2

Module 5: What you will learn

This module deals with a number of IFRS® Standards that give rise to the
recognition of liabilities:

 Fair value measurement - IFRS 13

 Financial Instruments: Presentation - IAS 32, Recognition and measurement - IFRS 9,
Disclosure - IFRS 7
 Provisions, contingent liabilities and contingent assets - IAS 37
 Events after the reporting period - IAS 10
 Employee benefits - IAS 19
 Income taxes - IAS 12
 Shared-based payment - IFRS 2
 Agriculture - IAS 41
 Exploration for and evaluation of mineral resources - IFRS 6.
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Table of contents
Module 5: What you will learn
IFRS 13 Fair Value Measurement
Measurement Approach (IFRS 13)
Fair Value of Financial Instruments and Disclosures (IFRS 13)
Exercise - IFRS 13 Question
Financial Instruments
IAS 32 Financial Instruments: Presentation
Exercise - IAS 32 Question
IFRS 7 Financial Instruments: Disclosures
IFRS 9 Financial Instruments
Impairment of Financial Assets (IFRS 9)
Hedge Accounting (IFRS 9)
Exercise - IFRS 9 Question 1
Exercise - IFRS 9 Question 2
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
Provisions (IAS 37)
Contingent Liabilities and Contingent Assets (IAS 37)
Exercise - IAS 37 Question 1
Exercise - IAS 37 Question 2
Case study - Provisions, Contingent Liabilities and Contingent Assets
Case study Question - Provisions, Contingent Liabilities and Contingent Assets
IAS 10 Events After the Reporting Period
Exercise - IAS 10 Question 1
Exercise - IAS 10 Question 2
IAS 19 Employee Benefits
Pensions (IAS 19)
Exercise - IAS 19 Question 1
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Exercise - IAS 19 Question 2

IAS 12 Income Taxes
Exercise - IAS 12 Question 1
Exercise - IAS 12 Question 2
IFRS 2 Share-Based Payment
Exercise - IFRS 2 Question
IAS 41 Agriculture
IFRS 6 Exploration for and Evaluation of Mineral Resources
Frequently asked questions
Quick Quiz
5

IFRS 13 Fair Value Measurement

IFRS 13 establishes a single source of guidance for the fair value measurement of assets
and liabilities when this is required by other IFRS. It was issued in 2011 and became
effective in 2013.

Scope of IFRS 13
IFRS 13 does not prescribe when fair value should be used, only how to determine it
when required by another Standard.

This Standard is applicable to all transactions and balances requiring measurement

at fair value under another Standard, with the exception of:
 Share-based payments (IFRS 2)
 Leases falling within the scope of IFRS 16
 Measurements that are similar to, but are not, fair value e.g. net realisable value (IAS 2).
(IFRS 13 paragraph 6)
Definition of fair value
"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 Appendix A)

Measurement approach

In order to measure fair value the entity must determine:

1. The asset or liability to be measured
2. For a non-financial asset, the valuation premise that is appropriate for the measurement
(highest and best use)
3. The principal market or most advantageous market for the asset or liability
4. An appropriate valuation technique to use (to reflect the assumptions market participants
would use when valuing the asset or liability).
(IFRS 13 paragraph B2
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Measurement Approach (IFRS 13)

1. Asset or liability
The characteristics of the asset or liability being measured should be considered
when determining fair value if these would be relevant to buyers and sellers in the
market.

Example
Greenfield Co owns land that is subject to a legal right for an electricity company to run
power lines across it. The land could be sold for $3million without these lines and
$2.7million with them.
The legal right would be transferred to a purchaser of the land and therefore it must be
taken into account when determining fair value. Fair value is $2.7million.

2. Highest and best use

The fair value of a non-financial asset is determined based on highest and best
use from the point of view of market participants, even if the reporting entity intends a
different use.
The highest and best use must be physically possible, legally permissible and financially
feasible.
(IFRS 13 paragraph 27)

Example
Redletter Co owns land that is currently used for industrial purposes. It could be sold for
$1.5million on this basis. Nearby sites have been developed as residential sites and there
is no legal restriction to prohibit Redletter Co from selling the land for this purpose. Such
a sale would achieve a price of $1.8million. The fair value is $1.8million, based on the
highest and best use.
7

3. Principal or most advantageous market

The principal market is that with the most volume of activity for the asset or
liability. The most advantageous market is that which maximises the amount that would
be received to sell an asset (or paid to settle a liability) after taking into account
transaction and transport costs.
Fair value is determined based on the principal market; where there is no principal
market, it is based on the most advantageous market.
(IFRS 13 paragraph 16)

Example

Bluebell Co sells its product in China for $40 and in France for $38. Transaction costs
are $1 per item in China and $3 per item in France. Transport per item to China is $8
and transport per item to France is $5. If France were the principal market, the fair
value of Bluebell Co's product would be $33 ($38 less $5 transport costs, which form
part of fair value).

If there were no principal market, fair value is based on the most advantageous
market. In China, net proceeds per item would be $31 ($40 - $1 - $8). In France net
proceeds per item would be $30 ($38 - $3 - $5). Therefore China is the most
advantageous market. The fair value of Bluebell Co's product would be $32 ($40 less
$8 transport costs).

Note that transaction costs are taken into account when determining the most
advantageous market but are not part of fair value.

4. Valuation technique
IFRS 13 discusses three valuation approaches:
1. Market approach - uses prices and other relevant information generated by market
transactions involving identical or similar assets or liabilities
2. Cost approach - uses current replacement cost
3. Income approach - uses discounted future cash flows or income and expenses.

Any one, or where appropriate a combination, of these valuation techniques should be

selected and consistently applied.
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In order to use a valuation technique, 'inputs' are required. For example, an income
approach requires cash flow estimations and appropriate discount rates.

Inputs used to measure fair value are divided into three categories:

Level 1 Quoted prices in active markets for identical assets and liabilities

Level 2 Observable inputs other than those classified as level 1

Level 3 Unobservable inputs

Fair Value of Financial Instruments and Disclosures (IFRS 13)

Financial instruments

IFRS 13 includes specific guidance on measuring the fair value of financial

instruments. For example:
 When measuring fair value, assume a transfer of a liability or own equity instrument
(i.e. assume the liability remains outstanding but is passed to a 3rd party, not that the
liability is paid off or settled)
 Reflect non-performance risk where a liability is concerned (including the entity's own
credit risk).
(IFRS 13 paragraphs 34, 42)
Disclosure
Detailed disclosure requirements are prescribed by the Standard, for the most part
following the fair value hierarchy described. The disclosures are both qualitative and
quantitative.
9

Exercise - IFRS 13 Question

whether the following inputs to valuation techniques are Level 1 or Level 2 or Level 3,
in the IFRS 13 fair value hierarchy.
 10

Financial Instruments

The topic of financial instruments is sufficiently complex that it is split into 3 standards:
 IAS 32, which deals with presentation issues
 IFRS 9, which deals with recognition and measurement
 IFRS 7, which deals with disclosure

IFRS 9 is a new Standard, issued in full in 2014 and effective for accounting periods
beginning on or after 1 January 2018. It was developed over a number of years in response
to calls for less complex accounting for financial instruments. The Standard replaces IAS
39 Financial Instruments: Recognition and Measurement.

