Financial reporting 2: Exam essential knowledge and short summary PDF

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Financial Reporting 2Key Issues, and loopholes to be aware ofTopic IssuePPE Capital vs revenue expenditurePPE Revaluation model accountingInventory Be CAREFUL to not add these NRV costs to the initial cost of purchasing or converting or getting the goods to their present location and condition.NRV c...

Description

Financial Reporting 2 Key Issues, and loopholes to be aware of

Topic

Issue

PPE

Capital vs revenue expenditure

PPE

Revaluation model accounting

Inventory

Be CAREFUL to not add these NRV costs to the initial cost of purchasing or converting or getting the goods to their present location and condition. NRV calculation uses additional estimated costs that have not yet been incurred to make the sale. They are deducted from the selling price to give NRV.

Basic

Remember: A debit ↑ asset or expense accounts, and ↓ liability, revenue or equity accounts. A credit (right side ) ↑ increases liability, revenue or equity accounts and ↓ asset or expense accounts.

Depreciation is reducing asset value, but revaluation is increasing asset value

Carrying amount/ NBV

Compared with fair value when doing revaluations

Once asset is revalued it is restated at fair value (it’s no longer stated as historical cost, but it’s new current cost) ● Subsequent (new) depreciation is based on this “new fair value” ● At that point when we recalculate depreciation expenses we are using IAS 8 (changes in estimates)

WEEK 2: PPE

Tangible, Non-current (Long term assets used >1 year) benefiting more than one accounting period therefore are depreciated over useful life capitalised and recorded as assets on the balance sheet.

Acquisition: All costs necessary to bring asset to condition and location necessary for its intended use

capitalised= cost is recorded as a fixed asset in balance sheet, instead of an expense in SoPL

Accounts in PPE: -Equipment -Cash -Repairs and Maintenance (expensed) i.e. costs of day to day servicing Definition: - IAS 16 → Tangible, non current asset expected to be used > 1 year - IAS 16 only includes assets held for use e.g. operations, rental, or administrative purposes that bring future economic benefits: -

Land Buildings (factories/ distribution centres / warehouses / offices) Mines/ Quarries, Oil rigs/ drilling platforms

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Machinery/Plant

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Motor vehicles (cars / delivery vans / lorries)

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Office equipment (e.g printer)

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Computer equipment (PC/ Laptop)

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Construction Vehicles

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Aircraft

Measurement related standards : Initial PPE cost may include Government grants (IAS 20)

may be deducted from initial cost of PPE E.g. actual transfer of asset (plot of land), or cash given Recognition criteria for government grant: Only if “Reasonable assurance” that

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Company will comply with conditions attached to the grant Grant will be received

2 methods for accounting for them: - Deferred income approach

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Intial PPE cost may include Borrowing costs IAS 23

Netting off method

Any borrowing costs that are directly attributable to the acquisition or construction of a qualifying asset are capitalised as included as part of the cost of the asset

E.g. interest on bank overdrafts, borrowings, finance charge on leases, exchange differences on foreign currency borrowings regarded adjustment to interest costs

Time frame is key … knowing when to start capitalising

borrowing costs and when to stop Start capitalising borrowing costs when the company: ● Incurs expenditure on the asset ● already has incurred borrowing costs ● starts undertaking activities that are necessary to prepare the asset for its intended use (e.g. construction work) Stop capitalising borrowing costs when: ● Asset is ready for use ● Or construction is substantially complete ● Should not incur interest after property is ready even if you have some borrowing left because that borrowing is no longer relevant and intended to be used for the property

Non-current assets held for sale (IFRS 5)

De-recognition from PPE, presented separately (discontinued operations disclosed separate line in SoPL)

PPE (IAS 16)

1)Special case: costs of day-today servicing= activity doesn’t improve efficiency or capacity instead helps warehouse maintain status and he operates as usual

→ written off a SoPL expense,incurred in “repairs and maintenance” account E.g. business repaint warehouse 2)Capital expenditure: increases efficiency, effectiveness of office (upgrade) = which yields future economic benefits → Once asset is capable of being operated in manner intended - no further capitalisation of costs 3)Historical cost doesn’t change 4)Decommissioning costs (PPE), other side of double entry= provision/ contingent liability set up depending on obligation type (Always discount back to present value, present value of cost= sum of discounted cash flow basis)

