Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
ii
Contents
Page
Introduction
iv
Chapter features
vi
Learning outcomes
vii
xiii
Non-financial reporting
39
71
Non-current assets
101
Intangible assets
135
Impairment of assets
155
Leases
181
209
241
10
Revenue
267
11
Income taxes
297
12
Financial Instruments
331
13
Employee Benefits
389
14
Disclosure Standards 1
439
15
Disclosure Standards 2
467
16
Principles of consolidation
497
17
557
18
593
19
627
20
667
21
701
22
727
Index
757
Introduction
iii
Introduction
KC1 Corporate Financial Reporting
At the Corporate Level a student should have achieved comprehensive knowledge on accounting and
financial reporting, and built on the analytical skills acquired at the Business Level. One should also
have developed advisory capacity on financial reporting, impact of accounting standards, various
accounting options and their implications to management. One should be able to critically analyse
different types of reports produced by an organisation in communicating its results to the stakeholders
and deal with ethical issues arising from financial reporting. The ability to integrate with other
functions of the business is a rounding off skill that is also expected at this level.
Syllabus structure
Main syllabus areas
Weightings
35%
30%
25%
5%
5%
One of the key elements in examination success is practice. It is important that not only you fully
understand the topics by reading carefully the information contained in this Study Text, but it is also
vital that you practise the techniques and apply the principles that you have learned.
In order to do this, you should:
Work through all the examples provided within the chapters and review the solutions, ensuring
that you understand them;
Complete the progress test for each chapter.
In addition, you should use the Practice & Revision Kit. These questions will provide you with excellent
examination practice when you are in the revision phase of your studies.
iv
Pillar structure
The Curriculum 2015 is structured around three pillars, namely, Knowledge, Skills and Personal.
The Pillars are subdivided into specific subject areas or sub pillars and content is delivered to meet the
requirements of three progressively ascending levels of competency, namely, Executive, Business and
Corporate.
The Corporate Level aims to produce a CA professional fully equipped with the required knowledge,
skills and personality to be a corporate leader.
The Knowledge Pillar focuses on imparting sound technical knowledge required of a competent CA,
and comprises five sub pillars that focus on the following subject areas:
Sub pillar 1: Financial Accounting and Reporting (FA&R)
Sub pillar 2: Management Accounting and Finance (MA&F)
Sub pillar 3: Taxation and Law (T&L)
Sub pillar 4: Assurance and Ethics (A&E)
Sub pillar 5: Management and Contemporary Issues (M&C)
Introduction
Chapter features
Each chapter contains a number of helpful features to guide you through each topic.
vi
Topic list
This tells you what you will be studying in the chapter. The topic items form
the numbered headings within the chapter.
Chapter
introduction
The introduction puts the chapter topic into perspective and explains why it is
important, both within your studies and within your practical working life.
Learning
Outcomes
The learning outcomes issued for the module by CA Sri Lanka are listed at the
beginning of the chapter, with reference to the chapter section within which
coverage will be found.
Key terms
These are definitions of important concepts that you really need to know and
understand before the exam.
Examples
Case study
Often based on real world scenarios and contemporary issues, these examples
or illustrations are designed to enrich your understanding of a topic and add
practical emphasis.
Questions
These are questions that enable you to practise a technique or test your
understanding. You will find the answer underneath the question.
Formula to
learn
These are the formula that you are required to learn for the exam.
Section
introduction
Chapter
roundup
Progress
Test
Progress tests at the end of each chapter are designed to test your memory.
Bold text
Throughout the Study Text you will see that some of the text is in bold type.
This is to add emphasis and to help you to grasp the key elements within a
sentence or paragraph.
Evaluation/
Synthesis
Metacognitive
1.1 Level A
(Refer Appendix 3)
Where:
Knowledge
Process
Knowledge
Dimension
Knowledge Component
1, 3, 4, 5,
6,7,8,9, 10,
11, 12, 13,
14, 15, 16,
17, 18, 19,
20, 21
Chapter
Learning outcomes
Learning Outcome
CA Sri Lankas Learning outcomes for the Module are set out on the following pages. They are cross-referenced to the chapter in the Study Text where they are
covered.
Learning outcomes
vii
viii
Application/
Analysis/
Evaluate
Conceptual/
Procedural
1.2 Level B
(Refer Appendix 3)
Where:
Knowledge
Process
Knowledge
Dimension
Knowledge Component
9, 12, 13,
20
Chapter
Learning Outcome
(Refer Appendix 3)
Where:
1.3 Level C
Knowledge Component
Knowledge
Dimension
Conceptual
8, 11, 12,
20
Chapter
Learning outcomes
Learning Outcome
ix
Metacognitive
Metacognitive
Procedural/
Metacognitive
Knowledge
Dimension
Knowledge Component
Evaluate/
Synthesis
Evaluate/
Synthesis
Synthesis
Knowledge
Process
Learning Outcome
16
16
16, 17, 18
Chapter
Trend analysis
Evaluate
Evaluate
Knowledge
Process
3.2.2
3.2.1
3.1.1
Knowledge
Process
Evaluate/
Synthesis
Knowledge
Dimension
Metacognitive
Knowledge Component
4.1.1
4.1.2
4.1.3
Learning Outcome
Chapter
22
22
Chapter
Learning outcomes
Learning Outcome
Procedural
Procedural
Knowledge
Dimension
Knowledge Component
xi
xii
Procedural
Knowledge
Dimension
Evaluate
Knowledge
Process
Metacognitive
Knowledge
Dimension
Knowledge Component
Evaluate
Knowledge
Process
Knowledge Component
Learning Outcome
4.2.1
Learning Outcome
Chapter
Chapter
Verb List
Verb Definitions
Tier 1 Remember
Define
Draw
Identify
List
Relate
State
Calculate/
Compute
Discuss
Explain
Interpret
Recognise
Record
Summarise
Tier 2 Comprehension
Explain important
information
xiii
Knowledge Process
Verb List
Verb Definitions
Tier 3 Application
Apply
Assess
Demonstrate
Graph
Prepare
Prioritise
Reconcile
Solve
Analyse
Compare
Contrast
Differentiate
Outline
Tier 4 Analysis
Draw relations among ideas
and to compare and
contrast/solve open-ended
problems
xiv
Knowledge Process
Verb List
Verb Definitions
Tier 5 Evaluate
Advise
Convince
Criticise
Evaluate
Recommend
Resolve
Validate
Compile
Design
Develop
Propose
Tier 6 Synthesis
Solve unfamiliar problems by
combining different aspects
to form a unique or novel
solution
xv
xvi
CHAPTER
INTRODUCTION
This chapter revises the regulatory and conceptual frameworks studied at KB1 together with SLFRS
13 Fair Value Measurement. The chapter also considers current developments in financial reporting.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
4.2
New exposure
drafts
5.1
Recent ethical
issues
4.2.1
5.1.1
CHAPTER CONTENTS
1 The regulatory framework
2 Ethics
3 The Conceptual Framework
4 SLFRS 13 Fair Value Measurement
1.
2.
3.
CA Sri Lanka
Section 69
Section 148
Section 171
Section 192
For further details of the content of these sections, refer to your KB1 study text.
1.1.2 SEC Regulations
SEC Rules govern the listing of Securities on the Exchange and continuing listing
requirements in order to ensure the creation and maintenance of a market in
which Securities can be issued and traded in an orderly and fair manner and
which secures efficiency and confidence of all stakeholders in the operation and
conduct of the market. The rules are summarised below:
CA Sri Lanka
Initial listing
Listing of
shares and
debentures
Prospectus
and
introductory
documents
The Rules set out the basic requirements for the contents of a
prospectus. The Exchange is within its rights to require
additional information to be disclosed.
Further issue
Further shares of the same class as shares already listed may
of securities of not be issued until approved by the Exchange.
a listed entity In the case of an application to issue another class of shares, the
total value of all the other classes of shares issued at any given
time (as set out in the latest statement of financial position of
the Entity), must not exceed fifteen percent of the entitys
shareholders funds (ie stated capital and reserves).
A rights issue or issue through public subscription is for cash
only.
Articles of
Must contain the following provisions:
association/
Shares must be freely transferable and registration not
other
subject to restriction
corresponding Notices must be published in Sinhala, Tamil and English
documents
newspapers
More than 3 persons may not be registered as joint holders of
shares other than in relation to a deceased member
The company must comply with the Rules.
Continuing
listing
requirements
Corporate
disclosure
Related party
transactions
Enforcement
For further details of the content of the rules, refer to your KB1 study text.
CA Sri Lanka
CA Sri Lanka
LKAS 1
LKAS 2
Inventories
LKAS 7
LKAS 8
LKAS 10
LKAS 11
Construction Contracts
LKAS 12
Income taxes
LKAS 16
LKAS 17
Leases
LKAS 18
Revenue
LKAS 19
Employee benefits
LKAS 20
LKAS 21
LKAS 23
Borrowing costs
LKAS 24
LKAS 26
LKAS 27
LKAS 28
LKAS 29
LKAS 32
LKAS 33
Title
LKAS 34
LKAS 36
Impairment of assets
LKAS 37
LKAS 38
Intangible assets
LKAS 39
LKAS 40
Investment property
LKAS 41
Agriculture
SLFRS 1
SLFRS 2
Share-based payment
SLFRS 3
Business combinations
SLFRS 4
Insurance Contracts
SLFRS 5
SLFRS 6
SLFRS 7
SLFRS 8
Operating segments
SLFRS 9*
Financial instruments
SLFRS 10
SLFRS 11
Joint arrangements
SLFRS 12
SLFRS 13
SLFRS 15*
SLFRS
*SLFRS 9 and SLFRS 15 are not yet effective; therefore they are examinable as
current developments rather than in full detail.
The Sri Lanka Accounting and Auditing Standards Act No 15 of 1995 requires all
special business enterprises to comply with accounting standards established by
CA Sri Lanka. Therefore full SLFRS must be applied by:
All companies with debt or equity securities traded in a public market in Sri
Lanka (in both separate and consolidated financial statements), and
CA Sri Lanka
CA Sri Lanka
IFRIC 1
IFRIC 2
IFRIC 4
IFRIC 5
IFRIC 6
IFRIC 7
IFRIC 9
IFRIC 10
IFRIC 12
IFRIC 13
IFRIC 14
IFRIC 15
IFRIC 16
IFRIC 17
Title
IFRIC 18
IFRIC 19
IFRIC 20
SIC 15
SIC 25
SIC 27
SIC 29
SIC 31
SIC 32
Interpretations form part of full SLFRS and are therefore applicable by those
companies that apply full SLFRS.
1.
Setting the agenda involves identifying an item and adding it to the IASBs
work agenda.
2.
Planning the project involves the IASB deciding whether to conduct a project
alone or jointly with a national standard-setter.
3.
4.
5.
6.
After the standard is issued the IASB monitors its use and application in order
to identify whether further amendments are required. A post-implementation
review, being a formal review, normally takes place in respect of major new
standards and amendments, usually after they have been applied for two
years (which is normally 30-36 months after their effective date).
IASB exposure drafts and draft interpretations are exposed for public
comment by CA Sri Lanka.
2.
At the same time CA Sri Lanka conducts round table discussions to identify
the impact of the proposed standard in Sri Lanka.
3.
CA Sri Lanka reviews the IFRS and related technical materials. This may
result in modification of the standard for use in Sri Lanka, or deferral of a
standards adoption.
2.
The standard is translated into Sinhala and Tamil and published in the Extra
Ordinary Gazette as required by the Accounting and Auditing Standards Act
No: 15 of 1995 in Sri Lanka.
CA Sri Lanka
CA Sri Lanka
about an entitys financing activities and provide disclosures that help users to
understand the liquidity of an entity. Further detail is provided in Chapter 19
Statements of Cash Flows.
Classification and measurement of Share-based payment transactions
(proposed amendment to IFRS 2). The proposed amendments clarify
accounting where there is a performance vesting condition or a modification
and classification where there is a net settlement feature. The proposed
amendments are considered in more detail in Chapter 13 Employee benefits.
1.3.4 Recently issued standards
Two major standards were issued in 2014 but are not examinable within this
edition of the KC1 study text. They are:
IFRS 9 Financial Instruments (effective 1 January 2018), and
IFRS 15 Revenue from Contracts with Customers (effective 1 January 2017).
The full detail of the impact of these standards is discussed in the relevant
chapters (Chapter 12 Financial Instruments and Chapter 10 Revenue).
IFRS 14 Regulatory Deferral Accounts was also issued in 2014. This standard is an
interim standard applicable whilst the IASB works on its rate-regulated activities
project. The new standard permits an entity adopting IFRS for the first time to
continue to account for regulatory deferral account balances in accordance with
its previous GAAP.
Amended standards
In addition to the new standards detailed above, the following amended standards
have been issued by the IASB.
CA Sri Lanka
11
12
CA Sri Lanka
(2)
2 Ethics
Accountants must behave ethically and abide by ethical codes in order to apply
accounting standards correctly and achieve a fair presentation of financial
statements.
As we have seen, a regulatory framework of financial reporting exists, which
includes company law and accounting standards. Such a regulatory framework is
necessary in order to ensure that a companys financial position and performance
is fairly presented in its financial statements. This is turn is important because the
financial statements are relied on by investors, lenders and other users in order to
make economic decisions.
A regulatory framework can, however, only go so far in achieving an
outcome of fair presentation. In addition, the individuals who prepare the
financial statements must ensure that they adhere to the regulatory
framework. This raises the issue of professional ethics and ethical
behaviour.
CA Sri Lanka
13
14
CA Sri Lanka
They should not succumb to pressure from others to deviate from the
requirements of law and accounting standards and guidance.
They should raise concerns with the relevant individuals of bodies (such as an
audit committee) where they are subject to pressure from other individuals to
deviate from the requirements of law and accounting standards and guidance.
This is referred to as whistleblowing.
2.1.1 Example: Professional ethics
A Chartered Accountant joined a manufacturing company as its Finance Director.
The company had acquired land on which it built industrial units. The Finance
Director discovered that, before he began work at the company, one of the units
had been sold and the selling price was significantly higher than the amount that
appeared in the company's records. The difference had been siphoned off to
another company one in which his boss, the Managing Director, was a major
shareholder. Furthermore, the Managing Director had kept his relationship with
the second company a secret from the rest of the board.
The Managing Director acted unethically and not in the best interests of the
company. Having identified this, the Finance Director was obliged by CA Sri
Lankas Code of Ethics to pursue the matter.
The Finance Director confronted the Managing Director and asked him to reveal
his position to the board. However, the Managing Director refused to disclose his
position to anyone else. The secret profits on the sale of the unit had been used, he
said, to reward the people who had secured the sale. Without their help, he added,
the company would be in a worse position financially.
The Finance Director then told the Managing Director that unless he reported to
the board he would have to inform the board members himself. The Managing
Director still refused. The Finance Director disclosed the full position to the board.
The Finance Director therefore displayed integrity and objectivity and did not
succumb to pressure from the Managing Director to keep quiet. In disclosing the
position to the board, the Finance Director took a whistleblowing approach to
remedying the situation.
QUESTION
Draft financial statements for World Tea Plc for the year ended 31 March 20X2
have been prepared, and the statement of profit or loss shows a sharp drop in
operating profits compared to the previous year. This has a knock on effect on
operating cash flow in the statement of cash flows. The directors of World Tea Plc
are of the opinion that this is the result of a major customer suffering financial
CA Sri Lanka
15
difficulties together with a general reduction in the level of trade in the second
half of 20X1. They are, however, sure that this was a temporary problem and
believe that trading has improved significantly in the final two months of the
reporting period.
The directors are concerned that the fall in operating cash flow may result in the
breach of loan covenants and a drop in market confidence. They are also aware
that a drop in operating profits will adversely affect the performance related pay
awarded to directors and senior management of World Tea. They therefore
believe that it is in the best interests of the company and its long-term health to
make some adjustments to the draft financial statements. They have suggested to
the financial controller, a Chartered Accountant, that she:
1.
2.
Required
Explain the ethical responsibility of the financial controller in respect of the
directors suggestion.
ANSWER
The financial controller is a Chartered Accountant and as such:
1.
2.
Requirements of SLFRS
LKAS 1 is clear that no items of income or expense can be presented as
extraordinary. Therefore to make the adjustment requested by the directors
would result in an unfair presentation of profit.
LKAS 7 states that cash flows associated with the sale of an item of owner-used
plant are cash flows from investing activities. They are only cash flows from
operating activities if the plant was held to be rented out to others. This is not the
case here.
The requirements of SLFRS can be departed from, however only where
compliance would be so misleading that it would conflict with the objectives of
16
CA Sri Lanka
financial statements set out in the Conceptual Framework. This is not the case
here.
Code of Ethics
If the financial controller were to accept the directors suggestion to manipulate
the accounts this would be a clear breach of integrity ie that the financial
controller is honest in her professional conduct.
Acceptance of the suggestion by the financial controller also displays a lack of
objectivity ie the requirement that an accountant should not allow bias, conflict of
interest or the influence of others to override professional judgment. It is unclear
whether the financial controller is senior management and therefore benefits
from performance related pay, but if this is the case, objectivity becomes even
more relevant since the financial controller herself would benefit from adjustment
of the normalised profit figure. It is also unclear to what extent the directors are
exerting pressure on the financial controller. Allowing herself to be influenced to
act wrongly would display a lack of objectivity on her part.
The requirements to behave professionally and display professional
competence and due care mean that the financial controller must comply with
applicable professional standards and regulations and avoid any act that
discredits the profession. The inclusion of proceeds from the sale of non-current
assets in operating cash flow and classification of normal operating expenses as
extraordinary would display a lack of professional behaviour.
The financial controller should explain to the directors the requirements of
accounting standards and principles in respect of the suggested amendments to
the financial statements. She should attempt to persuade the directors to refrain
from amending the financial statements.
If the directors insist on the suggested adjustments being made, the financial
controller should consider her position and identify the misstated amounts to the
companys internal or external auditors.
CA Sri Lanka
17
In other companies, it may be the norm to deviate from the rules in order to
achieve a particular outcome. In the next section we consider examples of
companies throughout the world that have not behaved ethically and as a result
have issued misleading financial statements, sometimes leading to their downfall.
In many cases it was not a single individual at these companies that resulted in
problems, but an underlying unethical culture.
18
CA Sri Lanka
Investors confidence in the company began to decline in 2000, the CEO left the
company in 2001, and after a period of rapidly falling share prices, Enron
announced, in 2001, that it had to restate its financial statements for 1997 2000
as a result of accounting violations. These restatements reduced earnings for the
period by $613 million (a reduction of 23%) and in December 2001, Enron filed
for bankruptcy protection.
As a result of the dubious accounting practices at Enron and its subsequent
collapse:
Several executives were jailed.
The companys auditor was convicted of criminal obstruction of justice charges
and subsequently collapsed.
21,000 jobs were lost.
Xerox (2002)
In 2002 a complaint was made by the US regulator alleging that Xerox deceived
the public between 1997 and 2000 by using several accounting manoeuvres, the
most significant involving recording revenue in the period a lease contract was
signed, rather than spreading it over the length of the contract.
The regulator identified that the accounting irregularities increased fiscal year
1997 pre-tax profits by $405 million, 1998 pre-tax earnings by $655 million and
1999 pre tax earnings by $511 million.
Xerox restated its income for each of the years 1997 2001 and paid a civil
penalty of $10 million.
WorldCom (2002)
From 1999 2002, senior management at WorldCom used fraudulent accounting
practices to hide the companys poor financial position and report better
profitability and growth than actually existed. This was achieved by capitalising
costs that should have been expensed, and inflating revenues with entries from
bogus accounts. By the end of 2003 it was estimated that the companys assets had
been inflated by about $11 billion.
The fraud was discovered by a routine assessment of capital expenditure by the
companys internal audit function.
As a result of the fraud, shareholders lost $180 billion, 20,000 employees lost their
jobs and the CEO was sentenced to 25 years in prison.
CA Sri Lanka
19
Parmalat (2003)
Parmalat was an Italian dairy group that collapsed in 2003 in Europes biggest
bankruptcy. The companys 2003 financial reports were found to misrepresent
the underlying situation; in particular:
4 billion funds in a Bank of America account were found to be non-existent.
The company was found to owe 14.3 billion, being 8 times the amount
reported.
As a result the company was declared insolvent in December 2003 and the CEO
was charged with financial fraud and money laundering and imprisoned. Several
other Parmalat executives were also convicted and the Deloitte partners involved
in the Parmalat audit were banned from practising for 2 years.
Olympus (2011)
In 2011 Olympus, the Japanese electronics company, employed a new CEO. He was
dismissed from the post within a fortnight, after challenging the Board over
suspiciously large payments relating to acquisitions. As a result of the challenge,
an investigation was launched which revealed a cover up of losses dating back to
the 1990s. This was described by the Wall Street Journal as one of the longestrunning loss-hiding arrangements in Japanese corporate history.
In December 2011, Olympus offices were raided by the Japanese authorities and
in February 2012, 7 executives were arrested; three were subsequently given jail
sentences. The company lost 80% of its value in the aftermath of the scandal,
however it subsequently returned to profit and its shares regained most of their
losses.
3.1 Revision
The IASBs Conceptual Framework for Financial Reporting (Conceptual
Framework), as adopted by CA Sri Lanka, was explained in detail in the KB1 study
text. The following is a summary of its main contents; you should go back and
review your KB1 notes for further detail.
20
CA Sri Lanka
The Conceptual Framework is not a Sri Lanka Accounting Standard and so does
not define standards for any particular measurement or disclosure issue.
Nothing in the Conceptual Framework overrides any specific Sri Lanka
Accounting Standard.
The objective of general purpose financial reporting is to provide information
about the reporting entity that is useful to existing and potential investors,
lenders and other creditors in making decisions about providing resources to
the entity.
These users need information about the economic resources of the entity; the
claims against the entity; and changes in the entitys economic resources and
claims.
The Conceptual Framework makes it clear that financial information should be
prepared on an accruals basis (with the exception of the statement of cash
flows).
Going concern is the underlying assumption in preparing financial statements.
Qualitative characteristics are the attributes that make financial information
useful to users.
The fundamental qualitative characteristics are relevance and faithful
representation. A faithful representation is complete, neutral and free from
error.
The enhancing qualitative characteristics are comparability, verifiability,
timeliness and understandability.
The elements of financial position are assets, liabilities and equity:
An asset is a resource controlled by an entity as a result of past events and
from which future economic benefits are expected to flow to the entity.
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 is the residual interest in the assets of the entity after deducting all of
its liabilities.
The elements of financial performance are income and expenses:
Income is increases in economic benefits 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.
Expenses are decreases in economic benefits during the accounting period in
the form of outflows or depletions of assets or incurrences of liabilities that
CA Sri Lanka
21
22
CA Sri Lanka
QUESTION
Conceptual Framework
ANSWER
The Conceptual Framework is not itself an SLFRS and it does not override any
specific SLFRS.
It is used as a basis in the development of accounting standards, and therefore
several standards reflect its content exactly. For example, the Conceptual
Frameworks definition of an asset is reproduced in standards relating to assets,
such as IAS 16 Property, Plant and Equipment and IAS 38 Intangible assets. Equally
the definition of a liability is reproduced in standards including IAS 37 Provisions,
Contingent Liabilities and Contingent Assets.
It is also the case that the recognition criteria given within the Conceptual
Framework are reproduced in a number of standards, and in some cases expanded
to become more relevant to a particular topic. For example the recognition criteria
relevant to a liability are reflected in IAS 37 on provisions, however additional
detail is added to reflect the fact that the application of these criteria where there
is uncertainty may be difficult.
In the rare case that there is a conflict between an accounting standard and the
Conceptual Framework, the requirements of the accounting standard prevail.
Cases of conflict will, however, reduce as older accounting standards are revised
and amended and brought into line with the general principles presented in the
Conceptual Framework.
CA Sri Lanka
23
(b)
(c)
In each of these cases, the relevant standard provides the required guidance.
This is an exit price ie the price that an entity disposing of an asset or liability
would achieve rather than the price that an entity acquiring an asset or liability
would have to pay.
4.3 Measurement
Fair value is a market-based measurement, not an entity-specific measurement.
Therefore, fair value is measured using the assumptions that market participants
would use when pricing the asset under current market conditions, taking into
account any relevant characteristics of the asset. Whether an entity actually
intends to hold an asset or settle a liability is irrelevant when measuring fair value.
24
CA Sri Lanka
(ii)
For a non-financial asset, the highest and best use of the asset and whether
the asset is used in combination with other assets;
(iii) The market in which an orderly transaction would take place for the asset or
liability, and
(iv) The appropriate valuation technique to use when measuring fair value.
CA Sri Lanka
25
QUESTION
You work in the accounting department at Mannar Machines Ltd. As you have
recently studied SLFRS 13, the financial controller has asked you to review her
workings to establish the fair value of inventory held by a subsidiary that Mannar
Machines has recently acquired:
Product line 1 (100,000 units)
Market
Sales volume in previous 12 months
Selling price per unit
Transaction costs
Transport to market costs
Net price received
Product line 2 (500 units)
Sales volume in previous 12 months
Selling price per unit
Transaction costs
Transport to market costs
Net price received
26
Asia
240,300
Rs.
350
10
5
335
10,000
Rs.
2,300
100
60
2,140
Europe
180,300
Rs.
390
20
30
340
Africa
90,200
Rs.
325
15
20
290
10,000
Rs.
2,450
120
90
2,240
CA Sri Lanka
Therefore:
Product line 1: 100,000 Rs 340
Product line 2: 500 Rs 2,240
Fair value of inventory acquired
Rs.
34,000,000
1,120,000
35,120,000
Required
Prepare notes explaining how the fair value of the above inventory acquired
should be determined in accordance with SLFRS 13.
ANSWER
Product line 1
Product line 1 is sold in three markets Asia, Europe and Africa.
Asia is the principal market as it has the greatest sales volume.
If a principal market exists then the price in that market must be used to
establish fair value.
Fair value takes into account transport costs but not transaction costs.
The selling price of product line 1 is Rs. 350 and transport costs are Rs. 5.
Therefore the fair value of one unit is Rs. 345.
The fair value of inventory held is therefore 100,000 Rs. 345 = Rs. 34,500,000.
Product line 2
Product line 2 is sold in equal volumes in Asia and Africa. Therefore there is no
principal market.
The most advantageous market is Africa as each sale in this market results in
greater net proceeds (Rs. 2,240) than each sale in Asia.
Although transaction costs are taken into account when determining the most
advantageous market, fair value once determined is not adjusted for these
costs.
Fair value is the selling price Rs. 2,450 less transport costs of Rs. 90 = Rs. 2,360.
The fair value of inventory held is therefore 500 Rs. 2,360 = Rs. 1,180,000.
The total fair value of inventory is Rs. 34,500,000 + Rs. 1,180,000 = Rs. 35,680,000
CA Sri Lanka
27
Techniques
Market approach
Cost approach
Income approach
28
CA Sri Lanka
29
The specific approach to fair value liabilities and an entitys own equity
instruments sometimes differs from the concepts to fair value an asset and is
summarised in the following flowchart:
Is there a quoted price for
the transfer of an
identical or a similar
liability or entitys own
equity instrument?
Yes
Use quoted
price
No
Yes
No
30
CA Sri Lanka
4.10 Disclosure
An entity should disclose information that helps users of the financial statements
assess both of the following:
(a)
For assets and liabilities that are measured at fair value on a recurring or
non-recurring basis in the statement of financial position after initial
recognition, the valuation techniques and inputs used to develop those
measurements.
(b)
Level 1
Rs'000
Level 2
Rs'000
Level 3
Rs'000
Total
Rs'000
30,000
30,000
7,000
25,000
32,000
37,000
25,000
62,000
4,500
4,500
4,500
4,500
The company has measured land held for sale at fair value on a non-recurring
basis as a result of its classification as held for sale.
There have been no transfers between levels 1 and 2 during the year.
Company policy is to recognise transfers into and out of the different fair value
hierarchy levels at the date the event or change in circumstances causing the
transfer occurred.
Valuation processes for level 3 fair values
The company engages qualified valuers to determine the fair value of the groups
financial instruments that are in level 3 of the fair value hierarchy every 6 months.
The fair value of investment property is determined at the end of each reporting
period.
CA Sri Lanka
31
The following table sets out the amount of total gains or losses for the period
included in profit or loss in relation to assets measured on a recurring basis using
level 3 of the fair value hierarchy:
Unrealised gains
and losses
recognised in profit
or loss
Available-for-sale
equity shares
Rs'000
(1,200)
Investment
properties
Rs'000
3,400
Total
Rs'000
2,200
Valuation techniques
The following valuation techniques are used:
Level 1
Available-for-sale equity shares
Level 2
Land held for sale
Level 3
32
Investment properties
CA Sri Lanka
QUESTION
After a company's year end 31 March 20X7, but before its financial statements
were authorised for issue, some non-current assets were put on the market and
classified as held for sale.
Explain the appropriate accounting treatment in the financial statements for the
year ended 31 March 20X7, and evaluate this treatment in the context of the
Conceptual Framework for Financial Reporting.
ANSWER
At the year end, it was not the intention of management to sell the assets. This is a
situation that has arisen after the end of the reporting period.
Consequently, SLFRS 5 Non-current assets held for sale and discontinued
operations, confirmed by LKAS 10 Events After the Reporting Period does not
permit classification as held for sale at the end of the reporting period unless it is
'highly probable' that the assets will be sold at the time, supported by a number of
rules which establish whether this is the case.
The Conceptual Framework for Financial Reporting is principally concerned with
recognition of assets and liabilities, and changes in those assets and liabilities.
Whether the non-current asset is classified as held for sale or not, it still meets the
Conceptual Framework definition of an asset, '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'. Those economic benefits can be realised by use or by sale.
Conceptual Framework requires an asset's recognition when it is probable that it
will generate future economic benefits and they can be measured with reliability.
Again whether the asset is held for sale or not, it is probable that economic
benefits will be generated, and a decision to sell provides another way to measure
those benefits.
SLFRS 5 only allows classification as held for sale when the sale is 'highly'
probable, a concept not addressed by the Conceptual Framework. However, this is
not a recognition issue, which requires merely 'probability', but a classification
issue, an area not covered in detail by the Conceptual Framework.
Consequently, the accounting treatment is consistent with the relevant
requirements of the Conceptual Framework.
CA Sri Lanka
33
QUESTION
ABC Ltd acquired a property by way of a finance lease in the year ended
31 December 20X3. It sublets the property to small businesses. The lease
stipulates that the property must be used for commercial rather than residential
purposes. This restriction is not imposed by the planning authorities and
therefore at a future date the property could be used for residential purposes. The
owner has established that were the property to be sold at 31 December 20X3, it
would raise Rs. 29 Mn if sold as a residential apartment block, or Rs. 25 Mn if sold
as offices. In either case, legal fees of 1% of the sale price would be incurred.
Explain how the fair value of the property is determined.
ANSWER
The fair value is determined in accordance with SLFRS 13 by reference to exit
(selling) prices. It is assumed that the property will be sold to a market participant
that will use the property in its highest and best use. In this case the higher value
is Rs. 29 Mn for residential purposes.
Where there is a restriction in use of an asset, as is the case here, SLFRS 13
considers whether that restriction would be passed on to a purchaser in a future
sale. That is not the case here the property could be used on a residential basis in
the future. Therefore the current restriction in use is not relevant when
determining fair value.
Transaction costs are not taken into account when determining fair value and
therefore the 1% legal fees are not relevant.
Fair value is therefore Rs. 29 Mn.
34
CA Sri Lanka
CHAPTER ROUNDUP
The IASB issues IFRS and Interpretations that are adopted by CA Sri Lanka as
SLFRS and Interpretations.
The IASB has a work plan for the development of new and revised IFRS. There are
several on-going projects at various stages of development.
Accountants must behave ethically and abide by ethical codes in order to apply
accounting standards correctly and achieve a fair presentation of financial
statements.
The Conceptual Framework is a work in progress and the IASB expects to issue an
exposure draft in relation to outstanding sections in 2015.
CA Sri Lanka
35
PROGRESS TEST
36
What topics are the subject of the two major IASB exposure drafts currently in
issue?
IFRS 9 and IFRS 15 were issued in 2014, what financial reporting topics do they
cover?
What are level 2 inputs in the fair value hierarchy of SLFRS 13?
CA Sri Lanka
The principal market; where there is no principal market the most advantageous
market.
Inputs other than quoted prices included within Level 1 that are observable for
the asset or liability, either directly or indirectly.
CA Sri Lanka
37
38
CA Sri Lanka
CHAPTER
INTRODUCTION
The concept of non-financial reporting was introduced at KB1. This
chapter revises and expands on that knowledge and explains the
relevance of professional ethics to financial reporting.
Knowledge Component
4
Corporate Governance and Recent Developments in Financial Reporting
4.1
4.1.1
4.1.2
4.1.3
39
CHAPTER CONTENTS
1 Introduction to non-financial reporting
2 Corporate governance reporting
3 Sustainability and integrated reporting
40
CA Sri Lanka
CA Sri Lanka
41
42
CA Sri Lanka
CA Sri Lanka
43
This Code states that directors should include in a companys annual report a
corporate governance report that sets out the manner and extent to which the
company has complied with the principles and provisions of the Code:
Directors
(in respect of each director)
Name, qualifications and profile
Nature of expertise in relevant areas
Immediate family and/or material business relationships with other Directors
of the company
Whether the Director is executive/non-executive/independent
Names of listed companies in Sri Lanka for which the Director serves as a
Director
Names of other companies in Sri Lanka for which the Director serves as a
Director (other than those in the same Group as the reporting company)
Number/percentage of Board meetings of the company attended in the year
Total number of Board seats held (and an indication of whether the company is
listed/unlisted and the directorship is executive/non-executive)
Names of Board Committees in which the Director serves as Chairman/a
member
Number/percentage of committee meetings attended in the year.
Directors remuneration
The names of Directors who serve on the remuneration committee
A statement of remuneration policy and
Aggregate remuneration paid to executive and non-executive directors.
Relations with shareholders
The policy and methodology for communication with shareholders and how
this is implemented
The process for responding to shareholder matters.
Major and material transactions
All proposed material transactions which, if entered into, would materially alter
the Companys (or Groups) net asset base.
44
CA Sri Lanka
45
Compliance
Status
JKH Action
A.1 Company to be
headed by an
effective Board to
direct and control the
company
46
CA Sri Lanka
Rule
A.1.2 Board should be
responsible for
matters including
implementation of
business strategy,
skills and succession
of the management
team, integrity of
information, internal
controls and risk
management,
compliance with
laws and ethical
standards,
stakeholder
interests, adopting
appropriate
accounting policies
and fostering
compliance with
financial regulations
and fulfilling other
Board functions
Compliance
Status
JKH Action
Powers specifically vested in the
Board to execute their
responsibility include:
Providing direction and
guidance to the Company in the
formulation of its strategies,
with emphasis on the medium
and long term, in the purchase of
its operational and financial
goals.
Reviewing and approving annual
budget plans.
Reviewing HR process with
emphasis on top management
succession planning.
Appointing and reviewing the
performance of the ChairmanCEO.
Monitoring systems of
governance and compliance.
Overseeing systems of internal
control and risk management.
Determining
CA Sri Lanka
47
Rule
A.1.3 Act in accordance
with the laws of the
country and obtain
professional advice
as and when
required
48
Compliance
Status
JKH Action
CA Sri Lanka
Rule
Compliance
Status
JKH Action
CA Sri Lanka
49
50
Organisational profile
Identified material
aspects and
boundaries
Stakeholder
engagement
Report profile
Governance
CA Sri Lanka
Economic performance
Market presence
Indirect economic impacts
Procurement practices
Environmental
Materials
Energy
Water
Biodiversity
Emissions, effluents, and waste
Products and services
Compliance
Transport
Overall
Supplier environmental assessment
Environmental grievance mechanisms
Social: Labour
Practices and Decent
Work
Employment
Labour/management relations
Occupational health and safety
Training and education
Diversity and equal opportunity
Equal remuneration for men and women
Supplier assessment for labour practices
Labour practices grievance mechanisms
Investment
Non-discrimination
Freedom of association and collective bargaining
Child labour
Forced or compulsory labour
Security practices
Indigenous rights
Assessment
Supplier human rights
Human Rights grievance mechanisms
CA Sri Lanka
51
Social: Society
Local communities
Anti-corruption
Public policy
Anti-competitive behaviour
Compliance
Supplier assessment for impacts on society
Grievance mechanisms for impacts on society
Social: Product
Responsibility
PERFORMANCE
52
CA Sri Lanka
TARGET
PERFORMANCE
CA Sri Lanka
Economic sustainability
The environment
Labour practice
Society
Product responsibility
Stakeholder identification,
engagement and effective
communication
54
CA Sri Lanka
Comment
Financial capital
Manufactured
capital
CA Sri Lanka
55
Capital
Comment
Intellectual capital
Human capital
Natural
Social and
relationship capital
56
CA Sri Lanka
CA Sri Lanka
57
58
1.