Definitions
Key elements of definitions are provided below. For full definitions refer to paragraph 11
of IAS 32.
Financial instrument - any contract that gives rise to a financial asset in one entity and a
financial liability or equity instrument of another entity (e.g. debentures are a financial
instrument as the issuing company has a liability and the investing entity has a financial
asset, or right to receive cash).

Financial asset - cash, an equity instrument of another entity (i.e. an investment) or a

contractual right to receive cash (e.g. trade receivables).

Financial liability - a contractual obligation to deliver cash or another financial asset to

another entity.

Equity - any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities.

Note that investments in subsidiaries, associates and joint ventures and employee benefit
obligations are excluded from the scope of IAS 32 and IFRS 7.
Financial instruments may be primary instruments (e.g. amounts receivable or payable,
loans, equity investments) or they may be derivative instruments. A derivative financial
instrument derives its value from the price or rate of an underlying item e.g. forward
contracts.
11

IAS 32 Financial Instruments: Presentation

IAS 32 Presentation of Financial Instruments establishes the principles for classifying

financial instruments into financial assets,
financial liabilities and equity.

Equity or liability?

Financial instruments used to raise funds must be classified as either equity or

liability.Determining whether an instrument is equity or a liability is not always
straightforward and IAS 32 requires that the substance of the contractual arrangement is
considered. The critical feature of a liability is an obligation to deliver cash or another
financial instrument.
Classification of shares
 If an entity has issued preference shares that are redeemable on a specified date then the
shares must be treated as a liability
 If an entity has issued ordinary shares, it has no contractual obligation to pay a dividend
and so the shares are equityDOn
 If an entity has issued irredeemable preference shares these may be equity (if there is no
contractual obligation to deliver cash) or may be a liability (if there is a contractual
obligation to deliver cash).

Convertible instruments
Most convertible loan stock and convertible preference shares are classified as
compound instruments and so are 'split accounted'.
The instrument is split into a liability and an equity component at initial recognition and
each is accounted for separately. This reflects the economic reality that the instrument has
characteristics of both debt and equity.
The liability component is measured at the present value of the cash flows associated with
a similar liability with no conversion rights attached. The difference between this figure
and the value of the compound instrument as a whole is the value of the equity part.
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Example
On 1 January 20X0, an entity issues convertible loan notes for $500,000. Interest is
payable annually in arrears at 6%. The market rate of interest for similar loan notes
with no conversion rights attached is 7%. The loan notes are redeemable on 31
December 20X3.

The liability component is initially measured at:

Date Cash Flow Discount Present value
factor
31.12.X0 (30,000)* 1/1.07 $28,037
31.12.X1 (30,000)* 1/1.072 $26,203
31.12.X2 (30,000) 1/1.073 $24,489
31.12.X3 (530,000) 1/1.074 $404,334
$483,063

*$500,000 x 6% = $30,000
Therefore the equity component is $500,000 - $483,063 = $16,937
On 1 January 20X0, the entity will record a liability equal to $483,063 and $16,937 in a
separate reserve in equity, which represents the value of the option to convert to shares
at a later date.
Subsequently the discount of 7% will unwind, creating a finance charge each year in
the statement of profit or loss and increasing the value of the liability in the statement
of financial position. Each annual payment of interest at 6% (i.e. $30,000) will reduce
the liability. (In addition IFRS 9 rules will probably require the liability to be
remeasured to fair value).

Note that not all convertible instruments are split accounted; any convertible
instrument that could not result in an exchange of a fixed number of shares for
a fixed amount of debt is classified as a liability in its entirety (e.g. convertible debt
denominated in foreign currency)
Interest and dividends
The presentation of the returns on financial instruments should follow the above
classifications. For example, any instrument recognised as debt should have a return
recognised as a finance cost, even if it is legally called a dividend.
Offsetting

Offsetting of financial assets against financial liabilities is only allowed when there is
a legally enforceable right of set off which the entity intends to use.
13

Exercise - IAS 32 Question

Simpson Co issued $2.5 million 5% convertible preference shares at par on 1 January

20X5. Dividends are payable annually in arrears. The market interest rate for similar
debt without conversion rights is 8%. On 1 January 20X5, Simpson Co's account applied
IAS 32 and split the preference shares into a liability element of $2,307,137 and an equity
element of $192,863.
Fill in the amounts in the boxes below to complete the sentences.
Click on the 'Check Answer' button to see if you are correct.

The total charge to profit or loss in respect of the convertible preference shares in the year
ended 31 December 20X5 is

The total charge to profit or loss in respect of the convertible preference shares in the year
ended 31 December 20X5 is

and the carrying amount of the liability at that date is

The carrying amount of the equity element at 31 December 20X5 is

The carrying amount of the equity element does not change over the term of the shares.
The liability element at the year end is calculated as follows:

Finance cost Dividend paid

b/f c/f
for year at 8% at 5%
Year ended 31
2,307,137 184,571 (125,000) 2,366,708
December 20X5
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IFRS 7 Financial Instruments: Disclosures

IFRS 7 specifies financial instrument disclosures. IFRS 13 disclosures are also relevant
where a financial instrument is measured at fair value.
An entity must group its financial instruments into classes of similar
instruments and, when disclosures are required, make disclosures by class.

The two main categories of disclosures required by IFRS 7 are:

a. Information about the significance of financial instruments
b. Information about the nature and extent of risks arising from financial instruments

IFRS 9 Financial Instruments

IFRS 9 deals with the recognition and measurement of financial assets and liabilities, the
impairment of financial assets and hedging.

Recognition
"An entity shall recognise a financial asset or financial liability when the entity
becomes a party to the contractual provisions of the instrument."
(IFRS 9, paragraph 3.1.1)
Note that this recognition rule differs from that seen in the Conceptual Framework for
Financial Reporting and several other Standards.

Measurement of financial asset

All financial assets are initially measured at fair value plus transaction costs with the
exception of 'financial assets at fair value through profit or loss', which are measured at fair
value only (no transaction costs).
Subsequent measurement is at:
 Amortised cost if certain conditions are met
 Fair value through other comprehensive income (FVTOCI) if certain conditions are met, or
 Fair value through profit or loss (FVTPL) otherwise or if designated as such to avoid an
accounting mismatch.
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Recognition is at amortised cost if:

 The asset is held within a business model for which the objective is to collect contractual
cash flows
 The contractual terms of the asset give rise to cash flows on specific dates that are
payments of principal and interest.

