F7 notes for acca PDF

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F7 – FINANCIAL REPORTING (INT) REVISION NOTES

F7 Revision notes

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TABLE OF CONTENTS The conceptual and regulatory framework for financial reporting IAS 1 Companies - Basic adjustments IAS 16 IAS 38 – Intangible assets IAS 36 – Impairment of assets IAS 40 – Investment property IAS 2 – Inventories IAS 41 – Agriculture IAS 8 – Accounting policies, Changes in accounting estimates and Errors IAS 23 – Borrowing cost Financial Instruments IAS 37 – Provisions, Contingent liabilities and Contingent assets IFRS 16 – Leases IFRS 13 – Fair value measurements IAS 20 - Government grants IAS 10 – Events after reporting date IAS 12 – Income taxes IFRS 15 – Revenue from contract with customers IAS 7 – Statement of cashflows IFRS 5 – Non-current assets held for sale and discontinued operations IAS 21 – The effects of changes in foreign exchange rates IAS 33 – Earnings per share Consolidated Financial Statements Consolidated statement of financial position Consolidated statement of profit or loss IAS 28 – Investment in Associates Disposal of investment Ratio analysis Not for profit & Public sector entities

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3 8 12 14 17 20 23 26 28 30 32 33 39 42 45 48 50 52 55 60 63 65 67 71 73 76 78 80 81 89

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THE CONCEPTUAL AND REGULATORY FRAMEWORK FOR FINANCIAL REPORTING CONCEPTUAL FRAMEWORK The IFRS Framework describes the basic concepts that underlie the preparation and presentation of financial statements for external users. A conceptual framework can be seen as a statement of generally accepted accounting principles (GAAP) that form a frame of reference for the evaluation of existing practices and the development of new ones.

Purpose of framework Assist in the development of future IFRS and the review of existing standards by setting out the underlying concepts Promote harmonisation of accounting regulation and standards Assist the preparers of financial statements in the application of IFRS and dealing with accounting transactions for which there is not (yet ) an accounting standard

Advantages of a conceptual framework Financial statements are more consistent with each other Avoids firefighting approach and a has a proactive approach in determining best policy Less open to criticism of political/external pressure Has a principles based approach Some standards may concentrate on effect on statement of financial position; others on statement of profit or loss

Disadvantages of a conceptual framework A single conceptual framework cannot be devised which will suit all users Need for a variety of standards for different purposes Preparing and implementing standards may still be difficult with a framework The purpose of financial reporting is to provide useful information as a basis for economic decision making.

Qualitative characteristics of useful financial information They identify the types of information likely to be most useful to users in making decisions about the reporting entity on the basis of information in its financial report.

Fundamental qualitative characteristics Relevance Relevant financial information is capable of making a difference in the decisions made by users if it has predictive value, confirmatory value, or both. Materiality is an entity-specific aspect of relevance based on the nature or magnitude (or both) of the items to which the information relates in the context of an individual entity's financial report Faithful representation Information must be complete, neutral and free from material error

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Enhancing qualitative characteristics Comparability Comparison with similar information about other entities and with similar information about the same entity for another period or another date: Verifiability It helps to assure users that information represents faithfully the economic phenomena it purports to represent. Verifiability means that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement Timeliness It means that information is available to decision-makers in time to be capable of influencing their decisions. Understandability Classifying, characterising and presenting information clearly and concisely. Information should not be excluded on the grounds that it may be too complex/difficult for some users to understand The IFRS framework states that going concern assumption is the basic underlying assumption The five elements of financial statements Asset: An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Liability: A liability is 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. Equity: Equity is the residual interest in the assets of the entity after deducting all its liabilities. Income: Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. Expense: Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

Recognition of the elements of financial statements Recognition is the process of incorporating in the statement of financial position or statement of profit or loss an item that satisfies the following criteria for recognition: The item that meets the definition of an element It is probable that any future economic benefit associated with the item will flow to or from the entity and The item’s cost or value can be measured with reliability.

Application of recognition criteria An asset is recognised in the statement of financial position when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably. A liability is recognised in the statement of financial position when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably.

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Income is recognised in the income statement when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. Expenses are recognised when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably.

Measurements of elements in financial statements The IFRS Framework acknowledges that a variety of measurement bases: Historical cost Current cost (Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently) Net realisable value (The amount of cash or cash equivalents that could currently be obtained by selling an asset in an orderly disposal) Present value (A current estimate of the present discounted value of the future net cash flows in the normal course of business) Fair value (As per IFRS 13)

HISTORICAL COST ACCOUNTING The application of historical cost accounting means that assets are recorded at the amount they originally cost, and liabilities are recorded at the proceeds received in exchange for the obligation.

