F7 – FINANCIAL

REPORTING (INT)

REVISION NOTES

F7 Revision notes Page 1

 TABLE OF CONTENTS

The conceptual and regulatory framework for 3

financial reporting
IAS 1 8
Companies - Basic adjustments 12
IAS 16 14
IAS 38 – Intangible assets 17
IAS 36 – Impairment of assets 20
IAS 40 – Investment property 23
IAS 2 – Inventories 26
IAS 41 – Agriculture 28
IAS 8 – Accounting policies, Changes in accounting 30
estimates and Errors
IAS 23 – Borrowing cost 32
Financial Instruments 33
IAS 37 – Provisions, Contingent liabilities and 39
Contingent assets
IFRS 16 – Leases 42
IFRS 13 – Fair value measurements 45
IAS 20 - Government grants 48
IAS 10 – Events after reporting date 50
IAS 12 – Income taxes 52
IFRS 15 – Revenue from contract with customers 55
IAS 7 – Statement of cashflows 60
IFRS 5 – Non-current assets held for sale and 63
discontinued operations
IAS 21 – The effects of changes in foreign exchange 65
rates
IAS 33 – Earnings per share 67
Consolidated Financial Statements 71
Consolidated statement of financial position 73
Consolidated statement of profit or loss 76
IAS 28 – Investment in Associates 78
Disposal of investment 80
Ratio analysis 81
Not for profit & Public sector entities 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. Setting the agenda

2. Planning the project
3. Development and publication of Discussion Paper
4. Development and publication of Exposure Draft
5. Development and publication of an IFRS Standard
6. 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 International Accounting International Financial

(IFRS AC) Standards Board (IASB) Reporting Standards
Interpretations Committee (IFRS
Provide advice to IASB on:  Develop new accounting IC)
standards
 their agenda and work  Liaise with national  Assist the IASB to establish and
prioritization standard-setting bodies to improve
 the impact of proposed promote convergence of standards
standards international and national
 Provides strategic accounting standards  Issues Interpretations
advice (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 Exam Attempt Question

Sept. 16 MCQ. 1,9
Spec. exam Sept. 16 MCQ.4, 13
June 15 MCQ.1,6
Dec. 14 MCQ.3,5,7,20
Framework
Dec. 13 Q.4 (a)
Dec. 12 Q.4(a)
June 12 Q.5
June 11 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 X
Intangible assets X

X
Current assets:
Inventories X
Trade receivables X
Cash and cash equivalents X
X
Total assets X

Equity and liabilities

Capital and reserves:
Share capital X
Retained earnings X
Other components of equity X
X
Total equity X
Non-current liabilities:
Long-term borrowings X
Deferred tax X
X
Current liabilities:
Trade and other payables X
Short-term borrowings X
Current tax payable X
Short-term provisions X
X
Total equity and liabilities 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
$ $ $ $ $
Balance at 31 X X X X X
December 20X6
Change in (X) (X)
accounting policy __ __ __ __
Restated balance X X X X X
Dividends (X) (X)
Issue of share X X X
Capital
Total X X X
Comprehensive
income for the year
Transfer to (X) X -
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 X
Finance costs (X)
Profit before tax X
Income tax expense (X)
Net Profit for the period X

$
Profit for the year X
Other comprehensive income
Gain on property revaluation X
Income tax relating to components of other comprehensive income (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 Nominal value of shares issued

Cr Share capital 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 Exam Attempt Question

Dec. 15 Q.1 (iv), (vii)
June 15 MCQ.19 Q.3(i),(ii)
Dec. 14 Q.2(i)
June 14 Q.2 (iii),(v)
Basic adjustments – Companies Dec. 13 Q.2 (v)
June 13 Q.2(v)
Dec. 12 Q.2(ii),(iii)
June 12 Q.2 (i)
June 11 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. It may be appropriate to aggregate individually insignificant items, such as moulds, tools dies, etc.
ii. 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 dismantling cost will be added to the cost of asset and
provision will be created and it will be unwinded at every year end and the amount will be
recognized in statement of profit or loss as finance cost and provision will be increased in
statement of financial position).
 Directly attributable cost of bringing the assets to the location and condition necessary for the
intended performance, e.g.

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  Costs of employees benefits arising directly from the construction or acquisition of property,
plant and equipment
 The cost of site preparation
 Initial delivery and handling costs
 Installation costs
 Cost of testing whether the asset is functioning properly after the net proceeds from the sale
of any trial production (samples produced while testing equipment)
 Professional fees (architects, engineers)

 Cost of self-constructed assets will be the cost of its production

 If an asset is exchanged, the cost will be measured at the fair value unless
(a) The exchange transaction lacks commercial substance or

(b) The fair value of neither the asset received nor the asset given up is reliably measurable. If the
acquired item is not measured at fair value, its cost is measured at the carrying amount of the
asset given up.

Measurement Subsequent to Initial Recognition:

IAS 16 permits two accounting models:

 Cost Model. The asset is carried at cost less accumulated depreciation and impairment.
 Revaluation Model. The asset is carried at a revalued amount, being its fair value at the date of
revaluation less subsequent depreciation and impairment, provided that fair value can be
measured reliably.

The change from cost model to revaluation model is a change in accounting policy but is dealt with
prospectively.

Revaluation model:
 Revaluations should be carried out regularly, so that the carrying amount of an asset does not
differ materially from its fair value.
 If an item is revalued, the entire class of assets to which that asset belongs should be revalued.
 Revalued assets are depreciated in the same way as under the cost model.
 Gain on revaluation should be credited to other comprehensive income and accumulated in
equity under the heading "revaluation surplus" unless it represents the reversal of a revaluation
decrease of the same asset previously recognized as an expense, in which case it should be
recognized as income.
 A loss on revaluation should be recognized as an expense to the extent that it exceeds any
amount previously credited to the revaluation surplus relating to the same asset.
 Each year, the amount by which the new depreciation exceeds the old depreciation should be
transferred from the revaluation reserve in the capital section of the statement of financial
position to the retained earnings.
 When a revalued asset is disposed of, any revaluation surplus may be transferred directly to
retained earnings, or it may be left in equity under the heading revaluation surplus.

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Depreciation:

 The depreciable amount should be allocated on a systematic basis over the asset's useful life.
 The residual value and the useful life of an asset should be reviewed at least at each financial year-
end and any change accounted for prospectively.
 The depreciation method used should reflect the pattern in which the asset's economic benefits
are consumed by the entity.
 Depreciation should be charged to the statement of profit or loss.
 Depreciation begins when the asset is available for use and continues until the asset is
derecognized. Temporary idle activity does not suspend depreciation of the asset.

Impairment:
An item of PPE shall not be carried at more than recoverable amount. Recoverable amount is the higher of
an asset's fair value less costs to sell and its value in use.

De-recognition:
 Remove from statement of financial position when disposed of or abandoned
Recognize any gain or loss in the statement of profit or loss.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 16 MCQ. 6,16 Q.31(ii)
March/June 16 Q.3 (iv)
Spec. exam Sept. 16 MCQ.1
Dec. 15 Q.1 (iii)
June 15 MCQ.9,13 Q.3(iii)
Dec. 14 Q.2(ii)
IAS 16
June 14 Q.2(ii), Q.4
Dec. 13 Q.2(ii)
June 13 Q.2(ii)
June 12 Q.2 (ii)
Dec. 11 Q.2 (ii)
June 11 Q.2 (ii)

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 IAS 38 - INTANGIBLE ASSETS

OBJECTIVE

The objective of this IAS is to prescribe accounting treatment for intangible assets.

DEFINITIONS

An intangible asset is an identifiable non-monetary asset without physical substance held for use in the
production or supply of goods or services, for rental to others, or for administrative purposes.

IDENTIFIABILITY:
An intangible asset can be termed identifiable if it:

 is separable or
 arises from contractual or other legal rights

Research is original and planned investigation undertaken with the prospect of gaining new scientific
or technical knowledge and understanding.

Development is the application of research findings or other knowledge to a plan or design for the
production of new or substantially improved materials, devices, products, processes, systems or services
before the start of commercial production or use.

RECOGNITION AND MEASUREMENT

The recognition of an intangible asset requires an entity to demonstrate that the item meets:-
a) The definition of an intangible asset
b) The recognition criterion that:-

 It is probable that the expected economic benefits that are attributable to the asset will flow
to the entity; and
 The cost of the asset can be measured reliably

An intangible asset shall be measured initially at cost.

Separate rules for recognition and initial measurement exist for intangible assets depending on whether
they were:

 Acquired separately: At cost

 Acquired as part of a business combination: At fair value
 Acquired by way of a government grant: As per IAS 20
 Obtained in an exchange of assets: At fair value
 Generated internally

INTERNALLY GENERATED INTANGIBLE ASSETS

To assess whether an internally generated intangible assets meets the criteria for recognition, an
enterprise classifies the generation of the asset into:

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RESEARCH PHASE

Recognised as expense in statement of profit or loss

DEVELOPMENT PHASE

An intangible asset arising from development (or from the development phase of an internal project)
should be recognized as asset if, and only if, an enterprise can demonstrate all of the following:

(a) The technical feasibility of completing the intangible asset so that it will be available for use or
sale;
(b) Its intention to complete the intangible asset and use or sell it;
(c) Its ability to use or sell the intangible asset;
(d) How the intangible asset will generate probable future economic benefits. Among other things, the
enterprise should demonstrate the existence of a market for the output of the intangible asset or
the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset;
(e) The availability of adequate technical, financial and other resources to complete the
development and to use or sell the intangible asset; and
(f) Its ability to measure the expenditure attributable to the intangible asset during its development
reliably.

Internally generated brands, mastheads, publishing titles, customer lists and similar items should not be
recognised as intangible assets.

MEASUREMENT AFTER RECOGNITION

COST MODEL

After initial recognition, an intangible asset shall be carried at its cost less any accumulated amortization
and any accumulated impairment loss.

REVALUATION MODEL

After initial recognition an intangible asset whose fair value can be determined with reference to the
active market shall be carried at revalued amount, less subsequent accumulated amortization and
subsequent accumulated impairment losses.

 The depreciable amount of an intangible asset with a finite useful life shall be allocated on a
systematic basis over its useful life
 The amortization period and the amortization method for an intangible asset with a finite useful
life shall be reviewed at least at each financial year end.
 An intangible asset with an indefinite useful life shall not be amortized but will be tested for
impairment at every reporting date.
 The useful life of an intangible asset that is not being amortized shall be reviewed in each
period
 The recoverable amount of the asset should be determined at least at each financial year end and
any impairment loss should be accounted for in accordance with IAS 36.
 Remove from statement of financial position when disposed of or abandoned. Recognize any gain
or loss in the statement of profit or loss.

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GOODWILL

Goodwill is not normally recognised in the accounts of a business at all. The reason for this is that
goodwill is considered inherent in a business and it does not have any objective value.

PURCHASED GOODWILL

There is one exception to the principle that goodwill has no objective value, this is when a business is sold.

Purchased goodwill is shown in the statement of financial position because it has been paid for. It has no
tangible substance, and so it is an intangible non-current asset.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Dec. 15 Q.1 (ii)
IAS 38 June 15 MCQ.2
June 14 Q.5(i)

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 IAS 36 – IMPAIRMENT OF ASSETS

OBJECTIVE

The objective of this IAS is to set rules to ensure that the assets of an enterprise are carried at no more
than their recoverable amount.

DEFINITIONS
 Recoverable amount is the higher of an asset’s net selling price and its value in use.
 Value in use is the present value of estimated future cash flows expected to arise from the
continuing use of an asset and from its disposal at the end of its useful life.
 Net selling price the amount obtainable from the sale of an asset in an arm’s length transaction
between knowledgeable, willing parties, less the costs of disposal.
 An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable
amount.
 A cash-generating unit is the smallest identifiable group of assets that generates cash inflows from
continuing use that are largely independent of the cash inflows from other assets or groups of assets.
 Corporate assets are assets other than goodwill that contribute to the future cash flows of both the
cash-generating unit under review and other cash-generating units.

IMPAIRMENT ASSESSMENT
An enterprise should assess at each reporting date: -

a) Whether there is any indication that an asset may be impaired;

b) Irrespective of any indication of impairment, an entity shall also: -
 Test in case of intangible assets having indefinite life or under development; and
 Test goodwill acquired in business combination for impairment annually

External sources of information include:

 Decline in asset’s market value
 Adverse effect in the technological, market, economic or legal environment in which the
enterprise operates;
 Increase in market interest rates

Internal sources of information include:

 Obsolescence or physical damage
 Significant changes with an adverse effect in the extent to which, or manner in which, an asset is
used or is expected to be used
 Economic performance and expected net cashflows of an asset are worse than expected

MEASURING RECOVERABLE AMOUNT

Net selling price is the price in Binding Sale Agreement less Disposal Cost
Value in Use is the present value of estimated the future cash inflows and outflows to be derived from
continuing use of the asset and from its ultimate disposal (The discount rate should be a pre-tax rate)

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RECOGNITION AND MEASUREMENT OF IMPAIRMENT LOSS

An impairment loss should be recognized as an expense in the statement of profit or loss immediately,
unless the asset is carried at revalued amount (Recognized directly against any revaluation surplus. Any
over and above amount as expense in P&L)

CASH GENERATING UNIT

A cash generating unit (CGU) is the smallest identifiable group of assets for which independent cash flows
can be identified and measured. For example, for a restaurant chain a CGU might be each individual
restaurant.

 As goodwill acquired in a business combination does not generate cash flows independently of
other assets, it must be allocated to each of the acquirer’s cash generating units
 A CGU to which goodwill has been allocated is tested for impairment annually. The carrying
amount of the CGU including the goodwill is compared with its recoverable amount.