Recognition at FVTOCI if:

 The asset is held within a business model for which the objective is to collect contractual
cash flows and sell financial assets
 The contractual terms of the asset give rise to cash flows on specific dates that are
payments of principal and interest.

Therefore, normally:
 Investments in equity instruments must be measured at FVTPL as they do not result
in cash flows on specific dates
 Investments in debt instruments may be measured at amortised cost or FVTOCI or
FVTPL depending on the circumstances
 Derivatives are measured at FVTPL.

An irrevocable election may be made at initial recognition to measure an equity investment

at FVTOCI.

(IFRS 9 paragraphs 4.1.1-4.1.5)

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Gains and losses

Interest and dividend revenue on all financial assets is recognised in profit or loss.

Impairment losses on all financial assets are recognised in profit or loss.

Other gains or losses on remeasurement to fair value are recognised as follows:

Debt investment at OCI (and reclassified to profit or loss on disposal of the

FVTOCI investment)
Equity investment at OCI (but not reclassified to profit or loss on disposal of the
FVTOCI investment)
FVTPL Profit or loss

(IFRS 9 paragraphs 5.2.1-5.2.3)

Measurement of financial liabilities
There are two categories of financial liability:

 Those held for trading or designated at fair value through profit or loss (FVTPL)
 Any other financial liability.

An entity can only choose to designate a liability at FVTPL if doing so eliminates or

significantly reduces an accounting mismatch. The result is that most financial liabilities
will fall into the second 'default' category of the two listed above.

Financial liabilities are initially measured at fair value plus transaction costs with the
exception of those held for trading or designated 'at fair value through profit or loss', which
are held at fair value only (no transaction costs).

After initial recognition liabilities held for trading or those designated at FVTPL are held
at fair value. All other financial liabilities are held at amortised cost.
17

Impairment of Financial Assets (IFRS 9)

IFRS 9 uses an expected loss approach to the impairment of financial assets. This
approach results in impairments (called credit losses by IFRS 9) being recognised before
indicators of impairment exist.

The general approach to credit losses is as follows:

 At initial recognition, 12 month expected credit losses are recognised.
 Beyond this, a 3 stage approach is taken:

If credit risk has not increased significantly since initial

Stage 1
recognition, recognise 12 month expected credit losses.
If credit risk (the risk of default) has increased significantly
Stage 2 since initial recognition, recognise lifetime expected credit
losses, and calculate interest on gross asset.
If there is evidence of impairment at the reporting date,
Stage 3 recognise lifetime expected credit losses, and calculate interest
on asset net of impairment.

12 month expected credit losses are lifetime losses expected to arise from a default within
12 months.
Lifetime credit losses are expected losses arising from a default at any time in the life of
the asset.
(IFRS 9 paragraphs 5.5.1-5.5.8)

Example

On 1 January 20X4, Barkers Co purchased a debt investment, measuring it at par of

$500,000. At this date there is a 3% probability that the borrower will default, resulting
in a 100% loss.
At 31 December 20X4 it is expected that the borrower will breach loan covenants and
there is a 30% probability of them defaulting over the remainder of the term.
At 1 January 20X4 an impairment allowance of 3% x $500,000 = $15,000 is recognised
(based on 12 month credit losses).
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At 31 December 20X4, there is a significant increase in the risk of default and so the
impairment allowance is based on lifetime credit losses.
It is increased to 30% x $500,000 = $150,000.
Interest revenue continues to be calculated based on $500,000.
If the loan covenants had been breached at 31 December 20X4 (i.e. stage 3 had been
reached), interest revenue would have been calculated based on:
$500,000 - $150,000 = $350,000.

Credit losses are recognised in profit or loss and, depending on the asset, may be net off
against the carrying amount of the asset in the statement of financial position or recognised
as a separate credit balance.
(IFRS 9 paragraphs 5.5.8 and B8E)
Hedge Accounting (IFRS 9)

Hedge accounting constitutes an extra, special set of rules that can be applied to
financial instruments when an entity enters a hedging arrangement.

An entity can designate a hedging instrument so that its change in fair value is offset against
the change in fair value of a hedged item in the same statement (usually the statement of
profit or loss), thus reducing volatility in the financial statements.

For example, if an entity has committed to pay an amount of foreign currency in six months,
it might enter into a forward contract to buy the currency at a future date at a pre-determined
exchange rate. Thus it avoids the risk of the foreign currency rising in value before the date
of payment.

There are three types of hedge:

1. A fair value hedge (hedges changes in the value of a recognised asset or liability)
2. A cash flow hedge (hedges exposure to variability in future cash flows)
3. A net investment hedge (hedges exposure to changes in the value of a foreign operation).

Hedge accounting is only allowed when certain conditions are met:

 The hedging relationship consists only of eligible hedged items and eligible hedging
instruments as defined by IFRS 9
 At the inception of the hedge there is formal documentation of the relationship
 Hedge effectiveness criteria are met.
(IFRS 9 paragraph 6.4.1)
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Exercise - IFRS 9 Question 1

How can an auditor tell whether a financial asset should be measured at fair value through profit or
loss, fair value through other comprehensive income or at amortised cost?; You should refer to the text
of the Standard when answering all exercises

Exercise - IFRS 9 Answer 1

Model Answer
It is impossible to tell by looking at a financial asset (which is represented merely by
a piece of paper) whether it should be held at amortised cost or at fair value through
profit or loss.

The auditors must consider the properties of the instrument.

If the financial asset is an equity instrument, then it should be measured at fair value
through profit or loss. However, if the instrument is not held for trading, the entity has an
irrevocable option at the inception to recognise gains and losses in OCI.

If the financial asset is a debt instrument then the business model test has to be applied.
The outcome of this test will determine whether the instrument is measured at amortised
cost, FVTOCI or FVTPL.

Exercise - IFRS 9 Question 2

Ulms Co purchased two financial assets on 1 January 20X5.

The first asset is a $2 million 6% bond issued at par by Greyfox Co. The bond is redeemable on 1
January 20X7 at a premium of $200,000, and Ulms Co expects to hold the bond until maturity.
Repayments of $120,000 are made in arrears on 31 December each year. The effective rate on
the bond is 10.88%.
The second asset is 300,000 equity shares in Bruno Co, purchased for $12.50 each. At 31
December 20X5 the fair value of a share in Bruno is $16.60.
Explain how the financial instruments should be measured in the financial statements of Ulms Co.
You should refer to the text of the Standard when answering all exercises.
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Exercise - IFRS 9 Answer 2

Model Answer
The bond from Greyfox Co should be measured at amortised cost because it pays specified
amounts on specified dates, and the intention of Ulms Co is to collect those specific cash
flows rather than sell the asset.

Therefore at 31 December 20X5 the bond should be recognised as a financial asset

measured at $2,098,000 ($2 million plus interest of $217,600 (10.88%) less the cash
interest paid of $120,000). In the statement of profit or loss investment income of $217,600
arises.