2.
3.
4.
5.
6.
7.
Outlook - the report should identify the challenges and uncertainties that
the organisation is likely to encounter in pursuing its strategy; it should
explain the potential implications for the business model and future
performance.
8.
Comment
IT costs
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59
Implications
Comment
Consultancy costs
Disclosure
Governance
Risk management
The report is too big to reproduce in this study text, however you can access it
online at http://www.keells.com/annual-reports.html.
The IIRC maintains a database of emerging practice in integrated reporting; in that
database it singles out the John Keells Holdings PLC 2012/2013 Annual Report
review of stakeholder engagement as demonstrating the IR Guiding Principles of
60
CA Sri Lanka
CA Sri Lanka
61
62
CA Sri Lanka
Annual disclosures
Quarterly reports
Regular Investor road shows
On-going through phone calls, e-mail, written communication and websites
CA Sri Lanka
63
64
CA Sri Lanka
Initially, John Keells outlines the engagement process which the business
undertakes to determine the material issues of the business as determined by the
companys stakeholders, which is followed by an explanation of who the business
considers to be their key stakeholders. Interestingly, for each of these key
stakeholder groups, John Keells outlines the methods of engagement and the
frequency of engagement which provides the reader with an understanding of the
scope and scale of activities which the business undertakes to ensure the business
is engaged with key stakeholders.
This section of the Report is concluded by summarising the key concerns
identified from the engagement process. Through a graphic representation, the
Groups stakeholder concerns are mapped demonstrating the impact each issue
has on the company against the impact it has on key stakeholders by four main
categories social, economic, labour and environment. This presentation provides
the reader with a good sense of how the stakeholder and company concerns
compare.
Finally, these material issues are mapped to the performance indicators of the
business, demonstrating the link between the material issues and the strategic
progress of the business.
QUESTION
Explain the benefits of the adoption of integrated reporting in Sri Lanka.
ANSWER
Integrated reporting has a number of benefits for reporting organisations, for
stakeholders in those organisations and for Sri Lanka as a capital market.
As far as reporting organisations are concerned, the benefits of integrated
reporting include the following:
Lower operational and strategic risk
New business opportunities and increased sales
Improved decision making
Greater customer loyalty
Better stakeholder relations
Improved access to capital at a lower cost as a result of increased confidence in
the organisation
Improved reputation and a stronger brand
CA Sri Lanka
65
QUESTION
The financial controller of Lankasport, a Colombo-based based manufacturer and
retailer of sporting goods, prepares quarterly accounts for the Finance Director. At
the end of the first quarter of 20X4 the financial controller identified that net
assets were below the level required by a bank covenant and alerted the Finance
Director to this. The following week the financial controller identified that
amended quarterly accounts had been sent to the bank, in which the inventory
figure had been increased.
The same issue arose at the end of the second quarter of 20X4, and again the
financial controller noted that the accounts sent to the bank included a different
inventory figure from those that he had prepared the previous week.
The financial controller is sure that cut-off procedures and valuation were
correctly adhered to and so has asked the Finance Director to explain the
adjustments.
Her response was as follows:
The adjustment is just for some goods held at one of our customers retail
premises we missed it out from the stock count. Dont worry Ive got it all in
hand!
The financial controller has reviewed the contract with the customer in question
and notes that it clearly states that the customer will be supplied with goods as
ordered and has no right of return in the case of unsold goods. He also notes that
Lankasport has sold goods to this customer for a number of years on the same
terms, and no adjustment has ever been made before.
66
CA Sri Lanka
Both the financial controller and finance director are chartered accountants.
Required
Explain why the inventory adjustment suggests an ethical issue.
ANSWER
In accordance with LKAS 18, goods held at a customer's premises remain the
inventory of the selling entity if the risks and rewards of ownership have not
transferred to the customer.
In this case, the customer has no right of return of unsold goods. This would
suggest that the risks and rewards of ownership have transferred to the customer
and that Lankasport should have recognised a sale when the goods were delivered
to the customer.
The fact that no such adjustment has taken place previously, even though sales
have taken place on the same terms would appear to support this assertion.
If this is the case, the finance director is incorrect to increase closing inventory by
the goods held at the customer's premises.
It would appear that the finance director might be trying to manipulate the net
assets figure in order to meet bank covenants.
If these were breached, the bank could take action and Lankasport's funding
package could be withdrawn and the company could be put out of business.
In this case shareholders, employees and the public would all be affected. The fact
that the finance director may be trying to protect these parties does not, however,
make her actions acceptable.
Adjustment to the closing inventory figure will also result in an overstated profit
figure as cost of sales is reduced by the adjustment.
If Lankasport gives its employees profit related bonuses, this may also result in a
personal gain being made by the finance director.
CA Sri Lanka
67
CHAPTER ROUNDUP
68
CA Sri Lanka
PROGRESS TEST
What four key areas of performance and impact does a sustainability report deal
with?
CA Sri Lanka
69
70
The system by which companies and other entities are directed and controlled
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter revises the LKAS 1 presentation requirements in respect
of financial statements, the LKAS 8 requirements for the selection of
accounting policies and LKAS 21 requirements for accounting for
transactions denominated in a foreign currency. It also expands on the
topic of interim reports that was introduced at KB1.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
71
CHAPTER CONTENTS
1 LKAS 1 Presentation of Financial Statements
2 LKAS 8 Accounting Policies, Changes in Accounting Estimates
and Errors
3 LKAS 21 The Effects of Changes in Foreign Exchange Rates
4 LKAS 34 Interim Financial Reporting
CA Sri Lanka
CA Sri Lanka
73
QUESTION
Going concern
Pretoran Ltd manufactures components for electrical devices. You work for the
companys audit firm and have recently received the following email from the
Financial Controller of The Pretoran Group:
To:
Preena Da Silva
From:
James Perera
Subject:
Problem subsidiary
Dear Preena,
I hope that you are well. I am currently preparing the statutory accounts for the
2014 year-end for some of the Groups subsidiaries and Im a little worried that
one of them may not be trading for very much longer. The company produces a
single high tech component, but is being sued for copyright violation by a much
bigger player in the market. Theres a chance that our subsidiary will lose the case.
What should I do about the preparation of the statutory accounts for the
subsidiary?
I look forward to hearing from you,
James
74
CA Sri Lanka
(a)
(b)
ANSWER
(a)
(b)
CA Sri Lanka
75
CA Sri Lanka
LKAS 1 requires that certain line items are disclosed as a minimum. These are
detailed in your KB1 study text.
Current and non-current assets and liabilities should be presented separately in
the statement of financial position other than where a presentation based on
liquidity provides more relevant and reliable information.
QUESTION
The following are assets and liabilities of a boat and ship building company at
31 December 20X4:
(a)
Specialist steel that is used in the construction of warships. The steel is left
over from a recently completed order; it is unlikely to be used within
12 months as the company has no current orders for warships.
(b)
Two completed small fishing boats that are available for sale to the general
public.
(c)
An amount of Rs. 6 million due from a customer that has contracted the
company to build a tugboat. Rs. 3.7 million of the Rs. 6 million has been
billed to the customer.
(d)
A part complete tourist boat that the company intends to offer for sale to
local river cruise companies when complete. The boat is likely to take
14 months to complete.
(e)
The company has an outstanding bank loan of Rs. 60 million. The maturity
date attached to the loan was 20Y0, however the company has breached a
covenant during 20X4 making it repayable on demand. The bank has stated
that it will not demand repayment.
Required
Explain how these assets should be presented in the statement of financial
position of the boat and shipbuilding company at 31 December 20X4.
ANSWER
CA Sri Lanka
(a)
The specialist steel is raw material inventory. It will be used within the
normal operating cycle of the company and therefore it is classified as a
current asset. As there are currently no orders for warships the company
should assess whether the inventory might be impaired.
(b)
The completed fishing boats are finished goods inventory. They are held for
the purpose of being traded and are expected to be sold in the normal
operating cycle of the company. Therefore they are classified as current
assets even if a sale is not expected within 12 months.
77
(c)
The amount due from a customer forms part of trade and other receivables.
It is expected to be realised in the normal operating cycle of the company
and is therefore classified as current. It is irrelevant to classification and
recognition that part of the Rs. 6 Mn has been billed and part has not. These
parts are, however separately disclosed as a trade receivable (the billed
element) and an amount due from customers in respect of construction
contracts in accordance with LKAS 11 (the unbilled element).
(d)
(e)
CA Sri Lanka
(X)
X
(X)
(X)
X
X
X
(X)
X
X
X
(ii)
LKAS 1 allows
LKAS 1 requires that certain line items are disclosed as a minimum. These are
detailed in your KB1 study text.
Other comprehensive income comprises income and expense items that are not
recognised in profit or loss. It includes reclassification adjustments where an
item is reclassified to profit or loss.
Other comprehensive income:
Must be classified according to whether it will not or may be reclassified to
profit or loss.
May be stated net of related tax effects or before related tax effects with one
aggregate tax amount disclosed.
CA Sri Lanka
79
Balance at 1.1.X2
Changes in accounting policy
Restated balance
Changes in equity for 20X2
Issue of shares
Dividends
Total comprehensive income
or the year
Issue of stated capital
Balance at 31.12.X2
(X)
(X)
X
X
X
X
X
X
(X)
X
(X)
X
X
(X)
X
X
X
X
X
Dividends paid during the year are not shown on the statement of profit or loss;
they are shown in the statement of changes in equity.
Total comprehensive income attributable to owners of the parent and the noncontrolling interest are disclosed separately.
The effects of retrospective application or retrospective restatement (LKAS 8)
are disclosed for each component of equity.
For each component of equity, a reconciliation is disclosed between the
carrying amount at the beginning and the end of the period, separately
disclosing changes resulting from:
(i)
profit or loss;
(ii)
80
CA Sri Lanka
CA Sri Lanka
81
QUESTION
AB Trading Ltd acquired a small office block on 1 January 20X4 for Rs. 35 Mn
which it immediately leased to tenants. The company has no other investment
properties and applied the cost model to the office block, depreciating it over 50
years. At 31 December 20X6, the directors of AB Trading decided that the LKAS 40
fair value model should be applied to the property and this would result in more
relevant and reliable information in the financial statements.
Fair values of the office block were:
31 December 20X4
31 December 20X5
31 December 20X6
82
(a)
(b)
CA Sri Lanka
ANSWER
Extracts from the statement of financial position at
31 December
20X6
Rs'000
Investment property
37,900
31 December
20X5
Rs'000
37,500
Extracts from the statement of profit or loss and other comprehensive income for
the year ended
31 December
31 December
20X6
20X5
Rs'000
Rs'000
Gain on re-measurement of investment
400
1,200
property
Extracts from the statement of changes in equity
Retained earnings
Rs'000
189,000
2,000
191,000
54,900
245,900
65,900
311,800
At 1.1.X5
Prior period adjustment (W2)
As restated
Profit for year ended 31.12.X5 (restated W1)
At 31.12.X5
Profit for year ended 31.12.X6 (W1)
At 31.12.X6
W1 Adjustments to draft profit
Year ended
31 December
20X6
Rs'000
65,500
400
65,900
31 December
20X5
Rs'000
53,000
1,900
54,900
W2 Investment property
1.1.X4
Profit or loss y/e 31.12.X4
31.12.X4
Profit or loss y/e 31.12.X5
31.12.X5
Profit or loss y/e 31.12.X6
31.12.X6
CA Sri Lanka
Cost model
Rs'000
35,000
(700)
34,300
(700)
33,600
Depreciation not
yet accounted for
Adjustment
Rs'000
2,000
1,900
400
37,900
83
(b)
84
CA Sri Lanka
2.3 Errors
Prior period errors are omissions from, and misstatements in the financial
statements for one or more prior periods arising from a failure to use, or a misuse
of, reliable information that:
Was available when financial statements for those periods were authorised for
issue, and
Could reasonably be expected to have been obtained and taken into account in
the preparation and presentation of those financial statements.
Such errors include the effects of mathematical mistakes, mistakes in applying
accounting policies, oversights or misinterpretations of facts, and fraud.
Errors arising in the current period are dealt with through profit or loss.
Material prior period errors are corrected retrospectively by restating
comparative amounts and where relevant restating opening balances of the
earliest period presented.
Retrospective restatement is correcting the recognition, measurement and
disclosure of amounts of elements of financial statements as if a prior period error
had never occurred.
Disclosure is made of:
The nature of the error
For each prior period, to the extent practicable, the amount of the correction.
(i)
(ii)
2.4 Impracticability
Retrospective adjustment is required in respect of both a change in accounting
policy and the correction of an error that occurred before the earliest comparative
period.
Where it is impracticable to apply this requirement:
The new policy is applied prospectively from the start of the earliest period
practicable
The error is corrected prospectively from the earliest date practicable.
CA Sri Lanka
85
CA Sri Lanka
4.1 Introduction
An interim period is a financial reporting period shorter than a full financial year.
An interim financial report is a financial report containing either a complete set
of financial statements (as described in LKAS 1) or set of condensed financial
statements (as described in LKAS 34) for an interim period.
CA Sri Lanka
87
LKAS 34 does not prescribe whether an entity should present interim statements,
nor how often. It does, however provide guidance on contents for those entities
that do present interim statements.
LKAS 34 encourages publicly traded companies to prepare interim financial
statements at least at the end of the first half of the financial year and make them
available within 60 days.
The rationale for requiring only condensed statements and selected note
disclosures is that entities need not duplicate information in their interim report
that is contained in their report for the previous financial year. Interim statements
should focus more on new events, activities and circumstances.
88
CA Sri Lanka
CA Sri Lanka
(a)
(b)
(c)
The nature and amount of items during the interim period affecting assets,
liabilities, capital, net income or cash flows, that are unusual, due to their
nature, incidence or size.
(d)
(e)
(f)
Dividends paid on ordinary shares and the dividends paid on other shares
(g)
(h)
(i)
(j)
The entity should also disclose the fact that the interim report has been produced
in compliance with LKAS 34 on interim financial reporting.
QUESTION
Disclosures
Identify examples of the type of disclosures required according to the above list of
explanatory notes.
ANSWER
The following are examples:
(a)
(b)
(c)
(d)
(e)
(f)
Litigation settlements
(g)
(h)
Any debt default or any breach of a debt covenant that has not been
corrected subsequently
(i)
90
(a)
(b)
CA Sri Lanka
(c)
Statement of cash flows data should be cumulative for the current year to
date, with comparative cumulative data for the corresponding interim
period in the previous financial year
(d)
Data for the statement of changes in equity should be for both the current
interim period and for the year to date, together with comparative data for
the corresponding interim period, and cumulative figures, for the previous
financial year
4.5 Materiality
Materiality should be assessed in relation to the interim period financial data. It
should be recognised that interim measurements rely to a greater extent on
estimates than annual financial data.
CA Sri Lanka
91
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93
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Inventories. An entity might not need to carry out a full inventory count at
the end of each interim period. Instead, it may be sufficient to estimate
inventory values using sales margins.
(b)
(c)
Income taxes. The rate of income tax (tax on profits) will be calculated at
the year end by applying the tax rate in each country/jurisdiction to the
profits earned there. At the interim stage, it may be sufficient to estimate the
rate of income tax by applying the same 'blended' estimated weighted
average tax rate to the income earned in all countries/jurisdictions.
CA Sri Lanka
95
QUESTION
SL Vehicles is a Sri Lanka based manufacturer of passenger vehicles. The company
has experienced low levels of profitability throughout 20X4 as a result of
increasing raw materials prices and pressure to lower prices in line with emerging
competitors. The companys latest cash flow budgets indicate that the company
will generate negative operating cash flows from the middle of 20X5 and as a
result the company is unlikely to be able to meet its mandatory debt repayments
that fall due in 20X5. The government of Sri Lanka, recognising the importance of
SL Vehicles to the economy, has committed to make a cash injection to the
company in January 20X5 in return for redeemable preference shares with a
20 year term. It has also guaranteed the companys bank debt.
Required
Discuss whether it is appropriate that the 20X4 financial statements of SL
Vehicles are prepared on the going concern basis.
ANSWER
In assessing going concern, management must assess all available information.
There are several indicators that suggest that SL Vehicles may not be a going
concern and may cease to trade within 12 months:
Based on these factors alone it would not be appropriate to prepare the companys
financial statements on the going concern basis.
It is however relevant that the Sri Lankan Government has committed to support
the company, both in terms of a bailout and providing a bank guarantee. This
support means that the company is likely to continue to trade for the foreseeable
future (12 months) and therefore the going concern basis is appropriate.
96
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QUESTION
Colombo Textiles Ltd purchased a weaving machine from an overseas supplier on
1 July 20X6 at a cost of TY 19.6 million. The cost of the machine was incorrectly
treated as a cost of sales. The prevailing exchange rate on the date of the
transaction was Rs. 1: TY 4.9. The exchange rate was Rs. 1: TY 5 at 30 June 20X7
and Rs. 1: TY 4.8 on 30 June 20X7. Colombo Textiles Ltd depreciated weaving
machines at a rate of 15% on cost until 1 July 20X8 when it revised its estimates
and adopted a rate of 20%.
Required
Explain what adjustments are required to the financial statements of Colombo
Textiles Ltd in the year ended 30 June 20X8 in respect of the error.
ANSWER
The printing machine is incorrectly accounted for at 1 July 20X6. This is a prior
period error and LKAS 8 requires that it is corrected retrospectively ie as if the
error had not occurred.
The machine should have been recognised as a non-current asset at 1 July 20X6
measured at Rs. 4 million (TY 19.6 million /4.9).
This is a non-monetary asset and is not therefore subsequently re-measured in
line with changing exchange rates.
The machine should have been depreciated in the year ended 30 June 20X7 by
15% of cost ie Rs. 600,000. The carrying amount of the machine at 30 June 20X7 is
therefore Rs. 3.4 million (4 million 600,000).
The machine should be depreciated in the year ended 30 June 20X8 by 20% of
cost ie Rs. 800,000. The carrying amount of the machine at 30 June 20X8 is
therefore Rs. 2.6 million (4 million 600,000 800,000).
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98
LKAS 34 does not prescribe which entities should produce interim financial
reports however for those that do it lays down principles and guidelines for their
production including recognition and measurement guidelines.
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PROGRESS TEST
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99
100
When it is:
(a)
(b)
due to be settled within 12 months of the reporting date held primarily for
the purposes of being traded.
The new policy is applied prospectively from the start of the earliest period
practicable
The currency of the primary economic environment in which the entity operates.
Seasonal revenue is not anticipated (or deferred); revenue is recognised when the
recognition criteria of LKAS 18 are met.
CA Sri Lanka
CHAPTER
INTRODUCTION
Non-current assets may be tangible or intangible and held for an entitys
own use or for long term investment purposes. In this chapter we cover
the requirements of LKAS 16 Property, Plant and Equipment and LKAS 40
Investment Property.
Much of the technical contents of the chapter is revision, however the
scenarios to which the standards requirements are applied are more
complex than those seen at KB1 level.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
101
CHAPTER CONTENTS
1 Property, Plant and Equipment
2 LKAS 40 Investment Property
accounting
policy
selection
of
subsequent
102
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103
Useful life is
(a)
(b)
It is probable that future economic benefits associated with the asset will
flow to the entity, and
(b)
Directly
attributable
costs of bringing
the asset into
working
condition for its
104
Include:
Costs of site preparation
Initial delivery and handling costs
Installation and assembly costs
Professional fees
CA Sri Lanka
intended use
Dismantling /
Where there is a present obligation (at the time of purchase /
removal and
construction) to dismantle and remove an asset at the end of
restoration costs its useful life or to put right land affected by the operation of
the asset
DEBIT
PPE
CREDIT Provision
Eligible
borrowing costs
Discounted costs
Discounted costs
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105
QUESTION
Koala Construction
Koala Construction Ltd builds office blocks and retail units on a speculative basis,
selling them to customers when complete. On 1 February 20X1, the company
began a project to build an office block in Kandy. The first stage of the build was
financed using the companys cash reserves; on 1 June 20X1, the project manager
drew down Rs. 15 million from general borrowings to finance the second stage. A
further Rs. 20 million was drawn down on 1 November to finance the third and
final stage of the build. The office block was completed on 30 November other
than final decoration in line with the purchasers specification. A purchaser was
identified immediately and between 1 December and 31 December, Koala
Construction Ltd finalised the decorating of the complex. The sale of the office
complex was completed in January 20X2.
Koala Constructions general borrowings are as follows:
Rs. 50 million bank loan with an interest rate of 4% per annum was arranged
on 1 May 20X1 and is due for repayment in 20X4.
Rs. 20 million bank loan with an interest rate of 6% per annum was arranged
on 1 August 20X1 and is due for repayment in 20X8.
Required
Explain what amount of borrowing costs should be capitalised and how the office
block is recognised in Koala Constructions statement of financial position at
31 December 20X1.
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ANSWER
Borrowing costs are capitalised when all of the following conditions are met:
1.
2.
3.
Activities necessary to prepare the asset for intended use or sale are
underway.
Activities necessary to prepare the office block for intended use or sale
commenced on 1 February 20X1, and from this date it is assumed that
expenditure is being incurred; borrowing costs in relation to borrowings used to
fund the build of the complex are incurred from 1 June 20X1 (when the first
drawdown occurs). Therefore the date of commencement is 1 June 20X1.
Borrowing costs cease to be capitalised when the activities to prepare the
qualifying asset for intended use or sale are substantially complete. LKAS 23
clarifies that an asset is normally ready for intended use or sale when the physical
construction of the asset is complete. If minor modifications (such as the
decoration of a property to the purchasers specification) are outstanding, this
indicates that substantially all activities to prepare the qualifying asset for
intended use or sale are substantially complete. Therefore the date on which
capitalisation ceases is 30 November 20X1.
Koala funds the construction using general borrowing costs.
The first draw down of funds on 1 June 20X1 is from the Rs. 50 Mn 4% loan (as the
6% loan had not been arranged at this date).
Borrowing costs to be capitalised in respect of this draw down are:
Rs 15 Mn 4% 6/12 months
Rs.
300,000
The second draw down of funds on 1 November is from borrowings which include
both the 4% and the 6% loan. A weighted average cost of borrowing applicable to
these general borrowings must be calculated:
(50/(50+20) 4%) + 20/(50 + 20) 6%) = 4.59%
This rate is applied to the draw down on 1 November 20X3 from the date of draw
down to the date on which activities to complete the build are substantially
complete (30 November). Borrowing costs to be capitalised are therefore:
Rs 20 Mn 4.59% 1/12months
Rs.
76,167
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107
1.4 Depreciation
Depreciation is charged on all assets with the exception of land. Expenditure on
repairs and maintenance does not negate the need to charge depreciation.
Depreciation commences when an asset is in the location and condition
necessary for it to be used in the manner intended by management.
Depreciation ceases when an asset is classified as held for sale or is disposed of.
Determination of useful life should take into account expected usage of the
asset, expected physical wear and tear, obsolescence, legal or other limits on
use of the asset.
Where residual value exceeds carrying amount the depreciation charge is zero.
The depreciation method used should reflect the pattern in which the assets
future economic benefits are expected to be consumed by the entity.
Residual value, useful life and depreciation method are reviewed at least at
each year end. Any change is accounted for as a change in accounting estimate.
Complex assets with several component parts with different useful lives are
treated as separate assets for depreciation purposes.
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Downwards revaluation
Not previously
revalued
DEBIT
DEBIT
Profit or loss
CREDIT
PPE
Previously
revalued
downwards /
upwards
DEBIT
DEBIT
OCI (revaluation
reserve)
DEBIT
Profit or loss
CREDIT
PPE
PPE
PPE
A revalued asset is depreciated in the same way as an asset held under the cost
model, with depreciation spreading the revalued amount over the assets
remaining useful life.
In the case of an upwards revaluation, LKAS 16 allows entities to transfer an
amount equal to the increase in depreciation charge from the revaluation
reserve to retained earnings in the equity section of the statement of financial
position, if they wish to do so.
When a revalued asset is disposed of, the revaluation reserve in respect of that
asset becomes realised and is transferred to retained earnings.
1.5.1 Determining fair value where the revaluation model is applied
Fair value is determined in accordance with SLFRS 13 Fair Value Measurement.
This standard is discussed in detail in Section 4 of Chapter 1. You should
remember that:
Fair value is an exit (selling) price.
It is based on the highest and best use of a non-financial asset.
It is assumed to take place in the principal or most advantageous market.
1.5.2 Advantages and disadvantages of each model
The main advantage of the revaluation model is the impact on the statement of
financial position: a companys net assets are instantly increased and that
company appears to be financially healthier than previously. It is also true that
adoption of the revaluation model results in a more relevant statement of financial
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109
110
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Revaluation model
Cost model
Carrying amounts of
revalued assets are on
comparable terms with
current assets.
Statement of profit or
loss
Increased expenses as a
result of higher
depreciation and costs of
revaluation.
Lower expenses.
Other comprehensive
income
Revaluation surplus
recognised in OCI (unless
reverses a previous
impairment loss).
No effect.
Statement of changes in
equity
Reserves movement to
transfer excess
depreciation to retained
earnings.
No effect.
Statement of financial
position
1.6 Disclosures
For each class of property, plant and equipment, the following must be disclosed:
(a)
Measurement bases for determining the gross carrying amount (if more
than one, the gross carrying amount for that basis in each category).
(b)
(c)
(d)
(e)
Additions
(ii)
111
(b)
(c)
(d)
The amount of compensation from third parties for PPE that was impaired,
lost or given up that is included in profit or loss.
112
(a)
(b)
(d)
Carrying amount of each class of property, plant and equipment that would
have been included in the financial statements had the assets been carried at
cost less accumulated depreciation and accumulated impairment losses.
(e)
Revaluation surplus, indicating the movement for the period and any
restrictions on the distribution of the balance to shareholders.
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Group
Cost/
revaluation
As at 1 April
Additions
Revaluation
Transfers
Disposals
Impairment
As at 31
March
Depreciation
/Impairment
As at 1 April
Charge for
the year
Disposals
Impairment
As at 31
March
Carrying
value
Capital work
in progress
Carrying
value
as at 31
March
Freehold
land
Freehold
building
Plant,
machinery
and
Other
Rs'000
Motor
vehicles
Total
2014
Total
2013
Rs'000
Expenditure
incurred on
leasehold
building
Rs'000
Rs'000
Rs'000
Rs'000
Rs. '000
8,162,101
68,440
121,000
8,351,541
2,048,686
308,364
43,000
2,400,050
3,175,739
892,626
4,068,365
10,294,565
1,905,365
(228,335)
(2,481)
733,644
160,504
(15,716)
878,432
24,414,735
3,335,299
164,000
(244,051)
(2,481)
27,667,502
17,639,692
3,540,035
3,556,295
(234,000)
(87,287)
24,414,735
360,951
69,933
1,443,130
392,660
4,833,921
1,094,793
440,767
117,594
7,078,769
1,674,980
5,804,901
1,331,017
430,884
1,835,790
(116,559)
719
5,812,874
(13,713)
544,648
(130,272)
719
8,624,196
(57,149)
7,078,769
8,351,541
1,969,166
2,232,575
6,156,240
333,784
19,043,306
17,335,966
3,077,485
3,301,601
8,351,541
1,969,166
2,232,575
6,156,240
333,784
22,120,791
20,637,567
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The details of assets mortgaged for banking facilities obtained have been given in
note 23.2 to the financial statements.
(b)
QUESTION
CA Sri Lanka
The amount billed by the architects includes Rs. 125,000 in relation to original
blueprints drawn up. These blueprints were scrapped when the directors of
Pacific Consumables Ltd instructed the architects to revise their plans in order to
make the building as environmentally friendly as possible.
In line with the green credentials of the new building, Pacific Consumables Ltd
have installed solar panels on the roof of the warehouse at a cost of Rs. 350,000. A
further Rs. 20,000 was spent on having the building certified as eco-friendly by the
Sri Lanka Green Building Council (SLGBC). The directors of Pacific Consumables
Ltd decided to obtain this certification in order to boost their credentials as a
sustainable company and so that they could refer to it within their sustainability
report.
The solar panels are expected to last 20 years before they will require
replacement; the SLGBC certificate must be renewed every 5 years. The property
was completed on 12 March 20X4 and brought into use on 1 April 20X4.
Pacific Consumables Ltd depreciates property over a 50 year useful life.
Required
(a)
In the context of property, plant and equipment and with reference to the
relevant accounting standard, explain the difference between an accounting
policy and accounting estimate, and calculate the carrying amount of the
head office at 30 April 20X4 assuming that the Managing Directors
suggestion is accepted.
(b)
Assuming that the Finance Directors suggestion is accepted, identify the fair
value of the head office at 30 April 20X4 and accounting entries required to
revalue the property.
(c)
ANSWER
(a)
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115
116
CA Sri Lanka
value of the property as a hotel is Rs. 15.5 Mn, however the question remains
as to whether this is reduced to take account of legal costs on sale.
SLFRS 13 classifies such costs as transaction costs and is clear that these are
not taken into account in establishing fair value. Therefore fair value is
Rs. 15.5 Mn at 30 April 20X4.
The carrying amount of the property at this date is Rs. 8,427,857 (8.74
27/28 years)
The revaluation increase is therefore Rs. 7,072,143.
This is recognised by:
(c)
DEBIT
Property
Rs. 7,072,143
CREDIT
Rs. 7,072,143
New warehouse
The initial cost of an item of PPE includes its purchase price plus any costs
directly attributable to bringing the asset to the location and condition
necessary for it to operate in the normal manner intended by management.
Site selection costs are not directly attributable costs and do not therefore
form part of the cost of the new warehouse; these are instead recognised in
profit or loss as incurred. Site preparation costs are, however, directly
attributable to the completion of the warehouse and these do form part of its
cost.
LKAS 16 is clear that professional fees are part of the cost of an item of PPE
and therefore both legal costs and architects fees are included in the initial
measurement. The architects fees include Rs. 125,000 relating to scrapped
blueprints. This came about as a result of the directors decision to make the
building environmentally friendly. These fees relate to wasted resources,
and as such LKAS 16 does not permit their inclusion in the initial
measurement of the property.
Both construction materials and labour are directly attributable to the
completion of the warehouse and are included in the initial cost of the
property. LKAS 16 does not allow the inclusion of a proportion of general
and administrative overheads in the cost of an asset; Rs. 190,000 is therefore
recognised in profit or loss.
The solar panels are an item of property, plant and equipment and their cost
is capitalised as part of the cost of the property. The cost of obtaining SLGBC
certification is not a cost attributable to bringing the warehouse into
working condition. The warehouse would operate in the manner in which it
CA Sri Lanka
117
Rs'000
1,320
340
325
2,720
2,400
350
7,455
2.1 Definitions
LKAS 40 includes a number of definitions, the most important of which is the
definition of investment property.
Investment property is property (land or a building or part of a building or
both) held (by the owner or by the lessee under a finance lease) to earn rentals or
for capital appreciation or both, rather than for:
(a)
(b)
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.
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 is the amount of cash or cash equivalents paid or the fair value of other
consideration given to acquire an asset at the time of its acquisition or
construction.
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119
QUESTION
120
Investment property
1.
Pacific Towers, an office building divided into small units which is owned by
Asia Property PLC and let out to several small businesses. Asia Property PLC
provides security and maintenance services for its tenants.
2.
CA Sri Lanka
3.
Required
State whether each of the above properties is classified as an investment
property.
ANSWER
1.
2.
3.
The Jaffna Property is a mixed use building. It is evident from the existing
arrangement that the twenty floors can be, and are, let separately and
therefore separate accounting is appropriate. 1/20th of the property is
accounted for as owner-occupied under LKAS 16 whilst the remaining
19/20ths are accounted for as investment property under LKAS 40.
2.3 Recognition
Investment property should be recognised 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)
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121
If the property is not measured at fair value its cost is equal to the carrying
amount of the asset given up.
122
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123
LKAS 40 states that it is highly unlikely that a change from the fair value model to
the cost model will result in a more appropriate presentation.
2.6 Transfers
Transfers to or from investment property are made when there is a change in use.
An investment property may be transferred to owner-occupied property or
inventories or vice versa.
Where the cost model is applied, the carrying amount of the property does not
change on the transfer. Where the fair value model is applied the following rules
apply:
Investment property is transferred to owner-occupied property or inventories:
the deemed cost of the property is the fair value at the date of transfer;
Owner-occupied property is transferred to investment property: an LKAS 16
revaluation is recognised at the point of transfer and the property is
transferred at fair value.
Inventories are transferred to investment property: on transfer the difference
between the previous carrying amount and fair value is recognised in profit or
loss.
2.7 Disposals
An investment property is derecognised on disposal or when it is permanently
withdrawn from use and no future economic benefits are expected from its
disposal.
Disposal may be achieved by a sale or by entering into a finance lease.
Any gain or loss on disposal is the difference between the net disposal proceeds
and the carrying amount of the asset; it is recognised in profit or loss.
Compensation from third parties for investment property that was impaired, lost
or given up is recognised in profit or loss when the compensation becomes
receivable.
QUESTION
1.
124
CA Sri Lanka
2.
Required
Advise the adjustments required to the financial statements in respect of the
above transfers of investment properties.
ANSWER
1.
2.
2.8 Disclosure
2.8.1 General disclosures
An entity with investment properties must disclose the following:
CA Sri Lanka
(a)
(b)
The criteria used to distinguish between investment property, owneroccupied property and inventory where classification is difficult;
(c)
The extent that the fair value of investment property (as measured or
disclosed in the financial statements) is based on valuation by an
independent, qualified and experienced valuer;
125
(d)
(e)
(f)
(b)
Where the fair value model is applied but an investment property is measured
using the cost model because its fair value cannot be measured reliably, a
description of the property must be provided together with an explanation of why
the fair value cant be measured reliably and if possible a range of estimates
within which the fair value is highly likely to lie.
2.8.3 Cost model disclosures
Where the cost model is applied, the following must be disclosed in addition to the
general disclosures listed above:
(a)
126
The depreciation methods used and useful lives or depreciation rates; and
CA Sri Lanka
(b)
(c)
(d)
QUESTION
Matara Developments PLC owns 2 properties within the city of Matara which are
let out to tenants under operating leases. The company has classified these
properties as investment properties and has elected to apply the LKAS 40 fair
value model. The following information is relevant to the year ended
31 December 20X3:
The properties generated rental income of Rs. 2 million during the year;
repairs, maintenance and other operating expenses amounted to Rs. 250,000.
One of the properties was transferred from owner-occupied property part way
through the year. At the date of the transfer the fair value of the property was
Rs. 13 million. At the end of the year the fair value of the property was
Rs. 13.8 million.
The other property has been investment property for a number of years. At the
start of the year it had a fair value of Rs. 16 million and this had increased to
Rs. 17.4 million by the end of the year.
All fair values are determined by an external company, Valuation Experts (Pte)
Ltd.
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127
ANSWER
Accounting policies
Investment property, which is property held to earn rentals and/or for capital
appreciation (including property under construction for such purposes) is stated
at its fair value at the reporting date. Gains or losses arising from changes in the
fair value of investment property are included in profit or loss for the period in
which they arise.
Investment property
Fair value
At 1 January 20X3
Increase in fair value in the year (0.8 Mn + 1.4 Mn)
Transferred from property, plant and equipment
At 31 December 20X3
Rs'000
16,000
2,200
13,000
31,200
The fair value of the companys investment property at 31 December 20X3 has
been arrived at on the basis of a valuation carried out by Valuation Experts (Pte)
Ltd., independent valuers not connected with the Company. The valuation was
arrived at by reference to market evidence of transactions for similar properties.
The Company has pledged all of its investment property to secure general banking
facilities granted to the Company.
The property rental income earned by the Company from its investment property,
all of which is leased out under operating leases amounted to Rs. 2 million. Direct
operating expenses arising on the investment property in the period amounted to
Rs. 250,000.
QUESTION
Mandalay Plantations (Pvt) Ltd owns significant amounts of land, much of which
has been held for more than 20 years. The company applies the cost model of
LKAS 16 to account for the land. The management of Mandalay Plantations (Pvt)
Ltd is currently developing an expansion strategy and wants to borrow funds from
a number of banks to fund this. In order to make Mandalay Plantations seem a
128
CA Sri Lanka
Explain why adopting the revaluation model may not be a good decision for
the company
(b)
ANSWER
(a)
The company owns land purchased several years ago and held at cost; it is
therefore likely to be the case that the carrying amount of land is
significantly less than its current market value.