Advantages Simple to understand Figures are objective, reliable and verifiable Results in comparable financial statements There is less possibility for manipulation by using 'creative accounting' in asset valuation.

Disadvantages The carrying value of assets is often substantially different to market value No account is taken of inflation meaning that profits are overstated and assets understated Financial capital is maintained but not physical capital Ratios like Return on capital employed are distorted It does not measure any gain/loss of inflation on monetary items arising from the impact Comparability of figures is not accurate as past figures are not restated for the effects of inflation

STANDARD SETTING PROCESS The due process for developing an IFRS comprises of six stages: 1. 2. 3. 4. 5. 6.

Setting the agenda Planning the project Development and publication of Discussion Paper Development and publication of Exposure Draft Development and publication of an IFRS Standard Procedures after a Standard is issued

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REGULATORY FRAMEWORK International Financial Reporting Standards Foundation (IFRS Foundation) Responsible for governance of standard setting process. It oversees, funds, appoints and monitors the operational effectiveness of:

IFRS Advisory Council (IFRS AC) Provide advice to IASB on: their agenda and work prioritization the impact of proposed standards Provides strategic advice

International Accounting Standards Board (IASB) Develop new accounting standards Liaise with national standard-setting bodies to promote convergence of international and national accounting standards

International Financial Reporting Standards Interpretations Committee (IFRS IC) Assist the IASB to establish and improve standards Issues Interpretations (known as IFRICs) which provide timely guidance on emerging accounting issues not addressed in full standards Assist in the international/national convergence process

PRINCIPLES VS RULES-BASED APPROACH Rules-based accounting system Likely to be very descriptive Relies on a series of detailed rules or accounting requirements that prescribe how financial statements should be prepared Considered less flexible, but often more comparable and consistent, than a principles-based system Can lead to looking for ‘loopholes’ Principles-based accounting system It relies on generally accepted accounting principles that are conceptually based and are normally underpinned by a set of key objectives More flexible than a rules-based system Require judgement and interpretation which could lead to inconsistencies between reporting entities and can sometimes lead to the manipulation of financial statements Because IFRSs are based on The Conceptual Framework for Financial Reporting , they are often regarded as being a principles-based system.

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PAST EXAMS ANALYSIS Topic

Framework

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Exam Attempt Sept. 16 Spec. exam Sept. 16 June 15 Dec. 14 Dec. 13 Dec. 12 June 12 June 11

Question MCQ. 1,9 MCQ.4, 13 MCQ.1,6 MCQ.3,5,7,20 Q.4 (a) Q.4(a) Q.5 Q.4 (a)

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PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES IAS 1 Presentation of financial statements A complete set of financial statements comprises: A statement of financial position either – A statement of comprehensive income, or – A statement of profit or loss and other comprehensive income A statement of changes in equity A statement of cash flows Accounting policies and explanatory notes

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The Statement of Financial Position A recommended format is as follows: XYZ Group Statement of Financial Position as at 31 December 20X7 Assets Non-current assets: Property, plant and equipment Intangible assets

$

$

X X X

Current assets: Inventories Trade receivables Cash and cash equivalents

X X X X

Total assets Equity and liabilities Capital and reserves: Share capital Retained earnings Other components of equity

X

X X X X X

Total equity Non-current liabilities: Long-term borrowings Deferred tax

X X X

Current liabilities: Trade and other payables Short-term borrowings Current tax payable

X X X

Short-term provisions

X

Total equity and liabilities

X X

Current assets include all items which: Will be settled within 12 months of the reporting date, or Are part of the entity's normal operating cycle. Within the capital and reserves section of the statement of financial position, other components of equity include: Revaluation reserve General reserve

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Statement of changes in equity The statement of changes in equity provides a summary of all changes in equity arising from transactions with owners in their capacity as owners. This includes the effect of share issues and dividends. XYZ Group Statement of changes in equity for the year ended 31 December 20X7 Share

Share

Revaluatio

Retained

Total

n capital

premium

surplus

earnings

equity

$

$

$

$

$

X

X

X

X

X

(X)

(X)

accounting policy

__

__

__

__

Restated balance

X

X

X

X

X

(X)

(X)

Balance at 31 December 20X6 Change in

Dividends Issue of share

X

X

X

Capital Total

X

X

X

(X)