The shares in Bruno Co should be measured at fair value, as they are equity instruments.
They are initially measured on 1 January 20X5 at $3.75 million (300,000 x $12.50) and at
31 December 20X5 are remeasured to $4.98 million (300,000 x $16.60). The movement of
$1.23 million is credited to the statement of profit and loss.
21

IAS 37 Provisions, Contingent Liabilities and Contingent Assets

IAS 37 deals with accounting for uncertainty.
Key definitions of IAS 37:
Provision
 A liability of uncertain timing or amount.
Liability
 Present obligation as a result of past events, for which
 Settlement is expected to result in an outflow of resources (payment).
Contingent liability
 A possible obligation depending on whether some uncertain future event occurs, or
 A present obligation that is not probable or cannot be measured reliably.
Contingent asset
 A possible asset 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.

Provisions (IAS 37)

Provisions - recognition
"A provision is a liability of uncertain timing or amount."
(IAS 37 paragraph 14)
A provision can only be recognised when three criteria are met:
1. There is a present obligation as a result of a past event
2. It will result in a probable outflow of economic benefits
3. A reliable estimate can be made of the obligation.

 A present obligation can be either legal or constructive. A legal obligation arises from
legal contracts, statute or other operation of the law. A constructive obligation arises
when an entity has created an expectation in others that it will meet certain
responsibilities
 A probable outflow of benefits is defined as 'more likely than not'. This is taken to mean
more than a 50% probability
 IAS 37 clarifies how a provision should be measured. Except in rare cases, an estimate
of an obligation that is sufficiently reliable can be made.
A provision is recognised as a current or non-current liability and the corresponding debit
is usually recognised in profit or loss.
 22

Example
Store Co operates clothes shops in a country where laws require that goods can be
returned by customers for a refund within 30 days of purchase. Store Co's advertising
slogan is 'Satisfaction guaranteed, but 90 days to return if not'.
Store Co has a liability of uncertain timing and amount: at any given date it may have to
refund goods sold in the previous 90 days. A legal obligation exists to refund goods sold
in the previous 30 days and a constructive obligation exists in respect of the other 60
days.
The related past events are sales to customers. Therefore, assuming that customer refunds
are probable and a reliable estimate can be made of the amount (probably based on past
experience), a refunds provision should be made.

Provisions - measurement
A provision must be measured at the best estimate of expenditure expected to settle the
obligation at the reporting date.
 In the case of a single obligation, the best estimate may be the single most likely
outcome or it may be higher or lower, depending on other possible outcomes
 In the case of a large population of items, expected values are used.
(IAS 37 paragraphs 36, 39, 40)

A provision should be discounted where the effect of this is material. The discount rate
should be a pre-tax rate reflecting market assessments of the time value of money and
risks specific to the liability.
(IAS 37 paragraphs 45, 47)

Changes in and the use of provisions

If a provision is increased or decreased due to a change in estimated outflow of
economic benefits, the corresponding debit or credit entry is usually made to profit or
loss.
A provision may only be used for the purpose that it was set up.
(IAS 37 paragraphs 59, 61)
23

Example
A washing machine manufacturer offers a free one year warranty with goods supplied.
In 20X1 it supplied 100,000 machines. It is expected that in 20X2 15% of these will
require minor repairs at an average cost of $50 and 4% will require major repairs at an
average cost of $150.
A provision is therefore made in the 20X1 financial statements for:
(100,000 x 15% x $50) + (100,000 x 4% x $150) = $1,350,000.

Reimbursements
Expenditure to settle a provision may be recoverable from a third party. In this case
the reimbursement is recognised as an asset only if it is virtually certain that it will be
received if the obligation is settled.
(IAS 37 paragraphs 53, 54)
Examples
 A provision may not be made for a future operating loss
 A provision should be made for the costs of an onerous contract (a contract in which
the unavoidable costs of fulfilling the contract exceed any revenue expected from it)
 A provision is made for restructuring only if there is a constructive obligation to
restructure at the reporting date (e.g. there is a formal plan that has been announced to
employees). In this case only the direct costs of restructuring are provided for
 A provision is made in respect of standard warranties (purchased extended warranties
are not within the scope of IAS 37)
 Where an entity that acquires or sets up operations in a certain location is required to
decommission its operations or restore the location at the end of the operations' useful
lives, the costs of decommissioning should be provided for. In this case the debit entry
on the setting up of the provision is recognised as part of the cost of the associated
asset in accordance with IAS 16.
 24

Example
Transit Co operates several bus routes in a foreign country. New laws were introduced
there on 1 October 20X4 requiring seatbelts to be fitted to all public buses.
Non-compliance would result in fines. The authorities have been vigilant in checking
buses and charging fines since the law was introduced.

At the year ended 31 December 20X4, Transit Co has only installed seat belts on half of
its buses. The cost to install them in the other half is $40,000. Unless the seat belts are
installed the company is liable for fines of $25,000.

In respect of the fitting of seatbelts Transit Co does not have a present obligation to pay
$40,000 as an obligating event has not occurred (i.e. the fitting of the seatbelts). It does,
however, have a present legal obligation in respect of the fines (the obligating event being
the non-compliance of Transit Co with the law). Payment is probable (given that the
authorities have been vigilant have charged fines) and therefore a provision of $25,000
should be made.

Example
Oil Co constructed an oil platform in 20X2 at a cost of $12 million. The company is
legally required to decommission the platform at the end of its useful life at a cost with
present value of $2million. The company is also legally required to restore the seabed at
this time. This is gradually eroded as oil is extracted. Restoration costs (at present value)
are estimated at $10 per barrel extracted. At 31 December 20X2, 50,000 barrels had been
extracted.

A provision is recognised at the time of construction for $2 million. This is debited to

property, plant and equipment, giving a total cost of the oil platform of $14 million.

An additional provision is made as barrels of oil are extracted. This will increase
throughout the useful life of the platform. At 31 December 20X2 it amounts to
$10 x 50,000 = $500,000. The corresponding entry is to profit or loss.

The appendix to IAS 37 includes several examples of situations in which provisions

are and are not made.
25

Contingent Liabilities and Contingent Assets (IAS 37)

Contingent Liabilities
A contingent liability is defined in two different ways:
1. Possible obligations
2. Existing obligations at the reporting date which are not recognised as liabilities either
because they will probably not lead to an outflow or are not able to be measured reliably.
(IAS 37 paragraph 10)
Contingent liabilities are not recognised but are disclosed where they are material in size
and the probability of payment is greater than remote.
Contingent Assets
A contingent asset is defined as
 A possible asset 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.
Contingent assets are disclosed if they are considered probable and otherwise they are not
represented in the financial statements.

Exercise - IAS 37 Question 1

A provision can only be recognised when there is an obligation at the reporting date. Should a provision
be recognised for the possible loss of a law case?