By adopting the revaluation model for land, management will immediately
boost net assets, which may make the company a more attractive
proposition to lenders. In particular the level of security available (in the
form of land) will be immediately obvious to lenders.
It is however important to remember that regardless of whether an
accounting revaluation is recognised, land is worth its market value. Most
lenders understand this and will perform their own valuation exercise for
the purposes of identifying the level of security available.
The management should also realise that by adopting the revaluation model,
they are committing the company to the requirements of LKAS 16, namely
that:
the revaluation model is applied to all assets in the same class (ie there is
no option to apply the model only to assets that have increased
significantly in value)
revaluations must be kept up to date such that carrying amount is not
significantly different from fair value.
These requirements make the revaluation model a costly and time
consuming accounting option. There is also the possibility that some more
recently acquired land may have fallen in value since purchase. In this case
there would be a requirement to recognise an impairment in profit or loss.
(b)
CA Sri Lanka
129
QUESTION
JB Investments PLC acquired a retail park in Colombo on 1 January 20X3 for
Rs. 190 Mn and immediately leased it to tenants. The property is held under the
LKAS 40 cost model and depreciated over 40 years. At 31 December 20X5, the
management of JB Investments PLC decided that application of the LKAS 40 fair
value model would result in more reliable and relevant information in the
financial statements. The fair value of the property at each year end since
acquisition was:
31.12.X3 Rs. 198 Mn
31.12.X4 Rs. 204 Mn
31.12.X5 Rs. 205 Mn
Reported profit for the year in 20X4 was Rs. 110 Mn and draft profit for 20X5 was
Rs. 117 Mn.
Required
Draft extracts from the financial statements of JB Investments PLC for the year
ended 31 December 20X5 in respect of the property. Your answer should reflect
the LKAS 1 requirements in respect of comparative figures.
ANSWER
A change from the cost model to the fair value model is a change in accounting
policy. LKAS 8 requires that this is accounted for retrospectively (as if the fair
value model had always been applied).
130
CA Sri Lanka
Adjustment
Rs'000
12,750
198,000
6,000
10,750
204,000
1,000
5,750
205,000
Investment property
31.12.X5
Rs'000
205,000
31.12.X4
Rs'000
204,000
31.12.X5
Rs'000
1,000
31.12.X4
Rs'000
6,000
At 1.1.X4
Prior period adjustment
As restated
20X4 profit (110 + 10.75)
At 1.1.X5
20X5 profit (117 + 5.75)
At 31.12.X5
CA Sri Lanka
Retained earnings
Rs'000
X
12,750
X
120,750
X
122,750
X
131
CHAPTER ROUNDUP
Two standards are relevant to property, plant and equipment; both have been
covered in detail at KB1 and KE1 levels. The standards are LKAS 16 Property,
Plant and Equipment and LKAS 23 Borrowing Costs.
LKAS 16 requires that PPE is initially measured at cost and subsequently using
the revaluation or the cost model.
LKAS 23 requires that eligible borrowing costs are capitalised within the cost
of qualifying assets.
PPE with the exception of land is depreciated over its useful life.
Investment property
132
Under the cost model investment property is measured at depreciated cost less
impairment losses; under the fair value model investment property is remeasured to fair value at each reporting date with gains and losses
recognised in profit or loss.
CA Sri Lanka
PROGRESS TEST
Where a property is part owner-occupied and part let out under operating leases,
what accounting standard applies?
CA Sri Lanka
133
134
If the parts are separable, LKAS 16 applies to the owner-occupied portion and
LKAS 40 applies to the portion that is rented out. If the parts are not separable,
LKAS 40 is applied to the whole property only where the owner-occupied portion
is insignificant.
The property is remeasured to fair value on the transfer with any gain or loss
recognised in profit or loss.
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter revises LKAS 38 Intangible Assets and SIC 32 Intangible
Assets Website Costs. You have studied both of these at KB1 level.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
135
CHAPTER CONTENTS
1 LKAS 38 Intangible Assets
2 SIC 32 Intangible Assets Website Costs
those within the scope of another standard (such as deferred tax assets,
lease receivable assets, employee benefits assets and goodwill acquired in a
business combination)
(b)
financial assets
(c)
(d)
1.1 Definition
An intangible asset is an identifiable non-monetary asset without physical
substance.
An asset is a resource:
(a)
136
(b)
something from which the entity expects future economic benefits to flow.
1.2 Recognition
An intangible asset is recognised if, and only if it meets the definition of an
intangible asset given above and both of the following criteria are met:
(a)
It is probable that the future economic benefits that are attributable to the
asset will flow to the entity, and
(b)
The following table summarises the criteria that must be met before an item is
capitalised as an intangible:
Identifiable
CA Sri Lanka
Controlled by entity
Future economic
benefits
Probable economic
benefits
Reliable
measurement
137
QUESTION
The new financial controller of Gin Traders Ltd is from a country where IFRS as
converged with SLFRS are not applied. She is unsure of the requirements of LKAS
38 and has asked for your advice as to whether an intangible asset should be
recognised in each of the following cases:
(a)
Gin Traders has an extensive customer list that it has built up for a new
product line over the last year. Employee timesheets reveal that the staff cost
of contacting new potential customers and compiling the list amounts to
Rs. 68,000.
(b)
The financial controller feels that the name Gin Traders is sufficiently well
known and respected that an element of goodwill should be capitalised in
the statement of financial position. She has suggested an amount of
Rs. 150,000, being the amount recognised when a large conglomerate
acquired one of Gin Traders competitors recently.
(c)
Required
Advise the new financial controller whether the items of expenditure listed may
be recognised as an intangible asset in accordance with LKAS 38.
ANSWER
138
(a)
(b)
(c)
1.3 Measurement
LKAS 38 provides guidance on the initial and subsequent measurement of
intangible assets. Subsequent measurement is based on the cost or revaluation
model.
1.3.1 Initial measurement
An intangible asset that meets the recognition criteria is initially measured at cost:
Separately acquired in
cash transaction
Separately acquired in
exchange transaction
CA Sri Lanka
139
Acquired in business
combination
Internally generated
140
CA Sri Lanka
CA Sri Lanka
141
Research costs do not meet the criteria for recognition as the research phase of
a project is too distant from an inflow of economic benefits. They are written off
as an expense as incurred.
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.
Development costs are capitalised as an intangible asset if all of the following
criteria are met:
(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 entity 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) Its ability to measure the expenditure attributable to the intangible asset
during its development reliably:
An internally generated intangible asset (development) is initially
recognised at cost being the costs that can be directly attributed or
allocated on a reasonable and consistent basis to creating, producing or
preparing the asset for its intended use.
Only those costs incurred after all recognition criteria are met are
capitalised.
Earlier expenditure is not retrospectively recognised.
Subsequently an internally generated intangible asset is measured using
the cost or revaluation model as discussed in the previous section.
QUESTION
SL Foods Ltd owns and operates a number of food outlets, half of which are
operated by SL Foods under franchise from a global company Pizza Pie Co. The
other outlets operate under the name Fresh, which SL Foods Ltd started a
number of years ago.
142
CA Sri Lanka
SL Foods Ltd has incurred the following expenses in the year ended 31 December
20X4 and wishes to know which can be recognised as intangible assets in the
statement of financial position:
1.
Franchise fees paid to Pizza Pie Co for the use of the trading name Pizza Pie
Co for a new outlet.
2.
3.
Advertising costs incurred prior to the opening of the new Pizza Pie outlet.
4.
5.
Costs incurred in developing a chiller process to ensure that the salads sold
at Fresh outlets remain crisp. This process is expected to be implemented by
20X6. Testing indicates that it will cut wastage as salads will last longer.
6.
7.
8.
9.
Required
Advise the management of SL Foods Ltd which costs can be capitalised as an
intangible asset.
ANSWER
CA Sri Lanka
1.
2.
3.
Advertising costs are the costs of introducing a new product or service; LKAS
38 specifically prohibits these costs forming part of an intangible asset.
4.
143
5.
6.
7.
Staff costs are also part of the development costs and should be capitalised
as described above.
8.
9.
1.5 Disclosure
LKAS 38 requires a number of general disclosures together with additional
disclosures about research and development expenditure and intangible assets
measured using the revaluation model.
1.5.1 General disclosures
An entity must disclose the following for each class of intangible assets,
distinguishing between those that are internally generated and those that are not:
144
(a)
Whether useful lives are indefinite, and where this is not the case, the
amortisation rates and methods used.
(b)
The gross carrying amount and accumulated amortisation at the start and
end of the period.
(c)
(d)
A reconciliation of the carrying amount at the start and end of the period
showing additions, assets classified as held for sale, revaluation increases
and decreases, impairment losses recognised and reversed, amortisation,
exchange differences and other changes.
CA Sri Lanka
The carrying amount of any intangible asset with an indefinite useful life and
the reasons supporting the assessment of an indefinite life.
(b)
(c)
(d)
The existence and carrying amounts of intangible assets with restricted title
/ pledged as security for liabilities.
(e)
(ii)
(iii) the carrying amount that would have been recognised if the cost model
were applied.
(b)
CA Sri Lanka
The amount of the revaluation surplus that relates to intangible assets at the
start and end of the period indicating changes in the period and restrictions
on the distribution of the balance to shareholders.
145
146
3 5 years
15 years
10 years
CA Sri Lanka
15 Intangible Assets
GROUP
As at 31 March,
License Fees
FLAG Cable
Software Cost &
Implementation
Total
Notes
COMPANY
2013
2012
Rs'000
215,895
2,113,785
33,647
As at
1 April
2011
Rs'000
79,248
2,300,302
25,866
Rs'000
17,277
Rs'000
16,061
2,405,416
17,277
16,061
16,061
2013
2012
15.1
15.2
15.3
Rs'000
353,225
1,927,268
35,813
2,316,306
2,363,327
As at
1 April
2011
Rs'000
16,061
Cost
Balance at the beginning
of the year
Additions during the year
Balance at the end of the
year
Accumulated
Amortisation
Balance at the beginning
of the year
Amortised during the year
Balance at the end of the
year
Net book value
2013
Rs'000
GROUP
2012
Rs'000
2011
Rs'000
2,797,761
2,797,761
2,797,761
2,797,761
2,797,761
2,797,761
683,976
497,459
310,942
186,517
870,493
186,517
683,976
186,517
497,459
1,927,268
2,113,785
2,300,302
SIC 32 Intangible Assets Website Costs addresses the issue of how to account for
the internal costs of developing and operating a website and in particular whether
the website is an intangible asset.
Note that certain associated costs are outside the scope of the Interpretation:
Hardware such as web servers are property, plant and equipment within the
scope of LKAS 16.
Hosting costs are an expense accounted for as service is received.
CA Sri Lanka
147
It is probable that future economic benefits will flow to the entity, and
2.
3.
The recognition criteria associated with development costs are met, ie:
Completion of the intangible asset is technically feasible
The entity intends to complete the website and use it
The entity can use the website
The entity can demonstrate how the website will generate economic
benefits
There are adequate resources to complete the website
Expenditure attributable to the website during development can be
measured reliably.
2.
Therefore the costs of developing a website that is not capable of taking orders
and is simply an advertising tool are recognised as an expense.
Application and
infrastructure development
stage
CA Sri Lanka
QUESTION
1
Acquired a patent for Rs 1.2 Mn. The patent has ten years left
to run at the date of acquisition.
31.3.X0
31.12.X0
31.12.X0
Required
Assess the carrying amount of intangible assets to be recognised in the
statement of financial position at 31 December 20X0.
2
CA Sri Lanka
149
operating systems. The costs of doing this are expensed to profit or loss for
the year.
Required
Discuss the accounting treatment applied by HeadsApp Ltd.
ANSWER
1
Patent
The patent is a purchased intangible and therefore the recognition criteria
are met. It is capitalised at its cost of Rs. 1.2 Mn. At 31 December 20X0 one
year's amortisation should be provided giving a carrying amount of
Rs. 1.08 Mn.
Advertising
Advertising expenditure is purchased, however the question arises as to
whether it meets the definition of an intangible asset. LKAS 38 is clear that
although future economic benefits are provided, no intangible asset is
created. Therefore this expenditure is recognised as an expense when
incurred.
Licence
The licence is a separately acquired intangible asset and as such is
capitalised at its cost of Rs. 6.5 Mn. As the licence is readily marketable it
may have an active market. Therefore there may be scope to apply the
revaluation model to this asset.
Training and goodwill
The costs of training cannot be capitalised as an intangible asset as they do
not meet the definition of an asset; specifically the benefit is not controlled
by the entity as employees may leave their employment at any time.
Additionally, LKAS 38 is clear that internally generated goodwill cannot be
recognised as an asset.
Therefore the carrying amount of intangible assets at the reporting date is
Rs. 7.58 Mn.
150
CA Sri Lanka
CA Sri Lanka
151
CHAPTER ROUNDUP
152
They are recognised if this definition and the LKAS 38 recognition criteria are
met.
They are initially measured at cost and subsequently under the cost or rarely
the revaluation model.
SIC 32 requires that the LKAS 38 recognition criteria for development costs are
applied to the costs of developing a website.
CA Sri Lanka
PROGRESS TEST
The costs of developing a website that is not capable of generating on line sales
may be capitalised if certain criteria are met. True or false?
CA Sri Lanka
153
154
Over its useful life if that useful life is finite; otherwise it is not amortised.
False. Only the costs of developing a website that can generate revenue may be
capitalised (if the relevant criteria are met).
CA Sri Lanka
CHAPTER
INTRODUCTION
In this chapter we revise the requirements of LKAS 36 Impairment of
Assets. This standard is relevant to a number of types of assets including
property, plant and equipment and intangible assets. It is not relevant to
financial assets; LKAS 39 provides detailed impairment rules for these
assets
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
155
CHAPTER CONTENTS
1 LKAS 36 Impairment of Assets
2 Cash-generating units
3 Disclosure
156
CA Sri Lanka
1.2 Definitions
LKAS 36 provides the following definitions:
An impairment loss is the amount by which the carrying amount of an asset or
cash-generating unit exceeds its recoverable amount.
Carrying amount is the amount at which an asset is recognised after deducting
any accumulated depreciation (amortisation) and accumulated impairment losses
thereon.
Recoverable amount is the higher of an assets fair value less costs of disposal
and its value in use.
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.
Costs of disposal are incremental costs directly attributable to the disposal of an
asset or cash-generating unit excluding finance costs and income tax expense.
Value in use is the present value of the future cash flows expected to be derived
from an asset or cash-generating unit.
CA Sri Lanka
157
No
Yes
Yes *
No
No impairment test
required
No
Yes
(section 1.5)
(section 2)
Recognise any
impairment loss
Recognise any
impairment loss against
assets of the CGU per
LKAS 36 (section 2.3)
(section 1.6)
Disclosure
(section 3)
158
CA Sri Lanka
These assets are first tested at the end of the year in which they were initially
recognised. Thereafter they are tested at the same time every year, however this
need not be at the end of the year. Different intangibles may be tested at different
times.
External indicators
CA Sri Lanka
159
(b)
The dividend exceeds the total comprehensive income of the investee in the
period in which the dividend is declared.
160
(a)
An estimate of the future cash flows the entity expects to derive from the
asset.
(b)
(c)
(d)
(e)
Other factors that would be reflected in pricing future cash flows from the
asset.
CA Sri Lanka
(b)
(c)
A steady or declining growth rate for each subsequent year (unless a rising
growth rate can be justified) is used in extrapolating short-term projections
of cash flows beyond this period. Unless a higher growth rate can be justified,
the long-term growth rate employed should not be higher than the average
long-term growth rate for the product, market, industry or country.
Include:
Exclude:
CA Sri Lanka
161
The discount rate should not include a risk weighting if the underlying cash flows
have already been adjusted for risk. For example, if the discount rate includes the
effect of price increases due to general inflation, future cash flows are estimated in
nominal terms; if the discount rate excludes the effect of price increases due to
general inflation, future cash flows are estimated in real terms.
Foreign currency future cash flows are initially prepared in the currency in
which they will arise and are then discounted using an appropriate rate.
Translation of the resulting figure into the reporting currency should be based on
the spot rate at the year end.
1.5.2 Fair value less costs of disposal
Fair value is established in accordance with the requirements of SLFRS 13 Fair
Value Measurement.
It 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.
LKAS 36 clarifies that costs of disposal may include legal costs, stamp duty and
similar transaction taxes, costs of removing the asset, and direct incremental
costs to bring an asset into condition for its sale. They do not, however, include
termination benefits, nor costs associated with reducing or reorganising a
business following the disposal of an asset.
1.5.3 Intangible assets with an indefinite useful life
These assets are tested annually for impairment.
LKAS 36 allows the most recent detailed calculation of recoverable amount (for a
previous period) to be used where:
The most recently calculated recoverable amount exceeded the assets carrying
amount by a substantial margin, and
Events and circumstances that have occurred since the most recent recoverable
amount calculation have been analysed and there is only a remote likelihood
that recoverable amount if determined now would be less than the assets
carrying amount, and
If the asset is part of a cash generating unit (section 2), the assets and liabilities
making up that unit have not changed significantly since the most recent
recoverable amount calculation.
162
CA Sri Lanka
QUESTION
Abekoon Traders Ltd acquired its head office on 1 January 20W8 at a cost of
Rs. 5.0 million (excluding land). Abekoon Traders' policy is to depreciate property
on a straight-line basis over 50 years with a zero residual value.
On 31 December 20X2 (after five years of ownership) Abekoon Traders revalued
the non-land element of its head office to Rs. 8.0 million. The company does not
transfer annual amounts out of revaluation reserves as assets are used: this is in
accordance with the permitted treatment in LKAS 16 Property, plant and
equipment.
In January 20X8 localised flooding occurred and the recoverable amount of the
non-land element of the head office property fell to Rs. 2.9 million.
Required
What impairment charge should be recognised in the profit or loss of Abekoon
Traders Ltd arising from the impairment review in January 20X8 according to
LKAS 36 Impairment of assets?
ANSWER
Rs. 700,000
LKAS 36.60 and 61 (also LKAS 16.40) require that an impairment that reverses a
previous revaluation should be recognised through other comprehensive income
to the extent of the amount in the revaluation surplus for that same asset. Any
remaining amount is recognised through profit or loss. Therefore:
CA Sri Lanka
(a)
The carrying amount at 31 December 20X2 is 45/50 Rs. 5.0 Mn = Rs. 4.5 Mn
(b)
The revaluation reserve created is Rs3.5m (ie Rs. 8.0 Mn Rs. 4.5 Mn)
(c)
The carrying amount at 31 December 20X7 is 40/45 Rs. 8.0 Mn = Rs. 7.1 Mn
(d)
(e)
The total impairment charge is Rs. 4.2 Mn (ie Rs. 7.1 Mn Rs. 2.9 Mn)
163
(f)
Of this, Rs. 3.5 million is a reversal of the revaluation reserve, so only Rs. 0.7
million is recognised through profit or loss.
2.
There has been a change in the estimates used to determine the assets
recoverable amount since the last impairment loss was recognised.
Where the asset is carried at a revalued amount, the reversal of the impairment
loss is treated as a revaluation increase.
The new carrying amount after the reversal cannot be higher than the carrying
amount would have been (after the relevant depreciation) if the original
impairment had not occurred.
Subsequent depreciation is based on the new carrying amount, estimated residual
value and estimated useful life.
2 Cash-generating units
Where the recoverable amount of an individual asset cannot be determined, it
should be tested for impairment as part of the cash-generating unit to which
it belongs.
LKAS 36 provides the following definitions relevant to cash-generating units
(CGUs):
164
CA Sri Lanka
QUESTION
Lanka Bus Company provides services under contract with a municipality that
requires a minimum service on each of five routes. Assets devoted to each bus
route and cash flows arising from each route can be identified separately; one of
the routes operates at a significant loss.
The management of the Lanka Bus Company has designated each of the five routes
as a separate CGU for the purposes of impairment testing.
CA Sri Lanka
165
Required
Comment on the management decision to designate each route as a CGU.
ANSWER
The Lanka Bus Company does not have the option to curtail only one bus route as
the contract with the municipality requires a minimum service on all five routes.
Therefore the smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets or groups of assets is
the bus company as a whole.
The management is therefore incorrect to designate each route as a separate CGU.
QUESTION
Minimart belongs to a retail store chain Maximart. Minimart makes all its retail
purchases through Maximart's purchasing centre. Pricing, marketing, advertising
and human resources policies (except for hiring Minimart's cashiers and
salesmen) are decided by Maximart. Maximart also owns five other stores in the
same city as Minimart (although in different neighbourhoods) and 20 other stores
in other cities. All stores are managed in the same way as Minimart. Minimart and
four other stores were purchased five years ago and goodwill was recognised.
Required
What is the cash-generating unit for Minimart?
ANSWER
In identifying Minimart's cash-generating unit, an entity considers whether, for
example:
(a)
(b)
All Maximart's stores are in different neighbourhoods and probably have different
customer bases. So, although Minimart is managed at a corporate level, Minimart
generates cash inflows that are largely independent from those of Maximart's
other stores. Therefore, it is likely that Minimart is a cash-generating unit.
166
CA Sri Lanka
comparing the carrying amount of the CGU excluding the corporate asset
with its recoverable amount.
(b)
(c)
Comparing the carrying amount of that group of CGUs (including the portion
of allocated asset) with the recoverable amount of the group of units.
2.2.2 Goodwill
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 cashgenerating units (or groups of cash-generating units) that are expected to benefit
from the synergies of the combination.
Each unit to which the goodwill is so allocated should:
(a)
CA Sri Lanka
Represent the lowest level within the entity at which the goodwill is
monitored for internal management purposes
167
(b)
168
CA Sri Lanka
Solution
Recognised goodwill is initially measured at Rs. 1.6 million (16m + (20% x 18 Mn)
18 Mn). At 31 December 20X therefore:
Goodwill
Net assets
Total
Rs'000
Rs'000
Rs'000
1,600
18,400
20,000
Carrying amount
400
400
Notional NCI goodwill
(20%/80% Rs 1.6 Mn)
2,000
18,400
20,400
(19,100)
Recoverable amount
1,300
Impairment loss
169
QUESTION
The Dias Company is testing for impairment two subsidiaries, which have been
identified as separate cash-generating units.
Some years ago Dias acquired 80% of The Horas Company for Rs. 600,000 when
the fair value of Horas identifiable assets was Rs. 400,000. As Horas policy is to
distribute all profits by way of dividend, the fair value of its identifiable net assets
remained at Rs. 400,000 on 31 December 20X7. The impairment review indicated
Horas recoverable amount at 31 December 20X7 to be Rs. 520,000.
Some years ago Dias acquired 85% of The Meses Company for Rs. 800,000 when
the fair value of Meses identifiable net assets was Rs. 700,000. Goodwill of
Rs. 205,000 (Rs. 800,000 (Rs. 700,000 85%)) was recognised. As Meses policy
is to distribute all profits by way of dividend, the fair value of its identifiable net
assets remained at Rs. 700,000 on 31 December 20X7. The impairment review
indicated Meses recoverable amount at 31 December 20X7 to be Rs. 660,000.
It is Dias group policy to measure the non-controlling interest using the
proportion of net assets method.
Required
Determine the following amounts in respect of Dias consolidated financial
statements at 31 December 20X7 according to LKAS 36 Impairment of assets.
170
(a)
(b)
(c)
CA Sri Lanka
ANSWER
(a)
(b)
(c)
Rs. 750,000
Rs. 96,000
Rs. 99,000
Workings
(a)
Book value of Horas net assets
Goodwill recognised on acquisition
Rs 600,000 (80% Rs 400,000)
Notional goodwill (Rs. 280,000 20/80)
Rs.
400,000
280,000
70,000
750,000
(b)
The impairment loss is the total Rs. 750,000 less the recoverable amount of
Rs. 520,000 = Rs. 230,000. Under LKAS 36 this is firstly allocated against the
Rs. 350,000 goodwill. (As the impairment loss is less than the goodwill, none
is allocated against identifiable net assets.) As only the goodwill relating to
Horas is recognised, only its 80% share of the impairment loss is recognised:
Rs.
280,000
Carrying value of goodwill
(184,000)
Impairment (80% Rs 230,000)
96,000
Revised carrying amount of goodwill
(c)
Rs.
700,000
205,000
36,176
941,176
(660,000)
281,176
241,176
40,000
CA Sri Lanka
171
QUESTION
Assume that the facts relating to the acquisition of Horas are the same as above,
except that The Dias Group chooses to measure the non-controlling interest on the
acquisition of Horas at fair value. The fair value of the non-controlling interest in
Horas at acquisition was Rs. 100,000.
Required
Determine the following amounts in respect of The Dias Groups consolidated
financial statements at 31 December 20X7 according to LKAS 36 Impairment of
assets.
(a)
(b)
ANSWER
(a)
(b)
Rs. 700,000
Rs. 120,000
Workings
(a)
Consideration transferred
Fair value of NCI
Fair value of net assets acquired
Goodwill
172
Rs.
600,000
100,000
700,000
400,000
300,000
Rs.
400,000
300,000
700,000
The impairment loss is the total Rs. 700,000 less the recoverable amount of
Rs. 520,000 = Rs. 180,000. Under LKAS 36 this is first allocated against the
Rs. 300,000 goodwill. (As the impairment loss is less than the goodwill, none
is allocated against identifiable net assets.)
Rs.
300,000
Carrying value of goodwill
(180,000)
Impairment
120,000
Revised carrying amount of goodwill
CA Sri Lanka
3 Disclosure
LKAS 36 has extensive disclosure requirements.
LKAS 36 requires that the following is disclosed for each class of assets:
(a)
(b)
(b)
In addition the following is disclosed for individual assets or CGUs for which a
material impairment loss is recognised or reversed in the period:
(a)
(b)
(c)
CA Sri Lanka
173
Asset
CGU
(d)
The recoverable amount and whether that is value in use or fair value less
costs of disposal.
(e)
Details of how fair value is determined (where fair value less costs of
disposal is recoverable amount);
The level of the SLFRS 13 fair value hierarchy within which the fair value
measurement is categorised.
For level 2/3 fair value measurements, a description of the valuation
techniques used and details of any change in valuation techniques.
For level 2/3 fair value measurements, each key assumption on which
management has based its determination of fair value less costs of
disposal.
(f)
Details of the discount rate used in value in use (where that is recoverable
amount).
For the aggregate impairment losses and the aggregate reversals of impairment
losses recognised during the period that are not material:
(a)
(b)
The main events and circumstances that led to the recognition of these
impairment losses and reversals.
174
CA Sri Lanka
QUESTION
Sports Reports Ltd owns 150 magazine titles of which 70 were purchased and 80
were created by the company. The following information is relevant:
The price of each purchased title is recognised as an intangible asset.
The costs of creating new titles together with the costs of maintaining existing
titles are expensed as incurred.
Cash inflows from sales and advertising are identifiable for each magazine title.
Titles are managed by sport (eg football, cricket, cycling and so on).
The level of advertising income for each title depends on the range of titles
relevant to a particular sport.
Management has a policy of abandoning old titles before the end of their
economic lives and replacing them immediately with new titles relevant to the
same sport.
Required
Advise on the criteria to be considered to identify the cash generating unit(s) of
Sports Reports Ltd.
ANSWER
A CGU is the smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets or groups of assets.
It is likely that the recoverable amount of each magazine title can be assessed. The
level of advertising income for a title is influenced to some extent by the number
of titles relevant to the same sport, however cash inflows from direct sales and
advertising are identifiable. In addition, although magazine titles are managed by
sport, decisions to abandon titles are made on an individual basis.
Therefore it is likely that individual magazine titles generate cash inflows that are
largely independent of one another and that each magazine title is a separate CGU.
CA Sri Lanka
175
QUESTION
Kalu Ltd has a number of cash-generating units and recognised an impairment
loss in two of them in the year ended 31 December 20X6. The recoverable amount
of the CGUs in both cases was value in use. Specific discount rates for the
calculation of value in use are not directly available from the market, and Kalu
management estimates the discount rates using its weighted average cost of
capital. In calculating the cost of debt as an input to the determination of the
discount rate, Kalu management used the risk-free rate adjusted by the company
specific average credit spread of its outstanding debt, which had been raised two
years previously. As Kalu did not have any need for additional financing and did
not need to repay any of the existing loans before 20X9, its management did not
see any reason for using a different discount rate.
Kalu has made no disclosure in relation to the impairment losses as it felt that
such disclosure may be prejudicial to its core business.
Required
Discuss the validity of the accounting treatments in Kalus financial statements for
the year ended 31 December 20X6.
ANSWER
While the cash flows used in testing for impairment are specific to the entity, the
discount rate is supposed to appropriately reflect the current market assessment
of the time value of money and the risks specific to the asset or cash generating
unit. When a specific rate for an asset or cash-generating unit is not directly
available from the market, which is usually the case, the discount rate to be used is
a surrogate. An estimate should be made of a pre-tax rate that reflects the current
market assessment of the time value of money and the risks specific to the asset
that have not been adjusted for in the estimate of future cash flows. According to
LKAS 36, this rate is the return that the investors would require if they chose an
investment that would generate cash flows of amounts, timing and risk profile
equivalent to those that the entity expects to derive from the assets.
Rates that should be considered are the entitys weighted average cost of capital,
the entitys incremental borrowing rate or other market rates. The objective must
be to obtain a rate that is sensible and justifiable. Kalu should not use the risk free
rate adjusted by the company specific average credit spread of outstanding debt
raised two years ago. Instead the credit spread input applied should reflect the
current market assessment of the credit spread at the time of impairment testing,
even though Kalu does not intend raising any more finance.
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CA Sri Lanka
Disclosures
With regard to the impairment loss recognised in respect of each cash generating
unit, assuming the loss is material, LKAS 36 requires disclosure:
The amount of the loss
The events and circumstances that led to the loss
A description of the impairment loss by class of asset
Kalu cannot avoid making the disclosures on the basis of the effect on its core
business.
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177
CHAPTER ROUNDUP
178
Assets are tested for impairment when there are indicators of impairment;
certain assets are tested annually.
Recoverable amount is the higher of value in use and fair value less costs of
disposal.
CA Sri Lanka
PROGRESS TEST
Are the following cash flows included or excluded from a value in use calculation?
Projected cash inflows from continuing use of the asset
Net cash flows from the disposal of the asset at the end of its life
Cash flows associated with improving the assets performance
Costs to service and maintain the asset
Interest costs associated with acquisition of the asset
Where an impairment loss is reversed, the new carrying amount of the relevant
asset is capped at what amount?
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179
180
Intangible assets that are not yet available for use, intangible assets with an
indefinite useful life and goodwill, arising on a business combination.
2
Projected cash inflows from continuing use of the asset.
Net cash flows from the disposal of the asset at the end of its life.
Cash flows associated with improving the assets performance
Costs to service and maintain the asset
Interest costs associated with acquisition of the asset
Include
Include
Exclude
Include
Exclude
The new carrying amount after the reversal cannot be higher than the carrying
amount would have been (after the relevant depreciation) if the original
impairment had not occurred.
Where goodwill is part of a CGU, there is a non-controlling interest and the noncontrolling interest is measured as a proportion of net assets at acquisition
(meaning that no NCI goodwill is recognised).
(a)
(b)
(c)
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter revises the topic of leasing. Lease arrangements are a
common way of financing the purchase of assets; you should be able to
account for such a transaction from both the lessor and the lessees
perspective. The chapter also introduces a new topic, also covered by
LKAS 17, being sale and leaseback.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
181
CHAPTER CONTENTS
1 Introduction
2 Operating leases
3 Finance leases
4 Sale and leaseback transactions
5 Related Interpretations
6 Current developments
1 Introduction
Leases are classified as finance or operating leases; substance over form is
important in distinguishing between them.
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CA Sri Lanka
QUESTION
ANSWER
LKAS 17 defines a finance lease as a lease that transfers substantially all risks and
rewards incident to ownership of an asset to the lessee.
Risks include the possibility of losses from idle capacity, technological
obsolescence and falls in returns due to varying economic conditions. Rewards of
ownership include the profitable use of the asset during its economic life.
An assessment of risks and rewards is subjective and there may not be a clear
conclusion. Therefore LKAS 17 provides examples of situations that normally
result in a lease being classified as a finance lease. They are:
Ownership of the asset is transferred to the lessee by the end of the lease term;
The lessee has the option to purchase the asset at a price that makes the option
reasonably certain to be exercised;
The lease term is for the major part of the economic life of the asset;
At the inception of the lease, the present value of the minimum lease payments
(discounted at the interest rate implicit in the lease) amounts to at least
substantially all of the fair value of the leased asset;
The leased asset is of such a specialised nature that only the lessee could use it
without major modifications.
All of these situations point to the lessor acquiring the asset and using the lease
arrangement as a form of finance for the acquisition.
The standard also provides indicators of situations that could also lead to a lease
being classified as a finance lease:
If the lessee can cancel the lease, the lessors losses associated with the
cancellation are borne by the lessee;
Gains or losses from the fluctuation in the fair value of the residual accrue to
the lessee;
The lessee has the ability to continue the lease for a secondary period at a rent
that is substantially lower than market rent.
CA Sri Lanka
183
QUESTION
A business has taken out a new lease on a factory building and surrounding land.
The fair value of the building is Rs. 7 Mn and the fair value of the land is Rs. 10 Mn.
The lease is for 20 years with annual payments in arrears of Rs. 1,100,000. After
20 years, the business can extend the lease for a further 20 years for an annual
payment of Rs. 50,000.
Required
Explain how the lease is classified in accordance with LKAS 17?
ANSWER
Land and buildings leased together are considered separately for the purposes of
lease classification.
A lease of land is normally treated as an operating lease, unless title is expected
to pass at the end of the lease term.
A lease of buildings will be treated as a finance lease if it satisfies the
requirements of LKAS 17.
There is no indication that title will pass in respect of the land and therefore the
lease in respect of the land is classified as an operating lease. The ability to extend
the lease for a secondary period for below market rent suggests that the lease in
respect of the building is a finance lease.
Therefore the lease payments will be split in line with the fair values of the land
and the building. Rs. 647,059 (1,100,000 10/17) will be treated as payment on
an operating lease for the land and Rs. 452,941 will be treated as payment on a
finance lease for the building.
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CA Sri Lanka
The inception of the lease is the earlier of the date of the lease agreement and
the date of commitment by the parties to the principal provisions of the lease. As
at that date:
The lease is classified either as an operating or finance lease, and
In the case of a finance lease the amounts to be recognised at the
commencement of the lease are determined.
The commencement of the lease term is the date from which the lessee is
entitled to exercise its right to use the leased asset. It is the date of the initial
recognition of the lease.
Minimum lease payments are the payments over the lease term that the lessee is
or can be required to make, excluding contingent rent, costs for services and taxes
to be paid and reimbursed to the lessor, together with:
(a)
(b)
The lessee;
(ii)
For a lessee, that part of the residual value that is guaranteed by the lessee or
by a party related to the lessee (the amount of the guarantee being the
maximum amount that could, in any event, become payable), and
(b)
For a lessor, that part of the residual value that is guaranteed by the lessee or
by a third party unrelated to the lessor that is financially capable of
discharging the obligations under the guarantee.
Unguaranteed residual value is that portion of the residual value of the leased
asset, the realisation of which by the lessor is not assured or is guaranteed solely
by a party related to the lessor.
Fair value is the amount for which an asset could be exchanged or a liability
settled between knowledgeable, willing parties in an arms length transaction.
The interest rate implicit in the lease is the discount rate that, at the inception
of the lease, causes the aggregate present value of:
(a)
(b)
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185
2 Operating leases
An operating lease expense is recognised in profit or loss on a straight-line
basis over the lease term in the lessees financial statements.
The lessor recognises income in profit or loss on a straight line basis over the
lease term.
2.
3.
QUESTION
Beira Baskets (Pvt) Ltd entered into a non-cancellable agreement with PV Leasing
Ltd to lease a property for 3 years from 1 July 20X7. PV Leasing incurred costs
associated with arranging the lease of Rs. 40,000. The property has an expected
remaining useful life of 40 years at this date and a carrying amount of
186
CA Sri Lanka
Rs. 3.4 million. The terms of the lease agreement require an initial non-refundable
deposit of Rs 12,000 and then monthly rentals of Rs. 3,000 paid in arrears.
Beira Baskets rents a number of properties under similar terms; the average lease
term is 5 years.