The impairment loss on a CGU is allocated in the following order:

 First to any asset that is impaired (e.g. if an asset was specifically damaged)
 Second, to goodwill in the cash generating unit
 Third, to all other assets in the CGU on a pro rata basis based on carrying value

When allocating an impairment loss the carrying amount of an asset should not be reduced below the
higher of its fair value less costs to sell, value in use or zero.

REVERSAL OF IMPAIRMENT LOSS

 An impairment loss may only be reversed if there has been a change in the estimates used to
determine the asset's recoverable amount since the last impairment loss had been recognised.
 The increase in the carrying value of the asset can only be up to what the depreciated historical
cost would have been if the impairment had not occurred.
 Any reversal of an impairment loss is recognised immediately in the statement of profit or loss,
unless the asset is carried at a revalued amount, in which case the reversal will be treated as a
revaluation increase.

Considerations on reversal of an impairment loss for a cash generating unit:

 First, reverse on assets other than goodwill on a pro-rata basis based on the carrying amount of
each asset in the unit; and
 An impairment loss recognized for goodwill shall not be reversed in a subsequent period.

F7 Revision notes Page 21

 PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 16 MCQ. 17,18,19,20
June 15 MCQ.4
IAS 36
Dec. 14 MCQ.12,18
June 12 Q.4

F7 Revision notes Page 22

 IAS 40-INVESTMENT PROPERTY

OBJECTIVE

The objective of this Standard is to prescribe the accounting treatment for investment property and
related disclosure requirements.

DEFINITIONS:
Investment property is property held to earn rentals or for capital appreciation or both, rather than
for:
a) Use in the production or supply of goods or services or for administrative purposes; or
b) Sale in the ordinary course of business.

Owner-occupied property is property held (by the owner or by the lessee under a finance lease) for
use in the production or supply of goods or services or for administrative purposes.

The following are examples of investment property:

a) Land held for long-term capital appreciation

b) Land held for a currently undetermined future use
c) A building that is vacant but is held to be leased out under one or more operating leases.
d) Property that is being constructed or developed for future use as investment property

The following are examples of items that are not investment property:
a) Property intended for sale in the ordinary course of business
b) Property being constructed or developed on behalf of third parties
c) Owner-occupied property (see IAS 16), including (among other things) property held for future
use as owner-occupied property, property held for future development and subsequent use as
owner-occupied property, property occupied by employees (whether or not the employees pay
rent at market rates) and owner-occupied property awaiting disposal.

RECOGNITION:
Investment property shall be recognized as an asset when
(a) It is probable that the future economic benefits that are associated with the investment property will
flow to the entity; and
(b) The cost of the investment property can be measured reliably.

MEASUREMENT
Initial measurement
 An investment property shall be measured initially at its Cost + Transaction costs.
 The cost of a purchased investment property = Purchase price + any directly attributable
expenditure.

SUBSEQUENT MEASUREMENT

IAS 40 permits entities to choose between

 A fair value model, and

 A cost model.

F7 Revision notes Page 23

 Fair value model
Under the fair value model the entity should:
 Revalue all its investment property to 'fair value' (open market value) at the end of each financial
year, and
 Take the resulting gain or loss to profit or loss for the period in which it arises.

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.

 Cost model:
Under cost model, investment property should be measured at depreciated cost, less any accumulated
impairment losses.

EXCEPTION:
All investment property must be valued under either one model or the other.

TRANSFERS:

Transfers to, or from, investment property should only be made when there is a change in use, evidenced
by one or more of the following

 Commencement of owner-occupation
 Commencement of development with a view to sale end of owner-occupation
 Commencement of an operating lease to another party end of construction or development

When an entity decides to sell an investment property without development, the property is not
reclassified as investment property but is dealt with as investment property until it is disposed of.

RULES FOR TRANSFER:

 For a transfer from investment property carried at fair value to owner-occupied property or
inventories, the fair value at the change of use is the 'cost' of the property under its new
classification
 For a transfer from owner-occupied property to investment property carried at fair value, IAS 16
should be applied up to the date of reclassification. Any difference arising between the carrying
amount under IAS 16 at that date and the fair value is dealt with as a revaluation under IAS 16
 For a transfer from inventories to investment property at fair value, any difference between the
fair value at the date of transfer and it previous carrying amount should be recognized in profit or
loss
 When an entity completes construction/development of an investment property that will be
carried at fair value, any difference between the fair value at the date of transfer and the previous
carrying amount should be recognized in profit or loss.

When an entity uses the cost model for investment property, transfers between categories do not change
the carrying amount of the property transferred, and they do not change the cost of the property for
measurement or disclosure purposes.

F7 Revision notes Page 24

DISPOSAL
 An investment property should be derecognized on disposal
 The gain or loss on disposal should be calculated as the difference between the net disposal proceeds
and the carrying amount of the asset and should be recognized as income or expense
 Compensation from third parties is recognized when it becomes receivable.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

IAS 40 June 13 Q.5

F7 Revision notes Page 25

 IAS 2 – INVENTORIES

Objective

The objective of this IAS is to prescribe the accounting treatment of inventories.

Definitions
Inventories are assets; -
a) Held for sale in the ordinary course of business
b) In the process of production for such sale; or (work in progress, finished goods awaiting
to be sold)
c) In the form of materials or supplies to be consumed in the production process or in the
rendering of services
Net Realizable Value is the estimated selling price in the ordinary course of business less the estimated
costs of completion and the estimated cost necessary to make a sale.

Cost of Inventories

The cost of inventories will comprise all costs of purchase, costs of conversion and other costs incurred in
bringing the inventories to their present location and condition.

(a) Purchase cost comprise the;

i) Purchase price plus;
ii) Import duties and other non –refundable taxes;
iii) Transport, handling and any other cost directly attributable to the acquisition of finished
goods, services and materials; less
iv) Trade discounts, rebates and other similar amounts

(b) Cost of conversion

i) Costs directly related to the units of production (direct labor); and
ii) Systematic allocation of fixed and variable production overheads that are incurred in
converting materials into finished goods. (Factory rent, depreciation of machinery,
supervisor salary, power consumption)

The allocation of fixed overheads to the costs of conversion is based on the normal capacity of the
production facilities.

(c) Other cost incurred in bringing the inventories to their present location and condition (i.e. non
production overheads or costs of designing products for specific customers).

The Standard excludes the following from the cost of inventories

a) The abnormal amount of wasted material, labor or other production cost;

b) Storage costs unless necessary for production before the further production process/stage;
c) Administrative overheads that do not contribute to bringing inventories to their present location and
condition; and
d) Selling cost

F7 Revision notes Page 26

Costs of Inventories of a service provider

The cost of inventories of service providers includes primarily the labour and other cost of the personnel
directly engaged in providing the service including supervisory personnel and directly attributable
overheads.

Cost Formulas
First –in –first out (FIFO) or weighted average cost formula.

Measurement of inventory
Inventory shall be measured at the lower of cost and net realizable value.

Rule:

 The write down of inventories would normally take place on an item-by-item basis but similar or
related items may be grouped together
 The NRV should be based on the most reliable evidence available at the time of estimates are made.
 NRV should be reassessed at each reporting date
 Reversal of write down is limited to the original write down of inventories.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Dec.14 MCQ.8
IAS 2 Dec. 11 Q.2 (iv)
June 11 Q.2 (v)

F7 Revision notes Page 27

 IAS 41 – AGRICULTURE

OBJECTIVE

The objective of IAS 41 is to establish standards of accounting for agricultural activity

SCOPE

Within scope are Biological assets, Agricultural produce at the point of harvest and Government grants
related to biological assets.

Excluded from scope are Land and Intangible assets related to agricultural activity

DEFINITIONS

ACTIVE MARKET:

Exists when; the items traded are homogenous, willing buyers and sellers can normally be found at any
time and prices are available to the public.

AGRICULTURAL ACTIVITY:

The management of the transformation of a biological asset for sale into agricultural produce or another
biological asset.

Biological asset: A living animal or plant.

Agricultural produce: The harvested produce of the entity’s biological assets.

Biological transformation: The process of growth, degeneration, production, and procreation that
cause an increase in the value or quantity of the biological asset.

Harvest: The process of detaching produce from a biological asset or cessation of its life.

RECOGNITION
Biological assets or agricultural produce are recognised when:
 Entity controls the asset as a result of a past event
 Probable that future economic benefit will flow to the entity; and
 Fair value or cost of the asset can be measurement reliably.

F7 Revision notes Page 28

MEASUREMENT
 Biological assets within the scope of IAS 41 are measured on initial recognition and at subsequent
reporting dates at fair value less estimated costs to sell, unless fair value cannot be reliably
measured.
 If no reliable measurement of fair value, biological assets are stated at cost less accumulated
depreciation and accumulated impairment losses.
 Agricultural produce is measured at fair value less estimated costs to sell at the point of harvest.
 The gain on initial recognition of biological assets at fair value less costs to sell, and changes in
fair value less costs to sell of biological assets during a period, are included in profit or loss.

 A gain on initial recognition (e.g. as a result of harvesting) of agricultural produce at fair value
less costs to sell are included in profit or loss for the period in which it arises.
 All costs related to biological assets that are measured at fair value are recognised as expenses
when incurred, other than costs to purchase biological assets.
 An unconditional government grant related to a biological asset is measured at fair value less
estimated point-of-sale costs is recognised as income when, and only when, the government grant
becomes available
 A conditional government grant, including where a government grant requires an entity not to
engage in specified agricultural activity, is recognised as income when and only when, the
conditions of the grant are met.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

IAS 41 June 15 MCQ.10

F7 Revision notes Page 29

 IAS-8
ACCOUNTING POLICIES, CHANGE IN ACCOUNTING
ESTIMATES AND ERRORS

Objective:

The objective of this Standard is to prescribe the criteria for selecting and changing accounting policies,
the accounting treatment and disclosure of changes in accounting policies, accounting estimates and
corrections of errors.

Definitions:
Accounting policies are the specific principles, bases, conventions, rules and practices applied by an
entity in preparing and presenting financial statements.

A change in accounting estimate is an adjustment of the carrying amount of an asset or liability, or

related expense, resulting from reassessing the expected future benefits and obligations associated with
that asset or liability.

Material Omissions or misstatements of items are material if they could, influence the economic
decisions that users make on the basis of the financial statements.

Prior period errors are omissions from, and misstatements in, the entity’s financial statements for one
or more prior periods arising from a failure to use, or misuse of, reliable information that:
 Was available when financial statements for those periods were authorized for issue; and
 Could reasonably be expected to have been obtained and taken into account in the preparation and
presentation of those financial statements.

Selection and application of accounting policies:

 The accounting policy applied to the item shall be determined by the IFRS.
 In the absence of an IFRS, management shall use its judgment in applying an accounting policy that
results in information that is relevant and reliable.

An entity shall select and apply its accounting policies consistently for similar transactions.

Changes in accounting policies:

A change in accounting policy is permitted only if

 Required by an IFRS or revised IAS

 If a change in accounting polity results in the financial statements providing reliable and more
relevant financial information.
 When a change in accounting policy is required by a new Standard, the Standard will often include
specific 'transitional provisions'.
 If transitional provision is not present applying to change required by standard, or the entity changes
the policy voluntarily then, it shall apply the change retrospectively. i.e.
 The entity shall adjust the opening balance of each affected component of equity for the earliest prior
period presented and the other comparative amounts disclosed for each prior period presented as if
the new accounting policy had always been applied.

F7 Revision notes Page 30

Changes in accounting estimates:

The effect of a change in an accounting estimate shall be recognized prospectively by including it in profit
or loss in:

 The period of the change, if the change affects that period only; or
 The period of the change and future periods, if the change affects both

To the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or
relates to an item of equity, it shall be recognized by adjusting the carrying amount of the related asset,
liability or equity item in the period of the change.

Errors:
An entity shall correct material prior period errors retrospectively in the first set of financial statements
authorized for issue after their discovery by:
 restating the comparative amounts for the prior period(s) presented in which the error occurred; or
 if the error occurred before the earliest prior period presented, restating the opening balances of
assets, liabilities and equity for the earliest prior period presented

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 17 Q.1 (iii)
Dec. 14 MCQ.1
IAS 8
June 14 Q.5(i)
June 12 Q.2 (iii)

F7 Revision notes Page 31

 IAS 23-BORROWING COST

OBJECTIVE:
To prescribe the accounting treatment for borrowing cost.

DEFINITIONS:
Borrowing costs are costs, for example interest costs, incurred by an entity in connection with the
borrowing of funds in order to construct an asset.

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its
intended use or sale.

ACCOUNTING TREATMENT:
RECOGNITION

 An entity should capitalize the borrowing costs that are directly attributable to the acquisition,
construction or production of a qualifying asset as part of the cost of that asset and, therefore, should
be capitalized.

 Other borrowing costs are expensed in statement of profit or loss when occurred.
 Return on any surplus funds invested is first deducted from the amount of interest and then the
remaining amount is capitalized.
 Where funds are borrowed specifically, costs eligible for capitalization are the actual costs incurred
less any income earned on the temporary investment of such borrowings. Where funds are part of a
general pool, the eligible amount is determined by applying a capitalization rate to the expenditure on
that asset. The capitalization rate will be the weighted average of the borrowing costs applicable to the
general pool.

PERIOD OF CAPITALIZATION
1.Commence capitalization when
 Expenditure on asset being incurred
 Borrowing cost being incurred
 Activities to prepare asset for use/sale are in progress
2. Suspend capitalization if construction is suspended (due to bad weather, strikes etc).
3. Cease capitalization when substantially all activities necessary to prepare the asset for use/sale are
complete.

DISCLOSURE
 The accounting policy adopted.
 Amount of borrowing cost capitalized during the period.
 Capitalization rate used.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

IAS 23 Sept. 16 MCQ.15

F7 Revision notes Page 32

 FINANCIAL INSTRUMENTS

Introduction

A financial instrument is any contract that gives rise to a financial asset of one entity and a financial
liability or equity instrument of another entity.