Exercise - IAS 37 Answer 1

Model Answer
A legal claim could be treated as a provision if three criteria are satisfied
 There is a present obligation due to a past event (the claim)
 An outflow of resources is probable (it is expected that the entity will lose the case)
 The amount can be reliably estimated (the entity has calculated an expected financial
cost of settling the claim).
If these criteria are satisfied, a liability (and related expense) are accounted for in the
financial statements.
If the advice given to the entity is that it will not necessarily lose the case, the legal claim
could also satisfy the definition of a contingent liability because:
 There is a possible obligation at the reporting date that arises from a past event (the claim)
 The existence of the liability will be confirmed by the occurrence or non-occurrence of an
uncertain future event (the ruling on the legal claim) not within the control of the entity.
Under these circumstances the claim would be disclosed in the notes to the accounts, unless
the chances of losing the case are deemed remote, in which case there would be no
disclosure.
 26

Exercise - IAS 37 Question 2

identify whether the following should be Recognised, Disclosed or Ignored when

Daleside Co is preparing the financial statements for the year ended 31 December 20X5.
Assume that all amounts are material.
27

Case study - Provisions, Contingent Liabilities and Contingent Assets

Newberg is a German company. You can see Newberg's statement of profit or loss for
20X1 and 20X2 below.
Consolidated statements of income (in billions Euro) 20X1 20X2

Sales 32 38

Cost of goods sold (10) (12)

Gross profit 22 26

Marketing and distribution (8) (10)

Research and development (5) (6)

Administrative (2) (2)

Other expenses (1) (1)

Operating profit 6 7

Non-operating income 3 3

Results before special charges and taxes 9 10

Special charges

Acquired in-process research and development - (9)

Restructuring - (6)

Taxes

On result before special charges (2) (2)

Benefit from special charges - 3

Net income (loss) 7 (4)

On the following page you can see some accounting policies and notes. The facts are
loosely based on a real case, but the company, year and exact numbers have been
changed.
 28

Extracts from significant accounting policies and notes

Basis of preparation of financial statements. The consolidated financial statements of

the Newberg Group are prepared in accordance with International Financial Reporting
Standards (IFRS Standards).

Consolidation policy. The consolidated financial statements of the Group include the
parent and the companies which it controls (subsidiaries). Control is normally evidenced
when the Group owns, either directly or indirectly, more than 50% of the voting rights
of a company’s share capital.

Changes in group organisation. On 24 June 20X2, a subsidiary of Newberg entered

into an agreement with the shareholders of Orange Co to purchase all of the issued and
outstanding common shares. Completion of the transaction was not possible until certain
regulatory clearances had been obtained. In view of the overall materiality of the
transaction and the advanced state of the integration planning, the consolidated financial
statements of the Group give effect to the acquisition of Orange Co from
31 December 20X2.
Obtaining clearance from the regulatory authorities caused a delay in completing
the transaction. These final clearances were received on 24 February 20X3 and the
purchase of the shares was completed on 10 March 20X3.

The acquisition was accounted for using the acquisition method of

accounting.Accordingly, the cost of the acquisition, including expenses incidental
thereto, was allocated to identifiable assets and liabilities and to in-process research and
development based on their estimated fair values. The portion of the acquisition cost
allocated to in-process research and development was charged in full against income.
This approach is consistent with the Group's accounting policy for research and
development costs. After consideration of these items, the excess of the acquisition cost
over the fair values was recorded as goodwill.

When you have studied the notes and table please go to the next page to see a question
relating to the case study
29

Case study Question - Provisions, Contingent Liabilities and Contingent Assets

Do you think that a provision for the costs of acquiring Orange Co should have been recognised in
Newberg's financial statements at 31 December 20X2?

Case study Answer - Provisions, Contingent Liabilities and Contingent Assets

Model Answer
According to IAS 37, a provision should be recognised when:
1. There is a probable expected outflow
2. It can be measured reliably
3. There is a past event, and
4. There is an obligation.

In this case, perhaps the first two criteria could be satisfied. It is not clear whether
there is a past event, and it seems most unlikely that there was an obligation. The latter
could only be set up by committing the company irrevocably to transferring resources to
a third party either through a legal agreement or a constructive obligation e.g. a public
announcement of the intended acquisition.

The exact facts would need to be examined and without further information a final
conclusion cannot be reached.
 30

IAS 10 Events After the Reporting Period

IAS 10 requires that in some cases the financial statements are adjusted for events
occurring after the reporting date but before they are authorised for issue. This provides
users with relevant information in a timely fashion.

The Standard deals with two types of event that occur after the reporting date:

IAS 10 provides examples of adjusting and non-adjusting events:

Adjusting
 The settlement of a court case that confirms a present obligation at the reporting date
 The receipt of information that confirms an asset was impaired at the reporting date
 The determination of cost of an asset purchased before the reporting date (or proceeds of
an asset sold before the reporting date)
 The discovery of fraud or errors meaning the financial statements are incorrect.
(IAS 10 paragraph 9)

Non-adjusting
 Acquisition or disposal of subsidiaries
 Announcement of plan to close a division
 Purchases or disposals of assets
 Destruction of property by fire or flood or similar
 Announcing or starting a restructuring
31

 An issue of shares
 Changes in tax rates
 Commencement of litigation
 Entering into commitments or issuing guarantees.
(IAS 10 paragraph 22)

If dividends on ordinary shares are declared, after the reporting date then these are
non-adjusting and should not be recognised as liabilities. They should however be
disclosed.
(IAS 10 paragraph 12,13)

If an event after the reporting period results in an entity no longer being a going
concern, then the accounts should be prepared on the break up basis. This of course
does not apply if only part of the entity is not a going concern. The reporting unit is the
whole of the entity and the status of going concern should be assessed for that whole
reporting entity.
(IAS 10 paragraph 14)

Exercise - IAS 10 Question 1

Can proposed dividends be a liability? You should refer to the text of the Standard when answering
exercises

Exercise - IAS 10 Answer 1

Model Answer

A proposed dividend could certainly be a liability if it has been approved at the

Annual General Meeting, but this will not have happened by the time that the financial
statements are prepared. This led IAS 10 to conclude that proposed dividends should not
be accrued.
 32

Exercise - IAS 10 Question 2

The following events have occurred after the year end but before the financial statements
have been authorised for issue.
33

IAS 19 Employee Benefits

The Basic Principle of IAS 19: The cost of providing employee benefits should be
recognised in the period in which the benefit is earned by the employee, rather than when
it is paid or payable.

This Standard applies to all employee benefits except those to which IFRS 2 "Share
Based Payment" applies. It deals with:
 Short-term employee benefits
 Post-employment benefits (pensions)
 Other long-term benefits
 Termination benefits.

