowance on bonds (SFP) 150
Recognition of 12-month expected credit losses
continued
Dr Cr
R R
31 December 20.15
Cash (SFP) 12 000
Financial asset at amortised cost: bonds (SFP) (balancing) 1 461
Effective interest income (P/L) (100 000 × 13,4611%) 13 461
Subsequent measurement of bonds
Expected credit loss (P/L) (7 977 – 150) 7 827
Loss allowance on bonds (SFP) 7 827
Recognition of lifetime expected credit losses
31 December 20.16
Cash (SFP) 12 000
Effective interest income (P/L) ((100 000 + 1 461) × 13,4611%) 13 658
Expected credit loss (P/L) (7 051 – 7 977) 926
31 December 20.17
Cash (SFP) 12 000
Effective interest income (P/L)
((100 000 + 1 461 + 1 658) × 13,4611%) 13 881
Cash (SFP) 105 000
Financial asset at amortised cost: bonds (SFP)
(100 000 + 1 461 + 1 658 + 1 881) 105 000
Redemption of corporate bonds
Expected credit loss (P/L) 7 051
Reversal of allowance for expected credit losses
Comment
¾ Since the bonds are not credit impaired, the interest revenue recognised is calculated using the
original effective interest rate on the gross carrying amount of the bonds. The gross carrying
amount is the amortised cost of a financial asset, before adjusting for any loss allowance.
¾ Since there was no actual incurred losses on the financial asset, the total expected credit loss
of R7 051 (R150 + R7 827 – R926) recognised over the three years in profit or loss, is reversed
on derecognition.
Example 20.25 Financial asset at amortised cost – credit impaired
date is 31 December 20.15. The bonds were classified as a financial asset measured at
amortised cost.
Contractual cash
Expected cash flow Cash shortfall
Date flow
R R
R
31 December 20.15 12 000 12 000 –
31 December 20.16 12 000 10 000 2 000
31 December 20.17 12 000 10 000 2 000
31 December 20.17 105 000 99 000 6 000
On 1 January 20.15 Retail Ltd determines the 12-month expected credit losses on the bonds as
R150. On 31 December 20.15 and 31 December 20.16, the credit risk increased significantly since
initial recognition. In addition, the corporate bonds became credit impaired on these dates. The
lifetime expected credit losses amounted to the following:
Lifetime expected credit losses
Reporting date
R
31 December 20.15 7 977
31 December 20.16 7 051
Assuming that all contractual cash flows for 31 December 20.15 and 31 December 20.16
were received, the journals will be as follows:
Dr Cr
R R
1 January 20.15
Financial asset at amortised cost: bonds (SFP) 100 000
Cash (SFP) 100 000
31 December 20.15
Cash (SFP) 12 000
continued
Dr Cr
R R
31 December 20.16
Cash (SFP) 12 000
((100 000 + 1 461 – 7 977 loss allowance 20.15) × 13,4611%) 12 584
Loss allowance on bonds (SFP) (7 977 × 13.4611%) 1 074
Expected credit loss (P/L) (7 051 – (7 977 + 1 074)) 2 000
Assuming that a default occurs at 31 December 20.17 and Retail Ltd only receives R10 000
in coupon interest and R99 000 as the capital redemption amount, the journals will be as
follows:
31 December 20.17
Cash (SFP) 10 000
((100 000 + 1 461 + 1 658 – R7 051 loss allowance 20.16) × 13,4611%) 12 932
Loss allowance on bonds (SFP) (7 051 × 13.4611%) 949
Cash (SFP) 99 000
Financial asset at amortised cost: bonds (SFP)
(100 000 + 1 461 + 1 658 + 3 881) 107 000
Redemption of corporate bonds
Loss allowance on bonds (SFP) (7 051 + 949) 8 000
Reversal of allowance for expected credit losses
Comment
¾ The interest revenue recognised is calculated using the original effective interest rate on the
amortised cost of the bonds. The amortised cost is the gross carrying amount minus the loss
allowance.
¾ The loss allowance is discounted over the remaining term of the financial asset at the original
effective interest rate.
¾ On redemption of the bonds, an impairment loss of R8 000 is incurred since the coupon
interest and redemption amount were not paid in full to Retail Ltd. The coupon interest was
underpaid by an amount of R2 000 (R12 000 – R10 000) and the redemption amount was
underpaid by R6 000 (R105 000 – R 99 000).
Financial asset measured at fair value through other comprehensive income

(mandatory classification) – investment in debt instruments
The expected credit losses on a financial asset measured at fair value through other
comprehensive income is calculated in the same manner as for financial assets
measured at amortised cost. However, the loss allowance for a financial asset measured
at fair value through other comprehensive income is not recognised in the statement of
financial position but is presented as an expected credit loss reserve in other
Interest revenue on the financial instrument is calculated using the effective interest
method on the financial asset’s gross carrying amount when the asset is not credit
impaired. If the financial asset is credit impaired, the interest revenue is calculated using
the effective interest method on the financial asset’s amortised cost (the gross carrying
amount minus the loss allowance account).
Example 20.26 Financial asset at fair value through other comprehensive income – not
credit impaired
date is 31 December 20.15. The bonds were classified as a financial asset measured at fair value
through other comprehensive income.
Cash shortfall
Date cash flow cash flow
R
R R
31 December 20.15 12 000 12 000 –
31 December 20.16 12 000 10 000 2 000
31 December 20.17 12 000 10 000 2 000
31 December 20.17 105 000 99 000 6 000
On 1 January 20.15, Retail Ltd determines the 12-month expected credit losses on the bonds as
R150. On 31 December 20.15 and 31 December 20.16, the credit risk had increased significantly
since initial recognition. However, the corporate bonds were not credit impaired on these dates.
The lifetime expected credit losses amounted to the following:
Lifetime expected credit losses
Reporting date
R
31 December 20.15 7 977
31 December 20.16 7 051
The fair value of the bonds on the respective dates were as follows:
Reporting date Fair value
R
31 December 20.15 103 000
31 December 20.16 106 000
31 December 20.17 108 000
continued
Assuming that all contractual cash flows for 31 December 20.15, 31 December 20.16 and
31 December 20.17 were received, the journals will be as follows:
Dr Cr
R R
1 January 20.15
Cash (SFP) 100 000
Expected credit loss reserve (OCI) 150
31 December 20.15
Cash (SFP) 12 000
Financial asset at fair value through OCI: bonds (SFP) (balancing) 1 461
Fair value gain (OCI) (103 000 – (100 000 + 1 461)) 1 539
Subsequent measurement of bonds to fair value
Expected credit loss reserve (OCI) 7 827
31 December 20.16
Cash (SFP) 12 000
Effective interest income (P/L) ((100 000 + 1 461) × 13,4611%) 13 658
Fair value gain (OCI) (106 000 – (103 000 + 1 658)) 1 342
Expected credit loss reserve (OCI) (7 051 – 7 977) 926
31 December 20.17
Cash (SFP) 12 000
Financial asset at fair value through OCI: bonds (SFP) (balancing) 1 881
((100 000 + 1 461 + 1 658) × 13,4611%) 13 881
Financial asset at fair value through OCI: bonds (SFP) 119
Fair value gain (OCI) (108 000 – (106 000 + 1 881)) 119
continued
Dr Cr
R R
Cash (SFP) 105 000
Redemption and derecognition of bonds
Fair value gain (OCI) (1 539 + 1 342 + 119) 3 000
Fair value gain (P/L) 3 000
Reclassify fair value gains in OCI to profit or loss
Expected credit loss reserve (OCI) 7 051
Reclassify expected credit loss reserve to profit or loss
Comment
¾ Since the bonds are not credit impaired, the interest revenue recognised is calculated using the
original effective interest rate on the gross carrying amount of the bonds. The gross carrying
amount is the amortised cost of a financial asset before adjusting for any loss allowance.
¾ After the recognition of interest revenue and the coupon interest, the financial asset is
measured to its fair value. The fair value adjustment on the financial asset is recognised in
other comprehensive income. All accumulated fair value gains or losses in other
comprehensive income are reclassified to profit or loss when the financial asset is
derecognised.
¾ The expected credit losses are accumulated in equity in the expected credit loss reserve. The
reserve is reclassified to profit or loss on derecognition of the financial asset.
20.13.4 Purchased or originated credit-impaired financial assets

These are financial assets purchased or originated that are credit-impaired on initial
recognition. This may be the case when the credit risk of the financial asset is very high on
initial recognition or the financial asset was purchased at a deep discount. For the
measurement of expected credit losses on purchased or originated credit-impaired financial
assets, there is a deviation from the general approach as discussed above. The
measurement principles for purchased or originated credit-impaired financial assets are as
follows:
A credit-adjusted effective interest rate is used on the amortised cost of the financial
asset from initial recognition.
When calculating the credit-adjusted effective interest rate, an entity estimates the
expected cash flows and expected credit losses.
At each reporting date, an entity recognises a loss allowance equal to the lifetime
expected credit losses.
20.13.5 Simplified approach

IFRS 9 allows for a simplified approach when determining expected credit losses for trade
receivables, contract assets (IFRS 15) and lease receivables (IFRS 16). In terms of the
simplified approach, an entity is not required to determine whether the credit risk has
increased significantly since initial recognition of the financial asset. Instead, the entity is
allowed to recognise a loss allowance equal to the lifetime expected credit losses on every
reporting date.
The simplified approach is applied as follows:

Type of asset Simplified approach
Trade receivables and contract assets that do The loss allowance is always measured at an
not contain a significant financing component. amount equal to lifetime expected credit losses.
Trade receivables and contract assets that do Entity chooses as its accounting policy to
contain a significant financing component. measure the loss allowance at an amount
equal to lifetime expected credit losses (the
policy may be applied separately to trade
receivables and contract assets).
Lease receivables. Entity chooses as its accounting policy to
measure the loss allowance at an amount
equal to lifetime expected credit losses (the
policy may be applied separately to finance and
operating lease receivables).
IFRS 9 allows entities to use practical expedients to measure expected credit losses,
provided that such methods are consistent with IFRS 9. An example of such a practical
expedient is the use of a provision matrix to determine the lifetime expected credit losses on
trade receivables.
Example
Example 20.2
20.27 Trade receivables and provision matrix
Manufacta Ltd has a portfolio of trade receivables of R12 000 000 at 31 December 20.15 and only
operates in one geographical region. The trade receivables do not have a significant financing
component in accordance with IFRS 15 Revenue from Contracts with Customers. To determine
the expected credit losses for the trade receivables, Manufacta Ltd uses a provision matrix. The
provision matrix is based on its historical observed default rates over the expected life of the trade
receivables and is adjusted for forward-looking estimates. Manufacta Ltd uses the following
provision matrix:
1–30 days 31–60 days 61–90 days More than 90
Current
past due past due past due days past due
Default rate 0,2% 1,2% 3% 6,5% 12%
The age analysis of trade receivables at 31 December 20.15 is as follows:
Gross carrying
amount
R
Current 9 000 000
1–30 days past due 1 200 000
31–60 days past due 800 000
61–90 days past due 600 000
More than 90 days past due 400 000
Total 12 000 000
continued
Determining the loss allowance

In accordance with paragraph 5.5.15 of IFRS 9, the loss allowance for such trade receivables is
always measured at an amount equal to the lifetime expected credit losses. Manufacta Ltd uses a
provision matrix to determine the amount of lifetime expected credit losses on trade receivables.
The lifetime expected credit losses are measured as follows:
Gross carrying Lifetime expected
Default rate
amount credit loss allowance
R R
Current 9 000 000 0,2% 18 000
1–30 days past due 1 200 000 1,2% 14 400
31–60 days past due 800 000 3% 24 000
61–90 days past due 600 000 6,5% 39 000
More than 90 days past due 400 000 12% 48 000
Total 12 000 000 143 400
The journal entry to account for the loss allowance in the financial statements of Manufacta Ltd is
as follows:
Dr Cr
R R
31 December 20.15
Loss allowance on trade receivables (SFP) 143 400
20.13.6 Modification of contractual cash flows and the effect on credit risk
If the contractual cash flows of a financial asset measured at amortised cost are modified
and the financial asset is not derecognised (see section 20.12.2.1) it should be determined
whether there was a significant increase in the credit risk of the financial asset after the
modification. Since a modification of contractual cash flows does not necessarily lead to a
lower credit risk, an entity has to perform a detailed assessment of the credit risk of the
financial asset. This assessment is made by comparing the risk of default at initial
recognition (before the modification) with the risk of default at reporting date (after
modification).
20.13.7 A summary of impairment

Calculate a
Is the financial instrument a credit-adjusted effective
purchased or originated interest rate and always
credit-impaired financial Yes recognise a loss
asset? allowance at an amount
equal to lifetime expected
credit losses
No
Is the simplified approach

for trade receivables,
contract assets and
lease receivables
applicable?
Yes No
Does the financial

instrument have a low Is the low credit risk
Yes
credit risk at the reporting simplification applied?
date?
No No Yes
Recognise 12-month
Has there been a
expected credit losses
significant increase in
No and calculate interest
credit risk since initial
revenue on gross
recognition?
carrying amount
Yes
Recognise lifetime
expected credit losses
And
Calculate interest Is the financial instrument Calculate interest

revenue on gross No a credit-impaired financial Yes revenue on amortised
carrying amount asset? cost
20.14 Reclassification
The criteria to classify a financial asset into its appropriate measurement category, in
effect require an entity to reclassify financial assets when the objective of the entity’s
business model for managing those financial assets changes.
Changes in the objective of an entity’s business model are expected to be very
infrequent and must be determined by the entity’s senior management.
The change must be a result of external or internal changes, and must be significant to
the entity’s operations and demonstrable to external parties (IFRS 9.B4.4.1).
The reclassification date is the first day of the first reporting period following the change
in business model that results in an entity reclassifying financial assets (IFRS 9
Appendix A). The entity does not restate any previously recognised gains, losses or
interest.
If an entity reclassifies financial assets, it shall apply the reclassification prospectively
from the reclassification date as follows:
Reclassifies from Reclassifies to Accounting treatment

Amortised cost Fair value through profit Remeasure the asset to fair value at
or loss (P/L) reclassification date. Recognise gain/loss
from the difference between fair value and
amortised cost of the asset in profit or loss.
Fair value through P/L Amortised cost The fair value at reclassification date is the
new gross carrying amount.
Amortised cost Fair value through other Remeasure the asset to fair value at
comprehensive income reclassification date. Recognise gain/loss
(OCI) from the difference between fair value and
amortised cost of the asset in OCI.
Fair value through OCI Amortised cost The fair value at reclassification date is the
new gross carrying amount minus
cumulative gains/losses previously
recognised in OCI.
Fair value through OCI Fair value through P/L Continue fair value measurement.
Cumulative gain or loss recognised in OCI is
reclassified from equity to profit or loss at
reclassification date.
Fair value through P/L Fair value through OCI Continue fair value measurement.
Determine the effective interest rate and
loss allowance on reclassification date.
Example 20.2
20.28 Reclassification of a financial asset
Seraphim Ltd acquired 1 000 R100 12% per annum corporate bonds on 1 January 20.12 at their
fair value of R100 000. Transaction costs of R500 were incurred. The bonds pay interest annually
on 31 December and the capital is settled at nominal value on 31 December 20.14. On
30 June 20.13, the business model of Seraphim Ltd relating to the corporate bonds changed,
resulting in a reclassification of the financial asset.
continued
The relevant information can be summarised follows:
Cash Gross carrying Effective Fair Fair value

Date
flow amount interest value gain/(loss)
R R R
1 January 20.12 – 100 500 100 500
31 December 20.12 12 000 100 352 11 852 97 852 – 2 148
30 June 20.13 – 106 269 5 917 97 336 – 516
31 December 20.13 12 000 100 186 5 917 97 823 487
31 December 20.14 112 000 – 11 814 100 000 2 177
The loss allowance on reclassification date amounted to R1 000, which equalled the lifetime
expected credit losses. The 12-month expected credit losses on the bonds amounted to R200 on
reclassification date. At 31 December 20.14, the credit risk and estimated 12-month expected
credit losses on the bonds remained unchanged from 1 January 20.14.
The journal entries for 20.14 to account for the corporate bonds in the financial statements of
Seraphim Ltd will be as follows:
Assume the corporate bonds were reclassified from amortised cost to fair value through
profit or loss (FVTPL)
Dr Cr
R R
1 January 20.14
Financial asset at FVTPL: corporate bonds (SFP) 97 823
Loss on reclassification (P/L) (balancing) 1 363
Reclassification of financial asset
31 December 20.14
Cash (SFP) 12 000
Recognition of payment received
Fair value gain (P/L) [100 000 – (97 823 – 12 000)] 14 177
Subsequent measurement of corporate bonds at FVTPL
Cash (SFP) 100 000
Assume the corporate bonds were reclassified from fair value through profit or loss
(FVTPL) to amortised cost
1 January 20.14
Reclassification of financial asset
Commencement of accounting for expected credit losses
continued
The effective interest rate for the corporate bonds at the reclassification date is 14,493% per
annum (PV = – 97 823; PMT = 12 000; FV = 100 000; n = 1; i = ?). The amortisation schedule for
these bonds can be illustrated as follows:
Gross
Cash Effective Capital Amortisation
Date carrying
flow interest repayments of difference
amount
1 January 20.14 – 97 823 97 823
31 December 20.14 112 000 14 177 – 100 000 2 177 –
Total 14 177 14 177 – 100 000 2 177
Dr Cr
Cash (SFP) 12 000
Cash (SFP) 100 000
Comment
¾ The change in business model occurred on 30 June 20.13. The reclassification date is
1 January 20.14.
20.15 Derecognition
Financial assets are derecognised only when:
the contractual rights to the cash flows from the financial assets expire; or
the entity transfers the financial asset and the transfer qualifies for derecognition.
In regard to the derecognition criteria above, it is important to note that in some
circumstances a substantial modification of the contractual cash flows of a financial asset
can lead to the derecognition of the financial asset.
A write-off of a financial asset also constitutes a derecognition event. A write-off is only
applied if there are no reasonable expectations of recovering the financial asset in its
entirety or a portion thereof. Where a write-off is applicable, the gross carrying amount of the
financial asset and the loss allowance are directly reduced in their entirety or a portion
thereof. If the amount of the write-off is greater than the loss allowance balance, the
difference is recognised in profit or loss as an impairment loss.
20.15.2 Financial liabilities

20.15.2.1 Extinguishing a financial liability
An entity shall remove a financial liability (or a part of a financial liability) from its
statement of financial position when, and only when, it is extinguished. A liability is
extinguished when the obligation specified in the contract is discharged, cancelled or
expires.
A substantial modification of the terms of an existing financial liability or a part of it
(whether or not attributable to the financial difficulty of the debtor) shall be accounted for
as an extinguishment of the original financial liability and the recognition of a new
financial liability.
An exchange between an existing borrower and lender of debt instruments with

substantially different terms shall be accounted for as an extinguishment of the original
financial liability and the recognition of a new financial liability.
20.15.2.2 Settlement of a financial liability with equity instruments
When equity instruments issued as settlement of a financial liability to a creditor are
recognised initially, an entity shall measure the equity instruments at the fair value of the
equity instruments issued, unless that fair value cannot be reliably measured.
If the fair value of the equity instruments issued cannot be reliably measured, then the
equity instruments shall be measured to reflect the fair value of the financial liability
extinguished.
In measuring the fair value of an extinguished financial liability that includes a demand
feature (e.g. a demand deposit), the exemption to fair value is not applied. Any gain
or loss due to the settlement should be recognised in profit or loss (IFRIC 19.5 to .7, .9
and .11).
This requirement does not apply when the creditor is also a shareholder and is acting in
its capacity as a shareholder; or the creditor and the issuer are controlled by the same
party before and after the transaction; or extinguishing the financial liability by issuing
equity shares is in accordance with the original terms of the financial liability
(IFRIC 19.3). In such cases, the equity instruments issued should be measured at the
carrying amount of the financial liability extinguished so that no profit or loss is
recognised.
Example 20.29 Settlement with equity instruments
Caesar Ltd borrowed R98 500 cash at 12% per annum from Bank Ltd on 1 January 20.12. The
loan is repayable in three equal annual instalments of R42 087 at the end of each year. The
effective interest rate for the loan is 13,522% per annum (PV = 98 500; PMT = 42 087; FV = 0;
n = 3; I = ?). The amortisation schedule for the loan can be illustrated as follows:
Cash Effective Capital Amortisation Amortised

Date
flow interest repayments of difference cost balance
1 January 20.12 – 98 500 98 500
31 December 20.12 42 087 13 319 – 28 768 1 319 69 732
31 December 20.13 42 087 9 429 – 32 658 2 571 37 074
31 December 20.14 42 087 5 013 – 37 074 6 987 –
Total 27 761 27 761 – 98 500 10 877
On 31 December 20.12, Caesar Ltd was able to renegotiate the terms of the loan payable in order
to improve its cash position for the next two years. Caesar Ltd issued 10 000 of its own ordinary
shares as full and final settlement of the loan payable. The quoted price (level 1 input) of one
Caesar Ltd ordinary share on 31 December 20.12 amounted to R7,00.
Application
The issue of an entity’s equity instruments to a creditor to extinguish all or part of a financial liability
is seen as consideration paid. Caesar Ltd shall remove the loan payable from its statement of
financial position as the shares were issued as full and final settlement of the loan payable.
continued
The journal entry to account for the derecognition will be as follows:

Dr Cr
Financial liability at amortised cost: loan payable (SFP) 69 732
Loss from derecognition of loan payable (P/L) (balancing figure) 268
Ordinary share capital (SCE) (10 000 × R7,00) 70 000
Derecognition of loan payable
Comment
¾ If only part of the financial liability is extinguished, the entity shall assess whether some of the
consideration paid relates to a modification of the terms of the liability that remains
outstanding. If part of the consideration paid does relate to a modification of the terms of the
remaining part of the liability, the entity shall allocate the consideration paid between the part
of the liability extinguished and the part of the liability that remains outstanding (IFRIC 19.8).
20.16 Hedge accounting
20.16.1 What is hedge accounting?

Hedging is a risk reduction method. The simplest way to explain hedging is to compare it to
insurance. In order to protect an asset against the risk of loss or damage, insurance is taken
out. The insurance premiums paid by the insured party ensure that compensation is
received from the insurer should an event occur where the asset is lost, stolen or damaged.
Therefore, by insuring the asset, the exposure to risk is limited.
The hedging terms used in IFRS 9 refer to the item that a company wants to ‘insure’ as the
hedged item. Hedged items usually expose an entity to risks such as foreign currency risk,
commodity price risk and interest rate risk. The ‘insurance’ taken out to protect an entity
against these risks associated with the hedged item is called a hedging instrument.
Hedging instruments are generally derivative instruments such as futures, options and
forward exchange contracts. It is evident from the above that hedging, as with insurance, is
a risk management tool.
An entity applying hedge accounting attempts to match any loss or gain on a hedged item
with the gain or loss on the hedging instrument. Hedge accounting therefore presents in the
financial statements the financial effect of an entity’s exposure to risk as well as
management’s activities to manage those risks and how effective they were. It is important
to note that hedge accounting is optional, that is, it is a voluntary accounting model.
An entity may choose to apply hedge accounting only when the following qualifying criteria
are met:
The hedging relationship consists only of eligible hedging instruments and eligible
hedged items.
At the inception of the hedging relationship there is formal designation and
documentation of the hedging relationship and the entity’s risk management objective
and strategy for undertaking the hedge. The documentation should include identification
of the hedging instrument, the hedged item, the nature of the risk being hedged and how
the entity will assess hedge effectiveness.
The hedging relationship meets the hedge effectiveness requirements.
In light of the discussion above, hedge accounting therefore involves the following steps:
Step 1: Identify the hedged item.
Step 2: Identify a potential hedging instrument.
Step 3: Determine if the qualifying criteria for hedge accounting are met.
Step 4: Account for the hedge transaction in terms of the appropriate hedge
accounting model.
The two main hedge accounting models are as follows:
Fair value hedge A hedge of the exposure to changes in fair value of a recognised asset
or liability or an unrecognised firm commitment, or a component of
any such item that is attributable to a particular risk and could affect profit
or loss.
If the hedge item is an equity instrument for which an entity elected to
present changes in fair value through other comprehensive income
(OCI), the hedge exposure must be one that could affect OCI.
Cash flow hedge A hedge of the exposure to variability in cash flows that is attributable to
a particular risk associated with a recognised asset or liability or a
highly probable forecast transaction, or a component of any such item
and could affect profit or loss.
A hedge of a foreign currency risk of a firm commitment may be accounted for as a fair
value hedge or a cash flow hedge.
The hedge accounting model applied depends on the objective of the risk being hedged. If a
fair value hedge meets the criteria for hedge accounting during the period, it shall be
accounted for as follows:
Accounting
Hedging Any gain or loss on the remeasurement of the hedging instrument is
instrument recognised in profit or loss.
(derivative) Exception:
If the hedging instrument hedges an equity instrument for which an
entity elected to present changes in fair value of the equity instrument in
other comprehensive income (OCI), any gain or loss on the hedging
instrument is also recognised in OCI.
Hedged item Any gain or loss on the remeasurement of a hedged item adjust the
carrying amount of the hedged item and is recognised in profit or
loss.
Exceptions:
If the hedged item is an equity instrument for which an entity elected to
present changes in fair value in other comprehensive income (OCI), any
gain or loss on remeasurement of the hedged item is recognised in OCI.
If the hedged item is a financial asset for which an entity mandatorily
has to present changes in fair value in OCI, any gain or loss on
remeasurement of the hedged item is recognised in profit or loss.
If the hedged item is a firm commitment, the initial carrying amount of
the asset or liability that results from the entity meeting the firm
commitment is adjusted by the cumulative change in the fair value of the
firm commitment.
If a cash flow hedge meets the criteria for hedge accounting for the period, it shall be
accounted for as follows:
Accounting
Hedging The portion of the gain or loss on the hedging instrument that is an
instrument effective hedge is recognised in other comprehensive income.
Any remaining gain or loss on the hedging instrument is as a result of
hedge ineffectiveness and is recognised in profit or loss.
Hedged item Step 1
Recognise a cash flow hedge reserve in equity associated with the
hedged item. The cash flow hedge reserve is the lower of the following:
the cumulative gain or loss on the hedging instrument from inception of
the hedge; and
the cumulative change in fair value (present value) of the hedged item
from inception of the hedge.
Step 2
If the hedged transaction subsequently results in the recognition of a
non-financial item or a firm commitment to which fair value hedge
accounting is applied, the cash flow hedge reserve is removed and
included in the carrying amount of the non-financial item or firm
commitment.
In all other cases (e.g. hedged transactions resulting in the recognition
of a financial item), the cash flow hedge reserve is reclassified to
profit or loss as a reclassification adjustment in the same period or
periods during which the hedged cash flows affect profit or loss.
Hedge accounting is discontinued only when the qualifying criteria are no longer met. An
entity cannot voluntarily discontinue hedge accounting.
20.17 Derivative financial instruments
20.17.1 What is derivative financial instruments?

IFRS 9 Appendix A defines a derivative instrument as a financial instrument or other
contract within the scope of IFRS 9 with all three of the following characteristics:
Its value changes in response to the change in a specified interest rate, financial
instrument price, commodity price, foreign exchange rate, index of prices or rates, credit
rating or credit index, or other variable, provided in the case of a non-financial variable
that the variable is not specific to a party to the contract (sometimes called the
‘underlying’).
It requires no initial net investment or an initial net investment that is smaller than
would be required for other types of contracts that would be expected to have a similar
response to changes in market factors.
It is settled at a future date.
Derivative financial instruments are more advanced instruments such as futures, forwards,
options and swaps.
A forward is a contractual agreement to buy or sell a particular commodity or financial instrument

at the forward price in the future. Both parties are obligated to act. The delivery of the underlying
asset in exchange for the forward price is therefore deferred until after the contract has been
concluded. Although the delivery is made in the future, the forward price is determined on the
initial trade date.
An option is a contractual agreement that gives the holder the right, but not the obligation, to buy
(for a call option) or sell (for a put option) a specific amount of a commodity or financial instrument
during a specified period of time. Each option contract has a buyer, referred to as the holder, and a
seller, known as the writer.
A swap is a contract between two parties in which the parties promise to make payments to one
another on scheduled dates in the future. In other words, the counterparties agree to exchange
one stream of cash flows against another stream. These streams are called the ‘legs’ of the swap.
The payments are determined using different criteria or formulas. There are four types of swaps
defined by the type of their underlying financial risk; namely interest rate, equity, currency, and
commodity swaps.
(a) Classification of derivatives

All derivative instruments are classified as financial assets or financial liabilities, except for
derivative instruments that meet the following criteria:
the derivative is a contract that will or may be settled in the entity’s own equity
instruments; and
the derivative will or may be settled by the exchange of a fixed amount of cash or
another financial asset for a fixed number of the entity’s own equity instruments (the
‘fixed-for-fixed’ test) (IAS 32.11).
Derivative instruments that meet the two criteria above should be classified as equity
instruments of the entity.
(b) Initial measurement of derivative financial instruments
Derivative financial instruments are initially measured at fair value as is the case with all
other financial instruments.
The fair values of the right and obligation contained in a forward-type contract (including
swaps with no optionality) are often priced to be equal at initial recognition, so that the net
fair value of the derivative is Rnil. If the net fair value is not Rnil, the derivative is referred to
as being ‘off-market’ and should be recognised at the fair value as either a financial asset or
a liability.
The fair value of an option-type contract at initial recognition equals the premium paid by
the holder to acquire the option. An option pricing model is used to calculate the fair value.
(c) Subsequent measurement of derivative financial instruments
All derivative financial instruments (assets and liabilities) not classified as equity
instruments or designated as hedging instruments shall be measured at fair value
Derivative financial instruments that are not designated as hedging instruments are deemed
to be held for trading. It is therefore appropriate for subsequent gains or losses on derivative
financial instruments held for trading to be recognised in profit or loss.
The subsequent measurement of derivative financial instruments that are designated as
hedging instruments is, however, not that simple. There are specific rules for the
subsequent measurement of derivates designated as hedging instruments. These rules are

not discussed in this text.
Transaction costs related to derivative financial instruments are always expensed in profit
or loss.
IFRS 7 Financial Instruments: Disclosures
20.18 Disclosure
IFRS 7 requires disclosure regarding the following two main categories:
information about the significance of financial instruments on the financial position
and performance of the entity; and
information about the nature and extent of risks arising from financial instruments and
how these risks are managed.
These two disclosure categories are discussed below.
20.18.1 Financial position and performance

20.18.1.1 Financial position
IFRS 7 requires the disclosure of information pertaining to the following in the statement of
financial position or in the notes:
Statement of financial position disclosures
Categories of financial assets and liabilities
(carrying amounts of each of the classification categories)
Financial assets or financial liabilities designated at fair value through profit or loss
Investments in equity instruments designated at fair value through other comprehensive income
Reclassification
Offsetting of financial assets and financial liabilities
Collateral
Allowance account for credit losses
Compound financial instruments with multiple embedded derivatives
Defaults and breaches of loans payable
Effects of hedge accounting
Significant accounting policies
An entity has to provide information regarding the fair value of a class of financial assets
and financial liabilities in a way that permits it to be compared with its carrying amount (this
is not required for those financial assets or liabilities such as trade receivables and trade
payables where the carrying amount approximates fair value).
The following information regarding the impairment of financial instruments has to be
provided in the financial statements:
a reconciliation of the 12-month loss allowance and the lifetime loss allowance balances
from the opening to the closing allowance balances. This is provided with a reconciliation
from the opening to the closing balances of the related carrying amounts of financial
instruments subject to impairment (IFRS 7.35H to .35I);
the basis for the expected credit loss calculations (IFRS 7.35G);
how the expected credit losses and changes in credit risk were assessed (IFRS 7.35F);
the credit risk of financial assets by rating grades (IFRS 7.35M); and
financial assets whose contractual cash flows have been modified (IFRS 7.35J).
The following is an example of a quantitative disclosure regarding exposure to credit risk
and impairment in terms of IFRS 7.35H:
Extract from the notes to the financial statements of Phoenix Ltd Group
Note 10. Allowance for expected credit losses: investment in bonds
12-month Lifetime Credit-impaired
expected expected instruments
credit losses credit losses (lifetime
expected
credit losses)
R R R
Loss allowance on 1 January 20.13 220 000 50 000 –
Change in credit risk of financial assets
on 1 January 20.13:
Transfer to lifetime expected credit losses (40 000) 40 000 –
Transfer to credit-impaired instruments – (50 000) 50 000
New bonds purchased 20 000 – –
Change in credit risk parameters 30 000 5 000 1 000
Loss allowance on 31 December 20.13 230 000 45 000 51 000
IFRS 7 has the following specific disclosure requirements for hedge accounting:
(a) Details regarding the following should be provided in terms of the risk management
strategy:
How does risk arise?
How is risk managed?
The extent to which risk exposure is managed.
The hedging instruments that are used.
The economic relationship between the hedging instrument and the hedged item.
How was the hedge ratio determined?
The sources of hedge ineffectiveness.
(b) Amount, timing and uncertainty regarding the hedging instruments’ future cash flows.
(c) The effects of hedge accounting on the financial position and performance.
20.18.1.2 Financial performance

An entity is required to disclose the following items of income, expenses, gains or losses in
the statement of comprehensive income or in the notes:
Statement of comprehensive income disclosures
Net gains or losses on:
financial assets or financial liabilities measured at fair value through profit or loss (separating
those that are designated from the mandatorily measured at fair value through profit or loss);
financial assets or financial liabilities measured at amortised cost;
investments in equity instruments designated at fair value through other comprehensive
income; and
investments in debt instruments mandatorily measured at fair value through other
Total interest revenue and interest expense on:
financial assets or financial liabilities measured at amortised cost; and
investments in debt instruments mandatorily measured at fair value through other
Fee income and expense (amounts not included in determining the effective interest rate) arising
from:
financial assets and financial liabilities that are not at fair value through profit or loss; and
trust and other fiduciary activities.
An analysis of the gain or loss arising from the derecognition of financial assets measured at
amortised cost and reasons for derecognition.
Effects of hedge accounting.
Significant accounting policies.
20.18.2 Risks
An entity is required to disclose information regarding the nature and extent of risks arising
from financial instruments and how these risks are managed.
The following risks arise from financial instruments:
credit risk;
liquidity risk; and
market risk (comprises of: currency risk, interest rate risk and other price risk).
The following illustrates the disclosure of the impact of a financial instrument on the financial
position and performance of the entity and the liquidity risk arising from the financial
instrument:
An extract from the notes to the financial statements of Phoenix Ltd Group for the year
ended 31 December 20.13
Note 20. Borrowings
Accounting policy (IFRS 7.21)
Classification
For measurement purposes, the company classifies its borrowings as measured at amortised
cost, as the borrowings are not held for trading.
Recognition
The company shall recognise borrowings in its statement of financial position when, and only
when, the company becomes a party to the contractual provisions.
continued
Initial measurement
Borrowings are recognised initially at fair value, net of transaction costs incurred.
Subsequent measurement
Borrowings are subsequently carried at amortised cost and any difference between the proceeds
(net of transaction costs) and the redemption value is recognised in profit or loss under ‘finance
cost’ over the period of the borrowings, using the effective interest method.
R
Composition
Borrowings 205 000
Less: current portion (40 000)
165 000
Fair value (IFRS 7.25)

The fair value of the borrowings at 31 December 20.13 amounts to R180 000 (level 2 inputs),
calculated using a discounted cash flow methodology and assuming a market-related discount
rate of 12% (IFRS 13.97).
Financial risk management (IFRS 7.31)
Source, objective, policies and processes (IFRS 7.33)
The borrowings expose the company to liquidity risk. The company actively monitors its liquidity
requirements for short-term liabilities and current portions of longer-term liabilities through
monitoring its net working capital position. Any potential shortfall will be financed through available
overdraft facilities. The liquidity risk of the overdraft facilities and non-current portion of longer-term
liabilities is managed through the investment strategy. All investments of surplus cash, except for
strategic investments, are made in highly liquid listed assets.
The following are the contractual maturity of the borrowings, including interest payments:
Carrying Contractual Within 1 2 to 5 5 years
amount cash flows year years and later
Borrowings R205 000 R226 000 R44 000 R182 000 –
The amounts disclosed in the table are the contractual undiscounted cash flows.
Extract from the notes to the financial statements of Phoenix Ltd Group for the year ended
31 December 20.13
Note 23. Finance cost
Accounting policy (IFRS 7.21)
Any difference between the proceeds (net of transaction costs) and the redemption value of
financial liabilities measured at amortised cost is recognised in profit or loss, over the period of the
financial liabilities, using the effective interest method.
Composition R
Financial liabilities at amortised cost (note 20) (IFRS 7.20(b)) 20 000
20.19 Deferred tax
Example 20.30 Deferred tax consequences of financial instruments
As a result of differences between the income tax and accounting treatment of financial
instruments, temporary differences may arise. The most important aspects of the relevant
deferred tax consequences of financial instruments are summarised in this example.
The following table summarises the financial assets and financial liabilities of Multi Ltd as at
31 December 20.12. Multi Ltd is a diversified company involved in the retail and financial services
sector. Multi Ltd has a rand (R) functional currency. Assume a normal income tax rate of 28% and
a capital gains tax inclusion rate of 80%.
Item Carrying
Additional information Tax treatment
amount
R’000
Financial assets
Investments 15 000 Investments in listed The capital profit or loss on
shares classified as sale of the shares will be
measured at fair value included in taxable income.
through OCI. The historic The base cost for capital
cost amounts to gains tax purposes amounts
R10 million. Multi Ltd to R10 million.
expects to recover the
carrying amount through
sale. No dividend income
has been received during
the year.
Loan 200 000 The loan is measured at Interest income is included
receivable amortised cost using the in taxable income as
effective interest method. accrued, using the effective
The carrying amount interest method. Capital
includes an expected repayments are not included
credit loss allowance of in taxable income. The tax
R10 000 000. authority does not allow
credit losses on the loan as
a tax deduction.
Inventory – 22 000 Listed shares that are held Total sale proceeds are
shares for trading and classified included in taxable income
as measured at fair value when the shares are sold.
through profit or loss. No The cost is allowed as a
dividend income has been deduction against the sale
received during the year. proceeds on date of sale.
The historic cost amounts
to R20 million.
SAFEX – Futures listed on SAFEX. Fair value gains and losses
instruments Gains and losses on on derivatives are included
derivatives are settled in/deducted from taxable
daily in cash. A net gain of income when realised in
R800 000 was realised cash.
during the year.
continued
Item Carrying
Additional information Tax treatment
amount
R’000
Trade receivables 150 000 The carrying amount Income is included in taxable
includes an expected credit income the earliest of receipt
loss allowance of or accrual. Only 25% of
R30 000 000. impairment losses are
allowed as a deduction when
incurred.
Financial liabilities
Borrowings 230 000 Borrowings are measured Interest expense is tax
at amortised cost using the deductible as accrued, using
effective interest method. the effective interest method.
Capital repayments are not
allowed as deductions.
Trade creditors 30 000 Trade creditors are Expenses are deducted at the
measured at the invoice earliest of payment or
amounts as the effect of accrual.
discounting is deemed to be
immaterial.
Compound financial 1 697 The instrument was issued Interest expense based on
instrument at year end for total the capital of R2 million is
proceeds of R2 million. The deducted from taxable
equity component amounts income, as accrued, using the
to R303 263. effective interest method.
Capital payments are not
allowed as deductions.
The deferred tax for each item as at 31 December 20.12 can be calculated as follows (brackets
signify deferred tax liabilities):
Temporary Deferred tax
Carrying difference Dr/(Cr) Recognised
Item Tax base
amount in
100% or 80% (28%)
R’000 R’000 R’000 R’000
Financial assets
Investments (1) 15 000 10 000 4 000 (1 120) OCI
Loan receivable (2) 200 000 200 000 – –
Inventory – shares (3) 22 000 20 000 2 000 (560) P/L
SAFEX instruments (4) – – – –
Trade receivables (5) 150 000 172 500 (22 500) 6 300 P/L
(1) The tax base of the investments represents the amount deductible when the shares are sold
in the future. This will be the base cost of R10 000 000. The temporary difference is taxable
at the capital gains tax inclusion rate of 80% since the tax authority will treat it as a capital
asset on disposal.
(2) The tax base of the loan receivable is firstly made up of R210 000 000 before the credit loss
allowance. As the taxation authorities also use the effective interest method to measure
interest income, and capital repayments are not included in taxable income, the future
recovery of the loan receivable amount of R210 000 000 will not result in any future tax
consequences. The second component relates to the ‘negative asset’ of R10 000 000 for the
credit loss allowance. The definition of a tax base of a liability can be applied to calculate the
tax base of the credit loss allowance. The tax base should therefore be the carrying amount
of R10 000 000 minus the amount deductible in the future, which is Rnil. The total tax base of
the loan receivable is therefore R200 000 000 (R210 000 000 – R10 000 000).
continued
(3) The tax base represents the amount deductible when the shares are sold in the future,
namely, the historic cost of R20 000 000.
(4) No asset or liability has been recognised as at year end, as the gains or losses are settled
daily in cash. The net gain of R800 000 would have been included in taxable income when
incurred. Therefore no temporary difference is created.
(5) The tax base of the trade receivables is firstly made up of R180 000 000 before the credit
loss allowance. The trade receivables’ related income had already been included in taxable
income when incurred. Therefore the future recovery of the R180 000 000 will not have future
tax consequences, and the tax base should equal the carrying amount. The second
component relates to the ‘negative asset’ of R30 000 000 for the credit loss allowance. The
definition of a tax base of a liability can be applied to calculate the tax base of the credit loss
allowance. The tax base should therefore be the carrying amount of R30 000 000 minus the
amount deductible in the future of R22 500 000 (R30 000 000 × 75%) = R7 500 000. The total
tax base of the trade receivables is therefore R172 500 000 (R180 000 000 – R7 500 000).
Note that the result is a deferred tax asset of R6 300 000 (R22 500 000 × 28%) representing
the future tax benefit when 75% of the credit loss allowance amounting to R22 500 000 will
be granted as a tax deduction in the future.
Deferred tax
Carrying Temporary Recognised
Item Tax base Dr/(Cr)
amount difference in
(28%)
R’000 R’000 R’000 R’000
Borrowings (1) (230 000) (230 000) – –
Trade creditors (2) (30 000) (30 000) – –
Compound financial
instrument (3) (1 697) (2 000) 303 (85) Equity
(1) The taxation authorities also use the effective interest method to measure interest expense,
and capital repayments are not allowed as deductions. There are therefore no amounts
deductible in the future; thus the tax base equals the carrying amount.
(2) The related expenses have already been deducted. There are therefore no amounts
deductible in the future; thus the tax base equals the carrying amount.
(3) The tax base of the liability component on initial recognition is equal to the initial carrying
amount of the sum of the liability and equity components (i.e. R2 000 000). The resulting
taxable temporary difference arises from the initial recognition of the equity component
separately from the liability component. Therefore, the initial recognition exception set out in
IAS 12.15(b) does not apply. Consequently, an entity recognises the resulting deferred tax
liability. In accordance with IAS 12 paragraph 61A, the deferred tax is charged directly to the
carrying amount of the equity component. Subsequent changes in the deferred tax liability are
recognised in profit or loss as a deferred tax expense (income) (IAS 12.23).
CHAPTER
21
Fair value measurement
(IFRS 13)
Contents
21.1 Summary of IFRS 13 Fair Value Measurement ................................................ 580
21.2 Background ....................................................................................................... 581
21.3 Meaning of fair value ......................................................................................... 581
21.3.1 Definition of fair value ......................................................................... 581
21.3.2 Price ................................................................................................... 582
21.3.3 Asset or liability .................................................................................. 582
21.3.4 Orderly transaction ............................................................................. 583
21.3.5 Market participants ............................................................................. 583
21.3.6 Measurement date ............................................................................. 583
21.4 Application of fair value ..................................................................................... 584
21.4.1 Non-financial assets ........................................................................... 584
21.4.3 Liabilities and own equity instruments ................................................ 585
21.5 Fair value at initial recognition ........................................................................... 588
21.6 Fair value techniques ........................................................................................ 589
21.6.1 Market approach ................................................................................ 589
21.6.2 Cost approach .................................................................................... 590
21.6.3 Income approach................................................................................ 591
21.7 Fair value hierarchy ........................................................................................... 593
21.8 Disclosure .......................................................................................................... 596
579
21.1 Summary of IFRS 13 Fair Value Measurement
Objective
IFRS 13 presents a framework for defining and measuring fair value and disclosing fair value
measurements.
Scope
All IFRSs that permit fair value measurement and disclosure except for:
share-based payment transactions within scope of IFRS 2;
leasing transactions within the scope of IFRS 16 Leases;
measurement of net realisable value of inventories within the scope of IAS 2;
measurement of value in use within the scope of IAS 36;
disclosure of plan assets measured at fair value within the scope of IAS 19;
disclosure of retirement benefit investments within the scope of IAS 26; and
disclosure when recoverable amount is fair value less costs to sell within the scope of IAS 36.
Definitions Measurement and application
The price that would be Non-financial assets: Fair value at highest and best use of
received to sell an asset or market participants.
paid to transfer a liability in Liabilities and own equity: At quoted price and if not
an orderly transaction available:
between market – If held as assets by other parties: Measure from perspective
participants at the of market participant that holds the asset.
measurement date.
– If not held by other parties as assets: Measure from
Asset or liability: perspective of market participant that owes the liability or
Consider characteristics issued the claim on equity.
of assets and liabilities.
Include non-performance risk and restrictions preventing the
Transaction: Orderly transfer.
transaction in either the
principal or most Application to financial assets and liabilities with offsetting
advantageous market options: Permits measurement of a group of assets and
liabilities on a net basis.
Market participants:
Consider their Application of fair value at initial recognition: Differences
assumptions. between transaction price and fair value are taken to profit or
loss.
The price: Exit price,
before transaction costs Valuation techniques:
that is directly – Market approach: Quoted prices.
observable, or by using – Cost approach: Adjusted replacement cost.
a valuation technique. – Income approach: Present value techniques.
Fair value hierarchy
– Level 1 – Inputs: Quoted prices for identical items in an
active market.
– Level 2 – Inputs: Observable inputs. Quoted prices for
similar items in an active market, quoted prices for identical
items in an inactive market or observable interest rates and
yields.
– Level 3 – Inputs: Unobservable inputs or significant
adjustments to observable inputs.
Disclosure
Refer to IFRS 13.91 to .99.
Fair value measurement 581
21.2 Background
Fair value as a measurement basis is part and parcel of modern accounting practices. Many
international financial reporting standards currently permit entities to use fair value as a
measurement basis. In the past, there was no proper, consistent guidance on how fair value
should be determined. Some IFRSs contained limited information on how to measure fair
value, whereas others contained extensive information which was not always consistent
across the Standards. Without guidance on how to determine fair value, preparers of
financial statements followed their own methods, which sometimes resulted in unverifiable
gains and losses in the statement of profit or loss and other comprehensive income. Against
this backdrop, there was a growing need for a framework on fair value. IFRS 13 was a joint
project of the IASB and the USA’s national Accounting Standard setter, the Financial
Accounting Standards Board (FASB). Having uniform measurement and disclosure
requirements for fair values will reduce diversity in application and will improve
comparability.
The purpose of IFRS 13 is to:
define fair value;
set out a framework for measuring fair value; and
describe the related disclosure requirements.
The framework focuses on the the statement of financial position and the fair value
measurement of assets and liabilities as they are the primary elements of accounting
recognition and measurement. The statement of profit and loss and other comprehensive
income is directly influenced as a result of measurements and movements of assets and
liabilities.
This Standard is applicable to all IFRSs that require or permit fair value measurements or
disclosures for assets and liabilities. IFRS 3, IFRS 9, IAS 16, IAS 40, IAS 41 etc. are just a
few examples thereof.
This Standard does not apply to the following measurement and disclosure requirements
(IFRS 13.6):
share-based payment transactions within scope of IFRS 2;
leasing transactions within the scope of IFRS 16 Leases;
measurement of net realisable value of inventories within the scope of IAS 2;
measurement of value in use within the scope of IAS 36;
disclosure of plan assets measured at fair value within the scope of IAS 19;
disclosure of retirement benefit investments within the scope of IAS 26; and
disclosure when the recoverable amount is the fair value less costs to sell within the
scope of IAS 36.
IFRS 13 is applicable to both initial and subsequent measurement of assets and liabilities
where fair value is required or permitted.
21.3 Meaning of fair value
21.3.1 Definition of fair value

IFRS 13 defines fair value as the price that would be received to sell an asset or paid to
transfer or to extinguish a liability in an orderly transaction between market participants at
the measurement date.
Fair value is a market-based value and not an entity-specific value, which means that it is
the value that market participants would agree upon under market conditions existing on the
measurement date. This is a very important principle of this Standard, The result of this is
that the current use of an entity is seen as an input and that the anticipated use of market
participants is also taken into account. When the fair value is not observable, an entity will
use valuation techniques that maximise observable inputs and minimise unobservable
inputs.
In order to obtain a better understanding of this definition, it is necessary to understand the
different elements of this definition separately, namely price, asset and liability, orderly
transaction, market participants and measurement date. These elements will be discussed
in the following sections.
21.3.2 Price
The fair value is the price that would be received to sell an asset or paid to transfer or
extinguish a liability. This price is referred to the exit price between market participants in
an orderly transaction under market conditions existing at measurement date. The exit price
can therefore be seen as the deemed selling price for an asset and as the deemed
settlement amount for a liability. The exit price may be directly observable or estimated by
using other valuation techniques.
IFRS 13.11 identifies three characteristics that should be considered when fair value of an
item is determined, namely:
• condition;
• location; and
• restrictions.
Transaction cost is not a characteristic of an asset or a liability but rather a charcteristic of a
transaction to realise an asset or settling a liability. Therefore the fair value is not adjusted
for the effect of transaction costs upon a sale of an asset, but rather treated in accordance
with other IFRSs. Transaction costs do not, however, include transport costs. Location is a
characteristic of an asset and therefore the transport cost that would be incurred to transport
the asset from its current location to its principal market should be taken into account in
determining fair value. The condition, age and restrictions of an item will also affect the fair
value.
Example 21.1 Transaction costs and transport costs
John Ltd decided to revalue its imported machinery. The machinery was imported from Germany,
which is the principal and most advantageous market for new and used machinery. In order to sell
the machinery it should therefore be transported to Germany. It was determined that the exit price at
measurement date of such a used machine in Germany would be ̀150 000 before sales commission
of 5% is taken into account. It is also estimated that John Ltd would incur R35 000 transport costs to
transport the machine to Germany if it were to be sold. The exchange rate at measurement date is
R15,80 to ̀1.
Fair value
R
Exit price, before commission (150 000 × 15,80) 2 370 000
Transport cost (35 000)
2 335 000
Note that the transaction costs (commission) were ignored in the calculation of fair value as they
do not form part of the characteristics of the asset.
21.3.3 Asset or liability

Fair value may be determined for a specific asset or liability and will consider the characteristics
thereof as if the market participants would have taken these characteristics into account.
Such characteristics may include location of the asset and any restrictions on sale or use.
The asset or liability that is being measured at fair value could be a stand-alone asset or
liability, or within a group of assets or liabilities. The asset or liability will be disclosed and
presented in accordance with the unit of account, which is the level at which the asset is
aggregated or disaggregated as required by an IFRS for recognition and disclosure purposes.
21.3.4 Orderly transaction

The measurement at fair value assumes that an asset or liability is exchanged in an orderly
transaction between market participants. In an orderly transaction, no market participant
should act under force or be under liquidation that will result in a distress sale. An orderly
transaction is also a transaction that is exposed to the market for some period before the
measurement date. A transaction can take place either in the principal market, or in the
most advantageous market for the asset or the liability. The principal market is the market in
which the entity would normally enter into a transaction to sell an asset or transfer a liability.
In the absence of a principal market, an entity can choose the most advantageous market.
An entity does not have to perform extensive market research, but should take into account
information that is reasonably available.
If there is a principal market for the asset or liability, the fair value measurement shall
represent the price in that market (whether that price is directly observable or estimated by
using another valuation technique), even if the price in a different market is potentially more
advantageous at the measurement date (IFRS 13.18). This means that the most
advantageous market can only be used if a principal market does not exist or when an entity
does not have access to that principal market.
Example 21.2 Most advantageous market
Victor Ltd owns 10 000 shares in Matfield Ltd. The shares are listed on both the JSE Ltd and the
London Stock Exchange. The shares trade in equal volumes in both markets and Victor Ltd
normally enters into transactions in both these markets. The Matfield Ltd shares are traded at
R210,00 per share on the JSE and at £13,00 on the London Stock Exchange at
31 December 20.13. Transaction costs are normally 2% on the JSE and 3% on the London Stock
Exchange. The Pound Sterling is traded at R17,00 at 31 December 20.13.
Since there is no principal market as shares are traded in equal volumes, the most advantageous
market should be established. The net value on the JSE Ltd is R2 058 000 (10 000 × 210 × 0,98)
and on the London Stock Exchange R2 143 700 (10 000 × 13 × 17 × 0,97). Therefore the
investment in Matfield Ltd will be measured at the fair value of R2 210 000 ((10 000 × 13 × 17) –
according to the London Stock Exchange), which represents the most advantageous market
(before transaction costs).
21.3.5 Market participants

An entity shall consider all assumptions that would be made by the market participants when
the assets or liabilities are priced, assuming also that the market participants will act in their
economic best interest. An entity need not identify specific assumptions for specific market
participants, but rather those assumptions that market participants generally would consider.
Market participants should also be seen to be independent, knowledgeable, able and willing
to enter into a transaction.
21.3.6 Measurement date

This date is very important, as fair values may differ from day to day. The measurement
date is the date when an asset or liability should be measured according to the different
IFRSs, and is normally the date of initial recognition or the reporting date. The date of
acquisition is a good example of a measurement date in accordance with IFRS 3 Business
Combinations.
On measurement date, there might not be a sales transaction for a listed share investment.
IFRS 13.70 and.71 state that if an item has a bid price and an ask price, the price within the
bid-ask spread that is most representative of fair value in the circumstances shall be used to
measure fair value. The use of bid prices for asset positions and ask prices for liabilitiy
positions is permitted. The use of mid-market pricing is also allowed as it is commonly used
in practice.
21.4 Application of fair value

It is clear from the above that the general approach to fair value measurement is to
determine the price in an orderly transaction between market participants at the
measurement date. Fair value measurement requires an entity to determine all of the
following (IFRS 13.B2):
the asset or liability that should be valued;
for a non-financial asset, the measurement that is consistent with its highest and best
use (valuation premise for non-financial assets as referred to by IFRS 13);
the principal market (or most advantageous market) for the asset or liability; and
the valuation technique that is appropriate considering the availability of data that
represents assumptions that market participants will generally make.
Please refer to IFRS 13.48 to .56 for applications relating to financial assets and financial
liabilities with offsetting positions in market risks or counterparty risks. These paragraphs
permit financial assets and liabilities to be measured as a group and will not be covered in
this chapter. In the sections below, the fair value measurement applications for non-financial
assets, financial assets, liabilities and own equity instruments will be discussed.
21.4.1 Non-financial assets

The fair value measurement of a non-financial asset, for example property, plant and
equipment or investment property takes into account a market participant’s ability to
generate economic benefits by using the asset in its highest and best use or by selling it
to another market participant that would use the asset in its highest and best use
(IFRS 13.27).
The highest and best use takes into account the use that is physically possible, legally
permissible and financially feasible. This is a very important consideration. Land, for
example, cannot be legally used for residential purposes if it is not zoned as such. When the
fair value is determined, the rezoning costs should be taken into account. If the land, for
example, is situated on a mountain slope, it may not be physically posssible to use it for
residential purposes and it may not be economically viable to use it for such a purpose.
The entity’s current use or its intended manner of use of an asset is not necessarily the
highest and best use thereof. The highest and best use is determined with reference to the
different market participants that may intend to use the asset for a different purpose when
acting in their economic best interest. Fair value is therefore, as referred to in section 26.3.1,
the market-based price, rather than an entity-specific value.
The highest and best use of a non-financial asset might provide the maximum value to the
market participants through:
its use in combination with other assets as a group or as a business; or
on a stand-alone basis.
Example 21.3 Highest and best use
An entity acquired an entity in a business combination.

The computer software was developed by the acquiree and consists of an integrated billing
programme and an inventory software programme. The parent determines that the highest and
best use of the intangible asset is its current use. It is determined that the fair value of the software
in its current use is R611 000. Market participants that might buy such intangible assets include
both strategic buyers and financial buyers. Strategic buyers might buy it for competitive reasons,
while financial buyers might buy it for financial reasons, for example to develop the intangible
asset for disposal at a later stage. The fair value for the intangible assets is R890 000 for strategic
buyers and R670 000 for financial buyers.
The acquiree also has land that is developed for industrial use as a site for a factory. The current
use of the land is presumed to be the highest and best use. However, nearby sites have recently
been developed for residential use. It is determined that the fair value of the land as it is currently
used by the acquired entity is R1,3 million (taking into account related factory operations in
combination with other assets to generate cash flows). The value of the land as a vacant site for
residential use, taking into account the cost of demolishing a factory (if any), is R1,45 million.
The fair value of the computer software and land will be determined by the highest and best use
thereof by the various market participants. The fair value of the computer software will therefore
be R890 000, while the land’s fair value will be R1 450 000.
Comment
¾ Assume that the land is currently zoned for factory/industrial purposes and the cost of rezoning
the land for residential purposes will cost the entity R45 000. The fair value of the land of
R 1 450 000 should therefore be adjusted to make it legally permissible. The fair value will then
be R1 405 000 (1 450 000 – 45 000).

In order to determine the fair value of financial assets for recognition or disclosure purposes
in terms of IFRSs 7 and 9, valuation techniques should be used that maximise the use of
observable inputs and minimise the use of unobservable inputs. Refer to section 26.6 for
more detail.
Entities that hold and manage a group of financial assets and are exposed to market and
credit risk should apply the guidelines in IFRS 13.48 to .56 on a net basis. This will not be
covered in this chapter.
21.4.3 Liabilities and own equity instruments

Fair value measurement assumes that a financial or non-financial liability (e.g. a provision)
or an entity’s own equity instrument (e.g. equity interests issued as consideration in a
business combination) is transferred to a market participant at the measurement date
(IFRS 13.34). The transfer of a liability or an entity’s own equity instrument assumes the
following:
a liability will remain outstanding and the entity would be required to settle the obligation;
and
the entity’s own equity instrument would remain outstanding and the transferee would
take on the rights associated with the risks.
In all cases, valuation techniques should be used that maximise the use of observable
inputs and minimise the use of unobservable inputs. The fair value of a financial liability
reflects the effect of non-performance risk. Non-performance risk includes, but is not
limited to, the entity’s own credit risk (credit standing) from the perspective of the market
participant holding the liability of the entity as an asset. Non-performance risk is the
likelihood that that the obligation might not be fulfilled.
Example 21.4 Non-performance risk
Bis Ltd and Mark Ltd entered into a contractual obligation to pay R1 000 cash to Bok Ltd in
5 years. Bis Ltd has an AAA rating and can borrow at 6%, while Mark Ltd has a BB credit rating
and can borrow at 12%. The risk-free rate is 5%. The differences between the interest rates
attributable to Bis Ltd and Mark Ltd, and the risk-free rate represent the non-performance risk
premiums of Bis Ltd and Mark Ltd.
In terms of IFRS 9, these liabilities should be recognised initially at fair value.
Bis Ltd will recognise the liability at R748 (present value of R1 000 in 5 years at 6%) for its
obligation to pay R1 000 in 5 years.
Mark Ltd will recognise the liability at R568 (present value of R1 000 in 5 years at 12%) for its
obligation to pay R1 000 in 5 years.
Comment
¾ The borrowing rates will be determined by the market participants holding the obligation as an
asset. This indicates how they perceived the risk of non-performance of Bis Ltd and Mark Ltd.
Liabilities and equity are classified in two categories, namely those that are carried as
assets by other entities (e.g. loans), and those that are not carried as assets by other
entities (e.g. provisions). These two categories will now be discussed:
21.4.3.1 Liabilities and equity held as assets by other entities or parties

When a quoted price for the transfer of an identical or similar liability or own equity
instrument is not available and the identical item is held by another party as an asset, the
fair value of the liability or equity shall be determined from the perspective of the market
participant that holds the identical item as an asset. It is important to emphasise that the
fair value is determined from the perspective of the party that holds the liability of the entity
as an asset and not from the perspective of the entity that issued the instrument. The fair
value of such a liability or equity instrument shall be measured as follows:
quoted price for an identical item in an active market; or
if quoted price is not available, use other observable inputs, for example a price in an
inactive market; or
if neither of the above prices are available, other valuation techniques, for example the
present value of cash flows receivable (income approach) or quoted prices for similar
items (market approach) should be used. Refer to section 26.6 for more detail.
If a quoted price in an active market is available, the fair value will always be the quoted
price. An entity shall adjust the quoted price only when there are factors specific to the
assets that are not applicable to the measurement of fair value. Such adjustments may
occur when the asset relates to a similar (but not identical) asset or when the units of
account for the liability and the asset are not the same.
Loans with a demand feature are a financial liability (IAS 32.19). Note that interest-free
shareholders’ loan accounts cannot be lower than the amount payable on demand, or the
present value from the date that the amount could be required to be paid (IFRS 13.47).
Example 21.5 Debt obligation (quoted price)
At the beginning of the reporting period, Hein Ltd issued 2 000 debentures of R1 000 each,
carrying interest at 10% per annum. The debentures are redeemable in five years’ time. Hein Ltd
designated this liability as subsequently measured at fair value through profit or loss. At the end of
the first reporting period, the instrument is trading in an active market at R951 per debenture for
market participants that hold the debentures as assets.
At the reporting date, using the market approach, this liability will be measured at R1 902 000
(2 000 × 951) in the statement of financial position and will be disclosed within level 1 of the fair
value hierarchy (refer to section 26.7).
Example 21.6 Debt obligation (present value technique)
At the beginning of the reporting period, Toks Ltd issued 2 000 debentures of R1 000 each,
carrying interest at 10% per annum. The fair value of the debentures at initial recognition is
R2 million as the market-related interest rate also equals 10% initially. The debentures are
redeemable in five years’ time and are not traded in the open market. Toks Ltd designated this
liability as subsequently measured at fair value through profit or loss. At the end of the first
reporting period, Toks Ltd’s credit spread, from the perspective of the holder of the corresponding
asset, has deteriorated by 50 basis points because of the likelihood of non-performance.
At the reporting date, this liability will be measured at fair value using the income approach’s
present value technique. The present value of the future cash flows at 10,5% is R1 968 641.
Toks Ltd will disclose this within level 2 of the fair value hierarchy (refer to section 26.7).
The fair value of a financial liability with a demand feature, such as a shareholder’s loan, is
not less than the amount payable on demand. This amount may be discounted from the first
date that the amount could be required to be paid. Such shareholder’s loans shall be
presented as current liabilites if the entity does not have an unconditional right to defer the
payment for longer than one year.
21.4.3.2 Liabilities and equity not held as assets by other entities or parties
When a quoted price for the transfer of an identical or similar liability or own equity
instrument is not available and the identical item is not held by another party as an asset,
the fair value of the liability or equity shall be determined from the perspective of the
market participant that owes the liability or that has issued the claim on equity.
Provisions, for example decommissioning liabilities, provision for warranties and provision
for dismantling costs will fall into the category of liabilities not held by another party as an
asset. It is important to emphasise that the fair value is now determined from the perspective
of the entity that holds the liability or has the obligation to issue equity. The fair value
measurement of such a liability or equity instrument shall take the following into account:
Future cash flows that the entity will incur to fulfil the obligation. The fair value represents
the expected present value of these cash flows.
The amount that a market participant would receive to enter into or issue an identical
liability or equity instrument, using the assumptions that market participants would use
when pricing the identical item.
Example 21.7 Decommissioning liability (expected present value technique)
Brian Ltd is legally required to dismantle its plant at the end of its useful life, which is estimated to
be in 10 years’ time. The estimated cost will consist of labour of between R200 000 and R300 000
and overheads allocated at 60% of the labour cost. The probability assessments on the labour,
which include increases for inflation, are as follows:
R200 000 (30% probability), R250 000 (50% probability) and R300 000 (20% probability)
Risk premium for uncertainty to be adjusted for in cash flows is 5%.
The risk-free rate of interest for a 10-year maturity is 6%.
The risk of non-performance of Brian Ltd is considered to be 1%.
The fair value of the obligation will be calculated as follows:
Expected cash flows
R
Labour (200 000 × 30% + 250 000 × 50% + 300 000 × 20%) 245 000
Overheads (245 000 × 60%) 147 000
Expected cost 392 000
Risk premium (392 000 × 5%) 19 600
411 600
Expected present value using a discount rate of 7% (6% + 1%) for 10 years 209 237
Brian Ltd will measure its decommissioning liability at its fair value of R209 237.
21.5 Fair value at initial recognition

All financial assets and financial liabilities should initially be measured at fair value
(IFRS 9.5.1.1). Sometimes, there is a difference between the transaction price and its fair
value. When an asset is acquired or a liability is assumed, the transaction price is the price
paid to acquire the asset or the amount received to assume the liability (an entry price). The
fair value, by contrast, is the price that would be received to sell an asset or paid to transfer
a liability (an exit price).
Entities do not acquire an asset just to sell it on the same day. Selling prices and buying
prices are not the same and therefore there might initially be differences between the
transaction price and fair value. However, in many cases the transaction price will still equal
the fair value.
An entity should consider all factors to determine whether the transaction price equals the
fair value. The transaction price and the fair value might differ for the following reasons
(IFRS 13.B4):
the transaction might be between related parties;
the transaction takes place under constraint or forced circumstances;
the market in which the transaction took place is different from the principal market; or
the unit of account represented in the transaction price might be different from the unit of
account of the asset or liability measured at fair value.
If the transaction price differs from the fair value at initial recognition, the financial asset or
liability shall be recognised at fair value and any differences shall be recognised in profit or
loss (IFRS 13.60).
Example 21.8 Fair value at initial recognition
At the beginning of the year, the board of directors decided to grant a three-year interest-free loan
of R300 000 to one of the directors. A market-related risk-free interest rate is considered to be 5%
and a systematic risk premium of 3% may be regarded as appropriate for any cash flow
uncertainties (in this instance, the risk of non-performance or credit risk).
Financial assets should initially be recognised at fair value in accordance with IFRS 9.
The income approach (refer to section 26.6.3) using the present value technique, should be used
in measuring the fair value of the loan. The difference between the fair value of R238 150 (FV =
300 000, n = 3, i 8% (5% + 3%), PV = ?) and the transaction price of R300 000 should be
recognised as a day one loss in profit or loss. The journal entry on initial recognition is as follows:
Dr Cr
R R
Financial Asset: Loan to director (SFP) 238 150
Day-one loss on financial liability (P/L) 61 850
Bank (SFP) 300 000
Initial recognition of loan and day one loss.
21.6 Fair value techniques

Various fair value techniques exist in the literature. An entity shall use valuation techniques
that are appropriate in the circumstances and for which sufficient data are available, by
maximising the use of relevant observable inputs and minimising the use of unobservable
inputs. The focus is to determine the price in an orderly transaction to sell an asset or to
transfer a liability by using observable inputs to the maximum. IFRS 13 defines fair value
and provides guidance on how to determine an appropriate fair value measure. Depending
on the nature of the item being fair valued, various valuation techniques may be used.
When a single valuation technique is not appropriate, multiple valuation techniques may be
used. In such cases, the results should be evaluated considering the reasonableness of the
range of values indicated by those results. A fair value measurement is the point at which
the value is the most representative in the circumstances.
If the transaction price is the fair value at initial recognition and a valuation technique that
uses unobservable inputs will be used to measure fair value in subsequent periods, the
valuation technique shall be calibrated so that at initial recognition the result of the valuation
technique equals the transaction price. Calibration ensures that the valuation technique
reflects current market conditions (IFRS 13.64).
Valuation techniques should be applied consistently from year to year, but sometimes it is
necessary to change the valuation technique to one that will result in a more representative
valuation. When a new valuation technique is used, it shall be accounted for as a change in
estimate in accordance with IAS 8.
There are three widely used valuation techniques, namely the market approach, the cost
approach and the income approach. These approaches to determine fair value are
discussed below.
21.6.1 Market approach

The market approach uses prices generated by market transactions in respect of identical or
similar assets, liabilities or groups of assets. The market can be active or inactive. An active
market is defined as a market in which transactions take place with sufficient frequency and
volume (IFRS 13 Appendix A). The exit price is therefore determined with reference to the
market. The market approach may use techniques such as market multiples (e.g. adjusted
or unadjusted earnings yields and price earnings multiples) and matrix pricing (valuation of
same type instruments without relying only on quoted prices). For more detail refer to
IFRS 13.B6 to B7.
Example 21.9 Market approach
At the beginning of the reporting period, Morné Ltd bought 5 000 listed ordinary shares at R44,40
each as an investment. Morné Ltd incurred a 2% transaction cost as well, on the same date.
Morné Ltd designates this investment as measured at fair value through other comprehensive
income. At the end of the reporting period, the shares were trading at R47,80. Transaction costs of
2% are normally incurred on all transactions.
At reporting date, this investment will be measured at fair value using the market approach, by
maximising the use of relevant observable inputs. At the end of the reporting period the investment
will be presented at R239 000 (R47,80 × 5 000) and will be disclosed within level 1 of the fair
value hierarchy. A gain of R12 560 will be recognised in other comprehensive income
(R239 000 – (5 000 × R44,40 × 1,02) at the end of the reporting period.
Note: Transaction costs were capitalised because the investment is classified as measured at fair
value through other comprehensive income. Transaction costs are ignored however when
measuring the fair value at the end of the reporting period.
21.6.2 Cost approach

The cost approach is often referred to as the replacement cost and represents the cost that
is currently required to replace the service capacity of an asset for current use (refer to
section 26.4.1). The value will represent the cost to acquire or to construct a substitute asset
of comparable utility, adjusted for obsolescence. Obsolescence will include adjustments for
physical deterioration, functional obsolescence and economic obsolescence and is broader
than depreciation for financial reporting purposes.
Example 21.10 Cost approach
On 1 January 20.12, Beast Ltd bought a machine for R800 000, and also incurred a cost of
R80 000 (10%) to install it. The machine is depreciated on a straight-line basis over its useful life
of 8 years and its residual value is considered to be immaterial. At 31 December 20.13, an
identical machine could be obtained at a cost of R950 000. This price was observable in the
market.
At 31 December 20.13, the depreciated replacement cost could be determined as follows:
R
Replacement cost 950 000
Installation cost (10%) 95 000
1 045 000
Depreciated replacement cost at 31 December 20.13 (1 045 000 × 6/8) 783 750
Beast Ltd will disclose this amount within level 2 of the fair value hierarchy.
Comment
¾ It is assumed in this example that depreciation includes consideration of adjustments for
physical deterioration, functional obsolescence and economic obsolescence.
21.6.3 Income approach

According to IFRS 13.B10, the income approach converts future cash flows to a single
discounted amount, which reflects the current market expectations about future amounts.
Refer to Example 21.6 above. The techniques under this approach are, for example, present
value techniques, option pricing models and multi-period excess earnings methods
(IFRS 13.B11).
21.6.3.1 Components of present value measurement
The present value technique is a tool used to link future amounts (e.g. cash flows or values)
to a present amount, using a discount rate. A fair value measurement of an asset or a
liability using a present value technique captures all the following elements from the
perspective of market participants at the measurement date:
future cash flows;
uncertainty in possible variations on cash flows;
uncertainty regarding cash flows;
time value of money represented by the risk-free interest rate;
the risk premium inherent to the uncertainty in cash flows;
in respect of a liability, the non-performance risk premium, which includes own credit
risk; and
any other factors that market participants would consider.
21.6.3.2 General principles of present value techniques
The above elements should all be combined to calculate the present value by using the
following general principles (IFRS 13.B14):
Assumptions of market participants should be reflected in the cash flows and discount
rates.
Attributes of the asset or liability should be reflected in cash flows and discount rates.
Double counting should be avoided, and the discount rate should not be adjusted if risks
are included in cash flows.
Calculations should be consistent. Nominal amounts of cash flows that include inflation
should be discounted at rates that include inflation. Risk-free rates include effects of
inflation. By contrast, real amounts of cash flows that exclude inflation should be
discounted at rates that exclude inflation. Similarly, after tax cash flows should be
discounted at an after tax discount rate, and the opposite is also true.
Discount rates should reflect the economic environment of the countries in which the
cash flows are dominant.
21.6.3.3 Risk and uncertainty
Future cash flows are based on estimates. The amounts of estimates and the timing thereof
are uncertain. Market participants generally seek compensation for these risks of uncertainty
and the fair value measurement should therefore include a risk premium. The estimation of
the risk premium is not easy to determine and is sometimes subjective, but this should not
be the reason for excluding a risk premium from the fair value measurement. Present value
techniques differ in how to incorporate risk in the fair value measurement (IFRS 13.B17).
The following are examples of how to incorporate risk in the present value calculation:
The discount rate adjustment technique (refer to IFRS 13.B18 to .B22 and Example 26.11)
uses the ‘market-adjusted discount rate’.
The expected present value technique (refer to IFRS 13.B25) uses systematic risk-
adjusted expected cash flows, which are discounted at a ‘risk-free rate’ (refer to
Example 26.12).
The expected present value technique (refer to IFRS 13.B26) uses expected cash flows
that are not risk-adjusted and are discounted at a discount rate adjusted to include the
risk premium that market participants require (the systematic risk) (refer to Example 26.13).
That rate is different from the rate used in the discount rate adjustment technique and is
represented by the ‘risk-free plus rate’.
According to the portfolio theory, there are two types of risk, namely unsystematic risk and
systematic risk. Unsystematic risk relates to the specific asset or liability and can be
diversified within a portfolio of assets or liabilities. Systematic risk relates to market risks and
cannot be diversified. The portfolio theory holds that market participants will only be
compensated for the systematic risk inherent in the cash flows and therefore risk-free rates
will only be adjusted for the systematic risk premium to be used in present value
calculations. For more information on the above methods, please refer to IFRS 13.B23 to
.B24 and IFRS 13.B27 to .B30.
Example 21.11 Discount rate: Market adjustment technique
An entity has a contract to receive R150 000 in a year’s time. There is an established market with
price information for comparable assets. A comparable asset for a contract to receive R100 000 in
a year’s time is trading in the market at R90 662. The nature of the cash flows is also contractual
and cash flows are likely to respond similarly to changes in economic conditions. All other factors
for example credit standing and liquidity, are also comparable.
The implied annual rate of return (market return) of the comparable asset is 10,30%
(FV = 100 000, PV = – 90 662 n = 1, i = ?). Using the 10,30% as a discount rate, the fair value of
the asset of the entity is R135 993 (FV = 150 000, n = 1, i = 10,30%, PV = ?).
Example 21.12 Expected present value technique: risk-free rate
An entity expects to receive R150 000 in two years’ time. This expected cash flow includes an
amount for uncertainty in cash flows. If this uncertainty is eliminated, the entity can be certain that
it will receive at least R135 000. The risk-free interest rate is 5% and the market-related rate
(including risks of uncertainty) is considered to be 7%.
The risk premium for uncertainty in the cash flow is R15 000 (the difference between R150 000
and R135 000). This represents the certainty equivalent adjustment on cash flow. In order to
determine the fair value, the risk adjusted cash flow of R135 000 should be discounted at the
risk-free interest rate. Using the 5% as a discount rate, the fair value of the asset of the entity is
R122 449 (FV = 135 000, n = 2, i = 5, PV =?).
Example 21.13 Expected present value technique: risk-free plus rate
An entity expects to receive roughly R160 000 in two years’ time. This expected cash flow includes
an amount for uncertainty in cash flow. The accountant believes that this estimate should
preferably be probability weighted. He expects that the cash flows (depending on different
outcomes) could be as follows:
Expected
Outcomes Probability
amount
R
Optimistic condition 30% 200 000
Normal condition 50% 150 000
Pessimistic condition 20% 120 000
The risk-free interest rate is 5% and the market-related rate (including risks of uncertainty) is
considered to be 7%.
continued
The expected cash flows are R159 000 and are determined as follows:
Cash flows Probability Weighted
R200 000 30% R60 000
R150 000 50% R75 000
R120 000 20% R24 000
R159 000
The above cash flows are not adjusted for systematic cash flow risk; therefore the discount rate
should also include a risk premium of 2% (7% – 5%). Using the 7% as a discount rate, the fair
value of the asset of the entity is R138 876 (present value of R159 000 for two years at a discount
rate of 7%).
21.6.3.4 Inputs to valuation techniques

It is apparent from the above that the valuation techniques should maximise the use of
observable inputs and minimise the use of unobservable inputs. These inputs should be in
harmony with the characteristics of the asset or liability being valued and aligned with what
the market participants will take into account. The level of inputs used in the measurement
will also determine the hierarchy of fair value that will be disclosed in the financial
statements (refer to section 26.7).
If an asset or liability has a quoted bid and ask price, the fair value is the price between the
bid-ask spread that is appropriate in the circumstances. Closing prices in exchange markets
are both readily available and are representative of the fair value. The use of bid prices for
asset positions and ask prices for liability positions is permitted, but is not required. For
more information on dealer markets, brokered markets and principal-to-principal markets,
please refer to IFRS 13.B34.
21.7 Fair value hierarchy

Valuation techniques may be based on different inputs. These inputs may be observable or
unobservable. The preceding sections indicate that it is better to use more observable
inputs, as this will enhance the reliability of the valuation. To increase the quality of
presentation and disclosure, IFRS 13 (as well as IFRS 7) establish a fair value hierarchy
that categorises the inputs to valuation techniques used to measure fair value into three
levels (refer to IFRS13.76 to .90). The fair value hierarchy with the highest priority consists
of unadjusted quoted prices (level 1) and the hierarchy with the lowest priority is based on
unobservable inputs (level 3). The user of the financial statements is therefore in a position
to assess the risk in relation to the fair value and to make decisions regarding that risk. The
information about fair value is more transparent.
Sometimes the fair value of an asset or liability may be classified into two hierarchy levels.
In such a case, the fair value measurement is categorised at the lowest applicable hierarchy
level.
The availability of relevant inputs and their relative subjectivity might affect the selection of
appropriate valuation techniques (refer to IFRS 13.61). However, the fair value hierarchy
prioritises the inputs to valuation techniques, not the valuation techniques used to measure
fair value. If observable inputs are materially adjusted with unobservable inputs, the fair
value measurement would be categorised within level 3.
The different hierarchy levels are as follows:

Level 1 inputs Level 1 inputs are unadjusted quoted prices in an active market, and
represent the most reliable evidence of fair value. If financial assets are
traded in multiple markets, emphasis should be placed on the principal
market. In the absence of a principal market, the most advantageous
market should be used in the fair value measurement. The principal or the
most advantageous market could be used if the entity can enter into that
market at measurement date. An entity shall not make an adjustment to a
level 1 input except for specific circumstances (as listed in IFRS 13.79).
Level 2 inputs Level 2 inputs are directly or indirectly observable inputs other than
the quoted prices referred to in level 1, and include the following:
quoted prices for similar items in active markets;
quoted prices for identical and similar items in inactive markets;
other observable inputs, for example interest rates, yields, implied
volatilities and credit spreads; or
any market-corroborated inputs.
Level 2 inputs will vary depending on the characteristics of the asset or
liability, for example condition, location, comparability and activity of the
market in which inputs are observed. When variations on the input
significantly influence the fair value measurement, the level 3 hierarchy will
be more appropriate. For more information on level 2 inputs for different
assets and liabilities, refer to IFRS 13.B35.
Level 3 inputs Level 3 inputs are unobservable inputs in situations where there is little or
no market activity. These unobservable inputs shall reflect the assumptions
that market participants would use when pricing the asset or liability,
including assumptions about risk, and would therefore meet the fair value
measurement objective. Risk adjustments are subjective and these inputs
are generally unobservable. The best information available should be used,
which might include the entity’s own data that is adjusted for specific
circumstances. For more information on level 3 inputs for different assets
and liabilities, refer to IFRS 13.B36.
Example 21.14 Fair value hierarchy
Faf Ltd (Faf) has an end of reporting period of 30 September 20.17. Faf purchased a small
investment (less than 10% interest in equity shares) in the ordinary shares of Kohli (one of the
companies referred to in the news article below) on 1 December 2013. Faf accounts for these
shares at fair value through profit or loss.
From 2013 to 2014 the shares of Kohli were not formally listed on a formal exchange, but were
traded on the over-the-counter (OTC) market. Pricing information was actually available due to
recent trades.
In 2015, the FSB ruled that no more over the counter (OTC) share trading may take place without
a licence. This means their shares traded over an electronic platform on the web without a stock
exchange in place, no regulation and purely just matching trades of different investors through a
broker. Shares investments were left in a situation where investors couldn’t buy or sell them any
longer, due to the regulatory issue. This situation continued during 2016.
After the FSB ruling in May 2015, due to the lack of market price information from OTC trades, Faf
estimated the fair value of the Kohli’s shares based on a price-earnings (“PE”) multiple valuation
method. This typically involved using the PE multiple for similar listed companies, making entity
significant specific risk adjustments to this multiple, and multiplying the risk-adjusted PE by the
companies unadjusted audited earnings for the year.
continued
SMEX was introduced in January 2017 as South Africa’s newest stock exchange, plans to give a
home to all these smaller companies. As listing on the JSE is expensive for small companies it
gives SMEX the perfect launching platform. SMEX obtained its licence during early 2017 and Kohli
immediately listed their shares on this exchange.
Since its listing on SMEX in February 2017, Kohli has been trading on a narrow band of between
R6.70 and R6.80 per share. The closing price at year end on 30 September 2017 was R6.75, based
on the most recently traded price (see below). Below is a screenshot from the SMEX website of the
5 most recent trades of Kohli shares prior to the end of reporting period of 30 September 2017.
Date Price Number of shares Amount

7 September 2017 6.75 1 000 R6 750
6 September 2017 6.75 3 600 R24 300
4 September 2017 6.77 4 500 R30 465
23 August 2017 6.76 10 100 R68 276
14 August 2017 6.74 13 000 R87 620
The fair value hierarchy over the past few years will be determined as follows:
Prior to 2015:
The shares of Kohli were not listed on a formal exchange, but were traded on an OTC market.
From this market, it appears that observable pricing information was available based on recent
trades etc. Although observable, the OTC market would not constitute a ‘quoted’ price (not listed),
so the OTC observable price would constitute a level 2 in the fair value hierarchy.
2015 and 2016
Kohli’s shares were no longer tradeable, and Faf resultantly valued its investment in Kohli using a
PE valuation method (income approach), as there was no market based measures/ approaches
available to get a price, which involves using a PE multiple of earnings. Significant unobservable
risk adjustments are made to adjust the PE ratio for the purposes of the valuation, making this
input a level 3 in the FV hierarchy. The audited earnings of Kohli is the other significant input into
the valuation model, which one would assume is observable (historic audited earnings) and then
one could argue in favour of a level 2. Where significant inputs into a valuation model are from
different levels in the fair value hierarchy, the overall level is the LOWEST level of the significant
inputs, i.e. 2015 and 2016 would constitute a level 3 in the hierarchy.
2017 and onwards
The shares of Kohli is listed on the SMEX exchange, which would constitute a ‘quoted price’.
There is doubt around whether the SMEX market would consistute an ‘active market’ - from the
trade history, there have only been 5 trades in the past (nearly) 45 days. Because of the lack of
activity (the most recent trade was nearly 3 weeks before year end), it is likely that adjustments to
the previous closing price would be required to arrive at a fair value estimate, and adjustments to
the closing price would downgrade the input to a level 2 in the fair value hierarchy.
However, it could also be argued that despite the lack of volume of activity, the price of R6.75
might not require adjustment, since the share had a very narrow trading range with little if any
change in price over the past month or more. If this is the case, and an unadjusted price of R6.75
is used (due to the narrow trading range), then it could be argued that the price would
nevertheless constitute a level 1 in the FV hierarchy (due to it being an ‘unadjusted’ quoted price).
UJ adjusted.
21.8 Disclosure
An entity shall disclose information that helps users of its financial statements to assess
both of the following:
the valuation techniques and inputs used to develop fair value measurements; and
the effect of the measurements on profit or loss or other comprehensive income for the
period when using significant unobservable inputs (level 3). The information that is
disclosed for level 3, will contain more detail than, for example, level 1.
An entity shall consider the level of detail necessary to satisfy the disclosure requirements.
Emphasis should be placed on each of the various requirements, the aggregation or
disaggregation to be undertaken, and the need for additional information to evaluate the
quantitative information disclosed.
An entity shall disclose, as a minimum, the following information for each class of assets
and liabilities measured at fair value after initial recognition:
for recurring and non-recurring fair value measurements, the fair value measurement at
the end of the reporting period;
for non-recurring fair value measurements, the reasons for the measurement;
for recurring and non-recurring fair value measurements, the level of the fair value
hierarchy;
for assets and liabilities that are measured at fair value on a recurring basis, the amounts
of any transfers between level 1 and level 2 of the fair value hierarchy, the reasons for
those transfers and the entity’s policy;
transfers into each level shall be disclosed and discussed separately;
for fair value measurements categorised within level 2 and level 3, a description of the
valuation technique(s) and the inputs used;
if there has been a change in valuation technique, the entity shall disclose that change
and the reason(s) for making it;
for level 3 of the hierarchy, an entity shall provide quantitative information about
significant unobservable inputs used;
for level 3 of the hierarchy, a reconciliation from the opening balances to the closing
balances (for more detail refer to IFRS 13.93(e));
for level 3 of the hierarchy, the amount of the total gain or loss recognised in profit or loss
that is attributable to the change in unrealised gains or losses and the line item(s) in
profit or loss in which those unrealised gains or losses are recognised;
for level 3 of the hierarchy, a description of the valuation processes used by the entity;
for level 3 of the hierarchy, a sensitivity analysis if unobservable inputs are changed
(refer to IFRS 13.93(h) for more detail); and
if the highest and best use of a non-financial asset differs from its current use, an entity
shall disclose that fact and why the non-financial asset is being used in a manner that
differs from its highest and best use.
An entity shall determine appropriate classes of assets and liabilities on the basis of the
following:
the nature, characteristics and risks of the asset or liability; and
the level of the fair value hierarchy.
An entity shall disclose and consistently follow its policy for determining when transfers
between levels of the fair value hierarchy may occur. Examples of policies for determining
the timing of transfers include the following:
the date of the event or change in circumstances that caused the transfer;
the beginning of the reporting period; and

the end of the reporting period.
An entity shall present the quantitative disclosures required by this IFRS in a tabular format
unless another format is more appropriate.
For detailed examples on the above disclosure requirements, please refer to
Illustrative Examples 15 to 19 in IFRS 13.