X

-

Comprehensive income for the year Transfer to retained earnings Balance at 31

__

__

__

__

X

X

X

X

X

December 20X7

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Statement Of Profit Or Loss And Other Comprehensive Income A recommended format for the statement of profit or loss and other comprehensive income is as follows: XYZ Group Statement of profit or loss and other comprehensive income For the year ended 31 December 20X6 $ Revenue

X

Cost of sales

(X)

Gross profit

X

Distribution costs

(X)

Administrative expenses

(X)

Profit from operations Finance costs Profit before tax Income tax expense Net Profit for the period

X (X) X (X) X

$ Profit for the year

X

Other comprehensive income Gain on property revaluation Income tax relating to components of other comprehensive income

X (X)

Other comprehensive income for the year, net of tax

X

Total comprehensive income for the year

X

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COMPANIES – BASIC ADJUSTMENTS TYPES OF SHARES There are a number of different types of shares which companies may issue. Ordinary shares Preference shares There are two types of preference share: Irredeemable preference shares exist, much like ordinary shares. The amount issued in form of Irredeemable preference shares is not payable after a fixed period. Redeemable preference shares are issued for a fixed term. At the end of this term, the shareholder redeems their shares and in return is repaid the amount they initially bought the shares for (normally plus a premium). In the meantime they receive a fixed dividend. ACCOUNTING FOR A SHARE ISSUE The accounting entry to record the issue of shares is: Dr Cash

Proceeds received

Cr Share capital

Nominal value of shares issued

Cr Share premium

Premium on issue of shares.

ACCOUNTING FOR A RIGHTS ISSUE A rights issue is an issue of new shares to existing shareholders in proportion to their existing shareholding. The issue price is normally less than market value to encourage shareholders to exercise their rights and buy shares. Dr Cash

Proceeds received

Cr Share capital

Nominal value of shares issued

Cr Share premium

Premium on issue of shares.

ACCOUNTING FOR A BONUS ISSUE A bonus issue is an issue of new shares at no cost to existing shareholders, in proportion to their existing shareholding. An issue of this type does not raise cash, but is funded by the existing share premium account (or retained profits if the share premium account is insufficient), and accounted for by: Dr Share premium/Retained profits Cr Share capital

Nominal value of shares issued Nominal value of shares issued

LOAN NOTES A company can raise finance either through the issue of shares or by borrowing money. An issue of loan notes is recorded by: Dr

Cash Cr

Loan notes (non-current liability)

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Interest paid on the loan notes is recorded by: Dr

Finance cost (interest expense)

Cr

Cash / accrual Finance cost is charged on effective rate of interest Cash paid is as per the nominal rate of interest The differential amount becomes a part of the closing liability of loan

DIVIDENDS Ordinary dividends

= No. of shares x Per share dividend

Preference dividends = Amount of preference shares x % of dividend

PAST EXAMS ANALYSIS Topic

Basic adjustments – Companies

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Exam Attempt Dec. 15 June 15 Dec. 14 June 14 Dec. 13 June 13 Dec. 12 June 12 June 11

Question Q.1 (iv), (vii) MCQ.19 Q.3(i),(ii) Q.2(i) Q.2 (iii),(v) Q.2 (v) Q.2(v) Q.2(ii),(iii) Q.2 (i) Q.2 (i)

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IAS 16 – PROPERTY, PLANT AND EQUIPMENT Objective: The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and equipment.

Definitions: Property plant and equipment are intangible assets that: Are held for use in the production or supply of goods or services ,for rental to others, or for administrative purposes; and Are expected to be used during more than one year. Carrying amount is the amount at which an asset is recognized after deducting any accumulated depreciation and accumulated impairment losses Depreciation is systematic allocation of the depreciable amount of assets over its useful life. Depreciable amount is the cost of an asset less its residual value. Residual Value is the estimated amount that an entity can obtain when disposing of an asset after its useful life has ended. When doing this the estimated costs of disposing of the asset should be deducted.

Recognition: PPE are recognized if It is probable that future economic benefits associated with the item will flow to the entity; and The cost of the item can be measured reliably. Aggregation and segmenting This IAS does not provide what constitute an item of property, plant and equipment and judgment is required in applying the recognition criteria to specific circumstances or types of enterprise. That is: i. ii.

It may be appropriate to aggregate individually insignificant items, such as moulds, tools dies, etc. It may be appropriate to allocate total expenditure on an asset to its component parts and account for each component separately e.g. an aircraft and its engines.

Initial measurement: PPE are initially recognized at the cost. Elements of costs comprise:  Its purchase price  Any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating,  The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located (the present value of dism...