Required
Prepare extracts from the financial statements of Beira Baskets (Pvt) Ltd for the
year ended 31 December 20X7 in respect of the lease.
ANSWER
Statement of profit or loss for the year ended 31 December 20X7 (extract)
Operating lease expense
Rs.
20,000
Rs.
10,000
Rs.
20,000
At the reporting date the company had outstanding commitments for future
minimum lease payments under non-cancellable operating leases which fall due
as follows:
Within one year (12m 3,000)
In the second to fifth years (18m 3,000)
After five years
Rs.
36,000
54,000
90,000
CA Sri Lanka
Rs.
120,000
40,000
20,000
30,000
10,000
187
The underlying asset is presented according to the nature of the asset, with
depreciation recognised in profit or loss. Any initial direct costs incurred in
negotiating and arranging an operating lease are added to the carrying
amount of the asset and recognised as an expense over the lease term.
2.
2.
QUESTION
Using the information in the question in section 1.1, prepare extracts from the
financial statements of PV Leasing Ltd for the year ended 31 December 20X7 in
respect of the lease.
ANSWER
Statement of profit or loss for the year ended 31 December 20X7 (extract)
Depreciation
Operating lease income
188
Rs.
(43,000)
20,000
CA Sri Lanka
Rs.
3,397,000
6,000
4,000
Rs.
36,000
54,000
90,000
Workings
Income
Total lease receipts (3 yrs 12m 3,000) + 12,000
Annual credit to income therefore 120,000/3years
Income in the year 40,000 6/12m
Deferred income
Income in the year
Cash received (6m 3,000) + 12,000
Deferred income
Deferred income within one year (40,000 (12 3,000))
Deferred income in more than one year (balance)
Non-current asset
Property carrying amount at commencement of lease
Initial direct costs
Depreciation (3,440,000 / 40 years) 6/12m
Carrying amount at reporting date
CA Sri Lanka
Rs.
120,000
40,000
20,000
Rs.
20,000
30,000
10,000
4,000
6,000
Rs.
3,400,000
40,000
3,440,000
(43,000)
3,397,000
189
3 Finance leases
Lessees should recognise an asset and corresponding lease obligation in
respect of assets acquired under a finance lease. A lessor derecognises an asset
that is leased out under a finance lease and instead recognises the amount
due from the lessee.
Asset
Lease liability
2.
Lease liability
Cash
3.
Depreciation expense
Asset (accumulated
depreciation)
4.
Finance costs
Lease liability
5.
Lease liability
Cash
DEBIT
CREDIT
20XX
B/f obligation
at 1 January
Rs.
X
Interest
charge (15%)
Rs.
X
Finance cost
in P/L
190
Payment
Rs.
(X)
C/f obligation at
31 December
Rs.
X
Total lease
liability at
reporting date
CA Sri Lanka
The table above shows payments in arrears; where payments are in advance
the table is rearranged so that interest is charged on the outstanding obligation
after the payment is recognised.
The table should include a row for each interest bearing period; therefore if
payments are made quarterly, 4 rows per annum are required.
3.1.1 Splitting the lease liability
In the statement of financial position the lease liability is split between the current
and non-current obligation:
The current obligation at the end of one reporting period is the payments to be
made in the next reporting period less any interest that has not yet accrued.
The non-current obligation is the lease liability less the current obligation.
3.1.2 Disclosure
LKAS 17 requires the following disclosures by lessees in respect of finance leases:
1.
2.
The net carrying amount at the end of the reporting period for each class of
asset
3.
CA Sri Lanka
4.
5.
191
QUESTION
Puttalam Plantations Ltd leases an asset on 1 January 20X4 and incurs Rs. 40,000
costs to set up the agreement. The leased asset has a fair value of Rs. 1.6 million on
1 January 20X4; this is equivalent to the present value of minimum lease
payments. Its useful life at that date is 5 years. The terms of the lease are:
A non-refundable deposit of Rs. 116,000 is payable at the commencement of the
lease.
Six annual instalments of Rs. 320,000 are payable in arrears.
Puttalam Plantations guarantees a sales value of at least Rs. 160,000 when the
lessor sells the asset in the general market at the end of the lease term.
The interest rate implicit in the lease is 10%.
Required
(a)
(b)
Explain what would happen at the end of the lease if the asset could be sold
by the lessor:
(i)
(ii)
ANSWER
(a)
192
1,344,000
Non-current liabilities
Finance lease liability over one year (W) (1,312,400
188,760)
1,123,640
Current liabilities
Finance lease liability within one year (W) (320,000
131,240)
188,760
CA Sri Lanka
Minimum
lease
payments
Rs.
320,000
1,280,000
1,600,000
(287,600)
1,312,400
PV of
minimum
lease
payments
Rs.
188,760
1,123,640
1,312,400
Working
Bal b/f
Rs.
1,600,000
(116,000)
1,484,000
1,312,400
20X4
20X5
(b)
Interest accrued at
10%
Rs.
Payment
31 Dec
Rs.
Bal c/f
31 Dec
Rs.
148,400
131,240
(320,000)
(320,000)
1,312,400
1,123,640
At the end of the lease term, Puttalam Plantations will have an asset at a
residual value of Rs. 160,000 and a finance lease liability of the same amount,
representing the guaranteed residual value.
(i)
If the lessor can sell the asset for Rs. 160,000, Puttalam Plantations has
no further liability and derecognises asset and finance lease liability by:
DEBIT
CREDIT
(ii)
Rs. 160,000
Rs. 160,000
If the lessor can only sell the asset for Rs. 130,000, Puttalam
Plantations must make up the difference of Rs. 30,000. It must first
recognise the impairment in the asset by:
DEBIT
CREDIT
Profit or loss
Asset
Rs. 30,000
Rs. 30,000
CA Sri Lanka
Rs. 160,000
Rs. 30,000
Rs. 130,000
193
Receivable
Finance income
2.
Cash
Receivable
DEBIT
CREDIT
194
1.
2.
A reconciliation between the gross investment in the lease at the end of the
reporting period and the present value of minimum lease payments
receivable at the end of the reporting period.
3.
The gross investment in the lease and present value of minimum lease
payments receivable at the end of the reporting period for each of the
following periods:
CA Sri Lanka
5.
QUESTION
SL Equipment Ltd leased an asset to a customer from 1 June 20X1. The fair value
of the asset on this date was Rs. 178,500 and legal fees payable by SL Equipment
amounted to Rs. 1,500. The terms of the lease were:
Eight annual rentals of Rs. 33,000 payable in advance
Implicit interest rate of 12.8%.
Required
Prepare numerical extracts from the financial statements of SL Equipment Ltd for
the year ended 31 May 20X2 in respect of the lease.
ANSWER
Statement of profit or loss for the year ended 31 May 20X2 (extract)
Rs.
Finance income
18,816
Statement of financial position at 31 May 20X2 (extract)
Rs.
Non-current assets
Net investment in finance lease (165,816 33,000)
Current asset
Net investment in finance lease
132,816
33,000
CA Sri Lanka
Rs.
33,000
198,000
231,000
(65,184)
165,816
PV of
minimum
lease
payments
Rs.
33,000
132,816
165,816
195
Workings
The net investment in the lease is calculated as:
Rs.
178,500
1,500
180,000
31 May 20X2
Bal b/f
Instalment
c/f
Rs.
180,000
Rs.
(33,000)
Rs.
147,000
Interest at
12.8%
Rs.
18,816
Bal c/f
31 Dec
Rs.
165,816
196
CA Sri Lanka
(ii)
Where the sale price is below fair value, any profit or loss should be
recognised immediately except that if the apparent loss is compensated
by future lease payments at below market price it should to that extent be
deferred and amortised over the period for which the asset is expected to
be used.
(iii) If the sale price is above fair value, the excess over fair value should be
deferred and amortised over the period over which the asset is expected
to be used.
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197
In addition, for an operating lease where the fair value of the asset at the time
of the sale is less than the carrying amount, the loss (carrying value less fair
value) should be recognised immediately.
The operating lease is recognised as described in Section 2.1 of this Chapter.
4.3 Disclosure
The disclosure requirements seen earlier for operating and finance leases apply
equally to such leases as a result of sale and leaseback transactions.
QUESTION
Kelani Industries Ltd sold an asset to LankaBank for Rs. 5,200,000 on 1 July 20X3.
On this date the asset had a carrying amount of Rs. 3,100,000. Kelani Industries
entered into an agreement on the same date to lease the asset back under a 20
year lease for annual rentals of Rs. 280,000. The lease arrangement has been
determined to be a finance lease.
Required
How is the transaction accounted for by Kelani Industries on 1 July 20X3 and
subsequently?
ANSWER
The Rs. 3,100,000 carrying amount of the asset is derecognised and proceeds of
Rs. 5,200,000 are recognised.
The Rs. 2,100,000 difference between these amounts is recognised as deferred
income. This amount will be recognised in profit or loss over the 20 year lease
term at a rate of Rs. 105,000 per annum.
An asset and corresponding lease obligation of Rs. 5,200,000 are recognised.
The asset will be depreciated over the lease term (assuming this is less than the
useful life) giving a depreciation charge of Rs. 260,000 per annum.
Interest will accrue to the finance lease obligation over the year to 30 June
20X4. The payment of Rs. 280,000 on 30 June 20X4 will pay this accrued
interest together with an amount of the capital outstanding. This pattern will
be repeated in each year of the lease.
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CA Sri Lanka
5 Related Interpretations
SIC 27 Evaluating the Substance of Transactions in the Legal form of a Lease and
IFRIC 4 Determining whether an Arrangement contains a Lease are relevant to
lease accounting.
SIC-15 Operating lease incentives is considered in section 2; it confirms that
operating lease expenses / income should be recognised on a straight-line basis
where the lessor provides incentives for the lessee to enter into the agreement.
Other relevant interpretations are SIC 27 and IFRIC 4.
(ii)
(iii) An option is included on terms that make its exercise almost certain.
These indicators are particularly relevant in the case of sale and leaseback
transactions, where the substance of the transaction may be a secured loan.
(b)
CA Sri Lanka
(ii)
How the entity should account for other obligations resulting from the
arrangement.
199
(iii) How the entity should account for a fee it might receive from an
investor.
SIC-27 includes a list of indicators that collectively demonstrate that, in
substance, a separate investment account and lease payment obligation do
not meet the definitions of an asset and a liability and should not be
recognised by the entity.
Other obligations of an arrangement, including any guarantees provided and
obligations incurred upon early termination, should be accounted for under
LKAS 37 or LKAS 39, depending on the terms. Further, the criteria in LKAS
18.20 should be applied to the facts and circumstances of each arrangement
in determining when to recognise a fee as income that an entity might
receive.
(c)
A series of transactions that involve the legal form of a lease is linked, and
therefore should be accounted for as one transaction, when the overall
economic effect cannot be understood without reference to the series of
transactions as a whole.
Outsourcing arrangements.
(b)
(c)
IFRIC 4 specifies that an arrangement that meets both of the following criteria is a
lease, or contains a lease and so should be accounted for in accordance with LKAS
17 Leases:
200
1.
Fulfilment of the arrangement depends upon a specific asset. The asset need
not be explicitly identified by the contractual provisions of the arrangement.
Rather, it may be implicitly specified because it is not economically feasible
or practical for the supplier to fulfil the arrangement by providing use of
alternative assets.
2.
The arrangement conveys a right to control the use of the underlying asset.
This is the case if any of the following conditions are met:
CA Sri Lanka
The purchaser in the arrangement has the ability or right to operate the
asset or direct others to operate the asset (while obtaining more than an
insignificant amount of the output of the asset),
The purchaser has the ability or right to control physical access to the
asset (while obtaining more than an insignificant amount of the output of
the asset), or
There is only a remote possibility that parties other than the purchaser
will take more than an insignificant amount of the output of the asset and
the price that the purchaser will pay is neither fixed per unit of output nor
equal to the current market price at the time of delivery.
5.2.1 Example: IFRIC 4
A manufacturing company enters into an arrangement with a utilities company to
supply a minimum amount of gas for a specified period of time. The utilities
company builds a facility next to the manufacturing company to produce the gas
as it is not practical to rely on one of its existing facilities. The utilities company
maintains ownership and control over the facility. The utilities company charges
the manufacturing company a fixed capacity charge plus a variable amount based
on the costs incurred in generating the gas supplied.
This arrangement contains a lease since:
1.
2.
The price the manufacturing company will pay is neither fixed per unit of
output nor equal to the current market price per unit of output.
6 Current developments
The IASB are in the process of developing a new standard to replace IAS 17
(LKAS 17). The new standard will not distinguish between finance and
operating leases.
LKAS 17 has not been without its critics. The original standard closed many
loopholes in the treatment of leases, but it has been open to abuse and
manipulation. For example companies may structure a lease specifically so that it
is classified as an operating lease and so the company avoids reporting a liability
in its statement of financial position. Whilst analysts frequently adjust the
statement of financial position to capitalise operating leases, other users of
financial statements do not have sufficient knowledge to do this.
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201
The IASB has been engaged in a project to replace IAS 17 Leases for a number of
years, with the aim of replacing its many shortcomings and a new standard is
likely to be issued in 2015. The proposed approach would require all leases to be
reported in the statement of financial position, so providing more complete and
useful information to users of the financial statements.
202
CA Sri Lanka
In respect of type B leases (eg property) the asset being leased continues to be
recognised in the statement of financial position. Rental income is recognised in
profit or loss.
Practically, there are few changes proposed to the accounting treatment applied
by lessors in respect of finance leases or operating leases in respect of property.
The proposed changes in respect of operating lease agreements for plant and
equipment are more significant.
QUESTION
A lessee enters into a 10-year operating lease on an office building. The developer
offers a 2-year rent free period, providing the tenant signs for 10 years. Lease
payments are Rs80m per annum payable in years 3-10.
Required
Recommend, showing the double entry, how the lease should be accounted for
over the ten years.
ANSWER
SIC 15 Operating Lease Incentives requires that where the lessor provides
incentives for the lessee to enter into the agreement, the benefit should be spread
over the lease term.
Consequently, the entity recognises an expense in each of the 10 years of
Rs. 64 Mn [(Rs. 80 Mn 8)/ 10 years]. In the first and second years this is shown
as an accrual which is reduced by Rs. 16 Mn per annum over years 3 to 10 as the
payments of Rs. 80 Mn are made, exceeding the profit or loss charge of Rs. 64 Mn
as follows:
In each of years 1 and 2:
DEBIT
CREDIT
Rs. 64 Mn
Rs. 64 Mn
CA Sri Lanka
Rs. 64 Mn
Rs. 16 Mn
Rs. 80 Mn
203
QUESTION
Pacific Ltd owns an asset with a carrying amount of Rs. 40,000 and a fair value of
Rs. 45,000. It has negotiated a number of possible agreements to sell the asset and
lease it back under an operating lease for 7 years starting on 1 January 20X8. The
agreements are:
A
B
C
D
Sell for Rs. 45,000; annual future lease payments at a market rate of
Rs. 7,500.
Sell for Rs. 37,500; annual future lease payments Rs. 7,500
Sell for Rs. 25,000; annual future lease payments Rs. 5,000
Sell for Rs. 55,000; annual future lease payments Rs. 8,750
Required
State how each of these agreements would be accounted for in Pacific Ltds
financial statements?
ANSWER
204
Sale for less than The loss is not compensated for by low future
fair value
rentals therefore the loss of Rs. 2,500 is
recognised immediately
Sale for less than The loss is compensated for by low future
fair value
rentals therefore the loss of Rs. 15,000 is
recognised in the statement of financial position
and released to profit or loss over the lease
term.
Sale for more than A profit of Rs. 5,000 (the profit based on sale at
fair value
fair value) is recognised immediately; the excess
profit of Rs. 10,000 is recognised in the
statement of financial position and released to
profit or loss over the lease term.
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CHAPTER ROUNDUP
A lessor derecognises an asset that is leased out under a finance lease and
instead recognises the amount due from the lessee.
In a sale and leaseback transaction, a vendor sells an asset and then the same
asset is leased back to the same vendor. The accounting treatment depends on
whether the transaction involves an operating or finance lease and whether
proceeds are at fair value.
SIC 27 Evaluating the Substance of Transactions in the Legal form of a Lease and
IFRIC 4 Determining whether an Arrangement contains a Lease are relevant to
lease accounting.
The IASB are in the process of developing a new standard to replace IAS 17
(LKAS 17). The new standard will not distinguish between finance and
operating leases.
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205
PROGRESS TEST
206
How is a deposit paid by the lessee to the lessor at the start of an operating lease
accounted for?
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A finance lease transfers substantially all the risks and rewards incident to
ownership of an asset. Title may or may not be transferred eventually.
An operating lease is a lease other than a finance lease.
The payment is spread across the lease term and recognised as income by the
lessor and an expense by the lessee, alongside the lease payments.
The shorter of useful life and lease term; if title passes at the end of the lease term,
use useful life.
(a)
(b)
If interest rates are artificially low, restrict the selling price to that applying
on a commercial rate of interest.
(c)
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A right of use asset and a lease liability would be recognised, initially at the
present value of lease payments. Two related expenses are recognised in profit or
loss, being the amortisation of the right of use asset and an interest expense on the
liability.
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CHAPTER
INTRODUCTION
This chapter deals with a number of standards relating to assets. Most of these should
be familiar to you from your previous studies, although SLFRS 6 Exploration for and
Evaluation of Mineral Resources is new at the KC1 level. The requirements of standards
that you have previously studied are summarised in this chapter; you should go back to
your previous material to refresh your knowledge if necessary.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
1.3
Level C
1.3.1
1.3.2
1.3.3
209
CHAPTER CONTENTS
1 LKAS 2 Inventories
2 LKAS 11 Construction contracts
3 LKAS 20 Government Grants
4 LKAS 41 Agriculture
5 SLFRS 6 Exploration for and Evaluation of Mineral Resources
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1 LKAS 2 Inventories
Inventories are measured at the lower of cost and net realisable value. Cost
includes costs of purchase and costs of conversion. Where items are
interchangeable cost is estimated using a cost formula. An inventory write
down to NRV is recognised in profit or loss.
Inventories are assets:
held for sale in the ordinary course of business;
in the process of production for such sale; or
in the form of materials or supplies to be consumed in the production process
or in the rendering of services.
Inventories can include goods purchased and held for resale, finished goods, work
in progress and raw materials.
In most businesses the measurement of inventory is an important factor in the
determination of profit. Inventory measurement is a highly subjective exercise
and consequently there is a wide variety of different methods used in practice.
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211
Certain inventories are exempt from the standard's measurement rules, ie those
held by:
Producers of agricultural and forest products
Commodity broker-traders
1.2 Measurement
Inventories are measured at the lower of cost and net realisable value (NRV).
Where NRV is less than cost, the carrying amount of inventories is written down.
Cost
The cost of inventories includes costs of purchase, costs of conversion and any
other costs in bringing the inventories to their present location and condition.
Cost does not include abnormal amounts (eg wasted materials or labour),
storage costs, administrative overheads or selling costs.
For individual items (ie non-interchangeable items) and specific projects, actual
costs can be established.
In the case of interchangeable items a cost formula should be used, being FIFO
or AVCO.
The same cost formula is applied to all inventories with a similar nature and
use.
Net realisable value
Net realisable value is the estimated selling price in the ordinary course of
business less the estimated costs of completion and the estimated costs
necessary to make the sale.
The reason why inventory is held should be considered eg some inventory is
held to satisfy a contract and the NRV is therefore the contract price.
The assessment of NRV should take place at the same time as estimates are
made of selling price, using the most reliable information available.
Fluctuations of price or cost should be taken into account if they relate directly
to events after the reporting period, which confirm conditions existing at the
end of the period.
Write downs to NRV
A write down of inventories normally takes place on an item by item basis but
similar items may be grouped.
On occasion a write down to NRV may be of such size, incidence or nature that
it must be disclosed separately.
212
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1.3 Disclosure
The financial statements should disclose the following.
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(a)
(b)
(c)
(d)
(e)
(f)
The amount of any reversal of write down recognised in profit or loss in the
period.
(g)
(h)
213
The following disclosure note relating to inventories is taken from the 2013/2014
Lion Brewery (Ceylon) PLC Annual Report
10 INVENTORIES
Raw and packing materials
Work in progress
Finished goods
Maintenance spares & others
576,712
145,249
1,795,380
220,632
372,640
97,672
1,763,434
284,785
2,737,973
(42,952)
2,518,531
(111,816)
2,695,021
2,406,715
111,816
74,719
(143,583)
90,891
71,836
(50,911)
42,952
111,816
QUESTION
Based on the types of inventory listed in the above disclosure note, draft a suitable
accounting policy note for Lion Brewery (Ceylon) PLC.
ANSWER
The following accounting policy note is taken from the 2013/2014 Annual Report:
Inventories
Inventories are stated at the lower of cost and net realisable value. Net realisable
value is the estimated selling price in the ordinary course of business less the
estimated costs.
The cost of inventories includes expenditure incurred in acquiring the inventories
and other costs incurred in bringing them to their existing location and condition.
Accordingly the costs of inventories are accounted as follows:
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Appropriate provisions will be made for the value of any stocks that are obsolete.
2.
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215
Contract
costs
216
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The effect of any change in the estimate of contract revenue or costs or the
outcome of a contract should be accounted for as a change in accounting estimate
under LKAS 8 Accounting policies, changes in accounting estimates and errors.
Therefore it is dealt with prospectively from the date of change.
Expected profit
Expected loss
Revenue / costs /
profit recognised by
reference to stage of
completion
Loss is recognised
in full immediately
Outcome cannot be
reliably estimated
Revenue is recognised
to the extent that
contract costs incurred
are recoverable.
Contract costs are an
expense in the period
in which they are
incurred.
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2.4 Disclosure
Where payments to suppliers for raw materials and progress billings to customers
are not in line with amounts recognised in the statement of profit or loss, a gross
amount due to or from customers is reported in the statement of financial
position. This is calculated as:
Costs incurred to date
Recognised profits/(losses) to date
Progress billings to date
Amount due from / (to)customers
Rs.
X
(X)
X
(X)
X (X)
QUESTION
Comprehensive question
Negombo Contracts PLC has a fixed price contract to build a commercial centre.
The initial amount of revenue agreed is Rs. 650 Mn. At the beginning of the
contract on 1 January 20X3 the initial estimate of the contract costs is Rs. 490 Mn.
At the end of 20X3 the estimate of the total costs has risen to Rs. 505 Mn.
During 20X4 the customer agrees to a variation that increases expected revenue
from the contract by Rs. 20 Mn and causes additional costs of Rs. 15 Mn. At the end
of 20X4 there are materials stored on site for use during the following period that
cost Rs. 10 Mn.
Negombo Contracts PLC has decided to determine the stage of completion of the
contract by calculating the proportion that contract costs incurred for work to
date bear to the latest estimated total contract costs. The contract costs incurred
at the end of each year were 20X3: Rs. 131.3 Mn, 20X4: Rs. 379.2 Mn (including
materials in store), 20X5: Rs. 520 Mn.
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Amounts billed to the customer by the end of each year were 20X3: Rs. 150 Mn,
20X4: Rs. 490 Mn, 20X5: Rs. 670 Mn and amounts received from the customer
were 20X3: Rs. 150 Mn, 20X4: Rs. 475 Mn and 20X5: Rs. 620 Mn.
Required
Prepare extracts from the financial statements of Negombo Contracts for each
year of the contract. Notes are not required.
ANSWER
Statement of profit or loss for the year ended 31 December
Revenue (W2)
Cost of sales (W2)
Profit (W2)
20X3
Rs'000
169,000
(131,300)
37,700
20X4
Rs'000
306,700
(237,900)
68,800
20X5
Rs'000
194,300
(150,800)
43,500
20X4
Rs'000
20X5
Rs'000
10,000
19,000
15,000
50,000
14,300
Workings:
W1 Stage of completion
20X3
Rs'000
650,000
20X4
Rs'000
650,000
20X5
Rs'000
650,000
650,000
20,000
670,000
20,000
670,000
131,300
373,700
505,000
379,200
140,800
520,000
520,000
520,000
Estimated profit
145,000
150,000
150,000
26%
71%
100%
Stage of completion
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219
To date
Rs'000
169,000
131,300
37,700
Recognised
in
prior years
Rs'000
Recognised
in
current year
Rs'000
475,700
369,200
106,500
169,000
131,300
37,700
306,700
237,900
68,800
670,000
520,000
150,000
475,700
369,200
106,500
194,300
150,800
43,500
20X3
Rs'000
131,300
37,700
(150,000)
19,000
20X4
Rs'000
369,200
106,500
(490,000)
(14,300)
20X5
Rs'000
520,000
150,000
(670,000)
-
20X3
Rs'000
150,000
(150,000)
-
20X4
Rs'000
490,000
(475,000)
15,000
20X5
Rs'000
670,000
(620,000)
50,000
Progress billings
Cash received
Receivables
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3.1 Scope
LKAS 20 does not cover the following situations.
Accounting for government grants in financial statements reflecting the effects
of changing prices
Government assistance given in the form of 'tax breaks'
Government acting as part-owner of the entity
3.2 Definitions
These definitions are given by the standard.
Government. Government, government agencies and similar bodies whether
local, national or international.
Government assistance. Action by government designed to provide an economic
benefit specific to an entity or range of entities qualifying under certain criteria.
Government grants. Assistance by government in the form of transfers of
resources to an entity in return for past or future compliance with certain
conditions relating to the operating activities of the entity. They exclude those
forms of government assistance which cannot reasonably have a value placed
upon them and transactions with government which cannot be distinguished from
the normal trading transactions of the entity.
Grants related to assets. Government grants whose primary condition is that an
entity qualifying for them should purchase, construct or otherwise acquire noncurrent assets. Subsidiary conditions may also be attached restricting the type or
location of the assets or the periods during which they are to be acquired or held.
Grants related to income. Government grants other than those related to assets.
Forgivable loans. Loans which the lender undertakes to waive repayment of
under certain prescribed conditions.
Fair value. The price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date.
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221
Recognition in
profit or loss
Presentation in
statement of
financial position
Presentation in
statement of profit
or loss
(b)
QUESTION
Explain how the following should be accounted for insofar as the information
provided permits:
222
1.
2.
3.
4.
Company D receives a grant for the purchase of land. A condition of the grant
is that the Company must build a property on the land.
ANSWER
1.
The grant is recognised in profit or loss in the period in which the specific
expenditure is recognised ie the period of receipt.
2.
3.
4.
The grant is recognised in profit or loss over the life of the property.
3.5 Disclosure
Disclosure is required of the following.
Accounting policy adopted, including method of presentation
Nature and extent of government grants recognised and other forms of
assistance received
Unfulfilled conditions and other contingencies attached to recognised
government assistance
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223
QUESTION
ANSWER
Government grants are not recognised until there is reasonable assurance that the
company will comply with the conditions attached to them and that the grants will
be received.
The benefit of a government loan at a below-market rate of interest is treated as a
government grant measured as the difference between proceeds received and the
fair value of the loan based on prevailing market interest rates.
Government grants towards staff training costs are recognised as income over the
periods necessary to match them with the related costs and are deducted in
reporting the related expense.
Government grants relating to property, plant and equipment are treated as
deferred income and released to profit or loss over the expected useful lives of the
assets concerned.
4 LKAS 41 Agriculture
Biological assets are measured at fair value less costs to sell with changes in
fair value recognised in profit or loss.
LKAS 41 Agriculture is relevant to entities that are engaged in agricultural activity
and deals with biological assets, agricultural produce at the point of harvest and
government grants related to biological assets.
It does not apply to land used for agricultural activities or intangible assets related
to agricultural activities.
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4.1 Definitions
LKAS 41 provides the following definitions relevant to agriculture:
Agricultural activity is the management by an entity of the biological
transformation and harvest of biological assets for sale or conversion into
agricultural produce or into additional biological assets.
Agriculture produce is the harvested product of an entitys biological assets.
A biological asset is a living plant or animal, for example sheep, pigs, beef cattle,
dairy cows, fish trees in a forest, plants for harvest (eg wheat) and plants from
which produce is harvested (eg fruit trees).
Biological transformation is the processes of growth, degeneration, production
and procreation that cause qualitative or quantitative changes in a biological asset.
Harvest is the detachment of produce from a biological asset or the cessation of a
biological assets life process.
Initial
measurement
Subsequent
measurement
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225
dealers, transfer taxes and duties and fees. They do not include income taxes or
finance costs.
LKAS 41 makes the following additional points about fair value:
Measurement at fair value may be facilitated by grouping assets according to
their age, quality or similar attributes used in the market as a basis for pricing.
Where a sales contract for a future date exists, the contract price is not
necessarily relevant in measuring fair value since it does not necessarily reflect
current market conditions.
Cost may approximate fair value, particularly when:
Little biological transformation has taken place since purchase, or
The impact of biological transformation is not expected to be material
Where biological assets are attached to land (eg trees in a plantation forest),
there may be no separate market for the biological assets. Here the fair value of
the biological assets should be measured using information about the combined
assets.
4.3.1 Inability to measure fair value reliably
There is a rebuttable presumption that the fair value of a biological asset can be
measured reliably. This presumption can be rebutted only on initial recognition
and only if quoted market prices are not available and alternative fair value
measurements are determined to be unreliable. If the presumption is rebutted, a
biological asset should be measured at cost less accumulated depreciation and
accumulated impairment losses.
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(b)
(c)
(d)
(e)
Details of biological assets whose title is restricted and commitments for the
acquisition of biological assets.
(f)
2014
Rs'000
1,475,236
74,293
2013
Rs'000
1,422,786
42,685
10,236
1,559,765
9,765
1,475,236
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227
(ii)
(iii) has a remote likelihood of being sold as agricultural produce except for
incidental scrap sales.
An example of a bearer plant is therefore a fruit tree. Annual crops such as wheat
or maize and plants cultivated to be themselves harvested (eg trees for lumber)
are not bearer plants.
QUESTION
Agriculture
Dias Dairy Ltd acquired a herd of 200 dairy cattle on 31 December 20X3 at a cost
of Rs. 1,000 each. The market value of a dairy cow on 31 December 20X4 was
Rs. 1,200 and at 31 December 20X5 was Rs. 1,250. Sellers auction costs for
livestock amount to 3% of the selling price.
Extracts from the Dias Dairy Ltd financial statements for the year ended
31 December 20X5 were as follows:
Statement of financial position
Biological assets (dairy herd)
20X5
Rs.
160,000
20X4
Rs.
180,000
20X5
Rs.
20,000
20X4
Rs.
20,000
The Company owns a herd of dairy cattle. The herd is measured at depreciated
cost in accordance with LKAS 41.
Required
Comment on the accounting treatment adopted by Dias Dairy Ltd for the herd of
cattle and redraft the numerical extracts from the financial statements in order
that they comply with LKAS 41.
ANSWER
The herd of dairy cattle meets the LKAS 41 definition of a biological asset, being a
living plant or animal.
LKAS 41 requires that a biological asset is recognised by an entity when the entity
controls the asset as a result of a past event, it is probable that future economic
benefits will flow to the entity and the fair value or cost of the asset can be
measured reliably.
Based on the information provided these criteria are met and the company is
correct to capitalise the dairy cattle.
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A biological asset is initially measured at fair value less costs to sell and the
difference between cost and this amount is recognised in profit or loss. In this case
fair value less costs to sell at 31 December 20X3 is Rs. 194,000 (200 Rs. 1,000
97%). The acquisition is therefore recognised by:
DEBIT
DEBIT
CREDIT
Biological assets
Profit/loss
Cash
194,000
6,000
200,000
A biological asset is subsequently measured at fair value less costs to sell with any
resulting gain or loss recognised in profit or loss. At 31 December 20X4 fair value
less costs to sell is Rs. 232,800 (200 Rs. 1,200 97%) and a gain of Rs. 38,800
(232,800 194,000) is recognised in profit or loss. At 31 December 20X5 fair
value less costs to sell is Rs. 242,500 (200 Rs. 1,250 97%) and a gain of
Rs. 9,700 (242,500 232,800) is recognised in profit or loss.
There is a presumption that the fair value of a biological asset can be measured
reliably. This presumption is rebutted only if quoted market prices for the asset
are not available and other fair value measurements are deemed unreliable. In
this case a biological asset is measured at depreciated cost.
Dias Dairy Ltd has measured its herd at depreciated cost. The extracts of financial
statements provided suggests that the herd was initially measured at its cost of
Rs. 200,000 (200 Rs. 1,000) and is being depreciated over a 10 year period. As
explained above this treatment is only allowed if quoted prices are unavailable. In
this case they clearly are and therefore the treatment applied by Dias Dairy Ltd is
incorrect.
Statement of financial position
Biological assets (dairy herd)
Statement of profit or loss
Gain on remeasurement to fair value
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20X5
Rs.
242,500
20X4
Rs.
232,800
20X5
Rs.
9,700
20X4
Rs.
38,800
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5.1 Scope
SLFRS 6 applies only to exploration and evaluation expenditures, defined as:
Expenditures incurred by an entity in connection with the exploration for and
evaluation of mineral resources before the technical feasibility and commercial
viability of extracting a mineral resource are demonstrable.
It does not apply to:
Expenditure incurred before an entity has obtained legal rights to explore a
specific area, or
Expenditure incurred after the technical feasibility and commercial viability of
extracting a mineral resource are demonstrable.
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(a)
(b)
(c)
exploratory drilling
(d)
trenching
(e)
sampling and
(f)
5.4 Presentation
Exploration and evaluation assets are classified as either tangible or intangible
according to their nature.
Tangible assets might include vehicles and drilling rigs; intangible might include
drilling rights.
When the feasibility and viability of extracting a mineral resource are
demonstrable, exploration and evaluation assets are no longer classified as such.
5.5 Disclosure
Information must be disclosed that identifies and explains the amounts recognised
in the financial statements from the exploration for and evaluation of mineral
resources.
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QUESTION
As part of its year end processes Adikari Textiles Ltd held its annual inventory
count on 31 August 20X4.
Materials included in work-in-progress at 31 August 20X4 have been costed at
Rs. 450,000, and the inventory sheets state that 1,000 labour hours have been
worked on these items. Labour was paid Rs. 180 per hour in 20X4.
The following working sheet has been prepared by a member of the accounts team
in order to assist with the measurement of work in progress.
WORKING SHEET ANNUAL OVERHEADS FOR Y/E 31.08.X4
Rs.
Factory rent, rates and insurance
Administration expenses
Factory floor supervisors salaries
Factory heat, light and power*
Sales commissions and selling costs*
Depreciation of production machinery*
Depreciation of delivery vehicles***
Storage of finished goods*
2,930,000
3,800,000
2,200,000
6,000,000
2,400,000
4,000,000
1,520,000
1,900,000
160,000
190,000
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ANSWER
Inventories are measured at the lower of cost and net realisable value. Net
realisable value is selling price less costs to completion and incurred in achieving a
sale.
In the case of Adikari Textiles Ltds work-in-progress, the direct costs to be
included in the measurement of inventories are:
Rs.
450,000
Direct materials
180,000
Direct labour (1,000 180)
630,000
Certain overheads are not included in the measurement of work-in-progress, as
they do not relate to bringing the inventory to its current location and condition.
In this case it is unclear whether the administrative costs are relevant to bringing
the inventory to its current location and condition. This is assumed not to be the
case. The costs to be recognised in profit or loss in the year are therefore:
Administration expenses
ales commission and selling costs
Depreciation of delivery vehicles
Storage of finished goods
Rs.
3,800,000
2,400,000
1,520,000
1,900,000
9,620,000
190,000
Rs 27/hour
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233
inventories. The remaining Rs. 5,130,000 Rs. 4,320,000 = Rs. 810,000 are
recognised in profit or loss.
Variable overheads are absorbed based on the actual level of production:
Rs.
6,000,000
Factory heat , light and power
4,000,000
Depreciation of production machinery
10,000,000
Actual level of activity
Recovery rate per hour 10,000,000/160,000
160,000
Rs 62.50/hour
Rs.
630,000
27,000
62,500
719,500
QUESTION
Perera Industries Ltd received a grant of Rs. 1 million on 1 October 20X4 on
condition that the money was used towards the purchase of a machine costing
Rs. 4 million. The company acquired the machine on 1 December 20X4 and
immediately started to depreciate it based on a 25% reducing balance. The
machine is expected to be used for 10 years at which time it will have a residual
value of Rs. 225,250.
Perera Industries recognises grants separately from related assets in the
statement of financial position.
Required
Explain how the asset and related grant are accounted for and prepare the
relevant extracts from the statement of financial position and statement of profit
or loss for the year ended 31 December 20X4 and 31 December 20X5.