Cheetah Ltd has a reporting date of 31 December. The entity has several assets that are measured at
fair value and the following details in respect of the year ended 31 December 20.13 are available:
Investment properties
Cheetah Ltd has an office building that is rented out to third parties. The fair value of the building was
R5 600 000 at 31 December 20.12. In its current use, the present value of the net cash flows of future
earnings was calculated at R5 700 000 on 31 December 20.13. On 31 December 20.13, this building
could be sold in the open market for R6 100 000 before transaction costs of 2%. This open market
value was determined with reference to similar buildings, situated in the same location, that are
currently in the market.
Listed share investments
On 31 December 20.13, Cheetah Ltd’s listed investments, consisting of equity investments, had a total
net market value of R2 623 500 after brokerage fees of 1% were deducted. These investments are
traded in an active market. The fair value of these investments was R2 510 000 at 31 December 20.12.
These investments were classified as measured at fair value through profit or loss.
Unlisted investments
Cheetah obtained a 10% interest in Bull (Pty) Ltd on 3 February 2010 for R1 521 000. The fair value
and carrying amount of the investment was R1 550 000 at 31 December 20.12. On 31 December
20.13, the accountant of Cheetah Ltd calculated the fair value of the investment in Bull (Pty) Ltd by
using a significantly adjusted after-tax earnings yield of 18% and sustainable before-tax earnings of
R401 000 as input variables in the measurement calculations. The tax rate is 28%. This investment
was designated as measured at fair value through other comprehensive income.
Foreign exchange contract
On 1 November 20.13, Cheetah Ltd entered into a foreign exchange contract to buy US$354 000 at
R7,60 per dollar on 31 January 20.14 in order to settle an existing foreign creditor. On 31 December
20.13, the spot exchange rate was R7,70 for US$1 and foreign exchange contracts expiring on
31 January 20.14 were quoted at R7,80.
Asset held for sale
On 31 December 20.13, Cheetah Ltd had a machine with a carrying amount of R350 000, that was
held for sale. The machine was written down to a fair value of R260 000, less costs to sell of 10%,
resulting in a loss, which was included in profit or loss for the year. The value in use was lower and was
calculated at R212 000.
Debentures
On 1 January 20.12, Cheetah issued 100 000 7% debentures of R10 each in the open market for
R961 000. The debentures are redeemable at nominal value on 31 December 20.16 and the interest is
payable annually in arrears. The market in which these debentures are traded became inactive and
one cannot rely on quoted prices or on the market prices of similar instruments. On
31 December 20.13, the risk-free rate was considered to be 7% and the risk premium for non-
performance was estimated to be 2%.
continued
The measurement of fair values will be as follows:
Investment property
This is a non-financial asset and should be valued at the highest best use.
Value in accordance with current use, namely to rent it out R5 700 000
Open market value if the asset is sold R6 100 000
Valuation
The highest best use therefore will be R6 100 000
Level of input = 2 (observable – unadjusted)
Note: Fair value is calculated before transaction cost is deducted (IFRS 13.25).
Listed share investment
This is a financial asset that should be valued using the market approach.
The market value of the shares before transaction cost is:
(R2 623 500/0,99) R2 650 000
Level of input = 1 (unadjusted quoted prices)
Note: Fair value is calculated before transaction cost is deducted (IFRS 13.25).
Unlisted investment
This is a financial asset that should be valued by using the income approach.
R
Sustainable earnings 401 000
Taxation (112 280)
Sustainable earnings after tax 288 720
The fair value of the unlisted shares:
(R288 729/0,18) R1 604 000
Level of input = 3 (significantly adjusted input variables (unobservable))
Note: After-tax earnings are used, as an after-tax earnings yield is provided
Foreign exchange contract
This is a financial asset that should be valued by using the market approach.
Quoted exchange rates are available
$354 000 × (7,80 – 7,60) R70 800
Level of input = 1 (quoted price)
Note: The foreign creditor will be measured at R2 725 800 using a spot rate of R7,70 to US$1.
Asset held for sale
This is a non-financial asset that should be valued by using the market approach.
According to IAS 36, it should be measured at the higher of
Fair value lest cost to sell (260 000 × 0,9), and R234 000
Value in use (not in the scope of IFRS 13) R212 000
Level of input = 3 (adjusted observable inputs)
Note: The calculation of the value in use is scoped out of IFRS 13 (IFRS 13.6(c)).
Debentures
This is a financial liability that should be valued by using the income approach.
This liability will be carried as an asset by a third party and should be valued from the perspective of
the market participants that hold these debentures as assets.
PV = ? (FV = 1 000 000, i = 9% (7 + 2), n = 3, PMT = R70 000) R949 374
Level of input = 3
continued
Disclosure requirements in terms of IFRS 13.93 (a), (b), (d) and (e) will be as follows:
Recurring fair value Fair Quoted Observ- Unobserv- Valuation
measurements values prices in able inputs able inputs techniques
active and inputs
markets
(level 1) (level 2) (level 3)
R 000 R 000 R 000 R 000
Non-financial assets
Investment properties 6 100 6 100 Inactive
market prices
Financial assets
Equity instruments:
Equity investments measured 2 650 2 650 Quoted prices
at fair value through profit or
loss (listed)
Equity investments measured 1 604 1 604 Earnings
at fair value through other adjusted
comprehensive income earnings
(unlisted)
Derivatives:
Foreign exchange contracts 71 71 Quoted FECs
Debentures measured at fair (949) (949) Present value
value through profit and loss at risk
adjusted rates
Foreign creditor (2 726) (2 726) Translated at
quoted spot
rate
Non-recurring fair value
measurements
Non-current assets held for 260 260 Adjusted
sale* market prices
* In accordance with IFRS 5, the non-current asset held for sale will be measured at R234 000.
Fair value measurements using significant unobservable inputs (level 3) (IFRS 13.93(e)):
Unlisted
equity investments
R 000
Opening balance 1 550
Purchases 0
Unrealised gains recognised
in other comprehensive 54
income
CHAPTER
22
Revenue from contracts
with customers
(IFRS 15)
Contents
22.1 Background ....................................................................................................... 602
22.2 Definition ........................................................................................................... 602
22.3 Scope ................................................................................................................ 602
22.4 Revenue model ................................................................................................. 603
22.4.1 Step 1 Identify the contract................................................................. 604
22.4.2 Step 2 Identify the performance obligations ....................................... 605
22.4.3 Step 3 Determine the transaction price .............................................. 607
22.4.4 Step 4 Allocate the transaction price to the performance
obligations .......................................................................................... 613
22.4.5 Step 5 Recognise revenue ................................................................. 618
22.5 Contract costs ................................................................................................... 621
22.5.1 Costs of fulfilling a contract ................................................................ 621
22.5.2 Cost of obtaining a contract................................................................ 621
22.5.3 Amortisation and impairment.............................................................. 622
22.6 Application guidance (Appendix B to the Standard) .......................................... 622
22.7 Presentation ...................................................................................................... 624
22.8 Disclosure .......................................................................................................... 624
22.8.1 Disaggregation of revenue ................................................................. 626
22.8.2 Contract balances .............................................................................. 626
22.8.3 Performance obligations..................................................................... 626
22.8.4 Transaction price allocated to the remaining performance
obligations .......................................................................................... 627
22.9 Synopsis: Revenue model ................................................................................. 628
601
22.1 Background
In 2006, the Financial Accounting Standards Board (FASB) and International Accounting
Standards Board (IASB) initiated a joint project to replace the previous revenue Standard,
IAS 18, with a single revenue model in order to provide uniform guidance on revenue
recognition and measurement. Prior to the issue of this new Standard, IFRS 15, there were
many inconsistencies in the accounting for revenue for similar transactions and in the
pattern used to recognise revenue. This made it difficult for users of the financial statements
to understand an entity’s revenue and to compare the revenue between different reporting
entities.
In 2010, the FASB and IASB issued ED/2010/06 Revenue from Contracts with
Customers as a first attempt at a uniform revenue model. However, in 2011, a revised
ED/2011/06 Revenue from Contracts with Customers was issued and was significantly
adjusted from the previous ED due to the number of issues raised by stakeholders during
the IASB and FASB's consultation process. The final Standard, IFRS 15 Revenue from
Contracts with Customers, was issued in May 2014. This Standard replaces the following:
IAS 11 Construction Contracts;
IAS 18 Revenue;
IFRIC 13 Customer Loyalty Programmes;
IFRIC 15 Agreements for the Construction of Real Estate;
IFRIC 18 Transfers of Assets from Customers; and
SIC 31 Barter Transactions Involving Advertising Services.
IFRS 15 is effective for annual periods on or after 1 January 2018, although earlier
application was permitted.
22.2 Definition
Revenue is income arising in the course of an entity’s ordinary activities. Income is increases
in assets, or decreases in liabilities, that result in increases in equity, other than those
relating to contributions from holders of equity claims (Conceptual Framework for Financial
Reporting (2018)).
The core principle of IFRS 15 is that an entity shall recognise revenue to depict the transfer
of promised goods or services to customers in an amount that reflects the consideration
to which the entity expects to be entitled to in exchange for those goods or services.
22.3 Scope
IFRS 15 only applies to revenue from contracts with customers.
A customer is a party that has contracted with an entity to obtain goods or services that are an
output of the entity’s ordinary activities in exchange for consideration.
Partially in the scope

A contract may be partially within the scope of IFRS 15 and partially in the scope of other
IFRSs. An example of such a contract could be a lease contract that includes a service
contract component. IFRS 16 Leases, will deal with the accounting of the lease component
of the contract, whilst the service component will fall within the scope of IFRS 15. If the other
Standards specify how to separate and/or initially measure one or more parts of the
contract, then the entity shall first apply the separation and/or measurement requirements in
those Standards and exclude such amount from the transaction price allocated per IFRS 15.
Revenue from contracts with customers 603
If the other Standards do not specify how to separate and/or initially measure one or more
parts of the contract, the entity shall apply IFRS 15 to separate and/or initially measure the
part.
Excluded from the scope
IFRS 15 does not apply to the following contracts with customers:
Lease contracts (IFRS 16 Leases).
Insurance contracts (IFRS 4 Insurance Contracts).
Financial instruments and other contractual rights or obligations within the scope of
IFRS 9 Financial Instruments; IFRS 10 Consolidated Financial Statements; IFRS 11,
Joint Ventures; IAS 27 Separate Financial Statements; and IAS 28 Investments in
Associations and Joint Ventures.
Non-monetary exchanges between entities in the same line of business to facilitate sales
to customers or potential customers. For example, A Limited and B Limited are both
suppliers of brand X cement. A Limited requests B Limited to provide one of A Limited’s
customers with brand X cement as they need it urgently and are closer to B Limited’s
store. A Limited will afterwards deliver the exact quantity of brand X cement to B Limited.
The contract between A Limited and the ultimate customer falls within the scope of IFRS
15. The contract between A Limited and B Limited falls outside the scope of IFRS 15.
22.4 Revenue model

The Standard describes a five-step revenue model. The revenue model directs the
recognition of revenue from contracts with customers.
Single contract
Step 1 Identify the contract. Combined contract
Contract modification
Goods or services that are

Identify the performance distinct
Step 2
obligations in the contract. A series of distinct goods or
services
Variable consideration
Time value of money
Non-cash consideration
Step 3 Determine the transaction price.
Consideration payable to
customers
Collectability
Allocation based on
Allocate the transaction price to the stand-alone selling price
Step 4 performance obligations in the Allocate discounts
contract. Allocate variable
consideration
Recognise revenue when (or as) the Control

Step 5 entity satisfies a performance Over a period of time
obligation. At a point in time
22.4.1 Step 1 Identify the contract

The first step in the revenue model is to determine whether a contract with a customer
exists. An entity may apply this revenue model for an individual contract or a portfolio of
contracts (or performance obligations) with similar characteristics if the entity reasonably
expects that the result of doing so would not differ materially from the result of applying this
revenue model to the individual contracts (or performance obligations) within the portfolio.
A contract is an agreement between two or more parties that creates enforceable rights and
obligations.
Enforceability is a matter of law. A contract with a customer can be written, oral or implied by
the entity’s customary business practices. The following criteria must be met:
the parties have approved the contract and are committed to perform;
the entity can identify each party’s rights regarding the goods or services to be transferred;
the entity can identify the payment terms of those goods or services to be transferred;
the contract has commercial substance (i.e. the risk, timing or amount of the entity’s
future cash flows is expected to change as a result of the contract); and
it is probable that the entity will collect the consideration. The entity shall consider only
the customer’s ability and intention to pay.
It is important to note that a contract does not exist if each party has the unilateral
enforceable right to terminate a wholly unperformed contract without compensation (i.e.
paying a penalty) to the other party. A unilateral enforceable right is one in which any one
party to the contact can terminate the contract without the consent of any of the other parties
to the contract. A contract is wholly unperformed when the entity has not yet transferred
goods or services to the customer and the entity has not yet received, and is not yet entitled
to receive, any consideration.
22.4.1.1 Combination of contracts
An entity shall combine two or more contracts and account for them as a single contract if
they are entered into at or near the same time with the same customer and meet one or
more of the following criteria:
the contracts are negotiated as a package with a single commercial objective;
the amount of consideration paid under one contract is dependent on the price or
performance under another contract; or
the goods or services promised under the contracts constitute a single performance
obligation.
Contract A
Combination of contracts accounted for as a single contract
(if above criteria are met)
Contract B
22.4.1.2 Contract modifications

A contract modification occurs when the parties to a contract agree on a change in the
scope and/or the price of a contract. It creates new (or changes existing) enforceable rights
and obligations of the parties to the contract. Like a contract, a contract modification can be
approved in writing, orally, or implied by the entity’s customary business practices.
The revenue recognition principles are applied to the contract modification either as a
separate contract or as part of the original contract.
Modifications that result in a separate contract

A contract modification results in a separate contract if both the following conditions are
present:
scope: increases because of additional promised goods or services that are distinct;
and
price: increases by an amount of consideration that reflects the stand-alone selling
price of these goods and services, and any appropriate adjustments to that price to
reflect the circumstances of the contract.
The contract modification meeting the above criteria results in a new and separate contract
for the delivery of future products or services. In such a case, revenue recognition principles
are applied to the separate contract that arose from the modification, and the accounting of
the existing contract (original contract) is not affected.
Example 22.1 Modifications that result in a separate contract
On 1 January 20.18, A Ltd enters into a contract with a customer to sell 100 products to a
customer over a period of six months. The transaction price for the 100 products amounts to
R150 000 (R1 500 per product). The products are transferred to the customer at various points in
time over a six-month period.
On 1 April 20.18, the contract with the customer is modified by both parties. On the date of the
modification, A Ltd had already delivered 70 products to the customer. In terms of the modification
agreement, the entity will deliver an additional 20 products for an additional consideration of
R28 000 (R1 400 per product). The pricing for the additional products reflects the stand-alone
selling price of the products at the time of the contract modification. In addition, the additional
products are distinct from the original products, because A Ltd regularly sells the products
separately.
Comment
¾ The contract modification results in a separate and new contract to deliver an additional 20
products, since the promised goods and services are distinct and their pricing reflects the
stand-alone selling price. The modification does not affect the accounting of the existing
contract to deliver the remaining 30 products. Consequently, the amounts recognised as
revenue when the remaining products are transferred consist of R45 000 (R1 500 × 30) from
the original agreement and R28 000 (R1 400 × 20) under the new and separate agreement. A
change in revenue is not recognised for changes in stand-alone prices of goods or services
after contract inception.
22.4.2 Step 2 Identify the performance obligations

At inception of the contract, an entity shall assess the goods or services promised in the
contract and shall identify the performance obligations.
A performance obligation is a promise in a contract with a customer to transfer to the customer

either:
a good or service (or bundle thereof) that is distinct; or
a series of distinct goods or services that are substantially the same and that have the same
pattern of transfer to the customer.
In general, a contract with a customer explicitly states the goods or services that an entity
promises to transfer to a customer. However, the performance obligations identified in a
contract with a customer may not be limited to the goods or services that are explicitly stated
in that contract. The performance obligations can be implied by the entity’s customary
business practices, published policies or specific statements if, at the time the contract is
entered into they create a valid expectation in the customer that the entity will transfer a
good or service to the customer.
Performance obligations do not include activities that an entity must undertake to fulfil a
contract unless those activities transfer a good or service to a customer. For example,
sometimes an entity has to perform specific administrative tasks related to setting up and
fulfilling the contract, this does not transfer any good or service to a customer and is thus not
a performance obligation.
A good or service that is promised to a customer is distinct if both the following criteria are
met:
The customer can benefit from the good or The entity’s promise to transfer the good or
service either on its own or together with service to the customer is separately
other resources that are readily available identifiable from other promises in the
to the customer. and contract.
(The goods or services are capable of (The goods or services are distinct within
being distinct) the context of the contract)
A customer can benefit from a good or service on its own if the good or service can be
used, consumed, sold for an amount that is greater than scrap value, or otherwise held in a
way that generates economic benefits. Various factors may provide evidence that the
customer can benefit from the good or service on its own or in conjunction with other readily
available resources. A readily available resource is a good or service that is sold separately
or a resource that the customer has already obtained from the entity or from other transactions
or events.
Factors that indicate that an entity’s promise is separately identifiable include:
The entity does not provide a significant service of integrating the good or service with
other goods or services promised in the contract into a bundle that represents the
combined output for which the customer has contracted.
The good or service does not significantly modify or customise another good or service
promised in the contract.
The good or service is not highly dependent on, or highly interrelated with, other goods
or services promised in the contract.
Example 22
22.2 Separate performance obligations exist
Extreme Motors Ltd enters into an agreement with customer A for the sale of a motor vehicle along
with three years of services for a total of R300 000.
A customer may also acquire a motor vehicle from Extreme Motors Ltd without a services plan.
Extreme Motors Ltd regularly sells a three-year service plan to customers on a stand-alone basis.
Comment
¾ The contract with customer A is a single contract, since it was negotiated as a package with a
single commercial objective.
¾ In terms of the contract with customer A, two performance obligations exist; namely the delivery
of a motor vehicle and the delivery of services. In order for performance obligations to be
accounted for separately, the entity first has to determine if the goods and services are distinct.
¾ Firstly, the motor vehicle and the service contract are regularly sold separately by
Extreme Motors Ltd, and the customer can benefit from the goods (motor vehicle) or service
plan either on its own or with other resources readily available to the customer.
¾ Secondly, the goods or services are not highly interrelated with other promised goods or
services in the contract and significant integration of goods and services is not required (the
motor vehicle as well as the service plan can be sold and used separately by customers) and
no significant modification to the performance obligations are required to fulfil the contract.
¾ Consequently, the two performance obligations (the motor vehicle and the service plan) are
accounted for separately for revenue purposes.
A good or service that is not distinct should be combined with other goods or services until
the entity identifies a bundle of goods or services that are distinct.
Example 22
22.3 Separate performance obligations do not exist
Extreme Software Ltd sells licensed accounting software to a customer for a total consideration of
R40 000. In addition, Extreme Software Ltd promises to provide consulting services to significantly
customise the software to the customer’s business environment.
Comment
¾ The contract with the customer is a single contract since the contract was negotiated as a
package with a single commercial objective. However, the contract requires
Extreme Software Ltd to provide a significant integration of goods and services (software and
consulting services). In addition, the software is significantly modified by Extreme
Software Ltd in accordance with the specifications negotiated with the customer.
¾ Consequently, Extreme Software Ltd should account for the licensed software and consulting
services together, as one performance obligation.
A series of distinct goods or services has the same pattern of transfer to the customer if
both the following criteria are met:
each distinct good or service in the series that the entity promises to transfer to the
customer would meet the criteria to be a performance satisfied over time; and
the same method would be used to measure the entity’s progress toward complete
satisfaction of the performance obligation to transfer each distinct good or service in the
series to the customer.
22.4.3 Step 3 Determine the transaction price

The transaction price is determined with reference to the terms of the contract and the
customary business practices of the entity. When the transaction price is determined, the
entity must assume that the goods or services will be transferred to the customer as
promised in the contract and that the contract will not be cancelled, renewed or modified.
The transaction price is the amount of consideration to which an entity expects to be entitled in
exchange for transferring promised goods or services to a customer, excluding amounts collected
on behalf of third parties (e.g. Value Added Tax). This may include fixed amounts, variable
amounts, or both.
Determining the transaction price can be straightforward in many arrangements, but might
be more complex when an entity has to consider the effects of all the following in
determining the transaction price:
Variable consideration An entity estimates an amount of variable

Variable consideration is wider than just consideration by using either the
contingent consideration, triggered by events expected value (probability weighted
outside the seller’s control. Variable method) or the most likely amount
consideration encompasses any amount that (single most likely amount in a range),
is variable under a contract. depending on whichever has the better
predictive value.
The amount of consideration received under
a contract can vary due to discounts, The entity applies one method
rebates, refunds, credits, incentives, consistently throughout the contract.
performance bonuses, penalties, In developing an estimate, an entity
contingencies, price concessions (including considers the historical, current and
concessions due to doubts about the forecasted information.
collectability from the customer’s credit risk)
and other similar items.
Constraining estimates of variable The estimate is revisited at each

consideration reporting date.
Variable consideration is only included in the
transaction price if, and to the extent that, it is
highly probable that its inclusion will not
result in a significant revenue reversal in the
future as result of a re-estimation. The
likelihood as well as magnitude of the
revenue reversal should be considered.
Time value of money To determine if the financing component is

The promised amount of consideration must significant, the entity considers several
reflect the time value of money if the contract factors, including both of the following:
includes a significant financing component. the difference between the amount of
Revenue should be recognised at an amount promised consideration and the cash
that reflects the price that a customer would selling price; and
have paid for the goods and services if the the combined effect of:
customer had paid cash when the goods and the expected length of time between
services transfer to the customer. when the entity transfers the goods or
The effects of financing (interest) shall be services to the customer and when the
presented separately from revenue in the customer pays for those goods or
statement of profit or loss and other services; and
comprehensive income. the prevailing interest rates in the
relevant market.
A contract will not have a significant
financing component if, for example, the
following conditions exist:
The customer paid in advance and the
timing of the transfer is at the discretion
of the customer.
continued
Time value of money – continued A substantial amount of the consideration

varies on the occurrence or
non-occurrence of a future event that is
not within the control of the customer or
entity.
As a practical expedient, it is not necessary
to make the above assessment if the period
between transfer of the goods or services
and receipt of payment is expected to be
less than one year.
Use a discount rate that would be reflected
in a separate financing transaction between
the entity and the customer at contract
inception. The discount rate should reflect
the customer’s credit risk.
Non-cash consideration An entity shall measure the non-cash

Customers may promise consideration in a consideration (or promise of non-cash
form other than cash. consideration) at fair value.
If an entity cannot reasonably estimate
the fair value of the non-cash
consideration, it shall measure the
consideration indirectly by reference to
the stand-alone selling price of the goods
or services promised to the customer.
Consideration payable to the customer Consideration payable to a customer is

These are amounts that an entity pays, or accounted for as a reduction of the
expects to pay, to a customer in the form of transaction price (revenue).
cash, credit or other items (such as coupons An entity recognises the reduction of
or vouchers) that the customer can apply revenue at the later of when the entity
against amounts owed to the entity. recognises revenue for the transfer of the
related goods to the customer, or the
entity pays/promises to pay the
consideration.
If the consideration payable to the
customer is a payment for distinct goods
or services received from the customer,
the consideration is accounted for as a
purchase from a supplier.
Collectability The transaction price equals the amount

Collectability refers to a customer’s credit risk the entity expects to be entitled to (rather
(the risk that an entity will be unable to collect than the amount it expects to actually
from the customer). collect).
In light of the above, the entity does not
adjust the transaction price for customer
credit risk.
If collectability is not considered probable,
a contract may not exist.
If there is subsequent evidence to
suggest that revenue already recognised
is not collectable, the Standard requires
impairment losses to be presented
separately as an expense.
Example 22
22.4 Variable consideration – settlement discount (most likely amount method)
Melda Ltd sold goods with a selling price of R100 000 to a customer on credit on 10 January 20.18.
In terms of Melda Ltd’s credit policy, a discount of 3% is granted to debtors, provided they pay
within 10 days after the date of sale. Based on historical information, the entity estimates that the
majority of its customers settle their accounts within 10 days after the date of sale. The customer
obtains control of the asset on 10 January 20.18.
The debtor actually does pay on 20 January 20.18 and consequently, the unfolding of the whole
transaction between 10 and 20 January 20.18 will be accounted for as follows:
Dr Cr
R R
10 January 20.18
Trade receivable (SFP) (Fair value per IFRS 9) 100 000
Revenue [(R100 000 – (R100 000 × 3%)] (P/L) 97 000
Allowance for settlement discount (SFP) 3 000
Recording revenue based on the most likely amount
on 10 January 20.13
20 January 20.18
Bank (100 000 × 97%) (SFP) 97 000
Allowance for settlement discount (SFP) 3 000
Trade receivable (SFP) 100 000
Consideration received within 10 days and the settlement
discount granted
Comment
¾ The transaction price should reflect the expected or most likely amount of the consideration.
¾ The most likely amount of consideration (i.e. the outcome with the highest probability), based
on historical information, is the transaction price, taking into account the 3% settlement
discount to be granted at settlement date.
¾ If the debt is settled late (i.e. after 20 January 20.18), the expected settlement discount will not
be granted. It is then written back against revenue. The total amount of the sales invoice is
therefore then recognised in the profit or loss section of the statement of profit or loss and other
comprehensive income as revenue (sales).
Example 22.
22.5 Variable consideration – trade discount
Charlie Ltd sells goods with a selling price of R100 000 to a large customer and grants a trade
discount of R25 000. In terms of company policy in respect of cash discounts, a 5% cash discount
is also given by Charlie Ltd if a customer settles an outstanding account in cash immediately. The
customer settled the account immediately in cash.
Under these circumstances, the sales transaction would by measured and accounted for as follows:
Dr Cr
R R
Bank ((R100 000 – R25 000) × 95%) (SFP) 71 250
Revenue (P/L) 71 250
Comment
¾ The trade discount as well as the cash discount are offset against the selling price of R100 000
immediately, and the net amount is recognised as revenue.
Example 22
22.6 Constraining (limiting) the amount of revenue
On 1 January 20.18, Invest Smart Ltd enters into a contract with a customer to provide asset
management services over 24 months. In terms of the contract, Invest Smart Ltd is entitled to a
monthly management fee that is based on a percentage of the value of the fund’s assets.
Invest Smart Ltd is also entitled to an incentive fee of 4% of the fund’s return in excess of the
return of an observable index at the end of the second year. Invest Smart Ltd has a 31 December
year end.
Invest Smart Ltd has experience with similar types of contracts, but considers this experience not
predictive of the outcome of the contract, because the incentive fee is highly susceptible to
external factors (i.e. volatility in the market).
Comment
¾ Invest Smart Ltd constrains the variable amount of revenue to the amount that is highly
probable not to result in significant revenue reversal due to re-estimation.
¾ Since Invest Smart Ltd’s experience is less predictive of the amount of consideration in respect
of the incentive, cumulative revenue recognised for the years ended 31 December 20.18 and
31 December 20.19 is constrained to the monthly management fee. These monthly amounts
will be allocated to the distinct management services provided during each month.
¾ Nearer the end of the 24-month period, and possibly only on 31 December 20.19,
Invest Smart Ltd updates its estimate of the transaction price and includes in the transaction
price the actual amount of the incentive fee, because the uncertainty is resolved.
Example 22
22.7 Time value of money (in arrears and in advance)
In arrears
On 1 January 20.18, Credit Goods Ltd sells a product for R10 000 to a customer on credit, on the
condition that the amount must be paid for on 31 December 20.19. Assume that the financing
component of this transaction is significant.
Credit Goods Ltd’s incremental borrowing rate is 8% per annum. Credit Goods Ltd determined that
the discount rate that reflects the customer’s credit risk is 12% per annum, which is a
market-related rate.
Comment
¾ Since the financing component is significant, the transaction price is adjusted for the time value
of money. The discount rate to be used is the rate that reflects the customer’s credit risk
namely 12% per annum.
Calculation
FV = 10 000
n=2
i = 12
PV = ? = 7 971,94 rounded to 7 972
R
Revenue 7 972
Finance income over 24 months (R10 000 – R7 972) 2 028
Total selling price 10 000
continued
Dr Cr
R R
1 January 20.18
Revenue (P/L) 7 972
Recognise revenue on date that control is transferred
31 December 20.18
Trade receivable (SFP) 957
Finance income (P/L) 957
Recognise finance income accrued on amount outstanding from the date
that a right to consideration was recognised
31 December 20.19
Finance income (P/L) 1 071
Recognise finance income accrued on amount outstanding from the date that
a right to consideration was recognised
Bank (SFP) 10 000
Recognise amount received in cash on settlement date
Comment
¾ IFRS 9 requires receivables to be discounted whenever the effect of discounting is material.
Therefore, on recognition of the revenue and the associated receivable, both of these accounts
are presented at the discounted value of R7 972.
¾ Interest is recognised on the effective interest rate method.
In advance
On 1 January 20.18, Credit Goods Ltd received payment of R7 972 from a customer (regular cash
selling price), on the condition that Credit Goods Ltd must deliver the product to the customer on
31 December 20.19. Assume that the financing component of this transaction is significant. The
market-related interest rate is 12%.
Calculation
n=2
i = 12
PV = 7 972
FV = ? = 10 000
1 January 20.18 Dr Cr
R R
Bank (SFP) 7 972
Contract liability (SFP) 7 972
Recognise the amount received and recognise a contract liability, as there is
a current obligation either to pay the money back or to deliver the product
31 December 20.18
Finance cost (P/L) 957
Contract liability (SFP) 957
Recognise finance cost accrued on amount received in advance from the
date that the contract liability was recognised
continued
31 December 20.19 Dr Cr
R R
Finance cost (P/L) 1 071
Recognise finance cost accrued on amount received in advance from the
date that the contract liability was recognised
Recognise revenue on date that control is transferred
Example 22
22.8 Collectability
On 1 January 20.18, Beta Ltd sells a product for a transaction price of R10 000 to a customer on
credit. Payment is due two months after the product is transferred to the customer on
1 January 20.18 (there is no significant financing component). Based on historical experience,
Beta Ltd assesses on 1 January 20.18 that there is a 10% chance that the customer will not pay
the consideration. On 1 February 20.18, Beta Ltd determines that, due to the financial deterioration
of the customer, there is a significant risk that the customer will not pay the consideration. No price
concessions were granted to the customer.
Comment
¾ Initial measurement: Beta Ltd recognises revenue of R10 000 when it transfers the product to
the customer on 1 January 20.18. If there had been significant doubt at initial recognition
already, about the collectability of the amount, no revenue would have been recognised.
Dr Cr
R R
1 January 20.18
Trade receivable (SFP) (fair value, IFRS 9 Financial Instruments) 10 000
Recognise revenue to the amount Beta Ltd is expected to be entitled
to (not expected to receive)
Comment
¾ Subsequent measurement: Beta Ltd recognises an impairment of the receivable. The
impairment loss will be recognised separately as an expense.
1 February 20.18
Allowance for expected credit losses (P/L) 10 000
Recognise an expense for subsequent amounts not deemed to be
collectable
22.4.4 Step 4 Allocate the transaction price to the performance obligations

At the inception of a contract with a customer, the entity allocates the transaction price to the
performance obligations identified in Step 2. The allocation of the transaction price is based
on the stand-alone selling prices of the underlying goods or services and depicts the
amount of consideration to which the entity expects to be entitled in exchange for satisfying
each performance obligation. If there is a single performance obligation in a contract, the
whole transaction price would be allocated to the one performance obligation, thus step 4
only applies if there is more than one performance obligation in a contract.
Stand-alone selling prices
A stand-alone selling price is the price at which an entity would sell a promised good or service
separately to a customer.
The best evidence of a stand-alone selling price is the observable price of goods or services
when the entity sells those goods or services separately in similar circumstances and to
similar customers. If the stand-alone selling prices are not directly observable, then the
entity needs to estimate them. The following are suitable estimation methods for determining
the stand-alone selling prices:
Adjusted market assessment The estimation is based on the prices of similar goods or
services in the market and adjusted for the entity’s cost
and margin structure.
Expected costs plus The estimation is based on the expected costs of

a margin satisfying a performance obligation plus an appropriate
margin.
Residual An entity may estimate the stand-alone selling price by

reference to the total transaction price less the sum of
the observable stand-alone selling prices of other goods
or services promised in the contract. It may use this
approach only if one of the following criteria are met:
the entity sells the same good or service to different
customers for a broad range of amounts; or
the entity has not yet established a price for that good
or service and that good or service has not previously
been sold on a stand-alone basis.
Example 22
22.9 Allocation of transaction price
Extreme Motors Ltd enters into an agreement with customer A for the sale of a motor vehicle
along with three years of services for a total of R300 000.
A customer may also acquire a motor vehicle from Extreme Motors Ltd without a service plan for a
stand-alone price of R280 000.
Extreme Motors Ltd regularly sells three-year service plan to customers on a stand-alone basis for
R25 000.
Comment
¾ As discussed in Example 22.2, Extreme Motors Ltd has two performance obligations (the
delivery of a motor vehicle and the delivery of a service plan) which are accounted for
separately for revenue purposes.
¾ The total consideration from customer A is allocated to the two separate performance
obligations based on the best estimate of the stand-alone selling prices.
¾ Revenue is recognised for these two performance obligations when the performance
obligations are satisfied.
continued
Allocation
Stand- Allocation
alone of trans-
Ratio
selling action
price price
R % R
Motor vehicle 280 000 91,80* 275 400^
Three-year service plan 25 000 8,20 24 600
Total 305 000 100 300 000
* 280 000/305 000 × 100
^ 300 000 × 91,80%
Allocation of a discount
In general, when the sum of the stand-alone selling prices of the promised goods or services
in the contract exceeds the transaction price (i.e. if a customer receives a discount for
purchasing a bundle of goods or services), an entity shall allocate that discount
proportionately to all performance obligations on a relative stand-alone selling price basis. In
certain cases, an entity may allocate a discount entirely to one (or more), but not all,
performance obligation(s) in the contract if all of the following criteria are met:
the entity regularly sells each distinct good or service (or each bundle of goods or services)
in the contract on a stand-alone basis;
the entity regularly sells, on a stand-alone basis, a bundle of some of those distinct goods
or services at a discount on the stand-alone selling price of the goods or services in each
bundle; and
the discount attributable to each bundle regularly sold by the entity is substantially the
same as the discount in the contract. An analysis of the goods or services in each bundle
provides observable evidence of the performance obligation to which the entire discount
in the contract belongs.
Example 22
22.10
.10 Allocation of discount to all performance obligations in the contract
V Ltd enters into an agreement with customer A to provide a cellular phone together with a call,
data and SMS bundle. The contract is for a 12-month period and the monthly fee to the customer
is R550. V Ltd has identified two separate performance obligations, namely the cellular phone and
the bundle (including calls, data and SMS).
A customer can acquire the cellular phone separately for R2 600 from V Ltd. A 12-month bundle
(consisting of the same level of call, data and SMS) is offered to customers at R350 per month.
There is no observable evidence in the contract that a discount is attributable to a specific
performance obligation in the contract.
Comment
¾ The transaction price of R550 × 12 = R6 600 will be allocated to the two performance
obligations based on the stand-alone selling prices.
continued
Allocation
Stand- Allocation
alone of trans-
Ratio
selling action
price price
R % R
Cellular phone 2 600 38,24* 2 524^
Bundle (R350 per month × 12 months) 4 200 61,76 4 076
Total 6 800 100 6 600
* 2 600/6 800 × 100
^ 6 600 × 38,24%
Example 22
22.11
.11 Allocation of discount to one or more but not all performance obligations
T Ltd enters into an agreement with customer B to provide a cellular phone, together with a call,
data and SMS bundle, as well as insurance on the cellular phone. The contract is for a 12-month
period and the monthly fee to the customer is R640. T Ltd has identified three separate
performance obligations, namely the cellular phone, the bundle (including calls, data and SMS)
and the insurance on the cellular phone.
A customer can acquire the cellular phone separately for R2 600 from T Ltd. A 12-month bundle
(consisting of the same level of call, data and SMS) is offered to customers at R350 per month
and insurance on cellular phones is offered to customers at R90 per month.
T Ltd regularly sells the cellular phone and the bundle (consisting of the same level of call, data
and SMS) together for R550 per month.
Comment
¾ The transaction price of R640 × 12 = R7 680 will be allocated to the three performance
obligations.
¾ The discount cannot be allocated proportionately to the three performance obligations based on
stand-alone selling prices as there is observable evidence in the contract that a discount is
attributable to only two of the three performance obligations, that being the cellular phone and
the bundle.
Allocation
The observable evidence is as follows:
Cellular phone and bundle if sold together (R550 per month × 12 months) 6 600
If cellular phone and bundle are sold separately:
Cellular phone 2 600
Bundle (R350 per month × 12 months) 4 200
6 800
Thus the discount for cellular phone and bundle sold together (R6 800 – R6 600) 200
Allocation of the transaction price of R7 680 between the three performance obligations:
Cellular phone (R2 600 – (R200 × 2 600/6 800)) 2 524
Bundle (R4 200 – (R200 × 4 200/6 800)) 4 076
Insurance (R90 per month × 12 months) 1 080
Total 7 680
Allocation of variable consideration

A variable consideration promised in a contract may be attributable to the entire contract, or
to a specific part of a contract, such as
one or more, but not all, performance obligations; or
one or more, but not all, distinct goods or services in a series of distinct goods or
services that form part of a single performance obligation.
An entity shall allocate a variable amount (and subsequent changes in that amount) entirely
to a performance obligation or to a distinct good or service that forms part of a single
performance obligation, if
the terms of the variable payment relate specifically to the entity’s efforts to satisfy the
performance obligation or transfer the distinct good or service; and
allocating the whole amount of the variable consideration to that performance obligation
or distinct good or service will depict the amount of the consideration that the entity
expects to be entitled to in exchange for the good or service it transferred to the
customer.
If the variable consideration is not allocated entirely to a performance obligation or to a
distinct good or service, the remaining amount should be allocated on the basis of stand-
alone selling prices.
Example 22
22.12
.12 Allocation of variable consideration to a contract with more than one
performance obligation
Air Ltd signed a contract with an airfreight company. In terms of the contract. Air Ltd must
manufacture three different aircraft. If the three aircraft are completed within one year, Air Ltd will
receive an additional R500 000.
The transaction price is R5 000 000. Air Ltd, based on past history with similar contracts,
estimates that construction on the three aircraft will be completed within one year and that
receiving the R500 000 is therefore the most likely outcome.
Comment
¾ The transaction price will be allocated to the three performance obligations (the three aircraft)
based on the stand-alone selling price of each.
Allocation
Stand- Allocation
alone of trans-
Ratio
selling action
price price
R % R
Aircraft 1 1 380 000 30* 1 500 000^
Aircraft 2 2 300 000 50 2 500 000
Aircraft 3 920 000 20 1 000 000
Total 4 600 000 100 5 000 000
* 1 380 000/4 600 000 × 100
^ 5 000 000 × 30%
Comment
¾ Air Ltd would use the most likely amount to estimate the variable consideration. There are two
possible outcomes: receiving the R500 000 or not receiving the R500 000.
¾ The variable consideration will be allocated to the performance obligations proportionately,
based on the stand-alone selling prices.
¾ The entire transaction price (R5 000 000 + R500 000) will therefore be allocated between the
three performance obligations.
continued
Allocation
Stand- Allocation
alone of trans-
Ratio
selling action
price price
R % R
Aircraft 1 150 000* 30# 1 650 000^
Aircraft 2 250 000 50 2 750 000
Aircraft 3 100 000 20 1 100 000
Total 500 000 100 5 500 000
* 500 000 × 30/100
^ 1 500 000 + 150 000
#
As calculated above
Change in transaction price

If, after contract inception, the transaction price changes, then the entity allocates the
change to the performance obligations on the same basis as at contract inception. Revenue
recognised for satisfied performance obligations is increased or decreased by this change in
transaction price in the period in which the change occurred. A change in revenue is not
recognised for changes in stand-alone selling prices of goods or services after contract
inception. A change in transaction price could be due to a contract modification, but could
also occur after a contract modification (for example the resolution of uncertain events).
22.4.5 Step 5 Recognise revenue

An entity shall recognise revenue when (or as) the entity satisfies a performance
obligation by transferring promised goods or services to a customer.
An asset (goods or services) is transferred when (or as) the customer obtains control of
that asset.
The customer has the ability to direct the use of the asset
and
The customer obtains
control of the asset if:
The customer has the ability to receive substantially all
the remaining benefits from the asset.
Control can also include the ability to prevent other entities from directing the use of, and
obtaining the benefits from, an asset. The benefits of an asset are the potential cash flows
that can be obtained directly or indirectly from the asset, such as using the asset to produce
goods, or by selling the asset.
In order to determine when revenue is recognised, it has to be determined when the
performance obligation is satisfied by the entity. A performance obligation may be satisfied
at a point in time or over a period of time. If a performance obligation is not satisfied over
time, it will be satisfied at a point in time.
Performance obligation satisfied over a period of time
If an entity satisfies a performance obligation over time, then it recognises revenue over time.
Before revenue is recognised over a period of time, the entity has to determine if the
performance obligation is indeed satisfied over time. A performance obligation is satisfied
over time if one of the following criteria is met:
the customer simultaneously receives and consumes the benefits provided by the entity’s
performance as the entity performs (for example cleaning services);
the entity’s performance creates or enhances an asset that the customer controls as the
asset is created or enhanced (for example the construction of a building); or
the entity’s performance does not create an asset with an alternative use for the entity,
and the entity has an enforceable right to payment for performance completed to date.
When considering whether an asset has an alternative use, a seller will need to assess, at
inception of the contract, whether, both contractually and practically, it is able to use the
asset for a purpose other than that set out in the contract with the customer. An asset
created by an entity’s performance does not have an alternative use to the entity, if:
the entity is either restricted contractually from readily directing the asset for another use
during the creation or enhancement of that asset; or
the entity is limited practically from readily directing the asset in its completed state for
another use.
An entity shall consider the terms of the contract as well as the law, when evaluating whether it
has an enforceable right to payment. The right to payment does not need to be a fixed
amount. The entity should however be entitled to an amount that at least compensates it for
performance completed to date as well as a reasonable profit margin.
Once it is determined that the performance obligation is indeed satisfied over time, the entity
recognises revenue over time by measuring the progress towards complete satisfaction of
that performance obligation. The objective when measuring progress is to depict an entity’s
performance in transferring control of goods or services promised to a customer. In order to
determine the entity’s performance and measure of progress, either the output method or
the input method is applied, depending on which one depicts the entity’s performance:
Output method: Revenue recognition is based on the goods or services produced up to
date (e.g. results of appraisals, milestones reached or units produced).
Input methods: Revenue recognition is based upon the entity’s efforts or inputs (e.g.
resources consumed, labour hours expended, costs incurred or time lapsed).
A single method should be applied for each performance obligation and should be applied
consistently to similar performance obligations and in similar circumstances. As
circumstances change over time, an entity shall update its measure of progress to depict
the entity’s performance completed to date. Such changes shall be accounted for as a
change in accounting estimate in accordance with IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors.
In some circumstances, for instance in the early stages of a contract, the entity is unable to
reasonably measure the outcome of a performance obligation, but the entity expects to
recover the costs incurred in satisfying the performance obligation. Revenue shall then only
be recognised to the extent of the costs incurred – until such time that the outcome can be
measured.
Example 22
22.13
.13 Input method
Projects Ltd enters into an agreement with a customer to construct a plant over a period of
12 months for a total transaction price of R2 000 000. The agreement includes an obligation to
obtain machinery for the plant and transfer it to the customer at cost. Control of the machinery will
be transferred to the customer six months after the construction of the plant begins. Projects Ltd
measures its performance by using the percentage of costs incurred compared to the total
estimated costs of the project. The total estimated cost of the project is R1 900 000, of which the
machinery represents a significant portion.
Projects Ltd purchased the machinery from a supplier for R500 000 six months after the project
was initiated and delivered it to the customer’s premises without being involved in the design or
manufacture of the machinery. On the same date, the total project cost incurred (including the cost
of the machinery) amounted to R1 200 000.
continued
Comment
¾ The construction of the plant and the acquisition of a machine are separate performance
obligations.
¾ Project Ltd recognises revenue of R500 000 when the customer obtains control of the
machinery. The related cost is recognised simultaneously. A Rnil profit is realised.
¾ Project Ltd measures the revenue from the rest of the construction activities as the
performance obligation is satisfied over time, based on the measure of progress.
¾ The measure of progress is determined by first eliminating the cost of the machinery from the
costs incurred (R1 200 000 – R500 000) and the total expected costs (R1 900 000 – R500 000).
The cost to date (R700 000) is then compared to the total expected cost (R1 400 000). On this
basis, Project Ltd recognises 50% (R700 000/R1 400 000) of the total revenue from the
contract. The revenue recognised excludes the revenue allocated to the machinery, and
amounts to R750 000 [(R2 000 000 – R500 000) × 50%].
Performance obligations satisfied at a point in time

To determine the point in time when a performance obligation was satisfied by the entity,
the entity first considers if the customer obtained control of the asset in terms of the two
requirements illustrated above, meaning that the customer has the ability to direct the use
of the asset and has the ability to receive the benefit from the asset.
In addition, an entity also considers the indicators of the transfer of control, which include,
but are not limited to the following:
The customer has a present obligation to pay

for the asset. The entity has a present right to
that payment.
The customer has accepted the asset.
Control indicators The customer has significant risks and rewards

of ownership of the asset.
The customer has physical possession of the

asset.
The customer has legal title to the asset.
Any one of these indicators will not always indicate control, for example, with consignment
arrangements, the customer could have physical possession, but not control over the asset.
Where legal title is, for example, retained by the entity purely for protection against credit
risk, the customer could still have control. The point in time where control is transferred
therefore needs to be determined after considering various factors and indicators.
Example 22
22.14
.14 Performance obligation satisfied at a point in time
Luxury Motors enters into a contract to sell a luxury motor vehicle to a customer. The delivery
terms of the contract are free on board shipping point (i.e. legal title to the motor vehicle and all
risks related to the vehicle passes to the customer when the motor vehicle is handed over to the
carrier).
Comment
¾ The customer obtains control of the motor vehicle at the point of shipment. Although he/she
does not have physical possession of the motor vehicle at that point, it has legal title to the motor
vehicle and carries all the risks from that point.
22.5 Contract costs

An entity recognises an asset for the costs of fulfilling or obtaining a contract if certain
criteria are met.
22.5.1 Costs of fulfilling a contract
If the costs incurred in fulfilling a contract with a customer are in the scope of another IFRS
(e.g. IAS 16 Property, Plant and Equipment or IAS 38, Intangible Assets) an entity accounts
for the costs of fulfilling the contract in accordance with those other IFRSs.
Otherwise, an entity shall recognise an asset from the costs incurred to fulfil a contract;
however, only if those costs meet all of the following criteria:
the costs are directly related to a contract (or a specific anticipated contract);
the costs generate or enhance resources of the entity that will be used in satisfying the
performance obligations; and
the costs are expected to be recovered.
Direct costs include costs such as:

direct labour;
direct material;
allocation of costs that relate directly to the contract (e.g. deprecation);
costs that are explicitly chargeable under the contract; or
other costs that were incurred because of the contract (e.g. payment to subcontractors).
An entity expenses the following costs when incurred:

general and administrative costs (unless these costs are explicitly chargeable to the
customer under the contract);
costs of wasted material, labour or other resources;
costs that relate to satisfied or partially satisfied performance obligations (i.e. costs that
relate to past performance); and
costs for which the entity cannot distinguish whether the costs relate to unsatisfied
performance obligations or satisfied performance obligations or partially satisfied
performance obligations.
22.5.2 Cost of obtaining a contract

An entity shall recognise as an asset the incremental costs of obtaining a contract with a
customer if the entity expects to recover those costs. Costs that would have been incurred
regardless of whether the contract was obtained shall be recognised as an expense when
incurred, unless those costs are explicitly chargeable to the customer regardless of whether
the contract is obtained.
The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a
contract with a customer and that it would not have incurred if the contract had not been obtained
(e.g. payment of sales commission).
As a practical expedient, an entity may recognise the costs of obtaining a contract as an

expense when incurred if the amortisation period of the asset is one year or less.
22.5.3 Amortisation and impairment

If an entity recognises an asset for contract costs, the asset is amortised on a systematic
basis, consistent with the pattern of transfer to the customer of the goods or services to
which the asset relates. The term ‘related goods and services’ includes goods and services
under an existing and/or anticipated contract (e.g. a renewal of an existing contract).
An entity shall update the amortisation to reflect a significant change in the entity’s expected
timing of transfer to the customer of the related goods or services. Such a change shall be
accounted for as a change in estimate in accordance with IAS 8 Accounting Policies,
Changes in Accounting Estimates and Errors.
An asset recognised shall also be tested for impairment (and subsequent reversal of
impairment) under IAS 36 Impairment of Assets.
Example 22
22.15
.15 Contract costs
On 1 January 20.18, Data Ltd enters into a five-year contract to provide outsource services for a
customer’s information technology data. Data Ltd incurs selling commission costs of R15 000 to
obtain the contract with the customer. Before providing the services, the entity designs and builds
a technology platform that interfaces with the customer’s systems. The initial costs incurred to set
up the technology platform are as follows:
R
Hardware costs 180 000
Software costs 50 000
Comment
¾ The R15 000 selling commission paid by Data Ltd is an incremental cost of obtaining the
contract, and is recognised as an asset since it cannot be capitalised in terms of another IFRS.
The asset is amortised over the term of the contract (5 years).
¾ The initial set-up costs of the technology platform relate primarily to activities to fulfil the
contract but do not transfer goods or services to the customer.
¾ The initial set-up costs of the technology platform are in the scope of other IFRSs and are
accounted for in accordance with the other IFRSs:
• Hardware costs – accounted for in accordance with IAS 16 Property, Plant and Equipment.
• Software costs – accounted for in accordance with IAS 38 Intangible Assets.
22.6 Application guidance (Appendix B to the Standard)

The Appendix to the Standard includes the revenue recognition criteria for certain specific
transactions. These transactions are not discussed in this chapter, as the Appendix provides
detailed discussions and examples of these transactions. Transactions addressed include
(but are not limited to):
sale with a right of return;
principal versus agent considerations;
repurchase arrangements;
consignment arrangements; and
bill-and-hold arrangements.
Example 22
22.16
.16 Customer incentives
Top Retail Ltd has a customer loyalty programme that rewards a customer with one customer
loyalty point for every R500 of purchases. Each point is redeemable for a R10 discount on any
future purchases at Top Retail Ltd.
During the financial year ending 31 December 20.18, customers purchased products to a total
value of R250 000, which is the stand-alone selling price of the purchased products. In terms of
Top Retail Ltd’s loyalty program, 500 points (R250 000/R500, assuming each customer purchased
for R500) were earned by customers during 20.18 and are redeemable for future purchases. Top
Retail Ltd expects 450 points to be redeemed in the future on the basis of its past experience that
it concludes is predictive of the amount of consideration to which Top Retail Ltd will be entitled.
The stand-alone selling price of the points is therefore estimated on the basis of likelihood of
redemption at 450/500 = 90% of R10 = R9 per point.
At 31 December 20.18, 300 of the points have been redeemed by customers. Top Retail Ltd
continues to expect 450 points to be redeemed in total.
Comment
¾ The points provide a material right to customers that they would not receive without entering
into a contract. The right to acquire additional goods or services is also at a price that does not
reflect stand-alone selling prices.
¾ The promise by the entity to provide the customer loyalty points is therefore a separate
performance obligation.
¾ Top Retail Ltd allocates the transaction price to the products and the points on a relative
stand-alone selling price basis as follows:
R
Products (R250 000 × R250 000/R254 500*) 245 580
Customer loyalty points (R250 000 × R4 500/R254 500*) 4 420
Total transaction price 250 000
* R250 000 + (R9 × 500 points) or R250 000 + (500 points × R10 × 90%)
The transaction price allocated to the sale of the products (R245 580) is immediately recognised
as revenue when control over the products is transferred to the customers. The transaction price
allocated to the customer loyalty points is recognised as deferred income (contract liability) in the
statement of financial position until the credits are redeemed. Accordingly, on 31 December 20.18,
revenue of R2 947 (300/450 × R4 420) is recognised for the redemption of the 300 customer
loyalty points.
Dr Cr
R R
Year ended 20.13
Bank/Trade receivable (SFP) 250 000
Deferred income/Contract liability (SFP) 4 420
Recognise revenue when performance obligations are satisfied
31 December 20.13
Deferred income/Contract liability (SFP) 2 947
Revenue (P/L) 2 947
Recognise revenue when performance obligations are satisfied
22.7 Presentation
When either party to a contract has performed, an entity shall present the contract in the
statement of financial position as a contract asset or contract liability, depending on the
relationship between the entity’s performance and the customer’s payment.
If a customer pays a consideration or an entity has a right to an amount of consideration
that is unconditional before an entity performs, the entity presents the contract as a contract
liability when the payment is made or when payment is due (whichever is earlier). The
liability recognised represents the entity’s obligation to either transfer goods or services in
the future or refund the consideration received. The liability shall be measured at the amount
of the consideration received by the customer.
A contract liability is an entity’s obligation to transfer goods or services to a customer for which the
entity has received consideration (or an amount of consideration is due) from the customer.
Example 22
22.17
.17 Contract liability
An amount received by a customer, for which revenue cannot be recognised yet, shall be treated as a
liability. This amount can only be recognised as revenue when:
the entity has no remaining obligation to transfer goods or services and all or substantially all of
the consideration promised by the customer has been received and the amount is non-
refundable, or
when the contract has been terminated and the amount is non-refundable.
The journal entries would be as follows:
Dr Cr
R R
Bank (SFP) xxx
Income received in advance (Contract liability) (SFP) xxx
Recognise consideration received
Income received in advance (SFP) xxx
Revenue (P/L) xxx
Recognise revenue
If an entity performs by transferring goods or services to a customer before the

customer pays the consideration, or before payment is due, the entity presents the contract
as a contract asset, excluding any amounts presented as a receivable.
A contract asset is an entity’s right to a consideration in exchange for goods or services that the
entity has transferred to a customer, when that right is conditional on something other than the
passage of time.
A receivable is an entity’s right to consideration that is unconditional. A right to consideration is
unconditional if only the passage of time is required before payment of that consideration is due.
22.8 Disclosure
The objective of the disclosure requirements is for an entity to disclose sufficient information
to enable users of financial statements to understand the nature, amount, timing and
uncertainty of revenue and cash flows arising from contracts with customers. To achieve
that objective, an entity shall disclose qualitative and quantitative information about all of the
following:
Assets recognised from the

Significant judgements, and
Contracts with customers costs to obtain or fulfil a
changes in the judgements
contract
An entity shall disclose all the An entity shall disclose: An entity shall disclose:
following amounts for the Judgements in determining the the closing balances of
reporting period, unless those timing of satisfying assets recognised from
amounts are presented performance obligations: the costs incurred to
separately in the statement of For revenue recognised over obtain or fulfil a contract
profit or loss and other time: with a customer, by main
comprehensive income in category of asset; and
accordance with other Revenue recognition
methods (output or input the amount of amortisation
Standards: and any impairment losses
methods); and
revenue recognised from recognised in the reporting
contracts with Explanation of why the
method used provides a period.
customers, separately An entity shall describe:
disclosed from other faithful depiction of the
sources of revenue; and transfer of goods or services. the judgements made in
For revenue recognised at a determining the amount of
any impairment losses the costs incurred to
recognised on any point in time:
Judgements made in obtain or fulfil a contract
receivables or contract with a customer; and
assets arising from an evaluating when a customer
entity’s contracts with obtains control of goods or the method it uses to
customers, which the services. determine the amortisation
entity shall disclose Judgement in determining the for each reporting period.
separately from transaction price and
impairment losses from amounts allocated to
other contracts. performance obligations:
Information about the methods,
assumptions and inputs used
for all of the following:
determining the transaction
price;
assessing whether an
estimate of variable
consideration is constrained;
allocating the transaction
price, including estimating
stand-alone selling prices
and allocating discounts and
variable consideration; and
measuring obligations for
returns, refunds and other
obligations.
An entity considers the level of detail necessary to satisfy the disclosure objective and how
much emphasis to place on each of the various requirements. An entity need not disclose
information in accordance with this Standard if it has provided the information in accordance
with another IFRS.
If the entity elected to use any of the practical expedients, this fact shall be disclosed.
22.8.1 Disaggregation of revenue

An entity shall disaggregate revenue recognised from contracts with customers into
categories that depict how the nature, amount, timing and uncertainty of revenue and cash
flows are affected by economic factors. Sufficient information shall be disclosed to
understand the relationship between the disclosure of disaggregated revenue and revenue
information disclosed for each reportable segment.
22.8.2 Contract balances

An entity shall disclose all the following:
the opening and closing balances of receivables, contract assets and contract liabilities
from contracts with customers;
revenue recognised in the reporting period that was included in the contract liability
balance at the beginning of the period;
revenue recognised in the reporting period from performance obligations satisfied in
previous periods (e.g. changes in transaction price).
An entity shall explain how the timing of satisfaction of its performance obligations relates to
the typical timing of payment, and the effect that those factors have on the contract asset
and contract liability balances.
An entity shall provide an explanation of the significant changes in the contract asset and
the contract liability balances during the reporting period.
22.8.3 Performance obligations

An entity shall disclose information about its performance obligations in contracts with
customers, including a description of all the following:
when the entity typically satisfies its performance obligations;
the significant payment terms;
the nature of the goods or services that the entity has promised to transfer, highlighting
any performance obligations to arrange for another party to transfer goods or services
(i.e. the entity is acting as an agent);
obligations for returns, refunds and other similar obligations; and
types of warranties and related obligations.
Refund liabilities
An entity shall recognise a refund liability if the entity receives a consideration from a
customer and expects to refund some or all of that consideration to the customer. A refund
liability is measured at the amount of consideration received to which the entity does not
expect to be entitled. The refund liability shall be updated at the end of each reporting period
for changes in circumstances.
Example 27.18
27.18 Refund liabilities
Echo Ltd retrospectively reduces the price of goods sold by 2% for the year, when a customer
purchases more than 500 items during the year. During the first month, a customer purchased 60
items at R1 500 per item. Based on historical experience with this customer, Echo Ltd expects that
the customer will purchase more than 500 items during the year and will be entitled to the rebate at
the end of the year.
The following journal entry will be prepared on date of sale of the 60 items:
Dr Cr
R R
Bank (SFP) (1 500 × 60) 90 000
Revenue (P/L) (1 500 × 60 × 98%) 88 200
Refund liability (SFP) (1 500 × 60 ×2%) 1 800
Recognise revenue at the amount the entity is expected
to be entitled to
22.8.4 Transaction price allocated to the remaining performance obligations

An entity shall disclose the following information about its remaining performance obligations:
the aggregate amount of the transaction price allocated to the performance obligations
that are unsatisfied or partially satisfied as of the end of the reporting period; and
an explanation of when the entity expects to recognise the revenue from these
performance obligations. This shall be disclosed in either of the following ways:
– on a quantitative basis, using time bands that would be most appropriate for the
duration of the remaining performance obligation; or
– by using qualitative information.
As a practical expedient, this information does not need to be disclosed if the performance
obligation is part of a contract that has an original expected duration of one year or less.
22.9 Synopsis: Revenue model
Five-step revenue model
Combination contract Contract costs

Account as a single contract when: Recognise an asset when:
entered into near the same time the cost is not in the scope of
with the same customer; and another IFRS; and
contracts have a single costs are directly related to the
commercial objective; or contract; and
consideration depends on price of costs generate resources that
other contract; or help satisfy the performance
CONTRACT
goods/services under contracts obligations; and
constitute a single performance costs are recoverable.
obligation.
Modification is a new separate contract when:

additional goods or services are distinct; and
the consideration reflects stand-alone selling prices of goods or
services.
Performance obligations in a contract are accounted for separately when

PERFORMANCE the goods or services are distinct, that is:
OBLIGATIONS capable of being distinct; and
distinct within the context of the contract.
Consider the following to determine the transaction price:

Variable consideration (revenue is the expected value or most likely
amount, but constrained).
DETERMINE Time value of money (reflect time value of money when significant
TRANSACTION financing component exists).
PRICE Non-cash consideration (recognised at fair value).
Consideration payable (reduce revenue if payment is not for distinct
goods or services).
Collectability (losses due to credit risk do not adjust transaction price).
Allocate transaction price to separate performance obligations based on

ALLOCATE
stand-alone selling prices.
TRANSACTION Allocate discount (sum of stand-alone selling prices > transaction price)
PRICE to separate performance obligations.
Allocate variable consideration.
Recognise revenue when the performance obligation is satisfied by

transferring control of the asset to the customer.
Performance obligations are satisfied at a point in time; or
Performance obligations are satisfied over time and revenue
recognised by measuring the progress towards completion when:
RECOGNISE
REVENUE
customer simultaneously receives and consumes the benefits provided
by the entity’s performance as the entity performs; or
the entity’s performance creates or enhances an asset that the customer
controls as the asset is created or enhanced; or
the entity’s performance does not create an asset with an alternative
use.
CHAPTER
23
Leases
(IFRS 16)
Contents
23.1 Overview ........................................................................................................... 631
23.2 Background ....................................................................................................... 632
23.3 Definitions .......................................................................................................... 633
23.4 Identifying a lease ............................................................................................. 633
23.4.1 Identified asset ................................................................................... 634
23.4.2 Right to obtain substantially all of the economic benefits
from use ............................................................................................. 635
23.4.3 Right to direct the use ........................................................................ 635
23.5 Separating components of a contract ................................................................ 638
23.5.1 Lessee ................................................................................................ 639
23.5.2 Lessor ................................................................................................. 639
23.6 Combinations of contracts ................................................................................. 639
23.7 Lease term ........................................................................................................ 639
23.8 Lessees ............................................................................................................. 640
23.8.1 Recognition exemptions ..................................................................... 641
23.8.1.1 Short-term leases .............................................................. 641
23.8.1.2 Low value underlying assets ............................................. 642
23.8.1.3 Taxation ............................................................................ 645
23.8.2 Recognition and measurement: Right-of-use assets and lease
liabilities ............................................................................................. 648
23.8.2.1 Initial measurement of the right-of-use asset .................... 648
23.8.2.2 Initial measurement of the lease liability ........................... 649
23.8.2.3 Lease payments ................................................................ 651
23.8.2.4 Interest rate ....................................................................... 653
23.8.2.5 Subsequent measurement of the right-of-use asset ......... 653
23.8.2.6 Subsequent measurement of the lease liability................. 654
23.8.3 Reassessment of the lease liability .................................................... 660
23.8.4 Lease modifications............................................................................ 665
23.8.4.1 Lease modifications accounted for as separate leases .... 665
23.8.4.2 Lease modifications not accounted for as separate
lease .................................................................................. 666
23.8.5 Tax implications.................................................................................. 667
23.8.6 Value-added tax ................................................................................. 669
23.8.7 Instalment sale agreements: From the purchaser’s perspective ........ 671
23.8.8 Presentation ....................................................................................... 674
23.8.9 Disclosure: The lessee and the purchaser (ISA) ................................ 674
629
23.9 Lessors .............................................................................................................. 678

23.9.1 Classification of leases ....................................................................... 678
23.9.2 Land and buildings ............................................................................. 679
23.9.3 Finance leases: recognition and measurement.................................. 681
23.9.3.1 Lease payments ................................................................ 688
23.9.3.2 Residual values ................................................................. 689
23.9.3.3 Interest rate changes ........................................................ 693
23.9.4 Subleases........................................................................................... 694
23.9.5 Lease modifications............................................................................ 698
23.9.6 Finance leases of a manufacturer or dealer lessor ............................ 698
23.9.8 Value-added tax ................................................................................. 703
23.9.9 Instalment sale agreements: From the seller’s perspective ............... 704
23.9.10 Disclosure: The lessor (finance leases) and the seller
(instalment sale agreements) ............................................................. 708
23.10 Operating leases ............................................................................................... 710
23.10.1 Recognition and measurement .......................................................... 710
23.10.3 Presentation ....................................................................................... 714
23.10.4 Disclosure ........................................................................................... 715
23.11 Sale and leaseback transactions ....................................................................... 716
23.11.1 Transfer of the asset is a sale ............................................................ 716
23.11.2 Transfer of the asset is not a sale ...................................................... 720
23.11.4 Disclosure ........................................................................................... 721
Leases 631
23.1 Overview
Objective
To ensure that lessees and lessors provide relevant information in a manner that faithfully
represents those transactions.
Scope
IFRS 16 does not apply to the following leases:
(a) leases to explore for, or use minerals, oil, natural gas and similar non-regenerative resources;
(b) leases of biological assets within the scope of IAS 41 Agriculture held by a lessee;
(c) service concession arrangements within the scope of IFRIC 12 Service Concession
Arrangements;
(d) licences of intellectual property granted by a lessor within the scope of IFRS 15 Revenue from
Contracts with Customers; and
(e) rights held by a lessee under licensing agreements within the scope of IAS 38 Intangible
Assets.
Definition
A lease is a contract, or part of a contract that conveys the right to use an asset (the underlying
asset) for a period of time (lease term) in exchange for consideration.
Identifying a lease
Assess at inception of a contract whether the contract is, or contains, a lease.
A contract is, or contains, a lease if the contract conveys the right to control the use of an
identified asset for a period of time in exchange for consideration, meaning that the customer
has both of the following:
(a) the right to obtain substantially all of the economic benefits from use of the identified asset;
and
(b) the right to direct the use of the identified asset.
Accounting by lessor (Operating lease)

Continue to recognise depreciation on the underlying asset similar to an item of property, plant
of equipment in terms of IAS 16 Property, Plant and Equipment or continue to fair value the
investment property in terms of IAS 40 Investment Property;
recognise lease income on a straight-line basis over the lease term; and
recognise lease incentives on a straight-line basis as a reduction in lease income.
Accounting by lessor (Finance lease)
Derecognise the asset;
recognise a gain or loss on the derecognition of the asset;
recognise a receivable equal to the net investment in the lease (net investment = gross
investment discounted at the interest rate implicit in the lease);
the interest rate implicit in the lease includes both the guaranteed and unguaranteed residual
values and is defined in such a way that the initial direct costs incurred by the lessor are
automatically included in the net investment in the lease;
recognise finance income in accordance with the effective interest rate method; and
recognise lease payments against the gross investment when the payments are received.
continued
Accounting by lessee
Single lessee accounting model;
recognise a right-of-use asset and a lease liability for all leases at the commencement of the
lease or elect not to apply this requirement for short-term leases and leases for which the
underlying asset is of low value;
initially measure a right-of-use asset and the lease liability on a present value basis including
non-cancellable lease payments, for example inflation-linked payments, and payments to be
made in optional periods if the lessee is reasonably certain to exercise an option to extend the
lease, or not to exercise an option to terminate the lease, and payments to be made for
acquiring the asset at the end of the lease term if it is reasonably certain that the lessee would
exercise such option;
include initial direct costs, lease payments made at or before the commencement date, less any
lease incentives received, and estimates of costs to be incurred by the lessee in dismantling and
removing the underlying asset or restoring the site on which it is located on, in the carrying
amount of the right-of-use asset;
the lease payments shall be discounted over the lease term using the interest rate implicit in the
lease, if that rate can be readily determined. If this rate cannot be readily determined, the lessee
shall determine and use its own incremental borrowing rate;
subsequently measure a right-of-use asset similarly to other non-financial assets, for example
depreciate the right-of-use asset and test for impairment; and
subsequently measure the lease liability similarly to other financial liabilities, for example reflect
interest on the lease liability, and deduct lease payments to reflect the capital redemption
portion when the payment is made.
Presentation and disclosure

Both the lessor and lessee should provide relevant information in a manner that faithfully
represent lease transactions in order for users of financial statements to assess the effect that
leases have on the financial position, financial performance and cash flows of the lessor and
lessee.
23.2 Background
IFRS 16, issued in January 2016, superseded the requirements in IAS 17 Leases, IFRIC 4
Determining whether an Arrangement contains a Lease, SIC 15 Operating Leases –
Incentives, and SIC 27 Evaluating the Substance of Transactions Involving the Legal Form
of a Lease, in response to concerns expressed by investors and others about the lack of
information about leasing transactions when companies applied IAS 17. IFRS 16 sets out
the principles for the recognition, measurement, classification, presentation and disclosure
of leases for both the lessee and the lessor. This Standard also applies to other credit
instalment agreements, for example hire-purchase agreements.
Entities are required to apply IFRS 16 for reporting periods beginning on or after
1 January 2019; however, an entity is permitted to apply IFRS 16 earlier, given that it also
applies IFRS 15.
IFRS 16 substantially carries forward the lessor accounting requirements in IAS 17, that is, a
lessor continues to classify its leases as operating leases or finance leases; however,
IFRS 16 changes lessee accounting substantially.
IFRS 16 eliminates the classification of leases as either operating or finance leases for
lessees and introduces a single lessee accounting model to reflect that such leases result in
an entity obtaining a right to use an asset (right-of-use asset) at the commencement of the
lease, and a corresponding lease liability (similar to how finance leases of lessees were
treated under IAS 17). However, IFRS 16 provides a recognition exemption option to this
single lessee leasing model for short-term leases and leases of underlying assets with a low
value. Entities electing this exemption will account for such payments and such assets on a
straight-line basis over the lease term similar to operating leases.
Leases 633
23.3 Definitions
Some of the key definitions in IFRS 16 in respect of lease accounting are as follows:
General aspects:
Appendix A of IFRS 16 defines a lease as a contract, or part of a contract, that conveys the
right to use an asset (the underlying asset) for a period of time in exchange for
consideration.
The inception date of the lease is the earlier of the date of the lease agreement and the
date of commitment by the parties to the principal terms and conditions of the lease. At
inception of a contract, an entity shall assess whether the contract is, or contains, a lease
(refer to section 23.4).
The commencement date of the lease is the date on which a lessor makes an underlying
asset available for use by a lessee. At this date:
a lessee shall recognise a right-of-use asset and a lease liability; and
a lessor shall recognise assets held under a finance lease in its statement of financial
position and present them as receivable at an amount equal to the net investment in the
lease (i.e. the accounting entries shall be made from this date).
Initial direct costs are the incremental costs of obtaining a lease that would not have been
incurred if the lease had not been obtained, excluding such costs incurred by a
manufacturer or dealer lessor in connection with a finance lease.
Lease incentives are payments made by a lessor to a lessee associated with a lease, or
the reimbursement or assumption by a lessor of costs of a lessee.
Definitions relating more specifically to the lessor:
A finance lease is a lease that transfers substantially all the risks and rewards incidental to
ownership of an underlying asset.
An operating lease is a lease that does not transfer substantially all the risks and rewards
incidental to ownership of an underlying asset.
For the purposes of applying the lessor accounting requirements of IFRS 16, fair value
refers to the amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm’s length transaction. This definition of fair value is in
a way different in some aspects from the definition of fair value in IFRS 13 Fair Value
Measurement. Therefore, when applying IFRS 16, an entity measures fair value in
accordance with IFRS 16, and not IFRS 13.
Definitions relating more specifically to the lessee:
A right-of-use asset is an asset that represents a lessee’s right to use an underlying asset
for the duration of the lease term.
The economic life is either the period over which an asset is expected to be economically
usable by one or more users, or the number of production or similar units expected to be
obtained from an asset by one or more users.
Useful life refers to the period over which an asset is expected to be available for use by an
entity; or the number of production or similar units expected to be obtained from an asset by
an entity.
Other fundamental definitions contained in IFRS 16 are specifically discussed later in the
chapter.
23.4 Identifying a lease

It is important to note that IFRS 16 generally applies to all contracts (not necessarily only
legal lease contracts). At the inception of a contract, a party to the contract need to assess
whether the contract is, or contains a lease, and account for the contract or a part thereof,
as a lease.
At first sight, the definition of a lease looks straightforward, but it can be challenging to
assess whether a contract conveys the right to use an asset for a period of time in exchange
for consideration. To determine whether a contract conveys the right to use an asset, one
has to focus on the substance of the arrangement.
A ‘take-or-pay’ contract is an example of such an arrangement that does not take the legal
form of a lease, but still conveys a right to use an asset for a period of time in exchange for
consideration (i.e. it is or contains a lease). In take-or-pay contracts, the purchaser is
contracted to make specified payments, regardless of whether he takes delivery of the
contracted products or services, for example a take-or-pay contract to acquire substantially
all of the output of a supplier’s power generator. The purchaser must pay a certain amount
regardless of whether he uses the power generated from the generator or not. This implies
that the purchaser may, in substance, have the right to use the generator for a period of time
in exchange for consideration.
A contract is, or contains, a lease if the contract conveys the right to control the use of an
identified asset. Such a contract conveys the right to control the use of an identified asset if
the customer has both:
(a) the right to obtain substantially all of the economic benefits from use of the
identified asset; and
(b) the right to direct the use of the identified asset throughout the period of use.
These components are discussed individually below:
23.4.1 Identified asset

An asset can be explicitly (e.g. identified in the contract by a serial number) or implicitly
specified in a contract. If implicit, the asset is not mentioned in the contract and the entity
cannot identify the particular asset; however, the supplier can effectively only fulfil the
contract by using a particular asset.
Even if an asset is explicitly specified in the contract, a customer does not have the right to
use that identified asset if the supplier has a substantive right to substitute that asset.
Substitution rights, considered at inception date, are substantive only if the supplier:
has the practical ability to substitute the underlying asset with an alternative asset, for
example the customer cannot prevent the supplier from substituting the asset and
alternative assets are readily available for substitution or could be sourced within a
reasonable period of time. However, if the supplier can only substitute the asset after a
particular date or the occurrence of a specified event, the substitution right is not
substantive; and
would benefit economically from substituting the asset (i.e. the economic benefits
associated with substituting the asset are expected to exceed the costs associated with
substituting the asset).
It is notable that the supplier’s right or obligation to substitute the asset if it is not operating
properly, or when a technical update is required, does not prevent the customer from having
the right to use that identified asset for the duration of the lease term.
Also, where a supplier is obliged to deliver a specified quantity of goods or services and has
the right and practical ability to provide those goods or services using alternative assets not
set out in the arrangement (i.e. has substantive substitution rights), then fulfilment of the
arrangement is not dependent on an identified asset. Consequently, such an arrangement
does not convey the right to control the use of an identified asset and the contract does not
contain a lease.
If the customer cannot readily determine whether the supplier has a substantive substitution
right, it is presumed that the substitution right is not substantive.
Leases 635
Furthermore, a capacity portion of a larger asset, such as the lease of one floor of a multi-
level building, is an identified asset if it is physically distinct. A capacity portion that is not
physically distinct is not an identified asset, unless it represents substantially all of the
capacity of the larger asset and thereby provides the customer with the right to obtain
substantially all of the economic benefits from use of the larger asset.
23.4.2 Right to obtain substantially all of the economic benefits from use
By having, for example, exclusive use of an identified asset for a period of time, the
customer has the right to obtain substantially all of the economic benefits from using that
asset throughout that period. Economic benefits can be obtained directly or indirectly, for
example, by using, holding or subleasing the asset, and include the primary output and any
by-products. Economic benefits relating to the ownership of the asset are however ignored.
If a contract requires a customer to pay the supplier or another party a portion of the cash
flows derived from using the identified asset, those cash flows paid shall be considered to
be part of the economic benefits that the customer obtains from using the asset.
Example 23.
23.1 Economic benefits from using an asset
Sunshine Ltd (lessee) rents a solar farm from Energex Ltd (lessor). Sunshine Ltd provides solar
energy to a neighbouring mine. The lease agreement stipulates that Sunshine Ltd should pay
Energex Ltd a fixed monthly fee, as well as a sales-based royalty from use of the solar farm as
consideration for that use. Energex Ltd receives a research and development rebate relating to the
ownership of the solar farm. Sunshine Ltd receives renewable energy rebates from the use of the
farm.
In assessing the economic benefits derived from using the solar farm (identified asset), the
renewable energy rebates are taken into account; however, the research and development rebate
does not relate to the use of the solar farm, but rather to ownership of the identified asset, and
should not be taken into account in the analysis.
Furthermore, the requirement to pay a sales-based royalty does not prevent Sunshine Ltd from
having the right to obtain substantially all of the economic benefits from the use of the solar farm.
This is because the cash flows arising from the sale of solar energy and the renewable energy
rebates are considered to be the economic benefits that Sunshine Ltd obtains from use of the
solar farm, a portion of which it then paid to Energex Ltd as consideration for the right to use the
solar farm.
23.4.3 Right to direct the use