Depreciation Depreciable amount= asset cost (revalued amount) - residual value Residual value= = how much it is expected to be sold for (disposal) estimated costs of disposal (estimate according to expected age, and condition of asset at the end of its useful life)

Don’t depreciate land (indefinite life) - Different useful lives? Recognised separately, depreciated separately. -De-recognise one part of PPE (engine if it runs out) and Rerecognise (after purchasing new ones) and apply new depreciation expense

Not given = assume its zero Carrying amount= Net Book Value= initial cost- accumulated depreciation/ accumulated impairment losses

-Residual value is taken out before we depreciate Recognition -recognise even if fair value (residual value) > carrying amount -recognise veen when asset is continuously subject to repairs and maintenance Methods: all have annual depreciation charge 1)Straight Line Annual depreciation charge= depreciable amount/useful life 2)Reducing Balance Use NBV (calculated in last year) to depreciate against in subsequent year -Sum of digits Annual depreciation charge =depreciable amount x depreciation rate -Units of production

Investment Property (IAS 40) Cost or revaluation model Impairment of Assets (IAS 36)

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Disclose discontinued asset if it meets following criteria

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1) Asset/ Business component disposed of/ reported as held for sale 2) Component must be distinguishable as a separate business which is being removed from operation intentionally or is a subsidiary of a component that is being held with intent to sell

Recognition of PPE : - 1)Meets definition (tangible, expected held for use, or used >1 year) - 2)Held for use? (in production) - Doesn’t have to be used right away (can be held for use in the future) - 3)Probable future economic benefits associated will flow to the entity (Judgement) - Cost item can be reliably measured -

Even if it misses this recognition criteria, if it is: 4)ESSENTIAL to continue using asset/ operate the asset = It must be recognised

Initial Measurement of PPE : initial cost - Purchase of PPE (monetary) → Asset increases → Cash purchase (Asset decreases) or Credit purchase (Liability increases) - Purchase of PPE (non-monetary) - Initial Asset is measured at fair value (measured reliably) -

Initial cost includes all costs directly attributable, to bringing the asset to its current location and condition necessary to be in capable position to operate as intended by the management

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Examples of costs to include in Initial PPE measurement: - Purchase price of asset (any discounts they need to deduct)= net trade discounts - Import duties, taxes - Costs of site preparation - Delivery of asset, handling costs - Installation and assembly costs (by professionals) - Wages, salaries of professionals/existing employees relating to the acquisition/construction/installation of asset

(identify the portion of their current salaries and working hours that goes into preparing such a machine, only that portion is capitalised) -

Costs of testing machine, see if it’s working the way we want it to Decommissioning costs (contract signed= = gives rise to an obligation to dismantle and remove the item at the end of use to restore the site) (estimate the cost, as this cost is incurred in the future,consider time value of money (present value of cost= sum of discounted cash flow basis) Double entry= Dr PPE (decommissioning costs) Cr Corresponding liability set up under IAS 37 Provisions

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Examples of costs to not include in initial measurement: Operational reorganisation costs (happening at the same time you purchase the machine) Generating laws that build asset capacity Losses incurred from building new asset Abnormal costs relating to acquisition , construction or installation ( if another entity installed the same machine, to keep the cost of the same PPE are comparable, we should not include abnormal costs that are specialised to the entity )

What costs to include in initial cost of the asset: Capital vs Revenue Expenditure - Expense costs that maintain the asset in SoPL in period incurred (happen frequently throughout life of asset) i.e. costs of day-to-day servicing, labour,ordinary repairs,routine maintenance (oil changes)

- Capital expenditure = Capitalise costs that extend the life of the asset or increase the productivity/ efficiency of the asset - (costs are added to the long term asset, these are investments in PPE) - ONLY CAPITALISE TILL asset is capable of being operated in the manner intended i.e. upgrade in office space

- IAS 16 special case small parts- can be spare parts (like nuts and bolts) - Either capital expenditure (expected use >1 year/ used especially in the production of that particular asset ) - Expense in P/L if Day-to-day servicing (screws and bolts that can be used everywhere not specific to the asset)