Financial assets
A financial asset is any asset that is:
 Cash
 A contractual right to receive cash or another financial asset from another entity
 A contractual right to exchange financial assets/liabilities with another entity under conditions that
are potentially favorable
 An equity instrument of another entity.

Examples of financial assets include:

 Trade receivables
 Investment in equity shares.

Financial liabilities
A financial liability is any liability that is a contractual obligation:
 to deliver cash or another financial asset to another entity

Examples of financial liabilities include:

 trade payables
 debenture loans
 redeemable preference shares

Initial recognition of financial instruments

An entity should recognise a financial asset or a financial liability in its statement of financial position:
 When, and only when, it becomes a party to the contractual provisions of the instrument, even at nil
cost
 At fair value of consideration given/received i.e. this is normally cost

Effective interest rate method

Total finance cost: $

Interest paid xx
Issuance cost xx
Discount xx
Premium xx
Total finance cost (Allocate over loan xx
term using effective interest rate)

Years Opening Finance cost Interest paid Rollover Closing

balance charged balance
Y1 xx Issue cost, discount & Nominal value Discount, issue Xx
premium x Par value cost & premium

F7 Revision notes Page 33

Calculation of fair value of financial instrument
 Fair value = Present value of future cash flows at current market interest for similar financial
instruments
 Use market rate of relevant year or date
 Future cash flows will be used.

CLASSIFICATION OF FINANCIAL ASSETS

An entity shall classify financial assets as subsequently measured at:
 Amortised cost or
 Fair value through profit or loss (FVTPL)
 Fair value through other comprehensive income (FVTOCI)

A financial asset (debt instrument only) shall be measured at amortised cost if both of the following
conditions are met:
(a) The asset is held within a business model whose objective is to hold assets in order to collect
contractual cash flows (Solely principal amount and interest).
(b) 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. Interest is
compensation for time value of money and credit risk.

Important points
 Assess business management model on portfolio level not on individual investment
 Irregular sales of investments do not impact business management model
 Businesses may have different business management models for different investments

Fair Value Designation of Financial Assets

Even if an instrument meets the two amortised cost tests, IFRS 9 contains an option to designate a
financial asset as measured at Fair Value Through Profit and Loss if doing so eliminates or significantly
reduces a measurement or recognition inconsistency.

Fair value through other comprehensive income

The criteria are as follows:
For investments in equity For investment in debt
Investment in equity not held for trading Business management model is to hold investment for
collection of contractual cash flows and to sell
Entity has made an irrevocable election to Investment can generate contractual cash flow at specified
recognize gain/ (loss) in other comprehensive time, Principal and Interest, where interest is
income compensation of time value of money & credit risk

Fair value through profit or loss

The criteria are as follows:
 It is the default category (After not meeting any other category’s criteria)
 Investments not categorized at amortized cost and FVTOCI will be classified here

F7 Revision notes Page 34

Examples

Investment in perpetuity bond At FVTPL

Investment in convertible bond At FVTPL
Investment in fixed rate bond Could be at amortised cost
Investment in variable interest rate Could be at amortised cost, market interest rates are
bond reset periodically therefore it accounts for time value
of money and credit risk of the company
Investment in bond of $10,000 at 6%
variable with:
Gold price At FVTPL
Stock market At FVTPL
Inflation (Credit risk & Time value of Could be at amortised cost
money)

Measurement of Financial Assets

1) At Amortised cost:
Initial measurement: Fair value (Cash paid) + Transaction cost
Subsequent measurement: At amortised cost using effective interest rate method

2) At FVTOCI:
Initial measurement: Fair value (Cash paid) + Transaction cost
Subsequent measurement: At fair value and gain/loss will be charged to OCI

3) At FVTPL:
Initial measurement: Fair value (Cash paid)
Transaction cost is charged to P&L
Subsequent measurement: At fair value and gain/loss will be charged to P&L

Classification of Financial Liabilities

Financial liabilities are either classified as:
 Financial liabilities at amortised cost; or
 Financial liabilities as at fair value through profit or loss (FVTPL).

Financial liabilities are measured at amortised cost unless either:

 The financial liability is held for trading and is therefore required to be measured at FVTPL (e.g.
derivatives not designated in a hedging relationship), or
 The entity elects to measure the financial liability at FVTPL (using the fair value option).

Measurement of Financial Liabilities

1) At Amortised cost:
Initial measurement: Fair value (Cash received) - Issue cost
Subsequent measurement: At amortised cost using effective interest rate method

Examples of items at amortised cost are

 Trade payables
 Loan payables
 Bank borrowings

F7 Revision notes Page 35

 2) At Fair value option:
Fair value Gain/Loss will be split
 Gain/Loss due to own credit risk will be charged to OCI
 Gain/Loss due to other credit risk will be charged to P&L

3) At FVTPL:
Initial measurement: Fair value (Cash received)
Transaction cost is charged to P&L

Subsequent measurement:
 Fair value will be calculated by PV(FCF) by using current market interest rate
 Any Gain or loss will be charged to P&L

Examples of items at FVTPL are

 Held for trading liability
 Derivatives standing at loss
 Contingent liability arising at business combination

EQUITY INSTRUMENT
An equity instrument is any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities.

Compound instruments
The issuer of a financial instrument must classify it as a financial liability or equity instrument on initial
recognition according to its substance.

A compound instrument is a financial instrument that has characteristics of both equity and liabilities.

 IAS 32 requires compound financial instruments be split into their component parts:
- A financial liability (the debt)
- An equity instrument (the option to convert into shares).
 These must be shown separately in the financial statements.

For example, a convertible bond:

 The value of a convertible bond consists of a liability component - the bond - and
 An equity component - the value of the right to convert in due course to equity.

To account for a convertible loan:

 Calculate fair value of liability component first
- Based on present value of future cash flows assuming non-conversion
- Apply discount rate equivalent to interest on similar non-convertible debt instrument

 Equity = remainder
 The double entry passed is as follows:
Dr. Cash/Bank
Cr. Liability
Cr. Equity option

F7 Revision notes Page 36

The liability component will be amortised like a loan as follows:

Opening Finance cost Interest paid Rollover balance Closing

balance balance

(Opening bal. x (Nominal value x (Difference between finance

Effective rate) Nominal interest rate) cost and interest paid)

 Finance cost is charged to statement of profit or loss.

The economic effect of issuing convertible bonds is substantially the same as the simultaneous issue of a
debt instrument with an early settlement provision and warrants to purchase shares.

 If preference shares are irredeemable they are classified as equity

 If preference shares are redeemable they are classified as a financial liability
 Offset of a financial asset and liability is only allowed where there is a legally enforceable right
and the entity intends to settle net or simultaneously

Issue and finance costs

 Interest, dividends, loss or gains relating to a financial instrument claimed as a liability are
reported in the statement of profit or loss while distributions to holders of equity instruments are
debited directly to equity (in the SOCIE)
 Examples are: Issue cost of ordinary shares are deducted from share premium or retained
earnings, ordinary dividends are deducted from retained earnings, issue cost of equity option is
deducted from the value of equity option.

Derecognition of financial assets

Financial assets are decrecognised when:
 Contractual rights related to financial assets expire e.g. cash received from receivable
 Financial assets are transferred to another party and substantial risks and rewards are
transferred

FACTORING OF RECEIVABLES/DEBTS:
This is where debts or receivables are factored the original creditor sells the debts to the factor.

If the seller has to pay interest on the difference between the amounts advanced to him and the amounts
that the factor has received, and if the seller bears the risk of non-payment by the debtor, then the
indications would be that the transaction is, in effect, a loan.

REQUIRED ACCOUNTING:
 Where the seller has retained no significant benefits and risks relating to the debts and has no
obligation to repay amounts received from the factors, the receivables should be removed from its
statement of financial position
 No liability should be shown in respect of the proceeds received from the factor
 A profit or loss should be recognized, calculated as the difference between the carrying amount of
the debts and the proceeds received.
 Where the seller does retain significant benefits and risks a gross asset should be shown in the
statement of financial position of the seller within assets, and a corresponding liability in respect
of the proceeds received from the factor should be shown within liabilities.
 The interest element of the factor’s charges should be recognized as it accrues and included in
profit or loss with other interest charges.

F7 Revision notes Page 37

 PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 16
MCQ. 7, Q.1(i)
March/June 16
Q.3 (iii)
Dec. 15
Q.1 (v)
June 15
Q.3
Dec. 14
Financial instruments MCQ.11
June 14
Q.2(iv)
Dec. 12
Q.2 (v)
Dec. 11
Q.2 (v), Q.5
Dec. 11
Q.2 (ii)
June 11

F7 Revision notes Page 38

 IAS 37 – PROVISONS, CONTINGENT LIABILITIES AND
CONTINGENT ASSETS

OBJECTIVE
The objective of this IAS is to ensure that appropriate recognition criteria and measurement bases are
applied to provisions, contingent liabilities and contingent assets.

DEFINITIONS
 A provision is a liability of uncertain timing or amount.
 An obligating event is an event that creates a legal or constructive obligation that results in an
enterprise having no realistic alternative to settling that obligation.
 A legal obligation is an obligation that derives from:

(a) A contract (through its explicit or implicit terms);

(b) Legislation; or
(c) Other operation of law.

 A constructive obligation is an obligation that derives from an enterprise’s action where:

(a) By an established pattern of past practice, published policies or a sufficiently specific current
statement, the enterprise has indicated to other parties that it will accept certain responsibilities;
and
(b) As a result, the enterprise has created a valid expectation on the part of those other parties that it
will discharge those responsibilities.

 A contingent liability is:

(a) A possible obligation that arises from past events and whose existence will be confirmed only by
the occurrence or non-occurrence of one or more uncertain future events not wholly within the
control of the enterprise; or

(b) A present obligation that arises from past events but is not recognized because:
(i) It is not probably that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
(ii) The amount of the obligation cannot be measured with sufficient reliability.

 A contingent asset is 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 enterprise.

 An onerous contract is a contract in which the unavoidable costs of meeting the obligations under
the contract exceed the economic benefits expected to be received under it.

 A restructuring is a program that is planned and controlled by management, and materially

changes either:

(a) The scope of a business undertaken by an enterprise; or

(b) The manner in which that business is conducted.

F7 Revision notes Page 39

RECOGNITION

PROVISIONS
A provision shall be recognized when:
a) An entity has a present obligation (legal or constructive) as a result of a past event;
b) It is possible than an outflow of resources embodying economic benefits will be required to settle
the obligation; and
c) A reliable estimate can be made of amount of the obligation.

If these conditions are not met, no provision shall be recognized.

MEASUREMENT
The amount recognized as a provision shall be the best estimate of the expenditure required to settle the
present obligation at the reporting date. This means that:

 Provisions for one-off events (restructuring, environmental clean-up, settlement of a lawsuit) are
measured at the most likely amount.
 Provisions for large populations of events (warranties, customer refunds) are measured at a
probability-weighted expected value.
 Both measurements are at discounted present value using a pre-tax discount rate that reflects the
current market assessments of the time value of money and the risks specific to the liability.

 In reaching its best estimate, the enterprise should take into account the risks and uncertainties
that surround the underlying events.
 In case of expectation of reimbursement of provision (some or all of the expenditure), the
reimbursement should be recognized when it is virtually certain that reimbursement will be
received
 In SOFP, reimbursement should be shown as an asset and provision should be shown at gross
amount however, in statement of profit or loss they can be netted off.

RE-MEASUREMENT OF PROVISIONS
 Review and adjust provisions at each reporting date
 If outflow is no longer probable, reverse the provision to income statement.

APPLICATION OF RECOGNITION AND MEASUREMENT RULES

Some specific requirements on applying recognition and measurement rules are as follows:
 Provisions shall not be recognized for future operating losses.
 If an entity has a contract that is onerous, the present obligation under the contract shall be
recognized and measured as a provision.

RESTRUCTURING
The following are examples of events that may fall under the definition of restructuring:
 Sale or termination of a line of business
 Closure of business locations
 Changes in management structure
 Fundamental re-organization of company

F7 Revision notes Page 40

Restructuring provisions should be accrued as follows:

Sale of operation: Accrue provision only after a binding sale agreement. If the binding sale agreement
is after reporting date, disclose but do not accrue

Closure or re-organization: Accrue only after a detailed formal plan is adopted and announced
publicly. A board decision is not enough.

Restructuring provision on acquisition (merger): Accrue provision for terminating employees,

closing facilities, and eliminating product lines only if announced at acquisition and, then only if a
detailed formal plan is adopted 3 months after acquisition.

A management or board decision to restructure taken before the reporting date does not give rise to a
constructive obligation at the reporting date unless the entity has, before the reporting date:

a) Stated to implement the restructuring plan; or

b) Announced the main features the restructuring plan to those affected by it in a sufficiently specific
manner to raise a valid expectation in them that the entity will carry out the restructuring.

Restructuring provisions should include only direct expenditures caused by the restructuring, not costs
that associated with the ongoing activities of the enterprise such as: -

a) retraining or relocating continuing staff;

b) marketing; or
c) investment in new systems and distribution networks

CONTINGENT LIABILITIES
 An enterprise should not recognize a contingent liability.
 A contingent liability is disclosed in financial statements, unless the possibility of an outflow of
resources embodying economic benefits is remote.

CONTINGENT ASSETS
 An enterprise should not recognize a contingent asset.
 A contingent asset is disclosed in financial statements, where an inflow of economic benefits is
probable.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 16 MCQ. 4
Spec. exam Sept. 16 MCQ.5
June 15 MCQ.16
Dec. 14 MCQ.17
IAS 37
June 14 Q.5(ii)
Dec. 13 Q.2(iii), Q.4(c)
Dec. 12 Q.5
Dec. 11 Q.4

F7 Revision notes Page 41

 IFRS 16 - LEASES

Objective
IFRS 16 establishes principles for the recognition, measurement, presentation and disclosure of leases,
with the objective of ensuring that lessees and lessors provide relevant information that faithfully
represents those transactions.