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ANSWER
The machine is initially recognised at cost of Rs. 4 million by:
DEBIT
CREDIT
PPE
Cash
Rs. 4 million
Rs. 4 million
Cash
Deferred income
Rs. 1 million
Rs. 1 million
Non-current assets
PPE
Non-current liabilities
Deferred grant income
Current liabilities
Deferred grant income
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20X4
Rs.
20X5
Rs.
3,916,667
2,937,500
734,375
550,781
244,792
183,594
235
Depreciation
Grant income
236
20X4
Rs.
83,333
(20,833)
20X5
Rs.
979,167
(244,792)
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CHAPTER ROUNDUP
Inventories are measured at the lower of cost and net realisable value.
Where the outcome can be reliably estimated and the contract is profitable,
revenue and costs are recognised depending on the stage of completion.
Where the outcome can be reliably estimated and the contract is loss making
the loss is recognised in full.
Government grants are recognised in profit or loss to match the costs that they
are intended to compensate.
Biological assets are measured at fair value less costs to sell with changes in
fair value recognised in profit or loss.
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237
PROGRESS TEST
238
IFRIC 20 states that there are two assets arising from stripping mine waste
materials. What are they?
How is a government loan at below the market rate of interest accounted for in the
recipients accounts?
SLFRS 6 requires that all expenditure after the technical feasibility and
commercial viability of extracting mineral resource are demonstrable is
capitalised. True or false?
CA Sri Lanka
The methods used to determine revenue in the period and the methods used to
determine stage of completion.
This is a government grant. The benefit is the difference between the initial
carrying amount of the loan in accordance with LKAS 39 and the proceeds
received.
At fair value less costs to sell. Any difference between this and cost is recognised
in profit or loss.
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239
240
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CHAPTER
INTRODUCTION
Both LKAS 37 and LKAS 10 are standards that you have already met in detail at KE1 and KB1. At KC1
level you may have to identify incorrect accounting treatment or comment on treatment applied in a
given scenario.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.2
Level B
1.1.7
1.2.1
1.2.2
1.2.3
1.2.4
1.2.5
241
CHAPTER CONTENTS
1 LKAS 37 Provisions, Contingent Liabilities and Contingent Assets
2 Related Interpretations
3 LKAS 10 Events after the Reporting Period
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and contingent assets and that sufficient information is disclosed in the notes to
enable users to understand their nature, timing and amount.
1.1 Definitions
A provision is a liability of uncertain timing or amount.
A liability is an obligation of an entity to transfer economic benefits as a result of
past transactions or events.
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 programme that is planned and controlled by management
and materially changes either:
(a)
(b)
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243
(b)
(c)
Present obligation as
result of past event
Probable transfer of
economic benefits
Reliable estimate
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Gains from the expected disposal of assets are not taken into account when
measuring a provision.
QUESTION
Subsequent events
On 12 October 20X3 the Board of Adikari Ltd decided to close one of its
operating divisions. The decision was publicly announced at a press
conference on 15 November 20X3, the day after a staff meeting was held to
inform employees of the decision. In its statement of financial position at
31 October 20X3, the financial controller of Adikari Ltd recognised a
provision of Rs. 25 million in respect of expected operating losses of the
division to its closure date and staff retraining costs.
2.
Required
ANSWER
1.
Adikari Ltd
The decision to close was made on 12 October 20X3 and this was first
announced to affected parties (staff members) on 14 November 20X3. At the
year-end of 31 October 20X3 a past event has occurred (the decision to
close), however there is no legal or constructive obligation. A constructive
obligation does not arise until 14 November 20X3. Therefore the financial
controller is incorrect to recognise a provision at 31 October 20X3.
Furthermore LKAS 37 only allows a provision to be made for the direct costs
of a closure or restructuring. The standard specifically prohibits provisions
for operating losses or provisions that reflect the future intentions of an
entity. Staff retraining is not a direct cost of closure it is related to future
intentions. Therefore even if the decision to close had been announced the
provision for Rs. 25 million should not be recognised.
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245
2.
Damages have been estimated at between Rs. 5 million and Rs. 5.5 million.
This is a single obligation and LKAS 37 requires that the best estimate of
outflow is the most likely outcome. In this case that is Rs. 5 million.
Therefore all recognition criteria are met and a provision should have been
made for Rs. 5 million.
The financial controller is correct to record an accrual in respect of unbilled
legal costs. These meet the definition of a liability ie they form 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.
DEBIT
CREDIT
Expense
Provision
DEBIT
CREDIT
Provision
Expense
Use of a provision
DEBIT
CREDIT
Provision
Cash
Provisions should be reviewed at the end of each reporting period and adjusted
to reflect the current best estimate.
A provision should only be used for the purpose for which it was recognised.
1.5 Reimbursements
Some or all of the expenditure needed to settle a provision may be expected to be
recovered from a third party. If so, the reimbursement should be recognised only
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when it is virtually certain that reimbursement will be received if the entity settles
the obligation.
The reimbursement should be treated as a separate asset, and the amount
recognised should not be greater than the provision itself.
The provision and the amount recognised for reimbursement may be netted off
inprofit or loss.
QUESTION
A corporate customer launched a legal case against Mattala Machinery PLC on
2 December 20X4 on the basis that a machine supplied by the company was faulty
and as a result goods produced by it were substandard, resulting in lost contracts
and wasted materials.
Mattala Machinerys legal team has advised that the company has a 75% chance of
losing the case and as a result would have to pay Rs. 15,000,000 in damages.
Mattala Machinery is covered by insurance for such an eventuality and if it loses
the case against the customer it is virtually certain that it can claim for the full
amount of the loss net of a 5% excess.
Required
How is the above situation reflected in the financial statements of Mattala
Machinery PLC at 31 December 20X4?
ANSWER
Mattala Machinery should recognise:
A provision for Rs. 15 million in respect of the customer claim
An asset for 95% 15 million = Rs. 14.25 million in respect of the insurance
claim
A net expense of Rs. 750,000 in profit or loss.
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Restructuring (see
definitions, section
1.1)
Includes:
Sale or termination of line of business
Closure of business locations in a geographical area
or relocation of business activities from one area to
another
Changes in management structure
Fundamental reorganisations that have a material
effect on the nature and focus of an entitys
operations.
A provision is made when there is a constructive
obligation ie
The entity has a detailed formal plan for
restructuring and
The entity has raised a valid expectation in those
affected that it will carry out the restructuring.
In the case of a sale of an operation there is only an
obligation when there is a binding sale agreement.
A restructuring provision includes only direct
expenditure arising from the restructuring.
1.7 Disclosure
Disclosures required in the financial statements for provisions fall into two parts:
For each class of provision:
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(a)
(b)
(c)
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(d)
(e)
The increase during the period in the discounted amount arising from the
passage of time and the effect of any change in the discount rate.
For each class of provision, disclosure of the background to the making of the
provision and the uncertainties affecting its outcome, including:
(a) A brief description of the nature of the provision and the expected timing of
any resulting outflows relating to the provision.
(b) An indication of the uncertainties about the amount or timing of those
outflows and, where necessary, to provide adequate information, the major
assumptions made concerning future events.
(c) The amount of any expected reimbursement relating to the provision and
whether any asset that has been recognised for that expected
reimbursement.
1.7.1 Non-disclosure
LKAS 37 permits reporting entities to avoid disclosure requirements relating to
provisions (and contingent liabilities and contingent assets) if they would be
expected to seriously prejudice the position of the entity in dispute with other
parties. However, this should only be employed in extremely rare cases. Details
of the general nature of the provision/contingencies must still be provided,
together with an explanation of why it has not been disclosed.
1.7.2 Example: Provisions disclosure note
Restructuring Litigation
Rs Mn
630
1,245
At 1 January 20X4
92
210
Provisions made in the
year
(180)
(450)
Amounts used
(25)
(165)
Unused amounts
reversed
(5)
4
Exchange difference
521
835
At 31 December 20X4
Other
390
60
Total
2,265
362
(30)
(85)
(660)
(275)
335
(1)
1,691
Restructuring
Restructuring provisions arose from a number of projects across the Group. These
include plans to close the Indian manufacturing division. Restructuring provisions
are expected to result in future cash outflows when implementing the plans
(usually over the following two to three years).
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Litigation
Litigation provisions have been set up to cover tax, legal and administrative
proceedings that arise in the ordinary course of business. These provisions cover
several cases whose detailed disclosure could be detrimental to the Group. The
Group does not believe that any of these litigation cases will have a material
adverse impact on its financial position. The timing of cash outflows depends on
the outcome of proceedings.
Other
Other provisions are mainly in respect of onerous leases. These result from
unfavourable leases, breach of contracts or supply agreements above market
prices in which the unavoidable costs of meeting the obligations under the
contracts exceed the economic benefits expected to be received or for which no
benefits are expected to be received.
(b)
(c)
(d)
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QUESTION
Settawa Plant Ltd operates in the mining and excavation industries. The following
issues are relevant to the company in the year ended 31 December 20X3:
1.
The company constructed a mine shaft during the year that was ready for
use on 31 December 20X3. Governmental planning permission was granted
for the mine shaft on condition that Settawa Plant dismantles the mine shaft
and restores the site on which it is located at the end of the mines useful life
(30 years). Settawa estimates that the cost of this in 30 years will be
Rs. 35 million and the present value of this amount is Rs. 10 million. The
accountant of Settawa Plant has created a provision for Rs. 35 million and
charged this as an exceptional expense in profit or loss.
2.
Required
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(a)
(b)
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ANSWER
(a)
Mine shaft
The planning permission for the mine shaft requires that at the end of its
useful life the mine shaft is removed and site restored.
The granting of the planning permission means that the company has a
legal obligation to incur restoration costs in the future. The past event is
the construction of the mine shaft. Therefore the company has a legal
obligation as a result of a past event at the reporting date.
The costs to be incurred in the future are a probable outflow of benefit.
Settawa Plant has estimated the restoration costs at Rs. 35 million.
Therefore the LKAS 37 provision recognition criteria are met and the
company accountant is correct to make a provision.
The provision should be measured at the full cost of restoration as estimated
at the time of construction (ie it should not gradually accrue over the mine
shafts life). LKAS 37 requires that provisions are measured at present value
where the time value of money is significant. This is the case here and so the
provision is measured at Rs. 10 million rather than Rs. 35 million.
Restoration costs form part of the cost of the mine shaft. Therefore the
provision should not be recognised in profit or loss but capitalised as part of
PPE:
DEBIT
CREDIT
PPE
Provision
Rs. 10 million
Rs. 10 million
Profit/loss
Provision
Rs. 7 million
Rs. 7 million
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(b)
Settawa Plant
Extract from statement of financial position at 31 December 20X3
Rs'000
Non-current assets
Property, plant and equipment
10,000
Non-current liabilities
Provisions
10,000
Current liabilities
Provisions
7,000
Extract from statement of profit or loss for year ended 31 December
20X3
Rs'000
Operating expenses
7,000
Note - Provisions
At 1 January 20X3
Provided in year
At 31 December 20X3
Restoration
Rs'000
10,000
10,000
Legal
Rs'000
7,000
7,000
Total
Rs'000
17,000
17,000
2 Related Interpretations
IFRIC 6, IFRIC 1, IFRIC 5 and IFRIC 21 deal with provisions arising as a result of
specific circumstances.
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Where the related asset is measured using the cost model these changes
should be capitalised as part of the cost of the asset and depreciated over the
remaining useful life of the item.
2.
Where the related asset is measured using the revaluation model, a change
in the value of the liability does not affect the carrying amount of the item,
but instead affects the revaluation surplus or deficit on the item. The effect of
the change is treated consistently with other revaluation surpluses or
deficits ie a surplus is credited to equity and a deficit recognised in profit or
loss.
The interpretation also states that the unwinding of the discount is recognised in
profit or loss as a finance cost.
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255
Levies that fall within the scope of LKAS 37 because their timing / amount is
uncertain, and
Levies for which the timing / amount is certain.
2.4.2 Obligating event
A liability is recognised when an obligating event occurs. IFRIC 21 confirms that
the obligating event in the case of a levy is the activity that triggers the payment of
the levy in accordance with the relevant legislation.
2.4.3 Example: Obligating event
Elephant Co is required to pay a levy on the last day of each calendar year as a
result of the generation of revenue in that year. The amount of levy payable is
calculated as 1.5% of the level of revenue generated in the previous year.
Therefore as a result of generating revenue throughout 20X2, Elephant must pay a
levy on 31 December 20X2 measured as 1.5% of revenue generated in 20X1.
In this case, the obligating event is the generation of revenue in 20X2, even though
the amount of levy payable is related to the level of revenue in 20X1.
The levy payable on 31 December 20X3 is not recognised until revenue is actually
generated in 20X3, even though as at 31 December 20X2, Elephant Co is
economically compelled to continue to operate in 20X3 and its financial
statements are prepared on the going concern basis, so indicating that it is
expected to continue to operate.
2.4.4 Recognition
If an obligation is triggered when a minimum threshold is reached, the liability is
recognised at that time.
If an obligating event occurs over a period of time, the liability is recognised
progressively.
2.4.5 Example: Progressive recognition
Iguana Co is required to pay a levy to the government on 31 December 20X3,
triggered by the generation of profits in 20X3. The amount of levy is related to the
level of profits generated in the year.
Iguana Co must recognise a liability progressively during 20X3. This reflects the
fact that at any point in 20X3, Iguana Co has a present obligation to pay a levy on
revenue generated to date.
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3.1 Definition
LKAS 10 provides the following definition.
Events after the reporting period are those events, both favourable and
unfavourable, that occur between the reporting date and the date on which the
financial statements are authorised for issue. Two types of events can be
identified:
Those that provide further evidence of conditions that existed at the reporting
date; and
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257
Those that are indicative of conditions that arose subsequent to the reporting
date
(LKAS 10)
The date on which the financial statements are authorised for issue may not be
clear. For the avoidance of doubt, LKAS 10 clarifies when the date is in three
specific circumstances:
If an entity is required to submit its financial statements to its shareholders for
approval after the financial statements have been issued, the financial
statements are authorised for issue on the date of issue, not the date when the
shareholders approve the financial statements.
If the management of an entity is required to issue its financial statements to a
supervisory board for approval, the financial statements are authorised for
issue when the management authorises them for issue to the supervisory
board.
The date on which the financial statements are authorised for issue is not
brought forward as a result of a public announcement of profit or other
selected financial information.
QUESTION
The following events are taken from LKAS 10. Identify whether they are adjusting
or non adjusting:
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Adjusting
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1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
commitments
Nonadjusting
or
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ANSWER
Adjusting events are numbers 1, 3,5,6,9 and 10.
Non-adjusting events are numbers 2,4,7,8, 11 and 12.
3.4 Dividends
The declaration of an ordinary dividend, in the period between the reporting date
and date on which the financial statements are authorised for issue, is a nonadjusting event, and no liability should be recognised.
The dividend should, however, be disclosed in accordance with LKAS 1
Presentation of Financial Statements.
3.5 Disclosure
LKAS 10 requires disclosure in respect of:
The date on which the financial statements were authorised for issue and who
gave that authorisation;
Material non-adjusting events.
The standard also requires that where a company receives information after the
reporting period about conditions that existed at the end of the reporting period,
it must update disclosures that relate to those conditions in the light of the new
information.
3.5.1 Material non-adjusting event disclosure
For each material category of non-adjusting event after the reporting period, the
following should be disclosed:
260
(a)
(b)
QUESTION
Abercrombie Processing Ltd is planning to close one of its business divisions due
to declining customer demand. Closure is expected to take place in April 20X4 and
the facts of the closure have been included in a detailed formal plan. The plan was
approved at a Board meeting on 12 December 20X3 and a press release was
issued on the following day. The Company accountant has made a provision at the
year end of 31 December 20X3 for the following costs of closure:
Consultancy fees re corporate strategy
Voluntary redundancy costs
Identifiable losses until closure
Retraining of staff
Rs. 40 million
Rs. 80 million
Rs. 45 million
Rs. 25 million
Required
Comment on the validity of the accounting treatment applied by the company
accountant.
ANSWER
The closure of a division is a restructuring activity as defined by LKAS 37 (sale or
termination of a line of business).
A restructuring provision is recognised if there is a detailed formal plan in place
and a valid expectation of the closure has been created by the reporting date.
Abercrombie Processing does have a formal plan in place; it has been approved by
the directors and announced before the year-end. Therefore a provision for the
costs of closure can be recognised in the statement of financial position at
31 December 20X3.
The provision can include only direct costs that are necessarily entailed by the
restructuring and are not associated with the ongoing activities of the company.
Consultancy fees cannot be provided for as these are associated with ongoing
activities. These are expensed as incurred
Voluntary redundancy costs are necessarily entailed by the restructuring and
are included in the provision
Future losses cannot be provided for as they do not relate to a past event
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QUESTION
Gigg Leisure Ltd operates a chain of health clubs throughout Sri Lanka. In the year
ended 31 December 20X5 it was sued by a customer who alleges that they were
injured whilst using a faulty machine at a Company owned gym in Colombo. At the
year end the accountant of Gigg Leisure Ltd has made a provision for damages of
Rs1.5million, based on legal advice that the Company had an expected 75% chance
of losing the case at that date. The court case was heard in February 20X6 and
damages were settled at Rs. 1.75 million. Gigg Leisure Ltds financial statements
were approved for distribution in March 20X6.
Required
Explain the correct accounting treatment for the claim for damages.
ANSWER
Gigg Leisure Ltd has made a provision for damages at 31 December 20X5. This is
correct as the LKAS 37 recognition criteria are met:
1.
There is a present obligation as a result of a past event (the past event is the
injury and resulting claim and the obligation is legal)
2.
3.
The subsequent settlement of the court case in February 20X6 is an event after the
reporting period. It is adjusting as it adds information about conditions that
existed at the period end.
Therefore the measurement of the provision should reflect the settlement amount
and the recognised provision should be remeasured to Rs. 1.75 million. This will
result in an extra charge to profit or loss of Rs. 250,000.
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CHAPTER ROUNDUP
IFRIC 6, IFRIC 1 and IFRIC 5 deal with provisions arising as a result of specific
circumstances.
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263
PROGRESS TEST
264
What is the best estimate of the expenditure expected to settle a single present
obligation?
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Best estimate is usually the most likely outcome, however if other possible
outcomes are mostly higher, the best estimate will be higher and if other possible
outcomes are mostly lower, the best estimate will be lower.
Any of:
The settlement after the reporting period of a court case that confirms that the
entity had a present obligation at the end of the reporting period.
The receipt of information after the reporting period indicating that a noncurrent asset was impaired at the end of the reporting period.
The bankruptcy of a customer that occurs after the reporting period.
The determination after the reporting period of the cost of assets purchased
before the end of the reporting period.
The determination after the reporting period of the amount of bonus or profitsharing payments (if the entity had a present legal or constructive obligation to
make such payments at the period end as a result of events before that date)
The discovery of fraud or errors showing that the financial statements are
incorrect.
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CHAPTER
INTRODUCTION
Revenue is often the single largest number in a set of financial
statements. It drives profit and is a key part of many financial ratios used
for appraisal. The relevance of revenue to the financial statements as a
whole means that consistent and reliable recognition policies are vital.
LKAS 18 and a number of related interpretations provides the current
accounting guidance, however SLFRS 15 will replace LKAS 18 with effect
from 2017.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
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CHAPTER CONTENTS
1 LKAS 18 Revenue
2 Related Interpretations
3 Current developments
1 LKAS 18 Revenue
LKAS 18 provides guidance on the measurement of revenue and when it should
be recognised in the case of sale of goods and rendering of services. It is
measured at the fair value of consideration received.
1.1 Scope
LKAS 18 covers the revenue from specific types of transaction or events.
Sale of goods (manufactured products and items purchased for resale)
Rendering of services
Use by others of entity assets yielding interest, royalties and dividends
Interest, royalties and dividends are included as income because they arise from
the use of an entity's assets by other parties.
The Standard specifically excludes various types of revenue arising from leases,
insurance contracts, changes in value of financial instruments or other current
assets, natural increases in agricultural assets and mineral ore extraction.
1.2 Definitions
Revenue is the gross inflow of economic benefits during the period arising in the
course of the ordinary activities of an entity when those inflows result in increases
in equity, other than increases relating to contributions from equity participants.
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Interest is the charge for the use of cash or cash equivalents or amounts due to
the entity.
Royalties are charges for the use of non-current assets of the entity, eg patents,
computer software and trademarks.
Dividends are distributions of profit to holders of equity investments, in
proportion with their holdings, of each relevant class of capital.
Revenue does not include sales taxes, value added taxes or goods and service
taxes which are only collected for third parties, because these do not represent an
economic benefit flowing to the entity. The same is true for revenues collected by
an agent on behalf of a principal. Revenue for the agent is only the commission
received for acting as agent.
1.3 Measurement
Revenue is measured as the fair value of the consideration received, taking
account of any trade discounts and volume rebates.
When the inflow of cash or cash equivalents is deferred and the arrangement
constitutes a financing transaction, the fair value of the consideration is
determined by discounting all future receipts using an imputed rate of interest.
The difference between the fair value of the consideration and the nominal
amount of the consideration is recognised as interest revenue.
1.3.1 Exchange transactions
The measurement of revenue where goods or services are exchanged depends
upon the nature of the goods or services:
Where goods or services are exchanged for similar goods or services (in nature
and value), the exchange is not regarded as a revenue-generating transaction.
Where goods or services are exchanged for dissimilar goods or services,
revenue is measured at the fair value of the goods or services received, adjusted
by any cash or cash equivalents transferred.
1.4 Recognition
LKAS 18 contains separate recognition criteria for the sale of goods and the
rendering of services:
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Sale of goods
Rendering of services
QUESTION
Revenue 1
1.
A Ltd sells goods to Z Ltd on a sale or return basis. The goods are transferred
on 1 September 20X3 and Z Ltd will pay A Ltd as and when it sells the goods
to its own customers. Any goods remaining unsold at 30 November 20X3 will
be returned to A Ltd.
2.
4.
C Ltd sells a computerised accountancy package with one years after sales
support. The cost of providing support to one customer for one year is
calculated to be Rs. 10,000 and the product is sold for Rs. 100,000. D Ltd has
an expected return of 15%.
5.
D Ltd sells goods to Y Ltd on 1 June 20X4. Legal title is transferred to Y Ltd
on this date and D Ltd issues an invoice. Y Ltd requests that delivery is
delayed until August when its new warehouse facility is available.
Required
Explain when revenue should be recognised in each case.
ANSWER
1.
270
2.
On 15 July 20X3 B Ltd should record the 20% deposit received as deferred
revenue rather than a sale. The sale is made and revenue recognised on
1 August 20X3 as B Ltd retains only an insignificant risk of ownership at this
date.
3.
4.
This is a bill and hold sale. Revenue is recognised at 1 June 20X4 provided
that it is probable delivery will be made, the goods are available for delivery,
Y Ltd has acknowledged delayed delivery and normal payment terms apply.
QUESTION
Revenue 2
Finance Department
Raj da Silva, MD South East Asia
Income recognition
Since moving to head up the companys operations in South East Asia Ive been
reviewing the performance of the division. There are a few things Im not clear on
and Id like your advice before discussing these issues with the divisional financial
controller.
1.
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271
2.
Thanks,
Raj
Pacific Worlds imputed interest rate is 6%.
Required
Prepare notes in response to the email. You may assume that the MD has an
understanding of debit and credit entries.
ANSWER
Components
There are two issues to consider here:
1.
2.
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The following illustration will help to explain the effect on the financial
statements:
Assuming a transaction with the Korean Car manufacturer of Rs. 1 Mn taking place
on the first day of an accounting year, the current accounting treatment is:
1.
2.
Receivable
Revenue
Rs. 1 Mn
Rs. 1 Mn
Finance cost
Receivable
Rs. 25,000
Rs. 25,000
2.
Rs. 845,496
Rs. 845,496
3.
Receivable
Revenue
Receivable
Finance income
Rs. 50,730
Rs. 50,730
Receivable
Finance income
Rs. 53,774
Rs. 53,774
The net income recognised over the two years is Rs. 950,000 in both cases,
however the revenue recognised in the first case is Rs. 154,504 greater. Therefore
revenue is currently overstated due to incorrect accounting treatment.
Property repairs
The contract is for services that are performed by an indeterminate number of
acts over (usually) a two-year period.
In this case LKAS 18 requires that for practical purposes revenue is recognised on
a straight-line basis over the period, unless there is evidence for the use of another
method that better reflects the stage of completion.
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273
As the number of call outs may vary significantly from year to year, it is unlikely
that this is the case. In particular it is impossible to identify what proportion of
total call outs over the two year period have occurred in any given accounting
period before the two year period is complete.
Therefore it would appear that the divisional accountant is correct in his / her
approach.
1.4.1 Interest, dividends and royalties
The revenue is recognised on the following bases.
(a)
Interest is recognised on a time proportion basis that takes into account the
effective yield on the asset
(b)
(c)
The effective yield on an asset mentioned above is the rate of interest required to
discount the stream of future cash receipts expected over the life of the asset to
equate to the initial carrying amount of the asset.
Royalties are usually recognised on the same basis that they accrue under the
relevant agreement. Sometimes the true substance of the agreement may require
some other systematic and rational method of recognition.
1.5 Disclosure
The following items should be disclosed.
(a)
The accounting policies adopted for the recognition of revenue, including the
methods used to determine the stage of completion of transactions involving
the rendering of services
(b)
(c)
274
Any contingent gains or losses, such as those relating to warranty costs, claims or
penalties should be treated according to LKAS 37 Provisions, contingent liabilities
and contingent assets.
2.
The legal title of an asset is separated from the risks and rewards of that
asset.
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275
There is no contractual
requirement for the seller to
repurchase the asset
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277
QUESTION
You are the accountant of Hippala, a listed company that prepares consolidated
financial statements. The year end of Hippala is 31 August.
On 1 March 20X1, Hippala sold a property to a bank for Rs. 50 million. The market
value of the property at the date of the sale was Rs. 100 Mn. Hippala continues to
occupy the property rent-free. Hippala has the option to buy the property back
from the bank at the end of every month from 31 March 20X1 until
28 February 20X6. Hippala has not yet exercised this option. The repurchase price
will be Rs. 50 million plus Rs. 500,000 for every complete month that has elapsed
from the date of sale to the date of repurchase. The bank cannot require Hippala to
repurchase the property and the facility lapses after 28 February 20X6. The
directors of Hippala expect property prices to rise at around 5% each year for the
foreseeable future.
Required
Explain how the transaction described above will be dealt with in the
consolidated financial statements (statement of financial position and statement
of profit or loss and other comprehensive income) of Hippala for the year ended
31 August 20X1.
ANSWER
The key issue here is whether Hippala has retained the risks inherent in owning
the property. This depends on whether Hippala is likely to exercise its option to
repurchase the property in practice.
(i)
Hippala can repurchase the property at any time until 28 February 20X6, but
the bank cannot require repurchase. This means that Hippala is protected
against any fall in the value of the property below Rs. 50 million. This
suggests that some risk has been transferred to the bank.
(ii)
In practice, the value of the property is expected to rise by 5% each year for
the foreseeable future. Therefore it is extremely unlikely that the value of the
property will fall below Rs. 50 million.
(iii) Hippala can benefit from the expected rise in the value of the property by
buying it back at a price that is well below its anticipated market value.
In conclusion, Hippala is likely to exercise the option and therefore has retained
the risk of changes in the property's market value. Other important aspects of the
transaction are:
(a)
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The 'sale' price of the property was only 50% of its market value.
CA Sri Lanka
(b)
(c)
The repurchase price depends on the length of time that elapses between the
date of the agreement and the date of repurchase, rather than on the market
value of the property.
2 Related Interpretations
Interpretations related to revenue deal with specific aspects of revenue
recognition such as customer loyalty programmes and the sale of real estate
off plan.
One in which the operator has a contractual right to receive cash or another
asset from the government
2.
One in which the operator has the right to charge for access to the public
sector asset that it constructs or upgrades.
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279
This is the case where the government / grantor contractually guarantees to pay
the operator:
(a)
(b)
the shortfall (if any) between the amount received from users of the public
service and a specified or determinable amount, even if the payment is
contingent on the operator ensuring that the infrastructure meets specified
quality or efficiency requirements.
280
A financial asset: a fixed and determinable amount of cash, being Rs. 6 million
per annum for 5 years, and
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2.
An intangible asset: the right to charge patents for the use of the scanner and
retain any amounts collected over Rs. 6 Mn per annum.
Financial asset
Intangible asset
Revenue
Rs. 35,000,000
Rs. 35,000,000
Rs. 35,000,000
The question is how to split the revenue between the financial and intangible
asset?
Initial recognition
The financial asset is a receivable and should be recognised in accordance with
LKAS 39. It is initially measured at 31 December 20X1 (ie when the scanners
construction is complete) at fair value, being the discounted future cash flows:
31.12.X2
31.12.X3
31.12.X4
31.12.X5
31.12.X6
Rs.
5,714,286
5,442,177
5,183,026
4,936,215
4,701,157
25,976,861
6,000,000 1/1.05
6,000,000 1/1.052
6,000,000 1/1.053
6,000,000 1/1.054
6,000,000 1/1.055
20X2
20X3
20X4
20X5
20X6
Rs.
25,976,861
21,275,704
16,339,489
11,156,463
5,714,286
Finance
income 5%
Rs.
1,298,843
1,063,785
816,974
557,823
285,714
Payment
received
Rs.
(6,000,000)
(6,000,000)
(6,000,000)
(6,000,000)
(6,000,000)
C/f
Rs.
21,275,704
16,339,489
11,156,463
5,714,286
-
Each year the minimum Rs. 6 Mn payment is allocated against the receivable
balance; any excess is recognised as revenue.
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281
20X2
20X3
20X4
20X5
20X6
Amortisation
expense
Rs.
(1,804,628)
(1,804,628)
(1,804,628)
(1,804,628)
(1,804,627)
C/f
Rs.
7,218,511
5,413,883
3,609,255
1,804,627
(b)
Significant terms of the arrangement that may affect the amount, timing and
certainty of future cash flows (eg the period of the concession, re-pricing
dates and the basis upon which repricing or renegotiation is determined)
(c)
The nature and extent (eg quantity, time period or amount as appropriate)
of:
(i)
(ii)
(e)
An operator shall disclose the amount of revenue and profits or losses recognised
in the period on exchanging construction services for a financial asset or
intangible asset.
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Revenue, and
Deferred revenue associated with the reward points/credits.
QUESTION
SuperMart Ltd is a supermarket chain operating in Sri Lanka. It awards customers
SuperPoints for every Rs. 200 spent in store. Customers can redeem these for
vouchers, which can be used at restaurants, cinemas and sports facilities.
Required
Prepare an extract of the accounting policy note which details SuperMart Ltds
policy for recognising revenue from the sale of goods in accordance with LKAS 18
/ IFRIC 13.
ANSWER
Accounting policy note Revenue recognition
Revenue from the sale of goods is recognised when all of the following conditions
are satisfied:
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283
1.
The Company has transferred to the buyer the significant risks and rewards
of ownership of the goods.
2.
3.
4.
It is probable that the economic benefits associated with the transaction will
flow to the entity, and
5.
Sales of goods that result in award credits for customers under the Companys
SuperPoint Scheme are accounted for as multiple element revenue transactions
and the fair value of the consideration received is allocated between the goods
supplied and the award credits granted. The consideration allocated to the award
credits is measured by reference to their fair value ie the amount for which the
award credits could be sold separately. Such consideration is not recognised as
revenue at the time of the initial sale transaction, but is deferred and recognised
as revenue when the award credits are redeemed and the Companys obligations
have been fulfilled.
Whether an agreement for the construction of real estate is within the scope
of LKAS 11 or LKAS 18
2.
284
1.
The major structural elements of the design of the real estate before
construction commences
2.
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If construction could take place independently of the agreement and buyers only
have limited ability to influence the design of the real estate, the agreement is
within the scope of LKAS 18.
2.4.2 Accounting treatment
LKAS 11
When a contract is within the scope of LKAS 11, the requirements of LKAS 11 are
followed ie revenue is recognised by reference to stage of completion provided
that the outcome of the contract can be estimated reliably.
LKAS 18
When a contract is within the scope of LKAS 18, it may be for the rendering of
services or provision of goods.
The contract is for the rendering of services where, for example, the customer
enters into several agreements with different entities relating to different aspects
of the construction, and the entity is responsible only for assembling materials
supplied by others. In this case, revenue is recognised by reference to stage of
completion.
When a contract is within the scope of LKAS 18 and for the sale of goods (ie the
provision of services together with the construction materials), the sale of goods
recognition criteria in LKAS 18 apply. IFRIC 15 focuses on the transfer of risks and
rewards and distinguishes between whether this transfer occurs at one point in
time or over a period of time.
Where it occurs at one point in time, revenue is recognised only when all of the
LKAS 18 criteria are met.
Where it occurs over a period of time (as construction progresses) the
percentage of completion method is applied.
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285
Accounting treatment
The agreement should be split into two components:
1.
2.
The sale of the land is a sale of goods within the scope of LKAS 18.
In terms of the office block, the major structural decisions were made by AsiaBuild
and included in the designs submitted to the planning authorities before the buyer
signed the purchase agreement. It is therefore assumed that no major design
changes will happen after the build has commenced. Therefore the sale of the
office block is within the scope of LKAS 18 rather than LKAS 11.
The construction takes place on land owned by the buyer and the buyer cannot
put the office block back to AsiaBuild. This indicates that AsiaBuild transfers the
significant risks and rewards of ownership to the buyer as construction
progresses. Therefore if the revenue recognition criteria of LKAS 18 are met
continuously as construction progresses, AsiaBuild should recognise revenue from
the construction of the office block by reference to the stage of completion.
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with LKAS 18. If only one component is identified then revenue is recognised
when the service is performed (eg when access to a utility network is provided).
3 Current developments
IFRS 15 (SLFRS 15) Revenue from Contracts with Customers was issued by the
IASB in May 2014 and becomes effective in 2017. It replaces IAS 18 (LKAS 18)
and IAS 11 (LKAS 11). The new standard requires that revenue is recognised
when performance obligations are met.
IFRS 15 Revenue from Contracts with Customers was issued by the IASB in May
2014 and when it becomes effective, on 1 January 2017, will replace both IAS 11
Construction Contracts and IAS 18 Revenue. The standard was developed in
conjunction with the American standard-setter, FASB, and an almost fully
converged US standard has also been issued. IFRS 15 has been adopted in Sri
Lanka as SLFRS 15 Revenue from Contracts with Customers.
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287
3.2 Scope
The standard applies to all contracts with customers with the exception of:
Lease contracts within the scope of LKAS 17
Insurance contracts within the scope of SLFRS 4
Financial instruments and other contractual rights or obligations within the
scope of LKAS 39, SLFRS 10, SLFRS 11, LKAS 27 or LKAS 28, and
Non-monetary exchanges between entities in the same line of business to
facilitate sales to customers (eg a contract between two oil companies to
exchange oil in order to fulfil demand from customers in different locations on
a timely basis).
(b)
A series of distinct goods or services that are substantially the same and that
have the same pattern of transfer to the customer.
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2.
3.
4.
5.
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289
3.5 Disclosure
The disclosure requirements of SLFRS 15 aim to provide sufficient information to
allow users to understand the nature, amount timing and uncertainty of revenue
and cash flows arising from a contract with a customer.
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QUESTION
Wave, a listed company, sells top of the range surfboards to professional surfers.
Wave requires its customers to pay a 10% deposit when placing an order for a
surfboard. If the customer cancels the order the deposit is non refundable.
However if Wave is not able to fulfil the order the deposit is returned. The balance
becomes payable when the board is delivered.
Required
Advise the directors of Wave how the revenue should be recognised in their
financial statements (detailing the relevant key principles of LKAS 18 Revenue).
ANSWER
LKAS 18 Revenue states that revenue from sale of goods should not be recognised
unless the following conditions have been met:
(1)
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291
(2)
(3)
(4)
The receipt of the 10% deposit does not meet the above conditions. If Wave is not
able to fulfil the contract the deposit will be returned.
Where a deposit is received in advance of delivery, the revenue should only be
recognised when the goods are delivered to the customer and accepted. (Risks
and rewards transferred and no further managerial involvement).
The deposit should be shown as a liability until delivery. If the customer cancels
the order the liability can be transferred to profit or loss and recognised as
revenue.
QUESTION
Kaffir Co entered into the following transactions in December 20X5.
1.12.20X5
15.12.20X5
21.12.20X5
31.12.20X5
Rs.