Short-term employee benefits

These include bonuses, sick pay, holiday pay and maternity leave, and are recognised:
 As an expense when the employee provides benefit, and
 As a liability to the extent they are unpaid.
(IAS 19 paragraph 11)

IAS 19 deals specifically with short-term paid absences and for bonus plans. In each
case the Standard requires an entity to establish whether there is a liability at the reporting
date and to account for any liability. Only accumulating paid absences
(those that can be carried forward such as holiday pay) are recognised as a liability.
(IAS 19 paragraphs 16 and 19)

Long term employee benefits

Other long-term benefits are recognised in the same way as post-employee
benefitshowever all amounts are recognised in profit or loss, including remeasurements.
(IAS 19 paragraph 155)
Termination benefits
Termination benefits are recognised as a liability and expense at the earlier of:
 When the entity can no longer withdraw from the offer of termination benefits, and
 When the entity recognises costs for restructuring in line with FRS 37.

(IAS 19 paragraph 165)

 34

Pensions (IAS 19)

Post-employment benefits (Pensions)

IAS 19 deals with two types of pensions: defined contribution and defined benefit
plans. In both cases the employer (and sometimes employee) contribute to a pension plan
(which invests the contributions) throughout the employee's working life. When the
employee retires, they are entitled to a pension.

In a defined contribution plan, the employee's pension depends upon how well the pension
plan investments have performed.

In a defined benefit plan, the employer is advised what contributions are required in order
that the plan has sufficient assets to meet the guaranteed amount of pension.
(IAS 19 paragraph 8)
In a country with special forms of employee benefit systems such as multi-employer
plans and government plans, these are accounted for on the basis of their legal and
institutional arrangements.
(IAS 19 paragraphs 32 and 43)

Defined contribution plans

The accounting for defined contribution plans is relatively straightforward:
contributions are recognised as an expense in the period in which they are payable. An
accrual or prepayment may result.
(IAS 19 paragraphs 32 and 43)
35

Defined benefit plans

The accounting treatment of defined contribution plans is not suitable for defined
benefit plans as a result of the variability of contributions.

Instead, a net defined benefit pension asset or liability is recognised in the statement of
financial position. This is calculated as the difference between:
 The fair value of the pension plan assets at the reporting date, and
 The present value of the defined benefit obligation at the reporting date.

IAS 19 includes guidance on how to establish the present value of the obligation using the
projected unit credit method. This method is also used to determine current service cost
i.e. the increase in the pension obligation as a result of an additional year's employee
service.
Each individual element of change in the value of plan assets and defined benefit
obligation from one year to the next is accounted for separately:

Plan assets PV of obligation

At start of year X X
DR plan assets
Contributions X
CR cash
DR obligation
Paid out as pensions (X) (X)
CR plan assets
Dr profit/loss
Current service cost X
CR obligation
DR plan assets
Net interest X X CR obligation
DR/CR profit/loss
DR/CR plan assets
Remeasurements
X/(X) X/(X) DR/CR obligation
(balancing figure)
DR/CR OCI
At end of year X X

Net interest is calculated on the value of the assets and obligation at the start of the
yearby reference to interest rates on high quality corporate bonds. It represents:
 The expected return on the investments that form the plan assets
 The unwinding of the discount on the obligation.
(IAS 19 paragraph 120)
 36

Remeasurements are the difference between calculated plan assets and defined
benefit obligation having taken account of contributions, pensions paid, current service
cost and interest, and the actual year end value of each. Remeasurements represent:
 The difference between the actual and expected return on plan assets, and
 The effect of changes in actuarial assumptions in the case of the obligation.

These are never reclassified to profit or loss.

(IAS 19 paragraph 122)

Actuarial assumptions are those assumptions that must be made in order to estimate the
value of the defined benefit obligation. They include salary increase, mortality rates and
retirement age.
(IAS 19 paragraph 76)
Remeasurements of the defined benefit obligation may be referred to as actuarial gains and
losses.

Past service costs may occur in some years, for example if plan benefits are
increased.These are recognised in profit or loss immediately.
Where an entity has a surplus in a defined benefit plan, the net defined benefit asset
can be recognised
but the amount is restricted to the asset ceiling, being the present value of economic benefits
available as a result of the surplus (e.g. refunds or reduction in contributions).

(IAS 19 paragraphs 8 and 64)

Exercise - IAS 19 Question 1

Do possible future pay rises give rise to a present liability for pensions?; You should refer to the text of
the Standard when answering all exercises

Exercise - IAS 19 Answer 1

Model Answer

The issue is not whether future pay rises give rise to a present liability. The liability
exists anyway and the future pay rises are a part of correctly estimating the size of the
liability. Therefore the best estimate of future pay rises should be taken into account.
37

Exercise - IAS 19 Question 2

When a defined benefit plan is enhanced, when should the cost of improving the benefits for existing
pensioners be recognised?

Exercise - IAS 19 Answer 2

Model Answer
These are past service costs; past service costs are all recognised in the period they are
granted. This includes those relating to existing pensioners and also to current employees
(who may or may not qualify for the enhanced benefit at the date it is granted).
 38

IAS 12 Income Taxes

IAS 12 deals mainly with deferred tax.

It requires that deferred tax is recognised for temporary differences.

Deferred tax is an accounting adjustment to take account of the future tax impact of an
asset or liability currently recognised in the statement of financial position.

Calculation of deferred tax

The IAS 12 approach to calculating deferred tax is as follows:

39

Tax base is the amount that is attributed to an asset or liability for tax purposes:
 In the case of an asset, the amount that will be deductible for tax purposes in the future
e.g. the tax written down value of a non-current asset
 In the case of a liability, usually the carrying amount less any amount that will be
deductible for tax purposes in the future.
(IAS 12 paragraphs 7, 8)

Taxable temporary differences arise where the carrying amount of an item exceeds its
tax base. In other words more tax relief has already been given than the carrying amount
in the statement of financial position would suggest. Therefore future tax will be higher
than might be expected.

Deductible temporary differences arise where the carrying amount of an item is less than
its tax base. In other words less tax relief has already been given than the carrying amount
in the statement of financial position would suggest. Therefore future tax will be lower than
might be expected.

The applicable tax rate is that which is expected to apply when the carrying amount of
the item is recovered. Normally this is a current rate although if new tax laws have been
enacted it may be future rates. The tax rate should reflect the manner of recovery (so may
be an income tax rate if an asset is to be used to generate income or a capital tax rate if the
asset will be sold to generate income).
(IAS 12 paragraph 47)

Example

Luella Co buys an item of plant on 1 January 20X7 at a cost of $400,000. The plant has
a useful life of 10 years and benefits from a 20% writing down allowance for tax
purposes. Luella has a year end of 31 December and pays tax at a rate of 30%.

There is no deferred tax impact on acquisition of the asset because carrying amount is
equal to tax base at $400,000.