Scope
IFRS 16 Leases applies to all leases, including subleases, except for:

 leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources;
 leases of biological assets held by a lessee (see IAS 41 Agriculture);
 licences of intellectual property granted by a lessor (see IFRS 15 Revenue from Contracts with
Customers); and
 rights held by a lessee under licensing agreements for items such as films, videos, plays,
manuscripts, patents and copyrights within the scope of IAS 38 Intangible Assets

Recognition exemptions
Instead of applying the recognition requirements of IFRS 16 described below, a lessee may elect to
account for lease payments as an expense on a straight-line basis over the lease term or another
systematic basis for the following two types of leases:

i) Leases with a lease term of 12 months or less and containing no purchase options – this election is
made by class of underlying asset; and
ii) Leases where the underlying asset has a low value when new (such as personal computers or small
items of office furniture) – this election can be made on a lease-by-lease basis.

Identifying a lease
A contract is, or contains, a lease if it conveys the right to control the use of an identified asset for a
period of time in exchange for consideration.
Control is conveyed where the customer has both the right to direct the identified asset’s use and to
obtain substantially all the economic benefits from that use.

An asset is typically identified by being explicitly specified in a contract, but an asset can also be identified
by being implicitly specified at the time it is made available for use by the customer.

However, where a supplier has a substantive right of substitution throughout the period of use, a
customer does not have a right to use an identified asset. A supplier’s right of substitution is only
considered substantive if the supplier has both the practical ability to substitute alternative assets
throughout the period of use and they would economically benefit from substitution.

A capacity portion of an asset is still an identified asset if it is physically distinct (e.g. a floor of a building).
A capacity or other portion of an asset that is not physically distinct (e.g. a capacity portion of a fiber optic
cable) is not an identified asset, unless it represents substantially all the capacity such that the customer
obtains substantially all the economic benefits from using the asset.

F7 Revision notes Page 42

Separating components of a contract
For a contract that contains a lease component and additional lease and non-lease components, such as
the lease of an asset and the provision of a maintenance service, lessees shall allocate the consideration
payable on the basis of the relative stand-alone prices, which shall be estimated if observable prices are
not readily available.
As a practical expedient, a lessee may elect, by class of underlying asset, not to separate non-lease
components from lease components and instead account for all components as a lease.
Lessors shall allocate consideration in accordance with IFRS 15 Revenue from Contracts with Customers.

Key definitions
Interest rate implicit in the lease
The interest rate that yields a present value of (a) the lease payments and (b) the unguaranteed residual
value equal to the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the
lessor.

Lease term
The non-cancellable period for which a lessee has the right to use an underlying asset, plus:
a) Periods covered by an extension option if exercise of that option by the lessee is reasonably
certain; and
b) Periods covered by a termination option if the lessee is reasonably certain not to exercise that
option
Lessee’s incremental borrowing rate
The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar
security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar
economic environment.

ACCOUNTING BY LESSEES
Upon lease commencement a lessee recognises a right-of-use asset and a lease liability.
The right-of-use asset is initially measured at the amount of the lease liability plus any initial direct
costs incurred by the lessee. Adjustments may also be required for lease incentives, payments at or prior
to commencement and restoration obligations or similar.
After lease commencement, a lessee shall measure the right-of-use asset using a cost model, unless:
ii) The right-of-use asset is an investment property and the lessee fair values its investment
property under IAS 40; or
iii) The right-of-use asset relates to a class of PPE to which the lessee applies IAS 16’s
revaluation model, in which case all right-of-use assets relating to that class of PPE can be
revalued.
Under the cost model a right-of-use asset is measured at cost less accumulated depreciation and
accumulated impairment.
The lease liability is initially measured at the present value of the lease payments payable over the
lease term, discounted at the rate implicit in the lease if that can be readily determined. If that rate
cannot be readily determined, the lessee shall use their incremental borrowing rate.

F7 Revision notes Page 43

Variable lease payments that depend on an index or a rate are included in the initial measurement of
the lease liability and are initially measured using the index or rate as at the commencement date.
Amounts expected to be payable by the lessee under residual value guarantees are also included.
Variable lease payments that are not included in the measurement of the lease liability are recognised in
profit or loss in the period in which the event or condition that triggers payment occurs, unless the costs
are included in the carrying amount of another asset under another Standard.

The lease liability is subsequently remeasured to reflect changes in:

 The lease term (using a revised discount rate);

 The assessment of a purchase option (using a revised discount rate);
 The amounts expected to be payable under residual value guarantees (using an unchanged
discount rate); or
 Future lease payments resulting from a change in an index or a rate used to determine those
payments (using an unchanged discount rate).

The re-measurements are treated as adjustments to the right-of-use asset.

Lease modifications may also prompt re-measurement of the lease liability unless they are to be treated as
separate leases.

Sale and leaseback transactions

To determine whether the transfer of an asset is accounted for as a sale an entity applies the requirements
of IFRS 15 for determining when a performance obligation is satisfied.

If an asset transfer satisfies IFRS 15’s requirements to be accounted for as a sale the seller measures the
right-of-use asset at the proportion of the previous carrying amount that relates to the right of use
retained. Accordingly, the seller only recognises the amount of gain or loss that relates to the rights
transferred to the buyer.

If the fair value of the sale consideration does not equal the asset’s fair value, or if the lease payments are
not market rates, the sales proceeds are adjusted to fair value, either by accounting for prepayments or
additional financing.

Disclosure
The objective of IFRS 16’s disclosures is for information to be provided in the notes that, together with
information provided in the statement of financial position, statement of profit or loss and statement of
cash flows, gives a basis for users to assess the effect that leases have.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 16 MCQ. 8, 21-25
Spec. exam Sept. 16 MCQ.3
June 15 Q.3(iii), (iv)
LEASES Dec. 14 Q.19
Dec.13 Q.2 (ii), Q.5
June 12 Q.2 (ii)
Dec. 11 Q.2 (ii)

F7 Revision notes Page 44

 IFRS 13 – FAIR VALUE MEASUREMENTS

NEED FOR FAIR VALUE GUIDANCE:

IFRS 13 provides a single source of guidance for all fair value measurements, clarifying the definition of
fair value and enhancing disclosures requirements about reported fair value estimates.

FAIR VALUE DEFINITION

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.

From the above definition, it can be inferred that fair value is an exit price.

IFRS 13 provides a new framework to estimate fair value in a consistent manner across standards. For a
fair value measurement, an entity has to determine:

 The particular asset or liability that is the subject of the measurement

 For an asset, the valuation premise that is appropriate for the measurement
 The most advantageous market for the asset or liability and
 The valuation technique appropriate for measurement

I. THE MOST ADVANTAGEOUS MARKET

It is assumed that transactions take place in the most advantageous market to which the entity has access.
This means that the entity is in a position to receive the maximum amount on sale of the asset or pay the
minimum amount to transfer a liability after considering transaction and transport costs.

While transaction and transport costs are relevant to identify the market, they are not considered in
determining the fair value.

II. MEASUREMENT ASSUMPTIONS

Fair value measurement of an asset or liability should use the assumptions that market participants would
use in pricing the asset or liability. These assumptions include:

 buyers and sellers are independent of each other

 they have knowledge about the asset or liability
 they are capable of entering into a transaction
 They are willing to enter into a transaction, rather than being forced or otherwise compelled.

III. ASSET -SPECIFIC VALUATIONS

For a fair value measurement of an asset, it is assumed that the asset will be sold to a market participant
who will use it at its highest and best use.

IV. LIABILITY-SPECIFIC VALUATION

Fair value measurement of a liability assumes that the liability is transferred to a market participant at the
measurement date. Where there is no observable market price for the transfer of a liability, an entity
would be required to measure the fair value of the liability using the same methodology that the
counterparty would use to measure the fair value of the corresponding asset.

F7 Revision notes Page 45

V. VALUATION TECHNIQUES
An entity uses valuation techniques appropriate in the circumstances and for which sufficient data are
available to measure fair value, maximising the use of relevant observable inputs and minimising the use
of unobservable inputs.

Where fair value is determined using a valuation technique, IFRS 13 prescribes that the technique should
be one of the following.

i. Market approach: uses price and other relevant market information for identical or
comparable assets or liabilities
ii. Income approach: converts future amounts to a single discounted present value amount or
iii. Cost approach: amount that would currently be required to replace the service capacity of
the asset
iv. Fair value hierarchy

IFRS 13 seeks to increase consistency and comparability in fair value measurements and related
disclosures through a 'Fair Value Hierarchy'. The hierarchy categorises the inputs used in valuation
techniques into three levels.

Level 1 Inputs
Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at
the measurement date.

Level 2 Inputs
Inputs other than quoted prices included in Level 1 that are directly or indirectly observable.

Level 3 Inputs
Inputs for the asset or liability that are not based on observable market data(unobservable inputs).

RULES IN BUSINESS COMBINATION:

IFRS 3 sets out general principles for arriving at the fair values of a subsidiary's assets and liabilities
only if they satisfy the following criteria:

 In the case of an asset other than an intangible asset, it is probable that any associated future
economic benefits will flow to the acquirer, and its fair value can be measured reliably. Vice versa
for liabilities
 In the case of an intangible asset or a contingent liability, its fair value can be measured reliably.
 The acquiree's identifiable assets and liabilities might include assets and liabilities not previously
recognised in the acquiree's financial statements
 An acquirer should not recognise liabilities for future losses or other costs expected to be incurred
as a result of the business combination.
 The acquiree may have intangible assets which can only be recognised separately from goodwill if
they are identifiable. They must be able to be capable of being separated from the entity.
 The acquirer should measure the cost of a business combination as the total of the fair values at
the date of acquisition
 If part of the consideration is payable at a later date, this deferred consideration is discounted to
present value at the date of exchange.
 In case of equity instruments as cost of investment, the published price at the date of exchange
normally provides the best evidence of the instrument's fair value.

F7 Revision notes Page 46

  Costs attributable to the combination, for example professional fees and administrative costs,
should not be included: they are recognised as an expense when incurred.
 If an asset or liability has been recognised at fair value at acquisition, it must be recorded in the
subsidiary’s statement of financial position at fair value consequently also
 Some fair value adjustments are made on depreciable assets such as buildings, the assets with fair
value adjustment must be depreciated at its fair value so there will be an adjustment, which flows
through to profit or loss for this additional depreciation.

F7 Revision notes Page 47

 IAS-20 GOVERNMENT GRANTS

Objective:
To prescribe the accounting for, and disclosure of, government grants and other forms of government
assistance.

Definitions:

Government assistance is provision of economic benefits by government to a specific entity or range

of entities which meet specific criteria.

Government grants are transfer of resources to an entity, from government, in return for compliance
with certain conditions.

Accounting treatment:

Recognition
A government grant is recognized only when there is reasonable assurance that

 The entity will comply with any conditions attached to the grant
 The grant will be received.

Grant related to income are recognized over the period and matched with the related expenses.

Grant related to depreciable assets are recognized over the useful life of the assets in the proportion of
depreciation charge.

Grant related to non-depreciable assets are also recognized over the period in which related expenses are
made.

Non-monetary grants are recognized at fair value.

Presentation:

A grant relating to assets may be presented in one of two ways:

 As deferred income, or
 By deducting the grant from the asset's carrying amount.

A grant relating to income may be reported separately as 'other income' or deducted from the related
expense.

F7 Revision notes Page 48

Repayment:
 A government grant that becomes repayable shall be accounted for as a revision to an accounting
estimate (IAS –8).
 Repayment of a grant related to income shall be applied first against any un-amortized deferred
credit and if repayment exceeds the deferred credit the rest will be recognized immediately as
expense.
 Repayment of grants related to assets shall be recorded by increasing the carrying amount of the
asset or reducing the deferred income balance by the amount payable. The cumulative additional
depreciation that would have been recognized to date as an expense in the absence of the grant
shall be recognized immediately as an expense.

If the conditions of a grant are breached, it may need to be repaid.

 In case of Revenue grants recognize repayment immediately as an expense.

 In case of Capital grant increase the carrying value of the asset by the amount of the repayment, or
reduce deferred income by the amount of the repayment.

Disclosure:

The following must be disclosed:

 Accounting policy adopted for grants, including method of statement of financial position
presentation
 Nature and extent of grants recognized in the financial statements
 Unfulfilled conditions and contingencies attaching to recognized grant

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 16 MCQ. 3
June 15 MCQ.15
IAS 20
June 14 Q.5(iii)
Dec. 12 Q.5

F7 Revision notes Page 49

 IAS 10 - EVENTS AFTER REPORTING DATE

Objective:
To prescribe:
 When an entity should adjust its financial statements for events after the reporting period; and
 The disclosures that an entity should give about the date when the financial statements were
authorized for issue and about events after the reporting period.

Definitions:
Event after the reporting period occurs between the end of the reporting period and the date that the
financial statements are authorized for issue. These include:

 Adjusting events provide evidence of conditions that existed at the end of the reporting period.
 Non-adjusting events are those that are indicative of conditions that arose after the reporting
period.

Accounting treatment:

 Adjust financial statements for adjusting events

 Do not adjust for non-adjusting events
 If an entity declares dividends after the reporting period, the entity shall not recognize those
dividends as a liability at the end of the reporting period. That is a non-adjusting event.
 An entity shall not prepare its financial statements on a going concern basis if management
determines after the reporting period either that it intends to liquidate the entity or to cease
trading.