After initial measurement: Accounting for depreciation → Expense increases (SoCI,measures profit/loss) → Negative Asset, asset reduces in value (SoFP) Depreciation is the USE of an asset for a specific duration of time, therefore you record an expense for the time period(1m, 2m…) only when you’re using the asset during the financial year -

Using this table below can be helpful for longer calculations Cost

Depreciation

Accumulated Depreciation

Carrying Amount

Carrying amount (book value)= Asset cost - accumulated depreciation -The methods of depreciation 1)Straight Line: a regular amount of depreciation written off over each period of asset’s useful life (COST is used as the basis of calculation) 2) Reducing balance 3)Sum of digits 4)Units of production Company chooses method, which reflects pattern in which asset future economic benefits will be consumed (fair and faithful view), apply IAS 8 for future prospectively (change in estimate) if method of depreciation is changed

Accounting for borrowing costs - Make sure cost is comparable and consistent between 2 companies,total cost for Company A= total cost for Company B

Company A building a qualifying asset (total cost inclusive of borrowing costs) 1.2 million = company B acquiring property from property developer for 1.2 million Accounting for government grants :

Method

Basically

Deferred Income

Netting off

recognise your asset cost

You receive the grant from

as usual but recognize the buying the asset, you pay grant gradually at the less for the asset → less same time you depreciate your asset.

asset cost.

Treatment of grant and asset cost

As two different things

Combine

Income recognition

Debit deferred income, reduces it in subsequent period as you use it up,and credit your income in SoPL as it increases

Recognised through reduction in depreciation expense

Intial Cost

Cost of ppe without grant

carrying amount (usually initial cost of asset )grant cost

Method

1)keep cost of PPE without grant 2) establish deferred income account 3)in subsequent period depreciate asset as normal

Initial cost- grant cost= net cost of grant

Initial cost/ useful life= depreciation expense per year 4) Release grant income each year following same systematic basis Total grant/ useful life= grant income credited each year to SoPL 5)Net expense= depreciation expense per year- grant income per

In subsequent period depreciate PPE based o net cost of grant Net cost of grant/ useful life = depreciation expense

year Effect on net expense

Same net expense in both methods

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✅ gives more info, breakdown of grant income and depreciation expense

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✅ less info ✅ initial cost of asset less comparable to other companies who don’t have gov grants ✅ Impairment may be less problem because carrying amount is already lower than market value (from deducting the grant cost)

Disclosures: Financial statements will summarise the accounting information but we need to refer to the details in the disclosures of the financial statements -useful life of asset -depreciation method

Depreciation: -

WEEK 3: Impairment of assets & testing Fair and faithfully representative view: don’t include PPE at excess amounts of what can expect to be recovered from use in future periods. Assets are carried at no more than recoverable amount - This is either through use OR through a sale Asset value = LOWER OF carrying amount OR recoverable amount If recoverable amount is LESS than carrying amount = IMPAIRED ASSET - Debit. Impairment loss (SoPL) - Credit. Asset (carrying amount) If recoverable amount is MORE than carrying amount - don’t recognise profit until realised (sold)

TESTING FOR IMPAIRMENT Test when there are indications of impairment loss. 3 exceptions for testing based on ‘indications’ (MUST test annually) - Intangible assets with indefinite useful life - Intangible assets not yet available for use - Goodwill on acquisition INDICATIONS OF IMPAIRMENT External: - Declining market value - Adverse changes in business/economic/legal environment - Increase in market interest rates (affects value in use - DCF) - Decline in company market capitalisation - Competitor actions Internal: - Physical damage - Changes to company operations that affect remaining useful life - Reorganisation of business

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Internal data indicating worse economic performance of asset than expected Idle/unused asset Change of use Loss of key employees Poor asset performance/operating losses in asset’s business area