A customer has the right to direct the use of an identified asset throughout the lease term
only if either:
the customer has the right to direct how and for what purpose the asset is used
throughout the period of use; or
the relevant decisions about how and for what purpose the asset is used are
predetermined, and
– the customer has the right to operate the asset throughout the period of use, without
the supplier having the right to change those operating instructions; or
– the customer designed the asset in a way that predetermines how and for what
purpose the asset will be used throughout the period of use.
The key factors in making this assessment are thus: Which party (the customer or the
supplier) has the right to direct how and for what purpose the identified asset is used
throughout the period of use? Examples of such decision-making rights that grant the right
to change how and for what purpose the identified asset is used, include:
rights to change the type of output that is produced by the asset;
rights to change when the output is produced;

rights to change where the output is produced; and
rights to change whether the output is produced, and how much of the output is
produced.
In making this assessment, the decision-making rights that are most relevant to changing
how and for what purpose the asset is used should be considered – ‘relevant’ in the sense
that they affect the economic benefits derived from the use of the asset.
Decisions about operating or maintaining an asset do not grant the right to direct the use
of the asset; however, such decision-making rights may drive the analysis, if the relevant
decisions about how and for what purpose the asset is used, are predetermined
(IFRS 16.B27).
Example 23.
23.2 Right to direct the use of the asset
Portos Ltd (customer) enters into a contract with Aramis Ltd (supplier), a ship-owner, for the
transportation of cargo from Walvis Bay to Cape Town. The ship is explicitly specified in the
contract and Aramis Ltd does not have substitution rights. The cargo will occupy substantially all of
the capacity of the ship. The contract specifies the cargo to be transported on the ship and the
dates of pickup and delivery. Aramis Ltd operates and maintains the ship and is responsible for
the safe passage of the cargo on board the ship. Portos Ltd is prohibited from hiring another
operator for the ship or operating the ship itself during the term of the contract. Portos Ltd
concludes the following in assessing whether the contract contains a lease:
There is an identified asset í the ship is explicitly specified in the contract and Aramis Ltd does not
have substitution rights.
Portos Ltd has the right to obtain substantially all of the economic benefits from use of the ship
over the period of use. Its cargo will occupy most of the capacity of the ship, thereby preventing
other parties from obtaining economic benefits from use of the ship.
However, Portos Ltd does not have the right to direct the use of the ship. Portos Ltd does not have
the right to direct how and for what purpose the ship is used. How and for what purpose the ship
will be used is predetermined in the contract. Portos Ltd does not have the right to operate the
ship nor does it have a say in how and for what purpose it would be used.
Consequently, the contract does not contain a lease.
A contract may also include terms and conditions designed to protect the supplier’s interest
in the asset. Such protective rights do not affect the assessment of which party to the
contract has the right to direct the use of the identified asset.
Example 23.
23.3 Right to direct the use
Athos Ltd (lessee) enters into a five-year contract with D’Artagnan Ltd (lessor), a ship-owner, for
the use of an identified ship. Athos Ltd decides whether and what cargo will be transported, and
when and to which ports the ship will sail throughout the five-year period of use, subject to
restrictions specified in the contract. These restrictions prevent Athos Ltd from sailing the ship into
waters at a high risk of piracy or carrying explosive materials as cargo. D’Artagnan Ltd operates
and maintains the ship and is responsible for the safe passage of the cargo on board the ship.
Athos Ltd is prohibited from hiring another operator for the ship or operating the ship itself during
the term of the contract. Athos Ltd considers the following in assessing whether the contract
contains a lease:
There is an identified asset – the ship is explicitly specified in the contract and D’Artagnan Ltd
does not have substitution rights.
continued
Leases 637
Athos Ltd has the right to obtain substantially all of the economic benefits from the use of the ship,
because it has exclusive use of the ship throughout the five-year period of use.
Athos Ltd has the right to direct the use of the ship because it makes the relevant decisions about
how and for what purpose the ship is used throughout the five-year period. It decides whether,
where and when the ship sails.
Decisions about maintaining and operating the ship should not be considered, because they are
only taken into account to determine if the decision-making rights about how and for what purpose
the asset is used, are predetermined.
The contractual restrictions about where the ship may sail and what cargo may be transported do
not affect the assessment of which party has the right to direct the use of the ship as they are
merely protective rights that protect D’Artagnan Ltd’s investment in the ship and its personnel.
Athos Ltd therefore has the right to control the use of the ship throughout the five-year period of
use. Consequently, the contract contains a lease.
Example 23.
23.4 An arrangement containing a lease
Boat Ltd (customer) is a manufacturer of luxury motor boats. On 1 June 20.12, Boat Ltd (lessee)
signed a long-term agreement with Part Ltd (supplier).
In terms of the agreement, Part Ltd has to supply portholes to Boat Ltd on a daily basis for a
period of ten years.
To ensure that Part Ltd fulfils its obligations in terms of the agreement, the management of
Part Ltd decided to construct a plant manufacturing portholes on the premises of Boat Ltd. The
close proximity of the plant will ensure that portholes can be supplied as and when needed by
Boat Ltd.
Other relevant matters:
to ensure the continuous availability of portholes, the arrangement stipulates that Boat Ltd has
to pay an annual fixed charge of R100 000 (at the end of the year) to Part Ltd;
since the portholes are unique, the plant has no other purpose and will be demolished at the
end of the agreement;
the purchases by Boat Ltd for the first year of production amounted to 1 000 portholes at R1 500
per unit – not yet transferred to work-in-process; and
the incremental borrowing rate of Boat Ltd is 12,50% per annum.
The application of IFRS 16 needs to be considered to determine whether the arrangement
contains a lease.
There is an identified asset: although the portholes manufacturing plant is not mentioned in the
long-term agreement between Boat Ltd and Part Ltd, this asset is implicitly specified, because
for Part Ltd to fulfil the requirements of the arrangement, it has to erect the plant (and that is
even done at the premises of Boat Ltd). It is also unlikely that Part Ltd can/would substitute the
plant with an alternative plant. Part Ltd would also not benefit economically from substituting the
asset – the costs associated with substituting the plant would be too high.
Boat Ltd has the right to obtain all of the economic benefits from the plant – the portholes are
unique and Boat Ltd is the only user thereof.
Boat Ltd has the right to direct how and for what purpose the plant is used throughout the period
of use – Boat Ltd has the decision-making rights to, for example, change the type of portholes
that is produced, whether portholes are produced and how much is produced.
Consequently, the arrangement conveys the right to Boat Ltd to control the use of the plant and it
can be concluded that the arrangement contains a lease.
continued
The journal entries to account for the lease in the books of Boat Ltd, are:
Dr Cr
R R
Right-of-use asset (plant) (SFP) *553 643
Lease liability (SFP) 553 643
Initial recognition of lease liability
Finance costs (P/L) (553 643 × 12,5%) (or 1 Amort) 69 205
Lease liability (SFP) (100 000 – 69 205) (or 1 Amort) 30 795
Bank (SFP) 100 000
Accounting for lease payment paid – interest and capital
Depreciation (P/L) (553 643 / 10) 55 364
Accounting for depreciation on right-of-use asset
Raw material (SFP) (1 000 × 1 500) 1 500 000
Bank (SFP) 1 500 000
Accounting for purchases of portholes as inventory
* PMT = 100 000; i = 12,50%; n = 10; thus PV = – R553 643
Comment
¾ IFRS 16 does not specifically require the separate disclosure of the cost and accumulated
depreciation of right-of-use assets (IFRS 16.53). The approach followed in this chapter to
account for the accumulated depreciation in a separate ledger account, is in line with the
approach followed under IAS 16 Property, Plant and Equipment.
23.5 Separating components of a contract

Contracts often combine different kinds of obligations of the supplier, which might be a
combination of lease components or a combination of lease and non-lease components. If
such a multi-element arrangement exists, each separate lease component should be
identified (using the guidance on the definition of a lease) and accounted for separately
from non-lease components, unless the entity applies the practical expedient (refer to 23.5.1
below).
The right to use an underlying asset is a separate lease component if both of the following
criteria are met:
the lessee can benefit from use of the underlying asset either on its own or together with
other resources that are readily available to the lessee. (For example, such resources
that are readily available are goods or services that are sold or leased separately (by the
lessor or other suppliers) or resources that the lessee has already obtained (from the
lessor or from other transactions or events); and
the underlying asset is neither highly dependent on, nor highly interrelated with, the other
underlying assets in the contract (For example, if the lessee could decide not to lease a
specific underlying asset without significantly affecting its rights to use other underlying
assets in the contract, it might indicate that the specific underlying asset is not highly
dependent on, or highly interrelated with, the other underlying assets).
A charge for administrative tasks does not transfer a good or service to the lessee and such
amounts payable do not give rise to a separate component of the contract, but are rather
part of the total consideration allocated to the separately identified components of the
contract.
Leases 639
23.5.1 Lessee
If the analysis concludes that there are separate lease and non-lease components in the
contract, the lessee shall allocate the consideration in the contract to each lease
component on the basis of its relative stand-alone price. The relative stand-alone price of
lease and non-lease components shall be determined on the basis of the price the lessor, or
a similar supplier, would charge an entity for only that component, or a similar component,
separately. If observable stand-alone prices are not readily available, the lessee shall
estimate the prices by maximising the use of observable information. The non-lease
component shall be treated in terms of the applicable Standard, unless the practical
expedient was applied.
As a practical expedient, lessees may elect not to separate non-lease components from
lease components, and instead account for each lease component and any associated non-
lease components as a single lease component. Thus, by electing the practical exemption,
the lessee’s lease liability will increase with the non-lease components. This practical
expedient is allowed for the lessee for cost benefit reasons. It is expected that lessees will
only adopt this practical expedient when the non-lease component components are
relatively small. This accounting policy choice has to be made by class of underlying asset.
23.5.2 Lessor
If the analysis concludes that there are separate lease and non-lease components in the
contract, the lessor shall allocate the consideration in the contract to each lease component
in accordance with step 4 of the 5-step revenue model of IFRS 15, that is, also allocate the
total consideration to the different components based on their stand-alone prices.
The practical expedient above is not available to the lessor, as it is believed that the lessor
would have the information (or reasonable estimate) about the value of each component
when pricing the contract.
23.6 Combinations of contracts

Often, several contracts are entered into at or near the same time with the same
counterparty. An entity shall combine such contracts and account for them as a single
contract if one or more of the following criteria are met:
the contracts are negotiated as a package with an overall commercial objective that
cannot be understood without considering the contracts together;
the consideration to be paid in one contract depends on the price/performance of the other
contract; or
the assets involved are a single lease component.
23.7 Lease term

The lease term begins at the commencement date and includes any rent-free periods
provided to the lessee by the lessor. IFRS 16 defines the lease term as the non-cancellable
period of the lease plus periods covered by an option to extend or an option to terminate if
the lessee is reasonably certain to exercise the extension option or not exercise the
termination option. Simply put, the lease term is thus the period (taking reasonable
estimates into account) for which the lessee has the right to use the underlying asset. In
determining the length of the non-cancellable period of the lease, an entity shall apply the
definition of a contract and determine the period for which the contract is enforceable. A
lease is no longer enforceable when the lessee and the lessor each have the right to
terminate the lease without permission from the other party with no more than an
insignificant penalty. If only a lessee has the right to terminate a lease, that right is
considered to be an option to terminate the lease available to the lessee that an entity
considers when determining the lease term. If only a lessor has the right to terminate a
lease, the non-cancellable period of the lease includes the period covered by the option to
terminate the lease.
In assessing whether a lessee is ‘reasonably certain’ to exercise, or not to exercise, the
option, all relevant facts and circumstances that create an economic incentive for the lessee
to exercise, or not to exercise, the option must be considered. A lessee’s past practice may
also provide information that is helpful in assessing whether the lessee is reasonably certain
to exercise, or not to exercise, an option.
Examples of factors to consider include:
contractual terms and conditions for the optional periods compared with market rates, for
example, it is more likely that a lessee will not exercise an extension option if the lease
payments that the lessee pays exceed market rates, or if the lessee must pay
termination penalties on early termination of the lease. It is more likely that the lessee will
not exercise its termination option.
significant leasehold improvements have already been undertaken (or are expected to
be undertaken). It is more likely that a lessee will exercise an extension option if the
lessee has made significant investments to improve the leased asset or to tailor it for its
special needs.
costs relating to the termination of the lease/signing of a replacement lease. It is more
likely that a lessee will exercise an extension option if doing so avoids costs such as
negotiation costs, relocation costs, costs of identifying another suitable asset or costs of
returning the original asset in a contractually specified condition. The shorter the non-
cancellable period of a lease, the more likely a lessee is to exercise an option to extend
the lease, or not to exercise an option to terminate the lease, because the costs
associated with obtaining a replacement asset are likely higher.
the importance of the underlying asset to the lessee’s operations. It is more likely that a
lessee will exercise an extension option if the underlying asset is specialised or if
suitable alternatives are not available.
conditions associated with exercising an option and the likelihood that such conditions
will exist.
If a contract combines one or more of the examples above and the net effect is substantially
the same regardless of whether the option is exercised, an entity shall assume that the
lessee is reasonably certain to exercise the option to extend the lease, or not to exercise the
option to terminate the lease.
The lease term is only reassessed (refer to section 23.8.3) where the lessee exercises (or
does not exercise) an option in a different way than previously anticipated, or where an
event occurs that now contractually obliges the lessee to exercise an option not previously
included in the determination of the lease term, or where a significant event or change in
circumstances occurs that is within the control of the lessee and affects whether it is
reasonably certain to exercise an option, for example the lessee incurred significant
leasehold improvements that were not anticipated at the commencement date of the lease.
23.8 Lessees
A lessee is defined as an entity that obtains the right to use an underlying asset for a period
of time in exchange for consideration. Legally, the lessee is not the owner of the leased
asset and is not required to take ownership of the leased asset at the end of the lease term.
However, the substance of the agreement and its financial reality is that the lessee obtains
the right to use the asset to generate economic benefits for itself over the lease term. For
this reason, the lessee is required to recognise both an asset (right-of-use asset) and a
Leases 641
liability (lease liability) on its statement of financial position for all assets leased by it under
lease agreements, except if the entity elects one of the two recognition exemptions allowed
by IFRS 16.
When applying the single lessee accounting model of IFRS 16, a right-to-use asset and a
lease liability shall be recognised at the commencement date of the lease.
Before discussing the single lessee accounting model, the recognition exemptions will first
be addressed:
23.8.1 Recognition exemptions

IFRS 16 includes two exemptions from the single lessee accounting model. A lessee may
elect not to recognise underlying assets and liabilities for:
leases of 12 months or less (short-term leases); and
leases for which the underlying asset is of low value, for example tablets, personal
computers and small items of office furniture.
If this exemption is elected, then basically ‘operating lease accounting’ is applied. The lease
payments (as defined in IFRS 16: Appendix A) are recognised as an expense in the profit or
loss section of the statement of profit or loss and other comprehensive income on a
straight-line basis over the lease term, unless another systematic basis is more
representative of the pattern of the lessee’s benefit. Accounting for rental expenses on the
basis of cash flows is not more representative of the pattern of the lessee’s benefit, and is
consequently not considered to be an appropriate basis for recognising lease payments for
the right to use the underlying asset of low value or the short-term lease.
Variable lease payments not based on an index or a rate, for example lease payments
linked to a lessee’s performance, such as payments of a specified percentage of sales, are
not included in the amount that is straight-lined. Such payments are recognised in profit or
loss in the period in which the event or condition that triggers such payments occurs.
In simplifying the measurement requirements for leases for which the underlying asset is of
low value, the straight-lining calculation requires a simple mathematical average of
undiscounted lease payments, which means that the lease payments are not discounted to
take the time value of money into account.
In order to encourage lessees to enter into lease agreements, lessors may offer them
incentives. Lease incentives for example contributions by the lessor to the lessee’s
relocation cost or rent-free periods, are considered to be an integral part of the consideration
for the right to use the underlying asset. The net lease payments (i.e. cost less benefit), are
thus recognised on a straight-line basis and the rent-free period forms part of the lease term to
equalise the lease expense. If cash flows are not equal, the difference between the cash
flows (actual lease payments paid) and the calculated equalised expense will result in either
an accrued expense or a prepaid expense in the statement of financial position. If the
cash amount paid exceeds the equalised expense, it is proposed that this amount should be
included under current assets in the statement of financial position as a prepaid lease
expense. If the cash amount paid is exceeded by the equalised expense, it is proposed that
this amount be included under current liabilities in the statement of financial position as an
accrued lease expense.
Payments for short-term leases and leases of low value assets should be presented within
operating activities in the statement of cash flows.
23.8.1.1 Short-term leases

A short-term lease has a lease term of 12 months or less. An option to extend or to
terminate a lease that is reasonably certain to be exercised should be considered in
determining if the lease term is 12 months or less; however, a lease that contains a
purchase option is not a short-term lease.
If a lessee elects this exemption, it has to be made by class of underlying asset, meaning
that the election must be applied to leases of the entire class of assets selected. A class of
underlying asset is a grouping of underlying assets of a similar nature and use in an entity’s
operations. Furthermore, if an entity applies the short-term lease exemption, it shall treat
any subsequent modification or change in lease term as resulting in a new lease.
23.8.1.2 Low value underlying assets
To determine if the underlying asset is of low value, the lessee needs to assess its value
based on the value when the underlying asset is new, regardless of the age of the asset
being leased. Leases of vehicles would typically not qualify as leases of low value assets
because the nature of a vehicle is such that, when new, it would not be of low value.
Furthermore, this assessment is performed on an absolute basis, meaning that leases of
low value assets will qualify for this exemption election regardless of whether those leases
are material to the lessee – the assessment is not affected by the size, nature or
circumstances of the lessee.
An underlying asset can also only be of low value if:
the lessee can benefit from use of the underlying asset on its own or together with other
resources that are readily available to the lessee; and
the underlying asset is not highly dependent on, or highly interrelated with, other assets.
Therefore, the exemption does not apply for assets that are highly dependent on, or highly
interrelated with, other underlying assets.
If a lessee subleases an asset, the head lease does not qualify as a lease of a low value
asset.
The election for leases for which the underlying asset is of low value can be made on a lease-
by-lease basis and the analysis therefore does not take into account whether low value
assets in aggregate are material.
IFRS 16 requires initial direct costs incurred by the lessee to be capitalised to the right-of-
use asset. It appears logical to expense these amounts immediately where the lessee
elected not to recognise underlying assets of low value.
Example
Example 23.
23.5 Leases of low value assets
Educo Ltd (lessee) provides training and online professional development courses. Educo Ltd has
the following leases:
lease of its office building;
leases of office furniture such as boardroom tables, chairs and couches;
leases of company cars – varying in make and value, for use by its training personnel;
leases of numerous items of IT equipment, such as laptops and data projectors;
leases of servers, including many individual modules that increase the storage capacity of
those servers. The modules have been added to the mainframe servers over time as Educo Ltd
has needed to increase the storage capacity of the servers as its client base grew.
Educo Ltd determines that the leases of its office furniture and IT equipment qualify for the
recognition exemption in IFRS 16 on the basis that these underlying assets, when they are new, are
individually of low value. Educo Ltd elects to apply this exemption to these leases on a lease-by-
lease basis.
The recognition exemption in IFRS 16 is not allowed for the leases of the office building, company
cars and servers. Consequently, Educo Ltd has to apply the single lessee accounting model to these
assets regardless of whether risks and rewards are transferred to Educo Ltd at the end of the lease
term.
continued
Leases 643
Comment
¾ Although each module within the servers, if considered individually, might be an asset of low
value, the leases of modules within the servers do not qualify as leases of low value assets
because each module is highly interrelated with other parts of the servers.
¾ The exemption for leases of low value items intends to capture leases that are high in volume,
but low in value.
Example 23.
23.6 Equalisation of the lease expense (fixed escalation) for which the
underlying asset is of low value and a rent-free period is offered as a lease
incentive
Perseus Ltd (lessee) entered into a lease agreement to lease a personal computer from
Pegasus Ltd (lessor) for a period of five years. Perseus Ltd elected the recognition exemption
not to recognise the underlying asset and liability. To encourage Perseus Ltd to enter into this
lease agreement, Pegasus Ltd offered an initial rent-free period of six months. Thereafter, the
lease payments are to increase by 10% annually on the anniversary of the signing date of the
lease to take inflation into account. The lease payments in the last six months of the first year of
the lease will amount to R350 per month. At the end of the fifth year, the agreement terminates.
The benefit for Perseus Ltd derived from the lease agreement remains constant over the lease
period. IFRS 16.6 requires that the lease payments shall be equalised for the measurement of the
accounting expense.
The total lease payments are:
R
Year 1 Rental in first 6 months –
Rental in second 6 months (350 × 6) 2 100
Year 2 (350 × 1,1 × 12) 4 620
Year 3 (350 × 1,1 × 1,1 × 12) or (4 620 × 1,1) 5 082
Year 4 (350 × 1,1 × 1,1 × 1,1 × 12) or (5 082 × 1,1) 5 590
Year 5 (350 × 1,1 × 1,1 × 1,1 × 1,1 × 12) or (5 590 × 1,1) 6 149
Total lease payments over lease term 23 541
Equalised lease expense per month (23 541/60) – rounded 392
Journal entries for Year 1 in the books of the lessee:
Dr Cr
R R
First 6 months
Low value asset lease expense (P/L) (392 × 6) 2 354
Accrued low value asset expenses (SFP) 2 354
Accruing lease payments in first 6 months
Second 6 months
Low value asset lease expense (P/L) (392 × 6) 2 354
Bank (SFP) (350 × 6) 2 100
Accrued low value asset expenses (SFP) 254
Accrual of future lease payments
In Year 1, R4 708 is recognised as a lease expense in profit or loss, but only R2 100 was paid.
This results in an accrued expense of R2 608 (R4 708 – R2 100). The same principle is applied to
each of the following four years. At the end of the lease term, the total lease payments paid will be
equal to the total lease expense recognised. This example rounded to the nearest rand.
continued
The journal entries over the next four years will be as follows:
Dr Cr
R R
Year 2
Low value asset lease expense (P/L) 4 708
Bank (SFP) 4 620
Accrued low value asset expense (SFP) 88
Recognition of lease payments and accrued lease
Year 3
Bank (SFP) 5 082
Recognition of lease payments and reversal of accrued
lease
Year 4
Bank (SFP) 5 590
lease
Year 5
Accrued low value asset expense (SFP) 1 442
Bank (SFP) 6 150
lease
Example 23.
23.7 Relocation expenses as a lease incentive for which the underlying asset is of
low value
Eridanus Ltd (lessor) enters into a lease agreement with Orion Ltd (lessee) on 1 April 20.12. In
terms of the agreement, Eridanus Ltd will lease office equipment to Orion Ltd at an annual lease
payment of R20 000 payable in arrears. Orion Ltd elected the recognition exemption not to
recognise the underlying assets and liabilities. The lease term is three years. The year end of both
entities is 31 March.
Orion Ltd will have to sell its existing office equipment and get a transport company to transport the
office furniture from Eridanus Ltd’s warehouse to Orion Ltd’s office building. In order to ensure that
Orion Ltd will enter into the lease agreement, Eridanus Ltd offers to pay these transport costs
directly to the transport company. The transport costs amount to R6 000.
Incentives must be treated as an integral part of the net return agreed upon for the right to use the
underlying assets. This implies that the cost or the benefit of the incentive must be included when the
net lease expense is calculated from the perspective of the lessee.
The net lease expense will be calculated as follows:
R
Lease payments payable in the next three years (20 000 × 3) 60 000
Benefit in the form of an incentive received from the lessor (6 000)
Net amount payable in terms of lease agreement 54 000
(Of the R60 000 paid, R6 000 is for the recovery of the expense and R54 000
for the use of the underlying assets)
Therefore the net lease expense to be recognised annually (54 000/3) 18 000
continued
Leases 645
The journal entries to record the transaction in the records of Orion Ltd are as follows:
Dr Cr
R R
1 April 20.12
Transport costs (P/L) 6 000
Deferred income (SFP) 6 000
Recognition of expense incurred on behalf of lessee on initial recognition
of the lease
31 March 20.13
Deferred income (SFP) (6 000/3) 2 000
Bank (SFP) 20 000
Recognise the annual lease payment
Alternatively, the above journal can be done as follows:
Bank (SFP) 20 000
Recognise annual lease payment if associated lease benefits are ignored
Deferred income (SFP) 2 000
Reduce lease expense by transport cost recovered from lessor
The accounting for the lease payments paid on 31 March 20.14 and 31 March 20.15 will be the
same as the journal entries on 31 March 20.13.
Comment
¾ The deferred income represents a liability in the statement of financial position of the lessee.
It therefore needs to be considered in the calculation of deferred tax.
¾ The nature of the item for deferred tax is income received in advance. The tax base of
income received in advance is the carrying amount less the amounts that will not be taxable
in the future.
¾ In the above example, the tax base is therefore the carrying amount less the full carrying
amount, as the benefit will not be taxed in the future. Consequently, a temporary difference
arises on the deferred income. This temporary difference is recognised as a deferred tax
asset at the corporate tax rate of the entity.
23.8.1.3 Taxation
As mentioned earlier, if the recognition exemption is elected, the lease payments are, for
accounting purposes, recognised as an expense in profit or loss on a straight-line basis over
the lease term (assuming this best represents the pattern of benefits received).
For tax purposes, the actual amounts paid in terms of the lease agreement will be allowed
as a deduction in the year of assessment in which they are paid in cash, subject to the
limitations imposed by section 23H of the Income Tax Act 58 of 1962.
Consequently, temporary differences, resulting in deferred tax, might arise as a result of
prepaid or accrued expenses. If no part of the lease expense is prepaid or accrued, no
deferred tax will arise.
In terms of section 23H of the Income Tax Act, the deduction of prepaid expenses in the
year in which they are actually paid in cash is limited as follows:
firstly, if the whole amount of the individual prepaid expense will be utilised within six
months of the next reporting date (same as the year of assessment), then the whole
amount of that prepaid expense will be deductible for tax in the year it is actually paid in
cash, regardless of the amount/size of this prepaid expense; and
secondly, for all those individual amounts that did not qualify for deduction in terms of the
first rule, thought should be given to the amount/size of the prepaid expense. If the total
of all of these prepaid expenses (that did not qualify for deduction in terms of the first
rule) is less than or equal to R100 000, then all of these prepaid expenses will be
deductible for tax in the year they are actually paid in cash. If the total of all of these
prepaid expenses (that did not qualify for deduction in terms of the first rule) is greater
than R100 000, then none of these prepaid expenses will be deductible for tax in the
year they are actually paid in cash. They would then only be deductible for tax in the
future (next year of assessment), when the expense is deemed to be actually incurred
(as defined in tax case law).
For VAT purposes, a short-term lease may typically not meet the definition of an instalment
credit agreement and the lessee may claim input VAT per payment made (refer to
section 23.8.6).
Example 23.
23.8 Prepaid lease payments and tax implications (lease of low value asset)
Mensa Ltd (lessee) has a year end of 31 December. Mensa Ltd entered into a lease agreement for
the lease of office equipment on 1 January 20.11. The office equipment is considered to be a low
value asset, and had a useful life of three years on 1 January 20.11. Mensa Ltd elected the
recognition exemption not to recognise the underlying assets and liabilities, meaning that it
elected the simplified accounting treatment for the equipment.
The following information has been extracted from the lease agreement:
Monthly lease payment: R2 125 per month for the first 24 months and R1 250 per month
thereafter. Lease payments are payable monthly in arrears.
Lease term: Three years, commencing on 1 January 20.11.
The normal income tax rate is 28%. The company does not have any other temporary differences.
Ignore VAT.
Deferred tax Movement
balance @ for the year
28% in P/L
asset / expense /
(liability) (income)
R R R R R
31 December 20.11
Prepayments: Low
value lease 3 500 – (a) 3 500 (980) 980
31 December 20.12
Prepayments: Low 7 000
value lease
(b)
Low-value lease 20.11 3 500 – 3 500 (980)
(b)
Low-value lease 20.12 3 500 – 3 500 (980)
(1 960) 980
31 December 20.13
Prepayments: Low
value lease – – – (1 960)
(a) The R3 500 prepaid lease expense will only be utilised during the twelve months ending
31 December 20.13 (and not within six months); however, the amount is less than R100 000 (no
other prepaid expenses to be taken into account) and thus the R3 500 will be allowed as a
deduction in the current tax calculation of 20.11. The full amount of R3 500 has already been
deducted for tax purposes in 20.11, thus there are no future tax deductions in respect of the
R3 500; therefore the tax base is Rnil.
continued
Leases 647
(b) Of the prepaid low value lease amount, R3 500 has already been deducted for tax purposes in
20.11 and the remaining R3 500 has been allowed as a tax deduction in 20.12 (see (a)
above). Thus there are no future tax deductions in respect of these amounts; therefore the tax
bases are Rnil.
Comment:
¾ If the total amount of all (including other) prepayments was greater than R100 000 (and not to
be utilised within six months), none of that amount would be allowed as a tax deduction during
the relevant year when it was paid in cash. That amount will then represent the tax base of the
prepaid expense as it is the amount deductible in future.
Current tax calculation

20.11 20.12 20.13
R R R
Profit before tax xxx xxx xxx
An analysis of temporary differences in respect
of prepaid expenses: (3 500) (3 500) 7 000
Amounts deductible for tax:
low-value lease (25 500) (25 500) (15 000)
Adjustment for amounts recognised
for accounting purposes:
Low-value lease 22 000 22 000 22 000
Taxable income xxx xxx xxx
Calculations
1. Equalisation of lease payments
R
2 125 × 24 months 51 000
1 250 × 12 months 15 000
66 000
Equalised amount per year (66 000/3 years) 22 000
2. Prepaid expense in respect of office equipment lease payments

31 December 20.11
Amount actually paid in cash (12 × 2 125) 25 500
Equalised amount recognised in profit or loss (calc 1) 22 000
Balance at end of the year 3 500
31 December 20.12
Balance at beginning of year (per above) 3 500
Prepaid expense for current year (25 500 – 22 000); (the same as calc 2) 3 500
Balance at end of the year 7 000
31 December 20.13
Balance at beginning of year (per above) 7 000
Used during the year (22 000 – 15 000); (with 12 × 1 250 = 15 000) (7 000)
Balance at end of the year –
23.8.2 Recognition and measurement: Right-of-use assets and lease liabilities

Under the general lease accounting requirements, the lessee will recognise a lease liability
and a right-of-use asset at commencement date. The next sections will discuss the initial
and subsequent measurement of these items, as well as the relevant lease payments to
include in these calculations and the applicable interest rate to use, in more detail:
23.8.2.1 Initial measurement of the right-of-use asset
At the commencement date, the right-of-use asset shall be measured at cost.
The cost of the right-of-use asset shall comprise:
the amount of the initial measurement of the lease liability (refer to section 23.8.2.2
below);
any lease payments made at (e.g. an initial deposit) or before the commencement
date, less any lease incentives received. Lease payments already made at or before the
commencement date will not be included in the lease liability anymore, but should still be
included in the cost of the right-of-use asset (i.e. the payments made would reduce the
liability, but not the right-of-use asset);
any initial direct costs (refer to the definition in section 23.3) incurred by the lessee.
Initial direct costs are incremental costs that relate to the lease (i.e. to the right to use
the asset) and typically do not include other cost of relocation (to be expensed) or costs
to design and construct the asset itself (to be treated as property, plant and equipment).
An example of initial direct cost is if the lessee sends the draft lease agreement to his
legal adviser to ensure that the contract is properly drawn up, and the legal adviser
charges the lessee R1 000, then this amount of R1 000 is an initial direct cost. Note that
the principle to capitalise initial direct costs to the right-of-use assets is similar to that of
other assets, such as property, plant and equipment. Furthermore, the definition of initial
direct costs is also consistent with the definition of incremental costs in IFRS 15.
Although for accounting purposes this amount will be capitalised to the cost of the right-
of-use asset, for tax purposes, it will have to be established whether the legal costs are
of a revenue or capital nature. If the initial direct cost is tax deductible (revenue nature), it
will give rise to a temporary difference: the South African Revenue service (SARS) will
allow this cost as a deduction for tax purposes in the year of assessment it is actually
incurred; however, for accounting purposes, such cost will probably form part of
depreciation of the right-of-use asset (if a depreciable asset) included in profit or loss
over the useful life of the asset. If the initial direct cost is non-deductible (capital nature),
it will give rise to a non-deductible expense. It is therefore advisable to treat initial direct
costs separately in deferred tax calculations;
an estimate of costs to be incurred by the lessee in dismantling and removing the
underlying asset, restoring the site on which it is located or restoring the underlying asset
to the condition required by the terms and conditions of the lease. Such cost is
recognised as part of the cost of the right-of-use asset when the entity incurs an
obligation for those costs. The lessee incurs an obligation for such costs either at the
commencement date or as a consequence of having used the underlying asset during a
particular period. If dismantling and restoring costs are incurred as a consequence of
having used the right-of-use asset to produce inventories, the lessee shall apply IAS 2
Inventories for such costs incurred.
The obligations (contra-entries) of such costs (accounted for under IFRS 16 or IAS 2) are
recognised and measured according to IAS 37 Provisions, Contingent Liabilities and
Contingent Assets. Note that the principle to capitalise the present value of the liability
for dismantling and restoring to the right-of-use assets, is similar to that of other assets,
such as property, plant and equipment (IAS 16.16(c)).
Leases 649
23.8.2.2 Initial measurement of the lease liability

At the commencement date, a lessee shall measure the lease liability at the present value of
the lease payments (refer to section 23.8.2.3 below) that are not paid at that date. The lease
payments shall be discounted over the lease term using the interest rate implicit in the
lease, if that rate can be readily determined. If that rate cannot be readily determined, the
lessee shall use its incremental borrowing rate.
Three aspects are therefore crucial when measuring the lease liability:
commencement of the lease (refer to section 23.3) and the lease term (refer to
section 23.7);
the lease payments; and
the interest rate (interest rate implicit in the lease or the incremental borrowing rate).
The lease payments and interest rate will be discussed after the following example.
Example 23.
23.9A Initial measurement of the right-of-use asset and lease liability
Aquila Ltd (lessee) leases a machine under a lease agreement from 1 June 20.12 from
Aquiries Ltd (lessor). Aquila Ltd did not elect the simplified accounting treatment for the machine.
The details of the lease agreement are as follows (assume all amounts are material and ignore all
taxes):
Lease term: 3 years
Annual lease payments payable in arrears on 30 May each year: R20 368
Payment made by Aquila Ltd on 17 January 20.12 relating to the design
of the machine: R19 500
Non-refundable deposit paid on 26 May 20.12 to secure the lease: R15 000
Interest rate implicit in lease: 15,66%
Legal fee paid to a legal adviser to check the contract: R2 500
50% of the legal fee reimbursed by Aquiries Ltd in cash: R1 250
Cost to assemble the machine paid by Aquila Ltd: R5 000
Annual inspection cost to be paid by Aquilla Ltd: R3 500
Estimated future dismantling cost to be paid on 31 May 20.15 under legal
obligation: R7 500
Pre-tax discount rate applicable to the dismantling provision: 9%
Aquiries Ltd did not incur any initial direct costs.
The contract did not specify guaranteed or unguaranteed residual values.
On commencement date, Aquila Ltd will recognise a right-of-use asset for the use of the machine
at the following amount:
R
Measurement of the lease liability: PMT = 20 368, n = 3, i = 15.66%, PV = ? 46 000
Lease payment made before the commencement date 15 000
Initial direct costs (2 500 legal fees + 5 000 assembly cost(e)) 7 500
Less lease incentive received (1 250)
Inspection cost(a) –
Cost relating to the design of the machine(b) –
Dismantling cost (FV = 7 500, n = 3, i = 9%, PV = ?) 5 791
Total cost of right-of-use asset 73 041
continued
Dr Cr
1 January 20.12 R R
Right-of-use asset – cost (SFP) 73 041
Prepaid expense(c) (previously ‘Bank’) (SFP) 15 000
Lease liability(c) (SFP) 46 000
Dismantling provision(d) (SFP) 5 791
Bank/Creditors(e) (SFP) (2 500 – 1 250 + 5 000) 6 250
Initial recognition of lease
Alternatively, the above journal entry can be done as follows:
Dr Cr
R R
Prepaid expense(c) (previously “Bank”) (SFP) 15 000
Lease liability(c) (SFP) 46 000
Dismantling provision(d) (SFP) 5 791
Bank/Creditors(e) (SFP) (2 500 + 5 000) 7 500
Bank 1 250
Comment
(a) Inspection cost may be regarded as a leasehold improvement as this cost does not directly
relate to the lease, but rather to the underlying asset itself (similar to costs of
design/construction). The lessee shall apply IAS 16 to account for such costs. Judgement may
be needed to classify related costs as either part of the right-of-use asset or as another asset
(for example, as property, plant and equipment).
(b) If a lessee incurs costs relating to the construction or design of an underlying asset, the lessee
shall account for those costs applying other applicable Standards, such as IAS 16. Costs
relating to the construction and design of the underlying asset are not incurred in connection
with the right to use the underlying asset.
(c) The non-refundable lease payment paid in advance to secure the lease will not form part of the
present value of the lease liability. Only lease payments that are not paid at commencement
date will be included in the initial measurement amount of the lease liability.
This prepaid lease payment made to secure the right to use the underlying asset is, regardless
of the timing of the payment, included in the cost of the right-of-use asset. The assumption is
made that the cash payment of R15 000 was initially (on 26 May 20.12.) credited to Bank and
debited as a Prepaid expense (SFP).
(d) The obligation to dismantle the machine at the end of the lease term shall be recognised and
measured in terms of IAS 37.
(e) The assembly cost is arguably also an “initial direct cost” as it represents an “incremental cost”
that would not have been incurred if the right to use the asset was not obtained. Although only
the net cash flow of the initial direct cost incurred and the lease incentive received are shown in
the journal entry above, these cash flows would probably occur on different dates (recorded in
various journal entries).
Leases 651
Example 23.
23.9B Initial measurement of the right-of-use asset and lease liability
Use the information in Example 23.9A, but assume that the initial direct cost which Aquiries Ltd
(lessor) agreed to reimburse will not be paid in cash to Aquila Ltd (lessee), but instead, Aquiries
Ltd agreed that Aquila Ltd could reduce its first lease payment by that amount. Payments are
made in arrears; consequently, the lease incentive will only be receivable at the end of the first
year. Aquila Ltd should reduce the lease liability by the present value of the recoverable lease
incentive.
On commencement date, Aquila Ltd will recognise a right-of-use asset for the use of the machine
at the following amount:
R
Measurement of the lease liability: PMT = 20 368, n = 3, i = 15,66%, PV = ? 46 000
Less PV of lease incentive receivable (1 250/1,1566) (1 081)
44 919
Lease payment made before the commencement date 15 000
Initial direct costs (2 500 + 5 000) 7 500
Dismantling cost (FV = 7 500, n = 3, i = 9%, PV = ?) 5 791
Total cost of right-of-use asset 73 210
Dr Cr
1 January 20.12 R R
Prepaid expense (SFP) 15 000
Dismantling provision (SFP) 5 791
Bank/Creditors (SFP) (5 000 + 1 250) 7 500
23.8.2.3 Lease payments

At the commencement date, the lease payments included in the measurement of the lease
liability comprise the following payments for the right to use the underlying asset during the
lease term that are not paid at the commencement date:
(a) fixed payments (including in-substance fixed payments), less any lease incentives payable
(refer to Examples 23.9A and 9B above);
(b) variable lease payments that depend on an index or a rate, for example, a consumer price
index (CPI), or linked to a benchmark rate (such as the Johannesburg Interbank Average
Rate (JIBAR)), initially measured using the index or rate as at the commencement date
(refer to Example 23.10 below);
(c) amounts expected to be payable by the lessee under residual value guarantees. Such
residual values can be fixed (e.g., contractually agreed regardless of the market value of
the underlying asset at the end of the lease term) or variable (an estimated amount
expected to be payable). A guaranteed residual value will result in the ‘normal’ lease
payments being smaller, resulting in the finance charges over the lease term being
higher, since payment of a part of the liability is deferred. The theory is that the residual
value will be equal to the estimated market value of the asset at the end of the lease
term. This will enable the lessee or the lessor to sell the asset for that amount (i.e.,
recover the residual value), and settle the balance of the liability using these proceeds;
(d) the exercise price of a purchase option if the lessee is reasonably certain to exercise that
option; and
(e) payments of penalties for terminating the lease, if the lease term reflects the lessee
exercising an option to terminate the lease.
Lease payments (a), (b), (d) and (e) above are the same for the lessee and the lessor.
However, lease payment (c) above, namely residual value guarantees, is different for the
lessee and the lessor. The lessee will only include amounts expected (refer to Case 4 of
Example 23.31 for an illustration of the expectation regarding a residual value guarantee) to
be payable by him when measuring the lease liability, whereas the lessor will include any
residual value guarantees provided to him by the lessee, a party related to the lessee or a third
party unrelated to the lessor when measuring the net investment in the lease (lessor). Refer to
section 23.9.3.1 for a discussion of the lease payments of the lessor.
In-substance fixed payments are lease payments that, in form, contain variability but, in
substance, are fixed, for example, where payments must be made if the asset is proven to
be capable of operating during the lease term, or where payments must be made only if an
event occurs that has no genuine possibility of not occurring. Furthermore, the existence of
a choice for the lessee within a lease agreement can also result in an in-substance fixed
payment, for example, if the lessee has the choice either to extend the lease term or to
purchase the underlying asset. The entity has to choose one option and cannot argue that
neither the extension option nor the purchase option will be exercised. In this example, the
lowest discounted cash outflow (i.e. either the discounted lease payments throughout the
extension period, or the discounted purchase price) represents an in-substance fixed
payment.
Variable lease payments that depend on an index or rate are unavoidable, because
uncertainty relates only to the measurement of the amount, but not to its existence;
consequently they form part of the lease liability (lessee) and net investment (lessor). Such
variable lease payments are initially measured using the index or the rate at the
commencement date. The entity does not forecast future changes of the index/rate;
changes are only taken into account at the point in time at which the lease payments
actually change.
A payment may in practice consist of a lease payment and a payment for other aspects,
such as maintenance, security, etc. (i.e. non-lease components). These non-lease
components should be excluded from the lease payments in calculation the present value of
the lease liability (lessee) and net investment (lessor). Such non-lease components should
be accounted for based on the nature thereof, for example, security costs would be
expensed when incurred.
Example 23.
23.10 Lease payments that depend on an index
Medex Ltd (lessee) operates in an inflationary environment. On 1 March 20.16, Medex Ltd entered
into a six-year lease contract with annual lease payments of R250 000, payable at the beginning
of each year. Every two years, lease payments will be adjusted to reflect changes in the
Consumer Price Index (CPI) for the preceding 24 months. On 1 March 20.16, the CPI was 125.
On 1 March 20.16, the lease liability is calculated based on the lease payments of R250 000 per
year based on the index of 125 as at the commencement date (refer to Example 23.17 for more
detail and an illustration of the journal entries).
Medex Ltd will only remeasure the lease liability on 1 March 20.18 (i.e. two years later), when the
contractual cash flows actually change. Refer to section 23.8.3 for reassessments of lease
liabilities.
Variable lease payments based on the future amount of something that changes other than
with the passage of time or not based on an index or rate (e.g., a lease payment linked to a
lessee’s performance derived from the underlying asset, such as payments of a specified
percentage of sales) are not part of the lease liability. Such lease payments, often referred
Leases 653
to as ‘contingent lease payments’, are recognised in profit or loss (expensed) in the period
in which the event or condition that triggers such payments occurs.
Example 23.
23.11 Variable lease payments linked to sales
Assume the same facts as Example 23.10 above, except that Medex Ltd is also required to make
variable lease payments for each year of the lease, which are determined as 2,5% of Medex Ltd’s
audited sales generated from the underlying asset.
At the commencement date, the lease liability will be recognised at the same amounts as in
Example 23.10. This is because the additional variable lease payments are linked to future sales
and, thus do not meet the definition of lease payments. Consequently, such contingent payments
are not included in the measurement of the lease liability.
If Medex Ltd’s audited sales generated from the underlying asset for the first year of the lease are
R1 000 000, Medex Ltd will recognise an expense (P/L) of R25 000 (R1 000 000 × 2,5%) in its
statement of profit or loss and other comprehensive income for the year ended 28 February 20.17.
The contra entry (credit) to this journal entry will probably be recorded as an accrual at year end,
because Medex Ltd’s sales generated from the underlying asset will first need to be audited after
year end to determine the exact amount.
23.8.2.4 Interest rate

The interest rate implicit in the lease is the rate of interest that causes the present value
of the:
lease payments; and
the unguaranteed residual value (in respect of the lessor)
to equal the sum of:
the fair value of the underlying asset; and
any initial direct costs of the lessor, for example legal costs and commissions in
negotiating and arranging a lease.
Consequently, the interest rate implicit in the lease represents the required rate of return
that the lessor excepts from the lease contract. Both the guaranteed residual value (included
per the definition of lease payments) and the unguaranteed residual value are taken into
account when calculating the interest rate implicit in the lease. Refer to section 23.9.3.2
where the detail of guaranteed and unguaranteed residual values are discussed.
Whenever it is impracticable for the lessee to determine this rate (it is calculated from the
lessor’s perspective), the lessee’s incremental borrowing rate of interest is used. This is
the rate the lessee would have to pay to borrow over a similar term, and with a similar
security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in
a similar economic environment.
23.8.2.5 Subsequent measurement of the right-of-use asset
Subsequently, a lessee shall measure the right-of-use asset applying the cost model unless
it applies one of the other measurement models mentioned below. Under the cost model,
the right-of-use is measured at:
initial cost (refer to section 23.8.2.1 above) less
accumulated depreciation (calculated in terms of IAS 16) and impairment losses
(calculated in terms of IAS 36 Impairment of Assets). If the lease transfers ownership
of the underlying asset to the lessee by the end of the lease term or if the cost of the
right-of-use asset reflects that the lessee will exercise a purchase option, the lessee shall
depreciate the right-of-use asset over its useful life (the period over which the asset is
expected to be available for use by the lessee).
If the transfer of ownership is not apparent, the right-of-use asset should be depreciated
over the shorter of its useful life or the lease term, since the lessee will probably use the
asset only for the period of the lease; and
adjusted for subsequent remeasurements of the lease liability (e.g., to reflect lease
modifications or revised in-substance fixed lease payments) – refer to section 23.8.3.
If a right-of-use asset in the records of the lessee relates to a class of property, plant and
equipment to which the lessee applies the revaluation model, then the lessee is allowed to
elect to apply the revaluation model to the right-of-use asset of the same class.
If a lessee applies the fair value model in IAS 40 Investment Property to its investment
properties, it shall also apply the fair value model to right-of-use assets that meet the
definition of an investment property.
23.8.2.6 Subsequent measurement of the lease liability
Subsequently, the lease liability should be measured by:
increasing the carrying amount (CA) to reflect interest (INT) on the lease liability;
reducing the carrying amount to reflect the lease payments (PMT) made; and
remeasuring the carrying amount to reflect lease modifications or revised in-substance
fixed lease payments.
To summarise:
PV + INT – PMT +/– reassessments and modifications +/– revised in-substance lease
payments = CA lease liability.
Example 23.
23.12 Lease agreement – lessee (initial recognition and subsequent measurement)
Orion Ltd (lessee) entered into a lease agreement with Cygnus Ltd (lessor) on 1 January 20.12.
Orion Ltd’s year end is 31 December. The terms of the lease agreement are as follows:
Annual lease payment payable in arrears: R75 760
Guaranteed residual value: R50 000
Unguaranteed residual value: R5 000
Lease term: Five years
Present value of the annual lease payments, the guaranteed and
unguaranteed residual values (also the fair value of the underlying asset): R280 000
On this date, the economic useful life of the underlying asset is estimated at eight years.
Ownership of the underlying asset will not transfer to the lessee at the end of the lease term. Orion
Ltd expects to use the asset evenly over its useful life (here the lease term).
Comment
¾ The existence of an unguaranteed residual value implies that the lessee will return the asset to
the lessor at the end of the lease term.
¾ The value of the underlying asset is not low in value, nor is this a short-term lease. Orion
cannot elect the simplified lessee accounting model for this lease agreement.
Initial measurement: Lease liability
The lease liability is initially measured at the present value of the lease payments of the lessee as
defined in IFRS 16.27, discounted over the lease term using the interest rate implicit in the lease.
The lease payments of the lessee only include guaranteed residual values, but the calculation of
the interest rate implicit in the lease takes both the guaranteed and unguaranteed residual values
into account.
Initial measurement: Right-of-use asset
In the absence of other permissible costs (e.g. initial direct cost) that need to be capitalised to the
right-of-use asset, the right-of-use asset will initially only be measured at the amount of the initial
measurement of the lease liability.
continued
Leases 655
Step 1: Calculation of interest rate implicit in lease agreement (the lessor’s perspective)
PV 280 000
PMT – 75 760
FV – 55 000 (50 000 + 5 000)
n 5
Therefore i = 15,182%
Comment
¾ When calculating the interest rate implicit in the lease agreement, both the guaranteed and the
unguaranteed residual value are taken into account.
Step 2: Calculation of the present value of lease payments of the lessee
PMT – 75 760
FV – 50 000
n 5
i 15,182%
Comment
¾ The present value is calculated by discounting the lessee’s lease payments (excluding the
unguaranteed residual value).
¾ The right-of-use asset and lease liability will initially be measured at R277 532.
¾ It is evident that the present value (R277 532) for the lessee is slightly less than the fair value of
the underlying asset (R280 000). This is due to the fact that the asset is returned to the lessor
at the end of the lease term and the lessor may realise the unguaranteed residual value. The
lessee does not have that portion of the economic benefits of the underlying asset.
The amortisation table for the lessee, using the present value calculated above, will be prepared
as follows:
Lease (a) Outstanding
Interest Capital
payments balance
R R R R
277 532
Year 1 75 760 42 135 33 625 243 907
Year 2 75 760 37 030 38 730 205 177
Year 3 75 760 31 150 44 610 160 567
Year 4 75 760 24 377 51 383 109 184
Year 5 75 760 16 576 59 184 50 000
(paid on last day) 50 000 –
151 268 277 532
Comment
¾ From the above, it is clear that, after subtracting the last capital portion of the last outstanding
annual lease payment, a balance of R50 000 remains. This is equal to the guaranteed residual
value which is paid at the end as well. In reality, this means that the lessee has paid interest on
this R50 000 outstanding capital from the first to the last day of the lease term.
(a) The interest expense is calculated by multiplying the outstanding balance of the lease liability
by the interest rate implicit in the lease.
The journal entries to account for the lease are as follows:
Dr Cr
R R
1 January 20.12 (Initial recognition)
Right-of-use asset (SFP) 277 532
continued
Dr Cr
R R
31 December 20.12 (First payment)
Bank (SFP) 75 760
Recognition of lease payments made
Depreciation (P/L) (277 532/5) 55 506
Recognition of depreciation on right-of-use asset
Comment
¾ The right-of-use asset must be depreciated over the shorter of its useful life or the lease term if
there is uncertainty on initial recognition about whether ownership will transfer to the lessee at
the end of the lease term. It is given that ownership of the underlying asset will not transfer to
the lessee at the end of the lease term. Consequently, the right-of-use asset will be depreciated
over the lease term of five years.
¾ In practice, it will be necessary to transfer the part of the lease liability payable within one year,
excluding interest, to current liabilities to comply with the presentation requirements of IAS 1
Presentation of Financial Statements. This principle applies to all lease, but it is not repeated in
every example.
Incremental borrowing rate:
If it was impracticable for Orion Ltd to calculate the interest rate implicit in the lease agreement
(perhaps it did not have access to the information of the lessor related to the unguaranteed
residual value), Orion Ltd could use its own incremental borrowing rate to initially recognise the
right-of-use asset and related lease liability in its accounting records.
Assume that Orion Ltd’s incremental borrowing rate is 16% and it was impracticable for Orion Ltd
to calculate the interest rate implicit in the lease.
Calculation of the present value of the lease payments of the lessee
PMT – 75 760
FV – 50 000
n 5
i 16%
Comment
¾ The right-of-use asset and related lease liability will initially be measured at R271 866.
as follows:
Lease Outstanding
Interest Capital
payment balance
R R R R
271 866
Year 1 75 760 43 499 32 261 239 605
Year 2 75 760 38 337 37 423 202 181
Year 3 75 760 32 349 43 411 158 770
Year 4 75 760 25 403 50 357 108 414
Year 5 75 760 17 346 58 414 50 000
156 934 271 866
Comment
¾ The journal entries for the lessee will be same as above, but the amounts will be based on the
amortisation table based on the lessee’s incremental borrowing rate.
Leases 657
Example 23.
23.13 Lease payments payable in advance (lessee)
Aries Ltd (lessee) entered into a lease agreement with Zodiac Ltd (lessor) on 1 January 20.12.
Aries Ltd did not elect the simplified accounting treatment for the underlying asset. The year end of
Aries Ltd is 31 December.
The lease agreement has the following terms:
Term: 5 years
Lease payments: R25 000, payable annually in advance on 1 January
Interest rate implicit in the lease: 19,369%
The contract determines that Aries Ltd has an option to obtain ownership of the asset at the end of
the term at a nominal amount. It is, however, uncertain on initial recognition whether the option will
be exercised. There are no guaranteed or unguaranteed residual values and no initial direct costs
have been incurred by the parties to the agreement.
On this date, the total economic life of the underlying asset is estimated at eight years. Aries Ltd
expects to use the asset evenly over the lease term.
Calculation of the present value (PV) of the lease payments (lessee):
Set financial calculator on BEGIN function; PMT = –25 000, n = 5, i = 19,369%, FV = 0, PV = ?
Therefore PV = R90 500
The right-of-use asset and the related lease liability are recognised initially at R90 500.
The amortisation table will be as follows:
Lease Outstanding
payment Interest Capital
balance
R R R R
90 500
Payment made in year 1 25 000 – 25 000 65 500
Payment made in year 2 25 000 12 687 12 313 53 187
Payment made in year 5 25 000 4 056 20 944 –
34 500 90 500
The journal entries to account for the lease in the records of Aries Ltd are as follows:
Dr Cr
R R
Right-of use asset (SFP) 90 500
The accounting treatment when the first lease payment is paid on 1 January 20.12 is as follows:
Dr Cr
R R
Lease liability (SFP) (1 Amort) 25 000
Bank (SFP) 25 000
Recognition of lease payment made in advance
Comment
¾ Interest accrues on a time basis. The first payment has no interest component as there has been
no time period between the initial recognition of the lease liability and the payment of the first lease
payment.
continued
Dr Cr
31 December 20.12 (year end): R R
Depreciation (P/L) (90 500/5) 18 100
Finance cost (P/L) ((90 500 – 25 000) × 19,369%) or (2 Amort) 12 687
Accrued finance expense (SFP) 12 687
Interest on lease accrued for first period
Comment
¾ The interest is included in the lease payment payable on 1 January 20.13 and is accrued for the
year ended 31 December 20.12. Use using a financial calculator, one need to use “2 amort” (for
payment 2) to obtain the interest accrued for period 1, as the interest that accrued during period 1 is
paid with payment 2 (at the beginning of the second year) – refer to the journal entry below.
Accounting treatment when the second lease payment is paid on 1 January 20.13:
Dr Cr
R R
Accrued finance expense (SFP) 12 687
Lease liability (SFP) (25 000 – 12 687) or (2 Amort) 12 313
Bank (SFP) 25 000
Recognition of lease payment made in advance
Example 23.
23.14 Accounting for a lease when ownership is transferred to the lessee
Orion Ltd (lessee) entered into a lease agreement with Cygnus Ltd (lessor) on 1 January 20.12.
Orion Ltd’s year end is 31 December. The terms of the lease agreement are as follows:
Balloon payment on the last day of the lease term to acquire ownership: R50 000
Lease term: Five years
Present value of the annual lease payments, the guaranteed residual
values (i.e. the balloon payment) (also the fair value of the underlying asset): R280 000
On this date, the economic useful life of the underlying asset is estimated at eight years.
Ownership of the underlying asset will transfer to the lessee at the end of the lease term when
the balloon payment is made. Orion Ltd expects to use the asset evenly over its useful life.
Calculation of interest rate implicit in lease agreement (the lessor’s perspective)
PV 280 000
PMT – 75 760
FV – 50 000
n 5
continued
Leases 659
as follows:
Lease Outstanding
Interest Capital
payments balance
R R R R
280 000
Year 1 75 760 41 535 34 225 245 775
Year 2 75 760 36 458 39 302 206 473
Year 3 75 760 30 628 45 132 161 341
Year 4 75 760 23 933 51 827 109 514
Year 5 75 760 16 246 59 514 50 000
148 800 280 000
Comment
¾ The balloon payment of R50 000 is paid at the end of the lease term, whereby the lessee
effectively obtains ownership of the underlying asset.
Dr Cr
The journal entries to account for the lease are as follows: R R
31 December 20.12 (First payment)
Bank (SFP) 75 760
Recognition of lease payments made
Depreciation (P/L) (280 000/8) 35 000
Comment
¾ The asset will be depreciated over its useful life in accordance with the entity’s normal
depreciation policy. Ownership will be transfer to the lessee at the end of the lease term.
Consequently, the right-of-use asset will be depreciated over the total useful life (the period the
asset is available for use by the lessee) of eight years.
¾ The lease liability is still paid off over the lease term of five years, irrespective of the fact the
ownership of the underlying asset is transferred at the end of the lease term.
Annual lease payments need not necessarily be equal. An entity may negotiate variable
lease payments for cash flow reasons. For instance, if an entity is experiencing cash flow
problems, it would initially prefer to pay lower lease payments and pay higher lease
payments in the future when the cash flow of the entity has improved. The following
example will illustrate this:
Example 23.
23.15 Uneven lease payments (lessee)
On 1 January 20.11, a machine with a cash selling price (equal to the present value of the lease
payments) of R17 000 is acquired under a lease agreement with the following terms:
Lease payments payable
1 Jan 20.11 R3 500
1 Jan 20.12 R4 880
1 Jan 20.13 R6 698
1 Jan 20.14 R9 079
Interest rate implicit in the lease = 22%
The lessee did not elect the simplified accounting treatment for the underlying asset.
Lease Outstanding
Amortisation table Interest* Capital***
payment balance**
R R R R
17 000
Payment in year 1 3 500 – 3 500 13 500
Payment in year 2 4 880 2 970 1 910 11 590
Payment in year 3 6 698 2 550 4 148 7 442
Payment in year 4 9 079 1 637 7 442 –
7 157 17 000
* (13 500 × 22% = 2 970); (11 590 × 22% = 2 550); (7 442 × 22% = 1 637)
** (13 500 + 2 970 – 4 880 = 11 590); (11 590 + 2 550 – 6 698 = 7 442)
*** (4 880 – 2 970 = 1 910); (6 698 – 2 550 = 4 148); (9 079 – 1 637 = 7 442)
Comment
¾ One would need to use the “cash flow function” of a financial calculator to determine the “net
present value”, or the “effective interest rate” as the payments are uneven:
CF0 = 3 500; CF1 = 4 880; CF2 = 6 698; CF3 = 9 079; I = 22; NPV = ?; NPV = 17 000.
23.8.3 Reassessment of the lease liability

If lease payments subsequently change (e.g. if in-substance lease payments change) the
lease liability should be remeasured to reflect such changes. Similarly, the lease liability
should be reassessed to reflect a revised payment over a revised lease term (when the
expectations regarding the exercise of an option to extend the lease term, or to purchase
the underlying asset changes (refer to section 23.7)). The amount of the remeasurement of
the lease liability is an adjustment to the right-of-use asset, limited to Rnil (excess
below Rnil will be recognised in profit or loss).
Using a revised discount rate
A lessee shall remeasure the lease liability by discounting such revised lease payments,
using a revised discount rate, if:
there is a change in the lease term; or
there is a change in the assessment of a purchase option to reflect the change in
amounts payable under the revised purchase option.
The revised discount rate is determined as the interest rate implicit in the lease (if this rate
can be readily determined) for the remainder of the lease term, or the lessee’s incremental
borrowing rate at the date of reassessment (if the interest rate implicit in the lease cannot
be readily determined).
The new interest rate implicit in the lease will thus be calculated using the remaining revised
lease term, the revised lease payments, and the capital balance that was outstanding on the
date of the lease modification (as the present value (PV)).
Leases 661
A change in the interest rate implicit in the lease is not considered to be a change in
estimate, as the interest rate implicit in the lease is not estimated. It is based on market
conditions on the date that the lease commences and reflects subsequent changes in
market conditions.
Example 23.
23.16 Change in the lease term
Ricon Ltd (lessee) leased a machine in terms of a lease agreement from 1 January 20.12. The
end of the Ricon Ltd’s reporting period is 31 December. Ricon Ltd did not elect the simplified
accounting treatment for the machine. The following relates to the lease agreement at the
commencement date:
Term of the lease: 5 years (not reasonably certain if a three year extension
option will be exercised)
Annual lease payments: R45 000 in arrears
There are no guaranteed or unguaranteed residual values.
Interest rate implicit in lease: 11% per annum
Expected useful life of the machine: 10 years (straight-line)
The journal entries to account for the lease in the books of Ricon Ltd for the year ended 20.12,
are:
Dr Cr
R R
Right-of-use asset (machine) (SFP) 166 315
Lease liability (SFP) *166 315
Initial recognition of lease liability
Finance costs (P/L) (166 315 × 11%) 18 295
Lease liability (SFP) (45 000 – 18 295) 26 705
Bank (SFP) 45 000
Depreciation (P/L) (166 315/5) 33 263
* PMT = – 45 000; i = 11%; n = 5; thus PV = R166 315
On 31 December 20.12, Ricon Ltd would have the following balances with regards to the lease
agreement:
Right-of-use asset: R133 052 (166 315 × 4/5)
Lease liability: R139 610 (Amort balance 1)
On 1 January 20.13 Ricon Ltd reassessed the lease agreement and came to the conclusion that it
was now reasonably certain that it would exercise the option to extend the lease at the end of the
lease term. Consequently, Ricon Ltd will have to remeasure the lease liability using the revised
lease term and interest rate. On 1 January 20.13, the interest rate implicit in the lease, for the
remainder of the lease term, decreased to 10% per annum.
The remeasured lease liability will be calculated by comparing the lease liability currently in the
records of Ricon Ltd (R139 610), with the amount it should now be measured at: R219 079
(PMT = – 45 000; i = 10%; n = 7; PV = ?). The difference of R79 469 will be recognised as an
adjustment to the lease liability and the carrying amount of the right-of-use asset. Subsequently,
Ricon Ltd will account for the lease liability at the new 10% interest rate. The change in the lease
term also results in the change of the useful life of the machine. This is a change in an accounting
estimate which, in terms of IAS 8 Accounting Policies, Changes in Accounting Estimates and
Errors, should be recorded prospectively.
continued
Lease Interest Outstanding

Amortisation table Capital
payment 10% balance
R R R R
219 079
20.13 45 000 21 908 23 092 195 987
20.14 45 000 19 599 25 401 170 586
20.15 45 000 17 059 27 941 142 645
20.16 45 000 14 265 30 735 111 910
20.17 45 000 11 191 33 809 78 101
20.18 45 000 7 810 37 190 40 911
20.19 45 000 4 089 40 911 –
95 921 219 079
The journal entries to account for the lease in the books of Ricon Ltd for the year ended 20.13,
are:
Dr Cr
R R
Right-of-use asset (machine) (SFP) 79 469
Reassessment of lease liability
Finance costs (P/L) (219 079 × 10%) 21 908
Lease liability (SFP) (45 000 – 21 908) 23 092
Bank (SFP) 45 000
Depreciation (P/L) ((133 052 + 79 469)/7) 30 360
Comment
¾The disclosure for Ricon Ltd is illustrated in Example 23.23.
Using an unchanged discount rate

A lessee shall remeasure the lease liability by discounting such revised lease payments,
using an unchanged discount rate, if:
there is a change in the amounts expected to be payable under a residual value
guarantee; or
there is a change in future lease payments to reflect market rates (e.g. based on a
market rent review) or a change in an index or a rate used to determine the lease
payments. As mentioned earlier (section 23.8.2.3), the present value of such variable
lease payments are initially measured using the index or the rate at the commencement
date. The entity does not forecast future changes of the index/rate (other than floating
interest rates) on commencement date. Consequently, the lessee shall only remeasure
the lease liability to reflect such revised lease payments when there is a change in the
cash flows (i.e., when the lease payments actually change); or
the variability of payments is resolved so that they become in-substance fixed payments.
Leases 663
Example 23.
23.17 Changes in variable lease payments dependent on an index
Medex Ltd (lessee) operates in an inflationary environment. On 1 March 20.16, Medex Ltd entered
into a six-year lease contract with annual lease payments of R250 000, payable at the beginning of
each year. Every two years, lease payments will be adjusted to reflect changes in the Consumer
Price Index (CPI) for the preceding 24 months. On 1 March 20.16, the CPI was 125. Medex Ltd
expects the CPI in two years’ time to be 130. Assume the rate implicit in the lease is not readily
determinable. Consequently, Medex Ltd determined its incremental borrowing rate as 7% per
annum, which reflects the fixed rate at which Medex Ltd could borrow an amount similar to the
value of the right-of-use asset, for a six-year term, and with similar collateral.
On 1 March 20.16, Medex Ltd recognises a right-of-use asset and a lease liability at the following
amounts:
Dr Cr
R R
Right-of-use asset (SFP) 1 275 049
Lease liability (SFP) 1 025 049
Bank (SFP) 250 000
Initial recognition of lease and first payment made
Alternatively, the journal entry may be done as follows:
Dr Cr
R R
Right-of-use asset (SFP) 1 275 049
Bank (SFP) 250 000
Initial recognition of lease and first payment made
Comments
Comments
¾ The right-of-use asset is initially measured at the present value of the lease liability, including
amounts paid at or before commencement of the lease.
¾ Medex Ltd should not use forecasts of future changes to an index/rate; changes are only taken
into account at the point in time at which the lease payments actually change. The CPI of 130 is
thus ignored in this example.
¾ The lease liability is initially measured at the present value of the lease payments not yet paid,
discounted over the lease term using the Medex Ltd’s incremental borrowing rate. At the
commencement date, Medex Ltd makes the lease payment for the first year and measures the
lease liability at the present value of the remaining five payments of R250 000, discounted at
the interest rate of 7% per annum, which is R1 025 049 (PMT (END) = 250 000, n = 5, i = 7%,
PV = ?). Although the lease payments are made at the beginning of the year, if the first lease
payment is not included in the present value calculation it is as if the remaining five lease
payments will be made at the end of each year (to be precise, 1 day after the end of the year)
and consequently the financial calculator should be set on its END function (using n = 5).
Alternatively, if n = 6 is used in the calculation, the financial calculator should be set to its
BEGIN function to calculate the present value of the lessee’s lease payments (PMT (BEGIN) =
250 000, n = 6, i = 7%, PV = 1 275 049 less the payment already made at inception date
(250 000) = 1 025 049).
continued
Medex Ltd expects to consume the right-of-use asset’s future economic benefits evenly over the
lease term of six years and thus depreciates the right-of-use asset on a straight-line basis. In
aggregate, the following relate to the lease for FY20.16 and FY20.17:
Dr Cr
R R
Interest expense (SFP) (if n = 6 (BEGIN), INT period 1-3) 131 030
Lease liability (SFP) (if n = 5 (END), INT period 1-2) 131 030
Interest accrued for FY20.16 and FY20.17
Depreciation (P/L) (1 275 049/6 × 2 years) 425 016
Recognition of depreciation for FY20.16 and FY20.17
Bank (SFP) 250 000
Payment made at beginning of year
At the beginning of the third year, before accounting for the change in future lease payments
resulting from a change in the CPI and making the lease payment for the third year, the lease
liability is R906 079. This balance can be calculated as follows:
– Calculating the present value of four payments (BEGIN) of R250 000 discounted at the interest
rate of 7% per annum; or
– PMT (BEGIN) = 250 000, n = 6, i = 7%, Balance period 3 increased by the lease payment of
R250 000 not yet paid – note the signs; or
PMT (END) = 250 000, n = 5, i = 7%, Balance period 2 increased by the lease payment of
R250 000 not yet paid – note the signs; or
– 1 025 049 + 131 030 – 250 000.
On 1 March 20.18, the CPI is 140. The lease payment, adjusted for a CPI of 140, is R280 000
(R250 000 × 140/125). Because there is now an actual change in the lease payments resulting
from a change in the CPI used to determine those payments, Medex Ltd remeasures the lease
liability to reflect the revised lease payments. The revised measurement of the lease liability,
R1 014 808, now reflects four annual lease payments of R280 000, payable in advance (BEGIN)
for the remainder of the lease term using the unchanged incremental borrowing rate of 7% per
annum. Consequently, Medex Ltd increases the lease liability by R108 729 (R1 014 808 í
R906 079), which represents the difference between the remeasured liability and the previous
carrying amount (prior to the CPI adjustment). The corresponding adjustment is made to the right-
of-use asset, recognised as follows:
Dr Cr
R R
Recognition of reassessment of lease liability
On 1 March 20.18, Medex Ltd makes the lease payment for the third year and recognises the
following:
Dr Cr
R R
Bank (SFP) 280 000
Recognition of revised payment made on 1 March 20.18
The process to record the depreciation and the interest expense will be repeated for the remainder
of the period.
Leases 665
23.8.4 Lease modifications

There are many different reasons why the parties to a lease agreement might decide to
renegotiate and modify an existing lease contract during the lease term. For example, if the
lessee is in financial difficulties, the lessor might agree to reduce lease payments, or the
parties to the contract might subsequently negotiate to shorten the lease term of the original
contract because the lessee is not satisfied with the performance of the underlying asset.
IFRS 16 defines a modification as a change in the scope of a lease, or the consideration
for a lease, that was not part of the original terms and conditions of the lease (e.g. adding
or terminating the right to use one or more underlying assets, or extending or shortening the
contractual lease term).
Any change that is triggered by a clause which is already part of the original lease contract
is thus not regarded as a modification. The key factor of a lease modification is thus that the
original contract is changed. Reassessing the lease liability (discussed in the previous
section) does not necessarily result in the modification of the lease, for example, a
subsequent change in the CPI does not modify the lease if the condition that ‘the lease
payment is linked to CPI’ forms part of the original contract. However, if the condition that
‘the lease payment is from now on linked to CPI’ is subsequently negotiated and added to
the original lease contract, it will result in a lease modification.
If a change in a lease results in a lease modification, the lessee needs to determine if it
should account for the lease as a separate lease (i.e. a different and new lease) or if the
modification requires an adjustment to the original contract. Each of these lease
modifications will be discussed:
23.8.4.1. Lease modifications accounted for as separate leases
A lessee shall account for a lease modification as a separate lease if both:
the modification increases the scope of the lease by adding the right to use one or
more underlying assets; and
the consideration for the lease increases by an amount commensurate with the stand-
alone price for the increase in scope and any appropriate adjustments to that stand-
alone price to reflect the circumstances of the particular contract.
If both criteria above are met, the lessee will simply apply the principles of IFRS 16 to that
‘new’ lease, independent of the original lease.
Example 23.
23.18 Lease modification – adding to the right-of-use asset of an existing lease
At incorporation of its business on 1 April 20.16, Nko Ltd (lessee) entered into a five-year lease for
500m2 of office space in Potchefstroom. Nko Ltd experienced significant growth and at the end of
the first year of the lease term, Nko Ltd and Nku Ltd (lessor) agreed to amend the original lease
for the remaining four years to include an additional 600m2 of office space in the same building.
The additional space is available for use by Nko Ltd from the beginning of the second year of the
lease term. The increase in total consideration for the lease is commensurate with the current
market rate for similar sized office space in Potchefstroom, adjusted for the discount that Nko Ltd
receives, reflecting that Nku Ltd does not incur costs, such as marketing cost, that it would
otherwise have incurred if leasing the same space to a new tenant.
Nko Ltd accounts for the modification of the original lease agreement as a separate lease,
separate from the original five-year lease. This is because the modification grants Nko Ltd an
additional right to use an underlying asset, and the increase in consideration for the lease is
commensurate with the stand-alone price of the additional right-of-use adjusted to reflect the
circumstances of the contract.
At the commencement date of the new lease (1 April 20.17), Nko Ltd recognises a right-of-use
asset and a lease liability relating to the lease of the additional 600m2 of office space. Nko Ltd
does not make any adjustments to the accounting for the original lease of 500m2 of office space as
a result of this modification.
23.8.4.2 Lease modifications not accounted for as a separate lease

For a lease modification that is not accounted for as a separate lease, a lessee shall at the
effective date of the lease modification (the date both parties to the lease agreement agree
to the lease modification):
allocate the consideration in the modified lease agreement to the lease and non-lease
components by applying the general principles provided in IFRS 16;
determine the lease term of the modified lease agreement by applying the general
principles provided in IFRS 16; and
remeasure the lease liability by discounting the revised lease payments using a revised
discount rate:
– the revised discount rate is determined as the interest rate implicit in the lease (if that
rate can be readily determined) for the remainder of the lease term; or
– as the lessee’s incremental borrowing rate (if the interest rate implicit in the lease
cannot be readily determined) at the effective date of the modification.
If the lease modifications reflect the partial or full termination of the lease that decrease the
scope of the lease, the lessee shall remeasure the lease liability (i.e. adjust the carrying
amount of the lease liability to reflect the modified terms and conditions), decrease the
carrying amount of the right-of-use asset, and recognise in profit or loss any gain or loss
relating to the partial or full termination of the lease.
For all other lease modifications (e.g. an increase in the scope with a corresponding
increase in the lease consideration, an increase in scope without a corresponding increase
in the lease consideration, or a change in the lease consideration) the lessee shall make
the adjustment to the right-of-use asset as the contra entry for the remeasurement of the
lease liability.
Example 23.
23.19 Lease modification – decrease in the scope of the lease
Nicon Ltd (lessee) enters into a six-year lease for 2 000m2 of office space. The annual lease
payments are R100 000 payable at the end of each year. The interest rate implicit in the lease is
10% per annum. The amortisation table would be as follows:
Outstanding
Lease payment Interest Capital
balance
R R R R
PV 435 526
Year 1 100 000 43 553 56 447 379 079
Year 2 100 000 37 908 62 092 316 987
Year 3 100 000 31 699 68 301 248 685
Year 4 100 000 24 869 75 131 173 554
Year 5 100 000 17 355 82 645 90 909
Year 6 100 000 9 091 90 909 –
At the end of Year 1, Nicon Ltd and the lessor agree to amend the original lease to reduce the
space to only 1 000 m2 of the original space, starting from the beginning of the Year 2. The annual
fixed lease payments (from Year 2 to Year 6) are R50 000. The incremental interest rate implicit in
the lease at the beginning of Year 2 is 9% per annum. At the effective date of the lease
modification (at the beginning of Year 2), Nicon Ltd remeasures the lease liability based on:
(a) a five-year remaining lease term;
(b) annual lease payments of R50 000; and
(c) the interest rate implicit in the lease of 9% per annum.
continued
Leases 667
The amortisation table would be as follows:

Outstanding
balance
R R R R
PV 194 483
Year 1 50 000 17 503 32 497 161 986
Year 2 50 000 14 579 35 421 126 565
Year 3 50 000 11 391 38 609 87 956
Year 4 50 000 7 916 42 084 45 872
Year 5 50 000 4 128 45 872 –
Nicon Ltd determines the proportionate decrease in the carrying amount of the right-of-use asset
on the basis of the remaining right-of-use asset (i.e. 1 000 m2, corresponding to 50% of the original
right-of-use asset). 50% of the depreciated pre-modification right-of-use asset is R181 469
(R435 526 × 5/6 × 50%).
50% of the pre-modification lease liability is R189 540 (R379 079 × 50%). Consequently, Nicon Ltd
reduces the carrying amount of the right-of-use asset by R181 469 and the carrying amount of the
lease liability by R189 469. The difference between the decrease in the lease liability and the
decrease in the right-of-use asset (R189 469 – R181 469 = R8 000) is recognised as a gain in
profit or loss at the beginning of Year 2.
Dr Cr
R R
Gain on lease modification (P/L) 8 000
Recognition of decrease in lease liability and right-of-use asset
Nicon Ltd recognises the difference between the remaining lease liability of R189 540 and the
modified lease liability of R194 483 (which equals R4 943) as an adjustment to the right-of-use
asset reflecting the change in the consideration paid for the lease and the revised discount rate.
Dr Cr
R R
Recognition of lease modification

The intention is not to give a comprehensive exposition of the relevant tax matters here, but
rather to mention the most important aspects. Tax consequences are generally based on
the legal form of the agreement rather than on its faithful representation – for the SARS the
accounting treatment does not affect the tax consequences. Consequently, differences
arising in the different treatments of the lease agreement (for accounting and tax purposes)
will result in deferred tax (on temporary differences) and an adjustment to profit before tax
when calculating taxable income.
When a lease agreement for accounting purposes is also a lease agreement for tax
purposes, the lease payments are normally deductible for income tax purposes, provided
they comply with the normal conditions for deduction. SARS allows the lease payments as
deductions because it views them as expenses incurred in the production of income. No
distinction is made between the capital and interest portions of a lease payment. The lessee
is not entitled to tax allowances (wear-and-tear) on the asset, because from a legal
perspective (tax point of view) the lessee is not viewed as the owner of the underlying asset.
If, at the termination of the lease, ownership of the particular asset is transferred to the
lessee for no consideration or for an inadequate consideration, the lessee (who at this stage
is the owner) will be taxed in accordance with section 8(5) of the Income Tax Act.
If the lessee leases underlying assets for longer than 12 months, the underlying assets are
not considered to be low in value, or the lessee does not elect the recognition exemption
allowed in IFRS 16, deferred tax will arise as a result of the capitalised right-of-use asset
and the corresponding lease liability (both recognised for accounting purposes).
The tax base of the right-of-use asset is the amount that will be deductible for tax purposes
in the future. In the case of a right-of-use, since this asset is not recognised for tax
purposes, the tax base will be Rnil.
In the case of the lease liability, the tax base will be the carrying amount less the amount
that will be deductible for tax purposes in the future. As the full lease payments are
deductible for tax purposes, the tax base of the lease liability will generally be Rnil. (This may
however not be the case where VAT is financed – refer to the section below.)
Example 23.
23.20 Basic deferred tax on leased assets (lessee)
Carina Ltd (lessee) leased a machine in terms of a lease agreement on 1 January 20.12.
Carina Ltd did not elect the simplified accounting treatment for the machine. The following relates
to the lease agreement:
Term of the lease: 4 years
Annual lease payments: R32 923 in arrears
Present value of the lease payments: R100 000
Interest rate implicit in lease: 12%
Depreciation: 25% per year (straight-line)
SARS did not view the lease as an instalment sale agreement. Ignore VAT.
Assume a profit before tax of R500 000 (after all the accounting entries were recorded).
The carrying amounts, tax bases and temporary differences will be as follows:
On initial recognition
R R R
Lease liability (100 000) – ** (100 000)
Right-of-use asset 100 000 – * 100 000
Net temporary difference –
* No future deduction – the SARS does not recognise this asset
** 100 000 – 100 000 = Rnil
End of Year 1
Lease liability (100 000 + 12 000 – 32 923) (79 077) – (79 077)
Right-of-use asset (100 000 × 75%) 75 000 – 75 000
Net temporary difference (deductible) (4 077)
Current tax calculation:
R
Accounting profit before tax 500 000
Movement in temporary differences: 4 077
Temporary differences may be broken down as follows:
Depreciation on right-of-use asset 25 000
Finance cost on lease liability 12 000
Annual lease payment (32 923)
Current tax payable at 28% 141 142
Total income tax expense:
Current tax 141 142
Deferred tax (4 077 × 28%) (1 142)
Income tax expense (being 28% of accounting profit of R500 000) 140 000
Leases 669
23.8.6 Value-added tax

Value-added tax (VAT) is payable by the lessor on the cash selling price of the asset on the
signing of the agreement, if the agreement qualifies as an ‘instalment credit agreement’ as
defined by the Value-Added Tax Act 89 of 1991. It can be argued that the VAT is ‘financed’
by the lessor. The lessor will however recover the VAT from the lessee, either as part of the
lease payments over the lease term (the lease liability will consequently include VAT, and
the lessor continues to ‘finance’ the VAT over the lease term) or alternatively the VAT can
be paid at the beginning of the lease by the lessee to the lessor (the lease liability will
consequently exclude VAT, and the lessor does ‘not finance’ the VAT).
In the aforementioned context, ‘financed’ thus means that the VAT is paid back by the
lessee to the lessor over the lease term, whilst ‘not financed’ means that it is paid all at once
to the lessor at the inception of the lease.
When the lessee applies the right-of-use asset to make taxable supplies, the lessee may
immediately recoup the total VAT from the SARS by claiming a VAT input credit.
Consequently, the cost of this asset excludes VAT. The input VAT claimed by the lessee
would be the same amount of the output VAT for the lessor (and may not always be 15/115
of the present value used by the lessor to calculate the initial measurement of the lease
liability). Where the lessor then continues financing the VAT (i.e. the lessee does not pay the
VAT recouped from the SARS over to the lessor at the beginning of the lease), the lease
payments paid by the lessee include a portion of VAT. This portion must then be removed
from the lease payment which is deducted for income tax purposes, to avoid deducting the
VAT twice – once for VAT purposes and once for income tax purposes. In terms of section
23C of the Income Tax Act, any deduction of the lease payment is reduced by the VAT input
credit that has been claimed. The removal of VAT from the lease payments to be deducted
for income tax purposes is done in proportion to lease payments – thus, if lease payments
are all equal, VAT will be removed on the straight-line basis from the lease payments (or
lease payment paid in a specific year ÷ total lease payments over the lease term × the VAT
claimed from SARS on inception of the lease).
If the right-of-use asset is not applied to make taxable supplies, the VAT paid by the lessee
cannot be recouped, and the full lease payment will be allowed as an income tax deduction,
if all the requirements for a deduction apply. Consequently, the cost of such asset includes
VAT.
Example 23.
23.21 Deferred tax and VAT
A machine with a cash selling price (excluding VAT) of R57 391 is leased by Calico Ltd (lessee).
Calico Ltd did not elect the simplified accounting treatment for the machine. The lessor pays
R8 609 VAT (15% in this example) and determines that three lease payments of R28 907 each,
are payable annually in arrears. Calico Ltd will redeem the total amount of R66 000 at an interest
rate implicit in the lease of 15% per annum. There are no guaranteed or unguaranteed residual
values. No initial direct costs were incurred by either Calico Ltd or the lessor. The lease agreement
met the definition of an instalment credit agreement for VAT purpses. As the lessee applies the
asset to make taxable supplies, the R8 609 (VAT) can be recouped immediately from SARS.
Calico Ltd did not pay the VAT claimed from the SARS over to the lessor at inception of the lease.
Ownership will not transfer to Calico Ltd at the end of the lease term. The lessee depreciates this
type of asset on the straight-line basis. Assume a normal income tax rate of 28%.
continued
The amortisation table of Calico Ltd (lessee) will be as follows:

Outstanding
balance
R R R R
66 000*
Year 1 28 907 9 900 19 007 46 993
Year 2 28 907 7 049 21 858 25 135
Year 3 28 907 3 772 25 135 –
86 721 20 721 66 000
* Since VAT is being financed by the lessor (Calico Ltd did not pay the claimed VAT over to the
lessor at inception of the lease), it is included in the lease liability. The lessor will recoup the VAT,
initially paid to SARS, over the lease term from Calico Ltd.
The entries of Calico Ltd at the beginning of the first year will be as follows:
Dr Cr
R R
VAT control account (input) (SFP) 8 609
Initial recognition of lease and input VAT claimed
Bank (SFP) 8 609
VAT control account (SFP)
(assuming this is the only VAT item for the period) 8 609
Input VAT claimed from SARS
The full lease payments of R28 907 per annum (including the VAT portion) will not be deductible
for income tax purposes, because R8 609 has already been recouped from SARS. For income tax
purposes, each lease payment will first be reduced by an equal portion of VAT, because the lease
payments are equal (no initial deposit or guaranteed residual value). The reduction is thus
proportionate to the relative size of the lease payments. From the above information, it follows that
R28 907 – (1/3 × R8 609) = R26 037 will be deductible annually for income tax purposes.
(Alternatively the amount can be determined as follows: Total VAT = R8 609, consequently the
VAT per payment is 8 609 × 28 907/86 721 = 2 870. The deductible amount is therefore
R28 907 – R2 870 = R26 037.)
If the asset is depreciated equally over three years (i.e., the lease term, because ownership of the
asset will not transfer at the end of the lease), the accounting expenses and tax deductions for the
lessee will be as follows:
Accounting Tax
R R
Year 1 Depreciation (57 391/3) 19 130
Finance costs 9 900
Lease payment (28 907 – 2 870) 26 037
Year 2 Depreciation 19 130
Finance costs 7 049
Lease payment 26 037
Year 3 Depreciation 19 131
Finance costs 3 772
78 112 78 112
Comment
¾ Deferred tax arises as a result of the difference between the accounting expenses (depreciation and
finance costs) and the deductions (lease payments net of VAT) that are allowed for tax purposes.
continued
Leases 671
Using a normal income tax rate of 28%, the balance on the deferred tax account at the end of the
first year arising from this transaction will be calculated as follows:
R R R
Lease liability* (8 609 × 2/3)** (46 993)* (5 739)** (41 254)
Right-of-use asset (57 391 × 2/3) 38 261 – 38 261
Deductible temporary difference (2 993)
Deferred tax asset at 28% 838
* Includes VAT, since the VAT is also being financed.