Adjusting events – examples

Adjusting events, as is evident by the name, require adjustments in the financial statements. Following
are some examples:

 Invoices received in respect of goods or services received before the year end
 The resolution after the reporting date of a court case giving rise to a liability
 Evidence of impairment of assets, such as news that a major customer is going into liquidation or the
sale of inventories below cost
 Discovery of fraud or errors showing that financial statements were incorrect
 Determination of employee bonuses/profit shares
 The tax rates applicable to the financial year are announced
 The auditors submit their fee
 The sale of a non-current asset at a loss indicates that it was impaired at the reporting date
 The bankruptcy of a customer indicates that their debt was irrecoverable at the reporting date
 The sale of inventory at less than cost indicates that it should have been valued at NRV in the
accounts
 The determination of cost or proceeds of assets bought/sold during the accounting period indicates at
what amount they should be recorded in the accounts

F7 Revision notes Page 50

Non-adjusting events – examples
Usually non-adjusting events do not require adjustments. However, if the event is of such importance that
its non-disclosure will affect the economic decision making of users it should be disclosed in the notes to
the accounts. Some examples of non-adjusting events are as follows:

 Business combinations
 Discontinuance of an operation
 Major sale/purchase of assets
 Destruction of major assets in natural disasters
 Major restructuring
 Major share transactions
 Unusual changes in asset prices/foreign exchange rates
 Commencing major litigation
 A purchase or sale of a non-current asset
 The destruction of assets due to fire or flood
 The announcement of plans to discontinue an operation
 An issue of shares

Disclosure:

Non-adjusting events should disclose the nature and financial effect of the event if its non-disclosure
would affect the judgment of users in making decisions.

Companies must disclose the following

 When the financial statements were authorized for issue

 Who gave that authorization
 Who has the power to amend the financial statements after issuance

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

IAS 10 June 15 MCQ.3

F7 Revision notes Page 51

 IAS 12 – INCOME TAXES

Objective
The objective of IAS 12 is to prescribe the accounting treatment for income taxes.

Definitions

Accounting profit
This is the net profit (or loss) for the reporting period before deducting tax expense.

Taxable Profit
This is the profit (or loss) for a period, determined in accordance with the local tax authority's rules, upon
which income taxes are payable.

CURRENT TAX
This is the amount of income tax payable (or recoverable) in respect of the taxable profit (or loss) for the
period.

Accounting for Current Tax

 Current taxes include tax payable for current period and adjustment of under/over provision of
prior periods
 Current taxes are to be treated as an expense
 If the tax expense and the provision at the end of the year are greater than the payment, the
shortfall in the payment will be disclosed as a current tax liability and vice versa.

Tax Expense
Tax in the income statement may consist of three elements:
 Current tax expense
 Adjustments to tax charges of prior periods (over/under provisions)
 Transfers to/from deferred tax.

DEFERRED TAX

Tax Base
This is the amount attributed to an asset or liability for tax purposes.

Tax base-Asset
The tax base of an asset is the amount that will be deductible for tax purposes against any future taxable
benefits derived from the asset.

Tax base-Liability
The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes
in respect of that liability in future periods.

Accounting for Deferred Tax

Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable
temporary differences.

F7 Revision notes Page 52

Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:
 Deductible temporary differences
 The carry forward of unused tax losses
 The carry forward of unused tax credits

Temporary differences are differences between the carrying amount of an asset or liability in the
SOFP and its tax base.

Temporary differences may be of two types:

i. Taxable temporary differences are temporary differences that will result in taxable amounts in
determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is
recovered or settled.

A taxable temporary difference occurs when:

 Depreciation or amortisation is accelerated for tax purposes
 Development costs capitalised in the statement of financial position deducted against taxable
profit when the expenditure was incurred
 Interest income is included in the statement of financial position when earned, but included in
taxable profit when the cash is actually received
 Prepayments in the statement of financial position deducted against taxable profits when the
cash expense was incurred
 Revaluation/Fair value adjustment of assets with no adjustment of the tax base.
 Deferred tax on impairment where these adjustments are ignored for tax purposes until the asset
is sold.

ii. Deductible temporary differences are temporary differences that will result in amounts that
are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of
the asset or liability is recovered or settled.

A deferred tax asset (DTA) shall be recognised for all deductible temporary differences to the extent it is
probable that taxable profit will be available against which the deductible temporary difference can be
utilised.

 Provisions, accrued product warranty costs for which the taxation laws do not permit the
deduction until the company actually pays the claims. This is a deductible difference as its taxable
profits for the current period will be higher than those in future, when they will be lower.

Measurement of deferred tax assets and liabilities

 Measurement shall be at the tax rates expected to apply to the period when the asset is realised or
liability is settled.
 The rates used shall be those enacted or substantially enacted by the end of the reporting period.
 Measurement depends upon the expectations about the manner in which the recovery of tax asset
or settlement of tax liability will take place.
 In the case of deferred tax assets and liabilities, the values are not to be discounted.
 Deferred tax expense is recognized as an expense in statement of profit or loss. If the tax relates to
items that are credited or charged directly to equity, then this current tax and deferred tax shall
also be charged or credited directly to equity.

F7 Revision notes Page 53

Presentation
Current tax assets and current tax liabilities should be offset on the SOFP only if the entity has the legal
right and the intention to settle on a net basis.

Deferred tax assets and deferred tax liabilities should be offset on the SOFP only if the entity has the legal
right to settle on a net basis.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 16 MCQ. 19, 20, 31(iv)
March/June 16 Q.3 (v)
Dec. 15 Q.1 (vi)
June 15 Q.3 (vi)
Dec. 14 Q.2 (iii)
June 14 Q.2 (vi)
IAS 12
Dec. 13 Q.2 (iv)
June 13 Q.2 (iv)
Dec. 12 Q.2 (vi)
June 12 Q.2 (iv)
Dec. 11 Q.2 (vi)
June 11 Q.2 (iv)

F7 Revision notes Page 54

 IFRS 15 – REVENUE FROM CONTRACTS WITH CUSTOMERS
IFRS 15 specifies how and when an IFRS reporter will recognise revenue.

THE FIVE-STEP MODEL FRAMEWORK

The standard provides a single, principles based five-step model to be applied to all contracts with
customers.

STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER

A contract with a customer will be within the scope of IFRS 15 if all the following conditions are met:

 The contract has been approved by the parties to the contract;

 Each party’s rights in relation to the goods or services to be transferred can be identified;
 the payment terms for the goods or services to be transferred can be identified;
 the contract has commercial substance; and
 It is probable that the consideration to which the entity is entitled to in exchange for the goods or
services will be collected.

STEP 2: IDENTIFY THE PERFORMANCE OBLIGATIONS IN THE CONTRACT

At the inception of the contract, the entity should assess the goods or services that have been promised to
the customer, and identify as a performance obligation:

 a good or service (or bundle of goods or services) that is distinct; or

 A series of distinct goods or services that are substantially the same and that have the same
pattern of transfer to the customer.

A series of distinct goods or services is transferred to the customer in the same pattern if both of the
following criteria are met:

 Each distinct good or service in the series that the entity promises to transfer consecutively to the
customer would be a performance obligation that is satisfied over time; and
 A single method of measuring progress would be used to measure the entity’s progress towards
complete satisfaction of the performance obligation to transfer each distinct good or service in the
series to the customer.

A good or service is distinct if both of the following criteria are met:

 The customer can benefit from the good or services on its own or in conjunction with other
readily available resources; and
 The entity’s promise to transfer the good or service to the customer is separately identifiable from
other promises in the contract.

Factors for consideration as to whether a promise to transfer the good or service to the customer is
separately identifiable include, but are not limited to:

 The entity does not provide a significant service of integrating the good or service with other
goods or services promised in the contract.
 The good or service does not significantly modify or customise another good or service promised
in the contract.
 The good or service is not highly interrelated with or highly dependent on other goods or services
promised in the contract.

F7 Revision notes Page 55

STEP 3: DETERMINE THE TRANSACTION PRICE
The transaction price is the amount to which an entity expects to be entitled in exchange for the transfer
of goods and services. When making this determination, an entity will consider past customary business
practices.

Where a contract contains elements of variable consideration, the entity will estimate the amount of
variable consideration to which it will be entitled under the contract.

However, a different, more restrictive approach is applied in respect of sales or usage-based royalty
revenue arising from licences of intellectual property. Such revenue is recognised only when the
underlying sales or usage occur.

STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE

OBLIGATIONS IN THE CONTRACTS
Where a contract has multiple performance obligations, an entity will allocate the transaction price to the
performance obligations in the contract by reference to their relative standalone selling prices. If a
standalone selling price is not directly observable, the entity will need to estimate it. IFRS 15 suggests
various methods that might be used, including:

 Adjusted market assessment approach

 Expected cost plus a margin approach
 Residual approach (only permissible in limited circumstances).

STEP 5: RECOGNISE REVENUE WHEN (OR AS) THE ENTITY SATISFIES A

PERFORMANCE OBLIGATION

Revenue is recognised as control is passed, either over time or at a point in time.

Control of an asset is defined as the ability to direct the use of and obtain substantially all of the remaining
benefits from the asset. The benefits related to the asset are the potential cash flows that may be obtained
directly or indirectly. These include, but are not limited to:

 Using the asset to produce goods or provide services;

 Using the asset to enhance the value of other assets;
 Using the asset to settle liabilities or to reduce expenses;
 Selling or exchanging the asset;
 Pledging the asset to secure a loan; and
 Holding the asset.

An entity recognises revenue over time if one of the following criteria is met:

 The customer simultaneously receives and consumes all of the benefits provided by the entity as
the entity performs;
 The entity’s performance creates or enhances an asset that the customer controls as the asset is
created; or
 The entity’s performance does not create an asset with an alternative use to the entity and the
entity has an enforceable right to payment for performance completed to date.

F7 Revision notes Page 56

If an entity does not satisfy its performance obligation over time, it satisfies it at a point in time. Revenue
will therefore be recognised when control is passed at a certain point in time. Factors that may indicate
the point in time at which control passes include, but are not limited to:

 The entity has a present right to payment for the asset;

 The customer has legal title to the asset;
 The entity has transferred physical possession of the asset;
 The customer has the significant risks and rewards related to the ownership of the asset; and
 The customer has accepted the asset.

CONTRACT COSTS
The incremental costs of obtaining a contract must be recognised as an asset if the entity expects to
recover those costs.

Costs incurred to fulfill a contract are recognised as an asset if and only if all of the following criteria are
met:

 The costs relate directly to a contract (or a specific anticipated contract);

 The costs generate or enhance resources of the entity that will be used in satisfying performance
obligations in the future; and
 The costs are expected to be recovered.

The asset recognised in respect of the costs to obtain or fulfill a contract is amortised on a systematic basis
that is consistent with the pattern of transfer of the goods or services to which the asset relates.

PRINCIPLES OF REVENUE RECOGNITION

Sale on return basis

 In case of sale on return basis, an estimate should be made of the amount of goods expected to be
returned.
 The most likely amount of return can be determined by past experience or by assigning
probability to estimated figures
 For the goods expected to be returned, sale is not recognized. A refund liability is recorded with
the amount.
 The right to receive inventory with a corresponding adjustment to cost of sales
 If the item is ultimately not returned, then it will be recognized as sale at the point of
confirmation of no return.

Warranty
 In case of option to purchase warranty separately (extended), warranty is distinct and should be
recognized as a separate performance obligation
If a customer does not have the option to purchase a warranty separately, an entity shall account for the
warranty in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Asset
Principal versus agent considerations
 When another party is involved in providing goods or services to a customer, the entity shall
determine whether the nature of its promise is a performance obligation to provide the specified
goods or services itself (ie the entity is a principal) or to arrange for the other party to provide
those goods or services (ie the entity is an agent).
 An entity is a principal if the entity controls a promised good or service before the entity transfers
the good or service to a customer. However, an entity is not necessarily acting as a principal if the
entity obtains legal title of a product only momentarily before legal title is transferred to a
customer.

F7 Revision notes Page 57

 When an entity that is a principal satisfies a performance obligation, the entity recognises revenue
in the gross amount of consideration to which it expects to be entitled in exchange for those goods
or services transferred.
 An entity is an agent if the entity’s performance obligation is to arrange for the provision of goods
or services by another party. When an entity that is an agent satisfies a performance obligation, the
entity recognises revenue in the amount of any fee or commission to which it expects to be entitled
in exchange for arranging for the other party to provide its goods or services.
Indicators that an entity is an agent are as follows:

a. Another party is primarily responsible for fulfilling the contract;

b. The entity does not have inventory risk before or after the goods have been ordered by a
customer, during shipping or on return;
c. The entity does not have discretion in establishing prices for the other party’s goods or
services and, therefore, the benefit that the entity can receive from those goods or services is
limited;
d. The entity’s consideration is in the form of a commission; and
e. The entity is not exposed to credit risk for the amount receivable from a customer in exchange
for the other party’s goods or services.

Repurchase agreements
A repurchase agreement is a contract in which an entity sells an asset and also promises or has the option
(either in the same contract or in another contract) to repurchase the asset. The repurchased asset may be
the asset that was originally sold to the customer, an asset that is substantially the same as that asset, or
another asset of which the asset that was originally sold is a component.

Repurchase agreements generally come in three forms:

a. An entity’s obligation to repurchase the asset (a forward);
b. An entity’s right to repurchase the asset (a call option); and
c. An entity’s obligation to repurchase the asset at the customer’s request (a put option).