At 31 December 20X7:
 The carrying amount of the asset is 9/10 x $400,000 = $360,000
 The tax base of the asset is 80% x $400,000 = $320,000
 There is therefore a temporary difference of $40,000
 This is a taxable temporary difference
 It results in a deferred tax liability of 30% x $40,000 = $12,000
 40

Accounting for deferred tax

The corresponding entry when recognising a deferred tax asset or liability is usually
profit or loss. Taking the above example, the correct entry to recognise the deferred tax
liability is:

DEBIT Tax charge in profit or loss $12,000

CREDIT Deferred tax liability $12,000

If, however, deferred tax relates to an underlying item that is recognised in OCI or directly
in equity, then the deferred tax impact is also recognised in OCI or equity. For example:
 The deferred tax impact of a revaluation is recognised in OCI
 The deferred tax impact of prior period error is recognised in equity.
(IAS 12 paragraph 58)
From year to year, only the change in the deferred tax amount is recognised. For example
if a deferred tax liability is $120,000 one year and $155,000 the next, a tax charge of
$35,000 is recognised in profit or loss.

An entity should calculate the deferred tax impact of all relevant items in its statement
of financial position and, providing that the tax arises in a single jurisdiction, and
there is a right of set off, present a net deferred tax asset or liability.
(IAS 12 paragraph 74)
A deferred tax asset is only recognised to the extent that it is probable that future taxable
profits will be available to utilise the benefit.
(IAS 12 paragraph 56)
Additional points
 Tax losses carried forward result in a deferred tax asset to the extent that profits are
available against which the losses can be offset
 Deferred tax liabilities should be recognised for all temporary differences, except those
relating to non-deductible goodwill and the initial recognition of certain assets and
liabilities in transactions that affect neither accounting profit nor taxable profit
 There are also special rules for investments in subsidiaries, associates and joint ventures.
They amount to saying that temporary differences that are unlikely to reverse where the
investor is in control of that process (for example, by being able to stop the payment of
dividends) need not be accounted for
 Deferred tax amounts should not be discounted.
(IAS 12 paragraphs 15, 24, 34, 39, 53)
41

Exercise - IAS 12 Question 1

A deferred tax liability is recognised on the revaluation of an asset that is intended for
continuing use in the business. Does this meet the Conceptual Framework’s definition of
liability? You should refer to the text of the Standard when answering exercises.

Exercise - IAS 12 Answer 1

Model Answer

Despite the requirements of IAS 12, this amount does not meet the Conceptual
Framework's definition of a liability because at the reporting date there is no legally
enforceable obligation of the entity to pay any tax since the entity has not disposed of the
asset.
 42

Exercise - IAS 12 Question 2

Suppose that a company, Acrobat, applies IFRS Standards. It purchases a machine for £10,000 in
early 20X8. The machine is expected to last for ten years and to have no residual value. The
accounting year is the calendar year. The company is fairly small and is able to claim 40% tax
depreciation (capital allowances) in the year of purchase. Suppose also, that Acrobat buys land at £3m
in early 20X8, and revalues it to fair value of £5m at 31 December 20X8.

What are the "temporary differences" in 20X8?

Exercise - IAS 12 Answer 2

Model Answer
The temporary differences are:

(i) Machine
Financial reporting basis of asset:
10000 - 1000 = $9000
Tax basis of asset: 10000 - 4000 = $6000

$3000

(ii) Land

Financial reporting basis of asset $5m

Tax basis of asset $3m

$2m

The temporary differences total $2,003,000.

43

IFRS 2 Share-Based Payment

IFRS 2 deals with transactions in which an entity received goods or services in return for
its own equity instruments or an amount of cash based on the value of its equity
instruments.

The basic principle of IFRS 2 is that an entity should recognise an expense related to
goods or services received when they are received, even if payment is at a future date and
made in equity instruments.
The Standard deals with three types of share-based payment:
 An equity settled share-based payment is a transaction in which a company grants
equity instruments to another party in exchange for goods and services. The most
common example of such a transaction is where employees receive share options in
exchange for services rendered
 A cash settled share based payment is where another party (again usually an
employee) receives a cash payment the amount of which depends on the share price of
the company.
 Share-based payments in which the entity or counterparty has a choice of cash or
equity instruments

Equity-settled share based payments

These are recognised by:

DEBIT Expense / asset

CREDIT Equity

The issue is how the transaction is measured and when it is recognised.

If the transaction is with an employee, it is measured by reference to the fair value of
the equity instruments granted at the grant date. If the transaction is with a third party,
it is measured at the fair value of goods or services received.
If the transaction relates to goods or services already received (i.e. the equity
instruments vest immediately), the transaction is recognised in full on the grant
date. If the transaction requires the counterparty to meet specified conditions over a future
period (vesting period), then the transaction is recognised over that period.

(IFRS 2 paragraphs 10, 14, 15)

 44

Example

A company grants three directors 200 share options on 1 January 20X6, and these vest
(i.e. the director becomes entitled to them) after two years, providing that the director
still works for the company. This is expected to be the case. Each option has a fair value
of $3 at the grant date.

The total expense to be recognised is $1,800 (3 directors x 200 options x $3). This is
spread over the two year vesting period giving an expense of $900 in each year.

At the end of year 1 the balance in equity is $900; at the end of year two it is $1,800.
Assuming that the options are exercised, the equity balance is transferred to the share
capital account.

The measurement of equity-settled share-based payments must take into account

the number of instruments expected to vest (become an entitlement).

In the above example, suppose that one director left unexpectedly during the second
year. In that case the accounting entry in year one would remain the same (an expense of
$900 credited to equity). In year 2, however, the expense would be adjusted to take account
of the fact that only 2 directors' share options would vest:
 Total expense $1,200 (2 directors x 200 x $3)
 Year 2 expense therefore $300 ($1,200 - $900)

Cash-settled share-based payments

These are recognised by:

DEBIT Expense / asset

CREDIT Liability

The fair value of the liability is re-measured at each reporting date as the amount of cash
expected to be paid.
(IFRS 2 paragraph 30)
45

Example

On 1 January 20X4 a company grants a director share appreciation rights whereby she is
entitled to cash equivalent to 1,000 shares on 31 December 20X5, assuming she remains
in employment.

The share price is $3.40 on 31 December 20X4 and $4.05 on 31 December 20X5.

At 31 December 20X4 a liability and expense are recognised of $1,700

(1,000 x $3.40 x 1/2 years). At 31 December the total liability is $4,050 (1,000 x $4.05).
Therefore the year 2 expense is $2,350 ($4,050 - $1,700).

Share-based payments with a choice of settlement

 Where the counterparty has the choice of settlement, the entity is deemed to have granted
a compound instrument and a separate equity and liability component are recognized

 Where the entity has the choice of settlement, the whole transaction is treated as either
equity-settled or cash-settled depending on whether the entity has an obligation to settle
in cash.
(IFRS 2 paragraphs 35, 41)

Exercise - IFRS 2 Question

Select the correct word/phrase from the drop down choices to populate the relevant
numbered spaces and complete the following sentences
 46

IAS 41 Agriculture

IAS 41 provides guidance on accounting for biological assets and agricultural produce.