Comment
¾ The tax base of a liability is computed as the carrying amount of the liability (R46 993) less future
tax deductions. It implies that the tax base would be that portion of the carrying amount that would
not be deductible for tax purposes in future. The lessee was granted an input VAT of R8 609 upon
entering into the lease. SARS will not allow the lessee an income tax deduction on this amount as
well. It follows that R5 739 (R8 690 × 2/3, as payments are equal) would not be deductible for tax
purposes in future.
** If the asset in the example is not applied to make taxable supplies, the lessee will not be able
to claim the R8 609 as an input credit for VAT purposes and the asset will be capitalised at
R66 000. This will result in an annual depreciation charge of R22 000 and the full payments of
R28 907 will be deductible annually for income tax purposes. Deferred tax will then be determined
as follows:
R R R
Lease liability (46 993) – (46 993)
Leased asset (66 000 × 2/3) 44 000 – 44 000
Deductible temporary difference (2 993)
Deferred tax asset at 28% 838
23.8.7 Instalment sale agreements: From the purchaser’s perspective

IFRS 16 effectively also deals with the accounting treatment of instalment sale agreements
(‘hire purchase’ contracts or ISAs). Legally, the ownership of an asset acquired under an
ISA is transferred from the seller to the purchaser on payment of the last instalment. Unlike
a lease transaction, an initial payment (deposit) is required and a maximum repayment
period for the agreement is statutorily determined. Moreover, in the case of an ISA there is
no doubt as to the intention of both parties: the purchaser has the intention to obtain
ownership, and the seller to sell the asset concerned.
The accounting treatment of instalment sales is similar to that for leases (lessees not
electing the simplified measurement requirements), but there is a difference in the tax
position. If the asset is applied to make taxable supplies, the purchaser can claim a tax
allowance (wear-and-tear) on the cash price of the asset, while finance costs, in accordance
with the Income Tax Act, are deductible as they are incurred (as opposed to the full lease
payment as noted in section 23.8.5 above). Finance costs are deductible on a reducing
basis by applying the effective interest rate. Consequently, the only timing difference that
might arise is where the entity’s depreciation policy differs from the tax allowance allowed by
the SARS.
Example 23.
23.22 Accounting and tax treatment of an ISA
The following are the details of an instalment sales agreement (‘ISA’ or ‘hire purchase’) concluded
by Alfa Ltd (purchaser-lessee):
Cash selling price of the asset: R165 800
Deposit, payable immediately: 25%
Three instalments of R50 000 each are payable annually in arrears. No initial direct costs have
been incurred by the lessor or the lessee.
Alfa Ltd earns income of R100 000 per annum before taking into account any aspects related to
the ISA. The normal income tax rate is 28% and a tax allowance of 331/3% on cost is allowed
annually. Depreciation is calculated at 25% on cost.
It can be shown that the interest rate implicit in the agreement is 10%. The initial payment
(deposit) amounts to R165 800 × 25% = R41 450.
PV = – 124 350 (165 800 – 41 450); PMT = 50 000; n = 3; Comp i = 10%
Amortisation table
Outstanding
Year Lease payment Interest Capital
balance
R R R R
165 800
1 Deposit 41 450 41 450 124 350
1 50 000 12 430 37 570 86 780
2 50 000 8 675 41 325 45 455
3 50 000 4 545 45 455 –
191 450 25 650 165 800
Year 1 Year 2 Year 3 Year 4
R R R R
Profit before depreciation
and interest 100 000 100 000 100 000 100 000
Depreciation and interest (53 880) (50 125) (45 995) (41 450)
Depreciation
(25% × 165 800) 41 450 41 450 41 450 41 450
Finance costs (above) 12 430 8 675 4 545 –

Movement in temporary
differences # (13 817) (13 817) (13 816) 41 450
Movement in temporary
differences may be broken down
as follows:
Depreciation 41 450 41 450 41 450 41 450
Tax allowance
(165 800/3) (55 267) (55 267) (55 266) –
Taxable income 32 303 36 058 40 189 100 000
The interest component is treated similarly for both accounting and tax purposes.
R R R R
Current tax at 28% 9 045 10 096 11 253 28 000
continued
Leases 673
Deferred tax on asset (no deferred tax arises in respect of the liability)
R R R R
Carrying amount 124 350 82 900 41 450 –
Tax base 110 533 55 266 – –
Taxable temporary differences 13 817 27 634 41 450 –
Deferred tax balance at 28%
(SFP) (3 869) (7 738) (11 606) –
Income tax expense
(deferred) (P/L) 3 869 3 869 3 868 (11 606)
Comment
¾ The liability in respect of the ISA is not tax deductible and therefore its carrying amount is equal to
its tax base. (Carrying amount – Rnil = Carrying amount.) Since the instalment is not tax
deductible as in the case with a ‘normal’ lease, the VAT treatment is simpler in this case. The
interest is the same for both accounting and tax, and is deductible in both cases.
¾ For the asset acquired, the depreciation is written off at 25% per annum, giving a carrying
amount of R124 350 (165 800 × ¾) at the end of year 1.
¾ The tax base of the asset is the amount deductible for tax purposes in future and is R110 533
(R165 800 × 2/3 (tax allowance of 331/3%)) at the end of year 1.
#
The movement in temporary differences is calculated on the statement of financial position
approach; refer to the deferred tax calculation.
Year 1: Rnil – R13 817 = (R13 817)
Year 2: R13 817 – R27 634 = (R13 817)
Year 3: R27 634 – R41 450 = (R13 816)
Year 4: R41 450 – Rnil = R41 450
The finance costs for tax purposes are deducted in accordance with the effective interest method
in terms of the Income Tax Act.
Journal entries
Dr Cr
R R
Year 1
Asset (SFP) 165 800
ISA liability (SFP) 165 800
Recognition of asset acquired through instalment sale agreement
Bank (SFP) 41 450
Deposit made under instalment sale agreement
Recognition of depreciation on asset
Finance costs (P/L) 12 430
Bank (SFP) 50 000
Allocating payment made between interest and capital repaid
Tax owing/SARS (SFP) 9 045
Current tax in respect of instalment sale agreement
Deferred tax in respect of instalment sale agreement
Comment
¾ The balance of the deferred tax account will be utilised in full in Year 4.
23.8.8 Presentation
A lessee shall present and disclose right-of-use assets (excluding right-of-use assets
classified as investment property) separately from other assets and lease liabilities
separately from other liabilities, either in the statement of financial position, or in the notes.
If a lessee does not present these items separately in the statement of financial position, it
shall disclose which line items in the statement of financial position include each of them.
Right-of-use assets not presented separately in the statement of financial position shall be
included in the same line item within which the underlying assets would have been
presented, if they were owned by the lessee, for example, if the underlying asset would
have been classified as property, plant and equipment if it was owned (and not leased), the
lessee shall present the underlying asset within the property, plant and equipment line item.
However, right-of-use assets that meet the definition of investment property shall never be
presented separately in the statement of financial position, but always presented as part of
A lessee shall present the interest expense (on the lease liability) separately from the
depreciation charge (for the right-of-use asset) in the statement of profit or loss and other
Interest expense on the lease liability is a component of the finance costs line item, which
IAS 1 requires to be presented separately in the statement of profit or loss and other
Statement of cash flows
In the statement of cash flows, a lessee shall classify:
cash payments for the principal portion of the lease liability within financing activities;
cash payments for the interest portion of the lease liability applying the requirements in
IAS 7 Statement of Cash Flow for interest paid (refer to chapter 5), meaning that, such
cash flows can either be presented separately as cash flows from operating activities or
cash flow from financing activities, depending on the guidance of IAS 7; and
short-term lease payments, payments for leases of low value assets and variable
lease payments not included in the measurement of the lease liability (e.g. contingent
rentals) within operating activities.
23.8.9 Disclosure: The lessee and the purchaser (ISA)

The objective of the disclosure requirements for lessees is to disclose information that will
give a basis for users of financial statements to assess the effect that leases have on the
financial position (SFP), financial performance (P/L) and cash flows of the lessee. To meet
this objective, the lessee should also consider, amongst others, whether additional
information needs to be disclosed. In making this assessment, the lessee shall consider
whether such disclosures would be relevant to users of its financial statements, for example,
would additional disclosure help users to better understand the flexibility provided by leases,
the restrictions imposed by leases, and the exposure to other risks arising from leases.
IFRS 16 further requires a lessee to disclose information about its leases in a single note or
separate section in its financial statements. However, a lessee is not required to duplicate
information that is already presented elsewhere in the financial statements, provided that the
information is cross-referenced to the single lease note or separate lease section.
In terms of IFRS 16.53 to .60, the lessee shall disclose the following amounts in a tabular
format (unless another format is more appropriate):
(a) the depreciation charge for right-of-use assets by class of underlying asset;
(b) the interest expense on lease liabilities;
Leases 675
(c) for short-term leases where the recognition exemptions were elected:
i. the fact that the recognition exemptions were elected;
ii. the expense relating to such short-term leases (this expense need not include the
expense relating to leases with a lease term of one month or less);
iii. the amount of its lease commitments for such short-term leases if its portfolio of
short-term leases, to which it is committed at the end of the reporting period, is
dissimilar to the portfolio of short-term leases to which the disclosed short-term
lease expense relates;
(d) for low value asset leases where the recognition exemptions were elected:
i. the fact that the recognition exemptions were elected;
ii. the expense relating to such low value assets (this expense need not include the
expense relating to low value assets already disclosed under short-term leases
above – only disclose once);
(e) the expense relating to variable lease payments not included in the measurement of
lease liabilities, for example contingent rentals;
(f) income from subleasing right-of-use assets;
(g) total cash outflow for leases (i.e. the sum of all the different ‘activities’ included in the
statement of cash flows);
(h) additions to right-of-use assets;
(i) gains or losses arising from sale and leaseback transactions; and
(j) the carrying amount of right-of-use assets at the end of the reporting period by class of
underlying asset. Consequently, IFRS 16 does not require the separate disclosure of the
cost and accumulated depreciation of right-of-use assets.
As noted above, if a right-of-use asset meets the definition of investment property, it should
not be presented or disclosed separately from other investment property, therefore the
lessee shall apply the disclosure requirements in IAS 40 to such right-of-use assets and it is
not required to provide the disclosures in paragraph 53(a) (depreciation), (f) (income from
subleasing), (h) (additions) or (j) (carrying amount) for such right-of-use assets.
If a lessee measures right-of-use assets at revalued amounts (applying IAS 16), the lessee
shall disclose the information related to revalued assets required by IAS 16 for such
revalued right-of-use assets.
In addition to the above, a lessee shall also disclose a maturity analysis of its lease
liabilities in terms of IFRS 7 Financial Instruments: Disclosures separately from the maturity
analyses of other financial liabilities. IFRS 7.39 and .B11 does not require specific time
bands (payable within 1 year, two to five years, etc.) to be presented. However, and entity
should use its judgement to determine an appropriate number of time bands.
Furthermore, IAS 1 Presentation of Financial Statements, requires that the lease liability
(capital amount outstanding) be split into its non-current and current portions (payable within
one year). Note that IAS 7 Statement of Cash Flows requires disclosure that enable users of
financial statements to evaluate changes in liabilities arising from financing activities.
IAS 7basically require a reconciliation of the lease liability between the opening and closing
balances (IAS 7.44A-44E).
The following example illustrates some of the basic quantitative IFRS 16 disclosures.
Comparatives, although required by IAS 1, are not illustrated. This example also assumes
that the lessee elected to present right-of-use assets separately from other assets in the
statement of financial position, meaning that, it does not provide cross-references to other
asset notes.
Example 23.
23.23 Disclosure of leases (or instalment sale agreements) – lessee
Refer to the information in Example 23.16. The notes of Ricon Ltd for the year ended
31 December 20.13 could be presented as follows: (This example only shows current year
information. Comparative amounts required by IAS 1 are not illustrated.)
Ricon Ltd
1. Leases
1.1 Right-of-use assets:
Machine Total
R R
Carrying amount at the start of the period (166 315 – 33 263) 133 052 xx xxx
Depreciation ((133 052 + 79 469)/7) (30 360) (xx xxx)
Additions – xx xxx
Adjustments for lease reassessments 79 469 xx xxx
Adjustments for lease modifications – xx xxx
Total 182 161 xx xxx
1.2 Lease liability:
20.13
R
Opening balance (166 315 – 26 705) 139 610
New leases entered –
Adjustments for reassessments 79 469
Repayments of capital (23 092)
Interest accrued 21 908
Payment made (45 000)

Long-term portion presented under non-current liabilities 170 586
Short-term portion presented under current liabilities 25 401
On 1 January 20.13 Ricon Ltd reassessed the lease agreement and came to the conclusion that it
was now reasonably certain that it would exercise the option to extend the lease at the end of the
lease term for a further three years (in additional to the remaining four years of the lease
agreement. The interest rate implicit in the lease on 1 January 20.13 was 10% (a general
descriptive of the reassessment of the lease liability would improve the users’ understanding of
the lease).
Maturity analysis of lease payments to be paid at the reporting date:
20.13
R
Future lease payments (undiscounted)
(time bands based on entity’s own judgment; assumed that Ricon Ltd decided
to present information for the next three years separately and the total thereafter)
– For 20.14 45 000
– For 20.15 45 000
– For 20.16 45 000
– Remaining years (20.17, 20.18 and 20.19: R45 000 × 3 years) 135 000
Total future lease payments 270 000
Total future finance costs*(Total R95 921 in amortisation table – R21 908 for 20.13) (74 013)
Lease liability* 195 987
* Please note: Strictly speaking, this information is not necessarily required by IFRS 16, but is
shown here so that the subtotals tie up with amounts presented on the face of the statement of
financial position.
continued
Leases 677
1.3 Potential future lease payments relating to periods following the exercise date of
termination options are summarised below:
Lease Payable Payable Total
liabilities during during
recognised 20.xx–20.xx 20.xx
(discounted) (undiscounted)
R R R R
Business segment
Brand A xxx xxx xxx xxx
Brand B xx xxx xx xxx xx xxx xx xxx
Total xx xxx xx xxx xx xxx xx xxx
1.4 Income and expenses related to leases
R
Income
Income from subleasing right-of-use assets xxx xxx
Gain from sale and leaseback xxx xxx
Expenses
Variable lease payments xx xxx
Short-term lease expense – recognition exemption xx xxx
Low value lease expense – recognition exemption xx xxx
Ricon Ltd elected the recognition exemption on short-term leases of office equipment and low
value leases of office furniture.
1.5 Total cash outflows relating to leases
R
Presented under financing activities
Cash payments for principal portion of lease liabilities 23 092
Presented under operating activities
Cash payments for interest portion of lease liabilities 21 908
Cash payments for short-term leases xx xxx
Cash payments for low value leases xx xxx
Cash payments for variable lease payments xx xxx
Total cash outflow relating to leases xxx xxx
2. Finance cost
R
Finance cost on financial liabilities 21 908
Finance cost on lease liabilities xx xxx
Other finance cost xx xxx
Borrowing cost capitalised (xx xxx)
Finance cost recognised in profit or loss xxx xxx
Borrowing cost has been capitalised to qualifying assets using a capitalisation rate of x,xx% p.a.
The portfolio of short-term leases to which Ricon Ltd is committed at the end of
31 December 20.13 is similar to the portfolio of short-term leases expenses recognised during the
year.
IFRS 16 also requires disclosure of ‘additional qualitative and quantitative information’

about an entity’s leasing activities necessary to meet the disclosure objective of the
Standard. This would include, but is not limited to, the following:
the nature of the lessee’s leasing activities;
future cash outflows to which the lessee is potentially exposed that are not reflected in
the measurement of lease liabilities, for example, exposure arising from variable lease
payments (IFRS 16.B49), extension and termination options (IFRS 16.B50), residual
value guarantees (IFRS 16.B51) and leases not yet commenced but to which the lessee
is already committed;
restrictions imposed by leases; and
sale and leaseback transactions (IFRS 16.B52).
The IFRS 16 references provided in brackets above provide additional information that the
lessee needs to disclose to satisfy the disclosure objective of this Standard.
23.9 Lessors
IFRS 16 defines a lessor as an entity that provides the right to use an underlying asset for a
period of time in exchange for consideration. A lessor shall classify each of its leases as
either an operating lease or a finance lease.
23.9.1 Classification of leases

Lease classification is made at inception date. This classification depends on the
substance of the transaction rather than the legal form of the contract. As noted at the
beginning of this chapter, a lease is classified as a finance lease if it transfers substantially all
the risks and rewards incidental to ownership of an underlying asset, while an operating
lease is a lease that does not transfer substantially all the risks and rewards incidental to
ownership of an underlying asset. For the sake of the classification of a lease, risks include
the possibilities of losses from variations in return because of changing economic
conditions, and rewards may be represented by the expectation of profitable operations
through the use of the underlying asset over its economic life.
The classification of a lease may require judgement to be exercised. The following are
examples of situations that individually or in combination would normally lead to a lease
being classified as a finance lease (IFRS 16.63):
the lease transfers ownership of the underlying asset to the lessee at the end of the
lease term;
the lessee has the option to purchase the underlying asset at a price that is expected to
be sufficiently lower than the fair value at the date the option becomes exercisable, for it
to be reasonably certain, at the inception date, that the option will be exercised;
the lease term is for the major part of the economic life of the underlying asset, even if
title is not transferred;
at the inception date, the present value of the lease payments amounts to at least
substantially all of the fair value of the underlying asset; and
the underlying asset is of such a specialised nature that only the lessee can use it
without major modifications.
The following indicators of situations could, individually, or in combination, also lead to a
lease being classified as a finance lease (IFRS 16.64):
if the lessee can cancel the lease, the lessor’s losses associated with the cancellation
are borne by the lessee;
gains or losses from the fluctuation in the fair value of the residual values accrue to the
lessee (e.g., in the form of a rent rebate payable to the lessee equalling most of the sales
proceeds at the end of the lease); and
the lessee has the ability to continue the lease for a secondary period at a rent that is
substantially lower than market rent.
Leases 679
Lease classification is reassessed only if there is a lease modification. Changes in

estimates, for example a change in the residual value estimate of an underlying asset or
changes in circumstances, for example default by the lessee, will not give rise to a new
lease classification.
The most important differences between operating leases and finance leases can be
summarised as follows:
Area of difference Operating lease Finance lease
Payments Not directly related to cost Recover cost and interest
Term Usually shorter than economic life Approximates economic life
Renewal Negotiable Usually a nominal purchase option
Cancellation Negotiable Usually not cancellable
Ownership With the lessor Usually transfers at the end of the
lease term to the lessee
Maintenance Usually borne by the lessor Usually borne by lessee
Example 23.
23.24 Classification as finance or operating lease
Chelsea Ltd (lessor) leased a manufacturing machine to Zoe Ltd (lessee). The fair value of this
machine is R125 000 on the signing of the lease agreement.
The lease agreement contained the following clauses:
Zoe Ltd would pay Chelsea Ltd 20 six-monthly instalments of R10 000 each, payable in arrears,
and during the period, Zoe Ltd would be responsible for the maintenance and repair of the
machine.
Ownership of the machine will not be transferred to Zoe Ltd at the end of the lease period.
The nature of the machine is such that only Zoe Ltd can use it without making substantial
adjustments to the machine.
The expected economic life of the machine at inception of the lease is 10 years.
A loan with a similar term to acquire a similar asset will bear interest at a nominal rate of 10% per
annum.
In terms of IFRS 16, it should be determined whether substantially all the risks and rewards
incidental to ownership of the underlying asset transfers to the lessee to determine if the lease
agreement should be classified as an operating or a finance lease in the records of the lessor.
Although ownership of the asset does not transfer to the lessee at the end of the lease, the following
examples of situations, both individually or in combination, would normally lead to the lease being
classified as a finance lease:
The lease term of 10 years equals the expected economic life of the underlying asset.
The underlying asset is of a specialised nature and can only be used by Zoe Ltd.
At inception date, the present value of the lease payments is R124 622 (PV if PMT = 10 000,
n = 20, i = 10% (2 P/YR), FV = 0). This is very close to the fair value of R125 000 at this date.
Zoe Ltd also carries the risk of repairs and maintenance of the asset.
Based on the above, the lease is classified as a finance lease in the records of Chelsea Ltd in
terms of IFRS 16.61–63.
23.9.2 Land and buildings

Leasing of land and buildings requires a lessor to assess how the land and building
elements are to be classified, based on the criteria contained in paragraphs 62 to 66 and
B53 to B54 of IFRS 16. In determining whether the land element is an operating or finance
lease, the fact that land normally has an indefinite economic life is an important
consideration.
If ownership of both the land and buildings elements is expected to be transferred to the
lessee at the end of the lease term, each of these elements would be classified as a finance
lease. Where a lease of land and buildings is for, say, a 20-year period, and ownership is
not transferred to the lessee at the end of the lease term, the land would normally be
classified as an operating lease and the buildings may be classified as a finance lease in
the records of the lessor. The lessor shall then allocate lease payments (including any
lump-sum upfront payments) between the land and buildings elements in proportion to the
relative fair values of the leasehold interests in the land element and buildings element
of the lease at inception date. In other words, the allocation of the lease payments is
weighted to reflect their role in compensating the lessor (and not by reference to the relative
fair values of the underlying land and buildings itself).
If this allocation cannot be reliably done, the lease will be classified as a finance lease,
unless it is clear that both elements are operating leases, in which case the entire lease is
classified as an operating lease.
If the amount allocated to the land element is immaterial, then the lessor may treat the land
and buildings as if they were a single unit for the purpose of lease classification and classify
that lease as either an operating lease or finance lease, based on the classification of the
buildings element, applying the criteria for classification of leases contained in IFRS 16. In
these situations, the economic life of the buildings will be deemed to be the economic life of
the entire underlying asset.
Example 23.
23.25 Land and buildings – finance and operating lease
Build Ltd (lessor) leases land and buildings on the first day of its financial year, for a period of 25
years, to Landon Ltd (lessee) at an annual rental of R200 000 (payable at the beginning of each
year). The carrying amount of the building is R800 000 (cost R1 000 000) and the carrying amount
of the land is R200 000. The buildings have an economic life of 30 years, and, since the lease
term is a major part of the economic life of the buildings, the lease of the buildings will be classified
as a finance lease. The land, on the other hand, has an indefinite economic life, resulting in its
classification as an operating lease. At inception date, the relative fair value of the leasehold
interest in the land is R288 000, and that of the buildings, R864 000. Assume an interest rate
implicit in the lease of 10% per annum for the finance lease.
The annual rental of R200 000 needs to be allocated between the land and buildings based on the
relative fair value of their respective leasehold interests. As a result, R50 000 (288 000/(288 000
+ 864 000) × 200 000) is allocated to the land and R150 000 (864 000/(864 000 + 288 000)
× 200 000) to the buildings.
The following journal entries illustrate the accounting treatment of the above land and buildings in
the records of Build Ltd for the year in which the transaction occurred (note that the detailed
accounting treatment of operating and finance leases are discussed in the sections below):
Dr Cr
Building component (finance lease) R R
Initial recognition:
Gross investment in finance lease (SFP) 3 750 000
Unearned finance income (SFP) 2 252 288
Profit on sale of asset (P/L) 697 712
Building – cost (SFP) 1 000 000
Initial recognition of the building component as a finance lease
Bank (SFP) 150 000
Gross investment in finance lease (SFP) 150 000
Recognition of first payment received for finance lease component
continued
Leases 681
Calculate the gross investment

150 000 × 25 = 3 750 000
Calculate the net investment
PMT = 150 000 (begin), n = 25, I = 10%, FV = 0,
thus PV = 1 497 712
Calculate the unearned finance income
3 750 000 – 1 497 712 = 2 252 288
Dr Cr
R R
Land component (operating lease)
Bank (SFP) 50 000
Income received in advance (SFP) 50 000
Recognition of first payment received for operating lease component
Accounting treatment at the end of the year:
Building component (finance lease)
Unearned finance income (SFP) 134 771
Finance income (P/L) (1 497 712 – 150 000) × 10% 134 771
Interest accrued for first year on net investment in lease
Land component (operating lease)
Recognition of operating lease income for first year
For the sake of simplicity, VAT has been ignored in this example. In practice, however,
special attention is paid to the treatment of VAT, as the lease agreement is viewed as a
single unit for VAT purposes. Depending on whether the agreement qualifies as an
instalment credit agreement for VAT purposes, VAT will either be levied at commencement
of the agreement or on each individual instalment, which will affect the amount of input VAT.
Example 23.
23.26 Operating lease on land and buildings
Pyxis Ltd (lessor) leases a property with a factory building on it to Vela Ltd (lessee) for a period of
four years. The lease agreement is viewed in terms of IFRS 16 as an operating lease, as the
ownership of the property and factory building is not transferred to Vela Ltd at the end of the lease
agreement, and the lease period is substantially shorter than the useful life of the land (indefinite)
and the factory building (30 years).
In terms of IAS 40, the property is classified as investment property if it is held with the aim of
generating income or held for capital appreciation; rather than held for own use or for sale in the
normal course of business. The above land and building will therefore be classified as an
investment property in the records of the lessor. It will be measured and recognised in terms of the
requirements of IAS 40.
23.9.3 Finance leases: recognition and measurement

At commencement date, the lessor shall recognise assets held under a finance lease
according to the net investment method, which means that such assets are presented as
receivables equal to the net investment in the leases. The net investment (NI) in the lease
is defined as the gross investment in the lease discounted at the interest rate implicit in the
lease, resulting in the present value of the gross investment. This method aims to allocate
the finance income earned by the lessor on a systematic and rational basis over the lease
term. The allocation is made on the basis of the pattern that reflects the constant periodic
rate of return of the lessor’s net investment in the lease.
The gross investment (GI) in the lease is the sum of:

the lease payments (LP) receivable by a lessor under a finance lease (note that any
guaranteed residual value (GRV) is included in the definition of ‘lease payments’); and
that portion of the residual value of the underlying asset of which the realisation by a
lessor is not assured or is guaranteed solely by a party related to the lessor (i.e., the
unguaranteed residual value (URV) accruing to the lessor).
It should be noted that the unguaranteed residual value is only recognised in the lessor’s
records, but never in the lessee’s records. The unguaranteed residual value is however
used to calculate the interest rate implicit in the lease which the lessee also uses. The
unguaranteed residual value is the estimated selling price of the underlying asset at the end
of the lease term – the amount that the lessor expects to recover at the end of the lease
term if he sells the asset, either to the current lessee or to a third party. Therefore, if there
is an unguaranteed residual value, the implication is that the asset will be returned by
the lessee to the lessor at the end of the lease term. The important aspect to remember
is that the lessor has no guarantee that this amount will be received – it is merely an
estimate.
As mentioned earlier, the interest rate implicit in the lease (IRI) is the rate of interest that
causes the present value of the:
lease payments; and
the unguaranteed residual value
to equal the sum of:
the fair value of the underlying asset; and
any initial direct costs of the lessor, for example legal costs and commissions in
negotiating and arranging a finance lease. The interest rate implicit in the lease is thus
defined in such a way that the initial direct costs are included automatically in the net
investment in the lease; there is thus no need to add it separately.
The difference between the gross investment and net investment in the lease is the
unearned finance income (UFI).
To summarise:
GI = LP (including GRV) + URV
NI = GI discounted at the IRI in the lease
UFI = GI – NI
Example 23.
23.27 Finance lease in the records of the lessor
A lessor entered into a finance lease agreement for equipment on the following terms:
The lease term of the finance lease is five years from 1 January 20.12, with equal fixed annual
instalments of R25 982 payable at the beginning of each year. Each instalment includes R2 000 for
maintenance costs. Maintenance will be incurred at the end of each year. There are no
guaranteed or unguaranteed residual values.
The lessor did not incur any initial direct costs.
The fair value of the equipment is R100 000, which is also the carrying amount of the equipment
in the lessor’s books (original cost R180 000). The estimated useful life of the equipment is five
years.
Calculate the interest rate implicit in the lease
(BGN; PV = – 100 000; n = 5; PMT = 23 982 (25 982 – 2 000); i = ?)
i = 10,001%
continued
Leases 683
Calculate the gross investment

(25 982 – 2 000) × 5 = 119 910 (no guaranteed or unguaranteed residual value)
Calculate the net investment
The present value of the annual instalment of R23 982 (payable in advance) at 10,001% over five
years is R100 000. This represents the net investment.
Calculate the unearned finance income
The unearned finance income is the difference between the gross investment of R119 910 and the
net investment of R100 000, namely R19 910.
Amortisation table
Maintenance Interest Outstanding
Date Payment Capital
cost (10,001%) balance
(a) (b) (c) (d) (e)
R R R R R
1 Jan 20.12 100 000
1 Jan 20.12 25 982 2 000 – 23 982 76 018
1 Jan 20.13 25 982 2 000 7 603 16 379 59 639
1 Jan 20.14 25 982 2 000 5 964 18 018 41 621
1 Jan 20.15 25 982 2 000 4 163 19 819 21 802
1 Jan 20.16 25 982 2 000 2 180 21 802 –
(a) Annual lease instalment resulting in a return of 10,001% on the net investment.
(b) Cost of services included in lease instalments to be removed.
(c) 10,001% on the prior balance in (e) except for 1 January 20.12. On 1 January 20.12, no
finance income has accrued and the instalment represents only a capital redemption.
(d) (a) minus (b) and (c) = capital redemption in instalment.
(e) The prior balance less (d).
Journal entries in the books of the lessor will be as follows:
Dr Cr
R R
1 January 20.12
Gross investment in finance lease (SFP) (see comment below) 119 910
Equipment – cost (SFP) 180 000
Initial recognition of finance lease
1 January 20.12
Bank (SFP) 25 982
Recognition of payment received for finance lease
31 December 20.12
Recognition of interest for the year
31 December 20.12
Maintenance costs recovered (P/L) 2 000
Recognition of maintenance income for the year
1 January 20.13
Bank (SFP) 25 982
Recognition of payment received for finance lease
The above process is repeated for the accounting treatment for the remaining three payments.
continued
Comment
¾ As an alternative to the first journal entry for the initial recognition of the lease, an entity may
only recognise the ‘net investment in the lease’ at the present value of R100 000 (instead of the
gross investment and unearned finance income). This method would require additional
workings to obtain the information needed for disclosure purposes.
Journal entries in the books of the lessee will be as follows:
Dr Cr
R R
1 January 20.12
1 January 20.12
Prepaid expenses (SFP) 2 000
Bank (SFP) 25 982
Recognition of lease payment
31 December 20.12
Finance costs accrued (SFP) 7 603
Recognition of interest for the year
31 December 20.12
Maintenance expenses (P/L) 2 000
Recognition of maintenance expense for the year
31 December 20.12
Depreciation (P/L) (100 000/5) 20 000
1 January 20.13
Bank (SFP) 25 982
Recognition of lease payment
The above process is repeated for the accounting treatment for the remaining three payments.
Example 23.
23.28 Finance lease where year end and lease payment dates differ (instalment
payable in arrears)
Canis Ltd (lessor) leases equipment with a carrying amount of R220 000 (original cost R300 000)
to Ara Ltd in terms of a lease agreement that is classified as a finance lease for accounting
purposes. Canis Ltd has a 30 June year end.
The terms of the lease agreement are as follows:
The agreement was signed by both parties on 1 January 20.12 and Ara Ltd started using the
equipment on this date.
Ara Ltd will pay seven lease payments of R50 000 annually in arrears on 31 December to
Canis Ltd. The present value of the gross investment in the lease on 1 January 20.12 is
R250 000. There is no guaranteed or unguaranteed residual value. Canis Ltd did not incur any
initial direct costs.
continued
Leases 685
Assume that the terms of the agreement are market-related.

The asset has an estimated useful life of seven years and no residual value. The lessee expects
to use the equipment evenly over the useful life.
The accounting treatment in the books of the lessor is as follows:
Dr Cr
R R
Gross investment in finance lease (SFP) (50 000 × 7) 350 000
Unearned finance income (SFP) (350 000 – 250 000) 100 000
Profit on sale of asset (P/L) 30 000
Comment
¾ With a finance lease, substantially all the risks and rewards incidental to ownership of the
underlying asset are transferred to the lessee. It implies that, in substance, the equipment was
‘sold’ to the lessee from the lessor’s perspective. Consequently, the lessor will recognise a
‘profit on the sale of an asset’ as the difference between the ‘selling price’ and its carrying
amount.
30 June 20.12 (year end)
Calculation of interest rate implicit in lease:
PMT = 50 000, n = 7, PV = – 250 000, P/YR = 1, FV = 0
Finance income (P/L) (250 000 × 9,1961% × 6/12) 11 495
Recognition of interest for the first period of six months
Comment
¾ As the interest accrues on a time basis, the interest for 6 months between 1 January 20.12 and
30 June 20.12 is recognised on 30 June 20.12 (year end). When the unearned finance income
account is reduced by R11 495, the net investment in the lease (asset) increases by R11 495.
Accounting treatment when the first payment is made on 31 December 20.12:
Dr Cr
R R
31 December 20.12
Finance income for the remaining 6 months (1 July 20.12
to 31 December 20.12) is recognised on 31 December 20.12.
Bank (SFP) 50 000
Recognition of finance lease payment received
The above process is repeated for the accounting treatment for the remaining six payments.
Lessee:
If Ara Ltd’s depreciation policy is to depreciate equipment on the straight-line method and Ara Ltd
also has a 30 June year end, the journal entries by the lessee will be as follows:
1 January 20.12
continued
Dr Cr
R R
30 June 20.12
Finance costs (P/L) (250 000 × 9,1961% × 6/12) 11 495
30 June 20.12
Depreciation (P/L) ((250 000/7) × 6/12) 17 857
Example 23.
23.29 Finance lease where year end and lease payment dates differ (lease
payment payable in advance)
Pisces Ltd (lessor) leases equipment with a carrying amount of R220 000 (original cost R300 000)
to Pavo Ltd (lessee) in terms of a lease agreement that is classified as a finance lease for
accounting purposes. Pisces Ltd has a 30 June year end.
The terms of the lease agreement are as follows:
The agreement was signed by both parties on 1 January 20.12 and Pavo Ltd started using the
asset on this date.
Pavo Ltd will pay seven lease payments of R50 000, payable annually in advance on 1 January,
to Pisces Ltd. The fair value of the asset on 1 January 20.12 is R250 000.
There is no guaranteed or unguaranteed residual value and Pisces Ltd did not incur any initial
direct costs.
Assume that the terms of the agreement are market-related.
The asset has an estimated useful life of seven years and no residual value. The lessee expects
to use the equipment evenly over the useful life.
The accounting treatment in the books of the lessor is as follows:
Dr Cr
R R
Profit on sale of equipment (P/L) 30 000
Bank (SFP) 50 000
Recognition of lease payment received
Calculation of interest rate implicit in lease:
BGN, PMT = 50 000, n = 7, PV = – 250 000, FV = 0
continued
Leases 687
Comment
¾ As the finance income accrues on a time basis, the finance income for the 6 months between
1 January 20.12 and 30 June 20.12 is recognised on 30 June 20.12 (year end). When the
unearned finance income account is reduced by R12 978, the net investment in the lease
(asset) increases by R12 978.
Accounting treatment when the second lease payment is made on 1 January 20.13:
Dr Cr
R R
Finance income for the remaining 6 months (1 July 20.12 to
31 December 20.12) is recognised on 31 December 20.12.
Bank (SFP) 50 000
The above process is repeated for the accounting treatment of the remaining six lease payments.
If Pavo Ltd’s depreciation policy is to depreciate equipment on the straight-line method and
Pavo Ltd also has a 30 June year end, the journal entries made by the lessee will be as follows:
Dr Cr
R R
1 January 20.12
Bank (SFP) 50 000
Recognition of lease payment made
30 June 20.12
Finance costs (P/L) (200 000 × 12,978% × 6/12) 12 978
Depreciation (P/L) ((250 000/7) × 6/12) 17 857
Example 23.
23.30 Accounting treatment of initial direct costs
On 1 January 20.13, Virgo Ltd (lessee) leased a machine with a fair value of R100 000 (which is
also the carrying amount of the machine in the books of Libra Ltd (lessor); original cost: R180 000)
from Libra Ltd for a period of three years. There is no guaranteed or unguaranteed residual value.
The annual lease payment is R40 211, payable in arrears. Initial direct costs incurred by the
lessor, Libra Ltd, amounted to R5 000.
Taking the principle set out in IFRS 16.69 into account, it should be clear that the interest rate
implicit in the lease is the discount rate that would cause the present value of future lease
payments (R40 211 × 3) and the unguaranteed residual value (Rnil), to be equal to the sum of the
fair value of the lease asset (R100 000) and any initial direct costs of the lessor (R5 000).
continued
Using the above, the interest rate implicit in the lease is calculated as:
(PV = – (100 000 + 5 000); n = 3; PMT = 40 211; comp i = ?), thus i = 7,274%
Using the interest rate implicit in the lease, it can be established that the unearned finance income
on the transaction is the following:
R
Gross investment (40 211 × 3) 120 633
Net investment (n = 3; i = 7,274%; PMT = 40 211; PV = ?) (105 000)
Unearned finance income 15 633
Journal entries to account for the lease in the books of Libra Ltd at initial recognition (only):
Dr Cr
R R
Machinery í cost (SFP) 180 000
Bank (SFP) (initial direct costs) 5 000
Comment
¾ The net investment in the lease is measured at R105 000 [(120 633 – 15 633) or (100 000 +
5 000)], representing the fair value of the asset (100 000), plus the initial direct cost incurred by
the lessor (5 000).
23.9.3.1 Lease payments

The lease payments included in the measurement of the net investment in the lease at
commencement date comprise the following payments for the right to use the underlying
asset during the lease term:
(a) fixed payments (including in-substance fixed payments), less any lease incentives
payable;
(b) variable lease payments that depend on an index or a rate, for example CPI or linked to
JIBAR, initially measured using the index or rate as at the commencement date;
(c) any residual value guarantees provided to the lessor by the lessee, a party related to the
lessee or a third party unrelated to the lessor that is financially capable of discharging
the obligations under the guarantee;
(d) the exercise price of a purchase option if the lessee is reasonably certain to exercise
that option; and
(e) payments of penalties for terminating the lease, if the lease term reflects the lessee
exercising an option to terminate the lease.
Lease payments (a), (b), (d) and (e) above are similar for the lessee and the lessor.
However, as noted earlier, residual value guarantees (c), included in the measurement of
the net investment in the lease (lessor) comprises both guaranteed and unguaranteed
residual values. The lessee will only include guaranteed residual values as a lease payment
in the measurement of the lease liability (lessee).
Refer to section 23.8.2.3 for a discussion on in-substance fixed payments, variable lease
payments that depend on an index or a rate, and variable lease payments not based on an
index or a rate. Section 23.8.2.3 discusses these lease payments from the lessee’s point of
view, but as noted above, these lease payments are similar for the lessee and the lessor.
Residual values included in the measurement of net investment will be discussed next.
Leases 689
23.9.3.2 Residual values

IFRS 16 identifies two types of residual values: the guaranteed residual value and the
unguaranteed residual value. Both residual values shall be taken into account in determining
the interest rate implicit in the lease as it is calculated from the lessor’s perspective.
In terms of IAS 16.77, estimated unguaranteed residual values must be reviewed regularly.
If there has been a reduction in this amount, the allocation of the finance income over the
lease term must be revised. Any reductions in finance income must be recognised
immediately as a change in accounting estimate. This implies that the amortisation table of
the lessor will have to be re-prepared as if the unguaranteed residual value had been
estimated at the lower amount at the inception of the lease. This adjustment relates only to
the lessor and not the lessee. This paragraph further implies that any increases in the
unguaranteed residual value are ignored.
Example 23.
23.31 Accounting for a lease that contains both a guaranteed and an
unguaranteed residual value
Case 1
Assume that the cash selling price of an asset is R50 000 and the lease agreement includes a
guaranteed residual value of R5 000 that will be received at the end of the lease term, together
with the last lease payment. There are three lease payments of R20 459 each, payable annually in
arrears. There is no unguaranteed residual value and the lessor did not incur any initial direct
costs. The lessee has knowledge of this. The carrying amount of the asset in the lessor’s books
was R50 000 (original cost R100 000). The lessor is not a manufacturer/dealer.
The interest rate implicit in the lease is calculated as follows (and both the lessee and lessor will
use this rate):
PV = – 50 000; FV = 5 000 + 0 = 5 000; PMT = 20 459; n = 3; i = ? Thus i = 15%.
The amortisation table will be as follows:
Capital
payment (15%) balance
R R R R
50 000
Year 1 20 459 7 500 12 959 37 041
Year 2 20 459 5 556 14 903 22 138
Year 3 20 459 3 321 17 138 5 000
5 000 – 5 000 –
16 377 50 000
Both the lessee and lessor will use the above amortisation table to account for the lease
transaction. Assume the lessee did not elect the recognition exemption and elected to recognise
the underlying asset and liability.
Case 2
Assume that all the information above still applies but now the lessor estimates that there will be
an unguaranteed residual of R2 000 at the end of the lease term.
The interest rate implicit in the lease will be calculated as follows:
PV = – 50 000; FV = 5 000 + 2 000 = 7 000; n = 3, PMT = 20 459; i = ? Thus i = 16,5%. Since the
lessor will be receiving an additional amount of R2 000 (estimated), the return on the investment
will be higher, as reflected by the interest rate implicit in the lease, which is now 16,5% compared
to 15% above.
continued
As the lessee has knowledge of the unguaranteed residual value (and any initial direct costs
incurred by the lessor, if applicable) the interest rate implicit in the lease, calculated at 16,5%, can
now be used to determine the present value of the lease payments that are not paid at the
commencement date. If the lessee did not have knowledge of the unguaranteed residual value
and any initial direct costs incurred by the lessor, if applicable, the lessee would need to use its
own incremental borrowing rate to calculate the present value of the lease payments not paid at
that date (refer to Example 23.12).
At commencement date, the lessee will account for the above lease at the present value of the
lease payments not paid at that date using the interest rate implicit in the lease.
‫ ׵‬PV = R48 737
(PMT = – R20 459; FV = – R5 000 (only guaranteed residual value); n = 3; i = 16,5%; PV = ?)
The amortisation table of the lessee using 16,5% will be as follows:
payment Capital
(16,5%) balance
R R R R
48 737
Year 1 20 459 8 042 12 417 36 320
Year 2 20 459 5 993 14 466 21 854
Year 3 20 459 3 605 16 854 5 000
17 640 43 737
Journal entries for the lessee for Year 1: Dr Cr

R R
Bank (SFP) 20 459
Recognition of lease payments
Depreciation (P/L) (48 737/3) (assumed used evenly) 16 245
The amortisation table of the lessor using 16,5% will be as follows:
Capital
payment (16,5%) balance
R R R R
50 000
Year 1 20 459 8 251 12 208 37 792
Year 2 20 459 6 236 14 223 23 569
Year 3 20 459 3 890 16 569 7 000
18 377 43 000
Journal entries for the lessor for Year 1:

Dr Cr
R R
Gross investment in finance lease (SFP) ((3 × 20 459) + 7 000) 68 377
Asset – cost (SFP) 100 000
continued
Leases 691
Dr Cr
R R
Bank (SFP) 20 459
Recognition of interest on net investment in lease
Case 3
In terms of IFRS 16.77, the unguaranteed residual value must be reviewed regularly. Suppose that
after the receipt of the first lease payment, the unguaranteed residual value is revised to R1 000
due to new information that became available. In terms of this paragraph, the recognition of
finance income over the lease term by the lessor is revised, and any decrease in the amounts that
were previously recognised is accounted for immediately. The lessee will not be affected by any
change to the unguaranteed residual value.
This implies that the amortisation table of the lessor must be prepared as if the lower residual value had
been known from the inception of the lease.
The annual lease payment that is receivable by the lessor will still amount to R20 459 per year. The
lessor now needs to determine the required return on an investment of R50 000, repayable in three
annual lease payments of R20 459 each, with a guaranteed residual value of R5 000 and an
unguaranteed residual value of R1 000. This is calculated as 15,76% [PV = – 50 000; n = 3;
PMT = 20 459; FV = 6 000 (1 000 + 5 000)]. The amortisation table is therefore redrafted accordingly.
Capital
payment (15,76%) balance
R R R R
50 000
Year 1 20 459 7 879 12 580 37 420
Year 2 20 459 5 896 14 563 22 857
Year 3 20 459 3 602 16 857 6 000
61 377 17 377 44 000
Before any adjustment to the unguaranteed residual value is made, the accounting records reflect
the following (refer to Case 2):
Gross investment in finance lease
Finance lease R68 377 Bank R20 459
Finance income (P/L)
Unearned finance income R8 251
Asset – cost
Opening balance R100 000 Finance lease R100 000
Unearned finance income
Finance income R8 251 Finance lease R18 377
The balances in the general ledger accounts are therefore:
R
Gross investment in finance lease (68 377 – 20 459) 47 918
Unearned finance income (18 377 – 8 251) (10 126)
Net investment in the finance lease 37 792
continued
Should the unguaranteed residual value have been estimated at R1 000 from inception date, the
accounting records would have reflected the following:
Gross investment in finance lease
Finance lease R67 377 Bank R20 459
Finance income (P/L)
Unearned finance income R7 879
Asset
Opening balance R100 000 Finance lease R100 000
Unearned finance income
Finance income R7 879 Finance lease R17 377
The balances in the general ledger accounts should therefore have been:
R
Gross investment in finance lease (67 377 – 20 459) 46 918
Unearned finance income (17 377 – 7 879) (9 498)
Net investment in the finance lease 37 420
The balance on the unearned finance income account is therefore adjusted by R628
(10 126 – 9 498) to R9 498 and the balance in the gross investment in finance lease account is
adjusted by R1 000 (47 918 – 46 918). The following journal entry must be passed to effect these
changes:
Dr Cr
R R
Finance income (P/L) (balancing; or 8 251 – 7 879) 372
Unearned finance income (SFP) 628
Adjustment due to change in estimate of unguaranteed residual
value
The adjustment of R372 represents the effect of the change in estimate of the unguaranteed
residual value of R1 000. The effect of this on the finance income recognised in the current and
future years must be disclosed as required by IAS 8 (refer to chapter 6).
The new amortisation table will now be used for accounting purposes from this date forward.
Comment
¾ An aspect that is not dealt with in IFRS 16 is the accounting treatment of cases where the
unguaranteed residual value is estimated to have increased. Thus, if the unguaranteed residual
value had increased from R2 000 to R3 000, no cumulative/retrospective adjustments would be
made by the lessor.
Case 4
Assume that the cash selling price of an asset is R50 000 and there are three lease payments of
R20 459 each, payable annually in arrears. The lessee does not regard the asset as of a low
value. The asset will be returned to the lessor at the end of the lease term. Neither the lessor nor
lessee had incurred any initial direct costs. The lessee has knowledge of all the information from
the lessor. The carrying amount of the asset in the lessor’s books was R50 000 (original cost
R100 000). The lessor is not a manufacturer/dealer.
Under the lease agreement, the lessee has provided a residual value guarantee of R5 000 to the
lessor. In other words, the lessee guarantees to the lessor that the residual value of the underlying
asset will at least be R5 000 at the end of the lease term. If the lessor is unable to sell the
underlying asset for at least R5 000 at the end of the lease term, the lessee will pay any shortfall
to the lessor.
At the commencement date, the lessee did not expect to make a payment under the residual value
guarantee as the lessor reasonably expects to the sale the underlying asset for R7 000 in the
market at the end of the lease term.
continued
Leases 693
Application – lessor:
In terms of IFRS 16.70(c), the lessor shall include any residual value guarantees provided to it, in
its calculation of the net investment in the lease (at present value). The lessor expects to obtain
R7 000 at the end of the lease term (as a future value), of which R5 000 is guaranteed (GRV) and
the balance of R2 000 is unguaranteed (URV).
The interest rate implicit in the lease is calculated as follows by the lessor:
PV = – 50 000; FV = 5 000(GRV) + 2 000 (URV) = 7 000; n = 3, PMT = 20 459; i = ?
Thus i = 16,5%.
The amortisation table and the journal entries for the lessor will be same as in Case 2 above.
Application – lessee:
In terms of IFRS 16.27(c), the lessee shall include any amount expected to be payable under
residual value guarantees, in its calculation of the lease liability (at present value). The lessee
reasonably expects not to pay anything under this guarantee as the lessor expects to sell the
asset at price greater than the residual value guarantee in the market (i.e. and receive no amount
from the lessee).
The lessee calculate the initial measurement of the lease liability as follows:
i = 16.5%; FV = 0(GRV); n = 3, PMT = – 20 459; PV = ? Thus PV = 45 575.
The amortisation table of the lessee using 16,5% will be as follows:
Capital
payment (15%) balance
R R R R
45 575
Year 1 20 459 7 520 12 939 32 636
Year 2 20 459 5 385 15 074 17 562
Year 3 20 459 2 897 17 562 –
15 802 45 575
Comment
¾ A lessee should reasonably estimate the amount expected to be payable to the lessor under
residual value guarantees and included that amount in the initial measurement of the lease
liability.
¾ The amount that the lessee may have to pay can vary in response to movements in the value
of the underlying asset. In that respect, residual value guarantees are similar to variable lease
payments that depend on an index or a rate for the lessee (refer to section 23.8.3 for more
detail).
23.9.3.3 Interest rate changes

A finance lease may include an interest variation clause. When the interest rate implicit in a
finance lease agreement changes, resulting in a change in the finance lease payments
(although the net investment remains unchanged), it is necessary to do new calculations
from the date that this change takes place.
IFRS 16 is silent on the treatment of interest variations, but there is guidance in the
Standard regarding lease payments depending on variable interest rates from the lessee’s
perspective.
An increase in interest rates implicit in leases results in a change to the unearned finance
income and the change in lease payments results in a change to the gross investment. The
new lease payments discounted at the new interest rate implicit in the lease will be the same
as the capital outstanding (at present value) on the day of the interest rate change. The
procedure is the same as for lessees. The lessor will, however, make an entry in its
accounting records to adjust the gross investment and the unearned finance income on the
day of the rate change. If the interest rate implicit in the lease increased, both the gross
investment and the unearned finance income will increase. The opposite would be true if the
interest rate implicit in the lease decreased.
Example 23.
23.32 Change in interest rate (an increase)
Indus Ltd (lessor) entered into a finance lease agreement (containing a varying interest rate
implicit in the lease) with the following provisions:
Lease term: 3 years
Interest rate implicit in the lease (initial): 10%
Fair value (cash selling price) of the asset: R100 000
No initial direct costs were incurred.
Lease payments receivable annually in arrears R40 211
(n = 3; i = 10; PV = – 100 000; FV = 0; PMT = ?)
Taking the above information into account, it can be determined that the gross investment and
unearned finance income are the following:
Gross investment in finance lease (40 211 × 3) R120 633
Unearned finance income (120 633 – 100 000) R20 633
At the end of Year 1, the interest rate implicit in the lease contract changed to 12% and this resulted
in a new payment of R41 294 (n = 2; i = 12; PV = – 69 789 (calc 1 below); FV = 0; PMT = ?).
The journal entry is as follows:
Dr Cr
R R
Gross investment in finance lease (SFP) (calc 2) 2 166
Calculations
1. Amortisation table
Lease Outstanding
Interest Capital
payment balance
R R R R
Year 0 100 000
Year 1 (10%) 40 211 10 000 30 211 69 789
Year 2 (12%) 41 294* 8 375 32 919 36 870
Year 3 (12%) 41 294 4 424 36 870 –
* PV = – 69 789; n = 2; i = 12; PMT = ?; 41 294
2. Additional finance income
R
New gross investment beginning of Year 2 (41 294 × 2) 82 588
Old gross investment beginning of Year 2 (40 211 × 2) 80 422
New unearned finance income beginning of Year 2 (82 588 – 69 789) 12 799
Old unearned finance income beginning of Year 2 (80 422 – 69 789) 10 633
In both cases the difference is: 2 166
(82 588 – 80 422) and (12 799 – 10 633)
23.9.4 Subleases
In classifying a sublease, the intermediate lessor (also the lessee of the head lease) needs
to consider the following when classifying the sublease:
if the head lease is a short-term lease and the entity, as the lessee of the head lease,
elected the recognition exemption available to lessees, the sublease shall be classified
as an operating lease;
otherwise, the sublease shall be classified by reference to the right-of-use asset arising
from the head lease.
Leases 695
For a sublease that results in a finance lease, the intermediate lessor is not permitted to
offset the remaining lease liability (from the head lease) and the lease receivable (from the
sublease). The same is true for the lease income and lease expense relating to the head
lease and sublease of the same underlying asset.
As noted earlier, the head lease of a sublease does not qualify as a lease of a low value
asset.
In the case of a sublease, if the interest rate implicit in the sublease cannot be readily
determined, the intermediate lessor may use the discount rate used for the head lease
(adjusted for any initial direct costs associated with the sublease) to measure the net
investment in the sublease.
Example 23.33 Sublease of a property as an operating lease
Eagle Ltd (lessee) entered into a lease agreement with Bateleur Ltd (lessor) on 1 January 20.12,
whereby Eagle Ltd obtained the right to use an office building. Eagle Ltd’s year end is
31 December. The terms of the lease agreement are as follows:
Lease term: Ten years
Interest rate implicit in the lease 10% per annum
Present value of the annual lease payments: R800 000
Ownership of the underlying asset will not transfer to the lessee at the end of the lease term.
Eagle Ltd expects to use the office building evenly over its useful life (here the lease term).
On the same date, Eagle Ltd (as lessor) entered into a sub-lease agreement with Vulture Ltd
whereby the right to use the office building is transferred to Vulture Ltd. The terms of the lease
agreement are as follows:
Lease term: Four years
The sub-lease is correctly classified as an operating lease as the term for the sublease is not for
the major part of the term of the head lease. Substantially all the risks and rewards of the right-of-
use asset was not transferred.
Eagle Ltd accounts for its investment property at fair value. The fair value of Eagle Ltd’s leasehold
interest (right to use and sublease the office building) on 31 December 20.12 was R810 000.
Comment
¾ The right-of-use asset (IFRS 16.34) would be classified as an investment property, as it
represents a ‘property’ which are ‘held for rental’ (meeting the definition of an investment
property in terms of IAS 40.5). The investment property will be remeasured to fair value at
every reporting date. Consequently, depreciation on the right-of-use asset will not be
recognised.
¾ The investment property only represents the right to use and sublease the property and not the
full ownership of the property. Consequently, the fair value to be used should only be that of
this leasehold interest, and not the fair value of the actual property. Refer to IAS 40.50 for
guidance in measuring the fair value of such an investment property.
The journal entries to account for the head lease and the sublease are as follows:
Dr Cr
R R
continued
Dr Cr
R R
31 December 20.12
Finance cost (P/L) (800 000 × 10%) 80 000
Bank (SFP) 130 196
Recognition of annual head lease payments made
Investment property (SFP) (810 000 – 800 000) 10 000
Remeasurement of investment property to fair value
Bank (SFP) 140 000
Recognition of annual lease payment received under the sublease
Comment
¾ The lessee (under the head lease) shall continue to recognise its lease liability and payments
thereon separate from the income from the sublease.
¾ Payments received from the sublease (operating lease) shall be recognised on the straight-line
basis – refer to section 23.10.
Example 23.34 Sublease of a right-of-use asset as a finance lease
Kudu Ltd (lessee) entered into a lease agreement with Blesbok Ltd (lessor) on 1 January 20.12,
whereby Kudu Ltd obtained the right to use a machine. Kudu Ltd’s year end is 31 December. The
terms of the lease agreement are as follows:
Lease term: Four years
Interest rate implicit in the lease 10% per annum
On this date, the economic useful life of the machine is estimated at four years. Ownership of the
machine will not transfer to the lessee at the end of the lease term. Kudu Ltd expects to use the
machine evenly over its useful life.
The amortisation table for Kudu as the lessee will be prepared as follows:
Lease Outstanding
Interest Capital
payments balance
R R R R
158 493
Year 1 50 000 15 849 34 151 124 342
Year 2 50 000 12 434 37 566 86 776
Year 3 50 000 8 678 41 322 45 454
Year 4 50 000 4 546 45 454 –
41 507 158 483
Comment
¾ Kudu Ltd, as the lessee, will follow the normal principles of IFRS 16 and account for the right-
of-use asset and the lease liability. At the end of 20.12 (year 1), the carrying amount of the
right-of-use asset is R118 870 (158 493 × ¾) and the carrying amount of the lease liability is
R124 342 (refer to amortisation table above).
continued
Leases 697
Sublease:
On 1 January 20.13, the operations of Kudu Ltd changed and it longer required the use of the
machine leased from Blesbok Ltd. However, the lease could not be cancelled.
Kudu Ltd then entered into a finance lease agreement with Impala Ltd, whereby Impala Ltd will
lease the machine from Kudu Ltd for the remainder of the three years of the head lease. The terms
of the sublease agreement are as follows:
Lease term: Three years
Interest rate implicit in the lease 10,5% per annum
Comment
¾ The sublease is classified as a finance lease as the term for the sublease is for the major part
(all) of the remaining term of the head lease. Substantially all the risks and rewards of the right-
of-use asset was transferred to Impala Ltd.
¾ Consequently, Kudu will derecognise the right-of-use asset at its carrying amount and
recognise any difference between the lease receivable (present value of the sublease
payments) and the carrying amount of the right-of-use asset as a profit on the sale of an asset,
in profit or loss.
¾ However, Kudu Ltd will retain the lease liability (under the head lease) and will continue to
recognise the payments under the head lease (refer to the amortisation table above).
The amortisation table for Kudu Ltd (the lessor under the sublease agreement) will be prepared
as follows:
Lease Outstanding
Interest Capital
payments balance
R R R R
128 186
Year 1 52 000 13 460 38 540 89 646
Year 2 52 000 9 413 42 587 47 059
Year 3 52 000 4 941 47 059 –
27 814 128 186
Dr Cr
The journal entries to account for both leases are as follows: R R
1 January 20.13 (commencement date of sublease)
Gross investment in finance lease (SFP) (3 × 52 000) 156 000
Profit on the sale on an asset (P/L) 9 316
Initial recognition of sublease as finance lease and derecognition
of right-of-use asset from head lease
31 December 20.13
Bank (SFP) 50 000
Recognition of lease payments made under head lease
Bank (SFP) 52 000
Recognition of lease payment received under sublease
Recognition of interest on net investment in sublease
Comment
¾ The intermediate lessor (Kudu Ltd) is not permitted to offset the remaining lease liability (from the
head lease) and the lease receivable (from the sublease).
23.9.5 Lease modifications

A lessor accounts for the modification to a finance lease as a separate lease if both:
the modification increases the scope of the lease (adding the right to use one or more
underlying assets); and
the consideration for the lease increases by an amount commensurate with the stand-
alone price for the increase in scope and any appropriate adjustments to that price to
reflect the circumstances of the particular contract.
If the above criteria are not met, the lessor has to assess whether the modification would
have resulted in either an operating or a finance lease if it had been in effect at inception of
the lease:
If the lease would have been classified as an operating lease, the lessor accounts for the
modification as a new lease (operating lease) and the carrying amount of the underlying
asset that now has to be recognised (under a finance lease the lessor would have
derecognised the underlying asset at inception of the original finance lease) is measured
as the net investment in the original lease immediately before the lease modification.
If the lease would have been classified as a finance lease, the lessor shall apply the
requirements of IFRS 9 Financial Instruments.
23.9.6 Finance leases of a manufacturer or dealer lessor

When assets are sold by a manufacturer or dealer lessor, the lessor sells an asset that is
part of the inventories in its books and also provides financing for the transaction. A
transaction of this nature will result in the recognition of a profit or loss from the outright sale
transaction (as if the asset had been sold for cash) at commencement date, regardless of
whether the lessor transfers the underlying asset (as described in IFRS 15) as well as the
finance income earned from the financing provided to the purchaser of the asset (lessee).
The sales revenue is measured at fair value of the underlying asset, or if lower, the present
value of the lease payments accruing to the lessor, discounted using a market rate of
interest. The cost of sales is the cost, or carrying amount if different, of the underlying asset
less the present value of the unguaranteed residual value.
Costs incurred by manufacturer or dealer lessors in connection with obtaining a finance
lease are excluded from the definition of initial direct costs because they are mainly related
to earning the manufacturer or dealer’s selling profit. Consequently, such costs are excluded
from the net investment in the lease. Initial direct costs incurred by such a lessor are thus
expensed at the commencement date when the selling profit (gross profit) is recognised.
When a manufacturer or dealer enters into a finance lease, the lease gives rise to two types
of income, namely the usual profit or loss as a result of the outright sale and the finance
income over the lease term.
Example 23.
23.35 Accounting for a finance lease of a manufacturer or dealer lessor
Lyra Ltd (lessor) manufactures machines and sells them to the public. Financing is also provided
in terms of finance leases and ownership is transferred to the lessee at the end of the lease term.
Lyra Ltd uses a legal firm to draft the lease agreement. The legal cost is R7 500. The year end of
Lyra Ltd is 30 June. Lyra Ltd uses a perpetual inventory system.
A machine is sold to Hydra Ltd on 1 July 20.12. Hydra Ltd (lessee) is experiencing cash flow
problems; consequently it also entered into a finance lease agreement on this date. Ownership of
the asset will be transferred to Hydra Ltd at the end of the lease term. The cash selling price (equal
to the fair value) of the machine is R200 000. The cost to Lyra Ltd to manufacture the machine is
R150 000.
continued
Leases 699
The lease agreement provides that Hydra Ltd will pay five annual lease payments of R66 171 in
arrears on 30 June of each year. Each lease payment includes an amount of R10 000 for the
additional maintenance service that Lyra Ltd will provide over the lease term, at the end of each
year. There is no guaranteed residual value.
The accounting treatment of the lease agreement in the records of the manufacturer (lessor) is
as follows:
Dr Cr
R R
1 July 20.12 (Initial recognition)
Expense initial direct costs:
Selling costs (P/L) 7 500
Bank (P/L) 7 500
Recognition of initial direct costs
Sales transaction: any recovery of maintenance and other service
costs are per definition excluded from the lease payments:
Gross investment in finance lease (SFP) ([66 171 – 10 000] × 5) 280 855
Initial recognition of finance lease as a sales transaction
Cost of inventory sold
Interest rate implicit in the lease calculation:
PMT = (66 171 – 10 000), n = 5, PV = – 200 000, FV = 0, i = ?
Therefore i = 12,5%
Interest income (P/L) (200 000 × 12,5%) 25 000
Recognition of interest on finance lease
Bank (SFP) 66 171
Maintenance income (P/L) 10 000
Recognition of lease payment received and recognition of income
from other services
The above principles are repeated in the accounting treatment of the remaining four lease payments.
For marketing reasons, the manufacturer or dealer lessor may market an asset by offering
financing at a rate that is less than the market-related rate for similar types of transactions. In
order to earn the same return that it would have earned at market-related interest rates, the
lessor will need to adjust the cash selling price of the asset upwards. If the transaction was
accounted for by the lessor on this basis, too much gross profit would be recognised
immediately and a lower amount of finance income would be recognised over the lease term.
IFRS 16 recognises that this situation may arise, thus paragraph 73 requires that where
artificially low rates of interest are charged by manufacturer or dealer lessors, the gross
profit (selling profit) shall be restricted to that which would have resulted if a market-related
rate of interest had been charged. In this way, the correct amount of gross profit will be
recognised immediately and the correct amount of finance income will be recognised over
the lease term.
Example 23.
23.36 Artificially low interest rates
Assume the following information for a finance lease entered into by a manufacturer lessor:
Cost of manufacture of leased asset is R40 000.
Quoted cash selling price is R70 000.
Five equal annual lease payments payable in arrears.
There is no guaranteed residual value.
Quoted interest rate implicit in the lease is 10%.
The market-related interest rate implicit in such a lease transaction is 14%.
It can be shown through extrapolation that the finance lease payments are R18 466 per annum.
(PV = – 70 000; n = 5; i = 10; PMT = ?).
Journal entries if 10% is viewed as ‘normal’:
Dr Cr
R R
Revenue (P/L) (given) 70 000
Cost of sales (P/L) (given) 40 000
Thus, if this information were used to account for the transaction, the gross profit recognised
immediately would be R30 000 (R70 000 – R40 000) and the finance income recognised over the
term of the lease would be R22 330.
The lease payments of R18 466 are calculated using the 10% interest rate implicit in the lease
(which is artificially low), as this is the lease payment amount that the lessee is going to pay.
However, from the perspective of the lessor, an interest rate of 14% should be used to calculate
the ‘true’ cash selling price and finance income to be recognised over the lease term, as this is the
market-related interest rate. Using the same lease term and lease payments of R18 466, but a
higher interest rate (14%), the ‘true’ selling price (PV) will need to be calculated in order to ensure
that the gross profit recognised immediately by the lessor is restricted to that which would be
recognised if a market-related rate of interest was charged. This is calculated as follows:
(n = 5; i = 14; PMT = 18 466; PV = ?). Thus, PV = R63 395
Journal entries if 14% is used:
Dr Cr
R R
Gross investment in finance lease (SFP)(18 466 × 5) 92 330
Revenue (P/L) (calculated above) 63 395
Unearned finance income (SFP) (balancing) 28 935
Cost of sales (P/L) (given) 40 000
The amortisation table will be based on the 14% interest rate implicit in the lease. Using this
information, the gross profit recognised immediately would be R23 395 (R63 395 – R40 000) and the
finance income recognised over the lease term would be R28 935. In total, the amounts would be the
same (R52 330), but with the accounting treatment required by IFRS 16.73, the timing and
recognition of the different income amounts would be correct by reflecting market-related terms.
Leases 701

It is not the intention to provide a comprehensive exposition on the tax position of lessors as
far as finance leases are concerned, but rather to deal with the most important
requirements.
In general, the lessor is taxed on the finance lease payments received by or accrued to him
and no distinction is made between the interest and capital components of the lease
payments. The normal tax allowances (such as wear and tear) may be claimed as
deductions by the lessor, where applicable, if the lessee uses the asset for a qualifying
purpose. The tax deductions applicable to the owner of the particular asset, in the same
circumstances, would also apply to the lessor. (Take note of the stipulations of section 12C
of the Income Tax Act in respect of lessors.)
The aforementioned will thus result in temporary differences, because for accounting
purposes the gross profit (manufacturers and dealers) and finance income (all lessors) will
be recognised, while SARS taxes lease income (payments) received and gives tax
allowances.
The following demonstrates the statement of financial position method calculation for
deferred tax:
Carrying amount Tax base Temporary difference?