Forward & Call option

 In case of forward and call option, the customer does not obtain control
 If entity can or must repurchase at an amount less than original selling price of asset, then it will
be accounted for as lease
 If entity can or must repurchase at an amount equal to or more than original selling price of asset,
then accounting done as financing arrangement —recognize the asset and a financial liability
Put option
 If repurchase price lower than original selling price then see does customer have significant
economic incentive to exercise right
 If yes then account for as lease. If no, then recognize as sale of product with right of return
 If repurchase price is equal or greater than original selling price following two options arise
 If repurchase price is more than expected market value then accounting done as financing
arrangement —recognize the asset and a financial liability
 If Repurchase price is less than expected market value and no significant economic incentive to
exercise right then record as sale of product with right of return

Bill and hold arrangement

 Bill-and-hold arrangements are those whereby an entity bills a customer for the sale of a
particular product, but the entity retains physical possession until it is transferred to the customer
at a later date.
 In assessing whether revenue can be recognized in a bill-and-hold transaction, entities must first
determine whether control has transferred to the customer (as with any other sale under IFRS 15)
through review of the indicators for the transfer of control. One indicator is physical possession of

F7 Revision notes Page 58

 the asset; however, physical possession may not coincide with control in all cases (e.g., in bill-
and-hold arrangements).
 In determining whether control has transferred in such arrangements, the specific criteria
included in IFRS 15 for bill-and-hold transac-tions must all be met in order for revenue to be
recognized.

o The reason for the bill-and-hold arrangement must be substantive (e.g., the customer has
requested the arrangement).
o The product must be identified sepa-rately as belonging to the customer.
o The product currently must be ready for physical transfer to the customer.
o The entity cannot have the ability to use the product or to direct it to another customer.

 An entity that has transferred control of the goods and met the bill-and-hold criteria to recognize
revenue will also need to consider whether it is providing other services (e.g., custodial services).
If so, a portion of the transaction price should be allocated to each of the separate performance
obligations (i.e., the goods and the custodial service).

Consignment arrangements
When an entity delivers a product to another party (such as a dealer or a distributor) for sale to end
customers, the entity shall evaluate whether that other party has obtained control of the product at that
point in time. A product that has been delivered to another party may be held in a consignment
arrangement if that other party has not obtained control of the product.

Accordingly, an entity shall not recognise revenue upon delivery of a product to another party if the
delivered product is held on consignment.

Indicators that an arrangement is a consignment arrangement include, but are not limited to, the
following:
a. The product is controlled by the entity until a specified event occurs, such as the sale of the
product to a customer of the dealer or until a specified period expires;
b. The entity is able to require the return of the product or transfer the product to a third party
(such as another dealer); and
c. The dealer does not have an unconditional obligation to pay for the product (although it
might be required to pay a deposit).

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 16 MCQ. 26 - 28
March/June 16 Q.3 (i), (ii)
IFRS 15
Dec. 12 Q.2(i)
Dec. 11 Q.2 (i)
Dec. 15 Q.1 (i)
June 14 Q.2(i)
Substance over form Dec. 13 Q.4(b)
June 13 Q.2(i)
June 11 Q.2 (vi)

F7 Revision notes Page 59

 CASH FLOW STATEMENTS - IAS 7

Objective
The objective of IAS 7 - Cash-flow Statements is to ensure that enterprises provide information
about the historical changes in cash and cash equivalents by means of a cash flow statement which
classifies cash flows during the period according to operating, investing and financing activities for a
period.

Cash & Cash Equivalents

Cash comprises cash in hand and deposits repayable on demand less overdrafts repayable on demand.

Cash equivalents are short term, highly liquid investments that are readily convertible to known
amounts of cash and which are subject to an insignificant risk of changes in value. (Investments with a
maturity of three months or less from the date of acquisition)

Presentation of Cash Flow Statement

Operating Activities
Cash flows from operating activities are those that normally arise from transactions relating to trading
activities.

Cash flows from operating activities can be calculated in two ways, using the direct method or the indirect
method.

Direct method
The direct method shows operating cash receipts and payments directly. This is useful as it shows the
actual sources, and uses of cash flows by nature. The problem is that most businesses do not keep records
in this way and so it can be time consuming to gather the information. The information if available would
be presented as follows:

$
Cash receipts from customers X
Payments to suppliers (X)
Payments in relation to employees (X)
Payments in relation to other operating expenses (X)
Cash flows from Operations X
Interest paid (X)
Income taxes paid (X)
Dividends paid (might be shown in financing activities) (X)
Net cash flows from operating activities X

Whilst IAS 7 encourages the use of this method it is not mandatory.

Indirect Method
This method starts with profit before tax and adjusts for non-cash items to arrive at cash flows from
operations. Non operating items such as interest paid, tax paid are deducted to arrive at net cash flows
from operating activities. This method allows users to assess the quality of earnings as a comparison of
profit and cash flows can easily be made. Additionally, this method is popular with preparers, as it does
not give away such sensitive information as the direct method.

F7 Revision notes Page 60

Investing Activities
Investing activities are the acquisition and disposal of long term assets, and other investment that are not
considered to be cash equivalents but have been made to generate future income and cash flows.

Financing Activities
Financing activities are activities that alter the equity capital and borrowing structure (gearing) of the
entity and will comprise receipts and payments of capital/principal from or to external providers of
finance.

Proforma single Entity Cash Flow Statement

$'m $'m
Net cash inflow from operating activities
Profit before tax X
Adjustments for:
Add back interest expense X
Deduct investment income (X)
Add back depreciation X
Add back Loss on disposal of PP&E X
Add back Goodwill impairment X
Add back increase in provisions X
Deduct amortisation of government grants (X)
Operating profit before working capital changes X
(Increase) in inventory (X)
(Increase) in receivables (X)
Increase in payables X
Cash generated from operations X
Interest paid (X)
Tax paid (X)
Dividends paid (might be shown in Financing instead) (X)
Net cash flow from operating activities X/(X)
Cash flows from investing activities
Purchase of PP&E (X)
Purchase of non-current investments (X)
Receipts from sale PP&E X
Receipts from sale of investments X
Dividends received X
Interest received X
Receipt of government grant X
Cash used for investing activities X/(X)
Cash flows from Financing activities
Issue of ordinary share capital X
Issue of loan notes X
Payment of finance lease liabilities (X)
Cash from financing activities X/(X)
Net increase/(Decrease) in cash and cash equivalents
Opening balance for cash & cash equivalents X
Closing balance for cash and cash equivalents X

F7 Revision notes Page 61

 PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 16 MCQ. 11
June 15 Q.3(e)
Dec. 14 MCQ.9
Dec. 13 Q.3(a)
IAS 7
June 13 Q.3(a)
June 12 Q.3 (a)
Dec. 11 Q.3 (a)
June 11 Q.3 (a)

F7 Revision notes Page 62

 IFRS 5 – NON-CURRENT ASSETS HELD FOR SALE AND
DISCONTINUED OPERATIONS

OBJECTIVE
The objective of this standard is to specify the accounting for Non-current assets held for sale, and
presentation and disclosure of discontinued operations.

Non-Current Assets Held For Sale

HELD FOR SALE

This term refers to a non-current asset whose carrying amount will be recovered principally through a
Sale transaction rather than through continuing use.

DISCONTINUED OPERATION
A discontinued operation includes the following criteria:
 is a separately identifiable components
 must represent a major line of the entity’s business
 is part of a plan to dispose of a major line of business or a geographical area
 is a subsidiary acquired with a view to resell

DISPOSAL GROUP
This is a group of assets and possibly some liabilities that an entity intends to dispose of in a single
transaction.
Non-current assets or disposal groups that meet the criteria to be classified as held for sale are
measured at the lower of:
 their carrying amount and
 fair value less costs to sell,

ACCOUNTING TREATMENT:
 Non-current assets that meet the criteria are presented separately on the Statement of Financial
Position within current assets.
 If the held for sale item is a disposal group then related liabilities are also reported separately
within current liabilities.
 Discontinued operations and operations held for sale must be disclosed separately in the
statement of financial position at the lower of their carrying value less costs to sell.

CLASSIFICATION OF NON-CURRENT ASSETS AS HELD FOR SALE

For an asset to be classified as held for sale:
a) It must be available for immediate sale in its present condition allowing for terms that are usual
or customary;
b) Its sale must be highly probable {expected within 1 year of reclassification);
c) It must be genuinely sold, not abandoned.

F7 Revision notes Page 63

For a sale to be highly probable it must be significantly more likely than probable. In addition the
standard sets out the following criteria to be satisfied:

 Management, at a level that has the authority to sell the assets or disposal group, is committed to a
plan to sell;
 An active program to locate a buyer and complete the sale must have begun.
 The asset or disposal group must be actively marketed at a price that is reasonable compared to its
current fair value.
 The sale of the asset is expected to be recorded as completed within time, ear from the date of
classification.
 The actions required to complete the plan should indicate that it is not likely that there will be
significant changes made to the plan or that the plan will be withdrawn.

MEASUREMENT
They are measured at the lower of:
 Fair value less costs to sell; and
 Carrying amount (in accordance with the relevant Standard).

 Any impairment loss on initial or subsequent write-down of the asset or disposal group to fair value
less cost to sell is to be recognised in the statement of profit or loss.
 Any subsequent increase in fair value less cost to sell can be recognised in the statement of profit or
loss to the extent that it is not in excess of the cumulative impairment loss that has been recognised in
accordance with the IFRS 5 or previously in accordance with IAS 36.

SUBSEQUENT REMEASUREMENT
 Whilst a non-current asset/disposal group is classified as held for sale it should not be depreciated or
amortised.
 At each reporting date where a non-current asset or disposal group continues to be classified as held
for sale it should be re-measured at fair value less costs to sell at that date.
 This may give rise to further impairments or a reversal of previous impairment losses. In either case
recognise in the income statement.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

March/June 17 Q. 31(a)
June 15 MCQ.17
IFRS 5 Dec.14 MCQ. 14
June 13 Q.2(ii) Q.2(a)
June 11 Q.4 (b)

F7 Revision notes Page 64

IAS 21 — THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE
RATES

Objective of IAS 21
The objective of IAS 21 is to prescribe how to include foreign currency transactions (As per scope of F7)

Key definitions

Functional currency:
The currency of the primary economic environment in which the entity operates.

Presentation currency:
The currency in which financial statements are presented.

Foreign currency:
It is a currency other than the functional currency of the entity.

Exchange difference:
The difference resulting from translating a given number of units of one currency into another currency at
different exchange rates.

Closing rate:
It is the spot exchange rate at the end of the reporting period.

Exchange difference:
It is the difference resulting from translating a given number of units of one currency into another
currency at different exchange rates.

Exchange rate:
It is the ratio of exchange for two currencies.

Monetary items:
They are units of currency held and assets and liabilities to be received or paid in a fixed or determinable
number of units of currency.

Spot exchange rate:

It is the exchange rate for immediate delivery.

F7 Revision notes Page 65

Foreign currency transactions
A foreign currency transaction should be recorded initially at the rate of exchange at the date of the
transaction (use of averages is permitted if they are a reasonable approximation of actual).
At each subsequent reporting date:

 Foreign currency monetary amounts should be reported using the closing rate
 Non-monetary items carried at historical cost should be reported using the exchange rate at the
date of the transaction
 Non-monetary items carried at fair value should be reported at the rate that existed when the fair
values were determined
 Exchange differences arising when monetary items are settled or when they are translated at
different rates from initial recognition or previous financial statements are reported in profit or
loss in the period
 If a gain or loss on a non-monetary item is recognised in other comprehensive income (for
example, a property revaluation under IAS 16), any foreign exchange component of that gain or
loss is also recognised in other comprehensive income.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

IAS 21 Spec. exam Sept. 16 MCQ.6

F7 Revision notes Page 66

 IAS 33 – EARNINGS PER SHARE

INTRODUCTION
Earnings Per Share (EPS) is an unusual accounting ratio in that it has a whole standard devoted to its
calculation and presentation.

USES OF EPS
The uses of EPS as a financial indicator include:
 The assessment of management performance over time.
 Trend analysis of EPS to give an indication of earnings performance.
 An indicator of dividend payouts. The higher the EPS the greater the expectation of an increased
dividend compared to previous periods.
 An important component in determining the entity's price/earnings (P/E) ratio.

DEFINITIONS
Ordinary shares: an equity instrument that is subordinate to all other classes of equity shares.
Potential ordinary shares: a financial instrument or other contract that may entitle its holder to
ordinary shares.
Examples of potential ordinary shares include:
 Convertible debt
 Convertible preference shares
 Share warrants
 Share options

Warrants or options: financial instruments that give the holder the right to purchase ordinary shares.
Dilution: a reduction in EPS or an increase in loss per share resulting from the assumption that
convertible instruments are converted, the options or warranties are exercised, or that ordinary shares
are issued upon the satisfaction of specified conditions.

Antidilution: an increase in EPS or a reduction in loss per share resulting from the assumption that
convertible instruments are converted, the options or warranties are exercised, or that ordinary shares are
issued upon the satisfaction of specified conditions.

BASIC EPS
The basic EPS should be calculated by dividing the net profit or loss attributable to ordinary equity
shareholders by the weighted average number of ordinary shares outstanding during the period.

The net profit is profit after tax and preference dividends.

CHANGES IN THE CAPITAL STRUCTURE

The four most common reasons for adjusting shares in issue at the beginning of the period are:
 Issue of new shares during the period (fully or partly paid)
 Bonus issues
 Rights issues;
 Potential ordinary shares (resulting in calculation of diluted EPS)

Issue of new shares during the period (Fully paid)

Shares should be included in the weighted average calculation from the date consideration is receivable

F7 Revision notes Page 67

Issue of new shares during the period (Partly paid)
Shares should be included in the weighted average calculation from the date consideration is receivable.
Partly paid shares are treated as fractions of shares; based on payments received to date as a proportion of
the total subscription price.

Bonus issue, share split and share consolidation

IAS 33 requires that the bonus shares are treated as if they had occurred at the beginning of the period.
The EPS from the previous period should also be recalculated using the new number of shares in issue to
allow comparison with the current year's EPS, as if the issue had taken place at the beginning of that
period as well.