355,000
100,000
142,260
300,000
897,260
An appropriate discount rate, where appropriate is 1% per month. Other than the
amounts payable in instalments all debts have been paid.
The new Financial Controller is unsure of how to account for these transactions
and specifically what revenue to recognise. The Managing Director has suggested
that its always good to maximise profits and therefore to record Rs. 897,260 as
revenue.
Required
Advise the Financial Controller and Managing Director what amount should be
recognised as revenue in the year ended 31 December 20X5, referencing relevant
accounting standards.
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ANSWER
LKAS 18 has different criteria for the recognition of revenue in respect of goods
and services. The appendix to the standard gives examples of the application of
these criteria to specific scenarios.
Revenue from goods sold on a consignment basis is recognised only when the
goods are sold on to a third party. Therefore in respect of the transaction dated
1.12.X5, revenue of 50% Rs. 355,000 = Rs. 177,500 is recognised.
Where a sale transaction includes goods and an associated service, these are
unbundled and accounted for separately. Therefore in respect of the transaction
on 15.12.X5, Rs. 80,000 revenue from the sale of goods is recognised immediately.
The Rs. 20,000 revenue from servicing fees is recognised as the service is
provided. By the year end 1/8 of the service has been provided (1/2 month out of
4 months) and therefore 1/8 of Rs. 20,000 = Rs. 2,500 is recognised as revenue.
In respect of advertising commissions, the appendix to LKAS 18 states that
revenue is recognised when the advert appears before the public. Therefore no
revenue is recognised in 20X5.
Where goods are sold but payment is deferred, the deferred consideration is
discounted to present value to be recognised as revenue. As the associated
receivable balance is wound up over the period until payment, interest income is
recognised. Therefore revenue recognised on 31.12.20X5 is Rs. 100,000 +
Rs. 100,000/1.01 + Rs. 100,000/1.012 = Rs. 297,040
1.12.20X5
Consignment sales
15.12.20X5
Goods and servicing
21.12.20X5
Advertising commission
31.12.20X5
Goods
Total revenue recognised in the year
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Rs.
177,500
82,500
0
297,040
557,040
293
CHAPTER ROUNDUP
294
IFRS 15 (SLFRS 15) Revenue from Contracts with Customers was issued by the
IASB in May 2014 and becomes effective in 2017. It replaces IAS 18 (LKAS 18)
and IAS 11 (LKAS 11).
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PROGRESS TEST
How is revenue from the sale of an item with a service plan recognised?
A property is sold to a bank for half of its market value. The seller has a call option
to repurchase the property at a 10% premium over proceeds received at a later
date. How should this transaction be accounted for?
Where property is sold off plan and the purchaser can specify structural elements
of the plan and change these when construction is underway, how is the sale
accounted for by the seller?
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295
296
The amount of revenue related to the service plan is deferred and recognised as
revenue over the period during which the service is performed. The amount
deferred must cover the cost of the services together with a reasonable profit on
those services.
This is a sale and repurchase transaction that is, in substance a loan secured on
the property. It is accounted for as a loan balance, initially at proceeds, and wound
up to redemption value.
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CHAPTER
INTRODUCTION
In this chapter we revise the principles of current and deferred tax that
you met at KB1. The chapter then progresses to deal with the more
advanced topic of deferred tax arising in group scenarios.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
1.3
Level C
1.3.1
1.3.2
1.3.3
297
CHAPTER CONTENTS
1 Current tax
2 Deferred tax
3 Deferred tax and groups
4 Related Interpretations
5 Current developments
1 Current tax
Current tax is payable in respect of the trading activities of the period. The tax
charge is adjusted for any under or overprovision of a prior period.
This section revises in brief the accounting treatment applied to current tax. For
additional detail and examples you should refer to your KB1 study text.
1.1 Definitions
Current tax is the amount of income taxes payable (recoverable) in respect of the
taxable profit (tax loss) for a period.
Taxable profit (tax loss) is the profit (loss) for a period, determined in
accordance with the rules established by the taxation authorities, upon which
income taxes are payable (recoverable).
Accounting profit is profit or loss for a period before deducting tax expense.
Tax expense (tax income) is the aggregate amount included in the determination
of profit or loss for the period in respect of current tax and deferred tax.
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2 Deferred tax
Deferred tax is an accounting adjustment relating to temporary differences.
Taxable temporary differences result in deferred tax liabilities and deductible
temporary differences result in deferred tax assets.
Again this section of the chapter revises in brief material that you should be
familiar with. You should refer to your KB1 study text for additional examples and
explanations.
Deferred tax compensates for temporary differences between taxable and
accounting profits and attempts to match the tax impact of a transaction to the
accounting impact for the purposes of financial reporting, so that both are
reported in the same period.
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299
2.1 Definitions
Deferred tax liabilities are the amounts of income taxes payable in future
periods in respect of taxable temporary differences.
Deferred tax assets are the amounts of income taxes recoverable in future
periods in respect of:
(a)
(b)
(c)
(b)
The tax base of an asset or liability is the amount attributed to that asset or
liability for tax purposes.
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to
taxable
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301
302
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303
QUESTION
Revaluation
(b)
Explain how your answer would differ if the property had been impaired by
Rs 5.014 Mn at the end of 20X7.
ANSWER
(a)
The carrying amount of the factory before the revaluation was Rs. 30.8 Mn
(Rs. 35 Mn 44/50years).
A revaluation gain of Rs. 34.2 Mn (Rs. 65 Mn Rs. 30.8 Mn) is recognised on
31 December 20X9. This is a taxable temporary difference and results in a
deferred tax liability of Rs. 9,576,000 (Rs. 34.2 Mn 28%).
Both the revaluation gain and deferred tax liability are recognised in other
comprehensive income and accumulated in a revaluation reserve in equity.
The net amount recognised in OCI is Rs. 24,624,000 (Rs. 34.2 Mn
Rs. 9.576 Mn).
(b)
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QUESTION
Tax rates
A company has an asset with a carrying amount of Rs. 250,000 and a tax base of
Rs. 150,000. The company operates in Wunderland where the income tax rate is
20% and the capital gains rate is 30%. Explain the deferred tax implications of the
company owning the asset.
ANSWER
The deferred tax implication depends on whether the company sells the asset
without further use or recovers its carrying amount through use.
In either case there is a taxable temporary difference of Rs. 100,000.
If the intention is to sell the asset without further use a deferred tax liability of
Rs. 30,000 (30% Rs. 100,000) arises.
If the intention is to use the asset then a deferred tax liability of Rs. 20,000 (20%
Rs. 100,000) arises.
QUESTION
Lanka Machinery Makers Ltd (LMM) manufactures and sells commercial food
preparation machinery throughout the world. Its administration and distribution
functions operate from a small head office property in central Columbo owned by
LMM, whilst its manufacturing base is a rented factory on the outskirts of the city.
The finance department of LMM is currently preparing the companys financial
statements for the year ended 31 December 20X4, and the deferred tax treatment
of a number of items remains outstanding:
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1.
2.
LMM has been required to pay a penalty fee of Rs. 80,000 in respect of the a
breach of health and safety regulations. This amount has been charged as an
expense within Administration expenses in the statement of profit or loss.
305
3.
LMMs head office cost Rs. 16.5 million to construct four years ago (excluding
land). It is being depreciated over 50 years and has a carrying amount at
31 December 20X4 of Rs. 15.18 million.
4.
LMM own approximately half of the machines used on its production line
and lease the remainder under operating leases. The owned machines cost
Rs. 1,958,000 when purchased (including Rs. 182,000 for machinery
purchased in the year ended 31 December 20X4) and have a carrying
amount at 31 December 20X4 of Rs. 1,734,900.
5.
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Rs.
Taxed at 28%
Capital allowances head office
TWDV b/f
Annual allowance (6.66% 16.5 Mn)
TWDV c/f
Qualifying cost b/f and c/f
Rs.
2,223,298
Rs.
13,200,000
(1,100,000)
12,100,000
16,500,000
TWDV b/f
Additions
Annual allowance (12.5% 1,958,000)
TWDV c/f
Rs.
1,153,000
182,000
(244,750)
1,090,250
Allowances
Rs.
244,750
244,750
Required
What deferred tax position should be reflected in the statement of financial
position at the 30 September 20X4 year end, and what is the tax charge in profit or
loss for the year then ended? You should explain your calculations.
ANSWER
Statement of financial position for LMM as at 31 December
20X4
Rs.
Deferred tax liability
457,702
20X3
Rs.
371,300
Statement of profit or loss and other comprehensive income for LMM for the
year ended 31 December 20X4
Rs.
Income tax charge
Tax on profits for the year
Deferred tax
2,223,298
86,402
2,309,700
Workings
(1)
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307
Rs.
Tax base
Carrying amount
Temporary difference
Nil
(1,150,000)
1,150,000
As the carrying amount is less than the tax base, this is a deductible
temporary difference and results in a deferred tax asset of Rs. 322,000 (28%
Rs. 1,150,000).
(2)
(3)
Penalty fee
The penalty fee will never be an allowable expense for tax purposes, and it is
therefore treated as a permanent difference. There is no deferred tax impact
of permanent differences.
(4)
Head office
Deferred tax arises on the construction cost of the head office. The
temporary difference at 31 December 20X4 is calculated as:
Rs.
12,100,000
Tax base (tax computation)
15,180,000
Carrying amount
3,080,000
Temporary difference
As the carrying amount is more than the tax base, this is a taxable temporary
difference and results in a deferred tax liability of Rs. 862,400 (28%
Rs. 3,080,000).
(5)
Machinery
Again the temporary difference is calculated as the difference between the
tax base and carrying amount of the machinery:
Tax base (tax computation)
Carrying amount
Temporary difference
Rs.
1,090,250
1,734,900
644,650
As the carrying amount is more than the tax base, this is a taxable temporary
difference and results in a deferred tax liability of Rs. 180,502 (28%
Rs. 644,650).
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(6)
Pension contributions
Rs.
Tax base (tax computation)
Carrying amount
Temporary difference
nil
(940,000)
940,000
As the carrying amount is less than the tax base, this is a deductible
temporary difference and results in a deferred tax asset of Rs. 263,200
(28% Rs. 940,000).
(7)
Summary
All of the elements of deferred tax relate to the same jurisdiction (Sri Lanka),
and it is assumed that there is a right to set off the asset and liability.
Therefore the net deferred tax liability at the year end is:
Rs.
(322,000)
General provision for doubtful debts
862,400
Head office
180,502
Machinery
(263,200)
Pension contributions
457,702
The net provision has therefore increased by Rs. 86,402 (457,702
371,300). This is recognised in profit or loss for the period.
2.3 Disclosure
The following must be disclosed in relation to income taxes:
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(a)
the major components of tax expense in profit or loss including the current
tax expense, adjustments in relation to the tax of previous periods and
deferred tax expense/income amounts relating to the origination and
reversal of temporary differences and changes in tax rates.
(b)
The aggregate current and deferrred tax relating to items that are charged or
credited directly to equity.
(c)
(d)
ii.
(e)
(f)
The amount of any deductible temporary differences, unused tax losses and
unused tax credits for which no deferred tax asset is recognised.
(g)
(h)
(i)
i.
ii.
ii.
(j)
(k)
The amount of a deferred tax asset and the nature of evidence supporting its
recognition when:
i.
ii.
The entity has suffered a loss in either the current or preceding period
in the tax jurisdiction to which the deferred tax asset relates.
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%
28.0
1.17
0.47
(0.89)
0.19
28.94
311
2014
Rs.
20,421,066
612,934
21,034,000
2013
Rs.
15,149,748
(151,637)
1,658,705
16,656,816
The provision for income tax is based on the elements of income and expenditure
as reported in the Financial Statements and computed in accordance with the
provision of the Inland Revenue Act No.10 of 2006 and subsequent amendments
thereto. In terms of the Fifth schedule (section 43) of the Inland Revenue Act
No.10 of 2006 newly introduced by the Inland Revenue (Amendment) Act No.22 of
2011, the Company is liable for income tax at the concessionary rate of 10% on its
storage income, and 28% on other revenue sources and other income.
8.1 Current Income Tax Expense
2014
Rs.
77,234,190
10,295,779
(6,361,302)
81,168,667
81,168,667
1,281,200
19,139,866
20,421,066
2013
Rs.
56,434,242
19,375,974
(18,923,596)
56,886,620
157,896
57,044,516
444,758
14,727,143
(22,153)
15,149,748
2014
Rs.
(348,798)
(612,934)
(961,732)
2013
Rs.
1,309,907
(1,658,705)
(348,798)
16 DEFERRED TAXATION
As at 31st March
Balance at the beginning of the Year
Charge/(Reversal) for the Year
Balance at the end of the Year
312
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On Property, Plant
and Equipment
On Retirement
Benefit Obligations
2014
Temporary
Tax
Difference
Effect
Rs.
Rs.
2013
Temporary
Tax
Difference
Effect
Rs.
Rs.
(13,520,840) (3,785,835)
(9,506,463)
(2,661,810)
8,260,757
(1,245,706)
2,313,012
(348,798)8
10,086,081
(3,434,759)
2,824,103
(961,732)
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313
In a business combination, the cost of the acquisition must be allocated to the fair
values of the identifiable assets and liabilities acquired as at the date of the
transaction. Temporary differences will arise when the tax bases of the
identifiable assets and liabilities acquired are not affected by the business
combination or are affected differently. For example, if the carrying amount of an
asset is increased to fair value but the tax base of the asset remains at cost to the
previous owner, a taxable temporary difference arises which results in a deferred
tax liability and this will also affect goodwill.
The following are provided by LKAS 12 as other examples of group situations that
would result in a taxable temporary difference:
Unrealised losses resulting from intragroup transactions are eliminated
from the carrying amount of inventory or property, plant and equipment
however the tax bases of the assets are not adjusted to eliminate the URP.
Retained earnings of subsidiaries, branches, associates and joint ventures are
included in consolidated retained earnings, but income taxes will be payable if
the profits are distributed to the reporting parent.
Investments in foreign subsidiaries, branches or associates or interests in
foreign joint ventures are affected by changes in foreign exchange rates.
There may be either a taxable temporary difference or a deductible temporary
difference in this situation.
An entity accounts in its own currency for the cost of the non-monetary assets
of a foreign operation that is integral to the reporting entity's operations but
the taxable profit or tax loss of the foreign operation is determined in the
foreign currency.
3.1.2 Circumstances that give rise to deductible temporary differences
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3.2 Recognition
3.2.1 Deferred tax liability
LKAS 12 requires entities to recognise a deferred tax liability for all taxable
temporary differences associated with investments in subsidiaries, branches and
associates, and interests in joint ventures, except to the extent that both of these
conditions are satisfied:
(a)
(b)
LKAS 12 states that a deferred tax asset should be recognised for all deductible
temporary differences arising from investments in subsidiaries, branches and
associates, and interests in joint ventures, to the extent that (and only to the extent
that) both these are probable:
(a)
That the temporary difference will reverse in the foreseeable future, and
(b)
That taxable profit will be available against which the temporary difference
can be utilised.
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315
Foreign exchange
Where a foreign operation's taxable profit or tax loss (and therefore the tax base
of its non-monetary assets and liabilities) is determined in a foreign currency,
changes in the exchange rate give rise to temporary differences. These relate to
the foreign entity's own assets and liabilities, rather than to the reporting entity's
investment in that foreign operation, and so the reporting entity should recognise
the resulting deferred tax liability or asset. The resulting deferred tax is charged
or credited to profit or loss.
Associates
An investor in an associate does not control that entity and so cannot determine
its dividend policy. Without an agreement requiring that the profits of the
associate should not be distributed in the foreseeable future, therefore, an
investor should recognise a deferred tax liability arising from taxable temporary
differences associated with its investment in the associate. Where an investor
cannot determine the exact amount of tax, but only a minimum amount, then the
deferred tax liability should be that amount.
Joint ventures
In a joint venture, the agreement between the parties usually deals with profit
sharing. When a venturer can control the sharing of profits and it is probable that
the profits will not be distributed in the foreseeable future, a deferred liability is
not recognised.
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QUESTION
In 20X2 Sky Ltd acquired a subsidiary, Ocean Ltd, which had deductible temporary
differences of Rs. 3 Mn. The tax rate at the date of acquisition was 30%. The
resulting deferred tax asset of Rs. 0.9 Mn was not recognised as an identifiable
asset in determining the goodwill of Rs. 5 Mn resulting from the business
combination. Two years after the acquisition, Sky Ltd decided that future taxable
profit would probably be sufficient for the entity to recover the benefit of all the
deductible temporary differences.
Required
(a)
(b)
What would happen if the tax rate had risen to 40% by 20X4 or decreased to
20%?
ANSWER
(a)
The entity recognises a deferred tax asset of Rs 0.9 Mn (Rs. 3 Mn 30%) and,
in profit or loss, deferred tax income of Rs. 0.9 Mn. Goodwill is not adjusted
as the recognition does not arise within the measurement period (ie within
the 12 months following the acquisition).
(b)
If the tax rate rises to 40%, the entity should recognise a deferred tax asset
of Rs. 1.2 Mn (Rs. 3 Mn 40%) and, in profit or loss, deferred tax income of
Rs. 1.2 Mn.
If the tax rate falls to 20%, the entity should recognise a deferred tax asset of
Rs. 0.6 Mn (Rs. 3 Mn 20%) and deferred tax income of Rs. 0.6 Mn.
In both cases, the entity will also reduce the cost of goodwill by Rs 0.9 Mn
and recognise an expense for that amount in profit or loss.
QUESTION
Red is a private limited liability company and has two 100% owned subsidiaries,
Blue and Green, both themselves private limited liability companies. Red acquired
Green on 1 January 20X2 for Rs. 5 Mn when the fair value of the net assets was
Rs. 4 Mn, and the tax base of the net assets was Rs. 3.5 Mn. The acquisition of
Green and Blue was part of a business strategy whereby Red would build up the
'value' of the group over a three-year period and then list its existing share capital
on the stock exchange.
(a)
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(i)
(ii)
Green has sold goods worth Rs. 3 Mn to Red since acquisition and made
a profit of Rs. 1 Mn on the transaction. The inventory of these goods
recorded in Red's statement of financial position at the year-end of
31 May 20X2 was Rs. 1.8 Mn.
(ii)
(iii) When Red acquired Blue it had unused tax losses brought forward. At
1 June 20X1, it appeared that Blue would have sufficient taxable profit
to realise the deferred tax asset created by these losses but subsequent
events have proven that the future taxable profit will not be sufficient
to realise all of the unused tax loss.
The current tax rate for Red is 30% and for public companies is 35%.
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Required
Discuss the accounting of Green and Blue in the consolidated financial statements
of Red.
ANSWER
Acquisition of the subsidiaries general
Fair value adjustments have been made for consolidation purposes in both cases
and these will affect the deferred tax charge for the year. This is because the
deferred tax position is viewed from the perspective of the group as a whole. For
example, it may be possible to recognise deferred tax assets that previously could
not be recognised by individual companies, because there are now sufficient tax
profits available within the group to utilise unused tax losses. Therefore a
provision should be made for temporary differences between fair values of the
identifiable net assets acquired and their carrying amounts(Rs. 4 million less
Rs. 3.5 million in respect of Green). No provision should be made for the
temporary difference of Rs. 1 million arising on goodwill recognised as a result of
the combination with Green.
Future listing
Red plans to seek a listing in three years' time. Therefore it will become a public
company and will be subject to a higher rate of tax. LKAS 12 states that deferred
tax should be measured at the average tax rates expected to apply in the periods
in which the temporary differences are expected to reverse, based on current
enacted tax rates and laws. This means that Red may be paying tax at the higher
rate when some of its temporary differences reverse and this should be taken into
account in the calculation.
Acquisition of Green
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(i)
The directors have calculated the tax provision on the assumption that the
intangible asset of Rs. 0.5 Mn will be allowed for tax purposes. However, this
is not certain and the directors may eventually have to pay the additional
tax. If the directors cannot be persuaded to adjust their calculations a
liability for the additional tax should be recognised.
(ii)
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(i)
(ii)
A temporary difference arises when the provision for the loss on the loan
portfolio is first recognised. The general allowance is expected to increase
and therefore it is unlikely that the temporary difference will reverse in the
near future. However, a deferred tax liability should still be recognised. The
temporary difference gives rise to a deferred tax asset. LKAS 12 states that
deferred tax assets should not be recognised unless it is probable that
taxable profits will be available against which the taxable profits can be
utilised. This is affected by the situation in point (c) below.
(iii) In theory, unused tax losses give rise to a deferred tax asset. However, LKAS
12 states that deferred tax assets should only be recognised to the extent
that they are regarded as recoverable. They should be regarded as
recoverable to the extent that on the basis of all the evidence available it is
probable that there will be suitable taxable profits against which the losses
can be recovered. The future taxable profit of Blue will not be sufficient to
realise all the unused tax loss. Therefore the deferred tax asset is reduced to
the amount that is expected to be recovered.
This reduction in the deferred tax asset implies that it was overstated at
1 June 20X1, when it was acquired by the group. As these are the first postacquisition financial statements, goodwill should also be adjusted.
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QUESTION
You are the accountant of Payit. Your assistant is preparing the consolidated
financial statements of the year ended 31 March 20X2. However, he is unsure how
to account for the deferred tax effects of certain transactions as he has not studied
LKAS 12. These transactions are given below.
Transaction 1
During the year, Payit sold goods to a subsidiary for Rs. 10 Mn, making a profit of
20% on selling price. 25% of these goods were still in the inventories of the
subsidiary at 31 March 20X2. The subsidiary and Pay it are in the same tax
jurisdiction and pay tax on profits at 30%.
Transaction 2
An overseas subsidiary made a loss adjusted for tax purposes of Rs. 8 million
(Rs equivalent). The only relief available for this tax loss is to carry it forward for
offset against future taxable profits of the overseas subsidiary. Taxable profits of
the oversees subsidiary suffer tax at a rate of 25%.
Required
Compute the effect of both the above transactions on the deferred tax amounts in
the consolidated statement of financial position of Payit at 31 March 20X2. You
should provide a full explanation for your calculations and indicate any
assumptions you make in formulating your answer.
ANSWER
Transaction 1
This intra-group sale will give rise to a provision for unrealised profit on the
unsold inventory of Rs. 10,000,000 20% 25% = Rs. 500,000. This provision
must be made in the consolidated accounts. However, this profit has already been
taxed in the financial statements of Payit. In other words there is a timing
difference. In the following year when the stock is sold outside the group, the
provision will be released, but the profit will not be taxed. The timing difference
therefore gives rise to a deferred tax asset. The asset is 30% Rs. 500,000 =
Rs. 150,000.
Deferred tax assets are recognised to the extent that they are recoverable. This
will be the case if it is more likely than not that suitable tax profits will exist from
which the reversal of the timing difference giving rise to the asset can be deducted.
The asset is carried forward on this assumption.
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Transaction 2
An unrelieved tax loss gives rise to a temporary difference because the loss is
recognised in the financial statements but not yet allowed for tax purposes. When
the overseas subsidiary generates sufficient taxable profits, the loss will be offset
against these in arriving at taxable profits.
The amount of the deferred tax asset to be carried forward is 25% Rs. 8 Mn =
Rs. 2 Mn.
As with Transaction 1, deferred tax assets are recognised to the extent that they
are recoverable. This will be the case if it is more likely than not that suitable tax
profits will exist from which the reversal of the temporary difference giving rise to
the asset can be deducted
4 Related Interpretation
SIC 25 deals with changes in the tax status of an entity or its shareholders. The
effects of a change in tax status are normally recognised in profit or loss.
As a result of such an event, an entity may be taxed differently; it may for example
gain or lose tax incentives or become subject to a different rate of tax in the future.
A change in the tax status of an entity or its shareholders may have an immediate
effect on the entity's current tax liabilities or assets. The change may also increase
or decrease the deferred tax liabilities and assets recognised by the entity,
depending on the effect the change in tax status has on the tax consequences that
will arise from recovering or settling the carrying amount of the entity's assets
and liabilities.
A change in the tax status of an entity or its shareholders does not give rise to
increases or decreases in amounts recognised directly in equity. The current and
deferred tax consequences of a change in tax status shall be included in net profit
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or loss for the period, unless those consequences relate to transactions and events
that result, in the same or a different period, in a direct credit or charge to the
recognised amount of equity. Those tax consequences that relate to changes in the
recognised amount of equity, in the same or a different period (not included in net
profit or loss) shall be charged or credited directly to equity.
QUESTION
Nikatenna Holdings, a private company purchased 1% of the shares in a public
company for Rs. 350 Mn on 15 March 20X4.
Nikatenna Holdings intends to keep the shares for several years. At the reporting
date the shares have a fair value of Rs. 400 Mn. Gains are taxed when the
investments are sold.
Required
(a)
Discuss the tax implications of the scenario above for the year ended
31 December 20X4. Assume a tax rate of 28%.
(b)
ANSWER
(a)
A temporary difference arises when the shares are revalued as the tax
treatment is different from the accounting treatment. The fair value gain of
Rs. 50 Mn is recognised in other comprehensive income (as this investment
must be classified as available-for-sale).
The gain is a taxable temporary difference and the company should
recognise a deferred tax liability of Rs. 14 Mn (Rs. 50 Mn 28%),
representing the future tax to pay on the gain recognised, payable when the
investments are sold.
It should be charged to other comprehensive income, ie the same section of
the statement of profit or loss and other comprehensive income as the gain
recognised.
(b)
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If the company plans to list it will become subject to a higher tax rate. LKAS
12 states that deferred tax should be measured at the average tax rates
expected to apply in the periods in which the temporary differences are
expected to reverse (ie when the tax becomes payable), based on tax rates
enacted or substantively enacted by the year end date. This will need to be
taken into account in the calculation and any changes in opening balances
should also be disclosed separately.
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QUESTION
The Kandy Group headed by Kandy Co operates in a number of diverse industries
throughout Asia. It has recently appointed a new Managing Director from a
country where IFRS are not applied. The Managing Director has approached you,
the financial controller and asked you to explain how the provision for deferred
taxation would be calculated in the following situations under LKAS 12 Income
taxes:
(i)
(ii)
ANSWER
Intra-group sale
Sol has made a profit of Rs. 2 Mn on its sale to Kandy. Tax is payable on the profits
of individual companies. Sol is liable for tax on this profit in the current year and
will have provided for the related tax in its individual financial statements.
However, from the viewpoint of the group the profit will not be realised until the
following year, when the goods are sold to a third party. The profit must therefore
be eliminated from the consolidated financial statements. Because the group pays
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tax before the profit is realised there is a temporary difference of Rs. 2 million and
a deferred tax asset of Rs. 600,000 (30% Rs. 2 million).
Impairment loss
The impairment loss in the financial statements of Karri reduces the carrying
amount of property, plant and equipment, but is not allowable for tax. Therefore
the tax base of the property, plant and equipment is different from its carrying
amount and there is a temporary difference.
Under LKAS 36 Impairment of assets the impairment loss is allocated first to
goodwill and then to other assets:
Property,
plant and
Goodwill
equipment
Total
Rs Mn
Rs Mn
Rs Mn
1
6.0
7.0
Carrying amount at 31 October 20X5
(1)
(0.8)
(1.8)
Impairment loss
5.2
5.2
0.56
After
impairment
Rs Mn
5.2
(4)
1.2
Difference
0.34
0.22
Rs Mn
0.8
Therefore the impairment loss reduces the deferred tax liability by Rs. 220,000.
5 Current developments
The IASB has proposed narrow scope amendments to IAS 12 which will in turn
affect LKAS 12
ED/2014/3 Recognition of Deferred Tax Assets for Unrealised Losses was issued in
June 2014. It proposed to amend IAS 12 (LKAS 12 ) to clarify that:
Unrealised losses on debt instruments measured at fair value for accounting
purposes and at cost for tax purposes can give rise to deductible temporary
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CHAPTER ROUNDUP
Current tax is payable in respect of the trading activities of the period. The tax
charge is adjusted for any under or overprovision of a prior period.
SIC 25 deals with changes in the tax status of an entity or its shareholders. The
effects of a change in tax status are normally recognised in profit or loss.
The IASB has proposed narrow scope amendments to IAS 12 which will in turn
affect LKAS 12.
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327
PROGRESS TEST
328
The current tax liability in the statement of financial position is not usually equal
to the tax charge to profits. Why?
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The tax base of an asset is the amount that will be deductible for tax purposes
against any taxable economic benefits that will flow to the entity when it recovers
the carrying amount of the asset. Where those benefits are not taxable, the tax
base is the same as the assets carrying amount.
Rs. 3,500.
The tax rate which is expected to apply to the period when the underlying item is
realised/settled based on rates enacted or substantively enacted by the end of the
reporting period. Where different tax rates apply to different levels of income
average rates expected to apply are used. The tax rate used should reflect the
expected manner of recovery (income tax rate for use/capital gain tax rate for
sale).
When the carrying amounts of the investment become different to the tax base of
the investment.
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330
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CHAPTER
INTRODUCTION
This chapter revises KB1 material and introduces new, more advanced financial
instruments topics such as hedge accounting. You should go back and review your KB1
material for additional examples relating to topics that we revise at this level.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS
/ LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.2
Level B
1.1.7
1.2.1
1.2.2
1.2.3
1.2.4
1.3
Level C
1.2.5
1.3.1
1.3.2
1.3.3
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CHAPTER CONTENTS
1 LKAS 32 Financial Instruments: Presentation
2 LKAS 39 Financial Instruments: Recognition and Measurement
3 Derivatives
4 Hedge accounting
5 SLFRS 9 Financial Instruments
6 SLFRS 4 Insurance Contracts
7 SLFRS 7 Financial Instruments: Disclosures
8 IFRIC 19 Extinguishing Financial Liabilities with Equity
Instruments
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1.1 Definitions
Financial instrument. Any contract that gives rise to both a financial asset of one
entity, and a financial liability or equity instrument of another entity.
Financial asset. Any asset that is:
(a)
Cash;
(b)
(c)
(d)
A contract that will or may be settled in the entity's own equity instruments
and is:
(i)
(ii)
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A contractual obligation:
(i)
(ii)
333
(b)
A contract that will or may be settled in the entitys own equity instruments
and is:
(i)
(ii)
Equity instrument. Any contract that evidences a residual interest in the assets of
an entity after deducting all of its liabilities.
Derivative. A financial instrument or other contract with all three of the following
characteristics:
(a)
(b)
(c)
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QUESTION
During the financial year ended 31 December 20X5, Moora Co issued the financial
instrument described below. Identify whether it should be classified as liability or
equity, explaining in not more than 40 words the reason for your choice. You
should refer to the relevant SLFRS.
Redeemable preference shares with a coupon rate 5%. The shares are redeemable
on 31December 20X9 at premium of 20%.
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335
ANSWER
Liability. The preference shares require regular distributions to the holders but
more importantly have the debt characteristic of being redeemable. Therefore,
according to LKAS 32 Financial Instruments: Presentation they must be classified
as liability.
Calculate the value for the liability component as the future cash flows
associated with the instrument (assuming redemption) discounted at a
market interest rate for similar bonds having no conversion rights
(b)
Deduct this from the instrument as a whole to leave a residual value for the
equity component.
The reasoning behind this approach is that an entity's equity is its residual
interest in its assets amount after deducting all its liabilities. The sum of the
carrying amounts assigned to liability and equity will always be equal to the
carrying amount that would be ascribed to the instrument as a whole.
1.3.2 Contingent settlement provisions
An entity may issue a financial instrument where the way in which it is settled
depends on:
(a)
(b)
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that are beyond the control of both the holder and the issuer of the instrument.
For example, an entity might have to deliver cash instead of issuing equity shares.
In this situation it is not immediately clear whether the entity has an equity
instrument or a financial liability.
Such financial instruments should be classified as financial liabilities unless the
possibility of settlement is remote.
1.3.3 Settlement options
When a derivative financial instrument gives one party a choice over how it is
settled (eg, the issuer can choose whether to settle in cash or by issuing shares)
the instrument is a financial asset or a financial liability unless all the
alternative choices would result in it being an equity instrument.
1.3.4 Treasury shares
If an entity reacquires its own equity instruments, those instruments ('treasury
shares') must be deducted from equity. No gain or loss may be recognised in profit
or loss on the purchase, sale, issue or cancellation of an entity's own equity
instruments. Consideration paid or received shall be recognised directly in equity.
1.3.5 Puttable instruments
A puttable instrument is a financial instrument that gives the holder the right to
put the instrument back to the issuer (ie redeem it) for cash or another financial
asset.
LKAS 32 historically required such instruments to be classified as liabilities,
however a 2008 amendment to the standard requires entities to classify such
instruments as equity, so long as they meet certain conditions. The amendment
further requires that instruments imposing an obligation on an entity to deliver to
another party a pro rata share of the net assets only on liquidation should be
classified as equity.
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337
(b)
Intends to settle on a net basis, or to realise the asset and settle the liability
simultaneously, ie at the same moment.
This will reflect the expected future cash flows of the entity in these specific
circumstances. In all other cases, financial assets and financial liabilities are
presented separately.
QUESTION
Debt or equity?
During the financial year ended 28 February 20X5, MN issued the two financial
instruments described below. For each of the instruments, identify whether it
should be classified as debt or equity, explaining in not more than 40 words each
the reason for your choice. In each case you should refer to LKAS 32.
(i)
Redeemable preferred shares with a coupon rate 8%. The shares are
redeemable on 28 February 20X9 at premium of 10%.
(ii)
ANSWER
338
(i)
Debt. The preference shares require regular distributions to the holders but
more importantly have the debt characteristic of being redeemable.
Therefore according to LKAS 32 Financial instruments: presentation they
must be classified as debt.
(ii)
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QUESTION
Compound instrument
On 1 January 20X1, EFG issued 10,000 5% convertible bonds at their par value of
Rs. 500 each. The bonds will be redeemed on 1 January 20X6. Each bond is
convertible at the option of the holder at any time during the five year period.
Interest on the bond will be paid annually in arrears.
The prevailing market interest rate for similar debt without conversion options at
the date of issue was 6%.
At what value should the equity element of the hybrid financial instrument be
recognised in the financial statements of EFG at the date of issue?
ANSWER
Working in Rs'000, find the present value of the principal value of the bond,
Rs. 5,000,000 (10,000 500) and the interest payments of Rs. 250,000 annually
(5% 5 Mn) at the market rate for non-convertible bonds of 6%, using the
discount factor tables. The difference between this total and the principal amount
of Rs5m is the equity element.
Rs.
3,735,000
Present value of principal 5 Mn 0.747
1,053,000
Present value of interest 250,000 4.212
4,788,000
Liability value
5,000,000
Principal amount
212,000
Equity element
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339
2.1 Scope
LKAS 39 applies to all entities and to all types of financial instruments except
those specifically excluded, as listed below.
(a)
(b)
(c)
(d)
Insurance contracts
(e)
(f)
(g)
(h)
(i)
(j)
2.2 Recognition
A financial asset or financial liability is recognised in the statement of financial
position when the reporting entity becomes a party to the contractual
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CA Sri Lanka
QUESTION
Recognition
(b)
Required
Discuss whether a financial instrument should be recognised in each of these
cases.
ANSWER
Contract (a) is a normal trading contract. The entity does not recognise a liability
for the iron until the goods have actually been delivered. (Note that this contract
is not a financial instrument because it involves a physical asset, rather than a
financial asset.)
Contract (b) is a financial instrument. Under LKAS 39, the entity recognises a
financial liability (an obligation to deliver cash) on the commitment date, rather
than waiting for the closing date on which the exchange takes place.
Note that planned future transactions, no matter how likely, are not assets and
liabilities of an entity the entity has not yet become a party to the contract.
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341
2.3 Derecognition
Derecognition is the removal of a financial instrument from the statement of
financial position. The following table revises KB1 knowledge:
Derecognition of
financial assets
When:
(a)
(b)
Derecognition of
financial liabilities
Partial derecognition
Gain or loss on
derecognition
(a)
(b)
QUESTION
Derecognition
342
(a)
(b)
(c)
ANSWER
(a)
(b)
(c)
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343
(b)
Held to maturity
financial assets (HTM)
Available-for-sale
financial assets (AFS)
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2.4.2 Measurement
The following table summarises the initial and subsequent measurement of
financial assets:
Classification
Initial
Transaction
measurement costs
Subsequent
measurement
Gains and
losses
recognised in:
FVTPL
Fair value
Expense
Fair value
Profit or loss
HTM
Fair value
Loans and
receivables
Fair value
AFS
Fair value
Other
comprehensive
income
FVTPL and AFS financial assets are remeasured to fair value at each reporting
date. Fair value is determined in accordance with SLFRS 13 Fair Value
Measurement (see chapter 1).