Net investment in lease Asset (future wear-and-tear) Yes
Rnil Possible s 23A allowance carried Yes
forward to following year
Take note of the stipulations in section 23A of the Income Tax Act in respect of allowances
available to lessors of machinery, plant, aircraft and ships. The allowances granted to the
lessors of these assets in a specific year may not exceed the taxable income derived from
rental income during that year.
Example 23.
23.37 Finance lease with deferred tax for a lessor that is not a manufacturer
or dealer
The following is information regarding a finance lease transaction entered into by a lessor:
The cash selling price (equal to fair value, cost and carrying amount) of the asset is R24 868.
Three finance lease payments of R10 000 each are payable annually in arrears.
There is no guaranteed or unguaranteed residual value.
The lessor has not incurred any initial direct costs.
The tax allowance is claimed in equal amounts over the three years.
The normal income tax rate is 28%; ignore VAT.
Assume an accounting profit before tax of R100 000, but after the lease agreement had been
accounted for, in each of the relevant years under review.
The asset had not been used prior to the lease transaction.
It can be shown through extrapolation or a financial calculator that the interest rate implicit in the
lease is 10%.
(PV = – 24 868; PMT = 10 000; n = 3; i = ?)
continued
Amortisation table
Outstanding
Year Lease payment Interest Capital
capital
R R R R
Year 0 24 868
Year 1 10 000 2 487 7 513 17 355
Year 2 10 000 1 735 8 265 9 090
Year 3 10 000 910 9 090
30 000 5 132 24 868
Tax journal entries: Dr Cr
Year 1 R R
Tax payable – SARS (SFP) 27 783
Deferred tax liability (SFP) 217
Recognition of movement in deferred tax on lease
Year 2
Year 3
Income tax income (P/L) 224
Year 1 Year 2 Year 3
R R R
Movement in temporary differences may be broken
down as follows:
Accounting: deduct finance income (2 487) (1 735) (910)
Tax: deduct ^wear-and-tear allowance (8 289) (8 289) (8 289)
Tax: add finance lease payments received 10 000 10 000 10 000
Taxable income 99 224 99 976 100 801
Current tax payable at 28% 27 783 27 993 28 224
Leases 703

Year 1 Year 2 Year 3
R R R
Carrying amount of net investment in finance lease * 17 355 * 9 090 –
# #
Tax base (future tax allowances on asset) 16 579 8 290 –
Taxable temporary difference 776 800 –
Deferred tax liability balance at 28% (217) (224) –
Income tax expense/(income) (P/L) 217 7 (224)
* Balance from amortisation table
#
Tax allowance deductible in future:
Year 1: 24 868 × 2/3 and Year 2: 24 868 × 1/3
^ There is no depreciation expense to add back, because the equipment is no longer an asset in
the records of the lessor.
23.9.8 Value-added tax

When dealing with VAT from the lessor’s perspective, the issues that arise are similar to
those experienced by the lessee (refer to section 23.8.6). Where a lessee is financing the
VAT, the lease instalments include a portion of VAT. The lessor pays the full output VAT to
SARS immediately after entering into the lease agreement and then recovers the VAT from
the lessee as part of the lease instalments. The VAT portion must then be removed from the
instalment when calculating the taxable lease income of the lessor.
Example 23.38 Deferred tax and VAT
Duck Ltd (financier lessor) leases a machine with a cash selling price (excluding VAT) of R57 391
to Goose Ltd (lessee) under a finance lease agreement. Duck Ltd is not a manufacturer or dealer
of such machines. Duck acquired the machine at the same cash selling price before entering into
the lease agreement. Duck Ltd pays R8 609 output VAT (15% in this example) and determines
that three lease payments of R28 907 each, are payable annually in arrears. The total amount of
the net investment in the lease is R66 000 and the interest rate implicit in the lease is 15% per
annum. There are no guaranteed or unguaranteed residual values. No initial direct costs were
incurred by either the lessor or the lessee. The lease agreement met the definition of an instalment
credit agreement for VAT purposes. Goose Ltd did not pay the input VAT claimed from the SARS
over to Duck Ltd at inception of the lease. Ownership will not transfer to Goose at the end of the
lease term. Assume that SARS will grant a wear and tear allowance over three years to Duck Ltd
as the owner of the machine. Assume a normal income tax rate of 28%.
The amortisation table of Duck Ltd (lessor) will be as follows:
Outstanding
balance
R R R R
66 000*
Year 1 28 907 9 900 19 007 46 993
Year 2 28 907 7 049 21 858 25 135
Year 3 28 907 3 772 25 135 –
86 721 20 721 66 000
* Since VAT is being financed by the lessor (Goose Ltd did not pay the claimed input VAT over to
the lessor at inception of the lease), it is included in the net investment in the lease. The lessor will
recoup the VAT, initially paid to SARS, over the lease term from Goose Ltd.
continued
The entries of Duck Ltd at the beginning of the first year will be as follows:
Dr Cr
R R
Gross investment (SFP) 86 721
Machine (PPE) (SFP) 57 391
VAT control account (output) (SFP) 8 609
Initial recognition of lease and input VAT claimed
VAT control account (SFP) 8 609
(assuming this is the only VAT item for the period)
Bank (SFP) 8 609
Output VAT paid to SARS
The full lease payments of R28 907 per annum (including the VAT portion) will not be taxable for
income tax purposes, because R8 609 has already been paid to SARS. For income tax purposes,
each lease payment will first be reduced by an equal portion of VAT, because the lease payments
are equal (no initial deposit or guaranteed residual value). The reduction is thus proportionate to
the relative size of the lease payments. From the above information, it follows that R28 907 – (1/3
× R8 609) = R26 037 will be taxed for income tax purposes. (Alternatively the amount can be
determined as follows: Total VAT = R8 609, consequently the VAT per payment is 8 609 ×
28 907/86 721 = 2 870. The taxable amount per payment is therefore R28 907 – R2 870 =
R26 037.)
The accounting income, taxable amounts and tax deductions for the lessor will be as follows:
Accounting Tax
R R
Year 1 Finance income 9 900
Lease payment (28 907 – 2 870) 26 037
Wear and tear (57 391/3) (19 130)
Wear and tear (19 130)
Wear and tear (19 131)
20 721 20 721
Comment
¾ Deferred tax arises as a result of the difference between the accounting income (finance income)
and the amount taxed (lease payments net of VAT) less deductions (wear and tear allowances) that
are allowed for tax purposes.
Using a normal income tax rate of 28%, the balance on the deferred tax account at the end of the
first year arising from this transaction will be calculated as follows:
R R R
Net investment in the lease*; (8 609 × 2/3)** 46 993* 5 739** 41 254
Machine (57 391 × 2/3) – 38 261 (38 261)
Taxable temporary difference 2 993
Deferred tax liability at 28% 838
* Includes VAT, since the VAT is also being financed.
23.9.9 Instalment sale agreements: From the seller’s perspective

An instalment sale agreement (ISA) is in substance also a finance lease. It works the same
as a finance lease, except that a deposit needs to be paid on transaction date, the
Leases 705
repayment term is regulated by law, and ownership is always transferred (operating leases
can thus not be instalment sale agreements). The possession and use of the asset is
immediately transferred to the buyer; however, the legal ownership of the underlying asset
only transfers from the seller to the purchaser on the payment of the last instalment. The
payment of the full purchase price of the underlying asset is also delayed to be paid out in
payments over an extended and agreed period. As the intention of the lessor is to sell the
asset, the lease term is generally fixed, and options to exercise at the end of the lease term
and residual value guarantees are not present in the contract.
The accounting treatment for instalment sale agreements is similar to that of finance leases
(depreciation is not recorded on the leased asset and finance income is recorded), and as a
profit on the sale is usually realised here, the accounting procedures for finance leases used
by a manufacturer or dealer are followed by the seller. The profit (sales less cost of sales) is
recognised in the year of the sale.
An instalment sale agreement would constitute a purchase contract for tax purposes. As a
result, the lessee is viewed as the owner of the asset for tax purposes and the lessor no longer
receives a wear-and-tear allowance. The lessor will be taxed on finance income. Section 24 of
the Income Tax Act stipulates that the profit (sales less cost of sales) is deemed to accrue to
the seller, irrespective of whether the amount is received in cash or not. However, under
certain circumstances, an allowance for the amounts not yet received by the seller is
provided, by allowing a deduction equal to the gross profit percentage realised on the
instalment credit sale (ICS, term used in the VAT Act), applied to the capital portion
(excluding VAT) of instalment credit receivables (i.e. gross profit % × outstanding balance
on ICS (Amrt balance)). The allowance is added back to taxable income in the following year
and a new calculation is made of the allowance that may be deducted in that year. The effect of
the section 24 allowance is that the profit on the sale is taxed each year to the extent of
cash received.
The following demonstrates the statement of financial position method calculation for
deferred tax:

Net investment in ISA Net investment in ICS No
Rnil (s 24 allowance) Yes
Example 23.
23.39 Instalment sale (credit) agreement – accounting and deferred tax
Lebo Ltd (seller-lessor), a dealer in equipment, sold equipment with a cost of R15 000, to
Equipex Ltd (buyer-lessee) for R19 232 on 2 January 20.12 (its fair value on this date) in terms of
an instalment sale agreement. A deposit of R5 000 was payable immediately, whereafter four
equal instalments of R6 000, payable annually in arrears, are required. The first instalment was
payable on 31 December 20.12 (year end). The interest rate implicit in the contract is market-
related.
It can be shown that the interest rate implicit in the agreement is 24,754%.
(PV = – (19 232 – 5 000); n = 4; PMT = 6 000; i = ?)
Assume a tax rate of 28% and ignore VAT.
continued
Amortisation table
Interest Outstanding
Year Instalment Capital
(24,754%) balance
R R R R
19 232
20.12 5 000 5 000 14 232
20.12 6 000 3 523 2 477 11 755
20.13 6 000 2 910 3 090 8 665
20.14 6 000 2 145 3 855 4 810
20.15 6 000 1 190 4 810 –
9 768 19 232
The amount of the gross profit included in the taxable income would be as follows:
Taxable
income
R R
20.12 Sales 19 232
Cost price (15 000)
Gross income 4 232
4 232
Allowance: × 11 755 (Amort balance) (2 587)
19 232
Test: [(5 000 + 2 477) × GP% (4 232/19 232)] 1 645 1 645
20.13 Add back 20.12 allowance 2 587
4 232
Deduct × 8 665 (Amort balance) (1 907)
19 232
Test: [3 090 × GP% (4 232/19 232)] 680 680
4 232
Deduct × 4 810 (Amort balance) (1 058)
19 232
Test: 3 855 × GP% (4 232/19 232) 849 849
4 232
Deduct × 0 (Amort balance) –
19 232
Test: [4 810 × GP% (4 232/19 232)] 1 058 1 058
4 232
The taxable finance income is based on the amount calculated for accounting purposes. The total
taxable income will be as follows:
Finance
Year Gross profit Total
income
R R R *
20.12 1 645 3 523 5 168
20.13 680 2 910 3 590
20.14 849 2 145 2 994
20.15 1 058 1 190 2 248
4 232 9 768 14 000
continued
Leases 707
Deferred tax calculation for 20.12:

Instalment sales agreement (ISA) (SARS – lessor not legal owner of asset):
Carrying Tax Temporary Deferred tax (28%)
amount base difference asset/(liability)
R R R R
ISA debtor 11 755 11 755 – –
S 24 allowance – 2 587 2 587 (724)
Income tax expense:
Accounting profit (gross profit of R4 232 + finance income of R3 523) 7 755
Income tax expense (7 755 × 28%) 2 171
Current tax (5 168 calc above × 28%) 1 447
Deferred tax (calc above) 724
Comment
¾ The carrying amount of the net investment was obtained from the amortisation table.
¾ In the case of an instalment credit (sales) agreement, the carrying amount will be determined in
the same way as for a finance lease. For tax purposes, the selling price of the item sold will
accrue to the seller immediately. This will lead to a situation where the future economic benefits
to be received from the asset will not be taxable when they are received. Consequently, the tax
base is equal to the carrying amount (IAS 12.7).
¾ However, the section 24 allowance removes the portion of the gross profit still contained in the
ISA receivable. The section 24 allowance then represents profit that will be taxed in future and
thus generates a deferred tax liability.
The accounting treatment is as follows, irrespective of whether the transaction is a lease or an
instalment credit sale:
Journal entries for 20.12
Dr Cr
R R
2 January
Gross investment in finance lease/ISA (SFP) [(6 000 × 4) + 5 000] 29 000
Initial recognition of instalment credit sale, with cost of sales
Bank (SFP) 5 000
Gross investment in finance lease/ISA (SFP) 5 000
Recognition of deposit received
31 December
Bank (SFP) 6 000
Gross investment in finance lease/ISA (SFP) 6 000
Recognition of payment received
Finance income earned (P/L) 3 523
Recognition of interest on outstanding debtor
Income tax owing – the SARS (SFP) (5 168 × 28% 1 447
– if an instalment credit sale)
Recognition of current tax
Deferred tax (SFP) (2 587 × 28% – if an instalment credit sale) 724
Recognition of deferred tax
23.9.10 Disclosure: The lessor (finance leases) and the seller

(instalment sale agreements)
The following disclosures, in addition to the disclosure requirements of IFRS 7 (refer to
chapter 20), will give a basis for users of financial statements to assess the effect that
finance leases will have on the financial position (SFP), financial performance (P/L), and
cash flows of the lessor:
selling profit or loss, finance income on the net investment in the lease, and lease
income relating to variable lease payments not included in the measurement of the lease
receivable in a tabular format, unless another format is more appropriate;
qualitative and quantitative information to help users of financial statements assess the
nature of the lessor’s leasing activities and how the lessor manages the risk associated
with any rights it retains in underlying assets;
qualitative and quantitative explanations of the significant changes in the carrying
amount of the net investment in the lease;
a maturity analysis of lease payments receivable, showing the undiscounted lease
payments to be received on an annual basis for a minimum of each of the first five years
and a total of the amounts for the remaining years; and
a reconciliation of the undiscounted lease payments to the net investment in the lease,
identifying the unearned finance income relating to the lease payments receivable and
any discounted unguaranteed residual value.
Example 23.
23.40 Disclosure of a finance lease (or instalment sale agreement)
Some of the quantitative IFRS 16 disclosures in the records of the lessor are illustrated below.
(This example only shows current year information. Comparative amounts required by IAS 1 are
not illustrated.)
The reporting date of Cloudy Ltd is 31 December 20.16. Cloudy Ltd, a lessor, entered into a
finance lease agreement for equipment on the following terms:
The lease term of the finance lease is eight years from 1 January 20.16, with equal fixed annual
instalments of R30 000 payable at the end of each year.
The lessor did not incur any initial direct costs.
Cloudy Ltd expects to sell the equipment at the end of the lease term for R35 000 (unguaranteed
residual value).
The interest rate implicit in the lease is 9% per annum.
The fair value of the equipment on 1 January 20.16 was R183 610. The carrying amount of the
equipment in the records of Cloudy Ltd on 1 January 20.16 was R150 000.
Amortisation table
Outstanding
Year Instalment Interest Capital
balance
R R R R
183 610
20.16 30 000 16 525 13 475 170 135
20.17 30 000 15 312 14 688 155 447
20.18 30 000 13 990 16 010 139 437
20.19 30 000 12 549 17 451 121 986
20.20 30 000 10 979 19 021 102 965
20.21 30 000 9 267 20 733 82 232
20.22 30 000 7 401 22 599 59 633
20.23 30 000 5 367 24 633 35 000
91 390 148 610
continued
Leases 709

1. Finance income: R
Finance income on net investment in finance leases 16 525
2. Profit before tax:
Profit before tax is disclosed after the impact of the following, amongst others, has been take into
account:
Finance lease income R
Profit on the sale of assets (financier lessor) / selling profit realised
(manufacturer or dealer lessor) (183 610 – 150 000) 33 610
Income from variable lease payments xx xxx
3. Reconciliation of net investment in finance leases (IFRS 16.93): R

Opening balance 0
New leases entered into 183 610
Repayments of capital (13 475)
Interest accrued 16 525
Payment received (30 000)
Effect of lease modifications / reassessments –
#
Long-term portion presented under non-current asset 155 447
Short-term portion presented under current asset # 14 688
# in meeting the requirements of IAS 1
The company’s main leasing activities include the following:
(company specific detail)
The company manages the risks associated with its leasing activities as follows:
The most significant change in the carrying amount on the net investment in lease resulted
from a significant lease contract that were signed with X Ltd whereby …. (company specific
detail)
4. Maturity analysis of finance lease payments to be received at the reporting date:
Gross *Unearned *Net
investment finance investment
in the lease income in the lease
(undiscounted) (discounted)
R R R
20.17 (Year 1) 30 000 (15 312) 14 688
20.18 (Year 2) 30 000 (13 990) 16 010
20.19 (Year 3) 30 000 (12 549) 17 451
20.20 (Year 4) 30 000 (10 979) 19 021
20.21 (Year 5) 30 000 (9 267) 20 733
After 20.21 (remaining
years) including
unguaranteed residual value 95 000 (12 768) 82 232
Total 245 000 (74 865) 170 135
Included in the net investment in the analysis above, is the discounted unguaranteed residual
value to the amount of R19 146 (FV = 35 000; n = 7; i = 9%).
continued
Please note: IFRS 16 is not prescriptive about whether the reconciliation of the undiscounted
lease payments to the net investment should be done on an annual basis for a minimum of each
of the first five years and in total. The maturity analysis of the finance lease payments may also be
presented as follows:
4. Maturity analysis of finance lease payments to be received at the reporting date:
Undiscounted lease payments to be received at the reporting date: R
20.17 (Year 1) 30 000
20.18 (Year 2) 30 000
20.19 (Year 3) 30 000
20.20 (Year 4) 30 000
20.21 (Year 5) 30 000
After 20.21 (remaining years) excluding unguaranteed residual value 60 000
Total undiscounted lease payments 210 000
*Unearned finance income in respect of lease payments only
((30 000 × 7) – PV of R150 989 (PMT = 30 000, FV = 0; n = 7, i = 9%)) (59 011)
Discounted unguaranteed residual value (FV = 35 000; n = 7; i = 9%) 19 146
*Net investment in the lease (discounted) 170 135
23.10 Operating leases

23.10.1 Recognition and measurement
The asset subject to an operating lease is treated by the lessor as either a depreciable
asset (for example, as property, plant and equipment) or a non-depreciable asset,
depending on the nature of the asset. Property that is rented out would be classified as
Lease income is recognised as income over the lease term on a straight-line basis, even
if the cash is not received evenly, unless another systematic allocation basis is more
representative of the pattern in which benefit from the use of the underlying asset is
diminished.
Amounts incurred to generate the lease income (including depreciation) will be recognised
as expenses. The depreciation policy for depreciable assets leased out will be consistent
with the lessor’s normal depreciation policy for that class of asset.
The initial direct costs incurred by lessors in negotiating and arranging an operating lease
shall be added to the carrying amount of the leased asset and will be recognised over the
lease term on the same basis as lease income.
Example 23.
23.41 Initial direct costs
Phoenix Ltd (lessor) acquired equipment at a cost of R600 000 and entered into an operating
lease to lease it to Pictor Ltd (lessee) for a period of five years. The equipment has an estimated
useful life of 15 years and an insignificant estimated residual value. The initial direct costs incurred
by Phoenix Ltd in arranging the lease amounted to R12 000.
The amount of R12 000 is capitalised to the cost of the equipment, resulting in a depreciable
amount of R612 000. Of the total of R612 000, R600 000 is depreciated over fifteen years (total
useful life) at R40 000 per annum, while the R12 000 is depreciated over five years (lease term) at
R2 400 per annum. The annual depreciation expense in the first five years will therefore be
R42 400 per year; thereafter it will reduce to R40 000 per year.
Comment
¾ The approach to depreciate the initial direct cost over the lease term, while the asset itself is
depreciated over its useful life, is consistent with the ‘component approach’ of IAS 16.43 to.47.
Leases 711
Where a prepaid expense amount is recognised as a result of straight-lining of operating

lease income for investment properties, the fair value of the property is reduced by the
amount of this asset, as the fair value of the property reflects the future rentals, and
to avoid double counting of items already recognised in the statement of financial position
in terms of IAS 40.
Incentives, for example rent-free periods or contributions by the lessor to the relocation
costs of the lessee, are viewed as an integral part of the cost of the lease. The net lease
payments are recognised on a straight-line basis. Such incentives are recognised by both
the lessee and the lessor over the period of the lease.
Example 23.
23.42 Rent-free period as a lease incentive
Perseus Ltd (lessee) entered into a lease agreement with Pegasus Ltd (lessor) for a period of
five years. To encourage Perseus Ltd to enter into this lease agreement, Pegasus Ltd offered an
initial rent-free period of six months. Thereafter, the lease payments are to increase by 10%
annually on the anniversary of the signing date of the lease. The lease payments in the last six
months of the first year of the lease will amount to R20 000 per month. The lease is classified as
an operating lease in the records of Pegasus Ltd.
R
Year 1 Rental in first 6 months –
Rental in second 6 months (20 000 × 6) 120 000
Year 2 (20 000 × 1,1 × 12) 264 000
Year 3 (20 000 × (1,1)² × 12) 290 400
Year 4 (20 000 × (1,1)³ × 12) 319 440
Year 5 (20 000 × (1,1)4 × 12) 351 384
Total lease payments over lease term 1 345 224
Equalised lease income per month (1 345 224/60) 22 420
Journal entries for Year 1 in the books of the lessor:

Dr Cr
R R
First 6 months
Accrued income (SFP) 134 520
Operating lease income (P/L) (22 420 × 6) 134 520
Accruing lease income for first 6 months
Second 6 months
Bank (SFP) (20 000 × 6) 120 000
Operating lease income (P/L) (22 420 × 6) 134 520
Recognition of lease income earned
Example 23.
23.43 Relocation expenses as a lease incentive
Eridanus Ltd (lessor) enters into a lease with Orion Ltd (lessee) on 1 April 20.12. In terms of the
agreement, Eridanus Ltd will lease a building to Orion Ltd at an annual payment of R240 000
payable in arrears. The lease term is three years. The year end of both entities is 31 March.
Orion Ltd will have to move its existing machinery from the previous building to the newly leased
building. In order to ensure that Orion Ltd will enter into the lease agreement, Eridanus Ltd offers
to pay for these removal costs. The removal costs amount to R90 000.
continued
The incentive must be treated as an integral part of the net return agreed upon for the use of the
leased asset. This implies that the cost or the benefit of the incentive must be included when the net
lease income is calculated from the perspective of the lessor.
Calculation of operating lease income to be recognised annually:
R
Lease payment to be received during the following three years (240 000 × 3) 720 000
Relocation costs incurred in terms of a lease (90 000)
Net amount to be received in terms of lease agreement 630 000
(Therefore, of the R720 000 receivable, R90 000 comprises a recovery of costs
incurred, while R630 000 is for the use of the asset)
The net lease income to be recognised annually (630 000/3) 210 000
The journal entries to record the transactions in the books of Eridanus Ltd are as follows:
Dr Cr
R R
1 April 20.12
Bank (SFP) 90 000
Recognise the amount incurred on behalf of the lessee on initial
recognition of the lease
31 March 20.13
Bank (SFP) 240 000
Prepaid expenses (SFP) (90 000/3) 30 000
Recognise annual lease payment received
Alternatively, the above journal can be done as follows:
Bank (SFP) 240 000
Operating lease income (P/L)) 240 000
Recognise annual lease payment received if lease related
expenses are ignored
Recognition of lease income and incentives on a straight-line basis
The lease payments paid on 31 March 20.14 and 31 March 20.15 will be accounted for using the
same journal entries as for 31 March 20.13.
Comment
¾ The prepaid expense represents an asset in the statement of financial position of the lessor. It
will therefore have deferred tax implications.
¾ This item is an asset for deferred tax purposes. The tax base of an asset is the future tax
deduction.
¾ In the above example, the tax base is Rnil, as any deductions in terms of section 11(a) of the
Income Tax Act are claimed when the expense is incurred. This expense is incurred at the
commencement of the lease agreement (actually incurred). Therefore, a temporary difference
arises on the prepaid expense. This temporary difference will be recognised as a deferred tax
liability.

As noted earlier, operating lease payments received should be recognised on a straight-line
basis over the lease term for accounting purposes, whereas operating lease payments
received are included in taxable income as and when it is actually received or receivable
Leases 713
(the earlier of receipt or accrual). The straight-lining of operating lease payments received
might result in either income received in advance, or accrued income, where the equalised
lease income is different from the actual cash payments received. Consequently, temporary
differences may occur which will give rise to deferred tax.
There may also be deferred tax on the leased asset if the capital allowance (wear-and-tear)
differs from the lessor’s depreciation policy.
A typical operating lease agreement would often not meet the definition of an instalment
credit agreement for VAT purposes. The lessor would then pay output VAT per payment
received. The amount of the lease payment, excluding VAT, will then be used to calculate
the equalised lease income over the lease term.
Example 23.
23.44 Deferred tax on equalised operating lease payments
The following information refers to a vehicle that is leased by Antlia Ltd (lessor) to a third party.
The lease is classified as an operating lease in the records of the lessor. The vehicle was new
when the lease was entered into.
Cash purchase price of the vehicle: R140 000
The lease term is from 1 January 20.11 to 31 December 20.13. The financial year end of the
lessor is 31 December.
The monthly lease payments are: R3 500 per month for the first 12 months and R5 000 per month
thereafter.
You may assume that the SARS allows, in terms of section 11(e) of the Income Tax Act, a wear-
and-tear period of three years on the vehicle. Assume a tax rate of 28%. Ignore VAT.
Antlia Ltd depreciates vehicles on the straight-line basis over three years.
Antlia Ltd has no other temporary differences.
The following calculations are relevant in accounting for the operating lease in the records of
Antlia Ltd (lessor):
Equalisation of operating lease payments:
[(3 500 × 12) + (5 000 × 24)] ÷ 36 = 4 500 per month
R
Operating lease income recognised for the first 12 months (4 500 × 12) 54 000
Actually received in cash (3 500 × 12) 42 000
Accrued income on 31 December 20.11 12 000
Extract from current tax calculation
Profit before tax
Operating lease income (4 500 × 12) 54 000
Wear-and-tear allowance (140 000/3) (46 667)
Movement in temporary differences (refer to deferred tax calculation) (12 000)
(4 667)
Proof:
Gross income (actual cash received: 3 500 × 12) 42 000
Tax allowance per section 11(e) (140 000/3) (46 667)
(4 667)
continued
R
On the asset:
Carrying amount (assume a useful life of three years) (140 000 × 2/3) 93 333
Tax base (140 000 – 46 667) 93 333
Temporary difference –
On the accrued income:

Tax base (no future deductions on this asset) –
Taxable temporary difference 12 000
Deferred tax liability (12 000 × 28%) (3 360)
An extract from the financial statements of Antlia Ltd:
Antlia Ltd
Extract from the statement of financial position at 31 December 20.11
Non-current liabilities R
Deferred tax 3 360
Note: The accrued income of R12 000 will be included in current assets.
The journal entries for the lease and related deferred tax are as follows:
Dr Cr
R R
20.11
Bank (SFP) (3 500 × 12) 42 000
Recognise the equalised lease income for the year
Recognise deferred tax
20.12 and 20.13

Bank (SFP) (5 000 × 12) 60 000
Recognise the equalised lease income
Deferred tax (SFP) (6 000 × 28%) 1 680
Recognise reversal of deferred tax provision
Take note of the stipulations in section 23A of the Income Tax Act in respect of allowances
available to lessors of machinery, plant, aircraft and ships. The allowances granted to the
lessors of these assets in a specific year may not exceed the taxable income derived from
rental income during that year.
23.10.3 Presentation
A lessor shall present underlying assets subject to operating leases in its statement of
financial position according to the nature of the underlying asset (for example, as property,
plant and equipment under IAS 16, or as investment properties under IAS 40).
Leases 715
23.10.4 Disclosure
The following disclosures, in addition to the disclosure requirements of IFRS 7 (refer to
chapter 20), will give a basis for users of financial statements to assess the effect that
operating leases will have on the financial position (SFP), financial performance (P/L), and
cash flows of the lessor:
lease income, separately disclosing income relating to variable lease payments that do
not depend on an index or rate, in tabular format, unless another format is more
appropriate;
qualitative and quantitative information to help users of financial statements assess the
nature of the lessor’s leasing activities and how the lessor manages the risk associated
with any rights it retains in underlying assets;
the disclosure requirements in respect of specific leased assets in the books of the
lessor, arising from IAS 16; IAS 36; IAS 38, IAS 40 and IAS 41. If the underlying asset is
thus for example, property, plant and equipment subject to an operating lease, it is
required of the lessor to disaggregate each class of property, plant and equipment into
assets subject to operating leases and assets not subject to operating leases and
provide IAS 16 disclosures separately for each group; and
a maturity analysis of lease payments, showing the undiscounted lease payments to be
received on an annual basis for a minimum of each of the first five years and a total of
the amounts for the remaining years.
Example 23.
23.45 Disclosure of operating lease
Some of the quantitative IFRS 16 disclosures in the records of the lessor are illustrated below.
This example only shows current year information. Comparative amounts required by IAS 1 are
not illustrated. The illustration only includes disclosure related to the lease itself and not disclosure
relating to any underlying asset.
Profit before tax is disclosed after the impact of the following, amongst others, has been take into
account:
Operating lease income (1): R
Straight-line lease income:
Investment property xxx xxx
Other underlying assets xx xxx
Income from variable lease payments that do not depend on an index:
Machinery xxx xxx
Other underlying assets xx xxx
2. Operating lease agreements
The undiscounted (2) lease payments expected to be received under operating lease agreements at the
reporting date are as follows:
R
Year 1 x xxx
Year 2 x xxx
Year 3 x xxx
Year 4 x xxx
Year 5 x xxx
After Year 5 (remaining years) x xxx
Total xx xxx
continued
The company’s main leasing activities include the following:

The company manages the risks associated with its leasing activities as follows:
(1) These amounts must be the equalised (straight-lined) income amounts.
(2) These amounts must be the actual cash amounts receivable and not the equalised expense
amounts disclosed in the ‘Profit before tax’ note.
23.11 Sale and leaseback transactions

A sale and leaseback transaction involves the transfer of an underlying asset to the buyer-
lessor and the leasing back of the same asset by the seller-lessee, usually to alleviate cash
flow problems. As a result, the selling price and lease payments are often interrelated, as
they are negotiated as a package and need not, therefore, represent open market values.
The accounting treatment of a sale and leaseback transaction depends on whether the
transfer of the asset qualifies as a sale in accordance with IFRS 15. An entity shall apply
the requirements for determining whether when a performance obligation is satisfied in
IFRS 15 Revenue from Contracts with Customers to make this assessment. Refer to
chapter 22 for more detail on when a performance obligation is satisfied.
23.11.1 Transfer of the asset is a sale

If the buyer-lessor has obtained control of the underlying asset and the transfer of the asset
is classified as a sale in accordance with IFRS 15, the seller-lessee derecognises the
underlying asset and applies the lessee accounting model of IFRS 16. The right-of-use
asset arising from the leaseback should be measured at the retained proportion of the
previous carrying amount of the asset that relates to the right of use. No gain or loss is
recognised on the retained asset (albeit now classified as a right-of-use asset) as the seller-
lessee still has that portion under its control. The gain (or loss) that the seller-lessee
recognises is consequently limited to the rights transferred to the buyer-lessor.
The buyer-lessor shall account for the purchase of the asset by applying the applicable
Standards (such as IAS 16 if a machine was acquired), and for the lease by applying the
lessor accounting requirements of IFRS 16.
However, if the consideration for the sale is not equal to the fair value of the asset, or if the
payments for the lease are not at market rates, any resulting difference represents either a
prepayment of lease payments (i.e., if the purchase price or lease payments are below
market terms) or an additional financing (if the purchase price or lease payments are
above market terms).
Example 23.
23.46 Accounting treatment of sale and leaseback
Case 1 – selling price = fair value:

Cetus Ltd (seller-lessee) sells its plant on 1 January 20.12 to Prius Ltd (buyer-lessor) and
immediately leases the right to use the plant back for 18 years, with annual payments of R103 553,
payable at the end of each year. Details of the plant are as follows:
Carrying amount
R
Cost 1 125 000
Carrying amount (CA) immediately before the transaction 1 000 000
continued
Leases 717
Details of the sale and leaseback agreement are as follows:

The cash selling price is R1 800 000 and the fair value (FV) of the plant at the date of sale is
R1 800 000. The interest rate implicit in the lease is 4,5% per annum, which is readily determinable
by Cetus Ltd. The terms and conditions of the transaction are such that Prius Ltd obtained control of
the underlying asset. The transfer of the asset is thus classified as a sale in accordance with
IFRS 15. Accordingly, Cetus Ltd and Prius Ltd both account for the transaction as a sale and
leaseback.
The present value of the 18 annual payments of R103 553 each, discounted at 4,5% per annum,
amounts to R1 259 200 (PMT = R103 553, n = 18, i = 4,5%, PV = ? (rounded)) which relates to the
right to use the underlying asset.
Prius Ltd classifies the lease of the plant as an operating lease.
Cetus Ltd (seller-lessee):
At the commencement date, Cetus Ltd derecognises the plant sold at its carrying amount and
recognises a right-of-use asset arising from the leaseback of the plant at the retained proportion
of the previous carrying amount of the plant that relates to the right of use retained by Cetus Ltd,
which is R699 555 (R1 000 000 (CA)/R1 800 000 (FV of the plant) × R1 259 200 (the discounted
lease payments, representing the right of use)).
Cetus Ltd recognises only the amount that relates to the rights transferred to Prius Ltd as a gain.
R559 645 (R800 000 (R1 800 000 (FV) – R1 000 000 (CA) /R1 800 000 (FV) × R1 259 200)
relates to the right to use the plant retained by Cetus Ltd. Therefore the gain that relates to the
rights transferred is R800 000 – R559 645 = R240 355.
OR
R240 355 (R800 000/R1 800 000 (FV)) × (R1 800 000 (FV) – R1 259 200)).
The allocations in respect of the retained asset (right-of-use asset) and the rights transferred with the
sale can be summarised as follows:
Rights
Right-of-
transferred
use asset Total
with the
retained
sale
R R R
Fair value of consideration 1 259 200 540 800 1 800 000
Carrying amount (699 555) (300 445) (1 000 000)
Gain on disposal 559 645 240 355 800 000
Gain not Gain
recognised recognised
At the commencement date, the journal entries in the records of Cetus Ltd (seller-lessee)
are:
Dr Cr
R R
1 January 20.12
Accumulated depreciation (owned asset) (SFP) 125 000
Right-of-use asset (leased asset) (SFP) 699 555
Plant – Cost (owned asset) (SFP) 1 125 000
Gain on rights transferred – sale and leaseback (P/L) 240 355
Bank (SFP) 1 800 000
Recognition of sale and leaseback of plant previously held
continued
Dr Cr
R R
31 December 20.12
Finance costs including additional financing (P/L) 56 664
(Interest period 1)
Lease liability (SFP) (Principal period 1) 46 889
Bank (SFP) 103 553
The above journal is repeated for the remaining 17 payments and depreciation will be written off on
the right-of-use asset.
At the commencement date, the journal entries in the records of Prius Ltd (buyer-lessor) are:
Dr Cr
R R
1 January 20.12
Plant – cost (SFP) 1 800 000
Bank (SFP) 1 800 000
Acquisition of plant
31 December 20.12
Bank (SFP) 103 553
Recognition of operating lease payment received
The above process is repeated for the remaining 17 payments.
Case 2 – selling price > fair value:
The cash selling price is now R2 000 000 and the fair value (FV) of the plant at the date of sale is
still R1 800 000. The interest rate implicit in the lease is 4,5% per annum, which imply that the
payments would now be R120 000 (the selling price and lease payments of a sale and leaseback
transaction are typically interrelated and the one determines the other).
Because the consideration for the sale of the plant is not at fair value, Cetus Ltd and Prius Ltd make
adjustments to measure the sale proceeds at fair value. The amount of the excess sale price above
its fair value of R200 000 (R2 000 000 – R1 800 000) is recognised as additional financing
provided by Prius Ltd to Cetus Ltd.
amounts to R1 459 200, of which R200 000 relates to the additional financing and R1 259 200
relates to the right to use the underlying asset. The annual cash payments of R120 000 can be
split into 18 annual payments of R16 447 (for the additional financing of R200 000 because the
purchase price is above the fair value; PV = R200 000, n = 18, i = 4,5%, PMT = ?) and R103 553
(for the lease; PV = R1 259 200, n = 18, i = 4,5%, PMT = ?), respectively.
Cetus Ltd derecognises the plant, recognises a right-of-use asset and account for the gain on the
rights transferred – refer to case 1 above. In addition, Cetus Ltd recognises the additional
financing of R200 000 as a liability (it could increase the lease liability or it could perhaps be
treated as separate liability).
continued
Leases 719
are:
Dr Cr
R R
1 January 20.12
Lease liability including additional financing (SFP) 1 459 200
Bank (SFP) 2 000 000
31 December 20.12
(Interest period 1)
Lease liability including additional financing (SFP)
(Principal period 1) 54 336
Bank (SFP) 120 000
At the commencement date, the journal entries in the records of Prius Ltd (buyer-lessor) are:
Dr Cr
R R
1 January 20.12
Financial asset (SFP) 200 000
Bank (SFP) 2 000 000
Acquisition of plant acquired and additional financing provided
31 December 20.12
Bank (SFP) 103 553
Operating lease income (P/L) (120 000 – 16 447) 103 553
Recognition of operating lease payment received
Bank (SFP) (PV = 200 00, n = 18, i = 4,5%, PMT = ?) 16 447
Finance income (P/L) (Interest period 1) 9 000
Financial asset (SFP) (Principal period 1) 7 447
Recognition of payment received on loan provided
The above process is repeated for the remaining 17 payments.
Case 3 – selling price < fair value:
The cash selling price is now R1 600 000 and the fair value (FV) of the plant at the date of sale is
still R1 800 000. The interest rate implicit in the lease is 4,5% per annum, which imply that the
payments would now be R87 105 (the selling price and lease payments of a sale and leaseback
transaction are typically interrelated and the one determines the other).
Because the consideration for the sale of the plant is not at fair value, Cetus Ltd and Prius Ltd make
adjustments to measure the sale proceeds at fair value. The amount of the sale price below the fair
value of R200 000 (R1 600 000 – R1 800 000) is recognised as a prepayment of lease payments
paid by Cetus Ltd to Prius Ltd.
amounts to R1 059 200 (PMT = R87 105, n = 18, i = 4,5%, PV = ? (rounded)), which is R200 000
less then the R1 259 200 which relates to the right to use the underlying asset.
continued

Cetus Ltd derecognises the plant, recognises a right-of-use asset and account for the gain on the
rights transferred – refer to case 1 above. However, Cetus Ltd lease liability would be reduced by
R200 000.
are:
Dr Cr
R R
1 January 20.12
Lease liability (SFP) (could be the net amount of R1 059 200) 200 000
Bank (SFP) 1 600 000
31 December 20.12
(Interest period 1)
Lease liability (SFP) (Principal period 1) 39 441
Bank (SFP) 87 105
At the commencement date, the journal entries in the records of Prius Ltd (buyer-lessor)
are:
1 January 20.12
Operating lease income received in advance (SFP) 200 000
Bank (SFP) 1 600 000
Acquition of plant and received prepayment of lease payments
31 December 20.12
Bank (SFP) 87 105
Operating lease income received in advance (SFP) 11 111
(200 000/18)
Recognition of lease payment received and equalised lease
income (on the assumption that the operating lease is equalised)
23.11.2 Transfer of the asset is not a sale

If the transfer of the asset is not a sale (i.e., the buyer-lessor does not obtain control of the
asset in accordance with IFRS 15), the seller-lessee does not derecognise the transferred
asset (continues to recognise the underlying asset) and accounts for the proceeds
transferred as a financial liability in terms of IFRS 9.
The buyer-lessor does not recognise the transferred asset and, instead, accounts for the
transferred proceeds as a financial asset (receivable) in terms of IFRS 9. If the transfer of
the asset is thus not a sale in accordance with IFRS 15, IFRS 9 (and not IFRS 16) will
Leases 721
prescribe the accounting treatment. The transactions will then come onto the statement of
financial position as either a financial liability or a financial asset.

Since differences arise between tax treatment and the accounting recognition of sale and
leaseback transactions, temporary differences will result. Deferred tax therefore arises and
is accounted for in the usual manner.
23.11.4 Disclosure
Where sale and leaseback transactions have been entered into, the normal disclosure
requirements for lessees and lessors apply. The seller-lessee should also specifically
disclose the gains or losses arising from the sale and leaseback transaction. Furthermore,
the seller-lessee should provide qualitative and quantitative information about the
transactions for users of the financial statement to assess the effect of the transaction on the
financial position, financial performance and cash flow of the entity. For example, the seller-
lessee could disclose:
reasons for and prevalence of sale and leaseback transactions;
key terms and conditions of individual sale and leaseback transactions;
payments not included in the measurement of lease liabilities; and
the cash flow effect during the reporting period.
CHAPTER
24
Consolidated and separate financial
statements
(IAS 27; IFRS 10 and IFRS 12)
Contents
24.1 Background and overview of contents of the Standards ................................... 724
24.1.1 Background ......................................................................................... 724
24.1.2 Overview of the Standards .................................................................. 726
24.2 Separate financial statements (IAS 27) ............................................................. 727
24.3 Control ............................................................................................................... 730
24.3.1 Power .................................................................................................. 730
24.3.2 Returns ................................................................................................ 734
24.3.3 Link between power and returns ......................................................... 735
24.3.4 Other issues ........................................................................................ 736
24.3.5 Continuous assessment of control ...................................................... 737
24.4 Consolidated financial statements..................................................................... 737
24.4.1 Consolidate all subsidiaries ................................................................. 737
24.4.2 Consolidated financial statements need not be prepared ................... 738
24.4.3 Previous exclusions from consolidation .............................................. 738
24.4.4 Investment entities .............................................................................. 738
24.5 Consolidation procedures .................................................................................. 739
24.5.1 Basic consolidation procedures ........................................................... 739
24.5.2 Elimination of intragroup balances and transactions ........................... 742
24.5.3 Horizontal and vertical groups ............................................................. 745
24.5.4 Reporting date ..................................................................................... 746
24.5.5 Same accounting policies for parent and subsidiaries ........................ 747
24.5.6 Periods for inclusion of subsidiary and measurement ......................... 747
24.5.7 Non-controlling interests ...................................................................... 747
24.5.8 Losses of subsidiaries and non-controlling interests ........................... 748
24.5.9 Preference dividends ........................................................................... 749
24.5.10 Foreign subsidiaries ............................................................................ 749
24.5.11 Changes in percentage ownership interest of the parent,
without obtaining or losing control ....................................................... 749
24.5.12 Loss of control of a subsidiary ............................................................. 752
24.6 Disclosure .......................................................................................................... 757
24.6.1 Separate financial statements ............................................................. 757
24.6.2 Disclosure of interests in other entities ................................................ 758
24.6.3 Interests in subsidiaries and consolidated financial statements .......... 758
24.6.4 Interests in unconsolidated structured entities .................................... 759
24.6.5 Investment entities .............................................................................. 759
723
24.1 Background and overview of contents of the Standards
24.1.1 Background
The objective of consolidated financial statements or group statements is similar to the broad
objective as envisaged by the Conceptual Framework for general purpose financial
reporting, namely to provide financial information about the reporting entity (the group) that
is useful to existing and potential investors, lenders and other creditors in making decisions
about providing resources to the group of entities. A reporting entity may comprise both
the parent (the entity having control over a subsidiary) and its subsidiaries under its control
and its (the group) financial statements are referred to as “consolidated financial
statements”. The assets, liabilities, equity, income, expenses and cash flows of the parent
and its subsidiaries are presented as those of a single economic entity. IFRS 10 defines a
‘group’ as the parent and all its subsidiaries.
IAS 27 Separate Financial Statements, IFRS 10 Consolidated Financial Statements, and
IFRS 12 Disclosure of Interests in Other Entities, IFRS 3 Business Combinations, (with other
related Standards) deal with group reporting. These Standards are discussed below.
Separate Financial Statements (IAS 27)
The revised IAS 27 addresses the separate financial statements of a parent (i.e. not the
consolidated financial statements, but only those financial statements of the parent on its
own) and deals with the accounting treatment and disclosure requirements of investments
in subsidiaries, joint ventures and associates (refer to chapter 25).
Consolidated Financial Statements (IFRS 10)
IFRS 10 deals with the consolidated financial statements (i.e. that of the group) and
defines the principle of control that forms the basis for the preparation of consolidated
financial statements. The Standard sets out the requirements for applying the control
principle and prescribes the process of consolidation (i.e. incorporating the subsidiaries into
the financial statements of the group).
Disclosure of Interests in Other Entities (IFRS 12)
IFRS 12 deals with the disclosure of interests in other entities.
Business Combinations (IFRS 3)
IFRS 3 Business Combinations, deals with the initial accounting treatment of subsidiaries by
the acquirer on the date of acquisition (i.e. the date that control is obtained), while IFRS 10
addresses, amongst others, the consolidation procedures and accounting treatment after
the date of acquisition.
In terms of IFRS 3, entities are required to account for business combinations by applying
the acquisition method. This involves identifying the acquirer, determining the acquisition
date, determining the values of the identifiable assets and liabilities acquired, and the
consideration (investment) for the business combination, as well as the recognition and
measurement of goodwill or gain from a bargain purchase. IFRS 10 is used to effect the
consolidation after the initial business combination has been accounted for.
This chapter focuses primarily on the requirements of IAS 27 and IFRS 10. For Business
Combinations, refer to chapter 26.
Consolidated and separate financial statements 725
The following is a schematic presentation, on a time-line, of the interaction between IFRS 3

and IFRS 10 when control over a single subsidiary is acquired on 1 January 20.13:
Parent (acquirer)
purchases shares in
Not a business combination as Parent consolidates
subsidiary (acquiree) and a
the parent does not have an subsidiary after the
business combination takes
interest in the subsidiary business combination
place as control (in terms of
IFRS 10) is obtained
Period up to Period from

On 1 January 20.13
31 December 20.12 1 January 20.13
Apply IFRS 3 to
Apply individual accounting Apply IFRS 10 to account
determine the at
standards to items in the for the subsequent
acquisition fair values of
financial statements of consolidation of the
the identifiable assets and
individual companies subsidiary
liabilities of the subsidiary
The broad process of consolidation (refer to section 24.5 for detail) can be schematically
However, before consolidation can be discussed, it is important to consider the accounting

treatment of an investment in another entity. A parent typically holds an investment in the
equity shares of a subsidiary (i.e. the parent acquired a share investment). The accounting
treatment of an investment depends on the nature thereof and the degree of influence or
control exercised by the investor over the investee. A distinction should be made between
the accounting treatment in the investor’s separate financial statements and the
consolidated financial statements of the group.
The accounting treatment, applicable Standards and the interaction between the relevant
Standards can be schematically presented as follows:
Investor makes an investment in another entity.

Depending on the degree of influence or control, the
investment may be treated as follows:
Significant
Joint control Control No significant
influence
in terms of IFRS 11 in terms of IFRS 10 influence or control
in terms of IAS 28
The investor can choose to account for its investment in another entity
Account for as a
in its separate (individual) statements at cost or in accordance with
financial asset in
IFRS 9 or
terms of IFRS 9
using the equity method in accordance with IAS 28.
continued
The investment in another entity is included in the consolidated financial statements as follows:
Significant influence in Joint control in terms of Control in terms

terms of IAS 28 IFRS 11 over joint venture of IFRS 10
Equity method in terms of IAS 28 As a business

combination on the date
control is obtained in terms
of IFRS 3
Consolidation thereafter
in terms of IFRS 10
Disclosure in terms of IFRS 12
24.1.2 Overview of the Standards

The following is a schematic presentation of the contents of IAS 27, IFRS 10 and IFRS 12,
which are discussed in this chapter:
Consolidated financial
Separate financial statements
statements
IAS 27: Investment at cost or
in accordance with IFRS 9 or using the IFRS 10
equity method in accordance with IAS 28
Consolidated
Scope financial
statements
Definitions Control
Group
Exemptions Non-controlling
interests
Control
Parent
Separate financial
statements
Subsidiary
Consolidate:
line-by-line combination
Does control exist? eliminate carrying amount of
investment
calculate non-controlling interests
No Yes eliminate intragroup transactions
other considerations:
– accounting policies
– reporting date
changes in ownership interests, not
Apply other relevant Standards, resulting in loss of control
namely IFRS 9, IFRS 11 and IAS 28 loss of control
Disclosure: IFRS 12
24.2 Separate financial statements (IAS 27)

Separate financial statements provide financial information about the entity’s position viewed
from the perspective of an investor. Investments in subsidiaries, joint ventures and
associates are thus accounted for on the basis of the direct equity interest of the ‘parent’/
‘investor’, rather than on the basis of reported results and net assets of the subsidiaries, joint
ventures or associates. Where an entity does not have an interest in a subsidiary, joint
venture or associate, its financial statements are not called separate financial statements.
A parent that is exempt (refer to section 24.4.2) from preparing consolidated financial
statements would still have an interest in at least one subsidiary in order to qualify for the
exemption, and may therefore still present separate financial statements as its only financial
statements. An investment entity that is required not to consolidate its subsidiaries (refer to
section 24.4.4) presents separate financial statements as its only financial statements. An
investment entity shall measure an investment in a subsidiary at fair value through profit or
loss in accordance with IFRS 9 Financial Instruments, and does not have the choice as is
indicated below.
IAS 27 prescribes the treatment of investments in subsidiaries, joint ventures and
associates, if the investor presents separate financial statements.
To ensure comparability, investments in subsidiaries, joint ventures and associates in the
separate financial statements of a parent are treated as follows (IAS 27.10):
accounted for as a financial asset# in terms of IFRS 9 Financial Instruments; or
using the equity method in accordance with IAS 28; or
carried at cost.
#
The nature of such investments would probably lead to them being classified as equity
investments at fair value through other comprehensive income (IFRS 9.5.7.5).
An entity shall apply the same accounting treatment for each category of investments. Note
that each category of investment may be carried under a different basis of accounting. For
instance, all investments in subsidiaries may be carried at cost, all investments in joint
ventures at cost, and all investments in associates at fair value in terms of IFRS 9 Financial
Instruments. By implication, it is therefore not acceptable to carry some investments in
subsidiaries of a single parent at cost and others at fair value.
Where the investor accounts for its investment in a subsidiary in accordance with IFRS 9
Financial Instruments, the investment is continuously remeasured to its fair value. The
investor may choose to remeasure its equity investments that are not held for trading at fair
value through other comprehensive income (IFRS 9.5.7.5). These fair value adjustments are
normally reflected in a ‘mark-to-market reserve’. The fair value adjustments to the mark-to-
market reserve raised in terms of IFRS 9 Financial Instruments, must be reversed as a pro
forma consolidation entry on consolidation. Not reversing these fair value adjustments on
consolidation will lead to the goodwill amount changing every time a consolidation is
performed, and is not allowed in terms of IFRS 3 Business Combinations.
Example 24.
24.1 Investment in subsidiary – cost versus fair value
Charlie Ltd acquired an 80% interest in Sub Ltd on 1 January 20.14 for R100 000 when the share
capital of R100 000 and retained earnings of R10 000 were Sub Ltd’s only items of equity
(representing the fair value of the identifiable net assets). The fair value of this investment
amounted to R150 000 on 31 December 20.14. The non-controlling interests at the date of
acquisition are measured at their proportionate share of the identifiable net assets of the acquiree.
The group’s reporting date is 31 December. The normal income tax rate is 28%, and the capital
gains tax inclusion rate is 80%.
continued
Investment in subsidiary carried at cost:

If it is assumed that Charlie Ltd follows an accounting policy in its separate financial statements
whereby the investment in the subsidiary is carried at cost, the following would apply:
Extract from Charlie Ltd’s separate statement of financial position:
Non-current assets R
Investment in subsidiary (at cost) 100 000
The pro forma consolidation journal entry is:
Dr Cr
R R
31 December 20.14
Share capital (SCE) 100 000
Goodwill (SFP) 12 000
Investment in Sub Ltd (SFP) 100 000
Non-controlling interests (SFP) [(100 000 + 10 000) × 20%)] 22 000
Elimination of equity at acquisition and investment in subsidiary
Comment
¾ The non-controlling interests at the date of acquisition can either be measured at their
proportionate share of the identifiable net assets of the acquiree (as in this example), or at fair
value. For the purposes of this chapter, any non-controlling interests are measured at its
proportionate share of the identifiable net assets of the acquiree. The use of fair value as a
measurement basis for non-controlling interests is illustrated in chapter 21. Refer to IFRS 3.19
for the two measurement options for equity shares.
Investment in subsidiary carried at fair value:
If it is assumed that Charlie Ltd follows an accounting policy in its separate financial statements
whereby the investment in the subsidiary is carried at fair value in terms of IFRS 9 Financial
Instruments, and that Charlie Ltd chose to remeasure this investment through other
comprehensive income, the following will apply:
Extract from Charlie Ltd’s separate statement of financial position:
Non-current assets
R
Investment in subsidiary (100 000 + 50 000) (fair value) 150 000
Equity
Mark-to-market reserve [50 000 – 11 200 (50 000 × 80% × 28%)] 38 800
Deferred tax (50 000 × 80% × 28%) 11 200
The pro forma consolidation journal entries are:
Dr Cr
R R
31 December 20.14
Mark-to-market reserve (OCI of current year) 38 800
Investment in subsidiary (SFP) (the fair value gain) 50 000
Reversal of fair value adjustment and related deferred tax
Investment in Sub Ltd (SFP) (150 000 – 50 000) 100 000
Non-controlling interests (SFP) [(100 000 + 10 000) × 20%] 22 000
Elimination of equity at acquisition and investment in subsidiary
continued
Comment
¾ Where the investment is carried at fair value in terms of IFRS 9 Financial Instruments, the fair
value adjustment in the mark-to-market reserve and the related deferred tax will have to be
reversed on consolidation. This pro forma consolidation journal is necessary as the elimination
of the fixed amount of at acquisition equity needs to be made against the fixed amount of the
original cost of the investment in the subsidiary (consideration paid for the business
combination) to keep goodwill the same from year to year.
¾ Once the fair value adjustment has been reversed, the journal for elimination of equity at
acquisition is the same as that used where the investment in the subsidiary is carried at cost.
In terms of the accounting standard on associates and joint ventures (IAS 28), an
investment in an associate or joint venture must be accounted for in the investor’s separate
financial statements in accordance with the requirements of IAS 27.10 (i.e. either at cost, or
in accordance with IFRS 9 Financial Instruments or using the equity method in accordance
with IAS 28).
When an investment in an associate or a joint venture is held directly by, or indirectly
through, an entity that is a venture capital organisation, or a mutual fund, unit trust and
similar entities, including investment-linked insurance funds, the entity may elect to measure
investments in those associates and joint ventures at fair value through profit or loss in
accordance with IFRS 9 Financial Instruments (IAS 28.18). If an entity makes this election, it
shall also account for those investments in the same way in its separate financial statements
(IAS 27.11).
When an investment entity does not consolidate its subsidiaries or apply IFRS 3 Business
Combinations when it obtains control of another entity in terms of IFRS 10.31, the
investment entity shall measure the investment in the subsidiary at fair value through profit
or loss in accordance with IFRS 9 Financial Instruments. In this instance, the investment
entity must also account for its investment in the subsidiary in the same way in its separate
financial statements (IAS 27.11A).
If investments in subsidiaries, joint ventures and associates are classified as held for sale
in terms of IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, they
shall be accounted for in terms of IFRS 5 (refer to chapter 19).
An investor will (in terms of IAS 27.12) recognise a dividend from a subsidiary, joint venture
or an associate as income from the investment in profit or loss in its separate financial
statements as soon as the right to receive the dividend has been established.
If the entity elects to use the equity method to account for the subsidiary, joint venture or
associate in its separate financial statements, then the dividend is recognised as a reduction
from the carrying amount of the investment.
In terms of IAS 27.13, when a parent reorganises the structure of its group by establishing a
new entity as its parent in a manner that satisfies the following criteria:
the new parent obtains control of the old parent;
the assets and liabilities of the new and original groups are the same immediately before
and after the re-organisation; and
the owners of the original parent will, immediately before and after the re-organisation,
have the same absolute and relative interests in the original and the new group;
and such a new parent accounts for the investment in the original parent at cost in its
separate financial statements, the new parent shall measure the cost of this investment at
the carrying amount of its share of the equity items shown in the separate financial
statements of the original parent at the date of the re-organisation.
If an entity that is not a parent establishes a new entity to serve as its parent in a manner
that satisfies the above three criteria, the accounting treatment thereof will be the same. In
such cases, references to ‘original parent’ and ‘original group’ are replaced by ‘original
entity’.
24.3 Control
Control (IFRS 10.5 to 18 and .B2 to B85) forms the basis for determining which entities are
consolidated in the consolidated financial statements. An investor shall therefore determine
whether it controls an investee, regardless of the nature of its involvement with the investee.
An investor controls an investee when the investor is exposed to, or has rights to, variable
returns from its involvement with the investee and has the ability to affect those returns
through its power over the investee. Control would therefore exist if, and only if, the investor
has all of the following (IFRS 10.7):
power over the investee;
exposure to, or rights to, variable returns from its involvement with the investee; and
the ability to use its power over the investee to affect the amount of the investor’s returns
from the investee (i.e. there should be a link between power and returns).
Furthermore, the investor should consider the following factors to determine whether it has
control over another entity:
the purpose and design of the investee;
the activities of the investee that significantly affect the investor’s return (referred to as
‘relevant activities’) and how decisions about these activities are made;
whether the investor’s rights give it the current ability to direct the relevant activities;
the investor’s exposure to, or rights to, variable returns from its involvement with the
investee;
the ability of the investor to use its power over the investee to affect the amount of its
returns; and
the nature of its relationship with other parties (e.g. other investors in the investee and
agents).
The assessment of control requires professional judgement and investors should consider
all facts and circumstances. This assessment should be made on a continuous basis and
whenever facts and circumstances indicate any change in any of the three elements of
control indicated above. IFRS 10 provides detailed guidance on applying the control
principle, the core of which is briefly summarised and illustrated below.
24.3.1 Power
Existing rights
An investor has power over an investee when the investor has existing rights that give it
the current ability to direct the relevant activities that significantly affect its returns.
Power arises from rights
Sometimes an investor may have control solely from holding more than 50% of the voting
rights and sometimes other rights (e.g. contractual arrangements, or the right to appoint the
majority of the board of directors) need to be considered in the assessment of control.
Entities may be considered to be subsidiaries (controlled by a parent) even if the parent
does not hold the majority of the voting rights. For example, a company may exercise
‘passive control’ over another company through a small shareholding combined with other
rights, giving the parent power over the subsidiary. By contrast, an entity may hold the
majority of the voting rights in an investee, but if these voting rights are not substantive (see
below), the entity does not have power over the investee.
Example 24.
24.2 Basic voting rights and contractual agreements
Richy Ltd owns 60%, 40% and 30% respectively of the ordinary shares with voting rights in
Money Ltd, Wealthy Ltd and Cashy Ltd. A shareholder has one vote at a shareholders’ meeting for
each ordinary share held. The relevant activities of the investee are directed at a shareholders’
meeting with a majority vote.
Richy Ltd controls Money Ltd through its power over Money Ltd. The fact that Richy Ltd owns
more than 50% of the ordinary shares of Money Ltd gives it power over the majority of the
voting rights.
Richy Ltd does not control Wealthy Ltd, as it does not have power over the majority of the
voting rights of Wealthy Ltd. However, should Richy Ltd have an agreement with another
shareholder, who holds (say) 30% of the voting rights, whereby that shareholder would always
vote with Richy Ltd, Richy Ltd would have power and control over Wealthy Ltd, as it would then
have power over 70% (40% + 30%) of the voting rights.
Richy Ltd does not control Cashy Ltd as it does not have power over Cashy Ltd. However,
should Richy Ltd have the contractual right to appoint seven of the 10 directors (assume that
the board of directors has in this case the ability to direct the relevant activities of Cashy Ltd), it
may have power and control over Cashy Ltd.
Comment
¾ The relevant activities (i.e. the activities of the entity that affect the investor’s returns) are here
directed at a shareholders’ meeting. Therefore, voting rights are a key indicator of control in
these circumstances.
¾ Other existing rights, such as agreements with other shareholders, may supplement voting
rights to determine control over an investee.
Current ability to direct relevant activities

An investor that has the current ability to direct the relevant activities of its investee has
power, even if its rights to direct the activities have yet to be exercised. For the purpose of
assessing whether an investor has power over an investee, only substantive rights (refer
to IFRS 10.B22 to .B25) should be considered.
In terms of the principles of control, all potential voting rights (refer to IFRS 10.B47 to
.B50) that are substantive should be considered when determining whether control exists.
This means that these potential voting or conversion rights are taken into account when
deciding whether an entity controls (has power over) another entity. For any right to be
substantive, the holder must have the practical ability to exercise that right and those
rights should be exercisable when (refer to Application Example 3 to IFRS 10 for more
detail) decisions about the direction of the relevant activities need to be made. Furthermore,
potential voting rights should usually be currently exercisable or convertible in order to be
included in the assessment of control. Potential voting rights may also have to be
considered, even if they are not currently exercisable (refer to IFRS 10.B24). An investor
also needs to consider the purpose and design of any other involvement it may have in the
investee.
If, when taking the potential voting rights into account, it is decided that an entity is under the
control of another entity, the present ownership interest, excluding potential voting rights,
is used for consolidation purposes. Instruments containing potential voting rights are usually
accounted for in accordance with IFRS 9 Financial Instruments.
Example 24.
24.3 Potential voting rights and a call option
Alpha Ltd and Beta Ltd respectively own 38% and 40% of the ordinary shares with voting rights in
Delta Ltd. Various other individual shareholders hold the other shares. Delta Ltd’s relevant
activities are directed at a shareholders’ meeting with a majority vote. Alpha Ltd also holds a call
option from Beta Ltd to buy half of its shares in Delta Ltd (i.e. a 20% interest in Delta Ltd) at any
time, at R10 per share. Delta Ltd’s shares are currently trading at R25 per share. The business
activities of Delta Ltd are closely related to those of Alpha Ltd.
In this example, the potential voting rights arising from the call option are included in the
assessment of control arising from Alpha Ltd’s interest in Delta Ltd, as the option may be
considered to be substantive. Some of the factors that may indicate that the option is substantive
are:
Alpha Ltd is considered to have the practical ability to exercise the option.
The option is immediately exercisable (i.e. exercisable when decisions are to be made).
There are no barriers (e.g. financial penalties, unfavourable terms and conditions, regulatory
requirements, etc.) preventing Alpha Ltd from exercising the option.
There are no parties that must agree to the option being exercised.
The option is ‘in the money’ (the exercise price is substantially below the current market price of
the share).
Alpha Ltd would benefit from realising synergies if the option is exercised, as the business
activities of Delta Ltd are closely related to those of Alpha Ltd. This may have been Alpha Ltd’s
motive or reason for obtaining the option in the first place (i.e. the purpose and design of
potential voting right).
If the option is exercised, Alpha Ltd would have 58% (38% + 20%) of the voting rights over
Delta Ltd. Alpha Ltd may have power over Delta Ltd because it is considered to have the current
ability to direct the relevant activities of Delta Ltd.
If the decision is reached that Alpha Ltd controls Delta Ltd, the latter is a subsidiary of Alpha Ltd
and should be consolidated. The present ownership interest of 38% will be used in the
consolidation with the non-controlling interests actually representing a ‘majority’ of 62%. In order to
achieve fair presentation, the disclosure of the share options in terms of IFRS 7 Financial
Instruments: Disclosures, and the disclosure in terms of IFRS 12 should be followed. IFRS 12
specifically requires disclosure of information about significant judgements and assumptions that
Alpha Ltd made in determining that it has control over Delta Ltd. A description of the potential
voting rights would thus be needed.
Investors holding protective rights (refer to IFRS 10.B26 to .B28) do not normally have
power over an investee. Protective rights usually relate to fundamental changes to the
activities of an investee or apply only in exceptional circumstances. Protective rights are
designed to protect the interests of their holders without giving them power over the
investee. Protective rights may often be found in a franchise agreement, which gives the
franchisor rights that protect the franchise brand, rather than giving the franchisor power
over the operating activities of the franchisee.
Example 24.
24.4 Protective rights
Table Ltd and Chair Ltd respectively own 55% and 30% of the ordinary shares with voting rights in
Furniture Ltd. Various other individual shareholders hold the remaining shares. The relevant
activities of Furniture Ltd are directed at a shareholders’ meeting with a majority vote. In terms of a
shareholders’ agreement, Furniture Ltd needs the approval of 75% of the shareholders for any
major capital expenditures, or to enter into any new debt agreement.
Furniture Ltd commenced with operations during the previous year and was funded by R10 million
equity (i.e. 10 000 ordinary shares held by Table Ltd, Chair Ltd and others) and R5 million debt (i.e.
2 500 preference shares held by First Merchant Bank, with fixed annual preference dividends). The
preference shares only have voting rights if the preference dividends are in arrears.
continued
In this example, the approval from 75% of the shareholders may be considered to be a protective
right of Chair Ltd and the individual shareholders. Chair Ltd can effectively keep Table Ltd (the
controlling shareholder) from approving capital expenditure or from entering into any new debt
agreement. This right, however, does not give Chair Ltd power over Furniture Ltd as it cannot
change the relevant activities and how the business is managed.
The fact that the preference shares will have voting rights if the preference dividend is in arrears is
also a protective right for First Merchant Bank. Should this be the case, Table Ltd would only hold
44% of the total votes (5 500/12 500 (10 000 ordinary + 2 500 preference)), but may still have
power over Furniture Ltd. The possible voting right of First Merchant Bank if the preference
dividend is in arrears does not give it power over Furniture Ltd.
If the preference dividend is actually in arrears, Table Ltd need to consider if it still has control over
Furniture Ltd, by considering all guidance in IFRS 10 relating to “control”.
When assessing whether an investor’s voting rights are sufficient to give it power (i.e.
whether the investor has the practical ability to direct the relevant activities unilaterally), the
investor should also consider, amongst others, the following:
the size of the investor’s holding of voting rights relative to the size and distribution of
holdings of the other vote holders;
potential voting rights held by the investor, other vote holders and/or other parties (refer
to Example 24.3 above);
rights arising from other contractual arrangements (refer to Example 24.2 above); and
any additional facts and circumstances that indicate the investor has, or does not have,
the current ability to direct the relevant activities at the time that decisions need to be
made, including voting patterns at previous shareholders’ meeting.
Example 24.
24.5 Minority voting rights and power
Hocky Ltd has 1 000 ordinary shares in issue. Each share entitles the shareholder to one vote at a
shareholders’ meeting. The relevant activities of Hocky Ltd are directed by the shareholders’
meetings. Consider the following cases:
Case 1
Sport Ltd owns 400 ordinary shares of Hocky Ltd (40%), and the other shares are held by various
individuals. No individual owns more than 20 ordinary shares of Hocky Ltd. Most of these
individuals do not attend any shareholders’ meetings.
Sport Ltd may have control over Hocky Ltd even though it does not hold the majority of the voting
rights. Sport Ltd may only have 40% of the total voting rights, but it is significantly more than any
other shareholders or organised group of vote holders. The relative size of Hocky Ltd’s voting
rights compared to that of other shareholders may be enough for Hocky to have a majority vote,
especially if the other shareholders do not attend shareholders’ meetings. The fact that the other
shareholdings are widely dispersed (distribution of voting rights) contributes to the fact that Sport
Ltd has power over Hocky Ltd.
Furthermore, a large number of the other shareholders (with more than 500 voting rights) would
need to act together to outvote Sport Ltd.
Case 2
Sport Ltd owns 400 ordinary shares of Hocky Ltd (40%) and the other shares are held by Goal Ltd
(350 shares) (35%) and Stick Ltd (250 shares) (25%).
Sport Ltd may not have control over Hocky Ltd based on the size of its voting rights relative to the
other shareholders. In this case, only two shareholders, Goal Ltd and Stick Ltd, need to co-operate
to be able to prevent Sport Ltd from directing the relevant activities of Hocky Ltd.
Sport Ltd could have significant influence over Hocky Ltd (refer to IAS 28 Investments in
Associates and Joint Ventures).
continued
Case 3
Sport Ltd owns 400 ordinary shares of Hocky Ltd (40%), and the other shares are held by various
individuals. No individual owns more than 20 ordinary shares of Hocky Ltd. Voting patterns over
the past few years indicated that on average 75% of all voting rights are actually exercised at a
shareholders’ meeting (i.e. shareholders with a total of 75% of the voting rights are present at a
meeting and vote on a decision).
Sport Ltd may have control over Hocky Ltd as it effectively has the majority of the voting rights
exercised at a shareholder’s meeting. Sport Ltd may only have 40% of the total voting rights, but it
represents about 53% (45%/75%) of the average votes at a shareholders’ meeting.
It was mentioned above that an investor should, amongst other aspects, consider the:
relevant activities (the activities of the investee that significantly affect the investor’s
return and how decisions about these activities are made); and
purpose and design of the investee
in its assessment of control over that investee. These aspects are illustrated below:
Example 24.
24.6 Majority voting rights without power
Electric Ltd owns 55% of the equity shares of Sparky Ltd. Sparky Ltd was set (designed) up by a
local municipality to handle the supply of electricity to households and businesses within the
borders of the local municipality. The municipality owns the other 45% of the equity shares of
Sparky Ltd. The operating activities are closely regulated by the local municipality and Sparky Ltd
may only operate under a licence granted by the local municipality. Electricity prices are regulated
by the local municipality.
Electric Ltd would normally be considered to have power over Sparky Ltd as it holds 55% of the
voting rights. However, the voting rights of Electric Ltd are not considered to be substantive in this
case. Even though Electric Ltd holds the majority of the voting rights, it does not have power over
Sparky Ltd, as the relevant activities of Sparky Ltd are subject to direction by the local
municipality. The purpose and design of Sparky Ltd were such that the direction of its activities (it
operates under a licence from the local municipality) and its returns (electricity prices are
regulated) were predetermined by the local municipality. Electric Ltd’s 55% voting rights cannot
alter the relevant activities of Sparky Ltd in this case.
Electric Ltd would therefore not be fully able to utilise any decision-making ability (not power) it
may have over Sparky Ltd to affect its return from Sparky Ltd.
As a result, Sparky Ltd may in this case be controlled by the local municipality. Sparky Ltd can be
considered to be an ‘unconsolidated structured entity’ of Electric Ltd. IFRS 12 contains specific
disclosure requirements for such unconsolidated structured entities – refer to section 24.6.4.
24.3.2 Returns
The second element of the concept of control requires the investor’s involvement with the
investee to provide the investor with rights to, or exposure to, variable returns. To have
control, an investor must have:
power over the investee;
exposure to, or rights to, returns from its involvement with the investee; and
the ability to use its power to affect its own returns.
An investor has exposure to, or rights to, variable returns from its involvement with the
investee when its returns from its involvement have the potential to vary as a result of the
investee’s performance. IFRS 10 uses the term ‘returns’ rather than ‘benefits’, as the
returns may either be positive or negative and the Standard implies a broad definition of
‘returns’ which may include, for example,
dividends or other distributions;
interest (even fixed interest payments may be regarded as variable returns in the context
of IFRS 10 as they are subject to default risk and they expose the investor to the credit
risk of the investee);
changes in the value of the investor’s investment;
remuneration or other fees for services (the remuneration may depend on the investee’s
ability to generate enough income to pay the fee);
residual interest in net assets at liquidation; and
and returns not available to other interest holders, for example synergy, and even BEE
equity credentials in some cases.
24.3.3 Link between power and returns

For control to be present, an investor should not only have power over the investee and
exposure to, or rights to, variable returns from its involvement with the investee, but should
also have the ability to use its power to affect its returns from its involvement with the
investee. The existence of the link between power and returns can be illustrated as follows:
Investor
Power Link Variable

returns
Investee
Furthermore, an investor with decision-making rights shall determine whether it is a

principal or an agent. An agent would not control an investee when it exercises the
decision-making rights delegated to it, as it is primarily engaged to act on behalf of, and for
the benefit of, its principal(s). IFRS 10 provides detailed application guidance on determining
whether a decision-maker is an agent or principal. It also addresses issues such as
delegated power, scope of the decision-making authority, rights held by other parties,
remuneration, and exposure to variability of returns from other interests in an investee.
Example 24.
24.7 Agent and control
Offroad Ltd is a manufacturing company that specialises in the manufacturing of various off-road
vehicles. Ten shareholders hold the equity shares of Offroad Ltd equally.
Bakkies Ltd, one of the shareholders, is also a manufacturing company and specialises in the
manufacturing of trucks. The shareholders appointed Bakkies Ltd to manage the operating
activities of Offroad Ltd as it had extensive experience in manufacturing and operating in that
segment. In terms of an agreement between the shareholders, Bakkies Ltd would receive a
market-based service fee and a performance bonus of 5% of the excess profits of Offroad Ltd if
predetermined targets were met. The other investors can remove Bakkies Ltd as the manager by
a majority vote.
continued
Although Bakkies Ltd should make decisions in the best interests of all investors, it has extensive
decision-making authority in directing the relevant activities of Offroad Ltd. Bakkies Ltd (holding
decision-making rights) should assess whether it controls Offroad Ltd and should consider
whether it is a principal or agent. In this assessment, Bakkies Ltd should consider the following
aspects:
The scope of its decision-making authority: The scope of Bakkies Ltd’s decision-making
authority is such that Bakkies Ltd can direct all of the relevant activities of Offroad Ltd and has
full discretion when making decisions about these activities. This may indicate control.
However, the purpose and design of the shareholders’ decision to appoint Bakkies Ltd as the
manager of Offroad Ltd was rather that Bakkies Ltd would not have the opportunity or incentive
to obtain rights that are significantly different from those of the other shareholders. Bakkies Ltd
should operate Offroad Ltd to maximise returns for all the shareholders. This may indicate that
Bakkies Ltd is an agent.
Rights held by other parties: The other shareholders have the right to remove Bakkies Ltd as
the manager by a majority vote. Their removal right in this case may be substantive, rather than
only protective. Only five other shareholders would need to work together to remove
Bakkies Ltd, which may indicate that Bakkies Ltd is only an agent. The other shareholders
have substantive rights that may affect Bakkies Ltd’s ability to direct the relevant activities.
Remuneration: Bakkies Ltd has rights to, and is exposed to, variable returns from managing
the operating activities of Offroad Ltd. Bakkies Ltd receives a market-related service fee and a
performance bonus. This remuneration exposes Bakkies Ltd to variable returns from its
involvement with Offroad Ltd. However, if the performance bonus is considered to be linked to
the service performed and is not excessive, the remuneration is not of such significance that
Bakkies Ltd is exposed to significantly different variability of returns compared to other
shareholders. This, in isolation, may indicate that Bakkies Ltd is acting as an agent.
Exposure to variability of returns from other interests: Bakkies Ltd also has a 10% equity
interest in Offroad Ltd, which increases its exposure to variable returns from acting as the
manager of Offroad Ltd, in addition to the remuneration. Considering the fact that nine other
shareholders also have a 10% interest each, Bakkies Ltd’s exposure to variable returns may
not be of such significance in relation to the other shareholders. This may indicate that
Bakkies Ltd is acting as agent for the other shareholders.
The overall relationship between Bakkies Ltd and the other shareholders and their relative
shareholdings may indicate that Bakkies Ltd is an agent. Bakkies Ltd therefore does not control
Offroad Ltd.
24.3.4 Other issues

Another aspect that an investor should consider in the assessment of control is the nature
of its relationship with other parties (IFRS 10.B73 to .B75). The investor should also
consider whether those other parties are acting on its behalf (i.e. they are ‘de facto agents’),
and how those parties interact with each other and the investor itself. Examples of other
parties that, by the nature of their relationship, might act as de facto agents for the investor,
may include:
related parties;
parties that received their investment in the investee as a contribution or loan from the
investor;
parties bound not to transfer their investments;
parties that financed their operations with subordinate financial support from the investor;
investees with substantially the same members of key management personnel; and
parties with close business relationships with the investor.
IFRS 10.B76 to .B79 addresses the issue of control of specified assets. An investor
should consider whether it treats a portion of an investee as a deemed separate entity and
if so, whether it controls the deemed separate entity. Such deemed separate entity is often
referred to as a ‘silo’. If the silo is deemed to be controlled by the investor, the investor
should consolidate that portion of the investee, and other parties should exclude that portion
of the investee when assessing control.
24.3.5 Continuous assessment of control

An investor should continuously assess (refer to IFRS 10.B80 to .B85) whether it has
control over another entity. In doing so, an investor should assess control over another
entity whenever facts and circumstances indicate any changes in any of the three elements
of control. Changes in the assessment of control may occur when:
there is a change in how the relevant activities are directed;
if the investor or other investors enters into contractual arrangements;
when any contractual arrangements lapse;
when changes occur that may change an entity’s assessment of whether it is an agent or
principal, etc.
An event may cause an investor to gain or lose power over an investee even if the investor
was not involved in that event.
Example 24.
24.8 Changes in control
Since its incorporation, Colour Ltd (45%), Green Ltd (35%) and Gold Ltd (20%) have held the
shares of Rainbow Ltd. Green Ltd and Gold Ltd were both wholly-owned subsidiaries of
Bokkie Ltd. Therefore Bokkie Ltd had control over Rainbow Ltd as it controlled 55% (35% +
20%) of the voting rights of Rainbow Ltd.
On 1 October 20.13, Green Ltd (with the approval of Bokkie Ltd) sold its investment in the shares
(35%) of Rainbow Ltd to the general public. None of buyers bought more than a 1% interest in
Rainbow Ltd and they were considered to be passive investors.
Applying the concept of control in IFRS 10 and related application guidance, even though
Colour Ltd was not involved in the sale of the shares by Green Ltd, Colour Ltd may assess that it
now has control over Rainbow Ltd. Colour Ltd may only have 45% of the total voting rights, but it
is significantly more than any other shareholding (20% Gold Ltd and 35% passive investors (1%
individual shareholding). The fact that the other shareholdings are widely dispersed contributes to
the fact that Colour Ltd has power over Rainbow Ltd. Furthermore, a large number of the other
shareholders would need to act together to outvote Colour Ltd.
Colour Ltd should consolidate Rainbow Ltd from 1 October 20.13. Rainbow Ltd would represent a
‘business’ and the fact that Colour Ltd obtained control over Rainbow Ltd would constitute a
‘business combination’ to be accounted for in accordance with IFRS 3, Business Combinations
(see chapter 26).
24.4 Consolidated financial statements
24.4.1 Consolidate all subsidiaries

Consolidated financial statements (IFRS 10.4) are the financial statements of a group (i.e.
parent and all subsidiaries) presented as those of a single economic entity. A parent shall
(with limited exceptions as contained in section 24.4.2) present consolidated financial
statements, consolidating all its investments in subsidiaries. All entities under the control
(refer to section 24.3) of the parent are included in the consolidated financial statements.
The preparation of consolidated financial statements dealing with a group of companies
probably qualifies as the most significant result of the application of the requirement in the
Conceptual Framework that financial statements should faithfully represent the substance of
the phenomena that it purports to represent (the concept of substance over form). The
group may consist of various separate legal entities, but their financial information is
presented ‘as if’ (the Latin term ‘pro forma’ refer to the concept of ‘for the sake of form’ (i.e.
‘as if’)) they are one reporting entity.
24.4.2 Consolidated financial statements need not be prepared

A parent company need not present consolidated financial statements in terms of
IFRS 10.4 if:
it is a wholly-owned subsidiary, or it is a partially-owned subsidiary of another entity and
all its other owners (including those not otherwise entitled to vote) do not object to the
parent not preparing consolidated financial statements; and
its securities (debt and equity instruments) are not publicly traded; and
it is not in the process of issuing any class of instruments to the public; and
the ultimate or any intermediate parent publishes consolidated financial statements
available for public use that comply with IFRSs.
IFRS 10 does not apply to post-employment benefit plans or other long-term employee
benefit plans to which IAS 19 Employee Benefits, applies.
24.4.3 Previous exclusions from consolidation

Previously, it was assumed that if the business affairs of the parent and subsidiary differed
significantly, the subsidiary could be excluded from the consolidated statements. This is no
longer acceptable in terms of International Financial Reporting Standards. Furthermore,
IFRS 10 does not exclude a subsidiary from consolidation when control is intended to be
temporary, since the subsidiary is acquired and held exclusively with a view to its
subsequent disposal within twelve months. Such a subsidiary will therefore still qualify for
consolidation, but will, in terms of IFRS 5 Non-current Assets Held for Sale and
Discontinued Operations, be classified as a disposal group held for sale and even as a
discontinued operation that is accounted for in terms of IFRS 5 (refer to chapter 19).
If a subsidiary operates under severe long-term restrictions that significantly impair its ability
to transfer funds to the parent, this would still not be a reason for non-consolidation. It can
however, under extreme circumstances, be argued that in such cases the investor no longer
has control over the investee – consolidation of such an investee will then be discontinued
since control has been lost.
A subsidiary may not be excluded from consolidation because the investor is a venture
capital organisation, mutual fund, unit trust or similar entity.
Subsidiaries that are not consolidated in terms of IFRS 10 are accounted for as investments
in accordance IFRS 9 Financial Instruments.
24.4.4 Investment entities

An investment entity shall not consolidate its subsidiaries or apply IFRS 3 Business
Combinations, when it obtains control of another entity. Instead, an investment entity shall
measure an investment in a subsidiary at fair value through profit or loss in accordance
with IFRS 9 Financial Instruments (IFRS 10.31 to .32).
In terms of IFRS 10.27, a parent shall determine whether it is an investment entity. An
investment entity is an entity that:
obtains funds from one or more investors for the purpose of providing the investor(s) with
investment management services;
commits to its investor(s) that its business purpose is to invest funds solely for returns
from capital appreciation, investment income, or both; and
measures and evaluates the performance of substantially all its investments on a fair
value basis.
Refer to IFRS 10.B85A to .B85M for application guidance in assessing whether an entity is
regarded as an investment entity.
A parent that ceases to be an investment entity or becomes an investment entity shall
account for the change in its status prospectively from the date at which the change in
status occurred (IFRS 10.30). Refer to IFRS 10.B100-B101 and IAS 27.11B for more detail.
Notwithstanding the requirements above, if an investment entity has a subsidiary that is not an
investment entity itself, and its main purpose is to provide services that relate to the
investment entity’s investment activities, it shall consolidate that subsidiary in the normal
way. A parent of an investment entity shall consolidate all entities that it controls, including
those controlled through an investment entity subsidiary, unless the parent itself is an
investment entity.
24.5 Consolidation procedures
24.5.1 Basic consolidation procedures

Consolidated financial statements provide information about the assets, liabilities, equity,
income and expense (including items in other comprehensive income) of both the parent
and its subsidiaries as a single reporting entity. When preparing consolidated financial
statements, the consolidation process (see IFRS 10.19 to .26 and .B86 to .B99) commences
with adding together (combining) like items of assets, liabilities, equity, income and
expenses as they appear in the financial statements of the parent and its subsidiary on a
line-by-line basis. To ensure that the consolidated statements present information about the
group similar to that of a single reporting entity, it is required that:
the carrying amount of the investment in each subsidiary be offset against the parent’s
portion of equity in such a subsidiary at acquisition (refer to chapter 26 for the treatment
of any goodwill arising at the business combination);
non-controlling interests in the profit or loss and other comprehensive income of
consolidated subsidiaries for the period be calculated and identified separately from
those of the owners of the parent, to determine amounts attributable to the parent;
non-controlling interests in the net assets of consolidated subsidiaries be shown
separately from the interest of the owners of the parent in equity in the consolidated
statement of financial position. Such non-controlling interests consist of the sum of the
amount determined at the date of the original business combination (refer to IFRS 3.19)
as well as the non-controlling interests’ share of equity changes since that date; and
intragroup balances and transactions are eliminated (see below).
These consolidation procedures would be followed at every reporting date while the parent
has control over the subsidiary. The consolidation procedures would start ‘fresh’ every
time by combining the newest financial statements of the parent and subsidiaries. This
implies that all consolidation adjustments (from previous years) would be repeated every
time as no group general ledger is actually kept. Reperforming the consolidation
adjustments will ensure that the opening balances of the current period agree to the closing
balances of the previous period.
Example 24.
24.9 Basic consolidation procedures
Parent Ltd obtained an 80% interest in Subsidiary Ltd on 1 January 20.14 at a cost of R100 000. On
1 January 20.14 the fair value of the net identifiable assets of Subsidiary Ltd amounted to
R120 000 (represented by share capital of R50 000 and retained earnings of R70 000). The
non-controlling interests at acquisition date was recognised at R24 000 (20% × R120 000) and
goodwill of R4 000 (R100 000 (consideration paid) + R24 000 (non-controlling interests) –
R120 000 (fair value of net identifiable assets) was recognised in the group.
Comment
The consolidation procedures are illustrated in the extracts from the financial statements below and
are as follows:
¾ The assets, liabilities, income, expenses etc. of Parent Ltd and Subsidiary Ltd are combined on
a line-by-line basis (refer to the ‘combined’ column below).
¾ The carrying amount of Parent Ltd’s investment in Subsidiary Ltd (the subsidiary) is eliminated
against the equity of Subsidiary Ltd at the acquisition date. Non-controlling interests and
goodwill are recognised (refer to the first journal entry below). Thus, the line item ‘Investment in
subsidiary at cost’ will be NIL in the consolidated statement of financial position.
¾ The intragroup dividend (i.e. the dividend received by Parent Ltd from Subsidiary Ltd) is
eliminated (refer to the second journal entry below) as it represents an intragroup transaction
(i.e. the group cannot effectively receive a dividend from itself as the consolidated financial
statements reflect the financial information of the group as a single reporting entity).
¾ The non-controlling interests in the profit of Subsidiary Ltd since acquisition are recognised
(refer to the last journal entry below). The equity not attributable to the owners of the parent
(referred to as the non-controlling interests) are presented separately.
Extracts from the statement of financial position
for the parent, subsidiary and group (consolidated)
Consolidation Consoli-
Parent Subsidiary Combined
adjustments1 dated
Dr/(Cr)
Assets R R R R R
Other non-current assets 300 000 100 000 400 000 400 000
Investment in subsidiary at 100 000 – 100 000 (100 000) –
cost
Goodwill 4 000 4 000
Current assets 200 000 150 000 350 000 350 000
Total assets 600 000 250 000 850 000 754 000
Equity
Share capital 100 000 50 000 150 000 50 000 100 000
Retained earnings 380 000 140 000 520 000 436 0002
Non-controlling interests (24 000) 38 000
2 000
(16 000)
Liabilities
Current liabilities 120 000 60 000 180 000 180 000
Total equity and liabilities 600 000 250 000 850 000 754 000
continued
R R R R R
Gross profit 180 000 110 000 290 000 290 000
Dividends received from
subsidiary 8 000 – 8 000 8 000 –
Income tax expense (50 000) (30 000) (80 000) (80 000)
Profit and total
attributable to:
Non-controlling interests 16 000 16 000
210 000

Retained earnings R R R R R
Balance at 1 January 20.14 249 000 70 000 319 000 70 000 249 000
Change in equity for 20.14
Dividends paid (7 000) (10 000) (17 000) (10 000) (7 000)
Balance at 31 December 20.14 380 000 140 000 520 000 60 000 436 000
1
For calculation of amounts in the ‘consolidation adjustments’ column, refer to the journals.
2
This amount is transferred from the statement of changes in equity (consolidated amount).
3
The consolidated profit of R194 000, attributable to owners of the parent, is transferred from
the statement of profit or loss and other comprehensive income.
Pro forma consolidation journal entries
Dr Cr
R R
Retained earnings (at acquisition) (SCE) 70 000
Non-controlling interests (SFP) [(50 000 + 70 000) × 20%] 24 000
Elimination of equity at acquisition and the investment
in Subsidiary Ltd (main elimination journal at acquisition)
Other income (dividends received) (P/L) (10 000 × 80%) 8 000
Non-controlling interests (SFP) (10 000 × 20%) 2 000
Dividends paid (SCE) 10 000
Elimination of dividends received from Subsidiary Ltd and
recording of non-controlling interests in the dividend
Non-controlling interests (P/L) (80 000 (profit for the year) × 20%) 16 000
Non-controlling interests (SFP) 16 000
Recognition of the non-controlling interests in the profit for the
year of Subsidiary Ltd
Potential voting rights, if present, are used to establish whether control exists and whether
an entity should be consolidated or not. On consolidation, the actual present ownership
interest is used to allocate interests in net assets between equity shareholders of the parent
and the non-controlling interests (refer to Example 24.3).
24.5.2 Elimination of intragroup balances and transactions

IFRS 10 requires that intragroup balances and transactions must be eliminated in full as the
consolidated financial statements reflect the financial information of the group as a single
reporting entity. The same reporting entity (being the group) cannot, in substance, transact
with itself, realise profits from itself or owe money to itself. Any balances existing between
companies in the group (such as amounts payable/receivable by one entity to another entity
in the same group) are also fully eliminated, as are all transactions, sales, expenses and
dividends declared or paid (refer to the second journal in the example above) within the
group.
Unrealised losses must also be eliminated fully, unless the cost cannot be fully recovered
(where the unrealised loss in substance represents an impairment). Practice dictates the
elimination of such profit according to the shareholding in the selling company, which means
that the non-controlling interests, if any, will also bear a portion of the eliminated profit if the
subsidiary was the seller of the goods concerned.
Temporary differences that arise from the elimination of such profits and losses are dealt
with in accordance with IAS 12 Income Taxes.
Example 24.1
24.10
.10 Elimination of intragroup loan
Sell Ltd is a 70% subsidiary of Buy Ltd.