When calculating the prior period EPS comparator then multiply last year's EPS by the factor:

Number of Shares before bonus issue

Number of Shares after bonus issue

When calculating the weighted average number of shares then the bonus factor to apply is the inverse of
the above, i.e.
Number of Shares after bonus issue
Number of Shares before bonus issue

Similar considerations apply where ordinary shares are split into shares of smaller nominal value or
consolidated into shares of higher nominal value.

RIGHTS ISSUE
With a rights issue additional capital is raised by the issue of the shares. Then when dealing with a rights
issue at a discount, calculation of EPS should mark adjustment for the two elements:

 A bonus issue (reflecting the fact that the cash received would not pay for all the/shares issued if
based on fair values, rather than being discounted).
 An assumed issue at full price (reflecting the fact that new shares are issued in return for cash);

Consequently the number of shares outstanding at the beginning of the year should be adjusted for the
bonus factor to give a deemed number of shares in issue before the rights issue. This should be weighted
for the period up to the date of the rights issue.

The bonus factor is equal to: Fair Value before rights issue
Theoretical ex - rights Price after rights issue

Additionally the number of shares actually in issue after the rights issue is weighted for the period after
the rights issue.
As in the section on bonus issues, the prior period EPS should be adjusted for the bonus factor. This is
achieved by taking the reciprocal of the bonus factor (turn fraction Upside down) and multiplying by last
year's EPS.

F7 Revision notes Page 68

DILUTED EARNINGS PER SHARE
An entity may have in issue at the reporting date a number of financial instruments that give rights to
ordinary shares at a future date. IAS 33 refers to these as potential ordinary shares. Examples of potential
ordinary shares include:

 Convertible debt;
 Convertible preference shares;
 Share warrants
 Share options

Where these rights are exercised they will increase the number of shares. Earnings may also be affected.
The overall effect will tend towards lowering (or diluting) the EPS.

So that existing shareholders can see the potential dilution of their present earnings, IAS 33 requires that
a diluted EPS is calculated.
The calculation is performed as if the potential ordinary shares had been in issue throughout the period. If
the rights were granted during the reporting the period, then time apportion.

The diluted EPS is:

Earnings as per basic eps + Adjustment for dilutive potential ordinary shares
Weighted Average number of shares per basic EPS + Adjustment for dilutive potential
ordinal

Convertible Financial instruments

CALCULATION OF EARNINGS
Adjust:

1. Profits
There will be a saving of interest. Interest is a tax-deductible expense and so the post-' tax effects
will be brought into the adjusted profits.
There will be a saving of preference dividend. There is no associated tax effect

2. The number of shares

The potential ordinary shares are deemed to be converted to ordinary shares at the start of the
period unless they were issued during the reporting period.

SHARE WARRANTS AND OPTIONS

A share option or warrant gives the holder the right to purchase or subscribe for ordinary shares. IAS 33
requires that the assumed proceeds from these shares should be considered to have been received from
the issue of shares at fair value. These would have no effect on EPS.

The difference between the number of shares that would have been issued at fair value and the number of
shares actually issued is treated as an issue of ordinary shares for no consideration. This bonus element
has a dilutive effect with regard to existing shareholders.

F7 Revision notes Page 69

 PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 16 Q.1 (c)
Spec. exam Sept. 16 MCQ.7
June 15 Q3.(d)
Dec. 14 MCQ.2, 13
IAS 33
June 14 Q.2(d)
June 13 Q.2(b)
June 12 Q.2 (b)
June 11 Q.4(b)

F7 Revision notes Page 70

 CONSOLIDATED FINANCIAL STATEMENTS
A group is formed when one company, known as the parent, acquires control over another company,
known as its subsidiary.

The subsidiary and the holding company are considered separate legal entities. Group accounts are
presented as if the parent company and its subsidiary were one single entity – an application of the
substance over form concept.

DEFINITIONS
Group of Companies arises when one company (Parent) takes control of another company
(subsidiary).

Subsidiary is a company controlled by another company.

Parent is a company that controls one or more subsidiaries.

Non-Controlling Interest is a collective representation of the shareholders that normally own 49% or
less of equity.

Consolidated Financial Statements means F/S of whole Group presented as a single set of accounts.

CONTROL
According to IFRS 10 Consolidated Financial Statements an investor controls investee when it is exposed,
or has rights, to variable returns from its involvement with the investee and has the ability to affect those
returns through its power over the investee.

Existence of parent subsidiary relationship

Parent subsidiary relationship exists when:

 The parent holds more than one half of the voting power of the entity
 The parent has power over more than one half of the voting rights by virtue of an agreement with
other investors (common control)
 The parent has the power to govern the financial and operating policies of the entity under the
articles of association of the entity
 The parent has the power to appoint or remove a majority of the board of directors
 The parent has the power to cast the majority of votes at meetings of the board

1.1 EXEMPTION FROM PREPARING GROUP ACCOUNTS

A parent need not present consolidated financial statements if the following stipulations hold:

 The parent itself is a wholly-owned subsidiary or it is a partially owned subsidiary of another

entity Its securities are not publicly traded
 The parent’s debt or equity instruments are not traded in a public market
 The parent did not file its financial statements with a securities commission or other regulatory
organisation
 The ultimate parent publishes consolidated financial statements that comply with International
Financial Reporting Standards.

F7 Revision notes Page 71

GENERAL RULES

 Same accounting policies should be used for both the holding company and the subsidiaries.
Adjustments must be made where there is a difference
 The reporting dates of parent and subsidiary will be the same in most cases. In case of difference,
the subsidiary will be allowed to prepare another set of accounts for consolidation purposes (if the
difference is of more than three months).

Accounting for subsidiaries in separate financial statements of the holding company

The holding company will usually produce its own separate financial statements. Investments in
subsidiaries and associates have to be accounted for at cost or in accordance with IAS 39. Where
subsidiaries are classified as held for sale then the provisions of IFRS 5 have to be complied with.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 16 MCQ.2
Spec. exam Sept. 16 MCQ.9
Consolidation rules
June 15 MCQ.8
Dec.14 MCQ.10
Spec. exam Sept. 16 MCQ.2
IFRS 3
June 11 Q.1 (b)

F7 Revision notes Page 72

 CONSOLIDATED STATEMENT OF FINANCIAL POSITION
1. At the date of acquisition, the investment by the parent company in the subsidiary company is
cancelled of against the equity (share capital, state premium, retained earnings of subsidiary
company. Any excess remaining is known as goodwill.

2. All assets and liabilities of subsidiary company are than added on a line by line basis with the
assets and liabilities of the parent company.

3. If the parent contacts less than 100% of a subsidiary, the remaining investment is known as non-
controlling interest and a portion of equity shall now be attributable to NCI.

4. Consideration might be paid in the following ways:

 By cash
 By share for share exchange
 By deferred consideration
 By contingent consideration
 By loan notes

5. Contingent consideration: At times, the parent Co. agrees to pay the consideration only if
some specified conditions are met such conditions are contingent events and IFRS 3 requires to
measure such consideration at fair value

Initial recognition:

Dr. Cost of investment

Cr. Provision for contingent consideration

Deferred consideration: is recorded at present value at the date of acquisition.

Initial recognition:

Dr. Cost of investment

Cr. Provision for contingent consideration

Subsequent recognition Unwinding of discount

Dr. Consolidates retained earnings

Cr. Provision for deferred consideration

6. Intra-group balances: Such intra-group balances shall be removed from consolidated

statement of financial position (CSOFP) only if the balances reconcile.

Dr. Payables
Cr. Receivables

7. If balances do not reconcile:

Make the adjustments for in transit items

• Cash in transit
DR Cash
CR Receivables
• Goods in transit
DR Inventories
CR Payables

F7 Revision notes Page 73

 8. Intra-Group unrealized profits

Downstream transactions: if P Co has sold goods to S Co and these goods remain the in inventory
at the year end, the profit recognized by the parent Co. Shall be eliminated (No impact on NCI)

Dr. Consolidated Reserves

Cr. Inventory

Upstream transaction: If the S Co. has sold goods to the P.Co. the profits have been earned by the
S.Co. and shall be eliminated not only from group reserve but also from NCI

Dr. Consolidated Reserves

Dr. NCI
Cr. Inventories

9. Fair Value Adjustment

Gain or loss adjusted in the calculation of goodwill. Additional depreciation is deducted from
retained earnings.

FV of net assets.

10. Intra-group loans: The portion of loan given by the P.Co to its subsidiary is an intra-group
receivable, payable and shall be eliminated as such.

Dr. Loan liability

Cr. Loan Asset

Any interest receivable payable on such loans shall also be eliminated but only to the extent
related to the parent

Dr. Interest payable

Cr. Interest receivable

If the P.Co has not recorded interest receivable on loans given to the sub Co. the first treatment is
to record the interest receivable.

Dr. Interest receivable

Cr. Consolidated reserves

After this an intra-group interest receivable payables exists which shall be eliminated

Dr. Interest payable

Cr. Interest receivable

If P.Co. has recorded the receivable but subsidiary company has not included a payable in its own
financial statements, first treatment is to record the interest payable.

After this an intra-group interest receivable, payable asset which shall be eliminated.

11. Intra-group dividends: If the parent Co has not recorded the dividend recoverable the first
treatment is to record the receivables.

Dr. Dividend receivable

Cr. Consolidated reserve

F7 Revision notes Page 74

 After this an intra-group, dividends receivable/payable exists which shall be eliminated:

Dr. Consolidated reserves

Dr. NCI
Cr. Dividend payable

12. Redeemable Preference Shares: Treat like any other long-term loans i.e. eliminate as an
inter-company loan and adjust for any interest accrual.

13. Full or fair value of NCI: IFRS-3, allows/requires goodwill to be stated at full value i.e. a
part of goodwill shall now be attributable to NCI.

Now goodwill impairment shall be charged not only to be parent company but also to NCI

Dr. NCI
Dr. Consolidated Reserves
Cr. Goodwill

Goodwill in consolidated Statement of Financial Position:

Acquisition-date fair value of consideration transferred by parent X

Plus: Fair (or full) value of the N-CI at date of acquisition X
Less: Fair value of subsidiary's identifiable net assets at date of acquisition (X)
Equals: Total Goodwill X

Impairment Of Goodwill
Under this approach the goodwill appearing in the consolidated Statement of Financial Position is the
total goodwill. The accounting treatment will be:

Dr Group retained Earnings X

Dr Non-controlling interest X
Cr Goodwill X

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept./Dec. 17 Q. 32
March/June 17 Q. 32
Sept. 16 MCQ. 10,12,13,14
March/June 16 Q.1
Spec. exam Sept. 16 MCQ.10,15
Dec. 15 Q.3a
Consolidated SOFP
June 15 MCQ.5,11,12,14
Dec. 14 MCQ.16 Q.3(a),(c)
Dec. 13 Q.1(a)
June 13 Q.1
June 12 Q.1
Dec. 11 Q.1

F7 Revision notes Page 75

 CONSOLIDATED STATEMENT PROFIT OR LOSS AND OTHER
COMPREHENSIVE INCOME

 The basic idea is to show the results of the group as if it were a single entity.
 The majority of figures are simple aggregations of the results of the parent and all the subsidiaries
(line by line) down to profit after tax.
 In aggregating the results of the parent and subsidiaries, intra-group transactions such as
dividend income, interest income and unrealised profits are eliminated.
 Any non-controlling interest is ignored until profit after tax. Their interest in profits after tax is
then subtracted as a one-liner to leave profits attributable to members of the parent.

P group plc - Pro-forma Consolidated statement of profit or loss

For year ended 30 November 20X6
$'m
Sales revenue (P+S less intra-group sales) X
Cost of Sales (P+S less intra-group purchases plus unrealised profit in inventory) (X)
Gross Profit X
Distribution Costs (P+S) (X)
Administrative Expenses (P+S) (X)
Group operating Profit X
Interest and similar income receivable (P+S less intra group interest income) X
Interest expenses (P+S less intra-group interest expense) (X)
X
Share of Profits of Associate (PAT) X
Profit before tax X
Income tax expense (P+S) (X)
Profit for the period X
Profit attributable to :
Owners of the parent X
Non-controlling interest X
X

OTHER ADJUSTMENTS
 If the subsidiary is acquired during the current accounting period it is necessary to apportion the
profit for the period between its pre-acquisition and post-acquisition elements. This is dealt with
by determining on a line-by-line basis the post-acquisition figures of the subsidiary.
 After profit after tax in consolidated statement of profit or loss, total profits are divided between
profits attributable to group and profit attributable to NCI
 Any dividends receivable by the parent must be cancelled against dividends paid from the
subsidiary undertaking.
 Where group companies trade with each other one will record a sale and the other an equal
amount as a purchase. These items must be removed from the consolidated statement of profit or
loss by cancelling from both sales and cost of sales.
 The unrealized profit adjustment is to increase cost of sales. In case of upstream transaction, the
unrealized profit is deducted from profit attributable to NCI also.
 Investment in loans means an intra-group finance cost as well as inter-group dividends.
 These will cancel out in basically the same way as for dividends.
 Impairment of goodwill is treated as an administration expense unless otherwise stated
 There is no impact of fair value adjustment on acquisition at the statement of profit or loss.
However, any additional depreciation related to such fair value adjustment must be charged by
adding to cost of sales and deducting from profit after tax of subsidiary while calculating profit
attributable to NCI

F7 Revision notes Page 76

 PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept. 16 MCQ. 5
Spec. exam Sept. 16 MCQ.8
June 15 Q.1
Dec. 14 Q.3(b)
Consolidated P&L
June 14 Q.1
Dec. 13 Q.1(b)
Dec. 12 Q.1
June 11 Q.1

F7 Revision notes Page 77

 IAS 28 – INVESTMENTS IN ASSOCIATES

SCOPE
This Standard shall be applied in accounting for investments in associates.