HTM financial assets and loans and receivables are measured at amortised cost,
defined as follows:
Amortised cost is the amount at which a financial asset or liability is measured at
initial recognition minus principal repayments, plus or minus the cumulative
amortisation using the effective interest method of any difference between that
initial amount and the maturity amount.
The effective interest method is a method of calculating the amortised cost of a
financial instrument and of allocating the interest income or interest expense over
the relevant period.
The effective interest rate is the rate that exactly discounts estimated future cash
payments or receipts through the expected life of the financial instrument to the
net carrying amount of the financial asset or liability.
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345
QUESTION
Financial assets
ANSWER
(a) HTM
20X2
20X3
Rs'000
Rs'000
Profit or loss
Interest income (W1)/(W2)
Gain/(loss) due to change in
FV (W2)
Statement of financial
position
Financial asset (W1)/(W2)
(b) FVTPL
20X2
20X3
Rs'000
Rs'000
1,200
1,200
1,200
1,387
1,200
1,200
(187)
1,013
1,387
20,000
19,813
WORKINGS
1
Amortised cost
Cash 1.1.20X2
Effective interest at 6% (same as nominal as no discount on
issue/premium on redemption)
Coupon received (nominal interest 6% 20 Mn)
At 31.12.20X2
Effective interest at 6%
Coupon and capital received ((6% 20 Mn) + 20 Mn)
At 31.12.20X3
346
Rs'000
20,000
1,200
(1,200)
20,000
1,200
(21,200)
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Fair value
Cash
Effective interest (as above)
Coupon received (as above)
Fair value loss (balancing figure)
At 31.12.20X2 (W3)
Interest at 7% (7% 19,813)
Coupon and capital received ((6% 20 Mn) + 20 Mn)
At 31.12.20X3
Rs'000
20,000
1,200
(1,200)
(187)
19,813
1,387
(21,200)
Rs'000
19,813
(2)
This penalty is avoided only where the financial asset sold or reclassified is
insignificant compared to the total amount of held-to-maturity assets or the
reclassification was:
Within three months of maturity, or
After the entity has collected substantially all amounts of principal, or
Outside the entitys control.
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347
If a debt instrument would have met the definition of loans and receivables,
had it not been required to be classified as held for trading at initial
recognition, it may be reclassified out of fair value through profit or loss
provided the entity has the intention and ability to hold the asset for the
foreseeable future or until maturity.
(b)
If a debt instrument was classified as available for sale, but would have met
the definition of loans and receivables if it had not been designated as
available for sale, it may be reclassified to the loans and receivables category
provided the entity has the intention and ability to hold the asset for the
foreseeable future or until maturity.
(c)
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date on. This enables the increase in recoverability of cash flows to be recognised
over the expected life of the financial asset.
2.4.4 Impairment of financial assets
At each reporting date, an entity should assess whether there is objective evidence
that a financial asset or group of assets is impaired. Note that this is not necessary
for FVTPL financial assets since they are measured at fair value with changes
recognised in profit or loss in any case.
QUESTION
Indicators of impairment
ANSWER
Significant financial difficulty of the issuer
A breach of contract such as a default in interest or principal payments
The lender granting a concession, that it would not otherwise consider, to the
borrower as a result of the borrowers financial difficulty
It becomes probable that the borrower will enter bankruptcy
An active market for the financial asset disappears due to financial difficulties
Observable data that indicates there is a measurable decrease in the estimated
future cash flows from a group of financial assets.
An impairment loss is measured and recognised as follows:
Financial assets carried at amortised cost
The impairment loss is the difference between the asset's carrying amount and its
recoverable amount. The asset's recoverable amount is the present value of
estimated future cash flows, discounted at the financial instrument's original
effective interest rate.
The amount of the loss should be recognised in profit or loss.
If the impairment loss decreases at a later date (and the decrease relates to an
event occurring after the impairment was recognised) the reversal is recognised
in profit or loss. The carrying amount of the asset must not exceed what the
amortised cost would have been had there been no impairment.
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QUESTION
Impairment
350
(a)
What value should the loan stock have been stated at just before the
impairment became apparent?
(b)
At what value should the loan stock be stated at 31 December 20X4, after the
impairment?
(c)
How will the impairment be reported in the financial statements for the year
ended 31 December 20X4?
CA Sri Lanka
ANSWER
(a)
(b)
After the impairment, the loan stock is stated at its recoverable amount
(using the original effective interest rate of 10%):
80% Rs. 130,525 0.751 = Rs. 78,419
(c)
Rs. 32,081
Rs. 32,081
(b)
351
Initial
Transaction
measurement costs
Subsequent
measurement
Gains and
losses
recognised
in:
FVTPL
Fair value
Expense
Fair value
Profit or loss
Other financial
liabilities
Fair value
Profit or loss
QUESTION
FINANCIAL LIABILITIES
Adikari Co issues a bond for Rs. 503,778, on 1 January 20X2. No interest is payable
on the bond, but it will be held to maturity and redeemed on 31 December 20X4
for Rs. 600,000. The bond has not been designated as at fair value through profit
or loss.
Required
Calculate the charge to profit or loss of Adikari Co for the year ended
31 December 20X2 and the balance outstanding at 31 December 20X2.
ANSWER
The bond is a 'deep discount' bond and is a financial liability of Adikari Co. It is
measured at amortised cost. Although there is no interest as such, the difference
between the initial cost of the bond and the price at which it will be redeemed is a
finance cost. This must be allocated over the term of the bond at a constant rate on
the carrying amount.
To calculate amortised cost we need to calculate the effective interest rate of the
bond: 600,000/503,778 = 1.191 over three years.
To calculate an annual rate, we take the cube root, (1.191)1/3 = 1.06, so the annual
interest rate is 6%.
The charge to the statement of profit or loss is Rs. 30,227 (503,778 6%)
The balance outstanding at 31 December 20X2 is Rs. 534,005 (503,778 + 30,227)
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QUESTION
FINANCIAL LIABILITIES 2
On 1 January 20X3 Beehive Co issued Rs. 600,000 loan notes. Issue costs were
Rs. 200. The loan notes do not carry interest, but are redeemable at a premium of
Rs. 152,389 on 31 December 20X4. The effective finance cost of the debentures is
12%. The loan notes have not been designated as at fair value through profit or
loss.
Required
Calculate is the finance cost in respect of the loan notes for the year ended
31 December 20X4?
ANSWER
The premium on redemption of the loan notes represents a finance cost. The
effective rate of interest must be applied so that the debt is measured at amortised
cost (LKAS 39).
At the time of issue, the loan notes are recognised at their net proceeds of Rs.
599,800 (600,000 200).
The finance cost for the year ended 31 December 20X4 is calculated as follows.
B/f
Interest @ 12%
C/f
Rs'000
Rs'000
Rs'000
20X3
599,800
71,976
671,776
20X4
671,776
80,613
752,389
3 Derivatives
A derivative is a financial instrument that derives its value from the price or rate
of an underlying item. Embedded derivatives may require separation from
their host contract for accounting purposes.
A derivative is a financial instrument that derives its value from the price or rate
of an underlying item. Common examples of derivatives include:
CA Sri Lanka
(a)
(b)
(c)
Options: rights (but not obligations) for the option holder to exercise at a
pre-determined price; the option writer loses out if the option is exercised
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(d)
Swaps: agreements to swap one set of cash flows for another (normally
interest rate or currency swaps).
The nature of derivatives often gives rise to particular problems. The value of a
derivative (and the amount at which it is eventually settled) depends on
movements in an underlying item (such as an exchange rate). This means that
settlement of a derivative can lead to a very different result from the one
originally envisaged. A company which has derivatives is exposed to uncertainty
and risk (potential for gain or loss) and this can have a very material effect on its
financial performance, financial position and cash flows.
Yet because a derivative contract normally has little or no initial cost, under
traditional accounting it may not be recognised in the financial statements at all.
Alternatively it may be recognised at an amount which bears no relation to its
current value. This is clearly misleading and leaves users of the financial
statements unaware of the level of risk that the company faces. LKASs 32 and 39
were developed in order to correct this situation.
A derivative may be a financial asset or liability depending on the movement in
the underlying variable.
QUESTION
Orchid Co entered into a three-year interest rate swap with another company for
speculative purposes on 1 April 20X6.
The swap requires Orchid to pay interest at a fixed rate of 6% per annum and
receive interest at an annual variable rate equivalent to SLIBOR + 1%, reset at sixmonthly intervals. Interest is determined on a notional amount of Rs. 200 Mn,
however Orchid and the other company do not exchange this principal amount at
the inception of the agreement.
Settlement is on a net basis and paid six monthly in arrears.
SLIBOR is:
1 April 20X6
30 September 20X6
31 March 20X7
30 September 20X7
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5%
5%
6%
6.5%
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Rs. 5.85 Mn
Rs. 5.15 Mn
Required
(a)
(b)
Prepare extracts from the financial statements of Orchid for the year ended
30 September 20X7, explaining the amounts calculated.
ANSWER
(a)
(b)
Financial asset
Rs. 5.85 Mn
CREDIT
Profit or loss
Rs. 5.85 Mn
Profit or loss
Rs. 700,000
CREDIT
Financial asset
Rs. 700,000
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6 m/e:
30.9.X6
30.3.X7
Interest paid
(6% 200 Mn
6/12m)
6m
6m
30.9.X7
6m
Interest received
at SLIBOR + 1%
Net settlement
6m
7% 200 Mn
6/12m
7m
7.5% 200 Mn
6/12m
7.5m
1m
1.5m
Cash
Rs. 1 Mn
CREDIT
Finance income
Rs. 1 Mn
30 September 20X7
DEBIT
Cash
Rs. 1.5 Mn
CREDIT
Finance income
Rs. 1.5 Mn
Therefore extracts from the financial statements for the year ended
30 September 20X7 are as follows:
Statement of financial position
Non-current assets
Financial asset: interest rate swap
2014
Rs'000
2013
Rs'000
5,150
5,850
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Lease
Embedded Contingent
derivative
rentals
(b)
A bond which is redeemable in five years' time with part of the redemption
price being based on the increase in the Colombo Stock Exchange All Share
Index.
(c)
The economic characteristics and risks of the embedded derivative are not
closely related to those of the host contract, and
(b)
(c)
The hybrid instrument is not measured at fair value with changes recognised
in profit or loss (in which case there is no benefit to separating the
embedded derivative).
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357
4 Hedge Accounting
A hedge arises where the change in fair value of one item is offset by the change in
fair value or cash flows of another item. Hedge accounting is permitted in certain
circumstances, provided that the hedging relationship is clearly defined,
measureable and actually effective.
There are three types of hedge: fair value hedge, cash flow hedge and hedge of a
net investment in a foreign operation. The accounting treatment depends on
the type of hedge.
Introduction
LKAS 39 requires hedge accounting where there is a designated hedging
relationship between a hedging instrument and a hedged item. It is prohibited
otherwise. The following definitions relate to hedging:
Hedging, for accounting purposes, means designating one or more hedging
instruments so that their change in fair value is an offset, in whole or in part, to the
change in fair value or cash flows of a hedged item.
A hedged item is an asset, liability, firm commitment, or forecasted future
transaction that:
(a)
exposes the entity to risk of changes in fair value or changes in future cash
flows, and that
(b)
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Generally only assets, liabilities etc that involve external parties can be designated
as hedged items. The foreign currency risk of an intragroup monetary item (eg
payable/receivable between two subsidiaries) may qualify as a hedged item in the
group financial statements if it results in an exposure to foreign exchange rate
gains or losses that are not fully eliminated on consolidation. This can happen (per
LKAS 21) when the transaction is between entities with different functional
currencies.
In addition the foreign currency risk of a highly probable group transaction may
qualify as a hedged item if it is in a currency other than the functional currency of
the entity and the foreign currency risk will affect profit or loss.
(b)
(c)
For cash flow hedges, a forecast transaction that is the subject of the hedge
must be highly probable and must present an exposure to variations in cash
flows that could ultimately affect profit or loss.
(d)
(e)
The hedge is assessed on an on-going basis (annually) and has been effective
during the reporting period.
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359
In order to hedge the fluctuation in the market value of the oil the company signs a
futures contract to deliver 20,000 gallons of oil on 31 March 20X4 at the futures
price of Rs. 220 per gallon.
The market price of oil on 31 December 20X3 is Rs. 230 per gallon and the futures
price for delivery on 31 March 20X4 is Rs. 240 per gallon.
Required
Explain the impact of the transactions on the financial statements of the company:
(a)
(b)
Solution
The futures contract was intended to protect the company from a fall in oil prices
(which would have reduced the profit when the oil was eventually sold). However,
oil prices have actually risen, so that the company has made a loss on the contract.
Without hedge accounting:
The futures contract is a derivative and therefore must be remeasured to fair
value under LKAS 39. The loss on the futures contract is recognised in profit or
loss:
DEBIT
CREDIT
Rs. 40,000
Rs. 40,000
Inventory
Profit or loss
Rs. 60,000
Rs. 60,000
The net effect on the profit or loss is a gain of Rs. 20,000 compared with a loss of
Rs. 40,000 without hedging.
The standard identifies three types of hedging relationship.
Fair value hedge: a hedge of the exposure to changes in the fair value of a
recognised asset or liability, or an identified portion of such an asset or liability,
that is attributable to a particular risk and could affect profit or loss.
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Cash flow hedge: a hedge of the exposure to variability in cash flows that
(a)
(b)
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contract liability was Rs. 170,000 (10,000 (Rs. 227 Rs. 210)). Hedge
effectiveness was 85% (170,000 as a % of 200,000), so hedge accounting was still
permitted.
Debit
Credit
31 December 20X6
Rs.
Rs.
Profit or loss
Financial liability
(To record the loss on the forward contract)
170,000
Inventories
Profit or loss
(To record the increase in the fair value of the
inventories)
200,000
170,000
200,000
At 30 June 20X7 the increase in the fair value of the inventory was another
Rs. 100,000 (10,000 (Rs. 230 Rs. 220)) and the increase in the forward
contract liability was another Rs. 30,000 (10,000 (Rs. 230 Rs. 227)).
Debit
Credit
Rs.
Rs.
30 June 20X7
Profit or loss
30,000
Financial liability
30,000
(To record the loss on the forward contract)
Inventories
Profit or loss
(To record the increase in the fair value of the
inventories)
100,000
100,000
Profit or loss
Inventories
(To record the inventories now sold)
2,300,000
Cash
Profit or loss revenue
(To record the revenue from the sale of inventories)
2,300,000
Financial liability
Cash
2,300,000
2,300,000
200,000
200,000
(To record the settlement of the net balance due on closing the financial liability)
4.2.3 Cash flow hedges
The portion of the gain or loss on the hedging instrument that is determined to be
an effective hedge is recognised as other comprehensive income.
The ineffective portion of the gain or loss on the hedging instrument is recognised
in profit or loss.
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(b)
Affect the profit or loss at the same time as the hedged item (for example,
through depreciation or sale).
Rs.
48,387,096
40,000,000
8,387,096
Rs. 8,620,690
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363
Rs. 8,387,096
Rs. 8,387,096
Rs. 10,000,000
Therefore, the hedge is not fully effective during this period, but is still highly
effective (and hence hedge accounting can be used):
10,000,000/11,612,904 = 86% which is within the 80% 125% bandings.
DEBIT Financial asset (Forward a/c)
CREDIT Other comprehensive income
CREDIT Profit or loss
Rs. 11,612,904
Rs. 10,000,000
Rs. 1,612,904
Rs. 60,000,000
Rs. 60,000,000
Rs. 20,000,000
Rs. 20,000,000
or
Adjusts the initial cost of the asset (reducing future depreciation).
CA Sri Lanka
parent company's own currency, it should be the case that fluctuations in the
exchange rate affect the asset (the net assets of the subsidiary) and the liability
(the loan) in opposite ways, hence gains and losses are hedged.
In this type of accounting hedge, the hedging instrument is the foreign currency
loan rather than a derivative.
You may understand this type of hedge better after studying Chapter 20, but in a
simple sense, without applying hedging rules:
(a)
The loan would be retranslated to the parent's own currency at the year end
using the spot exchange rate; any resultant gain or loss would be recognised
in profit or loss.
(b)
(c)
The net investment hedge ensures that the gains and losses are both recognised in
other comprehensive income and accumulated in reserves by:
Recognising the portion of the gain or loss on the hedging instrument that is
determined to be effective in other comprehensive income
Recognising the ineffective portion in profit or loss
Any gain or loss recognised in other comprehensive income is reclassified to profit
or loss on the disposal or partial disposal of the foreign operation.
QUESTION
Hedge accounting
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365
Elephant has a reporting date of 30 September and at 30 September 20X4, the fair
value of the jewellery was Rs. 5.95 Mn and the forward price of gold per troy
ounce for delivery on 31 December 20X4 was Rs. 320.
Required
Advise how the transactions are reflected in Elephants financial statements in the
year ended 30 September 20X4.
ANSWER
1)
Rs.
4,020,000
3,840,000
180,000
(2)
Change in fair value of expected future cash flows on the hedged item
(not recognised):
Rs.
6,100,000
At 31 December 20X3
5,950,000
At 30 September 20X4
150,000
Reduction in expected future cash flows
(3)
Hedge effectiveness
Change in hedging instrument 180,000
=
= 120% therefore the hedge is effective
Change in hedged item
150,000
(4)
Accounting treatment
The hedge is highly effective and therefore hedge accounting can be applied.
As the change in the fair value of the gold is less than the change in the value
of the forward contract, only Rs. 150,000 of the gain on the contract is
recognised in other comprehensive income. The remainder is recognised in
profit or loss
Statement of financial position at 30 September 20X4
Current assets: derivative financial assets
Rs.
180,000
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The entity's business model for managing the financial asset, and
The contractual cash flow characteristics of the financial asset.
The objective of the business model within which the asset is held is to hold
assets in order to collect contractual cash flows, and
(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
outstanding.
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367
(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
outstanding.
Other financial assets that do not meet these criteria are measured at fair value
through profit or loss.
5.2.1 Application of classification criteria
An application of these rules means that:
Equity investments are classified as measured at fair value through profit or
loss. This is because contractual cash flows on specified dates are not a
characteristic of equity instruments. An entity may make an irrevocable
election at initial recognition to measure an equity instrument at fair value
through other comprehensive income. This is allowed where the instrument is
not held for trading.
Derivatives are measured at fair value
Debt instruments may be classified as measured at either amortised cost or
fair value depending on whether they meet the criteria above. Even where
the criteria are met at initial recognition, a debt instrument may be classified as
measured at fair value through profit or loss if doing so eliminates or
significantly reduces a measurement or recognition inconsistency (sometimes
referred to as an 'accounting mismatch') that would otherwise arise from
measuring assets or liabilities or recognising the gains and losses on them on
different bases.
5.2.2 Reclassification of financial assets
SLFRS 9 requires that where an entity changes its business model for managing
financial assets, it should reclassify all affected financial assets. This
reclassification applies only to debt instruments as equity instruments must be
measured at fair value.
Financial liabilities may not be reclassified.
QUESTION
Classification
ANSWER
No, because of the inclusion of the conversion option, which is not deemed to
represent payments of principal and interest
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369
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(b)
An accounting view that seeks to address the risk management issue of the
timing of recognition of gains and losses.
Although the categories of hedge remain the same as those under LKAS 39 and the
accounting treatment of each is largely unchanged, SLFRS 9 introduces new rules
as to which relationships qualify for hedge accounting.
5.8.1 Qualifying for hedge accounting
SLFRS 9 permits hedge accounting only if:
CA Sri Lanka
(1)
(2)
(3)
(b)
The effect of credit risk does not dominate the value changes that
result from that economic relationship, ie the gain or loss from credit
risk does not frustrate the effect of changes in the underlyings on the
value of the hedging instrument or the hedged item, even if those
changes were significant.
371
(c)
372
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effective portion to profit or loss when the hedged item affects earnings is
removed.
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373
Reinsurer
compensates for
losses
Insurer
compensates for
losses
Policyholder
The following are examples of insurance contracts if the transfer of insurance risk
is significant:
(a)
(b)
(c)
(d)
(e)
(f)
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Guarantees
Letters of credit
Credit derivative default contracts or
Insurance contracts.
CA Sri Lanka
These contracts are within the scope of LKAS 32/39 and not within the scope of
SLFRS 4, however if an issuer of such a contract has previously explicitly asserted
that it regards the contract as an insurance contract and has used accounting
applicable to insurance contracts, it may elect to continue to do so.
To date the IASB has issued two exposure drafts, one in 2010 and another in 2013.
The IASB is currently redeliberating the proposals and a final standard is expected
at the end of 2015 at the earliest.
6.3.1 Proposals
The ED issued in 2013 builds on the proposals of the earlier ED. It proposes that
insurance contracts are reflected in the financial statements in the following ways:
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375
7.1 Objective
The objective of the SLFRS is to require entities to provide disclosures in their
financial statements that enable users to evaluate:
(a)
(b)
The nature and extent of risks arising from financial instruments to which
the entity is exposed during the period and at the reporting date, and how
the entity manages those risks
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(b)
Reason for any reclassification between fair value and amortised cost (and
vice versa)
(c)
Details of the assets and exposure to risk where the entity has made a
transfer such that part or all of the financial assets do not qualify for
derecognition.
(d)
(e)
When financial assets are impaired by credit losses and the entity records
the impairment in a separate account (eg an allowance account used to
record individual impairments or a similar account used to record a
collective impairment of assets) rather than directly reducing the carrying
amount of the asset, it must disclose a reconciliation of changes in that
account during the period for each class of financial assets.
(f)
(g)
(b)
Interest income/expense
(c)
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377
Hedge Accounting
Disclosures must be made relating to hedge accounting, as follows:
(a)
Description of hedge
(b)
(c)
(d)
For cash flow hedges, periods when the cash flows will occur and when
will affect profit or loss
(e)
For fair value hedges, gains or losses on the hedging instrument and the
hedged item
(f)
Fair values
SLFRS 7 retains the following general requirements in relation to the disclosure of
fair value for those financial instruments measured at amortised cost:
(a)
For each class of financial assets and financial liabilities an entity should
disclose the fair value of that class of assets and liabilities in a way that
permits it to be compared with its carrying amount.
(b)
In disclosing fair values, an entity should group financial assets and financial
liabilities into classes, but should offset them only to the extent that their
carrying amounts are offset in the statement of financial position.
For assets and liabilities measured at fair value after initial recognition, the
valuation techniques and inputs used to develop those measurements.
(b)
For recurring fair value measurements (ie those measured at each period
end) using significant unobservable (Level 3) inputs, the effect of the
measurements on profit or loss or other comprehensive income for the
period.
In order to achieve this, the following should be disclosed as a minimum
for each class of financial assets and liabilities measured at fair value.
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(c)
(d)
The level of the fair value hierarchy within which the fair value
measurements are categorised in their entirety.
(e)
For assets and liabilities measured at fair value at each reporting date
(recurring fair value measurements), the amounts of any transfers between
Level 1 and Level 2 of the fair value hierarchy and reasons for the transfers.
(f)
(g)
For recurring fair value measurements categorised within Level 3 of the fair
value hierarchy:
(i)
(ii)
An entity should also disclose its policy for determining when transfers between
levels of the fair value hierarchy are deemed to have occurred.
7.2.4 Example: Fair value disclosures
For assets and liabilities measured at fair value at the end of the reporting period,
the SLFRS requires quantitative disclosures about the fair value measurements for
each class of assets and liabilities. An entity might disclose the following for assets:
Rs Mn
Description
Trading equity securities
Non-trading equity securities
Corporate securities
Derivatives interest rate
contracts
Total recurring fair value
measurements
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31.12.X9
45
32
90
78
245
159
32
379
Currency
risk
The risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in foreign exchange
rates.
Interest rate
risk
The risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in market interest
rates.
Liquidity
risk
Loans
payable
Market risk
The risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in market prices.
Market risk comprises three types of risk: currency risk, interest
rate risk and other price risk.
Other price
risk
The risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in market prices
(other than those arising from interest rate risk or currency
risk), whether those changes are caused by factors specific to the
individual financial instrument or its issuer, or factors affecting all
similar financial instruments traded in the market.
Past due
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(b)
Its objectives, policies and processes for managing the risk and the methods
used to measure the risk
(c)
(b)
(c)
(d)
Information about the credit quality of financial assets that are neither past
due nor impaired
(e)
Financial assets that are past due or impaired, giving an age analysis and a
description of collateral held by the entity as security
(f)
Collateral and other credit enhancements obtained, including the nature and
carrying amount of the assets and policy for disposing of assets not readily
convertible into cash
(b)
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QUESTION
Wijekoon Supplies (Pvt) Ltd purchased 0.5% of the shares in a listed company for
Rs. 180 Mn on 15 March 20X7. Transaction costs were Rs. 500,000. Wijekoon
Supplies intends to hold the shares for several years. At the year-end the shares
have a fair value of Rs. 200 Mn.
Required
382
(a)
Analyse the implications of the scenario above for the financial statements
of Wijekoon Supplies for the year ended 31 December 20X7. Give suitable
calculations where possible.
(b)
Advise how the change in value would be accounted for if, at the following
year end 31 December 20X8, the company issuing the shares experienced
financial difficulties and the shares were only worth Rs60m?
CA Sri Lanka
ANSWER
(a)
The shares are a financial asset in the books of Wijekoon Supplies. LKAS 39
Financial Instruments: Recognition and Measurement sets out four categories
of financial assets for accounting purposes:
Rs. 140 Mn
CREDIT
Rs. 140 Mn
CA Sri Lanka
DEBIT
Profit or loss
Rs. 120 Mn
CREDIT
Rs. 120 Mn
383
QUESTION
At 1 January 20X4 Oceanic Co acquired a debt instrument with a principal amount
of Rs. 10 Mn at a fixed interest rate of 6% per annum. This is classified as a FVTPL
financial asset and the fair value of the instrument at the acquisition date is
Rs. 10 Mn.
On the same date Oceanic Co enters into an interest rate swap exchanging the
fixed interest rate payments on the debt instrument for floating interest rate
payments in order to offset the risk of a fall in the fair value of the instrument. On
1 January 20X4, Oceanic designates and documents the swap as a hedging
instrument and the hedge as a fair value hedge. On this date the swap has a fair
value of zero.
At 31 December 20X4, market interest rates have increased to 7% and the fair
value of the debt instrument has decreased to Rs. 9.62 Mn. The fair value of the
swap at this date has increased by Rs. 450,000 Mn.
Required
Illustrate the impact of these transactions on the financial statements of Oceanic Co.
ANSWER
Hedge effectiveness =
20X3
Rs'000
10,000
Rs'000
(380)
450
31
December
20X3
Rs'000
9,620
450
(380)
450
70
This results in an ineffective hedge of Rs. 70,000 gain recognised in profit or loss.
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CHAPTER ROUNDUP
Financial assets should be derecognised when the rights to the cash flows from
the asset expire or where substantially all the risks and rewards of ownership
are transferred to another party.
A derivative is a financial instrument that derives its value from the price or rate
of an underlying item. Embedded derivatives may require separation from
their host contract for accounting purposes.
A hedge arises where the change in fair value of one item is offset by the change in
fair value or cash flows of another item. Hedge accounting is permitted in certain
circumstances, provided that the hedging relationship is clearly defined,
measureable and actually effective.
There are three types of hedge: fair value hedge, cash flow hedge and hedge of a
net investment in a foreign operation. The accounting treatment depends on the
type of hedge.
The complete version of SLFRS 9 Financial Instruments was issued in 2014. It is the
same as IFRS 9, which was the culmination of a long-term project by the IASB and
FASB to improve and simplify accounting for financial instruments. The standard
becomes effective on 1 January 2018, and from this date replaces LKAS 39.
SLFRS 7 specifies the disclosures required for financial instruments. The standard
requires qualitative and quantitative disclosures about exposure to risks
arising from financial instruments and specifies minimum disclosures about credit
risk, liquidity risk and market risk.
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PROGRESS TEST
386
What are treasury shares and how are they accounted for?
How are available for sale financial assets initially and subsequently measured?
When is an embedded derivative separate from its host contract for accounting
purposes?
10
11
What is a key difference between the LKAS 39 and the SLFRS 9 impairment
model?
12
The objective of SLFRS 7 is to provide disclosures that allow the user to evaluate
what?
CA Sri Lanka
Treasury shares arise when an entity reacquires its own equity instruments; they
are deducted from equity and no gain or loss is recognised in profit or loss.
Initially at fair value plus transaction costs and subsequently at fair value with
changes in value recognised in other comprehensive income.
The impairment loss is the difference between the asset's carrying amount and its
recoverable amount. The asset's recoverable amount is the present value of
estimated future cash flows, discounted at the financial instrument's original
effective interest rate.
When:
(a)
The economic characteristics and risks of the embedded derivative are not
closely related to those of the host contract, and
(b)
(c)
The hybrid instrument is not measured at fair value with changes recognised
in profit or loss (in which case there is no benefit to separating the
embedded derivative).
Between 80% 125% effective (ie the ratio of the gain or loss on the hedging
instrument compared to the gain or loss on the hedged item is 80%-125%)
Changes in the fair value of the hedging instrument are recognised in profit or
loss; changes in the fair value of the hedged item are also recognised in profit or
loss so that the gains / losses on the hedged item and instrument are matched.
Amortised cost, fair value through other comprehensive income (FVTOCI) and fair
value through profit or loss (FVTPL).
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388
10
Equity instruments are always measured at fair value. An irrevocable election may
be made at initial recognition to measure an equity instrument at FVTOCI rather
than FVTPL.
11
The LKAS 39 model is an incurred loss model (ie losses that have arisen are
recognised) whereas the SLFRS 9 model is an expected loss model (ie losses are
recognised before they arise).
12
(a)
(b)
The nature and extent of risks arising from financial instruments to which
the entity is exposed during the period and at the reporting date, and how
the entity manages those risks
CA Sri Lanka
CHAPTER
INTRODUCTION
Many companies reward their employees by way of short and long term benefits
including holiday pay and pension plans. An increasing number of companies
also provide employees with share-based payments including share options and
share appreciation rights schemes. LKAS 19 Employee Benefits deals with short
and long term benefits, whilst SLFRS 2 deals with share-based payments.
This chapter expands the knowledge acquired at the KB1 level in respect of
these two standards. It also introduces LKAS 26 Accounting and Reporting by
Retirement Benefit Plans.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.2
Level B
1.1.7
1.2.1
1.2.2
1.2.3
1.2.4
1.2.5
389
CHAPTER CONTENTS
1 LKAS 19 Employee Benefits
2 SLFRS 2 Share-based Payment
3 LKAS 26 Accounting and Reporting by Retirement Benefit Plans
390
CA Sri Lanka
1.1 Introduction
Employee benefits are all forms of consideration given by an entity in exchange for
services performed by employees. LKAS 19 recognises 4 types:
1
Short-term benefits eg salaries, sick leave, maternity leave and annual leave
1.2 Definitions
Definitions within the standard include the following:
Types of employee benefit
Short-term employee benefits are employee benefits (other than termination
benefits) that are expected to be settled wholly before twelve months after the
end of the annual reporting period in which the employees render the related
service.
Post-employment benefits are employee benefits (other than termination
benefits and short-term employee benefits) that are payable after the completion
of employment.
Other long-term employee benefits are all employee benefits other than shortterm employee benefits, post-employment benefits and termination benefits.
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391
(b)
Types of plan
Post-employment benefit plans are arrangements under which an entity
provides post-employment benefits for one or more employees.
Defined contribution plans are post-employment benefit plans under which an
entity pays fixed contributions into a separate entity (a fund) and will have no
legal or constructive obligation to pay further contributions if the fund does not
hold sufficient assets to pay all employee benefits relating to employee service in
the current and prior periods.
Defined benefit plans are post-employment benefit plans other than defined
contribution plans.
Multi-employer plans are plans that
(a)
Pool the assets contributed by various entities that are not under common
control, and
(b)
Use those assets to provide benefits to employees of more than one entity on
the basis that contribution and benefit levels are determined without regard
to the identity of the entity that employs the employees.
The asset ceiling is the present value of any economic benefits available in the
form of refunds from the plan or reductions in future contributions to the plan.
The present value of a defined benefit obligation is the present value, without
deducting any plan assets, of expected future payments required to settle the
obligation from employee service in the current and prior periods.
Plan assets comprise:
(a)
392
(b)
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.
Service cost comprises:
(a)
Current service cost, which is the increase in the present value of the defined
benefit obligation resulting from employee service in the current period
(b)
Past service cost, which is the change in the present value of the defined
benefit obligation for employee service in prior periods, resulting from a
plan amendment or a curtailment, and
(c)
Net interest on the net defined benefit liability (asset) is the change during the
period in the net defined benefit liability (asset) that arises from the passage of
time.
Remeasurements of the net defined benefit liability (asset) comprise:
(a)
(b)
The return on plan assets, excluding amounts included in net interest on the
net defined benefit liability (asset), and
(c)
Any change in the effect of the asset ceiling, excluding amounts included in
net interest on the net defined benefit liability (asset).
Actuarial gains and losses are changes in the present value of the defined benefit
obligation resulting from:
(a)
(b)
The return on plan assets is interest, dividends and other income derived from
the plan assets together with realised and unrealised gains or losses on the plan
assets less any costs of managing plan assets and any tax payable by the plan other
than that included in actuarial assumptions.
A settlement is a transaction that eliminates all further legal or constructive
obligations for part or all of the benefits provided under a defined benefit plan,
other than a payment of benefits to or on behalf of employees as set out in the
terms of the plan and included in actuarial assumptions.
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393
QUESTION
Holiday leave
The accountant of Asia Traders (Pvt) Ltd has prepared draft financial statements
at 31 December 20X3 including the following amounts:
Liability for paternity pay
Liability for holiday pay
394
Rs. 20,000
Rs. 290,000
CA Sri Lanka
The liability for paternity pay is in respect of an employee who was permitted to
take 2 weeks of leave within 3 months of the birth of his child. The child was born
in August 20X3 and no leave has been taken.
The liability for holiday pay was calculated based on 100 days of holiday carried
forward to 20X4 and an average daily wage of Rs. 2,900. Any employees who leave
Asia Traders are not entitled to a cash payment in respect of unused holiday
entitlement; staff turnover is 10% per annum on average.
Required
Comment on the validity of the amounts recognised in the financial statements of
Asia Traders at 31 December 20X3.
ANSWER
Paternity pay
Paternity pay is a short-term employee benefit.
It is non-accumulating in that any entitlement not used within the specified
period may not be carried forward.
Therefore no liability should be recognised for the paternity pay.
The liability and associated expense entry should be reversed in the financial
statements.
Had the leave been taken by the employee during the specified time, an expense
would have been recognised at that time.
Holiday pay
Holiday pay is also a short-term benefit.
It is clear from the information that it is an accumulating paid absence ie
unused entitlement is carried forward.
It is also clear that the accumulating paid absence is non-vesting ie it is not paid
in cash at such time as an employee leaves Asia Traders.
Therefore measurement of the liability should take into account the unused
entitlement that is expected to be used in the future, but ignore that entitlement
relating to employees who are expected to leave.
Based on the information given and an average staff turnover of 10%, a more
accurate estimation of the liability may be Rs. 261,000 (Rs. 2,900 100 days
90%).
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395
PENSION
PLAN
Variable
benefits
depending on
how well plan
performs
The entitys legal or constructive obligation is limited to the amount that it agrees
to contribute to the fund (the fixed contribution); the risk lies with the employee
who may receive lower benefits than expected.
Defined benefit plans
Variable
contributions
depending on
how well plan
performs
PENSION
PLAN
Fixed benefits
The entitys obligation is to provide the agreed benefits; the risk lies with the
entity as they may be obliged to increase contributions.
1.4.1 Multi-employer plans
Multi-employer plans are run for the benefit of several entities: various entities
contribute to the pool and the employees of those entities benefit on retirement.
Multi-employer plans may be defined contribution plans or defined benefit plans.
A multi-employer defined contribution plan is accounted for in the normal way; a
multi-employer defined benefit plan is also accounted for in the normal way, but
only to the extent to which an entity participates in it (ie a proportion of the
surplus / deficit and related costs are recognised). If the extent to which an entity
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CA Sri Lanka
QUESTION
Grand Designs Ltd contributes 7% of all employees salaries into a postemployment plan each period. The assets of the plan are held separately from
those of the company under the control of trustees. Salaries amounted to
Rs. 29 Mn in the year ended 31 December 20X4 and the company had paid
Rs. 1.9 Mn into the plan by the reporting date.
Required
Provide extracts from the financial statements of Grand Designs Ltd for the year
ended 31 December 20X4 together with relevant disclosure notes.