Biological assets

"A biological asset is a living plant or animal".

(IAS 41 paragraph 5)

Bearer plants (a plant that bears produce for more than one period such as a tea bush) are
biological assets, however are not within the scope of IAS 41. Instead IAS 16 Property,
Plant and Equipment applies to these.
(IAS 41 paragraph 1)

Agricultural produce

Agricultural produce is the harvested produce of biological assets at the point of

harvest(thereafter it becomes inventory).
(IAS 41 paragraph 5)

Accounting treatment

Biological assets and agricultural produce are measured at each reporting date at
their fair values less costs to sell.
(IAS 41 paragraphs 12, 13)

If fair value cannot be reliably determined, then measure at cost.

(IAS 41 paragraph 30)

Gains and losses arising on initial recognition of biological assets and agricultural
produce are recognised in profit or loss.

(IAS 41 paragraphs 26 and 28)

47

IFRS 6 Exploration for and Evaluation of Mineral Resources

IFRS 6 imposes few requirements on companies that are engaged in exploration for and
evaluation of mineral resources.

IFRS 6 requires entities to develop a policy for the extent to which such expenditure
should be capitalised and to disclose that policy clearly in the financial statements. It
does not, however, specify the capitalisation policy.
(IFRS 6 paragraph 9)
The Standard also requires entities recognising exploration and evaluation assets to
perform an impairment test on those assets when facts and circumstances suggest that
the carrying amount of the assets may exceed their recoverable amount.
(IFRS 6 paragraph 18)
IFRS 6 requires disclosure of "information that identifies and explains the amounts
recognised in its financial statements arising from the exploration for and
evaluation of mineral resources"
(IFRS 6 paragraph 23)
This should include:
 "Its accounting policies for exploration and evaluation expenditures including the
recognition of exploration and evaluation assets
 The amounts of assets, liabilities, income and expense and operating and investing cash
flows arising from [those assets]".
(IFRS 6 paragraph 24)
 48

Frequently asked questions

1. If a company's board of directors has decided to restructure part of its business should
the company not make a provision for the restructuring, redundancy costs, etc.?

Answer

It depends on the facts. A board decision does not of itself create an obligation to a third
party, and the board could change its mind. In such cases, IAS 37 does not allow a
provision. This may not be "prudent" but this is overridden by the need to comply with the
Conceptual Framework's definition of a liability. Only when the decision is communicated
to those affected by the restructuring would it be appropriate to recognise a provision.

1. Surely it gives useful information to the users of financial statements to show a

proposed dividend as a liability?

Answer

IAS 10 is based on the idea that it is not useful to show something as a liability that
does not meet the definition of a liability. The information about the proposed dividend
can be given in the notes.

2. Can a deferred tax asset be shown in the financial statements if the company is making
losses?

Answer

It is unlikely as it must be probable that future taxable profits will be available against
which to use the asset.
49

Module 5 quick quiz

 50

Question 1

Dodo Co is preparing its financial statements to 31 December 20X3. The accounts are
due to be finalised on 31 March 20X4.

Which of the following should not be adjusted in the financial statements?

The correct answer is B

The flood is not indicative of conditions that were in place at the year end and this type of
event is never reflected in the financial statements as it could not possibly have been
foreseen.
51

Question 2

The management team at Super Safe Co try to be as prudent as possible when preparing
the annual financial statements.
Under IAS 37 which of the following should they provide in the financial statements:

The correct answer is C

This is an onerous contract – effectively the company is tied in to recording a loss on this
matting.

Forecast operating losses should not be provided because at the reporting date there is no
‘obligation’ to record that loss in the following year.

Restructuring costs may be provided, if there is an obligation. At present, management

have not created any obligation to go ahead with their plans though. To create an
obligation to proceed they must announce the plans.
 52

Question 3

A company purchased an item of plant for $270,000 on 1 January 20X0. The plant is
depreciated in the financial statements on a straight-line basis over 5 years. For tax
purposes the plant has a life of 3 years and benefits from allowances on a straight-line basis.
What is the deferred tax balance in respect of the plant on 31st December 20X1?

The applicable rate of corporate income tax is 30%.

The correct answer is C

Annual depreciation in the financial statements: $270,000/5 = $54,000.
Allowed for tax purposes each year:
$270,000/3 = $90,000.

Carrying Tax base

amount
31December $270,000 $270,000
20X0 - $54,000 - $90,000
= $216,000 = $180,000
31December $216,000 $180,000
20X1 - $54,000 - $90,000
= $162,000 = $90,000

Taxable temporary difference at 31 December 20X1 is $162,000 - $90,000 = $72,000.

Deferred tax liability is therefore $72,000 x 30% = $21,600.
Where the tax allowance is accelerated (ie the asset is being written off faster for tax
purposes than through depreciation in the financial statements) this gives rise to a
deferred tax liability.
53

Question 4

IC Co manufactures fridge freezers and with each one sold offers a free guarantee. In one
year the company expects to sell 30,000 fridge freezers. Of these management expect 1%
to be returned under the guarantee requiring major repair work costing on average $300.
Management also expect 5% to be returned requiring minor repairs costing on average
$100.

How should the company treat this guarantee policy in their financial statements?

The correct answer is A

The company has created an obligation as a result of a past event in offering the
guarantee, and it is probable, over the entire population of 30,000 washing machines, that
it will have to pay something in repairs cost. Disclosure alone is therefore insufficient.
A provision is calculated using expected values:

(1% x 30,000 x $300) + (5% x 30,000 x $100)

= $240,000.
 54

Question 5

Sha La La Co recently suffered a small fire in one corner of its warehouse. The company
has placed a claim with its insurer for $220,000 to cover the cost of repairing the damage.
Sha La La Co has not had confirmation yet, but management of the company believe it is
more likely than not that the claim will be paid.

How should the company treat this in the annual financial statements?

The correct answer is D

The insurance claim represents a contingent asset that will probably result in an inflow of
economic benefits and so should be disclosed but not recognised on the statement of
financial position.
55

Question 6

Under IFRS 9, which of the following financial assets should be held at amortised cost:
1. A fixed interest rate loan
2. An investment in a convertible loan note
3. A zero coupon bond

The correct answer is B

IFRS 9 states that a financial asset should be held at amortised cost if the asset is held
within a business model whose objective is to hold assets in order to collect contractual
cash flows and the contractual terms of the financial asset give rise on specified dates to
cash flows that are solely payments of principal and interest on the principal amount
outstanding.

An investment in a convertible loan note does not therefore qualify to be held at

amortised cost because the conversion option would not be considered to represent either
principal or interest.