DEFINITIONS
The following terms are used in this Standard with the meanings specified:-
 An associate is an entity, including an unincorporated entity such as a partnership, over which the
investor has significant influence and that is neither a subsidiary nor an interest in a joint venture.
 The equity method is a method of accounting whereby the investment is initially recognized at cost
and adjusted thereafter for the post-acquisition change in the investor’s share of net assets of the
investee. The profit or loss of the investor includes the investor’s share of the profit or loss of the
investee.
 Significant influence is the power to participate in the financial and operating policy decisions of
the investee but is not control or joint control over those policies. Investments of 20% to 50% in
voting power of companies lead to existence of significant influence. Significant influence by an
investor is usually evidenced in one or more of the following ways:-

a. Representation on the board of directors or equivalent governing body of the investee.

b. Participating in policy making process, including participation in decisions about dividends or
other distributions.
c. Material transactions between the investor and the investee
d. Interchange of managerial personnel; or
e. Provision of essential technical information.

ACCOUNTING OF ASSOCIATE
Associate should be accounted for in consolidated financial statement using equity method; i.e.
investment is

 Initially recorded at cost;

 Adjusted for post-acquisition change in net assets (investor share); Or post acquisition profits/losses
(investor share);
 The profit or loss of the investor includes the investor’s share of the profit or loss of the investee.
 Dividend paid or distributions made will reduce the investment.
 On acquisition any difference between the cost of investment and investor’s share of net fair value of
associate’s identifiable assets, liabilities and contingent liabilities is accounted for in accordance with
IFRS-3.
 Goodwill relating to an associate is included in the carrying value of investment
 Any excess of the investor’s share of net fair value of the associate’s assets, liabilities and
contingent liabilities over the cost of investment is excluded from the carrying value of
investment and is included in the income statement of the year of acquisition.

 Adjustments in investor’s share of profit and loss after acquisition are made in respect of depreciation
based on Fair Value.
 If different reporting dates, adjust the effect of significant events between reporting dates;
 The investor’s financial statements shall be prepared using uniform accounting policies for like
transactions and events in similar circumstances.
 If the investor’s share of losses exceeds or equals its interest in associate, the investor will discontinue
the recognition of further losses. Additional losses can only be recognized if there exist any legal or
constructive obligation
 Impairment test will be applied on the entire amount of investment under IAS -36 and the
impairment loss will be recognized.

F7 Revision notes Page 78

 In case of trading between group and associate, the profits or losses resulting from these transactions
are recognized in the investor’s financial statements only to the extent of un-related investor’s interest
in associate.
 No netting-off is done between receivables and payables

EXCEPTIONS TO THE EQUITY METHOD

An investment in an associate shall be accounted for using the equity method except when:
1) There is an evidence that the investment is acquired and held exclusively with a view to its disposal
within twelve months from acquisition date (Then apply IFRS -5).
2) All of the following apply:
a. The investor is a wholly-owned subsidiary its other owners do not object if the investor does not
apply the equity method;
b. The investor’s debt or equity instruments are not traded in a public market
c. The investor did not file its financial statements with securities commission, and
d. The ultimate parent of the investor produces consolidated financial statements.

Some noteworthy points include:

 Investment described in 1 above shall be classified as held for trading and
accounted for in accordance with IFRS-5.

EQUITY METHOD
Statement of profit or loss
 Dividend income from associates (reported in the investor's books) is replaced by the profit after tax
of the associate.

STATEMENT OF FINANCIAL POSITION

Initially the Investments in Associates is shown at cost (same as in the individual accounts), identifying
any goodwill included in the cost.
In subsequent years the Investor's accounts will show:

 the investment at cost

 Plus group share of associate's post acquisition reserves.
 Less any impairment of investment to date.

On the bottom of the statement of financial position consolidated reserves will reflect the other side of
these adjustments.

Method $
Cost of Investment X
Plus group share of post-acquisition reserves X
Less impairment of investment (X)
INVESTMENT IN ASSOCIATES X

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Spec. exam Sept. 16 MCQ.11
Dec. 15 Q.3b
Associates
June 15 MCQ.18
Dec. 11 Q.1

F7 Revision notes Page 79

 DISPOSAL OF INVESTMENT
Subsidiaries are consolidated until the date control is lost therefore profits need to be time-apportioned.

 Disposal occurs when control is lost over subsidiary. F7 syllabus includes only full disposal i.e. all
the holding is sold (say, 70% to nil)
 The effective date of disposal is when control is lost
 Following is the accounting treatment for full disposal
 In case of Statement of profit or loss and other comprehensive income,
consolidate results and non-controlling interests to the date of disposal.
 Show the group profit or loss on disposal
 In case of Statement of financial position, there will be no non-controlling interests
and no consolidation as there is no subsidiary at the date the statement of financial
position is being prepared.

Parent company's accounts

In the parent's individual financial statements the profit or loss on disposal of a subsidiary will be
calculated as:

$
Sales proceeds X
Less: Carrying amount (cost in P's own statement of financial position) (X)
Profit (loss) on disposal X/(X)
Group accounts – Gain/loss on disposal of subsidiary

In the group financial statements the profit or loss on disposal will be calculated as:

$ $
Proceeds X
Less: Amounts recognised prior to disposal:
Net assets of subsidiary X
Goodwill X
Non-controlling interest _(X)_
Profit / loss X/(X)

 If the disposal is mid-year:

- A working will be required to calculate both net assets and the non-controlling interest at the
disposal date.
- Any dividends declared or paid in the year of disposal and prior to the disposal date must be
deducted from the net assets of the subsidiary if they have not already been accounted for.
 Goodwill recognised prior to disposal is original goodwill arising less any impairment to date.

F7 Revision notes Page 80

 RATIO ANALYSIS
Ratio analysis is a technique whereby complicated information is summarised to a common denominator
so that a meaningful comparison of the company's performance and financial position can be made, or
comparison be made with another similar company

ANALYSIS AND INTERPRETATION

Calculation of key ratios from Explanation of ratios to

financial statements establish strengths and
weaknesses

PURPOSE
Depends on USER

Management Lender / analyst Investors / analyst

Cost control Lending Buy/Hold/Sell shares
Profitability analysis Security Quality of management
Investment decisions Credit worthiness

Comparison required with:

Previous years
Predetermined forecasts
Industry averages

LIMITATIONS

Availability of information Consistency Historic cost accounting

Cost/difficulty of obtaining Changes in accounting policies Inherent limitations of HCA
Information between years in periods of price level
changes
Different policies used by
different companies

F7 Revision notes Page 81

LIMITATIONS OF RATIO ANALYSIS
1. It is an oversimplification of a harsh business world
2. Ratios are based on highly subjective accounting figures
3. Historical cost accounts do not take into account the impact of inflation
4. Ratios do not make allowances for external factors: economic or political
5. Users are more interested in future prospects rather than past events

WHAT IS THE OBJECTIVE OF FINANCIAL STATEMENTS?

To provide information about the financial position, performance and financial adaptability of an
enterprise that is useful to a wide range of users for assessing the stewardship of management and for
making economic decisions

PROVIDE USEFUL INFORMATION ON

Financial Performance Financial

Position adaptability

Statement of  Statement of profit or Statement of Resources, solvency &

Financial Position loss Financial Position financial structure

 Statement of Income Performance &

Changes in equity Statement Distributions

 Statement of Cash Statement of Realised gains/losses &

flows changes in equity unrealized gains losses
(reserve movements)

Cash flow Amounts of cash flow

statement Timings of cash flow
Quality of profits
Who are these users and what information do they want?

Shareholders (investment decisions) Profit and dividend prospects

Loan creditors {lending decisions) Creditworthiness and liquidity
Employees (safety of employment) Wage bargaining and future prospects
Suppliers (credit decisions) Ability to pay on time and short term liquidity
Note that most users will be interested in what has happened in the past, and what may happen in the
future!

F7 Revision notes Page 82

 OVERVIEW
DIVISION OF RATIOS

PERFORMANCE LIQUIDITY EFFICIENCY STOCK MARKET

ROCE%  SHORT Inventory t/o in days ROE%

TERM
Profit margin% Current ratio Debtors t/o in days EPS
Creditors t/o in days Dividend yield%
Gross profit% Acid-test ratio

Net profit%  LONG TERM Asset turnover

Gearing Dividend cover

Interest cover

EXAM TECHNIQUE:
• RATIO ANALYSIS-----------use appendices to show calculations / always show formula used

• COMMENTS (cause) & CONSEQUENCES (effect)

3 steps

- The gearing ratio has moved from......}

- The gearing ratio measures.................} What is the overall picture?

- The move may be due to................}

STYLE OF REPORT

FORMAT STRUCTURE BE CONCISE

Formal: External Use sub-headings: Keep it simply and short

Introduction Avoid
Informal: Internal Separate paragraphs
Conclusion

F7 Revision notes Page 83

 PERFORMANCE RATIOS
Profitability and asset utilization
Primary ratio Return on Capital Employed
(ROCE)

Profit before interest and tax (PBIT) Comments on how

Share capital + reserves + long term efficiently capital has been
liabilities employed by management
OR
Fixed assets + current assets – current
Liabilities (1 yr.)

Profitability Asset utilization

Profit margin Secondary ratios Asset utilization

PBIT Sales
Sales Non CA + CA - CL

Comments on how profitable are sales Measures performance of

and control of operating costs company in generating
sales from assets at their
disposal

Gross profit margin Tertiary ratios Non-current asset

utilization

GP Sales
Sales Non CA (ex investments)

 Measures margin earned  Measure turnover

 Indicates changes in margin and generated by Non CA
product mix  Indicates spare capacity

Operating cost margin

Distribution / Administration
Sales

Indicates whether costs are being

controlled

F7 Revision notes Page 84

LIQUIDITY AND EFFICIENCY RATIOS

Short term solvency, working capital management and gearing

Short term solvency

Can business pay its creditors / employees on time and service its assets

Current ratio (current ratio) Acid ratio (quick ratio)

Current assets Current assets – inventory

Current liabilities Current liabilities

 Indicates any potential  Indicates real short-term

liquidity problems liquidity

Working capital management /

efficiency
Inventory and credit control

Stock control Credit control

Raw materials: Debtors turnover in days

Average RM stock x 365 Trade debtors x 365
RM consumption Credit sales
 Indicates inventory holding policy  Indicates number of days taken to collect
Work-in-progress: debts
Average x 365
Cost of production Creditors turnover in days
Indicates production cycle Trade creditors x 365
Finished goods: Credit purchases
Average FG x 365  Indicates number of days to pay debts
Cost of sales
 Indicates shelf life

F7 Revision notes Page 85

 Gearing and long term financial strength
Risk business takes from using debt capital

Gearing: Debt / Equity ratio Interest cover gearing

Fixed interest capital* x 100 PBIT

Ordinary share capital + Interest payable
Reserves

 Indicates how vulnerable  Indicates safety of interest

company is to lenders of long payments
term finance or how reliant it
is on external finance

* Loans + redeemable preference shares payments

+ deferred tax + obligations under finance leases

F7 Revision notes Page 86

STOCK MARKET / INVESTOR RATIOS

Return on equity capital (ROE)

Profit after tax and preference dividends  Indicates how efficiently company is employing
Ordinary share capital + reserves funds provided by equity shareholders

Earnings per share (EPS)

Profit after tax and preference dividends  Used as measure of profitability; higher the EPS,
Number of equity shares in issue the higher the shareholders expectation re
dividend payout

Price earnings ratio (P/E)

Market price of equity share  Measures of a company’s market rating; higher
EPS the PER, the higher the market’s confidence in
company’s future prospects

Dividend cover
Profit after tax and preference dividends  Indicates how many times current year’s profit
Ordinary dividends appropriated in period covers dividends appropriated, and retention
policy

Dividend yield
Ordinary dividends appropriated in period  Measure of return on investment
Market price of equity shares

F7 Revision notes Page 87

 PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Sept./Dec. 17 Q. 31
March/June 17 Q. 31
Sept. 16 Q.2
March/June 16 Q. 2
Spec. exam Sept. 16 MCQ. 12,14
Dec. 15 Q.2
June 15 MCQ.7,20 Q.2
Interpretation of ratios Dec. 14 Q.1
June 14 Q.3
Dec. 13 Q.3(b)
June 13 Q.3(b)
Dec. 12 Q.3
June 12 Q.3 (b)
Dec. 11 Q.2 (iii), Q.3 (b)
June 11 Q.3 (b)

F7 Revision notes Page 88

 NOT-FOR-PROFIT AND PUBLIC SECTOR ENTITIES
 Not-for-profit and public sector entities are not expected to show a profit but must ensure that
they have managed their funds efficiently
 Not-for-profit and public sector entities do not exist to make profits, but they do have a diverse
range of stakeholders, many of whom have a legitimate interest in the body’s financial
stewardship.
 The corporate objectives of businesses are very different from those of not-for-profit and public
sector entities.
 Companies exist largely to make profits.
 In practice, the accounting policies adopted by not-for-profit and public sector entities are
increasingly similar.
 Not-for-profit and public sector entities include government agencies, healthcare agencies,
schools, colleges and charities
 Even though not-for-profit entities do not report to shareholders, they must be able to account for
the funds received and the way they have been allocated
 Their objective is to provide goods and services to various recipients and not make a profit
 A public sector entity such as local government will have the aim of providing services to its local
community such as fire services, refuse collection, libraries, theatres and sports facilities
 A charity will have the aim of providing assistance to a particular cause, for example poverty aid
in developing countries, child protection, animal rescue

 Performance measurement
 The performance of a public sector or not-for-profit entity will be in terms of measuring whether
its stated Key performance indicators have been achieved
 One measure of performance for public sector entities is the 3 Es – economy, efficiency and
effectiveness
 Another performance consideration is whether the entity has achieved value for money
 Charities must focus on demonstrating that they have made proper use of the funds received and
whether they have achieved their stated aims

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

Not-for-profit entities Dec. 14 MCQ.15

F7 Revision notes Page 89