During the current reporting period ending 31 December 20.13, Buy Ltd granted a loan of R70 000
to Sell Ltd. Interest paid during the period amounted to R7 000. The capital amount of the loan is
repayable in a lump sum in three years’ time. The tax rate is 28%.
(S = Sell Ltd as the subsidiary; P = Buy Ltd as the parent)
Dr Cr
R R
Loan payable to parent (SFP) (S) 70 000
Loan receivable from subsidiary (SFP) (P) 70 000
Elimination of intragroup loan
Other income (interest income) (P/L) (P) 7 000
Finance costs (interest expense) (P/L) (S) 7 000
Elimination of interest on intragroup loan
Comment
¾ The consolidation procedures commences with combining the line items of the financial
statements of the subsidiary with those of the parent. The elimination of the intragroup balance
(loan payable/receivable) causes these line items to be corrected in the group as the group is
viewed as a single reporting entity.
¾ It this case, the group’s total profits and net assets remain the same and it follows that the non-
controlling interests of the subsidiary remains unaffected by this elimination of an intragroup
transaction.
Example 24.
24.11A
11A Elimination of unrealised intragroup profits, and the resulting deferred tax
Subsidiary sells inventory to the parent

Sell Ltd is a 70% subsidiary of Buy Ltd. Sell Ltd sold inventories to Buy Ltd for the first time during
the current reporting period, at a profit mark-up of 25% on cost. Total sales from Sell Ltd to
Buy Ltd amounted to R350 000. At the end of the reporting period, Buy Ltd had inventory on hand
to the amount of R200 000 (all purchased from Sell Ltd). Sell Ltd’s profit for the year amounted to
R80 000.
The tax rate is 28%.
The unrealised profit included in the closing inventory can be calculated as follows:
% Rand
Cost 100 160 000
Profit 25 40 000
Selling price (amount paid by Buy Ltd for items in closing inventory) 125 200 000
Dr Cr
R R
Revenue (P/L) (S) 350 000
Cost of sales (P/L) (P) 350 000
Elimination of intragroup sales
Cost of sales (P/L) (S) (200 000 × 25/125) 40 000
Inventory (SFP) (P) 40 000
Elimination of unrealised intragroup profit
Deferred tax (SFP) (40 000 × 28%) 11 200
Adjustment for tax on unrealised profit in inventory
Non-controlling interests (P/L) [51 200 (80 000 – 40 000 + 11 200) x 30%] 15 360
Recording of non-controlling interests in profit for the year
The deferred tax can be calculated as follows:
Carrying Temporary Deferred
Tax base
amount difference tax asset
Inventory (200 000 – 40 000) 160 000 200 000 (40 000) 11 2000
Comment
¾ Since Sell Ltd (the subsidiary) sold the inventory to Buy Ltd (the parent), the non-controlling
interests of Sell Ltd bear a portion of the eliminated (unrealised) after-tax profit resulting from
the sales transaction.
¾ This portion of the unrealised profit and its impact on the non-controlling interests will be
reflected in a separate consolidation journal (refer to the last journal entry above).
¾ The consolidated carrying amount of the group’s inventory is reduced with the unrealised profit,
but the tax base remains the same as in the subsidiary’s own records (the tax authority would
tax each company in the group on its own).
Parent sells inventory to the subsidiary
Sell Ltd is a 70% subsidiary of Buy Ltd. Buy Ltd sold inventories to Sell Ltd for the first time during the
current reporting period, at a profit mark-up of 25% on cost. Total sales from Buy Ltd to Sell Ltd
amounted to R350 000. At the end of the reporting period, Sell Ltd had inventory on hand to the
amount of R200 000 (all purchased from Buy Ltd). Sell Ltd’s profit for the year amounted to R80 000.
continued

Dr Cr
R R
Revenue (P/L) (P) 350 000
Cost of sales (P/L) (S) 350 000
Elimination of intragroup sales
Cost of sales (P/L) (P) (200 000 × 25/125) 40 000
Inventory (SFP) (S) 40 000
Elimination of unrealised intragroup profit
Deferred tax (SFP) (40 000 × 28%) 11 200
Adjustment for tax on unrealised profit in inventory
Non-controlling interests (P/L) (80 000 x 30%) 24 000
Recording of non-controlling interests in profit for the year
Comment
¾ In this example, Buy Ltd (the parent) sold inventory to Sell Ltd (the subsidiary). The
non-controlling interests will thus not bear a portion of the eliminated (unrealised) after-tax
profit derived from the sales transaction as Sell Ltd did not make the profit. The parent, Buy Ltd
made the profit thus non-controlling interests are not impacted (refer to last journal above).
These unrealised intragroup profits (or losses) will only realised when it is sold to a party
outside the group. The assumption is generally made that closing inventory in one year
will be realised during the next year due to the relatively high turnover of inventory items.
It follows that unrealised intragroup profits from the sale of inventory between group
entities will be realised in the next year. Closing inventory in one year will be the opening
inventory in the next year. It was mentioned above that consolidation adjustments should
be repeated from year to year as each consolidation will commence with combining
the newest financial statement of the group entities. As such, the consolidation adjustments
to eliminate intragroup profits at the end of year 1 would be repeated during year 2.
However, the unrealised profits would be realised during year 2 and the cost of the sales
of year 2 would be adjusted as well to reflect the realisation of the intragroup profit on the
inventory.
Example 24.11B
24.11B Elimination of unrealised intragroup profits in opening inventory (year 2)
Subsidiary sells inventory to the parent

Sell Ltd is a 70% subsidiary of Buy Ltd. Sell Ltd sold inventories to Buy Ltd for the first time during
year 1, at a profit mark-up of 25% on cost. At the end of year 1, Buy Ltd had inventory on hand to
the amount of R200 000 (all purchased from Sell Ltd). Sell Ltd’s profit for year 1 amounted to
R80 000.
The tax rate is 28%.
The unrealised profit included in the opening inventory will be realised in year 2.
Pro forma consolidation journal entries relating to the unrealised
profit from year 1 only:
Dr Cr
R R
Retained earnings (opening balance) (SCE) (S)
(being the cost of sales of year 1) (200 000 × 25/125) 40 000
Cost of sales (P/L) (S)
(being the closing inventory becoming the opening inventory which was
sold during year 2 to parties outside the group) 40 000
Elimination of unrealised intragroup profit in opening inventory and
realisation thereof in year 2
Income tax expense (P/L) (40 000 × 28%) 11 200
Retained earnings (opening balance) (SCE)
(being the income tax expense of year 1) 11 200
Adjustment for tax on unrealised profit in opening inventory
Retained earnings (opening balance) (SCE) 15 360
[51 200 (80 000 – 40 000 + 11 200) x 30%]
Non-controlling interests (opening balance) (SCE) 15 360
Recording of non-controlling interests in retained earnings
Comment
¾ The effect of the journals above is that the unrealised profit is effectively shifted from year 1
(when it was still unrealised) to year 2 (when it was realised).
¾ The first two journals could be combined as one, whereby the retained earnings is debited with
R28 800 (40 000 – 11 200).
These unrealised intragroup profits (or losses) can also arise from the sale of other assets
(such as items of property, plant and equipment, or intangible assets) and should be
eliminated as long as the asset is held within the group. It follows that the group’s
depreciation or amortisation should also be adjusted as the buying entity would base its own
depreciation on its own cost (including the unrealised profit or loss), whereas the group’s
depreciation should be based on the cost of the asset for the group (i.e. without the
unrealised profit or loss).
24.5.3 Horizontal and vertical groups

A horizontal group refers to the scenario where a parent has direct control over more than
one subsidiary and no subsidiary has any interest in another subsidiary. The consolidation
procedures would be that each subsidiary is consolidated into the group on its own
(combining each line item of each subsidiary with that of the parent, eliminate common
items and intragroup transactions, allocate the equity of each subsidiary between the
owners of the parent and the non-controlling interests, etc.).
A vertical group in its simplest form consist of a parent controlling a subsidiary, which
controls another subsidiary (referred to as a sub-subsidiary). The parent has control over the
sub-subsidiary through its control over the subsidiary. The consolidation procedures would
still be same as above, whereby each line item of each subsidiary is combined to that of the
parent (100% of each line item, irrespective of the parent’s equity interest) and the other
consolidation adjustments are still made. However, care should be exercised in the
calculation of the non-controlling interests and the equity attributable to the owners of the
parent as only the parent effective interest in the sub-subsidiary is attributable to it. The
consolidation of a vertical group typically entails the consolidation of the subsidiary and the
subsidiary, where after that group is consolidated with the parent.
Example 24.12
24.12 Basic consolidation of a vertical group
Parent Ltd (P) has an 80% interest in Subsidiary Ltd (S), which has a 70% interest in Sub-
Subsidiary Ltd (SS). The profit after tax of the companies for the current reporting period was as
follows:
Parent R1 000 000
Subsidiary R850 000
Sub-Subsidiary R600 000
No company had any items in other comprehensive income.
The consolidation of the profits of the vertical group will be reflected as follows:
of the Parent Ltd Group
R
PROFIT AND TOTAL COMPREHENSIVE INCOME FOR THE YEAR 2 450 000
(1 000 000 (P) + 850 000 (S) + 600 000 (SS))
Profit and total comprehensive income attributable to:
In SS through S: [(600 000 × 70%) × 80%] = 336 000
In S itself: (850 000 × 80%) = 680 000
In P itself: 1 000 000
In SS: (600 000 × 30%) = 180 000
In SS through S: [(600 000 × 70%) × 20%] = 84 000
In S itself: (850 000 × 20%) = 170 000
In P itself: 0
2 450 000
24.5.4 Reporting date

The financial statements of the parent and its subsidiaries shall be prepared as of the same
reporting date (see IFRS 10.B92 to .B93). Should the end of the reporting periods of the
companies (parent and subsidiary/ies) differ, the subsidiary should prepare financial
statements as of the same date as the financial statements of the parent for consolidation
purposes, unless it is impracticable to do so (presumably in very limited cases).
In the case of the same year ends being impracticable, the financial statements with
different reporting dates may be consolidated, provided such dates do not differ by more
than three months. Adjustments are made for significant transactions or events that
occurred between the two reporting dates. Consistency dictates that the length of the
reporting periods and the chosen reporting dates should be the same from period to period.
It is thus evident that financial statements as of the same reporting date are indeed
preferred.
Example 24.
24.13 End of the reporting periods for parent and subsidiaries
Bully Ltd acquired a subsidiary on 1 January 20.14. Bully Ltd’s reporting period ends on
31 December.
If the subsidiary has a 31 December year end, no problem relating to the ends of the reporting
periods will arise on consolidation.
If the end of the reporting period of the subsidiary does not coincide with 31 December, the
following circumstances are possible:
The year end of the subsidiary is 31 October, but the subsidiary does not want to change the
year end, although it is practicable to do so.
Under these circumstances, the subsidiary should prepare financial statements for the year
ending 31 December 20.14, even though its year end falls on 31 October 20.14. The
newly-prepared 31 December financial statements will be used for consolidation purposes.
The year end of the subsidiary is 31 October, but the subsidiary cannot prepare additional
financial statements at 31 December 20.14, as it is impracticable to do so.
Under these circumstances, the subsidiary prepares its financial statements for the year ending
31 October 20.14. On consolidation, the subsidiary’s financial statements are adjusted for
significant events or transactions between 31 October 20.13 and 31 December 20.14, and these
adjusted financial statements are then used to prepare consolidated financial statements.
24.5.5 Same accounting policies for parent and subsidiaries

Consolidated financial statements are to be based on sets of financial statements in which
uniform accounting policies for like items are used. If accounting policies differ, appropriate
consolidation adjustments are required to align the accounting policies before consolidation
(IFRS 10.19 and .B87).
24.5.6 Periods for inclusion of subsidiary and measurement

A subsidiary shall be consolidated from the date the parent obtains control over it.
From the acquisition date, all items of income and expense of a subsidiary shall be
included in the consolidated financial statements, based on the acquisition date values of
the assets and liabilities recognised in terms of IFRS 3 Business Combinations. Refer to
chapter 26 for detail in this regard (Example 26.10).
Consolidation of a subsidiary shall cease when the parent loses control of the
subsidiary (IFRS 10.20 and .B88). Refer to section 24.5.12 for more details.
24.5.7 Non-controlling interests

The non-controlling interests in a group context represent the interests of the equity
participants (i.e. shareholders) of the subsidiary, other than the parent.
The non-controlling interests in the consolidated statement of financial position is
shown in equity, separately from the parent owner’s equity (IFRS 10.22).
The non-controlling interests’ share in the profit or loss and total comprehensive income
in the statement of profit or loss and other comprehensive income of the group is
presented separately in an analysis of the consolidated profit and total comprehensive
income attributable to:
– equity shareholders of the parent; and
– non-controlling interests.
It is not shown as a line item in the statement of profit or loss and other comprehensive
income, as the amount attributable to non-controlling shareholders is neither an income nor
an expense item.
Example 24.
24.14 Disclosure of non-controlling interests
Extract from the consolidated statement of financial position

of the XYZ Ltd Group
R
EQUITY AND LIABILITIES
Share capital xxx
Retained earnings xxx
xxx
Non-controlling interests xxx
Total equity xxx
of the XYZ Ltd Group
R
TOTAL COMPREHENSIVE INCOME FOR THE YEAR xxx
Owners of the parent xxx
Owners of the parent xxx
24.5.8 Losses of subsidiaries and non-controlling interests

The profit or loss and each component of other comprehensive income (i.e. the total
comprehensive income or loss) of a subsidiary are attributed to both the owners of the
parent and the non-controlling interests. Thus if there is a loss, it is allocated to the non-
controlling interests even if this results in the non-controlling interests having a deficit (debit)
balance on the statement of financial position (IFRS 10.B94). The view is that the non-
controlling interests also represent equity participants, and that it should thus share in both
the profits and losses of the subsidiary.
Example 24.
24.15 Losses allocated to non-controlling interests
Good Ltd obtained a 90% interest in Bad Ltd on 1 January 20.13. The end of the reporting periods of
both companies in the group is 31 December. The total equity of Bad Ltd at the acquisition date was
R100 000, of which R10 000 was allocated to the non-controlling interests. Since the acquisition of
Bad Ltd, the company has suffered operating losses due to aggressive new competitors entering the
market.
The operating losses of Bad Ltd for the two years since acquisition are as follows:
20.14 20.13
R R
Operating losses 60 000 55 000
During the year ended 31 December 20.13, a proportionate loss of R5 500 (10% × R55 000)
would be allocated to non-controlling interests. The remaining credit balance of the
non-controlling interests at 31 December 20.13 would thus drop to R4 500 ((R10 000 (at
acquisition) – R5 500 (losses since acquisition)).
During the year ended 31 December 20.14, a proportionate loss of R6 000 (10% × R60 000)
would be allocated to the non-controlling interests. The debit balance of the non-controlling
interests at 31 December 20.14 now amounts to R1 500 ((R4 500 (opening balance) – R6 000
(losses for current year)).
At the end of the reporting period, the parent should assess whether the losses of the
subsidiary are not an indication that an impairment loss should be recognised on the
investment in the subsidiary in the records of the parent.
24.5.9 Preference dividends

In the calculation of the non-controlling interests, and hence the parent’s interest in a
subsidiary’s profits, a subsidiary’s cumulative preference dividends should be deducted in
full, even though such dividends might not have been declared (IFRS10.B95). This
treatment is to ensure that profits related to preference shares are not erroneously allocated
to ordinary shareholders. The remaining profits (after deducting the preference dividends) is
then allocated to the owners of the parent and the non-controlling interests in their profit-
sharing ratio. This relates only to preference shares classified as equity in terms of IAS 32
Financial Instruments: Presentation. Such preference dividends are allocated to the parties
to whom such dividends would have accrued, namely the parent and/or the non-controlling
shareholders in their respective ratio in which the preference shares are held.
24.5.10 Foreign subsidiaries

For groups with foreign subsidiaries that present consolidated financial statements, the
presentation currency is normally that of the parent. However, some of the companies in the
group may have different functional currencies. The financial information of each company
with a functional currency different to the presentation currency of the parent is translated in
terms of IAS 21 The Effects of Changes in Foreign Exchange Rates (refer to chapter 11). If
the functional currency and the presentation currency of the parent are the same, no
additional disclosure is required in the group financial statements.
24.5.11 Changes in percentage ownership interest of the parent,

without obtaining or losing control
As indicated in section 24.5.6, a subsidiary is consolidated from the date on which control is
effectively obtained by the parent. Conversely, such subsidiary is excluded from
consolidation from the date that control is transferred to another, as discussed in
section 24.5.12.
If a parent subsequent to having obtained control of a subsidiary obtains additional equity
instruments (i.e. the parent already has control and buys additional shares from the
non-controlling shareholders), the transaction is between equity participants of the same
entity in their capacity as owners – such transactions between owners are accounted for
within equity. The same would apply if the parent sells some shares to the non-controlling
shareholders without losing control over the subsidiary (e.g. the parent owned 90% of the
voting rights of the subsidiary and this is reduced to 85% due to shares being sold to the
non-controlling shareholders).
The following adjustments are made if control is not lost (IFRS 10.23 to .24):
The carrying amounts of the controlling and non-controlling interests are adjusted to
reflect the changes in their respective interest in the subsidiary.
Any difference between the amount by which the non-controlling interests is adjusted
and the fair value of the consideration paid or received is recognised directly in equity
(not in profit or loss) (as the transaction was between equity participants only) and
allocated to the parent.
The carrying amounts of assets (including goodwill) and liabilities of the subsidiary will
not change.
This view is underpinned by the argument that additional shares acquired, or shares sold
under these circumstances, will not grant access to, or expose the parent to, any additional
assets or liabilities of the subsidiary as the parent already had control and still have control.
Example 24.
24.16 Parent purchases additional shares in existing subsidiary
More Ltd obtained a 60% interest in Changes Ltd several years ago. The end of the current
reporting period is 31 December 20.13. On 1 January 20.13, the equity of Changes Ltd amounted
to R1 000 000, of which R400 000 was allocated to non-controlling interests.
On 1 January 20.13, More Ltd purchased an additional 20% equity interest in Changes Ltd from
the non-controlling shareholders (i.e. 50% of their 40% interest) for R220 000 in cash. After this
purchase, More Ltd holds 80% of the equity instruments in Changes Ltd and still has control.
The journal entry for the purchase of additional shares in the separate records of More Ltd is as
follows:
Dr Cr
R R
1 January 20.13
Investment in Changes Ltd (SFP) 220 000
Cash/Bank (SFP) 220 000
Purchase of additional shares in subsidiary
The consolidation journal entry to account for the change in ownership of More Ltd in Changes Ltd
is as follows:
Dr Cr
R R
Non-controlling interests (SFP) (50% × R400 000) 200 000
Retained earnings (equity attributable to owners of parent) (SCE) 20 000
Investment in Changes Ltd (SFP) 220 000
Reversal of parent’s entry and accounting for change in ownership
Comment
¾ No goodwill is recognised with the acquisition of additional shares in the subsidiary, as IFRS 3
Business Combinations only deals with business combinations in which the acquirer obtains
control for the first time. The purchase of additional shares does not result in additional
goodwill being recognised.
¾ The non-controlling interests balance is reduced by R200 000 (50% × R400 000) or
[(20% × R1 000 000 (total equity)) – R400 000(balance before change)].
¾ The amount recognised in retained earnings attributable to the owners of the parent is
calculated as the difference between the adjustment (a reduction) in the non-controlling
interests (R200 000) and the amount received by them (paid to them) (R220 000) = R20 000.
¾ In this instance, the purchase price exceeded the non-controlling interests acquired, and the
transactions thus led to a reduction of R20 000 in the parent's equity. If the purchase price was
less than the non-controlling interests acquired (say R190 000), the transaction would lead to
an increase of R10 000 (200 000 – 190 000) in the parent’s equity.
The change in the ownership interest of More Ltd in Changes Ltd will be presented as follows in
the consolidated statement of changes in equity:
Non-
Retained
controlling
earnings
interests
R R
Changes in ownership interest of parent by purchase of additional
shares in a subsidiary (20 000) (200 000)
continued
Comment
¾ No gain or loss is presented in the consolidated statement of profit or loss and other
comprehensive income as the transaction is between equity participants, and it is thus
recognised in the statement of changes in equity.
¾ In terms of IAS 1.106(d)(iii)), transactions with owners in their capacity as owners are
presented as part of a reconciliation between the opening and closing balances for each
component of equity, in the statement of changes in equity. Changes in ownership interests in
subsidiaries that do not result in a loss of control are shown separately.
¾ The Standard does not state whether the amount recognised in equity should form part of
retained earnings and it is assumed that this amount could also be presented in a separate
column (‘change in ownership’) in the statement of changes in equity.
¾ IFRS 12.18 requires a schedule to be disclosed showing the effect of any changes in the parent’s
ownership interest that do not result in a loss of control, on equity attributable to the parent.
Example 24.
24.17 Parent sells shares in existing subsidiary (without losing control)
Less Ltd obtained an 80% interest in Changing Ltd for R500 000 several years ago and no goodwill
arose with the business combination. The end of the current reporting period is 31 December 20.13.
On 1 January 20.13, the equity of Changing Ltd amounted to R1 000 000, of which R200 000 was
allocated to the non-controlling interests.
On 1 January 20.13, Less Ltd sold 25% of its equity interest in Changing Ltd (i.e. 20/80 = 25% of its
interest) to the non-controlling shareholders for R220 000 in cash. After the transaction, Less Ltd
holds 60% of the equity instruments in Changing Ltd and has not lost control.
The journal entry for the sale of shares in the separate records of Less Ltd is as follows (assuming
Less Ltd accounted for the investment in the subsidiary on the cost method in terms of IAS 27):
Dr Cr
R R
1 January 20.13
Cash/Bank (SFP) 220 000
Gain on disposal of investment (P/L) [220 000 – (25% × 500 000)] 95 000
Investment in Changing Ltd (SFP) (25% (20/80) × R500 000 cost) 125 000
Sale of shares in subsidiary
The consolidation journal entry to account for the change in ownership of Less Ltd is as follows:
Dr Cr
R R
1 January 20.13
Investment in Changing Ltd (SFP) 125 000
Gain on disposal of investment (P/L) (220 000 – 125 000) 95 000
Retained earnings (equity attributable to owners of parent) (SCE) 20 000
Non-controlling interests (SFP) [25% × R800 000] or
[(40% × R1 000 000 (total equity)) – R200 000 (balance before change)] 200 000
Reversal of parent’s entries and accounting for change in ownership interest
through the sale of shares in subsidiary
Comment
¾ The debit to the investment in Changing Ltd is to account for the over-elimination of the amount
of the investment when the full initial investment in the subsidiary (at acquisition) was
eliminated first in chronological order. After the partial sale of shares, the parent’s investment in
the subsidiary will amount to R375 000 (500 000 – 125 000). The initial investment in the
subsidiary will still be eliminated as part of the main elimination at acquisition. The consolidation
journal entries to the investment-account will result in the following:
Investment: R375 000 – R500 000 (at acquisition) + R125 000 (with change) = Rnil.
¾ The amount recognised in retained earnings attributable to the owners of the parent is
calculated as the difference between the adjustment in the non-controlling interests (R200 000)
and the amount paid by them (R220 000) = R20 000.
continued
The change in the ownership interest will be presented as follows in the consolidated statement of
changes in equity:
Non-
Retained
controlling
earnings
interests
R R
Changes in ownership of parent by selling shares in subsidiary
to non-controlling shareholders 20 000 200 000
Comment
¾ No gain or loss is presented in the consolidated statement of profit or loss and other
comprehensive income, as the transaction is between equity participants, and it is thus
recognised in the statement of changes in equity.
¾ In terms of IAS 1.106(d)(iii), transactions with owners in their capacity as owners are presented
as part of a reconciliation between the opening and closing balances for each component of
equity in the statement of changes in equity. Changes in ownership interests in subsidiaries
that do not result in a loss of control are shown separately.
¾ The Standard does not state whether the amount recognised in equity should form part of
retained earnings and it is assumed that this amount could also be presented in a separate
column (‘change in ownership’) in the statement of changes in equity.
¾ IFRS 12.18 requires a schedule to be disclosed showing the effect of any changes in the
parent’s ownership interest that do not result in a loss of control on equity attributable to the
parent.
24.5.12 Loss of control of a subsidiary

When a parent loses control over a subsidiary (see IFRS 10.25 to .26), this subsidiary is
excluded from consolidation from the date on which control is transferred to another entity. A
parent can lose control of a subsidiary in various ways, and such transactions can also be
structured in various ways. For instance, a parent can lose control of a subsidiary without a
change in the ownership interest in the subsidiary, say as a result of a contractual
agreement, etc.
A transaction or series of transactions (two or more) leading to a loss of control should be
accounted for based on the substance of the transaction, and this could, under certain
circumstances, lead to a series of transactions being accounted for as one. For instance,
several separate transactions are in fact part of a single transaction or arrangement. By
contrast, a series of transactions or arrangements that are unrelated shall be accounted for
separately.
It should be noted that a gain or loss is only recognised where control is lost, and not
when the controlling ownership interest of the parent decreases or increases without a
corresponding loss of control. This situation could lead to possible manipulation by
structuring transactions or arrangements in a specific way. Specific guidance is given in
IFRS 10.B97 on when multiple transactions should be regarded as a single transaction. The
Standard states that one or more of those indicators must be present before multiple
transactions are treated as a single transaction. However, the list provided is not meant to
be all-inclusive.
When a parent loses control of a subsidiary, the following aspects should be accounted for
within the group’s consolidated financial statements at the date when control is effectively
lost:
Derecognition:
the individual assets and liabilities of the subsidiary are derecognised at their
consolidated carrying amounts;
the goodwill related to the subsidiary is derecognised at its consolidated carrying
amount;
the non-controlling interests in the former subsidiary is derecognised at the consolidated

carrying amount thereof (including any attributable components of other comprehensive
income);
(The above three components will together represent the net assets lost by the parent
when control of the subsidiary is lost.)
Recognition:
the fair value of the consideration (if any) received from the transaction, event or
circumstances that resulted in the loss of control is recognised. If a distribution of shares
of the subsidiary to owners in their capacity as owners formed part of the consideration,
this distribution shall also be recognised;
any investment retained in the former subsidiary is recognised at its fair value at the date
control is lost;
(The two components presented immediately above represent the total compensation
received by the parent in exchange for the loss of control.)
any amounts previously recognised in other comprehensive income are reclassified to
profit or loss (e.g. the foreign currency translation reserve), or transferred directly to
retained earnings (e.g. fair value gains on some equity investments, or revaluations on
property, plant and equipment of the subsidiary), as applicable, when the related assets
or liabilities are derecognised; and
any resulting difference is recognised as a gain or loss in profit or loss attributable to the
parent.
Any retained investments in the former subsidiary, and any amounts owed by or to the
former subsidiary subsequent to the loss of control, are accounted for in accordance with
the applicable Standards. Therefore, the retained investment is treated as an associate
(IAS 28 Investments in Associates and Joint Ventures), as a joint venture (IFRS 11 Joint
Arrangements and IAS 28 Investments in Associates and Joint Ventures), or as a financial
asset (IFRS 9 Financial Instruments) from the date control is lost.
The fair value of the retained investment at the date on which control is lost is deemed to be:
the cost on initial recognition of an investment in an associate or joint venture; or
the fair value on initial recognition of a financial asset.
It is important to note that the abovementioned accounting treatment is applicable to the
group (as in the consolidated financial statements). From a practical point of view, one
should remember that group accounts as such are not kept (consolidation is affected by
combining the financial statements, on a line-by-line basis, of the parent and the subsidiary).
This implies that journal entries for the abovementioned items will not be processed in a
group ledger. Once control over a subsidiary is lost, the parent will not combine that
subsidiary’s financial statements with its own at the reporting date. Furthermore, the parent
will account for the sale of its investment in the subsidiary in its separate financial
statements (the treatment depends on the parent’s accounting policy choice for the
investment, as was discussed in section 24.2). Consolidation adjustments are therefore
needed to effectively achieve the accounting treatment indicated above.
Example 24.
24.18 Parent loses control of subsidiary
Lost Ltd obtained an 80% interest (800 shares) in Gone Ltd on 1 January 20.11 for R1 500 000,
when the fair value of the identifiable assets acquired and the liabilities assumed amounted to
R1 800 000. At the acquisition date, Lost Ltd recognised the non-controlling interests at R360 000
(20% × R1 800 000) and goodwill of R60 000 (R1 500 000 + R360 000 – R1 800 000). The end of
the current reporting period is 31 December 20.13. Lost Ltd accounts for investments in
subsidiaries at cost in its separate financial statements. The group accounts for non-controlling
interests at their proportionate share of the subsidiary’s identifiable net assets at the acquisition
date.
The group recognises fair value adjustments on the initial recognition of a simple investment (here
with the loss of control over the subsidiary) in profit or loss (day 1 gain) The group recognises
subsequent fair value adjustments on other equity investments (not held for trading) in other
comprehensive income (mark-to-market reserve) in terms of IFRS 9.5.7.5. With the derecognition
of these equity investments, the cumulative adjustment is transferred to retained earnings in terms
of IFRS 9.B5.7.1.
Up to 1 January 20.13, the retained earnings of Gone Ltd increased by R400 000 and the
mark-to-market reserve (MtM) (fair value gain on equity investments) since the date of acquisition
amounted to R80 000. The total equity (net assets) of Gone Ltd on 1 January 20.13 therefore
amounted to R2 280 000 (1 800 000 + 400 000 + 80 000).
On 1 January 20.13, Lost Ltd sold a block of shares equal to 65% of the total equity of Gone Ltd
(i.e. 65/80 = 81,25% of its interest) to the non-controlling shareholders for R1 550 000 in cash.
After the sale, Lost Ltd holds only 15% of the equity instruments of Gone Ltd, having a fair value of
R350 000. Lost Ltd’s interest in Gone Ltd has decreased from 80% to 15% and Lost Ltd no longer
controls Gone Ltd.
Ignore all taxes.
The parent will account for the partial sale of its investment in shares in its separate financial
records as follows:
Dr Cr
R R
Bank (SFP) 1 550 000
Investment in subsidiary (at cost) (SFP) (650 / 800 shares × 1 500 000) 1 218 750
Profit with the sale of shares (P/L) (balancing) 331 250
Partial sale of share investment
Investment in subsidiary (at fair value) (SFP) 68 750
(350 000 fair value – 281 250 remaining cost carrying amount)
(with 150 / 800 shares × 1 500 000 = 281 250)
Remeasurement gain (P/L) 68 780
Remeasurement of retained investment to fair value after partial sale
Comment
Comment
¾ The remeasurement gain of the retained investment to fair value is treated as a day 1 gain in
terms of IFRS 9.B5.1.2A(a).
continued
If the accounting components involved in the loss of control in terms of IFRS 10.B98 are identified
separately, these would appear as follows in the consolidated financial records:
Dr (Cr)
R
Derecognise the assets (including goodwill of R60 000) and liabilities
of the subsidiary on the date of loss of control (2 340 000)1
Derecognise the carrying amount of the non-controlling interests in the
former subsidiary on the date of loss of control 456 0002
Net assets belonging to parent, lost due to loss of control (1 884 000)
Total consideration and other assets received due to loss of control 1 900 000
Recognise the fair value of the consideration received arising from the event
that resulted in the loss of control (in this case, proceeds on disposal) 1 550 000
Recognise the investment (15%) retained in the former subsidiary at its fair
value on the date of loss of control 350 000
Recognise any resulting difference as a gain/(loss) in the consolidated

profit or loss attributable to the parent. 16 000
1
2 280 000 (equity – 1 January 20.13) + 60 000 (goodwill) = 2 340 000
2
2 280 000 (equity – 1 January 20.13) × 20% (NCI%) = 456 000
The gain of R16 000 represents a combination of two components (see calculation below), namely,
the gain (R19 250) made on disposal of an interest in a subsidiary leading to a loss of control, and
the change in value (a loss of R3 250) from the carrying amount of the remaining interest in the
subsidiary to the fair value of this interest.
Gain on disposal of controlling interest
R R
Proceeds on disposal 1 550 000
Net assets (equity) disposed of:
At acquisition (1 800 000 × 65%) (1 170 000)
Since acquisition [(400 000 + 80 000) × 65%] (312 000)
Goodwill (60 000 × 65/80) (48 750)
Gain realised on loss of control 19 250
Effect of restating the carrying amount of the remaining
15% investment to fair value
Carrying amounts in the consolidated financial statements:
Net asset value (2 280 000 × 15%) 342 000
Goodwill (60 000 × 15/80) 11 250
Total 353 250
Fair value of the 15% interest – 1 January 20.13 350 000
Loss recognised when determining fair value (3 250)
Resulting difference to profit or loss 16 000
These amounts are accounted for in profit or loss.
Furthermore, an amount of R64 000 (80 000 × 80%) in respect of the parent’s portion of the mark-
to-market reserve is transferred to retained earnings within equity.
continued
Comment
¾ In terms of IFRS 12.19, a parent shall disclose the gain or loss attributable to restating the
interest (investment) retained in the former subsidiary to fair value at the date when control is
lost. In addition, it must also state the line item in the statement of profit or loss and other
comprehensive income in which the gain or loss is included (presumably ‘other income’).
Alternatively, it may be disclosed as a separate line item in the statement of profit or loss and
other comprehensive income (depending on significance), which would eliminate the need to
state in which line item it appears.
¾ IFRS 10.B99 requires that the mark-to-market reserve of the subsidiary be transferred directly
to retained earnings when control is lost. Based on the above information, an amount of
R64 000 should be transferred to retained earnings once control over the subsidiary has been
lost. This is the case as the investment linked to the mark-to-market reserve of the subsidiary
was disposed of by the group when it disposed of the subsidiary, and any associated
mark-to-market reserve would consequently be transferred within equity (IFRS 9.B5.7.1).
The consolidation journal entry to account for the loss of control by Lost Ltd is as follows:
Dr Cr
R R
1 January 20.13
Gain on disposal of subsidiary (Lost Ltd) (P/L)#
[1 550 000 – (1 500 000 × 65/80)] 331 250
Remeasurement gain (P/L)#
[350 000 – (1 500 000 × 15/80)] 68 750
Retained earnings (since acquisition of Gone Ltd – 400 000 × 80%)
(consolidated SCE)$ 320 000
Mark-to-market reserve (since acquisition of Gone Ltd
– 80 000 × 80%)(consolidated SCE)$ 64 000
Fair value adjustment (consolidated P/L) *3 250
Gain on loss of control in Gone Ltd (consolidated P/L) *19 250
Mark-to-market reserve (transfer to retained earnings)
(consolidated SCE) 64 000
Retained earnings (transfer from mark-to-market reserve)
(consolidated SCE) 64 000
Disposal of shares is subsidiary resulting in loss of control
Comment
¾ Lost Ltd would recognise two entries in respect of the investment in Gone Ltd in its separate
financial statements:
the profit or loss on the partial sale; and
the remeasurement of the retained investment (see below).
Both these entries will be reversed for consolidation purposes (refer to journals marked with #).
¾ The gain on disposal in the separate financial statements of Lost Ltd would be R331 250, being
[1 550 000 – 1 218 750(1 500 000 × 65/80)].
¾ The remeasurement gain of R68 750 in the books of Lost Ltd represents the difference between
the original cost of the remaining 15% adjusted to fair value, being R281 250 (1 500 000 ×
15/80) to R350 000.
¾ Gone Ltd is no longer a subsidiary of Lost Ltd and its financial statements will not be
combined with those of Lost Ltd. Although Gone Ltd is no longer a subsidiary, the since
acquisition amounts for reserves should be brought into the opening balances of the
consolidated financial statements, and should thus be accounted for (refer to journals marked
with $). This ensures that the opening balances of the reserves for the current year still equal the
closing balances of the reserves in the comparative year.
¾ The items marked * in the above journal represent the net gain (R16 000) to be recognised in
the consolidated profit or loss in terms of IFRS 10.B98 and can be shown as one entry.
¾ However, IFRS 12 effectively requires the separate disclosure of these items marked * in the
notes to the consolidated financial statements (refer to section 24.6.3 and IFRS 12.10(b)(iii)
and .19).
continued
The loss of control by Lost Ltd of Gone Ltd will be presented as follows:
Extract from the consolidated statement of changes in equity:
Non-
Retained MtM
controlling
earnings reserve
interests
R R R
Opening balance (retained earnings: xx + 320 000) xx 64 000 456 000
Loss of control of subsidiary 64 000 (64 000) (456 000)
Total comprehensive income for the year ended
31 December 20.13 xx xx xx
(xx + 16 000 – 331 250 – 68 780) (refer to
consolidation journals)
Profit or loss for the year xx xx
Other comprehensive income xx
Comment
¾ The gain of R16 000 (19 250 – 3 250) recognised due to the loss of control will be included in
the total comprehensive income allocated to the parent. This amount comprises the two
amounts marked with an * in the above journal.
24.6 Disclosure
24.6.1 Separate financial statements

When consolidated financial statements are not prepared (refer to IFRS 10.4(a) and
section 24.4.2), the separate financial statements of a parent shall disclose:
the fact that the financial statements are separate financial statements;
that the exemption from consolidation in terms of IFRS 10.4(a) has been used;
the name, principal place of business (and country of incorporation if different), of the
entity that prepares consolidated financial statements for public use, and the address
where these consolidated financial statements are obtainable;
a list of significant investments in subsidiaries, joint ventures and associates, including
the name, principal place of business (country of incorporation if different), proportion of
the ownership interest and, if different, the proportion of voting rights held in those
investees; and
a description of the method used to account for the abovementioned investments.
When an investment entity presents only separate financial statements, it shall disclose
that fact. It shall also disclose detailed information in terms of IFRS 12 (refer to
section 24.6.5).
When a parent (other than a parent described above), or an investor with joint control or
significant influence over an investee presents separate financial statements in addition to
consolidated financial statements, the parent or investor shall identify the financial
statements prepared in accordance with IFRS 10 Consolidated Financial Statements,
IFRS 11 Joint Arrangements, or IAS 28 Investments in Associates and Joint Ventures to
which they relate.
The parent or investor shall also disclose the following in its separate financial statements:
the fact that these financial statements are separate financial statements;
the reasons for preparation of these statements if not required by law;
a list of significant investments in subsidiaries, joint ventures and associates, including
the name, principal place of business, (and country of incorporation if different),
proportion of ownership interest (and if different, the proportion voting rights) held in
those investees; and
a description of the method used to account for the abovementioned investments.
24.6.2 Disclosure of interests in other entities

IFRS 12 Disclosure of Interests in Other Entities, deals with disclosures in respect of
interests in other entities, which refers to contractual and non-contractual involvement that
exposes an entity to variability of returns from the performance of the other entity (refer to
IFRS 12.B7 to .B9 for more detail in this regard). An entity’s involvement in another entity
can result from holding equity or debt instruments, having control, joint control or significant
influence over that entity, providing funding or guarantees to that entity, etc. IFRS 12
requires an entity to disclose information that enables users of its financial statements to
evaluate:
the nature of, and risks associated with, its interests in other entities; and
the effect of those interests on its financial position, financial performance and cash
flows.
The entity shall therefore disclose:
the significant judgement and assumptions it has made in determining whether it has
control, joint control (refer to chapter 27) or significant influence (refer to chapter 25), or
no control over that entity; and
information about its interest in subsidiaries, joint arrangements (refer to chapter 27) and
associates (refer to chapter 25), and structured entities that are not controlled by the
entity.
24.6.3 Interests in subsidiaries and consolidated financial statements

IFRS 12 requires an entity to disclose information that enables users of its consolidated
financial statements:
to understand:
– the composition of the group; and
– the interest that non-controlling interests have in the group’s activities and cash
flows (e.g. the name of the relevant subsidiary with non-controlling interests, its
principal place of business, the proportion of ownership and voting rights held, the
amount of profit or loss allocated to the non-controlling interests, the balance of their
interests, dividends paid to them and summarised information about the subsidiary in
terms of IFRS 12.B10 to .B17); and
to evaluate:
– the nature and extent of significant restrictions on its ability to access or use assets,
and settle liabilities of the group;
– the nature of, and changes in, the risks associated with its interest in consolidated
structured entities (e.g. the terms of contractual arrangements to provide financial
support, details of financial support provided, events that could expose the entity to a
loss, etc.);
– the consequence of changes in its ownership interest in a subsidiary that did not
result in a loss of control (refer to Examples 24.16 and .17) (i.e. a schedule showing
the effects on the equity attributable to the owners of the parent); and
– the consequence of losing control of a subsidiary during the reporting period (i.e. the
gain or loss recognised, as well as the portion of that gain or loss attributable to
measuring any investment retained in the former subsidiary at its fair value at that
date, and the line item(s) in the consolidated statement of profit or loss and other
comprehensive income in which the gain or loss was recognised, if not presented
separately (refer to Example 24.18 above).
Refer to IFRS 12.10 to .19 for more detailed disclosure requirements in respect of the
information in the list above.
If the end of the reporting period of the subsidiary is different to that of the parent, the
reporting date of the subsidiary and the reason for using different accounting dates for
consolidation should be disclosed.
The following disclosure requirements of IAS 1 Presentation of Financial Statements, are
also relevant to the topics discussed in this chapter:
The non-controlling interests must be presented under equity in the consolidated
statement of financial position, but should be presented separately from the equity
attributable to owners of the parent.
Profit or loss, as well as total comprehensive income in the consolidated statement of profit
or loss and other comprehensive income, shall be attributed respectively to the
non-controlling interests and owners of the parent.
As part of the reconciliation of opening and closing balances of each component of
equity, the following should be disclosed separately:
– profit or loss;
– each item of other comprehensive income; and
– in respect of transactions with owners in their capacity as owners, the contributions by
and distributions to owners and changes in ownership interests that do not lead to a
loss of control.
24.6.4 Interests in unconsolidated structured entities

IFRS 12 also requires disclosure of an entity’s interests in unconsolidated structured entities.
These structured entities are not controlled by the entity (unconsolidated), but the entity may
have some interests in, or involvement with that entity.
Structured entities are entities that have been designed so that voting or similar rights are
not the dominant factor in deciding who controls the entity, for example when any voting
rights relate to administrative tasks only and the relevant activities are directed by means of
contractual arrangements (refer to Example 24.6). Examples of such structured entities
include securitisation vehicles, asset-backed financing and some investment funds.
Entities that have an interest (or have sponsored) such unconsolidated structured entities
shall disclose information that enables users of its financial statements:
to understand the nature and extent of its interest in (or sponsorship of) the
unconsolidated structured entities; and
to evaluate the nature of, and changes in, the risks associated with its interest in (or
sponsorship of) unconsolidated structured entities.
Refer to IFRS 12.24 to .31 and .B21 to .B26 for more detail in this regard.
24.6.5 Investment entities

IFRS 12 also requires disclosures for a parent that determines that it is an investment entity
(in accordance with IFRS 10.27). Investment entities shall disclose:
information about significant judgements and assumptions it has made in determining
that it is an investment entity;
detailed information regarding a change in its status as an investment entity and the
financial effects thereof;
detailed information for each unconsolidated subsidiary; and
other information (e.g. restrictions, financial support, contractual arrangements, etc.).
Refer to IFRS 12.9A to .9B and .19A to 19G for more detail in this regard.
CHAPTER
25
Investments in associates and joint
ventures
(IAS 28 and IFRS 12)
Contents
25.1 Overview of IAS 28 Investments in Associates and Joint Ventures .................. 762
25.2 Background ....................................................................................................... 763
25.3.1 Significant influence ........................................................................... 763
25.3.2 Equity method .................................................................................... 765
25.3.2.1 Introduction to the equity method ...................................... 765
25.3.2.2 Other comprehensive income ........................................... 768
25.3.2.3 Contribution of a non-monetary asset ............................... 769
25.3.2.4 Goodwill and gain on bargain purchase on acquisition ..... 769
25.3.3 Application of the equity method ........................................................ 770
25.4 Specific requirements ........................................................................................ 772
25.4.1 Acquisition of additional interests ....................................................... 772
25.4.2 Disposal of interests ........................................................................... 775
25.4.3 Impairment losses .............................................................................. 776
25.4.4 Losses of associates or joint ventures ............................................... 779
25.4.5 Intragroup transactions....................................................................... 780
25.4.6 Different reporting dates ..................................................................... 783
25.4.7 Different accounting policies .............................................................. 784
25.4.8 Preference dividends.......................................................................... 784
25.4.9 Group’s interest in an associate or joint venture ................................ 784
25.5 Disclosure .......................................................................................................... 791
761
25.1 Overview of IAS 28 Investments in Associates and Joint Ventures
IAS 28 is to be applied by all entities that are investors with joint control or significant influence
over an investee.
Significant influence Joint control
An investor with significant influence An investor with joint control over an investee
over an investee has the power to has entered into a contractually agreed sharing
participate in the financial and operating of control over an arrangement, which exists
policy decisions of the investee, only when decisions about the relevant activities
but does not mean control or joint require the unanimous consent of the parties
control over those policies. sharing control.
Associate Joint venture
An associate is an entity over which the A joint venture is a joint arrangement whereby
investor has significant influence. the parties that have joint control of the
(The investor holds 20% or more voting arrangement have rights to the net assets
rights directly or indirectly.) of the arrangement.
Equity method
An investor in an associate or a joint venture accounts for its investments in such investees
in its financial statements by applying the equity method.
The equity method is an accounting method whereby the investment is initially recorded at cost
and is subsequently adjusted for the post-acquisition change in the investor’s share
of the net assets of the investee.
The investor’s profit or loss includes its share of the investee’s profit or loss
and the investor’s other comprehensive income includes its share of the investee’s other
Disclosure
The following is disclosed for each associate or joint venture that is material to the reporting entity:
whether the investment in the associate or joint venture is measured using the equity method or
at fair value;
summarised financial information (the total amounts obtained from the financial statements,
includeing dividends received, assets, liabilities, revenue, profit or loss for the year, other
comprehensive income and total comprehensive income);
for every material joint venture, cash and cash equivalents, financial current and non-current
liabilities (excluding trade and other creditors and provisions), depreciation and amortisation,
interest income, interest expense and income tax expense;
the fair value of investments in associates or joint ventures for which there are published price
quotations;
the amounts in the financial statements of the associate or joint venture must be adjusted by fair
value adjustments at acquisition and adjustments for differences in accounting policy;
a reconciliation must be provided between the summarised financial information and the carrying
amount of the interest in the associate or joint venture; and
if the interest is measured at fair value or if the associate or joint venture does not prepare
IFRS financial statements, the summarised financial information may be prepared on the basis of
the associate or joint venture’s financial statements.
Investments in associates and joint ventures 763
25.2 Background
The objective of financial statements is to provide information about the financial position,
performance and changes in the financial position of an entity that is useful to a wide range
of users in making economic decisions. With associates and joint ventures, the recognition
of only the distributions received (dividends) may not be a fair presentation of the profit
earned by the entity on its investment in the associate or joint venture.
It may be considered that the operations of the investee (associate or joint venture) are an
extension of those of the entity and therefore the financial impact should be disclosed in
more detail in the financial records of the entity. This is precisely the aim of equity accounting
and IAS 28 Investments in Associates and Joint Ventures. The Standard prescribes the
principles to be applied for the equity accounting of associates, or joint ventures identified in
terms of IFRS 11 Joint Arrangements. The following definitions are applicable:
An associate is an entity over which the investor has significant influence (IAS 28.3).
A joint venture is a joint arrangement whereby the parties that have joint control of the
arrangement have rights to the net assets of the arrangement (IAS 28.3).
Refer to chapter 27, which deals with joint arrangements, for a detailed discussion relating
to the classification of a joint arrangement as a joint venture.
25.3.1 Significant influence

Significant influence is defined as:
the power to participate in the financial and operating policy decisions of the investee;
but does not mean control or joint control over these policies.
The definition implies that the entity has the ability to exercise power, this being the ability to
do or effect something, irrespective of whether the power is actively demonstrated or
passive in nature.
In accordance with IAS 28, it is assumed that significant influence exists where:
the entity holds, directly or indirectly (through subsidiaries);
20% or more of the voting power of the investee,
unless it is demonstrated that this is not the case (IAS 28.5).
Conversely, if the entity holds less than 20% of the voting power, it is presumed that
significant influence does not exist, unless such influence can be demonstrated.
A substantial or majority ownership by another entity in the associate does not necessarily
preclude an entity from significant influence. Significant influence normally exists in the
following instances (IAS 28.6):
representation on the board of directors (or equivalent governing body) of the investee;
participation in policy-making processes (including decisions about dividends and other
distributions);
material transactions between the entity and the investee;
the interchange of management personnel; or
the provision of essential technical information.
When assessing possible significant influence, the following should be considered:
potential voting rights arising from instruments such as share warrants, share-call options,
debt or equity instruments that are convertible into ordinary shares or other instruments
that have the potential to change voting power (potential ordinary shares) (IAS 28.7).
All presently exercisable or presently convertible instruments held by the entity or other
shareholders (IAS 28.7 to .8).
The combined interest of the parent and the subsidiaries. The interests held by joint
ventures and associates in the group are, however, omitted.
The following are excluded from the assessment of significant influence:
Potential voting rights that are only exercisable or convertible at a future date or upon the
occurrence of a future event, as they are not presently exercisable or convertible. The
facts and circumstances surrounding the instruments with potential voting rights should
be considered in the assessment.
The intention of management and the financial ability to exercise or convert (IAS 28.8).
The associate becomes bankrupt or when it is in legal reorganisation (IAS 28.9).
Example 25.
25.1 Significant influence
Ark Ltd owns 15% of the voting rights of Bark Ltd. Ark Ltd also owns call options to acquire a
further 10% of the voting rights of Bark Ltd, which are excercisable at any time at the fair value of
the underlying shares.
As Ark Ltd potentially owns 25% of the voting rights, it is assumed that Ark Ltd has significant
influence over Bark Ltd, resulting in Bark Ltd being an associate of Ark Ltd. When Bark Ltd’s
results, assets and liabilities are equity accounted for in the records of Ark Ltd, only the 15%
existing interest will be taken into account and not the potential interest of 25%.
When equity accounting for associates, the present ownership interest is used to allocate
the proportion of net assets to an entity, thus potential voting rights are not taken into
account. Potential voting rights are therefore only taken into account when determining
whether significant influence exists, but are not taken into account when the financial
statements are equity accounted for. In some circumstances, instruments with potential
voting rights exist, which in substance grant the entity access to the returns associated with
such an interest. In such circumstances, the proportion allocated to the entity is calculated
by taking into account these potential voting rights which currently grant access to the
returns. An example of this is where a company sells its interest and simultaneously agrees
to repurchase the interest without the loss of significant influence. In such exceptional
instances, the future owner’s interest is used in equity accounting for the investee.
Example 25.
25.2 Future ownership
Aquila Ltd has a 40%, Belt Ltd a 25% and Cygnus Ltd a 35% ownership interest in Orion Ltd.
Aquila Ltd sells 10% of its ownership interest at its fair value for R100 to Belt Ltd and
simultaneously enters into a forward agreement with Belt Ltd to repurchase the 10% ownership
interest at R115. Belt Ltd receives a return of 7% per annum when the forward agreement settles.
The sale and forward repurchase agreements are linked, and the terms of the forward agreement
are such that Aquila Ltd retains significant influence over the economic benefits associated with
the 10% ownership interest. Therefore, Aquila Ltd would equity account for 40% of Orion Ltd when
preparing its consolidated financial statements.
Instruments containing potential voting rights are accounted for as financial instruments in
terms of IFRS 9 Financial Instruments. The exception to this rule occurs where, in
substance, the instruments form part of the ownership interests as explained above, in
which case they are accounted for as part of the investment in the associate and are not
subject to the conditions of IFRS 9.
25.3.2 Equity method

25.3.2.1 Introduction to the equity method
An investment in an associate or joint venture is recognised according to the equity
method. This investment is initially recorded at cost and after the date of acquisition,
increases or decreases are recorded by including the following:
the proportionate share of the profit or loss of the investor in the investee (associate or
joint venture) after the date of acquisition;
distributions received from the investee (reduces the carrying amount of the investment);
the portion of prior year adjustments in the investee since the date of acquisition; and
adjustments to the carrying amount due to changes to the proportionate interest of the
entity in the investee, flowing from changes to the equity interest of the investee not
included in profit or loss – such as the revaluation of property, plant and equipment after
the acquisition date, which is recognised in other comprehensive income (IAS 28.10).
Example 25.
25.3 Equity method
On 1 January 20.13, Khumalo Ltd acquired 25% of Mail Ltd for R132 000, which gives
Khumalo Ltd the power to participate in the financial and operating policy decisions of Mail Ltd.
Mail Ltd is thus an associate of Khumalo Ltd. Mail Ltd’s retained earnings were R200 000 on the
date of acquisition and R280 000 on 31 December 20.13 (year end). Mail Ltd declared an ordinary
dividend of R100 000 during the current year. Khumalo Ltd will equity account for its investment
in Mail Ltd as follows:
Journal entry in Khumalo Ltd’s own books
Dr Cr
R R
1 January 20.13
Investment in associate (SFP) 132 000
Bank (SFP) 132 000
Acquisition of associate – Mail Ltd
31 December 20.13
Investment in associate (SFP) ((280 000 – 200 000) × 25%) 20 000
Share of profit of associate (P/L) 20 000
Recording of share of associate’s profit for the year
Dividend income (P/L) 25 000
Investment in associate (SFP) (100 000 × 25%) 25 000
Elimination of intragroup dividend
Comment
¾ The effect on the investment in Mail Ltd is that the original investment declines from R132 000
to R127 000 (132 000 + 20 000 – 25 000). The carrying amount of the investment in the
associate of R127 000 is disclosed as a separate line item on the face of the statement of
financial position under non-current assets.
¾ The carrying amount is increased by the proportionate share of the profit or loss of the investor
in the associate after the date of acquisition. The share of profit of the associate (R20 000) is
presented as a separate line item on the face of the statement of profit or loss and other
¾ The dividend received from the associate reduces the carrying amount of the investment.
Example 25.
25.4 Comparison of consolidated statements and equity accounted statements
Assume that the reporting date of Chio Ltd and Juvé Ltd is 31 December. The abridged statements
of profit or loss and other comprehensive income for the year ended 31 December 20.14 and the
statements of financial position as at that date are as follows:
Statements of profit or loss and other comprehensive income
Chio Ltd Juvé Ltd
R R
Revenue 2 100 000 1 950 000
Cost of sales (1 470 000) (1 480 000)
Gross profit 630 000 470 000
Other expenses (580 000) (440 000)
Statements of financial position as at 31 December 20.14
R R
Assets
Non-current assets
Property, plant and equipment – 20 000
Investment of 30 000 ordinary shares in Juvé Ltd (cost) 39 000 –
Current assets 171 000 70 000
Total assets 210 000 90 000
Share capital (100 000; 60 000 ordinary shares) 100 000 60 000
Retained earnings 70 000 20 000
Long-term borrowings 40 000 10 000
Extract from the statement of changes in equity for the year ended 31 December 20.14
R R
Retained earnings beginning of year 54 000 5 000
Dividends (10 000) –
Retained earnings end of year 70 000 20 000
Chio Ltd acquired the 30 000 shares in Juvé Ltd on 2 January 20.14, and holds a 50%
(30 000/60 000) interest in the company. All assets and liabilities had fair values equal to their
carrying amounts at the date of purchase of the interest.
Assume the following two alternatives:
(a) Juvé Ltd is a subsidiary, as Chio Ltd exercises control over Juvé Ltd in accordance with
IFRS 10 Consolidated Financial Statements.
(b) The shareholding of 50% does not give Chio Ltd control, but significant influence. Juvé Ltd
is thus an associate of Chio Ltd (If joint control is exercised and the interest is classified as
a joint venture in accordance with IFRS 11, Joint Arrangements, the investment will continue
to be equity accounted for, exactly the same as in the case of an associate).
continued
The abridged consolidated annual financial statements will be as follows:

(a) (b)
Associate
Subsidiary or joint
venture
R R
Revenue (Subsidiary: 2 100 000 + 1 950 000) 4 050 000 2 100 000
Cost of sales (Subsidiary: 1 470 000 + 1 480 000) (2 950 000) (1 470 000)
Gross profit 1 100 000 630 000
Other expenses (Subsidiary: 580 000 + 440 000) (1 020 000) (580 000)
Share of profit of associate/joint venture (15 000 × 50%) – 7 500
Income tax expense (Subsidiary: 24 000 + 15 000) (39 000) (24 000)
Profit and total comprehensive income attributable to:
Owners of the parent 33 500 33 500
Non-controlling interests (Subsidiary: 15 000 profit × 50%) 7 500 –
41 000 33 500
Consolidated statement of financial position at 31 December 20.14

Associate
Subsidiary or joint
venture
R R
Assets
Non-current assets
Property, plant and equipment (Subsidiary: 0 + 20 000) 20 000 –
Goodwill1 6 500 –
Investment in associate/joint venture2 – 46 500
Current assets (Subsidiary: 171 000 + 70 000) 241 000 171 000
Total assets 267 500 217 500
Equity attributable to owners of the parent 177 500 177 500
Share capital (100 000 ordinary shares) 100 000 100 000
Non-controlling interests3 40 000 –
Total equity 217 500 177 500
Long-term borrowings (Subsidiary: 40 000 + 10 000) 50 000 40 000
1
39 000(investment at cost) – 32 500(50% × 65 000 (60 000 share capital + 5 000 retained
earnings, beginning of year)) = 6 500
2
39 000(investment at cost) + 7 500(share of profit) = 46 500
3
50% × 80 000(60 000 share capital + 20 000 retained earnings, end of year) = 40 000
continued
Consolidated statement of changes in equity for the year ended 31 December 20.14
Associate or
Subsidiary
joint venture
Non-
Retained Retained
controlling
earnings earnings
interests
R R R
Balance at 31 December 20.13 54 000 – 54 000
Interest in subsidiary acquired during the year – 32 5001 –
Total comprehensive income for the year 33 500 7 500 33 500
Other comprehensive income – – –
Dividends (10 000) – (10 000)
Balance at 31 December 20.14 77 500 40 000 77 500
1
50% × 65 000(60 000 + 5 000) = 32 500
Comment
¾ As the profits retained for the year, and therefore also the retained earnings in the statement of
financial position, are the same in both the consolidated and the equity accounted annual
financial statements, the earnings per share will also be the same.
¾ The statements of financial position differ as the assets and liabilities of the subsidiary
(investee) are included in the consolidated statements, but not under the equity method. In the
latter, an equity accounted investment in the associate or joint venture is disclosed as an asset
in a single line item.
¾ If joint control is exercised and the interest is classified as a joint venture in accordance with
IFRS 11 Joint Arrangements, the investment will continue to be equity accounted for, exactly
the same as in the case of an associate.
From the above example, it is clear that the equity method is a method of accounting and
reporting in terms of which the investment is initially recorded at cost and adjusted
thereafter for the post-acquisition change in the entity’s share of the net assets of the
associate or joint venture. The entity’s statement of profit or loss and other comprehensive
income reflects the entity’s share of the results of operations of the associate or joint
venture.
25.3.2.2 Other comprehensive income
Not all changes in equity of an associate or joint venture are recognised in profit or loss.
Some changes, for example revaluations of property, plant and equipment, as well as fair
value adjustments on financial assets subsequently measured at fair value through other
comprehensive income, are recognised in other comprehensive income. The entity must
recognise its share of these changes in other comprehensive income in its own statement of
profit or loss and other comprehensive income (to the extent that it has not already been
recognised at date of acquisition). These items must be presented in the line item ‘share of
other comprehensive income of associate/joint venture’ in the consolidated statement of
Example 25.
25.5 Other comprehensive income of an associate or joint venture
Alto Ltd obtained a 40% interest in Balto Ltd on 1 July 20.12, which constitutes significant
influence. Balto Ltd is thus an associate of Alto Ltd. On 30 June 20.14, Balto Ltd revalued its
machinery for the first time by R50 000. Assume a tax rate of 28%. Assume that Alto Ltd has no
revaluation surplus. Balto Ltd would equity account as follows:
Pro forma consolidation journal entry
Dr Cr
R R
30 June 20.14
Investment in associate (SFP) (50 000 × 40% × 72%) 14 400
Revaluation of machinery on 30 June 20.14.
This would be presented as follows in the statement of profit or loss and other comprehensive
income:
R
Other comprehensive income for the year:
Share of other comprehensive income of associate 14 400
This would be presented as follows in the statement of changes in equity:
Revaluation
surplus
R
Balance at 31 December 20.13 –
Other comprehensive income for the year 14 400
25.3.2.3 Contribution of a non-monetary asset

When an investor or joint venturer contributes a non-monetary asset to an associate or joint
venture in exchange for an equity interest in that entity, the profit or loss from this
contribution is recognised in the investor’s financial statements only to the extent of the
other investors’ interests in the associate or joint venture (IAS 28.30). However, if the
contribution lacks commercial substance and no other assets have been received, no profit
or loss is recognised.
When an investor receives, in exchange for its own non-monetary asset, a monetary or
dissimilar non-monetary asset over and above the equity interest in the associate or joint
venture, the entity will recognise, in full, in profit or loss, the portion of the gain or loss on the
non-monetary contribution relating to those assets.
25.3.2.4 Goodwill and gain on bargain purchase on acquisition
Where the purchase price of the shares in an associate or joint venture exceeds the portion of
the identifiable net assets acquired at fair value, and this is not attributable to a particular
asset(s), it is recorded as goodwill in accordance with IFRS 3 Business Combinations.
If the portion of identifiable net assets at fair value exceeds the purchase price of shares in
the associate or joint venture, a gain on bargain purchase at acquisition will be
recognised.
Goodwill that relates to an associate or joint venture is included in the carrying amount of
the investment. As the goodwill is an integral part of the investment, it cannot be
recognised separately, nor assessed separately for the purposes of recognising impairment.
The entire carrying amount of the investment is tested for impairment, if there are indications
of a reduction in value.
A gain on a bargain purchase on acquisition is recognised in the profit or loss section of
the statement of profit or loss and other comprehensive income as part of the share of
profit from the associate or joint venture. The initial investment is increased by the gain
on bargain purchase at acquisition to equal the entity’s share of the investee’s net asset
value on the date of acquisition.
Example 25.
25.6 Gain on a bargain purchase on acquisition
Car Ltd acquired an interest of 30% in Zar Ltd on 1 December 20.14 for R100 000. Since that
date, Car Ltd has exercised significant influence over the financial and operating policy decisions
of Zar Ltd; thus Zar Ltd is an associate of Car Ltd. The fair value of the entity’s share of the net
assets at date of acquisition was R110 000.
When a gain on a bargain purchase at acquisition is recorded, the following pro forma
consolidation journal entry is required:
Dr Cr
R R
1 December 20.14
Investment in associate (SFP) (110 000 – 100 000) 10 000
Share of profit of associate (gain on bargain purchase)(P/L) 10 000
Comment
¾ Effectively, this increases the initial investment of R100 000 by R10 000 to R110 000. This
amount is equal to the entity’s share of the net assets at date of acquisition.
25.3.3 Application of the equity method

Commencement of the equity method:
An investment in an associate or joint venture is equity accounted for from the date on
which it becomes an associate or joint venture.
An investor uses the equity method to account for its investments in associates and joint
ventures in its consolidated financial statements.
An investor accounts for its investments in associates and joint ventures in its separate
financial statements in accordance with IAS 27 Separate Financial Statements, either
at cost, or in accordance with IFRS 9 Financial Instruments, or using the equity method
as per IAS 28.
An entity need not apply the equity method to its investment in an associate or joint venture
if the entity is a parent that is exempt from preparing consolidated financial statements
(IFRS10.4(a)) or if all of the following apply (IAS 28.17):
the entity is a wholly-owned subsidiary; or
is a partially-owned subsidiary of another entity and its other owners have been informed
about, and do not object to, the entity not applying the equity method; and
the debt or equity instruments are not traded in a public market; and
the financial statements have not been submitted to a securities commission or other
regulator with a view to issuing any class of instruments to the public; and
the parent produces consolidated financial statements that comply with IFRS and are
available for public use.
Discontinuance of the equity method

An entity must discontinue the use of the equity method from the date that the investment
ceases to be an associate or joint venture (IAS 28.22). This will be as follows:
If the investment becomes a subsidiary, the investment must be accounted for in
accordance with IFRS 3 Business Combinations, and IFRS 10 Consolidated Financial
Statements.
If the retained interest in the former associate or joint venture is a financial asset, it must
be measured at fair value, which will be deemed its fair value on initial recognition of the
financial asset, in accordance with IFRS 9 Financial Instruments.
On the date that an investment ceases to be an associate or joint venture, the investor
will measure the retained investment at fair value. The difference between:
– the fair value of the retained interest plus any proceeds from the disposal of the equity
accounted investment; and
– the carrying amount of the equity accounted investment on the date that significant
influence was lost,
must be recognised in profit or loss.
If the equity method is discontinued or if the current interest in the associate or joint
venture is reduced and the entity continues to apply the equity method, all amounts, or a
proportionate part thereof relating to the investment previously recognised in other
comprehensive income will be accounted for on the same basis as would have been
required if the investee had directly disposed of the related assets or liabilities
(IAS 28.22(c)). This means that if an amount that was recognised in other
comprehensive income would be reclassified to profit or loss on disposal of the related
assets or liabilities, the entity would reclassify the gain or loss from equity via other
comprehensive income to profit or loss when the equity method is discontinued.
If an investment in an associate becomes an investment in a joint venture or vice versa,
the entity will continue to apply the equity method and the retained interest will not be
remeasured (IAS 28.24).
Example 25.
25.7 Discontinuance of equity method
Using the information in Example 25.3 for Khumalo Ltd and Mail Ltd, assume that Khumalo Ltd
sold 20% of its 25% interest in Mail Ltd on 31 December 20.14 for R110 000. The fair value of the
remaining 5% interest in Mail Ltd is R26 000 on 31 December 20.14.
Khumalo Ltd discontinues the use of the equity method from the date when it ceases to have
significant influence over the associate, Mail Ltd (i.e. from 31 December 20.14). The remaining
investment of 5% in Mail Ltd is accounted for in accordance with IFRS 9 Financial Instruments.
The profit or loss on the sale of part of the interest in the associate is calculated as follows:
R
31 December 20.14
Fair value of retained investment (5%) 26 000
Proceeds from disposal of interest (20%) 110 000
136 000
Carrying amount of investment in associate (25%) – see Example 25.3 (127 000)
Profit on disposal of interest in associate 9 000
Comment
¾ The profit on the disposal of the interest in the associate of R9 000 is recognised in the profit
or loss section of the consolidated statement of profit or loss and other comprehensive income.
¾ The fair value of the 5% investment is regarded as the fair value on initial recognition as a
financial asset in accordance with IFRS 9 Financial Instruments.
25.4 Specific requirements
25.4.1 Acquisition of additional interests

As with consolidated financial statements, adjustments to the carrying amount and even to
the statement of profit or loss and other comprehensive income are necessary where the
percentage interest in the investee changes due to the purchase of further shares without
obtaining control, the sale of part of the investment is concluded with the residual interest
still qualifying as an associate, or when the associate has a rights issue.
When an associate becomes a subsidiary (or vice versa), the new status of the investment
dictates the accounting treatment. Similarly, where a normal investment becomes one of
significant influence, the equity profit or loss from such a date is included in the statement of
During the period in which the investment was not yet an associate/joint venture (no
significant influence/joint control), it was carried at fair value in the separate financial
statements of the investor in terms of IFRS 9. When significant influence/joint control is
obtained, the fair value adjustment on the initial investment must be reversed in the group
Example 25.
25.8 Acquisition of additional interest
The following are the abridged financial statements of Bull Ltd and its subsidiaries, and Dog Ltd for
the year ended 31 December 20.14:
Extracts from the statements of profit or loss and other comprehensive income
Bull Ltd
and its Dog Ltd
subsidiaries
R R
Profit and total comprehensive income for the year attributable to:
Owners of the parent 600 000 305 000
Non-controlling interests 250 000 –
850 000 305 000
Extracts from the statements of changes in equity for the year

ended 31 December 20.14
Retained earnings
Bull Ltd
and its Dog Ltd
subsidiaries
R R
Balance at 31 December 20.13 250 000 230 000
Other comprehensive income for the year – –
Ordinary dividend (100 000) –
Balance at 31 December 20.14 750 000 535 000
continued
Statements of financial position at 31 December 20.14

Bull Ltd
and its Dog Ltd
subsidiaries
R R
Assets
Investment in Dog Ltd – 40 000 ordinary shares at fair value 260 000 –
Inventory 415 000 105 000
Total assets 1 325 000 635 000
Share capital (250 000; 100 000 ordinary shares) 250 000 100 000
Mark-to-market reserve 31 875 –
Non-controlling interests 293 125 –
Total equity and liabilities 1 325 000 635 000
Bull Ltd acquired its 15% interest in Dog Ltd’s issued share capital for R15 000 at the incorporation
of Dog Ltd. Bull Ltd could not exercise significant influence at this date.
Bull Ltd irrevocably elected on initial recognition to classify the 15% investment in Dog Ltd as a
financial asset subsequently measured at fair value through other comprehensive income, and
recognises fair value adjustments in equity (via other comprehensive income) in terms of IFRS 9
Financial Instruments.
On 30 November 20.14, Bull Ltd acquired a further 25% interest in Dog Ltd’s issued share capital
for R206 250. From this date, Bull Ltd has exercised significant influence over the financial and
operating policy decisions of Dog Ltd.
On 30 November 20.14, Bull Ltd irrevocably elected to classify the investment in Dog Ltd
(investment in associate) as a financial asset subsequently measured at fair value through other
comprehensive income in it’s separate financial statements.
The fair value of the previously held 15% interest amounted to R21 875 on 30 November 20.14.
On 31 December 20.14, the fair value of the 40% interest amounted to R260 000.
The identifiable assets and liabilities of Dog Ltd were regarded to be fairly valued at each of the
acquisition dates.
With the derecognition of these equity investments, the cumulative adjustment is transferred to
retained earnings in terms of IFRS 9.B5.7.1.
Dog Ltd earned its profit evenly throughout the year.
Analysis of owners’ equity of Dog Ltd
Total Bull Ltd (40%)
At Since Carrying
RE Amount
R R R R
At acquisition
Share capital 100 000 40 000
Retained earnings (230 000 + (305 000 × 11/12)) 509 583 203 833
609 583 243 833
Gain on bargain purchase A 15 708
Consideration paid (21 875 + 206 250) 228 125 228 125
Current year
Profit 1 December 20.14 – 31 December 20.14
(305 000/12); (25 417 × 40%) 25 417 B 10 167 10 167
Gain on bargain purchase A 15 708 15 708
635 000 228 125 C 25 875 254 000
continued

Dr Cr
R R
Investment in Dog Ltd (SFP) (260 000 – 228 125) 31 875
Reversal of fair value adjustment on investment in Dog Ltd after it
became an associate
Investment in Dog Ltd (SFP) 25 875
Share of profit of associate (P/L) (15 708A + 10 167B) 25 875
Equity accounting for associate Dog Ltd
The following consolidated financial statements are prepared:
Bull Ltd Group
R
Profit 850 000
Share of profit of associate ((15 708A + 10 167B)) 25 875
Profit and total comprehensive income for the year attributable to:
Non-controlling interests (relating to subsidiaries of Bull Ltd) 250 000
875 875
Bull Ltd Group

Non-
Total controlling
interests
R R R R R
Balance at 31 December 20.13 250 000 250 0001 500 000 43 1254 543 125
Total comprehensive income for the

year – 625 8752 625 875 250 000 875 875
Profit for the year – 625 8752 625 875 250 000 875 875
Other comprehensive income
for the year – – – – –
1
Dividends paid – (100 000) (100 000) – (100 000)
3
Balance at 31 December 20.14 250 000 775 875 1 025 875 293 125 1 319 000
1
Only Bull Ltd
2
Per consolidated statement of profit or loss and other comprehensive income; or
600 000 (Bull Ltd) + 15 708A + 10 167B = 625 875
3
750 000 (Bull Ltd) + 25 875C = 775 875
4
293 125(SFP) – 250 000 = 43 125
continued
Bull Ltd Group

R
Assets
Non-current assets 904 000
Investment in associate (228 125 + 25 875C) 254 000
Inventories 415 000
R
Equity attributable to owners of the parent 1 025 875
25.4.2 Disposal of interests

The carrying amount of the equity investment forms the basis for the calculation of profit or
loss on the sale of the investment, or a portion of it.
The profit or loss on disposal of the investment in the associate or joint venture is
calculated as the difference between:
the proceeds received on disposal; and
the carrying amount of the investment accounted for in accordance with the equity method.
The difference between the profit recognised by the entity in its own financial statements
and the profit in the consolidated financial statements will equal the post-acquisition profits
which were equity accounted for in the consolidated financial statements (or a part thereof if
only a share of the investment in the associate or joint venture was disposed of).
Example 25.
25.9 Sale of an investment in an associate
On 1 January 20.12, Zara Ltd purchased a 30% investment in the ordinary shares of Cara Ltd at a
cost of R80 000. This investment is classified as an investment in an associate since significant
influence is present. Zara Ltd elected to disclose this investment at cost in its separate financial
statements.
Cara Ltd’s profit for the three years to 31 December 20.14 amounted to the following:
R
1 January 20.12 to 31 December 20.12 200 000
continued
On 31 December 20.14, the carrying amount of the investment is calculated as follows:

R
Cost 80 000
Gain on bargain purchase at acquisition (assume correct) 5 000
Share in retained earnings ((200 000 + 250 000) × 30%) 135 000
Share of profit for the current year (300 000 × 30%) 90 000
Carrying amount of investment 310 000
On 31 December 20.14, Zara Ltd sold the entire investment for R380 000.
The profit on sale of the investment is calculated as follows:
Consolidated
Separate financial
financial
statements
statements
R R
Cost/Carrying amount of investment sold (80 000) (310 000)
Proceeds on disposal 380 000 380 000
Profit on disposal 300 000 70 000
The pro forma consolidation journal entries for the year ended 31 December 20.14 are as follows:
Dr Cr
R R
Retained earnings (at acquisition) 5 000
Recognition of gain on bargain purchase at acquisition
Retained earnings (since acquisition) 135 000
Recording of retained earnings of associate since acquistion
Share of profit of associate (P/L) 90 000
Share of associate’s profit for the year
Profit on sale of investment in associate (P/L) 300 000
Elimiation of profit recorded in the seperate financial statements
Profit on sale of investments in associate (P/L) 70 000
Recording profit made on sale of investment in the consolidated
financial statements
Comment
¾ If Zara Ltd sold only 20% of the investment in Cara Ltd and consequently lost significant influence,
the remaining 10% investment in Cara Ltd will be restated to fair value (IAS 28.22(b)). The gain or
loss made from the sale of the investment will be the difference between:
the fair value of the retained investment (10%) plus the proceeds from the interest sold (20%);
and
the carrying amount of the investment on the date significant influence is lost.
¾ The remaining investment stated at fair value is thereafter accounted for in accordance with
IFRS 9 Financial Instruments.
25.4.3 Impairment losses

After applying the equity method, including recognising losses in accordance with IAS 28.38,
the entity must determine whether there is any objective evidence that its net investment in
the associate or joint venture is impaired (IAS 28.40).
The net investment in an associate or joint venture is impaired and impairment losses are
incurred only if there is objective evidence of impairment as a result of an event/s that
occurred after the initial recognition of the net investment (a ‘loss event’) and such event/s
have an impact on the estimated future cash flows from the net investment that can be
reliably estimated. Losses expected as a result of future events are not recognised
(IAS 28.41A). Objective evidence that the net investment is impaired includes the following
loss events:
significant financial difficulty of the associate or joint venture;
a breach of contract by the associate or joint venture;
the entity, for economic or legal reasons relating to its associate’s or joint venture’s
financial difficulty, granting to the associate or joint venture a concession that the entity
would not otherwise consider;
the associate or joint venture will most likely enter bankruptcy or other financial
reorganisation; or
the disappearance of an active market for the net investment because of financial
difficulties of the associate or joint venture (IAS 28.41(A)).
In addition to the above, objective evidence of impairment of the net investment in the equity
instruments of the associate or joint venture includes:
information about significant changes with an adverse effect that have taken place in the
technological, market, economic or legal environment in which the associate or joint
venture operates, and indicates that the cost of the investment in the equity instrument
may not be recovered; and
a significant or prolonged decline in the fair value of an investment in an equity
instrument below its cost (IAS 28.41C).
The following events are not evidence of impairment unless considered with other available
information:
the disappearance of an active market because the associate’s or joint venture’s equity
or financial instruments are no longer publicly traded; and
a downgrade of an associate’s or joint venture’s credit rating or a decline in the fair value
of the associate or joint venture is not, of itself, evidence of impairment, although it may
be evidence of impairment when considered with other available information
(IAS 28.41B).
The entity applies the impairment requirements in IFRS 9 Financial Instruments to its other
interests in the associate or joint venture that fall within the scope of IFRS 9 and that do not
form part of the net investment. (IAS 28.40)
Since goodwill forms part of the carrying amount of the investment in the associate or joint
venture and is not recognised separately, it is not tested separately for impairment in
accordance with IAS 36 Impairment of Assets. If there is an indication of possible
impairment of the investment in the associate or joint venture, the entire carrying amount of
the investment will be tested for impairment in accordance with IAS 36, by comparing:
the recoverable amount (greater of value in use and fair value less costs of disposal) to
the carrying amount of the investment.
The impairment loss is not allocated to any asset, including goodwill, that forms part of the
carrying amount of the investment. In determining the value in use of the investment, an
entity estimates:
its share of the present value of the estimated future cash flows expected to be
generated by the associate or joint venture as a whole, including the cash flows from the
operations of the associate or joint venture and the proceeds on the ultimate disposal of
the investment; or
the present value of the estimated future cash flows expected to arise from dividends to
be received from the investment and from its ultimate disposal.
With appropriate assumptions, both methods provide the same recoverable amount
(IAS 28.42).
The recoverable amount of an investment in an associate or joint venture is assessed for
each individual associate or joint venture, unless it does not generate cash inflows that are
largely independent of those from other assets of the reporting entity (IAS 28.43).
Example 25.
25.10 Impairment of an investment in an associate
Suit Ltd acquired a 30% interest in a new entity, Case Ltd, on 1 January 20.12 at a cost of
R100 000, when the net asset value of the entity (only share capital) amounted to R300 000.
Suit Ltd has significant influence over Case Ltd.
The profit of Case Ltd for the years ended 31 December 20.12 and 20.13 amounted to R150 000
and R50 000 respectively. Case Ltd has not yet declared any dividends to its shareholders.
The equity accounted carrying amount of the investment is calculated as follows on
31 December 20.13:
R
Cost of investment 100 000
Net asset value at acquisition (300 000 × 30%) 90 000
Goodwill (100 000(cost) – 90 000(net asset value at acquisition)) 10 000
Share in retained earnings – to 31 December 20.12 (150 000 × 30%) 45 000
Share of profit of associate for the year ended 31 December 20.13 (50 000 × 30%) 15 000
Carrying amount of the investment 160 000
The significant decrease in profit for the year ended 31 December 20.13 occurred as a result of a
declining market. It can be assumed that there are indications of impairment present in respect of
this investment. After a thorough financial analysis, Suit Ltd’s financial advisor estimated that
Case Ltd will pay an annual dividend of R30 000 to its shareholders in future. It may also be
assumed that Case Ltd will not be liquidated in the near future. A fair dividend return rate for an
entity with a similar risk and growth profile is 10%.
The recoverable amount of the investment (30%) on 31 December 20.13 is as follows:
R
Expected annual dividend (30 000 × 30%) 9 000
Fair dividend return rate 10%
Recoverable amount – capitalised dividend (9 000/0,10) 90 000
The impairment loss on the investment is as follows:
Carrying amount of investment 160 000
Recoverable amount (90 000)
Impairment loss (recognised in profit or loss) 70 000
Journal entry
Dr Cr
R R
31 December 20.13
Recognition of impairment loss
continued
Comment
¾ The impairment loss of R70 000 on the investment in the associate is reversed against the
investment in the associate in subsequent periods to the extent that the recoverable amount of
the investment increases. Assume the recoverable amount increased to R120 000 on
31 December 20.14:
R
Recoverable amount 20.13 90 000
Recoverable amount 20.14 120 000
Reversal of impairment loss 30 000
Journal entry
Dr Cr
R R
31 December 20.14
Reversal of part of impairment loss due to an increase in recoverable
amount of the investment
25.4.4 Losses of associates or joint ventures