IMPAIRMENT TEST: Value asset at LOWER of carrying amount and recoverable amount Carrying amount = Book value (depreciated cost OR depreciated revalued amount) Recoverable amount = HIGHER OF value in use (PV of future cash flows) OR fair value minus costs to sell Value in use: - Difficult to estimate for single asset: done for cash generating units (CGUs) instead - Assets shared between CGUs allocated to CGUs on a reasonable and consistent basis Fair Value less costs to sell: - Include costs: legal, stamp duty, taxes, removal costs, incremental costs of bringing into a condition for sale - Exclude costs: general organisational costs

ACCOUNTING FOR IMPAIRMENT:

Cost model: impairment is written off to P/L - Debit. Impairment loss (SoPL) - Credit. Asset carrying amount (accumulated depreciation) Revaluation model: For asset carried at revalued amount and where a revaluation surplus exists in relation to the asset: - Impairment loss = DECREASE IN REVALUATION (to the extent surplus exists) -

Debit. Revaluation surplus Debit. Impairment loss (So PL)

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Credit. Asset Carrying Amount (accumulated depreciation)

Revaluation model & impairment test are 2 different issues ACCOUNTING FOR REVERSAL OF IMPAIRMENT LOSS - Company realises impairment losses in previous periods have decreases/no longer exist (increase in asset’s service potential) - Recoverable amount estimated and compared to carrying amount Dr Asset carrying amount Cr SoPL -

Only to the extent that the increased carrying amount doesn’t exceed original carrying amount before the INITIAL impairment

WEEK 3 LIVE LECTURE: -

Investment property Non-current assets held for sale Disclosures

INVESTMENT PROPERTY Land, buildings and other property held: - To earn rentals - For capital appreciation RATHER THAN use in production/supplying goods/sale in ordinary course of business 1) 2) 3) 4)

Held for long term capital appreciation Held for undetermined future use Building owned by company and leased out Property being constructed or developed for future use

Accounting for investment property (similar to PPE) - Measure initially at cost - Subsequent expenditure can be capitalised (same criteria) - Apply either value value model or cost model Fair value model: (prefered by IASB - more relevant info) - Carrying amount = FV (must be assessed annually) - Changes in FV pass through P/L: no depreciation or impairment losses

Cost model - Cost LESS Accumulated depreciation Less accumulated impairment loss

NON-CURRENT ASSETS HELD FOR SALE Classified as held for sale if carrying value will be recovered principally through SALE TRANSACTION rather than use in business Applies to non current assets OR disposal groups (group of assets to be disposed together in a single transaction) ALL CRITERIA MUST BE MET: - Management is committed to sell - Asset is available for immediate sale in present condition - Sale is highly probable & likely to be done within a year - Asset being actively marketed at reasonable price - Unlikely of any significant change to the plan Accounting for non-current assets held for sale: - Measured at LOWER of carrying value and FV less costs to sale - May result in impairment - Assets are not depreciated - Separate line on SoFP - not treated as revalued assets (IAS 16)

INTANGIBLE ASSETS: Definition: - Identifiable - Separable (capable of being separated/divided from the entity) I.e. can be sold, transferred = licensed, rented or exchange - Arises from contractual rights (patents, franchise agreements) Recognition : - If probable flow of economic benefits ( > 50% ) - Reliable measurement - CONTROL important in restricting benefits from third parties (i.e. loyal customer base not very controllable)

IAS 38- categorises intangible assets as: 1)Externally Purchased Assets (buy a single asset) 2)Acquired as part of a business combination -separately identified on acquisition - goodwill on acquisition 3) Internally generated assets NOTE: Recognition and measurement methods are determined by category

Category 1/2: Acquired externally/part of business combination -

Recognised at acquisition date

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Measured initially at cost (cost of bringing asset to current condition + capitalising additional costs)

IF intangible asset = identifiable and measured reliably THEN recognise on consolidated f/s at FAIR VALUE IF NOT include in “Goodwill on acquisition” amount Goodwill on acquisition (asset) = Purchase price - FV of separable net assets - Always deemed to have an indefinite life - Not amortised but tested annually for impairment

Category 3: Internally generated Systems, processes, knowledge, expertise, skills of employees -developed within a business as it operates daily - always question: can the costs be distinguished from the cost of maintaining or enhancing the entity internally generated goodwill or running of day-to-day operations Definition - if controlled as result of past events, from which economic benefi...