When an associate or joint venture incurs losses, the investment is decreased by the losses
and debited in profit or loss as ‘share of losses of associate/joint venture’. If an entity’s
share of losses in the associate or joint venture equals or exceeds its interest (the carrying
amount of the investment in the associate or joint venture including any long-term interests),
the entity will no longer recognise its share of additional losses, but will carry the investment
in the associate or joint venture at Rnil. Only in cases where the entity suffers additional
losses due to legal or constructive obligations or payments made on behalf of the associate
or joint venture, is provision made for the additional losses, even though the investment has
already been written down to Rnil. When the associate or joint venture generates profits
again, the entity resumes recognising its share of the associate or joint venture’s profits only
after its share of the profits equals the share of the unrecognised losses.
The interest in an associate or joint venture consists of various elements, namely ordinary
shares, preference shares, loans, advances and options. The interest in the associate or
joint venture is the carrying amount of the investment that includes long-term interests.
Short-term items, for example trade receivables and trade payables, and insured long-term
loans are, however, excluded. Losses can be written off against both the residual equity
interests, for example ordinary shares and participating preference shares, and non-equity
interests, for example long-term receivables and preference shares that form part of the net
investment, limited to writing down the carrying amount of the investment to Rnil. Losses are
allocated to components, other than ordinary shares, in the reverse order of preference in
which payments will be made on liquidation.
If an associate or joint venture continues to incur losses, the financial interests in the
associate or joint venture may become impaired and the requirements of IAS 36 Impairment
of Assets should be followed. However, the carrying amount of the investment used in the
impairment calculation will be the amount after adjusting for equity losses.
Example 25.
25.11 Loss of an associate
On 1 July 20.11, Wait Ltd acquired a 40% interest in the ordinary share capital of Jam Ltd for
R50 000. Since that date, Wait Ltd has exercised significant influence over the financial and
operating policy decisions of Jam Ltd. Wait Ltd also acquired 50% of the preference share capital
of Jam Ltd for R40 000 (fair value at acquisition and at year end). On 1 July 20.12, Wait Ltd
granted a shareholders’ loan of R150 000 to Jam Ltd. Wait Ltd required security for R30 000 of the
loan.
The carrying amount of the investment in ordinary shares on 30 June 20.14 is as follows:
Wait Ltd’s
investment
in Jam Ltd
R
Cost of investment 50 000
Profit for the period 1 July 20.11 – 30 June 20.13 300 000 × 40% 120 000
Carrying amount on 30 June 20.13 170 000
Loss for the year ended 30 June 20.14 (900 000) × 40% (360 000)
The 40% share of this loss should be recognised by Wait Ltd, limited to Wait Ltd’s interest in
Jam Ltd.
Wait Ltd’s interest comprises the following components:
R
Carrying amount of investment in ordinary shares 170 000
Carrying amount of investment in preference shares 40 000
Carrying amount of shareholders’ loan – unsecured portion (150 000 – 30 000) 120 000
Total 330 000
Since Wait Ltd’s share of the loss is more than its interest in Jam Ltd, the following portion of the
loss should not be recognised: R360 000 – R330 000 = R30 000.
The total investment in associate will be reduced to Rnil but will not become negative.
In terms of IAS 28.38, the loss should be allocated to the components of Wait Ltd’s investment in
the reverse order of preference at liquidation. The loss is thus firstly allocated to the ordinary share
investment, then to the preference share investment and lastly to the unsecured loan (which will
have preference at liquidation). The pro forma consolidation journal entry is as follows:
Dr Cr
R R
Share of loss of associate (limited to investment) (P/L) 330 000
Investment in associate: ordinary shares (SFP) 170 000
Investment in associate: preference shares (SFP) 40 000
Investment in associate: shareholders’ loan (SFP) 120 000
Recognition of loss in associate for the year
Assume the associate has a profit of R1 million in the following year. The entity’s (Wait Ltd) share
in the profit for the year is therefore R400 000 (R1 000 000 × 40%). Wait Ltd will only equity
account for R370 000 (R400 000 – R30 000 previously unrecognised loss) of the profits, due to
previous losses.
25.4.5 Intragroup transactions

Many of the procedures appropriate for the application of the equity method are similar to
consolidation procedures. Where an associate or joint venture is accounted for using the
equity method, unrealised profits and losses resulting from ‘upstream’ and ‘downstream’
transactions between an entity (or its consolidated subsidiaries) and associates or joint
ventures should be eliminated to the extent of the entity’s interest in the associate or joint
venture (IAS 28.28). ‘Upstream’ transactions are sales from an associate or joint venture to
the investor, while ‘downstream’ transactions are sales from the the investor to it’s associate or
joint venture.
When downstream transactions provide evidence of an impairment of the transferred asset,
the unrealised losses should be recognised in full by the investor. When upstream
transactions provide evidence of a reduction or an impairment of the transferred asset, the
investor shall recognise its share in the losses (IAS 28.29).
Example 25.
25.12 Unrealised profit with the sale of inventory
Case 1: Associate sells to investor

Refer to Example 25.3 (Khumalo Ltd and Mail Ltd). Assume that during the year, Mail Ltd sold
inventories to Khumalo Ltd at a mark-up of 35% on cost. At 31 December 20.13, the inventories on
hand and acquired from Mail Ltd amounted to R80 000. Assume a tax rate of 28%.
In terms of IAS 28, the unrealised profit recognised by the associate should be eliminated to the
extent of the interest of Khumalo Ltd (investor) in Mail Ltd (associate), namely 25%.
The pro forma consolidation journal entry is as follows:
Dr Cr
R R
Share of profit from associate (P/L) (5 185 × 72%) 3 733
Deferred tax (SFP) (5 185 × 28%) 1 452
Inventories (SFP) (80 000 × 35/135 × 25%) 5 185
Elimination of unrealised profit in closing inventories
Comment
¾ Khumalo Ltd recognises its interest in the profit of Mail Ltd as being 25%; consequently only
25% of the unrealised profit is reversed.
Case 2: Investor sells to associate
Assume instead that the above inventories were sold by Khumalo Ltd to Mail Ltd and that R80 000
is carried as inventories on hand by Mail Ltd on 31 December 20.13.
The unrealised profit now arises in Khumalo Ltd (investor).
The pro forma consolidation journal entry is as follows:
Dr Cr
R R
Sales (P/L) (R80 000 × 25%) 20 000
Cost of sales (P/L) (R80 000 × 100/135 × 25%) 14 815
Elimination of unrealised profit in closing inventories
Tax effect on elimination of unrealised profit in closing inventories
Comment
¾ As the income tax expense in the statement of profit or loss and other comprehensive income is
identified separately for Khumalo Ltd (investor), the tax effect of the reversal of unrealised profits
(1 452) must be credited to the tax expense.
¾ Only 25% of the unrealised profit is reversed, as it is assumed that 75% of the inventories were
sold to external clients or the other shareholders of Mail Ltd and therefore realised from the
perspective of Khumalo Ltd.
¾ The accounting treatment would be the same if the investment in Mail Ltd was classified as a
joint venture.
Example 25.
25.13 Unrealised profit with the sale of a depreciable asset
Case 1: Associate or joint venture sells to investor

Mar Ltd acquired a 20% interest in Mite Ltd on 1 January 20.12. On 30 June 20.13, Mite Ltd sold
office equipment to Mar Ltd for R450 000. The original cost price of this equipment was R620 000
and the carrying amount at the date of sale amounted to R400 000. On the date of sale, the tax
base was equal to the carrying amount of the equipment. It is the group’s accounting policy to
depreciate equipment on a straight-line basis. The remaining useful life of the office equipment on
30 June 20.13 was 10 years. Assume a tax rate of 28% for all the years. The group’s year end is
31 December.
The unrealised profit relating to the transaction with the associate or joint venture amounts to
R10 000 (R50 000(450 000 – 400 000) × 20%). The other 80% is realised, since that part of the
transaction is in effect with the other owners.
20% of Tax Net
R50 000 at 28% amount
R R R
30 June 20.13 10 000 (2 800) 7 200
Depreciation: 1 July 20.13 – 31 December 20.13
(10 000 × 10% × 6/12) (500) 140 (360)
Balance at 31 December 20.13 9 500 (2 660) 6 840
Depreciation: 1 January 20.14 – 31 December 20.14
(10 000 × 10%) (1 000) 280 (720)
Balance at 31 December 20.14 8 500 (2 380) 6 120
The following pro forma consolidation journal entries are required:
Dr Cr
R R
31 December 20.13
Share of profit from associate/joint venture (P/L) (10 000 × 72%) 7 200
Deferred tax (SFP) (10 000 × 28%) 2 800
Equipment – cost (SFP) (50 000 (450 000 – 400 000) × 20%) 10 000
Elimination of unrealised profit
Accumulated depreciation (SFP) (10 000 × 10% × 6/12) 500
Share of profit from associate/joint venture (P/L) (500 × 72%) 360
Deferred tax (SFP) (500 × 28%) 140
Realisation of unrealised profit by reversing excess depreciation
31 December 20.14
Retained earnings – beginning of year (SFP) (7 200 – 360) 6 840
Accumulated depreciation (SFP) 500
Deferred tax (SFP) (2 800 – 140) 2 660
Opening balances adjusted for 20.13 entries
Accumulated depreciation (SFP) (10 000 × 10%) 1 000
Share of profit of associate/joint venture (P/L) (1 000 × 72%) 720
Deferred tax (SFP) (1 000 × 28%) 280
continued
Case 2: Investor sells to associate or joint venture

Assume that the above equipment was sold by Mar Ltd (investor) to Mite Ltd (associate/joint
venture). The unrealised profit is now in Mar Ltd (investor) as Mar Ltd made the profit.
The following pro forma consolidation journal entries are required:
Dr Cr
R R
31 December 20.13
Other income (P/L) (profit from sale) 10 000
Investment in associate/joint venture (SFP) (cost of asset adjusted) 10 000
Elimination of unrealised profit
Tax effect of elimination of unrealised profit
Investment in associate/joint venture (SFP)
(accumulated depreciation adjusted) 500
Other expenses (P/L) (depreciation) (10 000 × 10% × 6/12) 500
Income tax expense (P/L) (500 × 28%) 140
Tax effect of unrealised profit that realises
31 December 20.14
Retained earnings – beginning of year (SFP) 6 840
Deferred tax (SFP) (2 800 – 140) 2 660
Investment in associate/joint venture (SFP) (10 000 – 500) 9 500
Opening balances adjusted for 20.13 entries
Investment in associate/joint venture (SFP)
(accumulated depreciation adjusted) 1 000
Other expenses (P/L) (depreciation) (10 000 × 6/12) 1 000
Income tax expense (P/L) (1 000 × 28%) 280
Tax effect of unrealised profit that realises
The gain or loss resulting from a downstream transaction involving assets that constitute a
business, as defined in IFRS 3 Business Combinations, between an entity (including its
consolidated subsidiaries) and its associate or joint venture is recognised in full in the
investor’s financial statements (IAS 28.31A).
When determining whether assets that are sold or contributed in two or more transactions
constitute a business in terms of IFRS 3 Business Combinations, an entity shall consider
whether the sale is part of multiple arrangements that should be accounted for as a single
transaction in accordance with the requirements in paragraph B97 of IFRS 10 (IAS 28.31B).
25.4.6 Different reporting dates
The reporting dates of the entity and the associate or joint venture often differ. The associate
or joint venture must preferably prepare financial statements for the same financial period as
that of the entity (investor) (IAS 28.33). When it is impracticable to prepare such statements,
the statements for another period may be used. The reporting date differences may not be
more than three months. In such cases, the financial statements must be adjusted for
significant transactions occurring between the reporting date of the entity and the reporting
date of the associate or joint venture. The length of the reporting periods and the difference
between the reporting dates must be consistent from year to year.
25.4.7 Different accounting policies

IAS 28 requires the entity and the associate or joint venture to use uniform accounting
policies in the preparation of financial statements (IAS 28.35). If the accounting policies of
the entity and associate or joint venture differ, suitable adjustments must be made to the
associate or joint venture’s financial statements before they are equity accounted. If
impracticable, that fact is disclosed.
25.4.8 Preference dividends
As indicated by the term ‘equity method’, only the income attributable to equity or ordinary
shares is included. Preference shares can be classified either as equity or as a financial
liability. If an associate or joint venture has issued cumulative preference shares which are
classified as equity, the current dividend payable on these shares should be deducted when
determining the equity income or loss, irrespective of whether such dividends have been
declared (IAS 28.37). If the preference shares are classified as a financial liability, the
dividends are regarded as interest and would therefore have already been recognised as an
expense in the calculation of the associate or joint venture’s profit for the year.
25.4.9 Group’s interest in associate or joint venture

A group’s interest in an associate or joint venture is the total of all the investments in that
associate or joint venture held by the parent and its subsidiaries. This means that if A has a
30% interest in C, as well as a 75% interest in B, then C will be an associate and B a
subsidiary of A. Assume B also has a 15% interest in C, then A’s total interest in C is 45%
(30% of A plus 15% of B) (assume that in all the aforementioned scenarios significant
influence and control is exercised respectively).
The interests of the group’s other associates and joint ventures are ignored for this purpose.
Assume A has a 25% interest in B and a 20% interest in C. B and C are therefore both
associates of A. If B also has a 25% interest in C, then C will also be an associate of B
(assume that in all the aforementioned scenarios significant influence is exercised
respectively). A will, however, only take into account its own interest of 20% in C and not B’s
interest of 25%.
If an associate or joint venture has subsidiaries, associates or joint ventures, the profit or
loss and net assets which are equity accounted are those recognised in the associate or
joint venture’s financial statements (including the associate or joint venture’s share of the
profits or losses and net assets of its own associates and joint ventures). Referring to the
example in the previous paragraph, A will only equity account for its own investment of 25%
in B. Consequently, B’s net assets and profits or losses will include the equity accounted
results of its 25% interest in C.
Example 25.
25.14 Group’s interest in associate
Spark Ltd acquired the following interest:

75% interest in the ordinary shares of Jess Ltd on 1 January 20.12 for R525 000. From this date,
Spark Ltd has controlled Jess Ltd. On this date, Jess Ltd’s retained earnings amounted to
R250 000, and the revaluation surplus relating to land amounted to R180 000. On the acquisition
date, the net assets of Jess Ltd were fairly valued. Spark Ltd measures the non-controlling interest
at fair value. On 1 January 20.12, the fair value of the non-controlling interest, based on market
prices, amounted to R180 000. On 1 January 20.12, Spark Ltd irrevocably elected to classify the
investment in Jess Ltd as a financial asset subsequently measured at fair value through other
comprehensive income. The land was revalued on 1 January 20.12.
continued
Jess Ltd acquired the following interest:

20% interest in the ordinary shares of Scat Ltd on 1 January 20.13. From this date, Jess Ltd has
exercised significant influence over the financial and operating policy decisions of Scat Ltd. On the
acquisition date, the net assets of Scat Ltd were fairly valued; the retained earnings amounted to
R180 000, and the revaluation surplus relating to land and buildings amounted to R50 000 for land
and R260 000 (before tax) for buildings. The investment in Scat Ltd is measured at cost in
Jess Ltd’s separate financial statement. The land and buildings were revalued for the first time on
1 January 20.13 and the remaining useful life of the buildings on this date was 20 years.
1. Jess Ltd leases all its buildings from Penny Ltd as operating leases.
2. Since 1 January 20.13, Scat Ltd sold inventories to Jess Ltd at a profit margin of 50% on cost
price. Total sales for the years ended 31 December 20.13 and 20.14 amounted to R90 000
and R120 000 respectively. The unsold inventories of Jess Ltd on hand on 31 December 20.13
and 20.14, purchased from Scat Ltd, amounted to R20 000 and R35 000 respectively.
3. On 1 January 20.14, Spark Ltd revalued its land and buildings, due to its accounting policy
stateing that land must be revalued every four years. Jess Ltd also revalued its land to
R620 000 on this date.
4. There were no changes in the issued share capital of any of the companies.
5. The following abridged financial statements were prepared on 31 December 20.14 for
management purposes:
Spark Ltd Jess Ltd Scat Ltd
(Sp) (Je) (Sc)
R R R
Assets
Land 150 000 620 000 160 000
Buildings 980 000 – 750 000
Furniture and equipment 260 000 130 000 100 000
Investments:
Jess Ltd at fair value 560 000 – –
Scat Ltd at cost – 160 000 –
Other investments at fair value
(subsequently measured at fair value through OCI) – 120 000 –
Inventory 120 000 60 000 90 000
Trade and other receivables 180 000 90 000 30 000
Cash and cash equivalents 40 000 110 000 150 000
2 290 000 1 290 000 1 280 000
Share capital (ordinary shares) 290 000 260 000 270 000
Revaluation surplus (RS) 220 000 290 000 218 480
Mark-to-market reserve (MMR) 35 000 40 000 –
Retained earnings (RE) 1 130 000 610 000 566 360
Deferred tax 30 000 25 000 84 160
Long-term liabilities 350 000 – 50 000
Trade and other payables 185 000 50 000 66 000
Current tax payable 50 000 15 000 25 000
2 290 000 1 290 000 1 280 000
continued
6. Profit for the year ended 31 December 20.14 consists of the following:
R R R
Revenue 1 440 000 1 210 000 760 000
Cost of sales (842 000) (675 500) (385 500)
Gross profit 598 000 534 500 374 500
Other income 30 000 15 000 –
Other expenses (54 000) (332 500) (109 500)
Finance costs (40 000) – (5 000)
Income tax expense (84 000) (37 000) (70 000)
7. An analysis of certain reserves for each of the companies at 31 December 20.14 is as follows:
7.1 Revaluation surplus
R R R
Balance at beginning of year 120 000 180 000 227 840
Revaluation during the year 100 000 110 000 –
Transfer to retained earnings for realisation based
on usage – – (9 360)
Balance at end of year 220 000 290 000 218 480
7.2 Mark-to-market reserve

Balance at beginning of year 25 000 25 000 –
Fair value adjustment 10 000 15 000 –
Balance at end of year 35 000 40 000 –
7.3 Retained earnings

Balance at beginning of year 730 000 470 000 397 000
Transfer from revaluation surplus for realisation
based on usage – – 9 360
Dividends (50 000) (40 000) (30 000)
Balance at end of year 1 130 000 610 000 566 360
continued
8. Assume a tax rate of 28%. Ignore capital gains tax (CGT).

Analysis of owners’ equity of Scat Ltd on 31 December 20.14
Jess Ltd (20%)
Total At Since
R R R
At acquisition (1 January 20.12)
Revaluation surplus (50 000 + (260 000 × 72%)) 237 200
687 200 137 4401
Consideration paid 160 000
Goodwill 22 560A
Since acquisition RE RS
To beginning of current year
(1 January 20.13 – 31 December 20.13)
Retained earnings 2 207 640 41 528 B
Revaluation surplus 3 – –
Current year
(1 January 20.14 – 31 December 20.14)
Profit for the year 190 000 38 000 C
Dividends (30 000) (6 000)D
1 054 840 73 528 E –
NB: Although the associate sold inventories to the entity and the unrealised profit is included in the
associate’s records, no adjustments are made to the analysis (i.e. this is not the same as in the
case of a parent and a subsidiary).
1 687 200 × 20% = 137 440
2 397 000 – 9 360(realisation of revalution of buildings) – 180 000 = 207 640
3 227 840 + 9 360(realisation of 20.13 revaluation of buildings) – 237 200(at acquisition) = Rnil
Thus, carrying amount of investment on 31 December 20.14:
R(160 000 cost + 73 528E) = R233 528 or
R(160 000 + 41 528 J1 – 6 000 J5 + 38 000 J6) = R233 528
Pro forma consolidation journal entries to equity account for the investment
in the associate for the year ended 31 December 20.14
(Associate = Scat Ltd sells inventories to investor = Jess Ltd)
Dr Cr
R R
J1 Investment in associate (SFP) 41 528
(207 640(397 000 – 9 360 (realisation of revalution of buildings) –
180 000) × 20%)
Retained earnings – beginning of year (SFP) 41 528
Opening balances for post-acquisition increase in net asset value
J2 Retained earnings – beginning of year (SFP) 960
((20 000 × 50/150) × 20% × 72%)
Inventories (SFP) ((20 000 × 50/150) × 20%) 1 333
Deferred tax (SFP) (1 333 × 28%) 373
Adjustment of opening balances for unrealised profit after tax 20.13
continued
Dr Cr
R R
J3 Inventories (SFP) 1 333
Share of profit of associate (P/L) 960
Unrealised profit 20.13 now realised 20.14
or alternative for J2 and J3
Retained earnings – beginning of year (SFP) 960
Share of profit of associate (P/L) 960
J4 Share of profit of associate (P/L) ((35 000 × 50/150) × 20% × 72%) 1 680
Inventories (SFP) ((35 000 × 50/150) × 20%) 2 333
Deferred tax (SFP) (2 333 × 28%) 653
Unrealised profit 20.14 eliminated
J5 Dividend income (P/L) 6 000
Investment in associate (SFP) (30 000 × 20%) 6 000
Elimination of intergroup dividend
J6 Investment in associate (SFP) 38 000
Share of profit of associate (P/L) (190 000 × 20%) 38 000
Share of associate’s profit for the year
Analysis of owners’ equity of Jess Ltd – 31 December 20.14
Spark Ltd (75%)
Total At Since NCI 25%
R R R R
At acquisition
(1 January 20.12)
(1) (1)
690 000 517 500 172 500
Goodwill A15 000 7 500 7 500
Consideration + NCI(2) 705 000 525 000 B180 000
Since acquisition RE RS MMR NCI 25%

To beginning of current
year (1 January 20.12 to
31 December 20.13)
Retained earnings 260 568 D195 426 C65 142
Jess Ltd (3) 220 000
Scat Ltd (4) 40 568
Mark-to-market reserve (Je) 25 000 F18 750 E6 250
251 392
continued
Current year RE RS MMR NCI 25%

(1 January 20.14
– 31 December 20.14)
Profit for the year 211 280 G158 460 H52 820
Jess Ltd (5) 174 000
Share of profit – Scat Ltd (6) 37 280
Dividends (Je) (40 000) (30 000) I(10 000)
Mark-to-market reserve (Je) 15 000 J11 250 K3 750
Revaluation surplus (Je) 110 000 L82 500 M27 500
N323 886 O82 500 P30 000 Q325 462
(1) (690 000 × 75%) = 517 500; (690 000 × 25%) = 172 500
(2) Spark Ltd measures non-controlling interests at fair value therefore NCI = R180 000
(3) (470 000 beginning of year – 250 000 at acquisition) = 220 000
(4) (41 528 B (per Scat Ltd’s analysis or J1) – 960 J2) = 40 568
(5) 180 000 (Je) – 6 000 (dividend income of Scat Ltd J5) = 174 000
(6) (38 000 C (per Scat Ltd’s analysis or J6) + 960 J3 – 1 680 J4) = 37 280
Consolidated financial statements (associate equity accounted)
Spark Ltd Group
R
Revenue (1 440 000 (Sp) + 1 210 000 (Je)) 2 650 000
Cost of sales (842 000 (Sp) + 675 500 (Je)) (1 517 500)
Gross profit` 1 132 500
Other income (30 000 (Sp) + 15 000 (Je) – 6 000 (J5 – intragroup dividend – Sc)
– 30 000 (40 000 × 75% – intragroup dividend – Je)) 9 000
Other expenses (54 000 (Sp) + 332 500 (Je)) (386 500)
Finance costs (40 000 (Sp)) (40 000)
Share of profit of associate (38 000C (per analysis of Sc/J6) + 960(J3) – 1 680(J4)) 37 280
Income tax expense (84 000 (Sp) + 37 000 (Je)) (121 000)
Items that will not be reclassified to profit or loss: 225 000
Financial asset subsequently measured at fair value through OCI/
Mark-to-market reserve:
Fair value adjustment for current year 15 000
Revaluation surplus:
Gain on revaluation of land (100 000 (Sp) + 110 000 (Je)) 210 000

Profit for the year attributable to:
Owners of the parent (balancing) 578 460
Non-controlling interest (H – analysis of Je) 52 820
631 280
continued
R
Total comprehensive income for the year attributable to:
Owners of the parent (balancing) 772 210
Non-controlling interest (52 820H + 3 750K + 27 500M) – see analysis of Je 84 070
856 280
Earnings per share (631 280/290 000 shares) R2,18
Spark Ltd Group
Assets R
Non-current assets 2 508 528
(150 000 (Sp) + 620 000 (Je) + 980 000 (Sp) + 260 000 (Sp) + 130 000 (Je)) 2 140 000
Goodwill (A see anlaysis of Je) 15 000
Other financial assets (120 000 (Je)) 120 000
Investment in associate (160 000 cost + 73 528E (refer analysis of Sc)) 233 528
Inventory (120 000 (Sp) + 60 000 (Je) – 2 333 J4) 177 667
Trade and other receivables (180 000 (Sp) + 90 000 (Je)) 270 000
Cash and cash equivalents (40 000 (Sp) + 110 000 (Je)) 150 000

Equity attributable to owners of the parent 2 076 386
Other components of equity ( (302 500 (RS) + 30 000 (MMR)) 332 500
Non-controlling interest (Q analysis of Je) 325 462
Non-current liabilities 404 347
Long-term liabilities (350 000 (Sp)) 350 000
Deferred tax (30 000 (Sp) + 25 000 (Je) – 653 J4) 54 347
Current liabilities 300 000
Trade and other payables (185 000 (Sp) + 50 000 (Je)) 235 000
Current tax payable (50 000 (Sp) + 15 000 (Je)) 65 000
continued
Spark Ltd Group

Reval- Mark-to- Non-
uation market Total controlling
surplus reserve interest
R R R R R R R
Balance at
beginning of year (1)290 000 (2)120 000 (5)18 750 (8)925 426 1 354 176 (11)251 392 1 605 568
Total
comprehensive
income for the
year – (3)182 500 (6)11 250 (10)578 460 772 210 (12)84 070 856 280
Profit for the year – – – 578 460 578 460 52 820 631 280
Other
comprehensive
income – 182 500 11 250 – 193 750 31 250 225 000
(1)
Ordinary dividend – – – (50 000) (50 000) (13) (10 000) (60 000)
Balance at
(1) (4) (7) (9) (14)
end of year 290 000 302 500 30 000 1 453 886 2 076 386 325 462 2 401 848
(1) Only for Spark Ltd (given)
(2) 120 000 (Sp)
(3) 100 000 (Sp) + 82 500L per Je analysis = 182 500
(4) 220 000 (Sp) + 82 500O per Je analysis = 302 500
(5) (25 000 – 25 000) (Sp) + 18 750F per Je analysis = 18 750
(6) (10 000 – 10 000) (Sp) + 11 250J per Je analysis = 11 250
(7) (35 000 – 35 000) (Sp) + 30 000P per Je analysis = 30 000
(8) 730 000 (Sp) + 195 426 D per Je analysis = 925 426
(9) 1 130 000 (Sp) + 323 886 N per Je analysis = 1 453 886
(10) (450 000 (Sp) – 30 000(40 000 × 75%) dividend income of Je) + 158 460 G per Je analysis
= 578 460 or see consolidated statement of profit or loss and other comprehensive income
(11) (180 000 B + 65 142 C + 6 250 E) = 251 392
(12) (52 820 H + 31 250(3 750 K + 27 500 M)) = 84 070 (per analysis of Je)
(13) 40 000 × 25% = 10 000 I ( per analysis of Je)
(14) 325 462 Q ( per analysis of Je)

Fair value adjustment on investment in Jess Ltd eliminated on consolidation (i.e 560 000
(FV given) – 25 000(FV adj) – 10 000(FV adj) = 525 000(cost of investment)).
25.5 Disclosure
The disclosure requirements for joint arrangements and associates are set out in
IFRS 12.20 to .23. An entity is required to disclose information that will enable users of
financial statements to evaluate:
the nature, extent and financial effects of its interests in joint arrangements and associates,
including the nature and effect of its contractual relationships with other investors with
joint control or significant influence;
the nature of and changes in the risks associated with its interests in joint ventures and
associates.
An entity must disclose information about significant adjustments and assumptions made in
determining:
whether the entity has joint control of an arrangement or significant influence over
another entity; and
the type of joint arrangement (i.e. a joint operation or joint venture) if the arrangement
was structured through a separate vehicle.
This may also include disclosure of assumptions and judgements made to determine that no
significant influence is excercised, although the entity holds more than 20% of the voting
rights of the investee, or vice versa, where an investor does exercise significant influence,
although it holds less than 20% of the voting rights.
The following information must be disclosed separately for each joint arrangement (which
includes joint operations and joint ventures) and associate that is material to the reporting
entity:
the name of the joint arrangement or associate;
the nature of the entity’s relationship with the joint arrangement or associate;
the principal place of business (and country of incorporation, if applicable or different);
and
the proportion of ownership interest or participating share and if different, the proportion
of voting rights held.
The following information must be disclosed for every joint venture and associate that is
material to the reporting entity:
whether the investment in the associate or joint venture is measured using the equity
method or at fair value;
summarised financial information of the associate or joint venture (obtained from the
financial statements, giving the total amount and not only the investor’s share thereof),
including:
– dividends received;
– non-current and current assets;
– non-current and current liabilities;
– revenue;
– profit or loss from continuing and discontinued operations;
– other comprehensive income; and
– total comprehensive income.
in addition, for every material joint venture:
– cash and cash equivalents;
– financial current and non-current liabilities (excluding trade and other payables and
provisions);
– depreciation and amortisation;
– interest income;
– interest expense; and
– income tax expense;
if the equity method is applied, the fair value of investments in associates or joint
ventures for which there are published price quotations (market price);
if the equity method is applied, the amounts in the financial statements of the associate
or joint venture must be adjusted by fair value adjustments at acquisition and
adjustments for differences in accounting policy;
if the equity method is applied, a reconciliation must be provided between the
summarised financial information and the carrying amount of the interest in the associate
or joint venture; and
if the interest is measured at fair value or if the associate or joint venture does not
prepare IFRS financial statements, the summarised financial information may be
prepared on the basis of the associate or joint venture’s financial statements.
The following information must be disclosed for joint ventures and associates which are
individually immaterial to the reporting entity. It must be disclosed in total and separately
for all joint ventures which are individually immaterial and in total for all associates which
are individually immaterial:
the carrying amount in total of all individually immaterial associates or joint ventures that
were equity accounted for; and
summarised financial information of the associate or joint venture, including profit or loss
from continuing and discontinued operations, other comprehensive income and total
The following must also be disclosed:
the nature and extent of any significant restrictions on the associate’s or joint venture’s
ability to transfer funds to the entity;
if the reporting periods of the entity and the associate or joint venture differ, the reporting
period of the associate or joint venture should be mentioned, as well as the reason for
the use of different reporting periods;
the unrecognised share of losses of an associate or joint venture, both for the current
period and cumulatively;
commitments that the entity has relating to its joint ventures, which must be separately
disclosed from any commitments mentioned above; and
any contingent liabilities incurred relating to interests in joint ventures or associates in
accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets, which
must be separately disclosed.
When an entity’s interest in a subsidiary, a joint venture or an associate (or a portion of
its interest in a joint venture or an associate) is classified as held for sale in accordance
with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, the entity is not
required to disclose summarised financial information for that subsidiary, joint venture or
associate.
Example 25.
25.15 Disclosure of an associate
Refer to the information provided in Example 25.14. Assume that Scat Ltd’s principal place of
business is Johannesburg and that it is a South African company and that the market price per
share on 31 December 20.14 is R3,50. The note as required in IFRS 12, will be as follows, if it is
assumed that the investment in Scat Ltd is material to the Spark Ltd Group:
Spark Ltd Group
1. Investment in associate
1.1 Nature, extent and financial effect of interest in Scat Ltd
A 20% interest is held in Scat Ltd, an associate of a subsidiary named Jess Ltd. Scat Ltd is
incorporated in South Africa and its principal place of business is Johannesburg. The interest is
equity accounted for.
continued
1.1.1 Summarised financial information of associate

R
Current assets (90 000 + 30 000 + 150 000) 270 000
Non-current assets (160 000 + 750 000 + 100 000) 1 010 000
Current liabilities (84 160 + 66 000 + 25 000) 175 160
Non-current liabilities 50 000
Revenue 760 000
Profit/(loss) for the year (disclose continuing and discontinued operations
separately, if discontinued operations exist) 190 000
Total comprehensive income 190 000
Reconciliation to the carrying amount of the investment in associate
Net assets of associate (270 000 + 1 010 000 – 175 160 – 50 000) 1 054 840
20% interest in net assets of associate 210 968
Plus: Goodwill at acquisition 22 560
Carrying amount of investment in associate 233 528
1.1.2 Fair value of investment in associate 189 000
R3,50 × 270 000 issued shares × 20% = 189 000
NB: Only if published price quotations are available.
1.1.3 Unrecognised share of losses
R
Unrecognised share of losses of associate for the current period Not applicable
Cumulative share of losses of associate at end of period Not applicable
2.1 Risks relating to the associate
Contingent liabilities in accordance with IAS 37 –
Comment
¾ If the investment had been held as a joint venture and not an associate, the following should
also have been disclosed in note 1.1.1: cash and cash equivalents, financial current and
non-current liabilities, depreciation and amortisation, interest income, interest expense and
income tax expense, as well as (at note 2.1), any commitments relating to the joint venture.
CHAPTER
26
Business combinations
(IFRS 3)
Contents
26.1 Overview of IFRS 3 Business Combinations ............................................ 796
26.2 Background and scope ............................................................................. 797
26.3 Introduction of acquisition method ............................................................ 800
26.4 Accounting treatment in terms of the acquisition method ......................... 800
26.4.1 Identify the acquirer ......................................................................... 800
26.4.2 Acquisition date ............................................................................... 801
26.4.3 Recognition of specific identifiable assets and liabilities ................. 802
26.4.4 Initial measurement of fair values .................................................... 808
26.4.5 Measurement of consideration transferred in a business
combination ..................................................................................... 814
26.4.6 Particular types of business combinations ...................................... 820
26.4.7 Goodwill and gain from bargain purchase ....................................... 822
26.4.8 Measurement period ........................................................................ 829
26.4.9 Determining what is part of the business combination .................... 833
26.5 Tax implications ........................................................................................ 834
26.6 Disclosure ................................................................................................. 836
795
26.1 Overview of IFRS 3 Business Combinations

IFRS 3: BUSINESS COMBINATIONS
Acquisition method
Identify the acquirer and account for Entity that obtains control is acquirer
business combination transactions Separate related transactions and apply other IFRS
separately from related transactions Standards
Date on which control of net assets and operations is

Acquisition date transferred to the acquirer
Use fair value as at acquisition date, also for business

combinations achieved in stages
Consideration transferred Costs directly attributable not part of business combination
Contingent consideration
Assets/liabilities recognised separately

Basic recognition: meet definitions in Conceptual Frame-
work
Recognition of identifiable assets and Intangible assets
liabilities Classifying or designating
Exceptions (contingent liabilities, income taxes, employee
benefits, indemnification assets, leases when acquiree is
the lessee)
Measure at fair value on acquisition date

Market values or valuation techniques
Initial measurement of fair value of
identifiable assets and liabilities Exceptions (income taxes, employee benefits, indemnifi-
cation assets, re-acquired rights, share-based payment
awards, assets held for sale)
At proportionate share of net assets, or

Non-controlling interests
at fair value
Consideration transferred + non-controlling interests + FV

of previously held interest as at acquisition date (only if it
is an acquisition achieved in stages) – net assets acquired
and measured in terms of IFRS 3 = goodwill/(gain on bar-
Goodwill/gain on bargain purchase gain purchase)
Goodwill: Recognise as asset, subsequent impairment
test
Gain on bargain purchase: reassess all items; if still a
gain, recognise at acquisition date in profit of loss
Limited to one year from acquisition date

Provisional values recognised if accounting incomplete
Provisional fair values adjusted retrospectively
Also recognise assets and liabilities that were previously
Measurement period not recognised even though they existed
Facts and circumstances existing at acquisition date
should be considered
Correction of error if it becomes known after measurement
period
Disclosure
Business combinations 797
26.2 Background and scope

A business combination is defined as a transaction or other event in which an acquirer
obtains control of one or more businesses. It is important to understand the following
definitions of control and a business:
An investor controls an investee when the investor is exposed to, or has rights to,
variable returns from its involvement with the investee and has the ability to affect those
returns through its power over the investee (Appendix A of IFRS 10).
A business is an integrated combination of activities and assets that is capable of being
conducted and managed to provide a return to investors; to lower costs; or to provide
other economic benefits to participants (Appendix A of IFRS 3).There are three elements
to a business, namely inputs, processes and outputs. A business consists of inputs and
processes applied to those inputs that have the ability to create outputs. Although
businesses usually have outputs, outputs are not required for an integrated set of
activities and assets to qualify as a business.
A business combination may be structured in a number of ways which are motivated by
legal, taxation, business or other considerations, but the assets or liabilities acquired must
constitute a business.
A business combination may include the purchase of the business of another entity
contained in a separate unit, or the purchase of the net assets of a business. The difference
between these two types of business combinations can be illustrated as follows:
Business Combinations
Purchase of net assets of another entity Purchase of shares in another entity

(say Lua Ltd) (say Fouché Ltd)
The net assets of Lua Ltd now belong to the

Fouché Ltd now becomes a subsidiary
acquirer, but no shares of Lua Ltd have been
of the acquirer (obtained control)
purchased by the acquirer
Goodwill or gain from a bargain purchase may

arise on the acquisition date if there is a Goodwill or gain from a bargain purchase
difference between the consideration may arise on the acquisition date
transferred and the value of the net assets
Consolidated financial statements must

be drawn up for the group in terms of
No consolidated financial statements
IFRS 10 Consolidated Financial Statements
are prepared
and IFRS 12 Disclosure of Interests
in Other Entities
Whilst IFRS 3 deals with the initial accounting treatment of subsidiaries by the acquirer on
the date of acquisition, IFRS 10 deals with the consolidation process and procedures that
take place after the acquisition date. Once the business combination has been accounted
for in terms of IFRS 3, IFRS 10 will be applied to the consolidation process after the
acquisition date. Refer to chapter 24 (section 24.1.1) for a more detailed discussion relating
to the interaction between IFRS 3 and IFRS 10.
A business combination transaction may take place between the shareholders of the
combining entities or between one entity and the shareholders of the other entity. The
business combination may involve the establishment of a new entity to have control over the
combining entities; the transfer of the net assets of one or more of the combining entities to
another entity; or the dissolution of one or more of the combining entities. When the
substance of the transaction is consistent with the definition of a business combination as
contained in IFRS 3, the accounting and disclosure requirements are applicable, irrespective
of the particular structure adopted for the combination.
IFRS 3 does not apply to the following:
the formation of a joint arrangement;
the combination of entities under common control;
the acquisition of assets that do not constitute a business (IFRS 3.2); or
a subsidiary that is measured at fair value through profit or loss, as defined in IFRS 10
Consolidated Financial Statements, (IFRS 3.2A).
Example 26.1
26.1A A common control transaction
Wock Ltd has two wholly-owned subsidiaries, namely Andy Ltd and Cat Ltd. Wock Ltd transfers its
equity interest in Andy Ltd to Cat Ltd, and in exchange, Cat Ltd issues further equity shares to
Wock Ltd. Since both Andy Ltd and Cat Ltd are under the common control of Wock Ltd, both be-
fore and after this last transaction took place, this transaction is a common control transaction.
This transaction thus falls outside the scope of IFRS 3.
When an entity obtains control of entities that are not businesses, the process cannot
constitute a business combination. When net assets that are not a business are acquired,
this Standard does not apply, and the reporting entity would account for it as an asset
acquisition. Under these circumstances, the cost for the group of assets is allocated
amongst the individual identifiable assets and liabilities on the basis of their relative fair
values as at the date of the purchase, and no goodwill or gain on bargain purchase on
acquisition is recognised. It is presumed, unless the contrary is evident, that if goodwill is
present in a particular set of assets and activities that are transferred, the transferred unit is
a business. However, a business need not have goodwill.
Example 26.1
26.1B
.1B Acquisition of a group of assets versus a business combination
Wood Ltd acquired the following assets of Grain Ltd for R3 000 000.
Carrying amounts Fair value Relative fair
in the records of on date of value
Grain Ltd acquisition percentages
R R
Property, plant and equipment 2 000 000 2 065 000 70 %1
Inventory 550 000 590 000 20 %2
Other assets 250 000 295 000 10 %3
2 800 000 2 950 000 100 %
continued
Comment
¾ The relative fair value percentages refer to the relative fair values of the assets acquired, rela-
tive to the aggregate fair value of all these asset classes.
1
2 065 000/2 950 000 = 70%
2
590 000/2 950 000 = 20%
3
295 000/2 950 000 = 10%
Case 1
Assume that the acquisition of the assets does not meet the definition of a business as the acquisi-
tion does not represent an integrated combination of assets and activities that could be managed to
provide a return for investors. The purchase price of the group of assets under these circumstances
is allocated among the individual, identifiable assets on the basis of their relative fair values as at the
date of the purchase. No goodwill on acquisition is recognised, since this is not a business combina-
tion.
Allocation of
purchase price
R
Property, plant and equipment (70%1 × 3 000 000) 2 100 000
Inventory (20%2 × 3 000 000) 600 000
Other assets (10%3 × 3 000 000) 300 000
Consideration transferred 3 000 000
Wood Ltd will include the following journal entry in its separate accounting records:
Dr Cr
R R
Inventory 600 000
Other assets 300 000
Bank 3 000 000
Accounting for the acquisition of assets
Comment
¾ The acquisition of the assets would be accounted for as a normal purchase and the relevant
assets would be measured at the amounts calculated.
¾ The acquirer may need to test for impairment on these assets, if new carrying amounts are
higher than fair value under the Standards applicable to the relevant assets.
Case 2
Assume the acquisition of the assets does meet the definition of a business.
Wood Ltd will measure the identifiable assets acquired at their acquisition date fair values (as
indicated in the fair value column), and will recognise goodwill of R50 000 (R3 000 000 –
R2 950 000 (aggregate fair value)). This goodwill will be recognised in the separate financial
statements of Wood Ltd, as the net assets of Grain Ltd have been legally merged into Wood Ltd.
Allocation of
purchase price
R
Inventory 590 000
Aggregated fair values 2 950 000
Goodwill 50 000
continued
Wood Ltd will include the following journal entry in its separate accounting records:
Dr Cr
R R
Inventory 590 000
Goodwill 50 000
Bank 3 000 000
Accounting for the acquisition of a business
26.3 Introduction of acquisition method

IFRS 3 states that all business combinations are accounted for by applying the acquisition
method (IFRS 3.4). The use of the acquisition method results in an acquisition of an entity
being accounted for on a similar basis to that used for the purchase of other assets. The
acquisition method views a business combination from the perspective of the acquirer. The
acquirer purchases the net assets of the acquiree, and recognises the assets acquired and
liabilities assumed as at fair value. The definition of fair value states that fair value is the
price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. The acquisition method
is applied from the acquisition date, this being the date on which the acquirer gains effective
control over the acquiree. Application of the acquisition method entails the following
process (IFRS 3.5):
identifying the acquirer;
determining the acquisition date;
recognition and measurement of the identifiable assets acquired, and liabilities and
contingent liabilities assumed;
recognition and measurement of any non-controlling interests;
measurement of the consideration transferred in the business combination; and
recognition and measurement of goodwill or a gain from a bargain purchase.
The application of the acquisition method inter alia results in the calculation of goodwill or a
gain on a bargain purchase. This calculation can be illustrated as follows:
Consideration transferred xxx
Plus: Non-controlling interests xxx
Plus: Fair value of previously held interest xxx
xxx
Less: Fair value of identifiable assets acquired and liabilities assumed (xxx)
Goodwill/(Gain on bargain purchase) xxx/(xxx)
The acquisition method also requires the recognition of any initial measurement period
adjustments (refer to section 26.4.9).
26.4 Accounting treatment in terms of the acquisition method

A business combination shall be accounted for using the acquisition method by following
each process as disucssed hereunder.
26.4.1 Identify the acquirer
The first step in a business combination is to identify the acquirer. The acquirer is the entity
that obtains control over the other entities as a result of the transaction. In accordance with
IFRS 10 Consolidated Financial Statements, an investor controls an investee when it is
exposed or has rights to variable returns from its involvement with that investee and has the
ability to affect those returns through its power over the investee.
26.4.2 Acquisition date

The acquisition date is the date on which control of the net assets and operations of the
acquiree are effectively transferred to the acquirer, that is the date from which the investor is
exposed to, or has rights to, variable returns from its involvement with the investee and has
the ability to affect those returns through its power over the investee. The Standard
determines that the closing date, in the case of a business combination, is the date on
which the acquirer legally transfers the consideration to shareholders of the acquiree,
acquires the assets, and assumes the liabilities of the acquiree (IFRS 3.9).
It is important to determine the acquisition date, as it is the date on which the fair value of
the consideration transferred in the business combination (refer to section 26.4.5) and the
fair value of the identifiable assets and liabilities (refer to section 26.4.4) will be measured. It
is also the date from which the results of the acquiree will be incorporated into the
consolidated financial statements of the acquirer.
If control is obtained in a single transition, the acquisition date and the closing date
normally coincide, but this is not necessarily the case. An acquirer shall consider all facts
and circumstance (e.g. written agreements, etc.) in identifying the acquisition date.
If a business combination is achieved through a series of successive share purchases,
there will be various dates on which the considerations were exchanged. However, the
acquisition date is the date on which the block of shares that finally results in control of the
acquiree is purchased (refer to section 26.4.6.1).
Example 26.2
26.2 Acquisition date – basic principles
Case 1
On 1 January 20.17, Parent Ltd acquired control of Subbie Ltd by acquiring 80% of the ordinary
shares in Subbie Ltd. Each share carries one vote.
The closing date and the acquisition date would be on 1 January 20.17, as 80% of the shares
were acquired (exchanged for cash) on this date and Parent Ltd also acquired control over Subbie
Ltd on the same date.
Case 2
On 1 January 20.14, Parent Ltd acquired 12% of the shares in Subbie Ltd, 35% on 30 June 20.15
and a further 13% (resulting in control) on 31 March 20.16.
There are three dates on which considerations were exchanged, namely: 1 January 20.14,
30 June 20.15 and 31 March 20.16. The acquisition date would be 31 March 20.16 – the date on
which Parent Ltd obtained control over Subbie Ltd (60%). Consolidation will therefore commence
on 31 March 20.16. The consideration of the business combination is the fair value of the consid-
eration as determined as at the acquisition date (31 March 20.16) (refer to sections 26.4.5 and
26.4.6, which deal with business combinations achieved in stages).
Business combinations may also include a combination where the acquisition date does not
coincide with the date of exchange of the consideration, assets and liabilities (closing
date).This would be the case where it is stated in a written agreement (which grants certain
rights to the acquirer) that an entity (acquirer) obtains control over the aquiree before the
purchase consideration involved changes hands. It is even possible for an entity to obtain
control without any consideration changing hands (refer to section 26.4.6). An example is
where the acquiree enters into a buy-back of shares arrangement with certain investors
only, and sells shares to the acquiree and, in the process (generally in terms of a written
contract), loses control to another party that did not lose any shares in the share buy-back
transaction. It may even happen with certain rights issue transactions. In these instances,
the consideration exchanged hands before control was acquired.
All conditions necessary to protect the interest of the parties involved must be satisfied
before the acquirer is deemed to exercise control. This does not mean, however, that a
transaction should be closed or finalised by law before control effectively passes to the
acquirer. In assessing whether control has effectively been transferred, the substance of
the acquisition should be considered. As from the acquisition date, an acquirer should:
incorporate the results of operations of the acquiree and any gain on bargain purchase
into the statement of profit or loss and other comprehensive income;
recognise the assets and liabilities of the acquiree, any non-controlling interests and any
goodwill arising on the acquisition, in the statement of financial position; and
recognise the cash inflows and outflows of the acquiree in the statement of cash flows.
26.4.3 Recognition of specific identifiable assets and liabilities

As of the acquisition date, the acquirer shall recognise the identifiable assets acquired and
liabilities assumed in the business combination separately from goodwill. Any non-
controlling interests shall also be recognised separately. In order for the identifiable assets
and liabilities to be recognised (IFRS 3.10 to .12):
they must first meet the definition of assets and liabilities as contained in the Conceptual
Framework for Financial Reporting (Conceptual Framework) as at the acquisition date;
and
second, they must be part of what the acquirer and acquiree (as well as former owners)
exchanged in the business combination transaction, rather than the result of a separate
transaction.
The identifiable assets acquired, liabilities assumed, and contingent liabilities to be
recognised and measured are therefore those of the acquiree that existed as at the
acquisition date. Liabilities are not recognised as part of the fair value exercise if they result
from the acquirer’s intention or future actions, because they did not exist at the acquisition
date. A restructuring provision can therefore be recognised only if it is an existing liability in
terms of IAS 37 Provisions, Contingent Liabilities and Contingent Assets, and the
Conceptual Framework on the acquisition date. Similarly, liabilities are not recognised for
future losses or for other costs expected to be incurred as a result of the acquisition,
regardless of whether they relate to the acquirer or the acquiree. Rather, they may be
recognised in the post-combination financial statements by using the principles established
by other IFRSs.
Example 26.3
26.3 Liabilities existed at the acquisition date
Case 1
On 1 January 20.17, New Ltd acquired 80% of the shares in Old Ltd and obtained control. Old Ltd
was in the process of restructuring its operations and communicated its detailed plan to all parties
affected. This liability already existed at the acquisition date and New Ltd will recognise it as part of
the business combination in terms of IFRS 3.
Case 2
New Ltd acquired 80% of the shares in Old Ltd on 1 January 20.17 and obtained control. Old Ltd
never planned to restructure its operations. However, New Ltd expects to restructure the operations
of Old Ltd after the business combination, and will incur a liability in this regard. This does not repre-
sent a liability that existed at the acquisition date; therefore New Ltd will recognise the liability in the
post-combination period in terms of IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
Identifiable assets and liabilities must be part of the business combination

transactions
In addition to the requirement that the identifiable assets and liabilities should meet the
definition of assets and liabilities in the Conceptual Framework, the identifiable assets and
liabilities must be part of what the acquirer and the acquiree exchanged in the business
combination transaction, rather than the result of a separate transaction. The Standard
requires an acquirer to account for the transaction of the business combination separately
from any other related transaction.
The identifiable assets and liabilities over which the acquirer obtains control may include
assets and liabilities which were not previously recognised in the financial statements of the
acquiree. This is the case, for example, when the acquirer now recognises some acquired
intangible assets and contingent liabilities that could not be recognised in the acquiree’s
individual financial statements. Such items are discussed below.
26.4.3.1 Intangible assets
All identifiable assets are recognised separately from goodwill in a business combination if
they meet the definition of an asset in terms of the Conceptual Framework.
The acquirer shall recognise the identifiable intangible assets acquired in a business
combination separately from goodwill. An intangible asset is identifiable if it meets either the
separability or the contractual-legal criterion. An intangible asset that meets the
contractual-legal criterion is identifiable even if the asset is not transferable or separable
from the acquiree or from other rights and obligations (IFRS 3. B31-32).
It is important to note that some internally generated intangibles of the acquiree, which were
previously not recognised, may now also qualify for recognition on the acquisition date. For
example, the acquiree may have had certain brands, patents or customer relationships that
were not recognised because the acquiree developed them internally and they therefore did
not meet the recognition criteria (IFRS 3.13). In terms of IAS 38, Intangible Assets the costs
of these intangible assets would have been expensed by the acquiree. The same would
apply to a basic in-process research and development project. If it meets the criteria as
discussed below, it will be recognised as part of the business combination. For the acquirer,
these assets are therefore identifiable and meet the definition of an asset in terms of the
Conceptual Framework, and are recognised separately from goodwill in the business
combination.
Intangible assets are seen to be identifiable if they are either:
separable (the item is capable of being separated or divided from the entity and sold,
transferred, licensed, rented or exchanged, either individually or together with a related
contract, irrespective of whether the entity intends to do so); or
have a contractual basis (which arises from contractual or other legal rights, irrespective
of whether those rights are transferable or separable from the acquiree, or from other
rights and obligations) (IFRS 3. B31).
The recognition of intangible assets in terms of IFRS 3 can be illustrated as follows:
Separable:
recognise separately
from goodwill
Identifiable
Intangible asset
meets definition of
Contractual/
an asset – Not identifiable:
legal rights:
Conceptual Frame- do not recognise,
work therefore included in recognise separately
goodwill from goodwill
The fair value of an intangible asset will reflect the expectation of market participants at the
acquisition date about the probability that the expected future economic benefits embodied
in the asset will flow to the entity (even if uncertainty exists about the timing or the amount of
inflow). This implies that the probability recognition criterion in IAS 38.21(a) is always
considered to be satisfied for intangible assets acquired in a business combination
(IAS 38.33). IFRS 3 furthermore assumes that sufficient information should always exist to
measure an identifiable intangible asset’s fair value reliably. Therefore, the reliable
measurement criteria as set out in IAS 38.21(b) is also considered to be satisfied for
intangible assets acquired in a business combination (IAS 38.33).
Consequently, provided intangible assets are either separable or arise from contractual or
legal rights, they will be deemed identifiable and will thus be recognised separately from
goodwill in a business combination.
After initial recognition of intangible assets as part of the business combination, the acquirer
accounts for them in accordance with IAS 38, Intangible Assets. Detailed examples of
intangible assets to be recognised in a business combination appear in the Application
Guidance to IFRS 3.B31 – B34.
Example 26.4A
26.4A Intangible assets (contractual/legal criterion)
X Ltd acquired a 75% interest in Y Ltd on 1 July 20.17. This qualifies as a business combination.
Y Ltd has a three-year agreement to supply goods to Z Ltd. Both X Ltd and Y Ltd believe that Z Ltd
will renew the supply agreement at the end of the term of the current contract.
The supply agreement meets the contractual/legal criterion for identification as an intangible
asset and its fair value is deemed to be measured reliably. It should be recognised separately from
goodwill. In addition, the customer relationship between Y Ltd and Z Ltd is also established through a
contract and therefore meets the contractual/legal criterion for recognition as an intangible asset.
This relationship should therefore also be recognised as an intangible asset distinct from goodwill.
Example 26.4B
26.4B Intangible assets (separability criterion)
Xen Ltd acquired a 75% interest in Yun Ltd on 1 July 20.17. This qualifies as a business combina-
tion. Yun Ltd owns a registered trade mark and documented, but unpatented, technical expertise
used to manufacture the trade-marked product. When transferring ownership of a trade mark, the
previous owner is also required to transfer everything else necessary for the new owner to pro-
duce a product or service that is indistinguishable from that produced by the former owner.
Although the trade mark is not individually separable from the acquiree or combined entity, it
meets the separability criterion for identification as an intangible asset, because it is separable in
combination with a related contract, identifiable asset or liability. The unpatented technical exper-
tise must be separated from the acquiree or combined entity and sold if the related trade mark is
sold. Its fair value is deemed to be measured reliably. It should therefore be recognised separately
from goodwill. (IFRS 3.B34)
An intangible asset that is not identifiable at the acquisition date is not recognised separately
and is included in goodwill. The same applies in the case of items such as potential
contracts, where the acquiree was involved in negotiations at the time of the acquisition.
Although the acquirer may place a value on these potential contracts, this value will form
part of goodwill, as the contracts would not qualify as assets at acquisition date.
Example 26.5
26.5 Intangible assets (not identifiable)
X Ltd acquired a 75% interest in Y Ltd on 1 July 20.17. This qualifies as a business combination.
Y Ltd has an assembled workforce, which is an existing collection of employees that permits X Ltd
to continue to operate all operations of Y Ltd from 1 July 20.17.
The assembled workforce does not represent the intellectual capital of the skilled workforce and is
not an identifiable asset to be recognised separately from goodwill. Furthermore, it does not meet
the ‘control’ criterion of the definition of an asset. Any value placed on the assembled workforce
shall thus be subsumed into goodwill. (IFRS 3.B37).
26.4.3.2 Contingent liabilities (exception to recognition principle)

The recognition of contingent liabilities as part of the business combination is a specific
exception to the recognition principles (i.e. meeting the definition of liabilities in terms of the
Conceptual Framework) as discussed earlier. In terms of IFRS 3.23, the acquirer shall
recognise a contingent liability assumed in a business combination as of the acquisition date
if the following conditions are met:
it is a present obligation;
that arises from past events; and
its fair value can be measured reliably.
This is in contrast with the requirements of IAS 37 Provisions, Contingent Liabilities and
Contingent Assets, and the acquirer will recognise a contingent liability assumed in a
business combination as long as there is a present obligation, even if it is not probable that
an outflow of resources will be required to settle the obligation. However, the measurement
of the contingent liability is still at its fair value, which will reflect assumptions regarding the
probability of the outflow of future economic benefits. Note that in the absence of a present
obligation (say there is only a possibility that the entity would incur an obligation) no liability
will be recognised at acquisition date.
Although the recognition of contingent liabilities in a business combination may appear
unusual at first glance, since their recognition is not allowed in terms of IAS 37, it does make
sense if one considers the practical implications. If an acquirer knows that a contingent
liability is present in a subsidiary for which it is making an offer, the acquirer will definitely
reduce his offer for the controlling interest in the subsidiary accordingly.
If the net assets of the acquiree are not reduced by recognising the contingent liability at
acquisition date, the goodwill arising at acquisition will be understated, or the gain on
bargain purchase at acquisition may be overstated.
Example 26.6 Contingent liabilities in a business combination
On 1 July 20.17, Conti Ltd is acquired all the shares in Liabi Ltd for R1 000 000. This qualifies as a
business combination. Conti Ltd was aware that Liabi Ltd had disclosed a contingent liability with a
fair value of R100 000 for a claim against the company and consequently factored this matter into its
purchase price of R1 000 000. The other net assets of Liabi Ltd (excluding the contingent liability)
amounted to R900 000. Goodwill, depending on whether or not the contingent liability was recognised at
the acquisition date, will be as follows:
Goodwill taking Goodwill
contingent ignoring
liability into contingent
account liability
R R
Consideration paid 1 000 000 1 000 000
Net assets
(900 000 – 100 000); (800 000) (900 000)
Goodwill 200 000 100 000
Comment
¾ The consideration paid by Conti Ltd, for the investment in Liabi Ltd takes into account the im-
pact of the contingent liability.
¾ The correct amount for goodwill is R200 000 because the fair value of the contingent liability
had been factored into both its composite parts (fair value of net assets and the consideration
paid).
¾ Where the contingent liability was taken into account in the consideration of the business com-
bination and not when calculating the net assets as at acquisition, goodwill would be R100 000.
¾ Consequently – in the latter case, goodwill is understated since the contingent liability was not
taken into account when determining the net assets of the subsidiary.
¾ Note that if there was no present obligation in respect of the claim against Liabi Ltd, no liability
would be raised for the business combination. Under these circumstances, the position would
be the same as where the contingent liability was ignored, namely goodwill would be R100 000.
Any subsequent measurement of contingent liabilities that were recognised at the time of
the business combination (i.e. after initial recognition and until the liability is settled, can-
celled or expired) will be recognised at the higher of (IFRS 3.56):
the amount that would be recognised in terms of IAS 37; and
the initial amount recognised less cumulative amortisation in terms of IFRS 15 Revenue
from Contracts with Customers.
The disclosure of contingent liabilities that are recognised as liabilities in terms of IFRS 3.23
is in accordance with the disclosure requirements of IAS 37.
Example 26.7 Contingent liabilities – initial and subsequent measurement and accounting
in the case of a business combination
Ignoring tax and using the same basic information and principles explained in Example 26.6, the
contingent liability of R100 000 (fair value) identified at the date of the business combination of
Conti Ltd and Liabi Ltd would result in the following consolidation journal entry:
Dr Cr
1 July 20.17 R R
Retained earnings (equity at acquisition) 100 000
Contingent liability (recognised) (SFP) 100 000
Accounting for the contingent liability at acquisition
continued
Dr Cr
1 July 20.17 R R
Retained earnings (equity at acquisition) (900 000 – 100 000) 800 000
Investment in Liabi Ltd (SFP) 1 000 000
Elimination of equity at acquisition date against investment in
L Ltd
Comment
¾ The equity at acquisition of R800 000 (900 000 – 100 000 (contingent liability)) will be eliminat-
ed against the investment in the subsidiary (Liabi Ltd) of R1 000 000, and will result in goodwill
of R200 000 being recognised in the consolidated financial statements.
If it is assumed that the year ends of Conti Ltd and Liabi Ltd fall on 30 September, the following
cases are possible at 30 September 20.17:
Case 1
At 30 September 20.17, the court case in respect of the claim (contingent liability) has progressed
to such an extent that it is virtually certain that Liabi Ltd will have to pay R150 000. Applying the
principles of IAS 37 in its own financial statements, Liabi Ltd will have to raise a provision of
R150 000 since the outflow has become probable and a reliable estimate is possible. The journal
in the records of Liabi Ltd will be as follows:
Dr Cr
Claim expense – legal (P/L) 150 000
Provisions (in respect of claim) (SFP) 150 000
Accounting for provision in respect of previous contingent liability
In the case of the business combination effected on 1 July 20.17, the liability raised in respect of
the contingent liability should be assessed in terms of IFRS 3.56 and measured at the higher of:
the amount recognised in terms of IAS 37, namely R150 000; and
the amount actually recognised in terms of IFRS 3, namely R100 000.
Since the R150 000 recognised in terms of IAS 37 is higher, the liability in the consolidated finan-
cial statements should be reflected at R150 000. This will result in the following consolidation jour-
nal entry:
Dr Cr
Contingent liability (recognised) (SFP) 100 000
Claim expense – legal (P/L) 100 000
Reversal of contingent liability raised initially at acquisition
Comment
¾ Although it would appear at first glance that the liability in respect of the claim is being removed
from the consolidated financial statement in its entirety, this is not the case, as the liability of
R150 000 in the individual financial statements of Liabi Ltd will replace it. If this is not reversed
the contingent liability would have been accounted for twice in the consolidated financial state-
ments.
¾ The net effect of the above two transactions (individual financial statements of Liabi Ltd and
consolidated financial statements) would be that a claim expense of R50 000 (150 000 –
100 000) would appear in the consolidated profit or loss.
Case 2
Although there were no further developments in respect of the claim (the court case was post-
poned till January 20.18), there is still a good chance that the claim will succeed. Consequently,
the measurement rules of IFRS 3.56 should still be applied. The contingent liability in the consoli-
dated financial statements should be measured at the higher of:
the amount recognised in terms of IAS 37: Rnil (this is still a contingent liability); and
the amount recognised in terms of IFRS 3: R100 000.
Since the R100 000 is higher, the contingent liability remains at R100 000 in the consolidated
financials and no further journals (consolidation or other) would be required.
26.4.3.3 Classifying or designating identifiable assets and liabilities

At the acquisition date, the acquirer in a business combination will classify or designate the
recognised identifiable assets and liabilities as necessary to apply other IFRSs
subsequently. Classification or designation refers to choices an entity makes in respect of a
specific asset or liability. For instance, under IFRS 9 Financial Instruments, the acquiree
might have a business model in terms of which it measures investments in debentures at
amortised cost, but by contrast, the acquirer’s business model may be to measure all
investments in debentures at fair value with any remeasurement gains or losses recognised in
profit or loss. The accounting treatment of such items changes after classification or
designation. The classification or designation shall be made on the basis of the contractual
terms, economic conditions, its operating or accounting policies and other pertinent
conditions as they exist at the acquisition date (IFRS 3.15).
Example 26.8 Classification or designation of assets acquired
Class Ltd obtained control over Design Ltd on 1 January 20.17. Design Ltd had the following as-
sets on the acquisition date:
Investments in bonds:
Design Ltd invested in certain bonds during 20.16 and holds the bonds within a business model
whose objective is to hold assets in order to collect contractual cash flows. The contractual terms
of the bonds give rise to interest payments on specified dates. The interest payments are based
on the principle amount outstanding. Design Ltd consequently classified the investment as a fi-
nancial asset subsequently measured at amortised cost in terms of IFRS 9.4.1.2.
However, Class Ltd (the acquirer) is convinced that from a group perspective, Design Ltd’s classi-
fication will lead to an accounting mismatch and exercised the option to designate the bonds at fair
value through profit or loss (IFRS 9.4.1.5). The group (Class Ltd + Design Ltd) shall therefore
classify and account for the investment as a financial asset designated at fair value through profit
or loss in terms of IFRS 9.
Investment property:
Design Ltd leased one of its buildings to Class Ltd some time ago and classified the building as an
investment property in terms of IAS 40 Investment Property.
However, from the date of the business combination, the property will be owner-occupied, as
Class Ltd occupies the building. From the group’s perspective, the building shall be classified and
accounted for as property, plant and equipment in terms of IAS 16 Property, Plant and Equipment,
rather than investment property.
The Standard provides an exception to the principle described above. The acquirer shall
classify the following contract on the basis of the contractual terms and other factors at the
inception of the contrac (or on date of subsequent modification of the contract, irrespec-
tive of the position at acquisition date) (IFRS 3.17):
a lease contract, when the aquiree is the lessor, shall be classified as either an operating
or finance lease in terms of IFRS 16, Leases.
In summary, an entity shall classify a lease on the conditions at the inception of the lease
contract and not the conditions that existed at acquisition.
26.4.4 Initial measurement of fair values

The acquirer shall measure the identifiable assets acquired and the liabilities assumed at
their fair values at the acquisition date (IFRS 3.18). The definition of fair value states that
fair value is the price that would be received to sell an asset, or paid to transfer a liability, in
an orderly transaction between market participants at the measurement date.
As has been the case traditionally, these new fair values are used in the consolidated
financial statements. The fair values of assets with uncertain cash flows will include the
effect of such uncertainties, and a separate allowance for the uncertainties is not recognised
(IFRS 3.B41). For example, the fair value of a receivable acquired in a business
combination will be determined on the expected cash flows, the timing thereof and the
appropriate discount rate. A separate allowance for credit losses is not recognised because
the discount rate will already incorporate any uncertainties.
The fair values of identifiable assets and liabilities existing at the acquisition date are not
affected by the acquirer’s intentions for the future use of the assets and liabilities; for
example, an acquired intangible asset that the acquirer plans to use defensively by
preventing others from using it. The acquirer will nevertheless measure the asset at fair
value, assuming its highest and best use by market participants in accordance with the
appropriate valuation premise, both initially and when measuring fair value less costs of
disposal for subsequent impairment testing (IFRS 3.B43).
Example 26.9A Intangible assets based on other use or no use after acquisition (fair value)
Local authorities grant water acquisition rights to manufacturers at no cost. The manufacturers
cannot operate their plants without water and as a result these rights are extremely valuable. Wa-
ter Ltd acquired 100% of the shares of Right Ltd and Right Ltd is in possession of such water ac-
quisition rights. However, Water Ltd owns new technology that would make the use of the water
rights virtually unnecessary. Despite this, the water acquisition rights at acquisition shall be valued
based on the highest and best use thereof by market participants.
No specific guidance is given in the Standard regarding operating leases in which the
acquiree is the lessor. However, the assets being leased by the acquiree will be recognised
and measured at fair value as with any identifiable assets and liabilities as at the date of the
acquisition. When the acquiree is the lessor to an operating lease, the terms of the lease will
be taken into account to measure the acquisition date fair value of an asset (IFRS 3.B42). In
other words, the acquirer does not recognise a separate asset or liability if the terms of the
operating lease are favourable or unfavourable in comparison to market terms.
Example 26.9B Fair value of assets of the acquiree leased out in terms of an operating
lease where the acquiree is the lessor
Alpha Ltd acquired an 80% interest in Beta Ltd on 1 April 20.17. This qualifies as a business
combination. Part of the assets of Beta Ltd consist of a crane leased out to a third party since
1 April 20.16. In terms of this operating lease agreement, the lease payments amount to R150 000
per annum for a period of 8 years (market rate is R120 000 per annum). Assume a fair discount
rate of 10% per annum (compounded annually). The fair value of the crane, without considering
the operating lease contract, amounts to R1 500 000. In terms of IFRS 3.B42, the fair value of the
operating lease (if any) should be determined and added to the fair value of the crane to establish
the value of the crane at acquisition. The total value of the crane would be calculated as follows:
R
Fair value without considering the lease agreement 1 500 000
Fair value of contract – favourable for lessor
[Pmt = 30 000 (150 000 – 120 000), n = 7 (8 – 1); i = 10%]
Thus, PV = R146 053 (present value) 146 053
Total value of crane 1 646 053
Comment
¾ If the carrying amount of the crane at acquisition amounted to R1 200 000 in the records of
Beta Ltd, it would be adjusted upwards by a consolidation journal to R1 646 053.
¾ For consolidation purposes, the carrying amount of R1 646 053 will be depreciated.
¾ Given the component approach in respect of depreciation as presented in IAS 16 Property,
Plant and Equipment, it may be appropriate to depreciate the at acquisition fair values of the
two components of the crane separately over their respective useful lives.
The statement of profit or loss and other comprehensive income of the acquirer shall incor-
porate the income and expenses of the acquiree after the acquisition date, as a result of the
restatement of assets and liabilities to fair value. For example, the depreciation expense will
be based on the fair value of the acquiree’s depreciable assets at the acquisition date,
irrespective of whether the restatement to fair value is recognised in the records of the
acquiree.
Example 26.1
26.10 Effect of fair value adjustments on subsequent consolidated profit or loss
Fair Ltd obtained control over Not Ltd on 1 January 20.17. At the acquisition date it was consid-
ered that all the assets of Not Ltd were fairly valued in the records of Not Ltd, except for its plant.
The carrying amount of the plant was R1 000 000 and the fair value was determined to be
R1 500 000. The remaining useful life was 10 years and the group accounts for depreciation on
the straight-line method, with no residual value. Not Ltd did not record the restatement in its rec-
ords. Assume a normal income tax rate of 28%.
To prepare the consolidated statement of profit or loss and other comprehensive income for the
year ended 31 December 20.17, the following pro forma consolidation journal is needed in respect
of the depreciation on the plant:
Dr Cr
R R
Pro forma consolidation adjustment on additional depreciation
Deferred tax (28% × 50 000) (SFP) 14 000
Pro forma consolidation adjustment of deferred tax implications
on additional depreciation
The calculation of the pro forma adjustment to depreciation is calculated as follows:
Depreciation from the perspective of the group: 1 500 000/10 150 000
Depreciation already recognised by the subsidiary: 1 000 000/10 100 000
Adjustment – additional depreciation per year (1 500 000 – 1 000 000)/10 50 000
26.4.4.1 Exceptions to both the recognition and measurement principles

(IFRS 3.24 to .28)
The exception to only the recognition principle was addressed in section 26.4.2 in respect
of contingent liabilities. IFRS 3 identifies the following as exceptions to both the general
recognition and measurement principles of the Standard, and these items should be
recognised and measured as described below:
Income taxes: The acquirer shall recognise and measure deferred tax assets or
liabilities arising from the assets acquired and liabilities assumed in a business
combination in accordance with IAS 12 Income Taxes (IFRS 3.24). These temporary
differences are prevalent where a new fair value was determined for purposes of a
business combination, while the tax base of the asset is not adjusted.
The potential tax effects of temporary differences and carry-forwards of an acquiree that
existed at the acquisition date, or arose as a result of the acquisition, shall be recognised
and measured in accordance with IAS 12 (IFRS 3.25). One should bear in mind that
temporary differences arising in a business combination are not exempt and deferred tax
should be recognised.
Employee benefits: The acquirer shall apply IAS 19 Employee Benefits to recognise
and measure an asset or liability related to the acquiree’s employee benefit
arrangements (IFRS 3.26).
The previous version of IAS 19 provided separate guidance with regard to the
recognition and measurement of defined benefit plans in a business combination, but the
revised version of IAS 19 does not contain similar guidelines. Due to the abolition of the
corridor method for actuarial gains and losses and the deferral of unvested past service
costs, additional guidelines for business combinations are redundant.
Indemnification assets: As part of a business combination, an indemnification
agreement is sometimes concluded. Under such an agreement, the former owners
(sellers) of the acquiree are required to reimburse the acquirer for any payments the
acquirer eventually makes upon settlement of a particular liability after the business
combination. The acquirer recognises the right to the indemnification or reimbursement
as an indemnification asset at the same time as it recognises the related liability, and
measures it initially on the same basis that it measured the indemnified item (at fair
value or on another basis, given the exceptions in the Standard), subject to the need for
a valuation allowance for uncollectibility (credit losses) (IFRS 3.27). The subsequent
measurement of the indemnification asset should also be based on assumptions
consistent with those used to measure the related indemnified liability. If such an asset is
not measured at fair value subsequently, such an amount is subject to management’s
assessment of the collectibility (credit losses) of the asset. This asset should only be
derecognised when the asset is collected, sold or when the right is lost.
Leases when the acquiree is the lessee: The acquirer shall measure the lease as if
the lease were a new lease at the acquisition date. At the acquisition date, the lease
liability is measured at the present value of the remaining lease payments. The right-of-
use asset is measured at the same value as the lease liability and adjusted by any
favourable or unfavourable terms of the lease when compared to market terms
(IFRS 3.28B). In accordance with IFRS 16 Leases, the two exceptions to lessee
accounting also apply to this Standard and requirement. The acquirer is not required to
recognise right-of-use assets and lease liabilities for leases for which the lease term
ends within 12 months of the acquisition date, or leases for which the underlying asset is
of low value.
26.4.4.2 Exceptions to the measurement principles only (IFRS 3.29 to .31)
In addition to the abovementioned exceptions to both the recognition and measurement
principles, the Standard also identifies the following exceptions to only the measurement
principle:
Reacquired rights;
Share-based payment transactions; and
Non-current assets held for sale.
IFRS 3.31 states that non-current assets, disposal groups of assets and liabilities acquired
that are classified as held for sale at the acquisition date, as well as subsidiaries acquired
exclusively with a view to re-sell, are to be measured at fair value, less costs to sell, in terms
of IFRS 5.15 to .18.
26.4.4.3 Recognition and measurement of non-controlling interests
At the acquisition date, the acquirer shall recognise, separately from goodwill, any
non-controlling interests. The Standard allows a choice of two methods according to which
non-controlling interests at the acquisition date could be measured. The two measurement
options available are (IFRS 3.19):
fair value at the acquisition date; or
the present ownership instruments’ proportionate share in the recognised amounts of
the acquiree’s identifiable net assets. Note that the recognised amounts mentioned here
refer to amounts recognised in terms of IFRS 3 and not those in the individual financial
statements of the acquiree.
The choice between the two methods of measuring non-controlling interests can be
exercised at each separate business combination when it occurs. A company may therefore
be part of two business combinations in one year and measure the non-controlling interests
in one instance at fair value and in the other at the proportionate share in the recognised
amounts of identifiable net assets of the acquiree.
It is important to note that this choice is only available if the non-controlling interests under
consideration meet two criteria, namely, they represent present ownership interests (e.g.
ordinary shares) and entitle their holders to a proportionate share of the entity’s net assets
at liquidation (i.e. ordinary shares as opposed to preference shares that allow a preferential
claim limited to a predetermined amount of (say) R1). All other components of the
non-controlling interests shall be measured at their acquisition date fair values (as indicated
by the quoted price in an active market, or in the absence thereof, calculated using another
valuation technique), unless another measurement basis is required by IFRS. For example,
a share-based payment transaction resulting in equity will be measured in terms of IFRS 2
Share-based Payment, while interests in preference shares that do not meet the conditions
required to allow the choice between the two measurement bases will be measured at fair
value.
The above is best explained by way of the examples contained in IFRS 3.
Example 26.1
26.11 Measurement of non-controlling interests
X Ltd decides to acquire all ordinary shares in T Ltd. This acquisition gives X Ltd control over
T Ltd. T Ltd also has 1 000 preference shares (classified as equity) in issue at acquisition date,
with a fair value of R1 200. These preference shares receive dividends before ordinary
shareholders are paid ordinary dividends.
Case 1 – Preference shareholders are entitled to only R1 per share on liquidation
The preference shareholders are entitled to receive, on liquidation of T Ltd, R1 per share before
ordinary shares become entitled to the net assets. (Note that this R1 per share would in most
cases not refer to the nominal value of shares, as par value shares are no longer allowed after
changes to corporate law in South Africa. Presumably the R1 per share limitation is declared in
the documentation that covers the conditions related to the preference shares).
In terms of IFRS 3, these preference shares do not qualify for the measurement choice available
in respect of non-controlling interests, as explained earlier, since they do not entitle their holders
to a proportionate share of the acquiree’s net assets on liquidation. Consequently, these preference
shares must be measured at their fair value of R1 200 at acquisition date. (IFRS 3.IE44B)
Case 2 – Preference shareholders are entitled to preference dividends AND are also
entitled to receive a proportionate share of net assets at liquidation – having equal right
and ranking with ordinary shares
If it is still assumed in this case that the fair value of preference shares at acquisition date is
R1 200 and that the proportionate share of T Ltd’s recognised amounts of identifiable assets
attributable to preference shares amounts to R1 100, the following applies:
The preference shares in this case would qualify for the measurement choice allowed for
non-controlling interests in terms of IFRS 3.19. X Ltd may therefore elect to measure preference
shares at either their acquisition date fair value of R1 200 or at their proportionate share in the
acquiree’s recognised amounts of identifiable net assets, amounting to R1 100.
The measurement of any non-controlling interests at the acquisition date will impact on the
calculation of goodwill or a gain on bargain purchase on acquisition. Where the non-controlling
interests are measured at their proportionate share of the acquiree’s identifiable net assets, the
restatement of the identifiable assets and liabilities to their fair values in terms of IFRS 3 is also
allocated to the non-controlling interests.
Example 26.12A Non-controlling interests (proportionate share of net assets fairly valued)
X Ltd acquired an 80% interest (80 000 of the 100 000 issued equity shares) in Y Ltd on
1 January 20.17. This qualifies as a business combination. At that acquisition date, the statement
of financial position of Y Ltd reflected net assets with a carrying amount of R5 000 000. This included
plant which was undervalued by R450 000. The normal income tax rate is 28%. The group is entitled
to choose a measurement option since both the criteria in IFRS 3.19 were met.
If the group elected to measure non-controlling interests at their proportionate share of the
acquiree’s identifiable net assets, they would be calculated as follows:
The calculated non-controlling interests should be based on the fair value of Y Ltd’s net assets
and not on their carrying amounts. As a result, it is necessary to adjust the value of Y Ltd’s plant
upwards, by R450 000. This will, however, give rise to deferred tax of R126 000 (450 000 × 28%).
These two adjustments will result in a total fair value for Y Ltd’s net assets of R5 324 000
(5 000 000 + 450 000 – 126 000), giving rise to the non-controlling interests of R1 064 800
(5 324 000 × 20%). Note that the non-controlling interests are measured at their proportionate
(20%) share of the acquiree’s identifiable net assets (R5 324 000) at acquisition date.
Example 26.12B Non-controlling interests (fair value)
Assume the same information as in Example 26.13A, except that the group elected to measure the
non-controlling interests for this business combination at fair value. The market price of Y Ltd’s
shares in an active market at the acquisition date is R54 each. This market price does not take
into account the impact of holding a controlling interest, as such prices generally portray a
non-controlling viewpoint.
The non-controlling interests should be based on the fair value of the 20 000 shares (20% of
100 000 shares) of Y Ltd not held by X Ltd. The non-controlling interests are measured at a fair
value of R1 080 000 (20 000 shares × R54).
If an active market price was not available, the fair value of the non-controlling interests could be
measured using other valuation techniques. If an independent consultant was employed to perform
the valuation and he or she determined it to be (say) R1 100 000, the non-controlling interests are
measured at a fair value of R1 100 000.
Comment
¾ The choice in respect of measurement of non-controlling interests takes place per business
combination and need not be general accounting policy for the group. The group may,
however, show it as accounting policy and should then apply it consistently.
¾ Note that determining fair value for non-controlling interests results in the non-controlling
shareholders contributing to the total goodwill associated with a subsidiary.
¾ In this specific instance, the contribution to goodwill of Y Ltd would amount to R15 200
(1 080 000 – (5 324 000 × 20%)) or R35 200 (1 100 000 – (5 324 000 × 20%)) respectively.
Although 20% of the net assets of the subsidiary (excluding goodwill) will remain constant, the
fair value of the non-controlling interests would have an impact on the goodwill amount.
26.4.4.4 Summary of recognition and measurement principles of IFRS 3

and exceptions thereto
The general recognition and measurement principles and exceptions thereto have been
discussed in detail in previous sections. These principles and exceptions can briefly be
summarised as follows:
IFRS 3
Recognition principle Measurement principle

All identifiable assets acquired and
All identifiable assets acquired and
liabilities assumed must be recognised
liabilities assumed are measured at their
if they meet the definitions of assets and
acquisition date fair values
liabilities in the Conceptual Framework
Exceptions to measurement principle:

Exception to recognition principle: Reacquired rights
Contingent liabilities Share-based payment transactions
Non-current assets held for sale
Exceptions to both recognition and measurement principles:

Income taxes
Employee benefits
Indemnification assets
Leases when the acquiree is the lessee
26.4.5 Measurement of consideration transferred in a business combination

The initial steps when accounting for a business combination are:
to identify the business acquired and the acquirer;
to determine the acquisition date; and then
to recognise and measure the identifiable assets acquired, liabilities assumed and any
non-controlling interests in the acquiree in the business combination.
All of the abovementioned steps have already been discussed. The final step given in the
Standard is to recognise and measure goodwill or a gain from a bargain purchase. However,
in order to do this, the consideration transferred in the business combination should first be
determined.
The consideration transferred to effect the business combination shall be measured at fair
value at the acquisition date. All items transferred shall be measured at their fair value on
the date of the acquisition (the effect of this requirement for a business combination
achieved in stages is discussed in section 26.4.6 below). The fair value of the consideration
is the sum of the following at the acquisition date:
the fair value of assets transferred by the acquirer (e.g. cash paid or the transfer to the
former owners of non-monetary assets such as property, plant and equipment, inventory,
a business or an existing subsidiary of the acquirer);
the fair value of liabilities incurred by the acquirer to former owners of the acquirer (e.g.
the amounts in respect of the purchase price payable to former owners of the acquiree
after the acquisition date); and
the fair value of equity instruments (interests) issued by the acquirer (e.g. ordinary or
preference shares issued, options issued and the transfer of member interests of mutual
entities) (IFRS 3.37).
Also refer to section 26.4.9 for a discussion of certain items that do not form part of a
business combination.
Detailed examples are included in the Illustrative Examples to IFRS 3 (refer to
paragraphs IE61 to IE71). Care should also be taken to separate the transactions for the
business combination from any other related transactions.
The carrying amounts of assets and liabilities transferred as part of the consideration may
differ from their fair values at the acquisition date used in the measurement of the
consideration for the business combination. The acquirer shall remeasure these assets and
liabilities to their fair values at acquisition date and recognise any resulting gains or losses in
profit or loss (IFRS 3.38).
Example
Example 26.1
26.13 Consideration transferred (fair value at acquisition date)
Plan Ltd obtained control of Sam Ltd on 1 July 20.17. Details of the consideration transferred to
the former owners of Sam Ltd are as follows:
Plan Ltd transferred one of its buildings to the former owners. At the acquisition date, the carrying
amount (cost model) was R800 000 and its fair value was determined to be R900 000.
Cash of R1 500 000 was paid on the acquisition date as part of the consideration.
As part of the consideration payable, Plan Ltd also had to issue 50 000 ordinary shares to the
former owners. The fair value of the shares on 1 July 20.17 was R20 each. For practical reasons,
the shares were actually issued three weeks later, when the share price was R18 each.
The consideration for the business combination will be measured at the fair value of all the items
transferred as at 1 July 20.17 namely [R900 000 + R1 500 000 + (50 000 × R20)] = R3 400 000.
The journal entry to account for the consideration transferred in the records of Plan Ltd will be as
follows:
Dr Cr
1 July 20.17 R R
Investment in Sam Ltd (SFP) 3 400 000
Buildings (SFP) 800 000
Gain on transfer of buildings (P/L) (900 000 – 800 000) 100 000
Bank/Cash (SFP) 1 500 000
Ordinary share capital (SCE) 1 000 000
Assets transferred and shares issued as consideration
for business combination
Comment
¾ The issuance of a fixed number of shares is classified as ‘equity’ and they are, in terms of
IAS 32 Financial Instruments: Presentation, not remeasured for changes in the value thereof.
The subsequent settlement thereof is accounted for within equity.
¾ Should a liability be incurred as part of the consideration, it will also be recognised at fair value.
For instance, this could happen when the acquirer agrees to pay, over and above the PPE,
cash and equity, an amount to the former owners of Sam Ltd, but cannot pay it immediately
(refer to Example 26.15).
Sometimes the assets and liabilities (as part of the consideration) are transferred to the
acquiree, rather than to the former owners of the acquiree. These assets and liabilities will
then remain in the combined entity after the business combination, and the acquirer will
therefore retain control over the assets and liabilities. This is most likely to occur in the
situation in which a new entity is incorporated and issues its ordinary share capital to the
acquirer in exchange for certain assets.
In this situation, the acquirer shall measure the assets and liabilities transferred as part of
the consideration, at their carrying amounts immediately before the acquisition date
(IFRS 3.38). The acquirer will thus not recognise any gains or losses in the consolidated
financial statements. In the acquirer’s own records, a gain or loss will be recognised, but the
gain or loss is eliminated in the consolidated financial statements (similar to any other
intragroup transaction) and the respective transferred assets or liabilities are restored to
their carrying amounts as before the business combination.
IFRS 3 provides no guidance in determining the fair value of equity instruments issued.
IFRS 13 Fair Value Measurement sets out, in a single Standard, a framework for measuring
fair value that must be applied to all IFRSs that require or permit fair value measurements.
Thus, in order to determine the fair values relating to equity instruments issued as part of the
consideration transferred in a business combination, IFRS 13.34 to .41 must be consulted
for guidance.
Although not specifically mentioned in IFRS 3, the authors are of the opinion that when
settlement of the purchase consideration is deferred, the consideration of the acquisition
should be measured at the present value thereof.
Example 26.1
26.14 Deferred settlement of the purchase consideration
Dingo Ltd purchased an 80% interest in the shares of Baby Ltd on 1 January 20.17 (this qualifies as
a business combination) under the following conditions:
20% of the purchase price of R1 000 000 has to be paid immediately in cash; and
the remainder of the purchase price will only be settled in cash by Dingo Ltd on
31 December 20.17.
An appropriate discount rate related to the above transaction is 12% compounded annually.
The consideration transferred for the business combination will be determined as follows:
R
Amount paid immediately (1 000 000 × 20%) 200 000
Amount for which payment is deferred, now discounted to present value
(1 000 000 × 80% × 100/112) 714 286
Consideration transferred 914 286
Comment
¾ Note that the difference between the R800 000 and R714 286 represents interest of R85 714,
to be shown on the statement of profit or loss and other comprehensive income as a finance
cost.
¾ The fraction 100/112 is used as the discount rate is compounded annually and the R800 000
includes 12% interest based on R714 286. Alternatively 1/(1,12) could also have been applied
to the R800 000 or with FV = 800 000; n =1; i = 12%.
26.4.5.1 Contingent consideration (IFRS 3.39 and .40)

The Standard defines contingent consideration as an obligation of the acquirer to transfer
additional assets or equity interests to the former owners of the acquiree as part of the
acquisition of control of an acquiree if specified future events occur or conditions
are met. However, a contingent consideration may also give the acquirer the right to the
return of a previously transferred consideration if specified conditions are met (IFRS 3,
Appendix A). Contingent consideration arrangements may sometimes be an inherent part of
the economic considerations in the negotiations between the buyer and seller. The two
parties may, for example, agree that the buyer will make an additional payment if a specified
earnings level is achieved at an agreed date after the business combination. The contingent
consideration is dependent on future events. The acquirer’s agreement to make contingent
payments is an obligating event in a business combination transaction. Although the amount
of the future payments the acquirer will make is dependent upon future events, the
obligation to make them if the specified future events occur, is unconditional. The same is
true for a right to the return of a previously transferred consideration if specified conditions
are met or not met. In terms of the Standard, the acquirer shall recognise contingent
considerations as part of the consideration transferred in exchange for the acquiree.
Obligations and rights associated with contingent consideration arrangements should be
measured and recognised at their acquisition date fair values (IFRS 3.39). It is assumed
that the acquirer should be able to use valuation techniques to develop estimates of the fair
values of contingent consideration that are sufficiently reliable for recognition. The
probability that the contingent consideration will be paid is considered in determining the fair
value.
Contingent obligations shall be classified as a liability or equity on the basis of the definitions
in terms of IAS 32 Financial Instruments: Presentation. A right to the return of previously
transferred considerations if specified conditions are met shall be classified as an asset
(IFRS 3.40).
The Standard also addresses the subsequent measurement of, and accounting for,
contingent considerations (IFRS 3.58). If the change in the fair value of the contingent
consideration is the result of additional information about facts and circumstances that
existed at the acquisition date, obtained at a later date, the change is regarded as a
measurement period adjustment and will be treated in accordance with IFRS 3.45 to .50
(refer to section 26.4.9).
If the change in the fair value of the contingent consideration is as a result of information
after the business combination, for example, the earnings target is reached or a certain
milestone is achieved, those subsequent changes in value are generally directly related to
post-combination events, while changes in circumstances are related to the combined
entity and do not affect the acquisition date fair value of the consideration transferred. The
acquirer shall account for changes in the fair value of contingent considerations after the
acquisition date as follows:
contingent considerations that were classified as equity (e.g. the issue of a fixed number
of the acquirer’s own ordinary shares) shall not be remeasured and their subsequent
settlement shall be accounted for within equity;
contingent assets or liabilities classified as financial instruments (e.g. the issue of a
variable number of the acquirer’s own ordinary shares or an obligation to pay cash), that
are within the scope of IFRS 9 Financial Instruments, shall be measured at fair value,
with any resulting gains or losses recognised in profit or loss in accordance with that
Standard; and
contingent assets or liabilities not within the scope of IFRS 9 shall be accounted for at
fair value, with any resulting gains or losses recognised in profit or loss.
The form of the consideration will therefore not affect the amount of goodwill recognised at
the acquisition, but the structure of the consideration may, therefore, have a significant
effect on the accounting in the post acquisition period.
Example 26.1
26.15 Contingent consideration for a business combination contingent upon
future events
Bambi Ltd acquired a 75% interest in the shares of Boo Ltd on 1 July 20.16 (this qualifies as a
business combination) at a cash amount of R10 000 000. The fair value of the net assets of Bambi Ltd
amounted to R12 000 000. In terms of the purchase agreement, Bambi Ltd is required to make an
additional cash payment of R1 000 000 if the sales figure of Boo Ltd increases by more than 12%
during the 18 months after the acquisition date. On 1 July 20.16, the fair value of Bambi Ltd’s
shares was R10 per share, and on 31 December 20.17, it was R12,50.
At the acquisition date, the fair value of this contingent payment was estimated (based on past sales
figures, estimates of future expected sales and other related factors) to be R780 000. The liability
was classified at fair value through profit or loss. Assume that Bambi Ltd elected to measure non-
controlling interests at their proportionate share of net identifiable assets at acquisition date.
continued
The end of the reporting period of the group is 31 December 20.16. The fair value of this contingent
payment was remeasured to R850 000 at that date.
Journal entries in the records of Bambi Ltd
Dr Cr
R R
1 July 20.16
Investment in Boo Ltd (SFP) 10 780 000
Cash/bank (SFP) 10 000 000
Liability for contingent consideration (SFP) 780 000
Contingent consideration (derivative) recognised as part
of consideration for business combination
31 December 20.16
Liability for contingent consideration (SFP) 70 000
Fair value adjustment on contingent consideration (derivative)
Assume that sales increased by more than 12% over the 18 months ended 31 December 20.17 as
stipulated in the contingent consideration clause of the purchase agreement. Bambi Ltd will
therefore be obliged to pay the R1 000 000 agreed upon. The relevant journal entries would be:
Dr Cr
R R
31 December 20.17
Liability for contingent consideration (SFP)
(1 000 000 – 850 000) 150 000
Fair value adjustment on date of settlement of obligation
Liability for contingent consideration (SFP) 1 000 000
Bank (SFP) 1 000 000
Settlement of liability for contingent consideration
The consolidation journal in respect of the initial acquisition is as follows:
Dr Cr
31 December 20.16 and 20.17 R R
Equity at acquisition (SFP) (given) 12 000 000
Goodwill (SFP) 1 780 000
Investment in Boo Ltd (SFP) 10 780 000
Non-controlling interests (SFP) (12 000 000 × 25%) 3 000 000
Elimination of investment against equity at acquisition
Comment
¾ The subsequent change in the fair value of the liability (derivative) for contingent consideration
does not affect the acquisition date fair value of the consideration transferred. Thus, subsequent
changes in value for post combination events and circumstances should not affect the
measurement of the consideration transferred or goodwill on the acquisition date.
¾ As indicated earlier, contingent considerations classified as equity would probably arise from
issuing a fixed number of ordinary shares (Bambi Ltd’s shares) and in terms of IAS 32 Financial
Instruments: Presentation and such items are not remeasured subsequently. If the original
agreement therefore stipulated that 78 000 (R780 000/R10) of Bambi Ltd’s shares should be
issued in settlement, R780 000 will be recognised as equity at initial recognition of the contingent
consideration and purchase. The amount will not be remeasured subsequently (differs from
liabilities) and will be settled on 31 December 20.17 by issuing 78 000 shares and accounting for
R780 000.
continued
¾ As also indicated earlier, the issuance of a variable number of Bambi Ltd’s shares in settlement of
a contingent consideration would be a liability (refer to the definition of a financial liability in
IAS 32). This would be treated exactly like a normal financial liability at fair value through profit
or loss and the liability would be remeasured to fair value intermittently (refer to the journals in
the first section of the question). On settlement at 31 December 20.17 the share issue will take
place at the ruling fair value (share price) of Bambi Ltd’s shares, namely R12,50. Sufficient
shares at a fair value of R12,50 would therefore be issued to cover the contingent consideration
of R1 000 000 – thus 80 000 shares (1 000 000/R12,50) accounted for at R1 000 000.
It is also important to note that most contingent consideration obligations are financial
instruments and nearly always derivatives. The latter is the case since the values of many
of these obligations will change in tandem with an underlying item. No (or a very small) initial
investment is required and settlement will take place at a date in the future.
26.4.5.2 Acquisition-related costs
The Standard describes acquisition-related costs as costs that the acquirer incurs to effect a
business combination, for example finder’s fees, advisory, legal, accounting and valuation
fees, general administrative costs, and the cost of registering and issuing debt and equity
instruments. These costs do not form part of what the acquirer and acquiree exchanged in
the business combination and are not part of the consideration transferred to the former
owners of the acquiree. Therefore, these costs are not accounted for as part of the business
combination but are expensed in the periods when the costs are incurred and services
received (IFRS 3.53). The only exception to this rule would be the costs to issue debt or
equity instruments that are recognised in accordance with IAS 32 Financial Instruments:
Presentation and IFRS 9 Financial Instruments, and form part of the initial measurement of
the equity or liability, rather than being expensed.
Example 26.1
26.16 Consideration and costs of a business combination
On 1 January 20.17, Parent Ltd acquired a 70% interest in Subbie Ltd, this qualifies as a business
combination. The purchase price was settled as follows:
A cash payment of R500 000 was made. As Parent Ltd did not have sufficient cash reserves to
make the payment, debentures to the value of R300 000 were issued to finance the cash short-
fall.
30 000 ordinary shares with a fair value of R10 each were issued.
A machine with a fair value of R200 000 was transferred to the former owners of Subbie Ltd.
The following related costs were incurred:
Debenture issue costs amounted to R1 500.
Share issue costs amounted to R1 000.
The cost to move the machine that formed part of the consideration amounted to R6 000. This is
for Parent Ltd’s account.
Legal fees of R15 000 were paid to a lawyer to draft the purchase agreement and to attend to
other related legal aspects.
An amount of R2 000 was paid to an appraiser to determine the fair value of the machine.
The consideration for the acquisition of Subbie Ltd is as follows:
R1 000 000, consisting of [(500 000 (cash) + (30 000 × 10) (shares) + 200 000 (machine)]
continued
The related costs are accounted for as follows:

The payment of R15 000 made to the attorney, the R2 000 paid to the valuer and costs of moving
the machine of R6 000 are expenses in the period in which the services were received and do not
form part of the consideration transferred.
The debenture issue costs (R1 500) will not form part of the consideration of the business combination
or be expensed, but will instead be debited to the debentures account (it will thus affect the
amortised cost at which the debentures will be carried). Similarly, the cost incurred in issuing the
shares (R1 000) will also not affect the consideration of the business combination or be expensed,
but will instead be debited directly to equity (IAS 32 Financial Instruments: Presentation).
26.4.6 Particular types of business combinations

IFRS 3 provides additional guidance for applying the acquisition method to particular types
of business combinations, namely a business combination achieved in stages and a
combination achieved without the transfer of consideration.
26.4.6.1 Business combination achieved in stages
In many instances, control over another entity is achieved after a series of transactions,
rather than after a single transaction, for example an entity may acquire an initial 15%
interest on a specific date and then later buy another 15% together with obtaining significant
influence over the investee, and some time later a further 22%. The first acquisition will be
an investment in equity shares which will be measured at fair value in terms of IFRS 9
Financial Instruments. The second acquisition result in the acquiree being accounted for as
an associate in terms of IAS 28 Investments in Associates and Joint Ventures. If the third
acquisition gives the acquirer control (i.e. the acquisition date), the acquiree will thereafter be
consolidated. IFRS 3.41 refers to this as a business combination achieved in stages or a step
acquisition.
It was indicated in section 26.4.5 that IFRS 3 requires the consideration transferred in a
business combination to be measured at the fair value of its components as at the
acquisition date. This also applies to a business combination achieved in stages, but a new
component is introduced in the calculation of goodwill.
The equity interest previously held in the acquiree is treated as if it were disposed of and
reacquired at fair value on the acquisition date. Accordingly, the acquirer shall remeasure its
previously held equity interest in the acquiree at its acquisition date fair value, and recognise
the resulting gain or loss in profit or loss or other comprehensive income as appropriate (in
the separate financial statements of the acquirer). In prior reporting periods, the acquirer
may have recognised changes in the value of its equity interest in the acquiree in other
comprehensive income. If so, the amount that was recognised in other comprehensive
income shall be recognised on the same basis as would be required if the acquirer had
disposed directly of the previously held equity interest (IFRS 3.42).
Example 26.1
26.17 Business combination achieved in stages and remeasurement
of acquisition date fair value
John Ltd acquired its 60% interest in Jonty Ltd during two successive share purchases. The
non-controlling interests are measured at their proportionate share of the net assets acquired.
Ignore all tax consequences. Details are as follows:
31 March 20.16: 10% of the shares of Jonty Ltd is acquired by issuing 40 000 of John Ltd’s
shares to the former owners of Jonty Ltd’s shares when the published price was
R10 per share.
30 June 20.17: 50% of the shares in Jonty Ltd is acquired by issuing 100 000 of John Ltd’s
shares to the former owners of Jonty Ltd’s shares when their published market
price was R24 per share. Since this date, John Ltd has exercised control over
Jonty Ltd.
continued
The fair value of John Ltd’s 10% equity interest held in Jonty Ltd since 31 March 20.16 was
determined to be R850 000 as at 30 June 20.17, and R750 000 as at 31 December 20.16 (year-
end). John Ltd elected irrevocably (in terms of IFRS 9.5.7.5) to present changes in the fair value of
the investment in Jonty Ltd’s shares in other comprehensive income. Thus the mark-to-market
reserve in respect of the 10% investment amounted to R350 000 (750 000 – 400 000) on
31 December 20.16. John Ltd also elected in terms of IFRS 9, Financial Instruments, to transfer
the cumulative gain/loss to retained earnings when the underlying instrument is derecognised. The
fair value of Jonty Ltd’s net assets on 30 June 20.17 is R5 500 000.
The fair value of the previously held equity interest and the consideration transferred in the business
combination on the acquisition date (30 June 20.17), would be calculated as follows:
R
10% purchased on 31 March 20.16 (40 000 shares in John Ltd,
remeasured to fair value at 30 June 20.17) 850 000
50% purchased on 30 June 20.17, by issuing 100 000 shares in John Ltd
at R24 per share (100 000 × 24) 2 400 000
Journals in consolidated accounting records:
Dr Cr
R R
30 June 20.17
Investment in Jonty Ltd (850 000 – 750 000) (SFP) 100 000
Restating previously held equity interest to fair value on date of
acquisition
Mark-to-market reserve (SCE) (350 000 + 100 000) 450 000
Transfer accumulative fair value adjustment on interest to retained
earnings
Comment
¾ If one ignores tax, the acquirer would first have remeasured its investment from R750 000 (fair
value 31 December 20.16) to R850 000 (fair value at 30 June 20.17). The gain of R100 000 will
be recognised in other comprehensive income for the current year (IFRS 3.42). At the acquisition
date in the consolidated accounting records, earlier accumulated gains will be transferred to
retained earnings from the mark-to-market reserve since John Ltd elected to do so in terms of
IFRS 9. Therefore an adjustment will be passed in other comprehensive income via a debit,
and a credit to retained earnings with R450 000. The acquirer will therefore transfer R450 000
from the mark-to-market reserve to retained earnings within equity (and not through other
comprehensive income).
¾ The acquirer accounts for all remeasurements in other comprehensive income in its separate
financial statements, and the transfer within equity then takes place only on group level.
¾ If one assumes that the equity of Jonty Ltd at acquisition date amounted to R5 500 000, the
calculation of goodwill/(gain on bargain purchase) in terms of IFRS 3.32 will be as follow:
R
Fair value of previously held equity interest 850 000
Non-controlling interests at their proportionate share (5 500 000 × 40%) 2 200 000
5 450 000
Less: Net identifiable assets acquired and liabilities assumed (given) (5 500 000)
Gain on bargain purchase (50 000)
¾ This gain on a bargain purchase shall be recognised in the consolidated profit or loss immediately
and will be attributed to the parent only.
26.4.6.2 Business combination achieved without the transfer of consideration

The acquisition method of accounting for a business combination applies to all forms of
business combinations, even if the acquirer obtains control of the acquiree without the
transfer of consideration. This may, for example, occur in the follow circumstances (IFRS
3.43):
a share buy-back by the acquiree, resulting in another existing investor (acquirer)
obtaining control;
a rights issue by the acquiree, where the parent does not exercise any rights and as a
consequence loses control;
lapsing of veto rights held by the non-controlling shareholders that kept the acquirer from
controlling the acquiree; and
the business combination is achieved by contract alone, for example when two entities
enter into a contractual arrangement which states that the operation will be under single
management, or voting powers will be equalised amongst the entities’ equity investors.
This usually occurs when a dual-listed entity is formed and results in the acquirer
obtaining control.
In a business combination that is achieved by contract alone, the acquirer transfers no
consideration and may hold no equity interests in the acquiree. The acquirer shall still
allocate the amount of the acquiree’s net assets at fair value to the non-controlling interests,
even if the non-controlling interests have a 100% interest in the acquiree (IFRS 3.44).
In the determining of goodwill in business combinations in which no consideration is
transferred, the acquirer shall substitute the acquisition date fair value of the consideration
transferred with the acquisition date fair value of the acquirer’s interest in the acquiree.
26.4.7 Goodwill and gain from bargain purchase

The final step in applying the acquisition method is to recognise and measure goodwill or a
gain from a bargain purchase. Goodwill or a gain from a bargain purchase at acquisition is
always calculated as a residual (balancing figure), and the measurement of the amount of
goodwill is dependent on the following components:
the recognition and measurement of all the identifiable assets and liabilities (net assets
of the subsidiary);
the recognition and measurement of any non-controlling interests, either at their
proportionate share of the identifiable net assets acquired or at fair value;
the recognition and measurement of the consideration transferred; and
the fair value at the acquisition date of the acquirer’s equity interest previously held in the
acquiree if the business combination was achieved in stages.
The acquirer shall measure the amount of goodwill (or a gain from a bargain purchase) at
the acquisition date as follows:
Consideration transferred# xxx
Plus: Non-controlling interests# xxx
Plus: Fair value of previously held interest# xxx
xxx
Less: Fair value of identifiable assets acquired and liabilities assumed (xxx)
Goodwill/(Gain on bargain purchase) xxx/(xxx)
#
If the residual is a positive amount (i.e. the three items above marked with exceed net
assets acquired), goodwill is recognised. If the residual is a negative amount (i.e. the three
items above marked with # are less than net assets acquired), then a gain from a bargain
purchase is recognised.
Example 26.18 Goodwill versus gain from a bargain purchase at acquisition and effect
of measurement of non-controlling interests
Alpha Ltd acquired control with the acquisition of a 50% interest in Beta Ltd on 1 July 20.17 and
thereby increased its original interest in the company from 10% to 60% – Beta Ltd is now a subsidiary.
The fair net asset value of identifiable assets acquired and liabilities assumed amounts to
R900 000. The following cases may be possible:
Case 1
The consideration transferred is R500 000 and the fair value of the acquirer’s equity (10%) interest
previously held in the acquiree in a business combination achieved in stages, is R100 000. The
non-controlling interests are measured at their proportionate share of the net assets acquired
and amount to R360 000 (900 000 × 40%).
Case 2
The consideration transferred is R400 000 and the fair value of the acquirer’s equity interest (10%)
previously held in the acquiree in a business combination achieved in stages) is R100 000. The
non-controlling interests are measured at their proportionate share of the net assets acquired,
and amount to R360 000 (900 000 × 40%).
Case 3
non-controlling interests are measured at their fair value of R370 000.
Case 4
non-controlling interests are measured at their fair value of R370 000.
Case 1 Case 2 Case 3 Case 4
R R R R
Consideration transferred 500 000 400 000 500 000 400 000
Plus: Fair value of previously held equity
interest 100 000 100 000 100 000 100 000
Plus: Non-controlling interests 360 000 360 000 370 000 370 000
Subtotal 960 000 860 000 970 000 870 000
Less: Net assets (900 000) (900 000) (900 000) (900 000)
Goodwill (debit) 60 000 70 000
Gain from a bargain purchase (credit) (40 000) (30 000)
Comment
Comment
¾ The debit amounts calculated represent goodwill recognised as an asset and carried in the
consolidated statement of financial position.
¾ The credit amounts calculated represent gains and are recognised in the statement of profit or
loss and other comprehensive income (as part of the profit and loss section) at the acquisition
date, once the acquirer has reassessed whether every item contributing to the gain is correct.
Where the non-controlling interests are measured at their proportionate share of the
identifiable net assets of the acquiree, no goodwill/gain from a bargain purchase is
included in the amount for the non-controlling interests. The goodwill/gain from a bargain
purchase recognised represents the acquirer’s share of goodwill/gain from a bargain
purchase only as under the previous version of the Standard (this may be referred to as the
partial goodwill method).
If the non-controlling interests are measured at fair value, their share of goodwill/gain
from a bargain purchase is also recognised (this may be referred to as the full goodwill
method). In the above example, this is evident from the fact that the non-controlling interests
and goodwill are both affected by the goodwill that relates to the non-controlling interests.
In Case 1 in the example above, the goodwill associated with the controlling interest is
R60 000 and no goodwill is attributable to the non-controlling interests. In the case of
Case 3, with a total goodwill number of R70 000, the goodwill attributable to the controlling
interest would still be R60 000, but the non-controlling interests will also contribute some
component of goodwill to the total goodwill in respect of this subsidiary. This amount of
R10 000 in respect of the goodwill of the non-controlling interests is calculated as follows:
fair value of non-controlling interests (R370 000) – net assets attributable to non-controlling
interests, namely (R360 000 = 900 000 × 40%) = R10 000. Alternatively, Case 3 can be
Total Alpha Ltd NCI
100% 60% 40%
Equity at acquisition date 900 000 540 000 360 000
Goodwill 70 000 60 000 10 000
Consideration paid and previously held equity at
fair value (500 000 + 100 000) 600 000
NCI at fair value (given) 370 000
The additional R10 000 of goodwill (over and above the partial goodwill method amount of
R60 000) is therefore associated with the non-controlling interests. These two methods of
measuring the non-controlling interests will also affect the determination of any impairment
to goodwill – please refer to Illustrative Example 7 of IAS 36 Impairment of Assets.
Due to the prescribed method of calculating goodwill/gain on bargain purchases in terms of
IFRS 3.32, the total goodwill/gain on the bargain purchase at acquisition date will represent
a net figure. For example, in the case of Case 3 in the example above, assume that the fair
value of the non-controlling interests at acquisition date is R350 000. Goodwill will be
Plus: Non-controlling interests at fair value 350 000
Plus: Fair value of previously held interest 100 000
950 000
Less: Fair value of identifiable assets acquired and liabilities assumed (900 000)
Goodwill 50 000
Or alternatively presented as:
Total Alpha Ltd NCI
100% 60% 40%
Equity at acquisition date 900 000 540 000 360 000
Goodwill/(gain on bargain purchase) 50 000 60 000 (10 000)
Consideration paid and previously held equity 600 000
at fair value (500 000 + 100 000)
NCI at fair value (given) 350 000
Only the net figure, goodwill of R50 000 will be disclosed in the consolidated statement of
financial position of the group.
26.4.7.1 Goodwill arising at acquisition
Goodwill arising at acquisition represents a payment made by the acquirer in anticipation of
future economic benefits from assets that are not capable of being individually identified and
separately recognised. The future economic benefits may result from a synergy between
the identifiable assets acquired or from assets which, individually, do not qualify for
recognition in the financial statements, but for which the acquirer is prepared to make a
payment in the acquisition. Goodwill acquired in a business combination should be
recognised as an asset and carried at the amount recognised at the acquisition date less
any accumulated impairment losses. To determine whether goodwill is impaired, an entity
applies the principles of the Standard on impairment of assets, namely IAS 36 Impairment of
Assets.
Example 26.19 Journal entries for recognition of goodwill at acquisition
Cheddar Ltd acquired an 80% interest in Gouda Ltd on 1 January 20.17. This qualifies as a busi-
ness combination. The fair value of the net assets of Gouda Ltd amounts to R2 000 000. The fair
value of the consideration transferred amounts to R1 700 000. The non-controlling interests are
measured at their fair value of R405 000.
The pro forma consolidation journal entries to account for the goodwill would be as follows:
Dr Cr
R R
Equity of Gouda Ltd (fair value of net assets) (SFP) 2 000 000
Investment in Gouda Ltd (consideration at fair value) (SFP) 1 700 000
Non-controlling interests (at fair value) (SFP) 405 000
Goodwill (balancing figure) (SFP) 105 000
Elimination of common items and recognition of goodwill in
business combination
Comment
¾ Note that the goodwill identified is a residual.
¾ If the non-controlling interests were not measured at fair value, but rather at the proportionate
share of the recognised amounts of identifiable net assets of the subsidiary amounting to
R400 000, the goodwill amount in the above journal will be reduced to R100 000 and the
non-controlling interests would appear in the consolidated financial statements at R400 000
(2 000 000 x 20%).
Refer to section 26.4.6 for a discussion of a business combination achieved without a

transfer of consideration. An example of the calculation of goodwill under those
circumstances follows.
Example 26.20 Goodwill in a business combination achieved without the transfer of

consideration
Bokma Ltd obtained control over Kierie Ltd through contract alone. The calculation of any goodwill
or gain on a bargain purchase will be as follows (as contrasted with the calculation of goodwill in
normal circumstances):
Goodwill as usually determined Goodwill in business combination without
transfer of consideration
Acquisition date fair value of consideration Acquisition date fair value of Bokma Ltd’s
transferred interest in the acquiree using valuation
techniques
Plus: Non-controlling interests Plus: Non-controlling interests
Less: Identifiable net assets at acquisition date Less: Identifiable net assets at acquisition date
fair value fair value
Equals: Goodwill/Gain from bargain purchase Equals: Goodwill/Gain from bargain purchase
26.4.7.2 Impairment of goodwill

The impairment of goodwill determined in terms of IFRS 3 is discussed at length in
section 18.5.3.
26.4.7.3 Gain at acquisition arising from a bargain purchase
A gain on a bargain purchase of shares leading to a business combination may arise, for
example, in a business combination that is a forced sale in which the seller is acting under
compulsion, or where the negotiation team of the acquirer is much more skilled than the
team of the acquiree. The existence of a gain on a bargain purchase at acquisition may also
indicate that identifiable assets have been overstated or identifiable liabilities have been
omitted or understated. IFRS 3.36 requires that where a gain on a bargain purchase at
acquisition arises, the acquirer:
reassesses the identification and measurement of the identifiable assets acquired
and liabilities assumed of the acquiree and then adjusts the values of the items
recognised, and/or recognises any additional assets or liabilities that are identified in this
review;
reviews the measurement of the non-controlling interests in the acquiree;
reviews the measurement of the fair value of its previously held equity interest in the
acquiree where the business combination was achieved in stages; and
reviews the measurement of the consideration transferred to effect the business
combination.
If any gain on a bargain purchase at acquisition is confirmed after such reassessment, the
acquirer shall then recognise the gain in the statement of profit or loss and other
comprehensive income (as part of profit or loss) on the acquisition date.
Example 26.2
26.21 Treatment of gain at acquisition arising from a bargain purchase
The following is a more complex example of how the fair value adjustments on the identifiable net
assets at acquisition may be allocated to the non-controlling interests and how the gain from a
bargain purchase is treated at acquisition date.
H Ltd obtained control and acquired a 70% interest in the equity shares of F Ltd for an amount of
R750 000 on 1 January 20.17. The group elected to measure any non-controlling interests at their
proportionate share of the acquiree’s net assets, and was able to do so since the requirements in
IFRS 3.19 were met. The abridged statements of financial position of both companies at the
acquisition date, before taking into account any adjustments related to the business combination,
were as follows:
H Ltd F Ltd
R’000 R’000
Identifiable assets 8 200 2 000
Investment in F Ltd 750 –
8 950 2 000
Equity 6 000 1 300
Identifiable liabilities 2 950 700
8 950 2 000
continued
The fair value of the identifiable assets of F Ltd amounts to R3 000 000 at acquisition. A normal
income tax rate of 28% is applicable. The business combination will be treated as follows:
Equity analysis of F Ltd at acquisition date
Non-
H Ltd
Total controlling
70%
interests
R’000 R’000 R’000
Equity 1 300 910 390
Revaluation surplus (3 000(FV) – 2 000(CA)) = 1 000
(1 000 × 72% (after tax)) 720 504 216
2 020 1 414 606
Gain on bargain purchase (refer to comments below) (664) (664) –
Consideration transferred and NCI 1 356 750 606
Goodwill/(gain on bargain purchase) in terms of IFRS 3.32 R

Consideration paid 750 000
Plus: Non-controlling interests 606 000
Plus: Fair value of previously held equity interest –
1 356 000
Less: Fair value of identifiable assets acquired and liabilities assumed (2 020 000)
Gain on bargain purchase (664 000)
The pro forma consolidation journal entries to account for the gain on the bargain purchase
would be as follows:
Dr Cr
R R
Assets (3 000 000 – 2 000 000) 1 000 000
Deferred tax 280 000
Revaluation of assets at acquisition date
Equity 2 020 000
Investment in F Ltd 750 000
Gain on bargain purchase (balancing figure) 664 000
Elimination of equity at acquisition date against the investment
in F Ltd
The abridged consolidated statement of financial position at the acquisition date will appear as
follows:
R’000
Assets (R8 200 + R 3 000) 11 200
Total equity 7 270
Equity of parent (6 000 + 664 (gain attributed to parent)) 6 664
Non-controlling interests 606
Deferred tax (28% × 1 000) 280
Other liabilities (2 950 + 700) 3 650
11 200
continued
Comment
¾ The identifiable net assets are calculated as follows: (Assets at fair value of R3 000 000 given –
liabilities of R700 000 given – deferred tax of R280 000 on revaluation) = R2 020 000. Remem-
ber that assets minus liabilities equal equity.
¾ If the non-controlling interests were measured at their fair value of, say R610 000, the gain
would be calculated as follows: Consideration of R750 000 + non-controlling interests of
R610 000 – identifiable net assets of R2 020 000 = R660 000. Note that a net figure will be
disclosed as discussed in section 26.4.7.
¾ The non-controlling interests form part of total equity, but are presented separately.
¾ The identification of a gain on a bargain purchase warrants a reassessment of the fair values of
the identifiable assets and liabilities; the fair value of non-controlling interests (if applicable);
and the fair value of the consideration transferred. If the amount of the gain is confirmed, the
gain at acquisition is recognised on the statement of profit or loss and other comprehensive
income (as part of profit or loss), and allocated to the acquirer. Therefore, the gain of R664 000
is part of the equity of the parent as indicated above.
Example 26.22 Basic consolidation
H Ltd obtained control and purchased all the equity shares in F Ltd in a share-for-share exchange
plus a cash amount of R200 000. It is assumed that the fair value of the shares of both the
companies is R30 per share. Ignore taxation. The abridged statements of financial position of the
companies before the business combination are as follows:
H Ltd F Ltd
R’000 R’000
Identifiable assets 4 000 3 000
Share capital (200 000 shares; 160 000 shares) 2 000 1 600
Identifiable liabilities 800 600
Equity and liabilities 4 000 3 000
H Ltd will therefore issue 160 000 shares in the share-for-share exchange with a market value of
R4 800 000 (160 000 × 30) and pay a further cash amount of R200 000 to acquire the shares in
F Ltd.
This would be recorded through the following entry in the records of H Ltd:
Dr Cr
R R
Investment in F Ltd (SFP) 5 000 000
Share capital of H Ltd (SFP) 4 800 000
Cash (SFP) 200 000
Accounting for investment in subsidiary
It is assumed further that the fair values of the identifiable assets of H Ltd and F Ltd are
R4 400 000 and R3 600 000 respectively. The liabilities are deemed to be shown at fair value.
H Ltd has a policy to revalue assets to fair value. Ignore deferred tax.
continued
The pro forma consolidation journal entries would be as follows:

Dr Cr
R R
Assets (3 600 000 – 3 000 000) 600 000
Revaluation of assets at acquisition date
Goodwill (balancing figure) 2 000 000
Non-controlling interests –
Investment in F Ltd 5 000 000
Elimination of equity at acquisition date against the investment
in F Ltd
The abridged consolidated statement of financial position of H Ltd and its subsidiary may be pre-
pared as follows after the business combination:
Assets R’000
Assets (4 400 (H) – 200 (cash) + 3 000(F) + 600(F)) 7 800
Goodwill (refer to comment below/journal above) 2 000
Total assets 9 800
R’000
Share capital (2 000 + 4 800) (refer to above journal) 6 800
Revaluation surplus H Ltd (4 400 – 4 000 + 600 – 600) 400
Retained earnings (1 200 + 800 – 800) 1 200
Total equity 8 400
Liabilities (800 + 600) 1 400
Comment
¾ Goodwill is calculated as follows:
R’000
Investment in F Ltd (consideration) 5 000
Net assets of F Ltd acquired at fair value (3 600 (assets) – 600 (liabilities)) (3 000)
2 000
26.4.8 Measurement period

The initial accounting for a business combination involves identifying and determining the
fair values to be assigned to the acquiree’s identifiable assets acquired and liabilities
assumed, as well as the consideration transferred for the business combination, and
sometimes also the non-controlling interests. Sometimes the values to be used in a
business combination can only be determined provisionally by the end of the reporting
period in which the business combination took place, because finality about the values of
identifiable items and the consideration transferred for the business combination had not
been reached at that stage.
If the initial accounting for a business combination is incomplete by the end of the first
reporting period, the acquirer shall use provisional amounts of those items for which the
accounting is incomplete (IFRS 3.45). In terms of IFRS 3, the acquirer is allowed a

measurement period in which the final fair values can be obtained and the accounting for
the business combination is finalised. This measurement period commences on acquisition
date. During this measurement period, the acquirer may retrospectively adjust the
provisional amounts recognised for the business combination as new facts and information
come to the fore. The acquirer would need to consider all pertinent factors in order to
determine whether the facts and information obtained after the acquisition date would result
in an adjustment to the provisional amounts. Such factors would include the date on which
the additional information is obtained, as well as whether the acquirer can identify a reason
for a change in provisional amounts. Note that the acquirer will, during the measurement
period, also be able to recognise new or additional assets and liabilities that existed at
acquisition date but were not taken into account. The measurement period ends as soon as
the acquirer has obtained all the relevant information about facts and circumstances that
existed as at the acquisition date. However, the maximum measurement period is one
year from the acquisition date. During the measurement period, the acquirer may
retrospectively (IFRS 3.46):
adjust the carrying amounts of the assets and liabilities recognised in the business
combination to reflect the fair value of the net assets at acquisition date;
recognise additional assets or liabilities as at the acquisition date;
adjust the fair value of the consideration transferred for the business combination;
adjust the fair value of the acquirer’s equity interest previously held in the acquiree in a
business combination achieved in stages;
adjust the fair value of the non-controlling interests; and
adjust the resulting goodwill or gain on a bargain purchase.
For instance, assume that the acquirer obtains new information that would lead to an
increase or decrease in the provisional amount recognised for an identifiable asset or
liability. This would lead to an adjustment to goodwill or gain on a bargain purchase during
the measurement period. It is obviously also possible for new information to indicate that the
provisional amounts of more than one asset or liability are affected. Should that be the case,
the net effect on goodwill or gain on a bargain purchase will be accounted for.
During the measurement period, the provisional amounts are, therefore, adjusted as if the
accounting for the business combination had been completed at the acquisition date.
Comparative amounts presented in periods before completion of the initial accounting are
thus restated as if the initial accounting was completed at acquisition date. Adjustments to
depreciation, amortisation, or other income effects may be required as a result of these
adjustments. The comparative information for these items is also restated as a result of
adjustments made during the measurement period. Certain narrative disclosures would also
be required in the notes to the financial statements (disclosure is discussed in more detail in
section 26.6).
Example 26.23 Adjustments during measurement period
Sering Ltd acquired a 60% interest in Boom Ltd on 31 March 20.16 at R2 496 000. This qualifies
as a business combination. One of the asset line items on the statement of financial position of
Boom Ltd represents a fleet of delivery vehicles. For purposes of the acquisition, Sering Ltd
requested an independent appraiser to value the delivery vehicles owned by Boom Ltd. The report
of the external appraiser was eventually received on 31 July 20.16. The other identifiable net
assets were fairly valued at R2 240 000.
At the acquisition date (31 March 20.16) the value of the delivery vehicles was provisionally
estimated to be R1 560 000 (carrying amount in Boom Ltd’s financials was R1 400 000), but the
independent appraiser placed a final fair value of R1 755 000 on the vehicles. The vehicles had a
remaining useful life of ten years on the acquisition date and a negligible residual value.
continued
On 10 July 20.16, Sering Ltd also became aware of a further liability of Boom Ltd in an amount of
R60 000, that had existed at the acquisition date, but that was not initially recognised. The purchase
agreement, however, does not provide for an adjustment to the purchase price. Settlement of the
liability will be deductible for tax purposes.
The end of the reporting period of the Sering Ltd Group is 30 April and the consolidated financial
statements for the year ending 30 April 20.16 were issued on 28 June 20.16. Assume a normal
income tax rate of 28%. The non-controlling interests are measured at their proportionate share of
the identifiable net assets acquired.
The consolidated financial statements for the year ending 30 April 20.16, will therefore place an
initial value of R1 560 000 on the delivery vehicles and the liability of R60 000 would initially not be
recognised at all. Since the independent valuation indicates that the value of the vehicles amounts
to R1 755 000, this value will have to be corrected in July 20.16 (in the 20.17 financial year) by
way of a retrospective adjustment, together with the related deferred tax implications. This should
happen since the initial accounting was determined provisionally and the adjustment was made
during the measurement period. The liability of R60 000 and the related deferred tax implications
will also be recognised retrospectively. The net effect of these adjustments as at the acquisition
date leads to an adjustment to the non-controlling interests and, in the end, to goodwill. The
consolidated depreciation after the business combination should also be adjusted.
The calculation of goodwill would be as follows:
Initial As corrected
accounting during the
incomplete at measurement
30 April 20.16 period
Consideration transferred 2 496 000 2 496 000
Plus: Non-controlling interests (40% of net assets below)
(3 755 200 × 40%; 3 852 400 × 40%) 1 502 080 1 540 960
Less: Net assets at acquisition fair value
(refer to comment for calculation) (3 755 200) (3 852 400)
Goodwill 242 880 184 560
Comment
¾ The net assets were initially calculated to be R2 240 000 + R1 560 000 – (28% × (1 560 000 –
1 400 000)) (deferred tax on revaluation) = R3 755 200. The final net assets as retrospectively
adjusted during the measurement period, are calculated to be R2 240 000 + R1 755 000 –
(28% × (1 755 000 – 1 400 000)) (deferred tax on revaluation) – (72% × R60 000) (after tax
amount) = R3 852 400.
¾ A detailed discussion of the tax implications follows in section 26.5.
The consolidation journal entries in the 20.17 financial year to retrospectively correct the fair values in
respect of the acquisition of the interest are as follows:
Dr Cr
R R
Delivery vehicles (SFP) (1 755 000 – 1 560 000) 195 000
Goodwill (SFP) (195 000 × 60%) 117 000
Correction of the initial accounting of delivery vehicles
Goodwill (SFP) (54 600 × 60% or 117 000 × 28%) 32 760
Non-controlling interests (SFP) (54 600 × 40% or 78 000 × 28%) 21 840
Deferred tax (SFP) (195 000 × 28%) 54 600
Deferred tax effect on the correcting adjustment in respect of
delivery vehicles
continued
Dr Cr
R R
Retained earnings (Equity) (1 625 × 60%) 975
Non-controlling interests (SFP) (after acquisition) (1 625 × 40%) 650
Accumulated depreciation (SFP) (195 000/10 × 1/12 (Apr)) 1 625
Additional depreciation on the correcting adjustment
– delivery vehicles
Deferred tax (SFP) (1 625 × 28%) 455
Non-controlling interests (after acquisition) (SFP) (455 × 40%) 182
Retained earnings (Equity) (455 × 60%) 273
Deferred tax effect on the additional depreciation
Goodwill (SFP) (60 000 × 60%) 36 000
Liabilities (SFP) (given) 60 000
Correction of the initial accounting of additional liability
Deferred tax (SFP) (60 000 × 28%) 16 800
Goodwill (SFP) (16 800 × 60%) 10 080
Deferred tax effect on the correcting adjustment in respect
of additional liability
Comment
¾ In this example, the effect of any adjustment on non-controlling interests is calculated at 40%,
because non-controlling interests are measured at their proportionate share of the net assets
acquired. Therefore, the effect on goodwill may be calculated at 60%.
¾ If the non-controlling interests had been measured at their acquisition date fair value, the
measurement period adjustments would not have an effect on the non-controlling interests.
Therefore, the effect on goodwill would have been calculated at 100% and not 60%.
¾ The net assets as at the acquisition date (after the journal entries) are as follows: R3 755 200
+ 195 000 – 54 600 – 60 000 + 16 800 = R3 852 400. The journals dealing with an adjustment
with regard to depreciation are ignored for this calculation since those journals refer to the period
after the acquisition date.
¾ The non-controlling interests as at the acquisition date (after the journal entries) are as fol-
lows: R1 502 080 + 78 000 – 21 840 – 24 000 + 6 720 = R1 540 960. The journals dealing with
an adjustment with regard to depreciation are ignored for this calculation since those journals
refer to the period after the acquisition date.
¾ The goodwill as at acquisition (after the journal entries) is as follows: R242 880 – 117 000 +
32 760 + 36 000 – 10 080 = R184 560.
¾ When the journal entries relating to movements in the 20.17 year are prepared, they will obviously
take into account the increased value of the vehicles as determined by the valuer; therefore the
depreciation charge will be based on the value of R1 755 000, and no correcting entries are
required.
Note that once the measurement period for a business combination has ended,
adjustments are recognised only to correct an error in accordance with IAS 8 Accounting
Policies, Changes in Accounting Estimates and Errors.
26.4.8.1 Income taxes around the measurement period

Deferred tax assets that arose during the measurement period and that resulted from
new information or facts and circumstances that existed at acquisition date, shall be
adjusted against the goodwill related to that acquisition. If the carrying amount of goodwill is
Rnil, the excess shall be recognised as a gain on bargain purchase in the profit or loss
section.
26.4.9 Determining what is part of the business combination

In many instances, the acquirer and acquiree may have a relationship that existed before
negotiations for the business combination commenced (pre-existing relationship). In addition,
they could also have entered into arrangements separate from the business combination
while they were involved in negotiations. Either way, as part of preparing to apply the
acquisition method, the acquirer shall establish which items are not part of what the
acquirer or acquiree (or its former owners) exchanged during the business combination and
which items are part of the business combination (IFRS 3.51).
IFRS 3.52 and IFRS 3.B50 to .B62 give guidance to determine what part of these
transactions is part of the business combination and what is not. Only the part of these
transactions that forms part of the business combination shall be accounted for in terms of
the acquisition method. In doing so, only amounts (consideration, assets and liabilities) that
are part of what the acquirer and the acquiree (or its former owners) exchanged in the
business combination shall be accounted for in terms of the acquisition method. Any
amounts that are identified as not being part of the exchange transaction for the business
combination shall be accounted for separately in accordance with the relevant Standards
applicable.
It was indicated earlier on in this chapter that acquisition related costs do not form part of
what the acquirer and acquiree exchanged in the business combination and, therefore,
those costs are not included in the consideration transferred for the business combination
(IFRS 3.53).
If the acquirer and acquiree had a pre-existing relationship or other arrangement before the
business combination was effected, or they entered into an arrangement during the
negotiations for the business combination that is separate from the business combination,
the acquirer should separate amounts that are not part of the business combination from
those that are part of it.
Some of the factors that should (either individually or in combination) be considered to
determine whether a transaction is part of the exchange for the acquiree or whether it is
separate from the business combination are as follows (IFRS 3.B50):
the reasons for the transaction;
the party who initiated the transaction; and
the timing of the transaction.
A transaction entered into by or on behalf of the acquirer or primarily for the benefit of the
acquirer or the combined entity, rather than primarily for the benefit of the acquiree or its
former owners before the business combination, is likely to be a separate transaction.
The following are examples of transactions that would not form part of the business
combination and are not included in applying the acquisition method (IFRS 3.52):
a transaction that in effect settles pre-existing relationships between the two parties;
a transaction that remunerates employees or former owners of the acquiree for future
services; and
a transaction that reimburses the acquiree or its former owners for paying the acquisition
related costs on behalf of the acquirer.
In addition to the abovementioned factors to be considered in separating the transaction for
the business combination from a separate transaction, IFRS 3.B54 and .B55 also states that
the following indicators should be considered in arrangements for contingent payments to
employees or selling shareholders:
continuing employment;
duration of continuing employment;
level of remuneration;
incremental payments to employees;

number of shares owned;
linkage to the valuation;
formula for determining consideration; and
other agreements and issues.
Further guidance for separating the business combination from contingent payments to
employees appears in the Illustrative Examples to IFRS 3 (IE58 to IE60).

In a business combination, one entity acquires another entity or the assets and liabilities of
another entity with the aim of obtaining control of that entity. In this type of acquisition, the
identifiable assets and liabilities are, with limited exceptions, measured at their fair values as
at the acquisition date. The result of the business combination through the acquisition of
equity is that the carrying amounts of the assets and liabilities change, but the tax bases of
the particular assets and liabilities remain unchanged.
In business combinations, temporary differences therefore arise between the fair value
amount and the tax base of assets and liabilities. These differences may be taxable
temporary differences which result in a deferred tax liability when the attributed values of
particular assets exceed the tax base of those assets. Otherwise, deductible temporary
differences may arise, which result in a deferred tax asset, when the attributed value of the
assets is less than the related tax base. A deferred tax asset shall be recognised as part of
the accounting for a business combination to the extent that it is probable that taxable profit
will be available against which the deductible temporary difference could be utilised.
The creation of either a deferred tax asset or a deferred tax liability influences the goodwill
or gain on a bargain purchase on acquisition. Deferred tax assets may also arise if a liability
is recognised at acquisition date but the costs are deducted for tax purposes in a later
period, or when the fair value of an identifiable asset acquired in a business combination is
less than its tax base. In both instances, the recognised deferred tax assets affect the
goodwill.
Deferred tax is, however, not recognised on the initial recognition of goodwill or gain
on a bargain purchase on acquisition, because impairment is not deductible/taxable for
tax purposes and such provision is specifically excluded by IAS 12.15(a). Furthermore, the
Standard states that goodwill is a residual and the recognition of a deferred tax liability
would increase the carrying amount of goodwill – which is a mere book entry.
Example 26.24 Deferred tax on goodwill at a business combination
Assume Taxy Ltd recognises goodwill in a business combination at R500. The tax base is Rnil as
nothing in respect of this asset is deductible for tax purposes and consequently a taxable temporary
difference arises. IAS 12.15(a) prohibits the recognition of this deferred tax liability. If goodwill is
subsequently impaired and an impairment loss of R100 is recognised, the carrying amount of
goodwill declines to R400, the tax base remains Rnil and the temporary difference declines to
R400. The decrease in the unrecognised deferred tax liability is still not recognised, as the
impairment is still recognised as being on the initial recognition of goodwill and is therefore still
prohibited in terms of IAS 12.15(a).
Deferred tax liabilities relating to goodwill will, however, be recognised if they do not arise from the
initial recognition of goodwill. An example, not applicable in South Africa, occurs where goodwill is
deductible for tax over a period of (say) five years. Because the tax base at initial recognition of
goodwill was R500, there was no taxable temporary difference at that stage. Subsequently, the tax
base changes as wear-and-tear is allowed on goodwill from year to year, and since this temporary
difference does not relate to the initial recognition of goodwill, a deferred tax liability will be
recognised.
Any deferred tax asset or liability that may result as part of the business combination will be
measured in accordance with IAS 12 Income Taxes. Although discounting is allowed in
IFRS 3 when measuring fair values, IAS 12 prohibits the discounting of deferred tax assets
acquired or deferred tax liabilities assumed in a business combination.
In South Africa, each company in a group of companies is treated as a separate entity for
tax purposes. This means, amongst others, that losses in one company cannot be set off
against the taxable profits in another company in the group. Since 1 March 2016, the
effective capital gains tax rate is 22,4% (being a 80% inclusion rate × 28% normal income
tax rate) and the SA normal income tax rate is 28% for companies. Paragraph 16 of the
Eighth Schedule to the Income Tax Act 58 of 1962 provides for the discarding of the loss if
the loss is incurred where intangible assets, for example goodwill, were acquired of part of a
business taken over from a connected person and the intangible assets were acquired
before valuation date (1 October 2001) from a connected person.
Example 26.25 Deferred tax arising from fair value adjustments
Alpha Ltd acquired a 100% interest in Beta Ltd for R5 500 000 and valued the identifiable assets
and liabilities at acquisition date as follows:
Carrying Tax Fair
amount base value
R’000 R’000 R’000
Buildings 500 500 700
Plant and equipment 1 800 1 200 3 000
Receivables 600 650 600
Inventory 900 900 1 300
Payables (600) (600) (600)
3 200 2 650 5 000
The calculation of the deferred tax at the acquisition date is as follows:

R’000 R’000
Carrying amount of identifiable assets and liabilities 3 200
Tax base of identifiable assets and liabilities 2 650
Deferred tax liability at acquisition date 550 × 28% 154
Adjustment of identifiable assets and liabilities to fair value:
Fair value of identifiable assets and liabilities 5 000
Carrying amount of identifiable assets and liabilities 3 200
Additional deferred tax liability on adjustments to fair value 1 800 × 28% 504
Total deferred tax liability 658
Proof of goodwill in terms of IFRS 3.32
Net identifiable assets at acquisition date (5 000 – 658) 4 342
Goodwill 1 158
The general rule is that whenever a deferred tax asset arises, the recoverability of the asset
should be assessed before the asset is recognised. It may occur that a deferred tax asset
does not satisfy the criteria for separate recognition when a business combination is initially
accounted for, but it might be realised subsequently. An entity recognises acquired deferred
tax benefits that it realises after the business combination in profit or loss (or outside
profit or loss) in accordance with IAS 12. The acquirer does not adjust the goodwill
recognised at the acquisition date. Refer to IAS 12.66 to .68.
It may also occur that a deferred tax asset that is not recognised by the parent in its own
records can be recognised after the business combination. For example, the acquirer may in
certain cases be able to use its own unused tax losses against future taxable profits
channelled to the parent by the acquiree. In such instances, the acquirer recognises the
deferred tax asset in accordance with IAS 12 and it does not form part of the accounting
of the business combination, nor does it influence the goodwill or gain on a bargain
purchase at acquisition.
26.6 Disclosure
IFRS 3.59 requires disclosure that enables users to assess the nature and financial impact
of:
business combinations during the current reporting period; and
business combinations after the end of the reporting period but before the approval of
the financial statements.
To enable users to assess the nature and financial impact of a business combination as
required in paragraph 59, the following disclosures should be made in the financial
statements for the reporting period during which the combination has taken place:
the names and descriptions of the acquiree;
the acquisition date;
the percentage of voting equity interests acquired;
the primary reasons for the business combination and a description of how control was
obtained;
a qualitative description of the factors that make up the goodwill recognised, for example
expected synergies from the business combination or intangible assets not recognised
separately, etc.;
the acquisition date fair value of the consideration transferred for the combination and
the fair value at acquisition date of each major class of the consideration, for example
cash, tangible or intangible assets, equity interests of the acquirer, etc.;
full details (amounts, descriptions, estimated outcomes) of contingent consideration
arrangements and indemnification assets;
the amounts recognised at the acquisition date for each major class of assets acquired
and liabilities assumed;
full details of receivables acquired;
total amount of goodwill to be deducted for tax purposes. In South Africa this will be Rnil,
and this disclosure will most probably be omitted;
the disclosure in terms of IAS 37 Provisions, Contingent Liabilities and Contingent
Assets for all contingent liabilities and for contingent liabilities not recognised, also the
reasons why the liability could not be measured;
full details of transactions that are recognised separately from the business combination,
including details of acquisition related costs;
for a gain on a bargain purchase, the amount of the gain recognised and the line item on
the statement of profit or loss and other comprehensive income (profit or loss section) in
which the gain was included and a description of the reasons why the transaction
resulted in a gain;
if the acquirer holds less than 100% of the equity interest, disclose the amount of the
non-controlling interests are recognised as at the acquisition date, as well as the
measurement basis thereof, and if the non-controlling interests were measured at fair
value, the valuation techniques and significant inputs to measure the fair value;
full details of a business combination achieved in stages, especially the acquisition date
fair value of the equity interest previously held in the acquiree and the gain or loss
recognised, as well as the line item on the statement of profit or loss and other
comprehensive income in which it appears – probably ‘other income’ in profit or loss; and
the amounts of revenue and profit or loss of the acquiree recognised since the
acquisition date, and the revenue and profit or loss of the combined entity on an annual
basis as if all business combinations of the year occurred at the beginning of the year.
Disclose most of the information listed above, in aggregate form for individually immaterial
business combinations that are collectively material.
If the acquisition date is after the end of the reporting period but before the financial
statements are authorised for issue, the acquirer shall disclose the information above,
unless the initial accounting is incomplete at the time the financial statements are authorised
for issue.
Disclosure is also required to enable the users to evaluate the financial effects of
adjustments recognised during the current reporting period that relate to business
combinations that occurred in previous periods. The following disclosure should be made:
if the initial accounting is incomplete and thus provisional amounts are used:
– the reason why the initial accounting is incomplete;
– the nature of the relevant individual items (assets, liabilities and items of considera-
tion) for which the initial accounting is incomplete; and
– the nature and amount of any adjustment recognised during the measuring period;
full details for contingent consideration assets or liabilities;
the disclosure in terms of IAS 37 Provisions, Contingent Liabilities and Contingent
Assets for contingent liabilities; and
the amount and explanation of any gain or loss recognised in the current reporting period
that relates to recognised identifiable assets and liabilities that was effected in the
current or previous period and are of such size, nature or incidence that disclosure is
relevant to the users.
For goodwill:
disclosure of a reconciliation of the carrying amount of goodwill at the beginning and end
of the period showing:
– the gross amount at the beginning of the period;
– accumulated impairment losses at the beginning of the period;
– additional goodwill recognised during the period;
– adjustments resulting from subsequent recognition of deferred tax assets (applicable
only in terms of the transitional provisions for some deferred tax assets);
– goodwill included in a disposal group held for sale in terms of IFRS 5 Non-current As-
sets Held for Sale and Discontinued Operations;
– goodwill derecognised during the period;
– impairment losses recognised during the reporting period in terms of IAS 36 Impair-
ment of Assets;
– net exchange differences during the reporting period;
– other changes in the carrying amount during the reporting period;
– the gross amount at the end of the reporting period; and
– the accumulated impairment losses at the end of the reporting period.
For more detail on the information to be disclosed, refer to the Application Guidance of
IFRS 3, paragraphs B64 to B67. For a full example illustrating the disclosure requirements
of IFRS 3, refer to the Application Guidance of IFRS 3, paragraph IE72.
CHAPTER
27
Joint arrangements
(IFRS 11 and IFRS 12)
Contents
27.1 Introduction and overview of IFRS 11 Joint Arrangements ............................... 840
27.2 Identification of joint arrangements ................................................................... 841
27.3 Types of joint arrangements .............................................................................. 842
27.4 Classification of joint arrangements .................................................................. 842
27.4.1 Structure of the joint arrangement ...................................................... 843
27.4.2 Legal form of the separate vehicle ..................................................... 843
27.4.3 Terms of the contractual arrangement ............................................... 843
27.4.4 Other facts and circumstances ........................................................... 843
27.5.1 Joint ventures ..................................................................................... 845
27.6 Disclosure .......................................................................................................... 845
839
27.1 Introduction and overview of IFRS 11 Joint Arrangements

IFRS 11 Joint Arrangements focuses on investments where an investor can exercise joint
control, in contrast to control that is established between a parent and a subsidiary in terms
of IFRS 10 Consolidated Financial Statements.
The following is a schematic presentation of the principles of IFRS 11 Joint Arrangements:
Joint arrangements
A joint arrangement is an arrangement over which two or more parties have joint control.
Assessing joint control
Parties collectively control the arrangement through contractual No

arrangements Not a joint
Yes arrangement
(apply other
Decisions about the relevant activities require unanimous No Standards)
consent
Yes
Arrangement is jointly controlled = joint arrangement
Classification: Rights and obligation of parties
Structure of joint arrangement
Not structured through a Structured through a

separate vehicle separate vehicle
Consider: Legal form,

terms of contractual
arrangement, other facts
and circumstances
Joint operation:
Joint venture:
The parties that have joint control of the
The parties that have joint control of the
arrangement have rights to the assets and
arrangement have rights to the net assets
obligations for the liabilities
of the arrangement
relating to the arrangement
Joint operators recognise their own items in Joint ventures recognise the investment and
the financial statements and their share of account for it using the equity method in
items shared jointly in terms of IFRS 11 terms of IAS 28 Investments in Associates
Joint Arrangements and Joint Ventures
Joint arrangements 841
27.2 Identification of joint arrangements

A joint arrangement is an arrangement where two or more parties exercise joint control, that
is, the contractually agreed sharing of control. This means that the unanimous consent of
the parties sharing control is required for all decisions about the relevant activities. A two-
step analysis must be followed in order to classify a joint arrangement, namely:
assess whether collective control of an arrangement exists; and
assess whether the contractual arrangement gives two or more parties joint control.
Collective control of an arrangement exists when all the parties must act together to direct
the activities that significantly affect the returns of the arrangement, ie the relevant activities
(IFRS 11.8). If collective control exists, it must be determined whether joint control exists.
Joint control is the contractually agreed sharing of control of an arrangement, which exists
only when decisions about the relevant activities require the unanimous consent of all the
parties sharing control (IFRS 11.7). An entity must assess whether all the parties have joint
control of the arrangement. It is very important to note that no single party can control the
arrangement individually (IFRS 11.10).
Control is not defined in IFRS 11. In accordance with IFRS 10 Consolidated Financial
Statements, an investor controls an investee when it is exposed or has rights to variable
returns from its involvement with that investee and has the ability to affect those returns
through its power over the investee.
An arrangement can be a joint arrangement even though not all of its parties have joint
control of the arrangement. Therefore, there are parties exercising joint control of an
arrangement and other parties participating in the arrangement (IFRS 11.11). An entity must
apply its judgement to assess whether all of the parties jointly control an arrangement.
In some cases, the agreed-upon decision-making process may implicitly lead to joint control.
For example, two shareholders with 50% voting rights each agreed that 51% of the voting
rights are required to make decisions about the relevant activities. They have implicitly
agreed that they have joint control of the arrangement. When the minimum required
proportion of the voting rights can be achieved by more than one combination of parties
voting together, that arrangement is not necessarily a joint arrangement.
Example 27..1 Assessment of joint control
A joint arrangement is established between three parties and the contractual terms state that 75%
of the voting rights are required to make decisions about the relevant activities of the arrangement.
Scenario A Scenario B
Voting rights held A = 50% A = 50%
B = 30% B = 25%
C = 20% C = 25%
Does collective control exist? Yes Yes
If yes, which parties must act together
to direct the relevant activities? A and B A and B or A and C
Does joint control exist? Yes* No**
Does a joint arrangement exist? Yes No **
* No decisions can be made if A and B do not agree unanimously.
** The contractual arrangement between parties must specify which combination of the parties is
required to agree unanimously to decisions. If no contractual agreement exists between A and
B, or A and C, joint control does not exist.
27.3 Types of joint arrangements

A joint arrangement is an arrangement over which two or more parties have joint control.
IFRS 11 identifies two types of joint arrangements: a joint operation and a joint venture.
A joint operation is a joint arrangement whereby the parties that have joint control of the
arrangement have rights to the assets and obligations for the liabilities relating to the
arrangement. Those parties are called ‘joint operators’ (IFRS 11.15).
A joint venture is a joint arrangement whereby the parties that have joint control of the
arrangement have rights to the net assets of the arrangement. Those parties are called
‘joint venturers’ (IFRS 11.16).
The following characteristics are present in both:
two or more parties are bound by a contractual arrangement; and
the contractual arrangement establishes joint control.
A contractual arrangement is often in writing in the form of a formal contract or Minutes of
discussions between parties. When the joint arrangement is structured through a separate
vehicle, the contractual arrangement or some aspects thereof will be incorporated in the
articles, charter or by-laws of this entity. A separate vehicle is a separately identifiable
financial structure, including separate legal entities, or entities recognised by statute,
regardless of whether those entities have a legal personality. The contractual arrangement
deals with matters such as (IFRS 11.B4):
the purpose, activities and duration of the joint arrangement;
the appointment of the Board of Directors or similar governing body of the joint
arrangement;
the decision-making process: the matters requiring decisions from the parties, the voting
rights of the parties and the required level of support for those matters. This process
establishes joint control of the arrangement;
capital or other contributions required of the parties; and
the sharing of production, revenues, expenses or profit or loss of the joint arrangement.
27.4 Classification of joint arrangements

The classification of a joint arrangement is determined by considering the rights and
obligations of the parties to the arrangement (IFRS 11.14). An entity must consider the
following in order to classify a joint arrangement:
the structure of the joint arrangement; and
when a joint arrangement is structured through a separate vehicle:
– the legal form of the separate entity;
– the terms of the contractual arrangement; and
– other facts and circumstances, if applicable.
Sometimes a framework agreement exists that contains the general terms for one or more
activities, and sets out the fact that the parties have established different joint arrangements
for specific activities that form part of the same agreement. Even though those joint
arrangements are governed under the same framework agreement, they may be classified
as different types of arrangements if the rights and obligations differ. Therefore, joint
operations and joint ventures can co-exist when different activities are undertaken by the
parties that form part of the same framework agreement (IFRS 11.18).
27.4.1 Structure of the joint arrangement

Joint arrangements can be structured through a separate vehicle, or not.
A joint arrangement which is not structured through a separate vehicle can only be
classified as a joint operation. In such cases, the contractual arrangement establishes the
rights and obligations of the parties. An example of such an arrangement is where the
parties agree to manufacture a product together, with each party being responsible for a
specific task, using its own resources and incurring its own liabilities. The contractual
arrangement can also specify how the revenues and expenses are to be shared. Another
example is where an asset is shared and operated together. The contractual arrangement
establishes the parties’ rights to the jointly operated asset and how the output or revenue
earned from the asset, and the operating costs, are shared between the parties. In such a
case, each joint operator accounts for its assets and liabilities used for the specific task or its
share of the jointly operated asset, as well as its share of the revenues and expenses
according to the contractual arrangement, in its financial statements.
A joint arrangement in which the assets and liabilities are held in a separate vehicle can be
classified either as a joint operation or a joint venture, depending on the rights and
obligations of the parties. The legal form of the separate vehicle, the terms of the contractual
arrangement and other facts and circumstances must be considered to assess whether the
parties have rights to the assets and obligations for the liabilities of the arrangement (i.e. a
joint operation), or rights to the net assets of the arrangement (i.e. a joint venture).
27.4.2 Legal form of the separate vehicle

The legal form of the separate vehicle is considered in the initial assessment of the parties’
rights to the assets and obligations for the liabilities held in the separate vehicle. When the
joint arrangement is structured through a separate vehicle, the legal form causes the
separate vehicle to be considered in its own right, meaning that the assets and liabilities
held in the separate vehicle are the assets and liabilities of the separate vehicle and not
those of the parties. In such a case, the assessment of the rights and obligations indicates
that the arrangement is a joint venture.
However, the terms agreed by the parties to the contractual arrangement, as well as other
facts and circumstances, can override the initial assessment of the rights and obligations as
was determined by the legal form.
An arrangement can only be classified as a joint operation when the assessment of the
rights and obligations as determined by the legal form indicates no separation between the
parties and the separate vehicle. Thus the assets and liabilities of the separate vehicle are
the assets and liabilities of the parties.
27.4.3 Terms of the contractual arrangement

In many cases, the rights and obligations agreed to by the parties in the contractual
arrangement are consistent with the rights and obligations determining the legal form of the
separate vehicle in which the arrangement has been structured.
In other cases, the parties use the contractual arrangement to reverse or modify the rights
and obligations as determined by the legal form of the separate vehicle.
When the contractual arrangement specifies that the parties have rights to the assets and
obligations for the liabilities of the arrangement, the arrangement is classified as a joint
operation and other facts and circumstances do not need to be considered for classification
purposes.
27.4.4 Other facts and circumstances

If a joint arrangement is structured through a separate vehicle where the legal form grants
separation and the contractual arrangement does not specify the rights of the parties, other
facts and circumstances can still lead to the classification as joint operation.
When the activities of the arrangement are designed to provide output to the parties, it is an
indication that the parties have rights to substantially all the economic benefits of the assets
of the arrangement. Parties to such arrangements often ensure their access to the output of
the arrangement by preventing sales to third parties. The effect of such an arrangement is
that the liabilities incurred by the arrangement are settled only by the cash flow received
from the parties through their purchases of the output. When the parties are the only source
of cash flow contributing to the continuity of the operations, this indicates that the parties
have an obligation for the liabilities of the arrangement and thus such an arrangement is
classified as a joint operation.
Example 27.2
.2 Joint arrangement as a separate company
Rain Ltd and Snow Ltd contractually agreed to have joint control over Ice Ltd, a newly formed
company. Rain Ltd and Snow Ltd each hold 50% of the equity shares of Ice Ltd. Rain Ltd and
Snow Ltd collectively (50% + 50%) have control over Ice Ltd and they have to act together to
direct the activities that significantly affect the returns of the arrangement. Rain Ltd and Snow Ltd
have joint control over Ice Ltd, as they have contractually agreed to share control over Ice Ltd.
Decisions about the relevant activities require the unanimous consent of Rain Ltd and Snow Ltd.
Ice Ltd is a separate juristic person incorporated in terms of the Companies Act 71 of 2008. Ice Ltd
is the legal owner of all its assets and responsible for settling its own liabilities.
Ice Ltd was formed to produce a specific type of raw material, used by Rain Ltd and Snow Ltd in
their own production processes. Ice Ltd sells the raw material to Rain Ltd, Snow Ltd and other
external parties.
Considerations for classifying this joint arrangement are as follows:
The structure of the joint arrangement: The joint arrangement is structured through a separate
vehicle, namely Ice Ltd, and it could be classified as either a joint operation or a joint venture.
The legal form of separate entity: Ice Ltd is a company and thus a separate legal person. The
assets and liabilities of Ice Ltd are its own (and not the assets and liabilities of Rain Ltd and
Snow Ltd). Rain Ltd and Snow Ltd only have an equity interest in the net assets of Ice Ltd.
The terms of the contractual arrangement do not modify the rights and obligations as
determined by the legal form of Ice Ltd.
Other facts and circumstances do not give Rain Ltd and Snow Ltd rights to the assets and
obligations for the liability of Ice Ltd. Ice Ltd also sells the raw material to other external parties
(see below).
The joint arrangement is classified as a joint venture.
However, if Rain Ltd and Snow Ltd agreed to exclusively buy all the output produced by Ice Ltd (no
sales to other parties), this might indicate that the joint arrangement is to be classified as a joint
operation. Rain Ltd and Snow Ltd have rights to all the output of Ice Ltd and therefore have rights
to all the economic benefits of the assets of Ice Ltd. Ice Ltd has no other sources to fund the
settlement of its liabilities and Rain Ltd and Snow Ltd effectively have the obligation to fund the
settlement of Ice Ltd’s liabilities. The joint arrangement is classified as a joint operation.

The following table is a summary of the accounting treatment of joint arrangements:
Financial statements Consolidated Separate
Joint operation Recognise own assets, liabilities and transactions, including its
share of those incurred jointly
Joint venture Equity method, IAS 28 Cost/Financial asset, IFRS 9
Investments in Associates Financial Instruments
and Joint Ventures or
equity method, IAS 28
Investments in Associates
and Joint Ventures
27.5.1 Joint ventures

A joint venturer shall recognise its interest in a joint venture as an investment and shall
account for that investment by applying the equity method in accordance with IAS 28
Investments in Associates and Joint Ventures.
The equity method is an accounting method in terms of which the interest in a joint venture
is initially recorded at cost and is subsequently adjusted for the venturer’s share of the
post-acquisition share of net assets of the joint venture. Refer to chapter 25 for a detailed
discussion and explanation of the equity method.
If a party only participates in a joint arrangement and does not have joint control, the interest
in the arrangement must be accounted for in accordance with IFRS 9 Financial Instruments,
or IAS 28 Investments in Associates and Joint Ventures if it has significant influence.
27.6 Disclosure
IFRS 12 Disclosure of Interests in Other Entities applies to entities that have an interest in a
subsidiary, joint arrangements and/or associates. The disclosure requirements of joint
arrangements are addressed in IFRS 12.7 to .9 and .20 to .23. An entity must disclose
information to enable users of the financial statements to evaluate the nature, extent and
financial effects of its interests in joint arrangements, including the nature and effects of
contractual relationships with other investors with joint control, as well as the nature of and
changes in the risks associated with these investments.
An entity must disclose information about significant adjustments and assumptions made in
determining:
whether the entity has joint control of an arrangement or significant influence over
another entity; and
the type of joint arrangement (namely a joint operation or joint venture) if the
arrangement was structured through a separate vehicle.
Since joint ventures are equity accounted for in terms of IAS 28 Investments in Associates
and Joint Ventures, all disclosure requirements relating to joint ventures are discussed in
chapter 25, and are not repeated in this chapter.
The following disclosure requirements are applicable specifically to joint arrangements that
are both joint operations and joint ventures:
The following information must be disclosed separately for each joint arrangement (which
includes joint operations and joint ventures) that is material to the reporting entity:
the name of the joint arrangement;
the nature of the entity’s relationship with the joint arrangement;
the principal place of business (and country of incorporation, if applicable or different);
and
the proportion of ownership interest or participating share and, if different, the proportion
of voting rights held.
CHAPTER
28
Financial reporting for small
and medium-sized entities
(International Financial Reporting Standard for Small
and Medium-sized Entities)
Contents
28.1 Background ....................................................................................................... 848
28.2 Scope ................................................................................................................ 848
28.3 How is IFRS for SMEs different to the full IFRS standards? ............................. 848
28.4 The South African context ................................................................................. 848
847
28.1 Background
Small businesses globally may be operated in numerous different formats, for example
private companies, close corporations, partnerships, sole traders, etc. These small
businesses are run by one or more shareholders/members/partners who, along with tax
authorities and financial institutions, are the main users of the financial statements produced
by these entities – the financial statements are therefore prepared for limited purposes.
Small businesses (including small companies) therefore do not have the same financial
reporting needs as large companies.
In an attempt to address the needs of the small entities, the International Accounting
Standards Board (IASB) issued the IFRS for Small and Medium-sized entities (IFRS for
SMEs) on 9 July 2009 as an alternative framework that can be applied by eligible entities in
place of the full set of IFRSs in issue. IFRS for SMEs is much shorter and easier to apply
than the full IFRS standards.
28.2 Scope
IFRS for SMEs is intended for use by small and medium sized entities. Small and medium
sized entities are defined as those entities that:
do not have public accountability; and
publish general purpose financial statements for external users.
An entity has public accountability when its securities (debt and equity instruments) are
traded in a public market (i.e. listed companies) or it holds assets in a fiduciary
capacity for a group of outsiders (e.g. banks) as its primary business.
It is important to note that general purpose financial statements are intended for the use
of a variety of users. These users include, amongst others, creditors, investors, employees,
lenders and goverments. Financial statements that are issued solely for the use of the
owners of the business or a tax authority are not general purpose financial statements.
The Standard allows subsidiaries of parent companies using full IFRS Standards to use the
IFRS for SMEs in their own separate financial statement if the subsidiary does not have
public accountability.
A parent entity assesses its eligibility to use IFRS for SMEs in its separate financial
statements on the basis of its own status, without considering whether other group entities
have, or the group as a whole has, public accountability.
28.3 How is IFRS for SMEs different from the full IFRS?
IFRS for SMEs is simpler and shorter than the full IFRS. IFRS for SMEs is also different to
the full IFRS in the following ways:
Standards that are not relevant to smaller SMEs are omitted (e.g. earnings per share,
interim financial reporting and segment reporting);
the recognition and measurement principles for assets, liabilities, expenses and
income are simplified; and
the disclosure requirements are significantly less.
28.4 The South African context

South Africa was one of the first countries in the world to adopt IFRS for SMEs. The
Companies Act 71 of 2008 determines which companies may use IFRS for SMEs as a
financial reporting framework. According to the Act, companies with a public interest score
of below 350 which are eligible to use IFRS for SMEs according to the scope requirements
may use IFRS for SMEs as their financial reporting framework.

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HOOFSTUK

J Sturdy Assisted by: C Brittz

Editor: Lisa Sandford

Acronym Meaning / Brief explanation

Acronym Meaning / Brief explanation

Publication Title Chapter

International Accounting Standard (IAS)

Publication Title Chapter

International Financial Reporting Standards (IFRS)

Publication Title Chapter

Financial Reporting Guides (FRG)

Small and Medium-sized entities

1.2 The due process of the IASB

1.2.2 Exposure Drafts

1.2.3 Finalising a Standard

1.3 Accounting publications

IFRIC Interpretations provide guidance on the application of IFRSs and on financial

1.3.3 IFRS for SMEs

1.4 Regulatory requirements for financial reporting in South Africa

1.4.1 The Companies Act, 2008

1.4.1.3 Financial reporting of respective companies

Category of profit company Financial reporting framework

1.4.2 The King IV Report

1.4.3 The JSE Limited Listings Requirements

1.4.4 The Financial Reporting Investigation Panel

2.1.2 The purpose of the Conceptual Framework

2.2 The objective of general purpose financial reporting

2.3 Qualitative characteristics of useful financial information

The qualitative characteristics in the Framework (1989) were relevance, reliability,

2.3.1 Fundamental qualitative characteristics

2.3.2 Enhancing qualitative characteristics

2.4 Financial statements and the reporting entity

2.4.1 Objective and scope of financial statements

2.4.4 Going concern assumption

2.4.5 The reporting entity

2.5 The elements of financial statements

The elements of financial statements in the Conceptual Framework are:

Main changes in the definition of a liability:

A group or series of contracts may be designed to achieve an overall commercial effect. To

2.6 Recognition and derecognition

Income minus expenses

Measurement is quantifying, in monetary terms, elements that are recognised in financial

2.7.1 Measurement bases

The historical cost of a liability is updated over time to depict, if applicable:

Cash-flow-based measurement techniques:

2.7.2 Factors to consider when selecting a measurement basis

2.7.3 Measurement of equity

2.8 Presentation and disclosure

2.9 Concepts of capital and capital maintenance

Should capital be measured using nominal monetary units, profit represents an

2.10 Overview of the Conceptual Framework

The objective of general purpose

The elements of financial

3.1 Overview of IAS 1 Presentation of Financial Statements

PRESENTATION OF FINANCIAL STATEMENTS

Prescribes the basis for preparation of general purpose financial statements.

 All income and expense items recognised in a period are presented as

 Reconciliation of equity at the beginning of the reporting period with equity

 Basis of preparation of the financial statements.

 Fair presentation and compliance with IFRSs.

 its policy in respect of dividends;

3.4 General features

3.4.1 Fair presentation and compliance with IFRSs

All income and expense items recognised in a period are presented as

Reconciliation of equity at the beginning of the reporting period with equity

Basis of preparation of the financial statements.

Fair presentation and compliance with IFRSs.

its policy in respect of dividends;

the nature of the requirement;

two statements of cash flows;

total other comprehensive income; and

capitalisation of borrowing costs and other expenditure;

be prepared in accordance with International Financial Reporting Standards and the

Changes in working capital: Movements in working capital, in other words, changes in