ANSWER
Statement of profit or loss
Rs'000
31,030
130
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397
The total cost charged to profit or loss of Rs. 2,030,000 represents contributions
payable to this plan at rates specified in the rules. At 31 December 20X4,
contributions of Rs. 130,000 due in respect of the current reporting period had not
been paid to the plan.
(X)
X/(X)
Where a net defined benefit asset arises, this is recognised in the financial
statements subject to the asset ceiling.
Note that the defined benefit obligation refers not only to the legal obligation
under the formal terms of a defined benefit plan that an entity must account for,
but also for any constructive obligation that it may have. A constructive
obligation, which will arise from the entity's informal practices, exists when the
entity has no realistic alternative but to pay employee benefits, for example if any
change in the informal practices would cause unacceptable damage to employee
relationships.
LKAS 19 advocates a 4-step approach to accounting for a defined benefit plan:
1.
2.
3.
4.
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CA Sri Lanka
This process should take place with sufficient regularity that reported amounts
are not materially different from the actual value at the reporting date.
Measurement involves three steps:
The cost of providing future benefits is estimated using the projected unit
credit method. This method assumes that each period of employee service
results in an additional unit of future benefit. These are measured separately
and then added together to measure the total obligation. The actuary will
employ a number of assumptions in this process, both demographic eg
mortality rates and employee turnover rates and financial eg the discount
rate and benefit levels.
The total obligation is discounted to present values using a rate determined
by reference to market yields at the end of the reporting period on high
quality corporate bonds.
Plan assets are measured at fair value (excluding unpaid contributions due
from an employer and less any liabilities of the fund that do not relate to
employee benefits).
1.6.2 Determine the amount of the net defined benefit liability or asset
The net defined benefit liability or asset is measured as the present value of the
defined benefit obligation at the reporting date minus the fair value of the plan
assets at the reporting date.
Where the resulting net amount is a surplus (the fair value of the assets exceeds
the present value of the obligation), the amount of the surplus that is recognised
may be limited by the asset ceiling (section 1.6.8).
1.6.3 Determine the amounts to be recognised in profit or loss
Service costs and the net interest on the defined benefit asset or liability are
recognised in profit or loss.
Service costs include current service cost, past service cost and gains or losses on
settlement of a defined benefit plan.
Current service cost is the increase in the present value of the defined benefit
obligation as a result of employees rendering service in the current period.
This is charged to operating expenses
Past service cost is the change in the present value of the defined benefit
obligation as a result of amendments or curtailments to the pension plan.
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399
The net interest on the defined benefit asset or liability includes the return on plan
assets and the unwinding of the discount on the obligation. It is calculated as:
Discount rate
Determined by reference
to year end market yields
on high quality fixed-rate
corporate bonds.
2.
The return on plan assets (excluding amounts included in net interest on the
net defined benefit liability)
3.
Any change in the effect of the asset ceiling (again excluding amounts
included in net interest on the net defined benefit liability).
Practically actuarial gains and losses is the difference between the obligation as
brought forward and adjusted for amounts paid out, service costs and interest and
the obligation at the end of the period as measured by the actuary.
The return on plan assets is the difference between the plan assets brought
forward and adjusted for amounts paid out, contributions paid in and interest and
plan assets at the end of the period as measured by the actuary.
Remeasurements are recognised in other comprehensive income and are never
reclassified to profit or loss.
1.6.5 Summary of reconciling items defined benefit plans
The following table shows the main items which reconcile the balance of a defined
benefit asset or liability at the start and end of a period. It does not include past
service costs, gains or losses on settlement or the effect of the asset ceiling.
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CA Sri Lanka
Balance at start of
year
Contributions in
Benefits paid
Current service
cost
Interest (5%)
As measured
Remeasurements
As advised by
actuary at end of
year
PV of DB obligation
Rs'000
13,000
1,000
(900)
(900)
1,200
500
10,600
(100)
10,500
QUESTION
650
13,950
50
14,000
Net deficit
Rs'000
(3,000)
1,000
(1,200)
(150)
(3,350)
(150)
(3,500)
The financial controller of Trincomalee Motors Ltd has sent you the following
email to ask for your advice in the preparation of the financial statements for the
year ended 31 December 20X4:
EMAIL
To: Chaturi de Silva
From: Asanka Weerasinghe
Re: Pension scheme accounting
Chaturi,
As you know I have recently returned from an extended leave, during which I
believe the accounting rules with regard to defined benefit pensions have
changed. I am therefore a little unsure as to what amounts should be recognised
in our financial statements. I have prepared a draft working and I would be
grateful if you would review it and report back to me whether it adheres to the
new rules.
Kind regards,
Asanka
CA Sri Lanka
401
Draft working
B/f
Contributions
paid (31.12.X4)
Benefits paid out
(31.12.X4)
Interest income at
5%
Interest cost at
6%
Actuarial
difference
Advised by
actuary
Asset
Rs'000
8,900
1,000
(300)
Obligation
Rs'000
10,100
Recognised in
profit or loss:
Rs 1 Mn expense
(300)
9,600
480
9,800
588
10,080
(100)
10,388
502
9,980
10,890
Rs 480,000
income
Rs588,000
expense
Rs 402,000
income
Required
Prepare notes for a meeting with Asanka which explain whether the draft working
conforms to the requirements of LKAS 19.
ANSWER
Notes for meeting
Contributions paid are not an expense; this accounting treatment is relevant to
defined contribution schemes where contributions due in a year are recognised
as an expense.
In the case of a defined benefit scheme, the correct accounting entry for cash
contributions to a scheme is:
DEBIT
CREDIT
You have correctly reduced both the asset and obligation by the benefits paid
out in the year.
Interest must be calculated on the net defined benefit asset or liability.
Although practically interest can be calculated separately on the asset and
liability, the same discount rate should be applied to both. This should be
determined by reference to year-end market yields on high quality fixed-rate
corporate bonds.
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2.
The past service cost is the change in the present value of the defined benefit plan
as a result of the amendment or curtailment. It may be positive (where additional
benefits are introduced) or negative (where existing benefits are withdrawn).
Past service costs are recognised in profit or loss as the earlier of
CA Sri Lanka
(a)
(b)
403
the present value of the defined benefit obligation being settled, valued at
the date of settlement, and
(b)
the settlement price including any plan assets transferred and any payments
made directly by the entity in connection with the settlement.
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CA Sri Lanka
reporting period that the entity has a right to receive as a refund less associated
costs.
Where economic benefits are available as a reduction in contributions, the
economic benefits are measured as the future service cost to the entity for each
period over the shorter of the expected life of the plan and the expected life of
the entity.
If minimum funding requirements exist, these are split into contributions
required to cover any existing shortfall for past service and contributions to
cover future service. The economic benefit available as a reduction in future
contributions is the sum of:
Any amount that reduces future minimum funding requirement
contributions for future service because the entity made a prepayment, and
The estimated future service cost in each period less the estimated minimum
funding requirement contributions that would be required for future service
in those periods if there were no prepayment.
1.6.9 Disclosure
A reporting entity with a defined benefit pension plan should disclose information
that:
(a)
explains the characteristics of its defined benefit plans and risks associated
with them;
(b)
identifies and explains the amounts in its financial statements arising from
defined benefit plans, and
(c)
describes how defined benefit plans may affect the amount, timing and
uncertainty of the entitys future cash flows.
CA Sri Lanka
405
406
CA Sri Lanka
Group
Group
2014
2013
2014
2013
1,385,072
121,138
(5,108)
1,372,161
110,096
(7,423)
134,075
8,434
(4,034)
126,864
7,796
(7,516)
152,358
(163,362)
137,216
(117,217)
14,748
(5,047)
12,686
(4,148)
51,981
(109,726)
(1,314)
(1,607)
(295)
1,541,784
(35)
1,385,072
146,862
134,075
The expenses are recognised in the income statement in the following line
items;
Cost of sales
Distribution expenses
Administrative
expenses
131,633
17,463
93,332
13,702
9,932
8,092
124,400
273,496
140,278
247,312
13,250
23,182
12,390
20,482
The employee benefit liability of the Group is based on the actuarial valuations
carried out by Messrs. Actuarial & Management Consultants (Pvt) Ltd., actuaries.
The principal assumptions used in determining the cost of employee benefits
were:
2014
2013
Discount rate
11%
11%
Future salary increases
6% - 10%
6% - 10%
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407
Salary increment
2014
Group
Company
(55,037)
(6,961)
(86,845)
(5,337)
78,563
7,234
45,754
7,615
58,619
5,690
(86,613)
(7,650)
2014
Group
247,404
338,509
420,425
341,282
194,164
1,541,784
Company
4,702
20,856
84,771
18,748
17,785
146,862
The Group and Companys weighted average duration of defined benefit obligation
is 5.80 years and 5.50 years respectively.
[Extracted from http://www.keells.com/annual-report-flash-2014/sources/indexPop.htm]
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CA Sri Lanka
Service cost
Net interest on the defined benefit liability (asset)
Re-measurement of the defined benefit liability (asset)
(b)
(c)
2.1 Definitions
A number of definitions are provided by SLFRS2:
A share-based payment arrangement is an agreement between the entity (or
another group entity) and another party that entitles the other party to receive:
CA Sri Lanka
(a)
Cash or other assets of the entity for amounts that are based on the price (or
value) of equity instruments of the entity or another group entity, or
(b)
409
(b)
CA Sri Lanka
(b)
Shall not extend beyond the end of the service period; and
(b)
May start before the service period on the condition that the commencement
date of the performance target is not substantially before the
commencement of the service period.
(b)
The price (or value) of the entitys equity instruments or the equity
instruments of another entity in the same group, including shares and share
options (ie a market condition).
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CA Sri Lanka
price of an equity instrument issued. These are taken into account when
estimating the fair value of equity instruments granted. They are not, however,
taken into account when estimating how many equity instruments will vest for the
purposes of measuring equity-settled share-based payments.
In summary therefore:
Relevant when determining:
the fair value of
instruments granted
the number of
instruments expected to
vest
Service conditions
Market performance
conditions
Non-market performance
conditions
Non-vesting conditions
QUESTION
You are the new Financial Controller at Liyanage Supplies PLC. The Board of
Directors have suggested that a new share option scheme is introduced in order to
reward the companys 400 employees. You have received the following email from
the Chief Operating Officers assistant:
To:
From:
Date:
Subject:
Financial Controller
PA to Athula Da Silva
13 December 20X0
Share option scheme
Hi Chandrika
Athula has asked me to contact you to ask for advice about the proposed new
share option scheme.
The plan is to introduce the scheme on 1 January 20X1, and on this date 100 share
options will be granted to each of our 400 employees. The options become
available to the employees only if they still work for the company on 31 December
20X3.
Athula says that for the purpose of providing illustrative calculations you should
assume the following:
the fair value of each option will be Rs. 20 on 1 January 20X1 and then Rs. 25,
Rs. 30 and Rs. 35 on 31 December 20X1, 20X2 and 20X3 respectively.
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413
ANSWER
This is an equity-settled share-based payment option.
SLFRS 2 requires the company to recognise an expense in respect of the scheme
in each of 20X1, 20X2 and 20X3 as the employees provide service.
The corresponding entry is to equity, therefore the Board should not be
concerned about the recognition of a liability.
The total amount to be recognised as an expense and as equity is based on the
number of options expected to vest ie the number of options that employees
will be entitled to on 31 December 20X3.
As 55 of the 400 employees are expected to leave over the 3 years of the
scheme, only 345 employees options will vest.
Therefore the total expense/equity to be recognised over the three year period
would be Rs. 690,000 (345 employees 100 options Rs. 20).
This is based on the fair value of the options at the grant date. The fair value of
the options at subsequent dates is irrelevant and calculations should not be
adjusted for this.
The Rs. 690,000 is spread over the three years of the vesting period ie until the
date on which employees are entitled to the options.
Therefore, based on our illustrative figures, each year an expense of
Rs. 230,000 is recognised and a similar amount accumulated in equity.
Note, however that if the estimated number of employees still employed at the
vesting date changes throughout the 3 year vesting period, this must be taken
into account in the calculations.
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2.2.4 Cancellations
An entity may cancel (or settle) equity instruments that it has previously granted.
Where this occurs:
The cancellation / settlement is treated as an acceleration of vesting and any
amount of the fair value of instruments at the grant date that has not yet been
recognised is recognised immediately.
Any payment made to an employee is accounted for as a deduction from equity
up to the repurchase date fair value of equity instruments granted. Any excess
is recognised as an expense.
If new equity instruments are granted to the employee as replacement for
cancelled equity instruments, this is treated as a modification of the original
instruments (see next section). The incremental fair value is the fair value of
the cancelled instruments immediately before cancellation less any payment
made to an employee on cancellation that is treated as a deduction in equity.
If new equity instruments are granted to the employee but not identified as a
replacement, they are accounted for as a new grant of instruments.
2.2.5 Example: Cancellations
Meepitiya Exports PLC granted 5,000 share options to each of its 10 managers on
1 January 20X5. The terms and conditions attached to the options required
continued employment until 31 December 20X7 in order for the options to vest.
At 1 January 20X5 the options had a fair value of Rs. 50 and it was expected that 8
managers would remain in employment until the vesting date.
On 30 June 20X6, the Board of Meepitiya cancelled the share option scheme,
deciding instead to reward management through a bonus scheme. On the
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415
cancellation date the fair value of the options was Rs. 60 and the market price of a
Company share was Rs. 96. Of the original 10 managers, 9 remained in
employment at this date and each was paid Rs. 64 per share option in
compensation.
Required
How is the cancellation recognised?
Solution
The original cost to Meepitiya Exports for the scheme was Rs. 2 Mn (5,000 8
Rs. 50).
An expense of Rs. 666,667 (Rs. 2 Mn/3years) was therefore recognised in 20X5
At the cancellation date the cost based on the number of options vested at that
date is Rs. 2.25 Mn (5,000 9 Rs. 50).
The charge to profit or loss in 20X6 is therefore Rs. 1,583,333 (Rs. 2.25 Mn
Rs. 666,667).
Compensation paid amounts to Rs 2.88 Mn (5,000 9 Rs. 64)
The amount of this attributable to the fair value of the options cancelled is
Rs 2.7 Mn (5,000 9 Rs. 60).
This is deducted from equity as a share buy back; the remaining Rs. 180,000 is
charged to profit or loss.
2.2.6 Modifications
An entity may modify the terms and conditions on which equity instruments are
granted. For example the exercise price may be changed, so affecting the fair value
of the instrument, additional instruments may be granted, or vesting conditions
may be changed.
SLFRS 2 requires that, in the case of a modification:
1.
2.
The effect of modifications that increase the fair value of the share-based
payment arrangement or otherwise benefit the employee are recognised in
addition.
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CA Sri Lanka
QUESTION
On 1 January 20X2Asia Imports PLC grants 200 cash share appreciation rights
(SARs) to each of its 800 employees, on condition that the employees continue to
work for the entity until 31 December 20X4.
During 20X2 55 employees leave. The company estimates that a further 70 will
leave during 20X3 and 20X4.
During 20X3 36 employees leave and the company estimates that a further 25 will
leave during 20X4.
During 20X4 27 employees leave.
At 31 December 20X4 250 employees exercise their SARs. Another 190 employees
exercise their SARs at 31 December 20X5 and the remaining employees exercise
their SARs at the end of 20X6.
The fair values of the SARs for each year in which a liability exists are shown
below, together with the intrinsic values (equal to the cash paid out) at the dates
of exercise.
Fair value
Intrinsic
value
Rs.
Rs.
20X2
18.50
20X3
19.50
20X4
20.00
18.00
20X5
21.40
19.00
20X6
25.00
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CA Sri Lanka
Required
Calculate the amount to be recognised in the profit or loss for each of the five
years ended 31 December 20X6 and the liability to be recognised in the statement
of financial position at 31 December for each of the five years.
ANSWER
For the three years to the vesting date of 31 December 20X4 the expense is based
on the entity's estimate of the number of SARs that will actually vest. The fair
value of the liability is re-measured at each year-end.
The intrinsic value of the SARs at the date of exercise is the amount of cash
actually paid.
Liability
Expense
Expense
at
for
year-end
year
Rs.
Rs.
Rs.
20X2
Expected to vest (800 125):
675 200 18.50 1/3
832,500
832,500
20X3
Expected to vest (800 116):
684 200 19.50 2/3
1,778,400
945,900
20X4
Exercised:
250 200 18.00
900,000
Not yet exercised (800 118 250)
432 200 20.00
1,728,000
(50,400)
849,600
20X5
Exercised:
190 200 19.00
722,000
Not yet exercised (253 140):
242 200 21.40
1,035,760
(692,240)
29,760
20X6
Exercised:
242 200 25.00
1,210,000
Nil
(1,035,760)
174,240
2,832,000
419
QUESTION
Choice of settlement
Rs. 90.00
Rs. 95.00
Rs. 110.00
Rs. 125.00
On 28 February 20X6, the director opts to receive the shares. The fair value of the
share route is estimated to be Rs. 86.00 per share.
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CA Sri Lanka
Required
Advise CCC how this transaction should be accounted for in each relevant year.
ANSWER
At the grant date:
The fair value of the cash route is Rs. 8,550,000 (95,000 Rs. 90.00)
The fair value of the share route is Rs. 8,600,000 (100,000 Rs. 86.00)
The fair value of the equity component is therefore Rs. 50,000 (Rs. 8.6 Mn
Rs. 8.55 Mn)
The transaction is therefore recognised as:
Liability
Rs.
28 February 20X4
95,000 Rs 95.00 1/3
3,008,333
Rs 50,000 1/3
28 February 20X5
95,000 Rs 110.00 2/3
6,966,667
Rs 50,000 1/3
28 February 20X6
95,000 Rs 125.00
11,875,000
Rs 50,000 1/3
Equity
Rs.
Expense
Rs.
16,667
3,008,333
16,667
16,667
3,958,334
16,667
16,667
4,908,333
16,667
On 28 February 20X6, since the director opts to receive shares rather than cash,
Rs. 11,875,000 is transferred from liabilities to equity, so resulting in an equity
balance of Rs. 11,925,000 (Rs. 11,875,000 + Rs. 50,000).
CA Sri Lanka
421
Entity
Obligation to Settlement
settle
in
receiving
goods/services
Subsidiarys
individual
financial
statements
Consolidated
financial
statements
Subsidiary
Subsidiary
Equity of the
subsidiary
Equitysettled
Equitysettled
Subsidiary
Subsidiary
Cash
Cash-settled
Cash-settled
Subsidiary
Subsidiary
Equity of
parent
Cash-settled
Equitysettled
Subsidiary
Parent
Equity of
parent
Equitysettled
Equitysettled
Subsidiary
Parent
Cash
Equitysettled
Cash-settled
The accounting expense is recognised over the vesting period, however the
related tax deduction is not available until the options granted are exercised.
2.
The accounting expense is based on the fair value of the options at the grant
date whereas the tax allowance is based on the share price at the exercise
date.
X
(X)
X
The tax base is the estimated amount that the tax authorities will allow as a
deduction in the future based on information at the reporting date.
If the estimated future tax deduction exceeds the amount of the cumulative
expense, this indicates that the tax deduction also relates to an equity item and
therefore the excess is recognised directly in equity.
422
CA Sri Lanka
Rs.
750,000
(375,000)
375,000
105,000
2.
3.
2.7 Disclosures
SLFRS 2 requires that information should be disclosed that enables users of the
financial statements to:
CA Sri Lanka
1.
2.
Understand how the fair value of the goods or services received or the fair
value of the equity instruments granted during the period was determined.
423
3.
(b)
(c)
The weighted average share price of share options exercised during the
period as at the date of exercise. Example:
The weighted average share price at the date of exercise for share options
exercised during the period was Rs X.
(d)
The range of exercise prices and weighted average remaining contractual life
for share options outstanding at the end of the period. Example:
The options outstanding at the end of the year had a weighted average
exercise price of RsX and a weighted average remaining contractual life of X
years.
424
CA Sri Lanka
For share options granted during the period, the weighted average fair value
of those options at the measurement date and information on how the fair
value was measured. Example:
In 20XX, options were granted on 1 August. The aggregate of the estimated
fair values of the options granted on that date is Rs X. The fair value of the
options was measured using the Black Scholes model and the following
inputs:
Weighted average share price
Rs X
Rs X
Expected volatility
Expected life
X years
X%
X%
(b)
For other equity instruments granted in the period, the number and
weighted average fair value of those instruments at the measurement date
and information on how fair value was measured.
(c)
CA Sri Lanka
425
(b)
(ii)
the total intrinsic value at the end of the period of liabilities for which
the right to cash had vested. Example:
payment
transactions
with
an
attached
IFRS 2 (SLFRS 2) does not currently address the effect of vesting conditions on the
fair value of a cash-settled share-based payment. The amendments proposed to
IFRS 2 (SLFRS 2) clarify that the accounting treatment should adopt the same
approach as that applied to equity-settled share-based payment transactions.
426
CA Sri Lanka
2.
CA Sri Lanka
427
3.1 Definitions
The definitions of different types of plan in LKAS 26 are similar to those in LKAS
19:
A defined contribution plan is a retirement benefit plan under which amounts to
be paid as retirement benefits are determined by contributions to a fund together
with investment earnings thereon.
A defined benefit plan is a retirement benefit plan under which amounts to be
paid as retirement benefits are determined by reference to a formula usually
based on employees earnings and / or years of service.
428
CA Sri Lanka
CA Sri Lanka
429
3.
4.
A description of the plan and the effect of any changes in the plan during
the period, including:
The names of the employers and employee groups covered
The number of participants receiving benefits and the number of other
participants classified as appropriate
The type of plan (defined contribution or defined benefit)
A note as to whether participants contribute to the plan
A description of the retirement benefits promised to participants
A description of any plan termination terms
Changes in any of the above.
430
CA Sri Lanka
QUESTION
A company is considering setting up a pension plan for its employees. The
directors have heard of two types of plan, defined contribution and defined benefit
plans. They are unsure of the differences between the two.
Required
Compare and contrast the two types of plan for the purpose of advising the
directors.
ANSWER
Defined contribution plans are pension plans under which an entity pays fixed
pension contributions into a separate entity (a fund) and has no legal or
constructive obligation to pay further contributions.
If the fund performs well the employee will have a greater fund and pension.
However if the fund performs badly the employee bears the risk and will receive a
lower pension.
Accounting is on an accruals basis for employer contributions and the entries for
contributions relating to the plan for the period are:
DEBIT
CREDIT
Staff costs
Cash/accruals.
CA Sri Lanka
431
amount from year to year are recognised in profit or loss and others in other
comprehensive income.
Accounting for a defined benefit plan is much more complex than a defined
contribution plan.
To conclude:
A defined contribution plan has a fixed input and a variable output (risk is with
the employee).
A defined benefit plan has a variable input and fixed output (risk is with the
employer).
QUESTION
Kagalle Co-operative PLC granted 100,000 share appreciation rights to each of its
five directors on 1 July 20X5.
The rights vest on 30 June 20X8 provided that the directors are still employed.
The fair value of each share appreciation right at 31 December 20X5 was Rs. 500
and at 31 December 20X6, Rs. 700.
At 31 December 20X5 it was expected that 4 directors would remain employed
after the three years and at 31 December 20X6 it is expected that all five directors
will be employed throughout the vesting period.
Required
Discuss the accounting treatment for the share appreciation rights for the years
ended 31 December 20X5 and 31 December 20X6, and assess amounts to be
recognised in the financial statements.
ANSWER
The granting of share appreciation rights is cash-settled share based payment per
SLFRS 2 Share-based Payment. These need to be measured at the fair value at each
year-end. An expense and a liability is recognised over the three year vesting period.
The company should estimate the number of directors that are expected to be
employed at the vesting date which in this case is 30 June 20X8.
432
CA Sri Lanka
Expense
Liability
Rs. 141,666,667
Rs. 141,666,667
CA Sri Lanka
433
CHAPTER ROUNDUP
434
Service costs, gains or losses on settlement and net interest on the net
defined benefit asset / liability are recognised in profit or loss.
Remeasurements including actuarial gains and losses, the return on plan assets
not included in net interest and changes in the asset ceiling are recognised in
other comprehensive income.
Other long-term benefits include disability benefit and sabbatical leave; they
are accounted for in a similar way to defined benefit plans, although no amounts
are recognised in other comprehensive income. There are no specific
disclosure requirements for other long-term employee benefits in the Standard.
CA Sri Lanka
The effect of modifications that increase the fair value of the share-based
payment arrangement or otherwise benefit the employee are recognised; the
effect of modifications that decrease the fair value or are detrimental to
employees are not.
Where the entity can choose the form of settlement the transaction is cashsettled if there is an obligation to deliver cash, otherwise it is treated as equitysettled.
Where the counterparty can choose the form of settlement the transaction is
treated as the granting of a compound instrument.
There is normally a deferred tax impact of share options since tax relief is given
at a different time from the recognition of an expense and normally for a different
amount.
It outlines the financial statements required and the measurement of various line
items.
CA Sri Lanka
435
PROGRESS TEST
436
What are defined benefit pension plan service costs and how are they recognised?
How is a modification that increases the fair value of share options accounted for?
CA Sri Lanka
Service costs include current service cost (the increase in the present value of the
defined benefit obligation resulting from employee service in the current period),
past service cost (the change in the present value of the defined benefit obligation
for employee service in prior periods, resulting from a plan amendment or a
curtailment) and gains or losses on settlement. These are recognised in profit or
loss.
The credit entry for a cash-settled transaction is a liability rather than equity, and
unlike an equity-settled transaction, the amount is remeasured at each reporting
date.
The difference between the fair value of the instruments granted measured
immediately before and after the modification is recognised in profit or loss. It is
recognised:
Immediately if modification takes place after the vesting date.
Over the remainder of the vesting period if modification takes place before the
vesting date.
CA Sri Lanka
437
438
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter is the first of two dealing with disclosure standards.
It concentrates on two standards:
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards
(SLFRS / LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
439
CHAPTER CONTENTS
1 SLFRS 5 Non-Current Assets Held for Sale and Discontinued
Operations
2 LKAS 24 Related Party Disclosures
1.1 Introduction
SLFRS 5 requires separate disclosure of non-current assets held for sale and
discontinued operations so that users of financial statements will be better able to
make projections about the financial position, profits and cash flows of the entity. If
an asset (or group of assets) is to be sold or distributed to owners, then it will not
contribute to future revenues; equally if part of a business is to be discontinued then
its results will not contribute to overall results in the future. By reporting these
440
CA Sri Lanka
amounts separately, SLFRS 5 provides users of financial statements with better and
more relevant information for decision-making purposes.
Distribution expected to be
completed within one year of date
of classification.
If the sale has not actually taken place within one year an asset can still be
classified as held for sale provided that the delay has been caused by events or
circumstances beyond the entity's control and there is sufficient evidence that the
entity is still committed to sell the asset.
If an entity acquires an asset exclusively with a view to its subsequent disposal,
the asset is classified as held for sale only if the sale is expected to take place
within one year and it is highly probable that all the other criteria will be met
within a short time (normally three months).
CA Sri Lanka
441
An asset that is to be abandoned cannot be classified as held for sale as its carrying
amount is recovered through use rather than sale.
QUESTION
A company is committed to a plan to sell a factory and its operations and had
started work to identify a buyer. At the date on which the company becomes
committed to the sale plan there is a backlog of orders.
Required
Advise the appropriate classification of each of the assets above.
ANSWER
1
The property is not available for sale as a result of the delay in timing of the
transfer imposed by the selling company. This is not classified as held for sale.
The company is selling both factory and operations and therefore any
incomplete orders at the sale date will be transferred to the buyer. Therefore
the factory is available for immediate sale in its present condition and is
classified as held for sale on the date on which the company becomes
committed to the plan.
The machine should remain classified as held for sale at the end of the one
year period as the deterioration in market conditions is beyond the control
of the company and all other conditions to classify the machine as held for
sale are met.
442
CA Sri Lanka
SLFRS 5 requires that costs to sell are discounted to present value where a sale is
expected to occur beyond one year. In practice this is only necessary where a sales
transaction is delayed beyond a year as described in section 1.2.
1.3.2 Impairment losses
Any impairment losses arising on classification as held for sale/distribution are
charged to profit or loss.
An impairment loss recognised on a disposal group is allocated to the non-current
assets of the disposal group that are within the measurement requirements of
SLFRS 5 in the following order:
CA Sri Lanka
(a)
(b)
to the other assets of the disposal group on a pro rata basis related to
carrying amounts.
443
QUESTION
Mannar Manufacturing PLC has owned a piece of equipment for a number of years.
The equipment has a carrying amount of Rs. 3.25 Mn at 1 July 20X3, on which date it
was classified as held for sale. The market value of the machine at 1 July 20X3 is
Rs. 3.1 Mn and Mannar Manufacturing expect transaction costs to amount to
Rs100,000. At the year-end of 31 December 20X3 the equipment remains unsold
although the criteria to classify it as held for sale are still met. At this date the
market value of the asset is Rs. 3.2 Mn.
Required
Calculate at what value should the equipment be included in the statement of
financial position at 31 December 20X3 and what amounts are recognised in profit
or loss during the year in respect of it (insofar as the information allows)?
ANSWER
At 1 July 20X3 the equipment is classified as held for sale. At this date it is
measured at the lower of carrying amount and fair value less costs to sell.
Carrying amount is Rs. 3.25 Mn
Fair value less costs to sell is Rs. 3 Mn (Rs. 3.1 Mn Rs. 100,000)
444
CA Sri Lanka
Therefore the asset is initially recognised as an asset held for sale at Rs. 3 Mn and
an impairment loss of Rs. 250,000 is recognised in profit or loss.
The asset is no longer depreciated.
At the period end the fair value less costs to sell has increased to Rs. 3.1 Mn
(Rs. 3.2 Mn Rs. 100,000). Therefore Rs. 100,000 of the impairment loss can be
reversed.
Summary amounts recognised in financial statements
Statement of financial position at 31 December 20X3
Non-current asset held for sale
Rs. 3.1 Mn
Rs. 250,000
(Rs. 100,000)
They are reclassified out of the held for sale category based on the normal
SLFRS classification.
Carrying amount before classification as held for sale, adjusted for any
depreciation, amortisation or revaluations that would have been
recognised had the asset not been held for sale, and
(b)
Recoverable amount is the higher of an assets fair value less costs to sell 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.
Any adjustments to the measurement of assets no longer classified as held for sale
are recognised in the profit or loss from continuing operations in the period in
which the held for sale classification is no longer met.
CA Sri Lanka
445
Total assets
X
X
X
X
X
X
Non-current liabilities
EEE
Current liabilities
FFF
GGG
Liabilities directly associated with non-current assets
classified as held for sale
Total equity and liabilities
446
X
X
X
X
X
CA Sri Lanka
Note that assets held for sale and the assets and liabilities of disposal groups are
not reclassified in the comparative statement of financial position presented
within a set of financial statements.
1.5.1 Additional disclosures
The following should be disclosed in the notes to the financial statements in the
period in which a non-current asset or disposal group has been classified as held
for sale or sold:
(a)
(b)
(c)
The loss recognised on transfer to held for sale and the caption in the
statement of profit or loss and other comprehensive income that includes
that amount;
(d)
In addition if there has been a change to a plan for sale, a description of the facts
and circumstances leading to the decision to change the plan and the effect of the
decision on the results of the operations for the period and any prior periods
presented should be disclosed.
(b)
(c)
A component of an entity comprises operations and cash flows that can be clearly
distinguished, operationally and for financial reporting purposes, from the rest of
the entity.
447
(b)
The post-tax gain or loss recognised on the measurement to fair value less
costs of disposal or on the disposal of the assets or disposal group(s)
constituting the discontinued operation.
(b)
(c)
The gain or loss recognised on the measurement to fair value less costs of
disposal or on the disposal of the assets of the discontinued operation
(d)
This may be presented either in the statement of profit or loss and other
comprehensive income or in the notes. If it is presented in the statement of profit
or loss and other comprehensive income, it should be presented in a section
identified as relating to discontinued operations, ie separately from continuing
operations. Gains and losses on the remeasurement of a disposal group that is not
a discontinued operation but is held for sale should be included in profit or loss
from continuing operations.
This analysis is not required where the discontinued operation is a newly
acquired subsidiary that has been classified as held for sale.
1.7.2 Statement of cash flows
An entity should disclose the net cash flows attributable to the operating,
investing and financing activities of discontinued operations. These disclosures
may be presented either on the face of the statement of cash flows or in the notes.
Again, this analysis is not required where the discontinued operation is a newly
acquired subsidiary that has been classified as held for sale.
448
CA Sri Lanka
Group
2013
2012
Rs'000
Rs'000
34,690,340
32,005,182
(26,216,569)
(24,628,455)
8,473,771
7,376,727
550,194
1,225,105
(1,454,437)
(3,783,849)
(64,470)
3,721,209
(1,058,464)
328,997
63,765
(1,306,746)
(3,249,903)
(92,545)
3,952,638
(798,277)
301,991
Company
2013
2012
Rs'000
Rs'000
1,164,265
1,542,190
1,164,265
1,542,190
515,832
(366,425)
797,840
(436,705)
28,475
62,436
Attributable to:
Equity holders of the
parent
Non-controlling interests
Earnings per share
Basic
Diluted
Earnings per share for
continuing operations
Basic
Diluted
Dividend per share
CA Sri Lanka
3,055,507
(770,237)
3,518,788
(644,540)
389,610
(11,314)
1,524,058
(19,683)
2,285,270
2,874,248
378,296
1,504,375
(581)
2,284,689
(4,374)
2,869,874
378,296
1,504,375
Group
Notes
(327,492)
1,730,530
(217,202)
10,730
2013
Company
2012
1,902,724
381,965
2,284,689
2,575,061
294,813
2,869,874
10
10
Rs. 0.98
Rs. 0.95
Rs. 1.33
Rs. 1.27
10
10
11
Rs. 0.98
Rs. 0.95
Rs. 0.20
Rs. 1.33
Rs. 1.27
Rs. 0.70
2013
2012
449
2.3 Definitions
The following important definitions are given by the standard. The definitions of
control, joint control and significant influence within SLFRS 10, SLFRS 11 and
LKAS 28 are also relevant:
Related party. A related party is a person or entity that is related to the entity
that is preparing its financial statements.
(a)
(ii)
450
CA Sri Lanka
(b)
The entity and the reporting entity are members of the same group
(which means that each parent, subsidiary and fellow subsidiary is
related to the others).
(ii)
(iii) Both entities are joint ventures of the same third party.
(iv) One entity is a joint venture of a third entity and the other entity is an
associate of the third entity.
(v)
CA Sri Lanka
451
Two entities simply because they have a director or other key management
in common (notwithstanding the definition of related party above, although
it is necessary to consider how that director would affect both entities)
(b)
Two venturers, simply because they share joint control over a joint venture.
(c)
(d)
Providers of finance
Trade unions
Public utilities
Government departments and agencies
QUESTION
Capital Contracts (Pvt) Ltd is a building contractor based in Colombo. Its directors
are Fathima Perera, Kasun Dias and Udari Da Silva. Udari is married to Chamath,
the Procurement Manager at SLF Supermarkets PLC. Kasuns brother Gayan owns
55% of the shares in Asia Bathrooms (Pvt) Ltd.
Capital Contracts has the following shareholdings:
A further 35% of the shares in Basin Builders (Pvt) Ltd are owned by Rathnayake
Construction (Pvt) Ltd.
Required
Explain which of the above are related parties to Capital Contracts (Pvt) Ltd?
ANSWER
452
Fathima Perera, Kasun Dias and Udari Da Silva are all directors of Capital
Contracts (Pvt) Ltd and so are related by virtue of being key management
personnel.
CA Sri Lanka
SLF Supermarkets PLC is not related to Capital Contracts (Pvt) Ltd. The two
companies would only be related if Chamath Da Silva controlled or jointly
controlled SLF Supermarkets PLC [(b)(vi) of the definition of a related party]
or if Udari Da Silva controlled or jointly controlled Capital Contracts (Pvt)
Ltd [(b)(vii) of the definition of a related party].
Capital Contracts (Pvt) Ltd is not related to Pacific Pipes (Pvt) Ltd as Pacific
Pipes (Pvt) Ltd is (based on a 10% shareholding) not a subsidiary, joint
venture or associate of Capital Contracts (Pvt) Ltd. This status is not changed
by the fact that Pacific Pipes (Pvt) Ltd is a supplier of Capital Contracts (Pvt)
Ltd.
Based on the information provided, Basin Builders (Pvt) Ltd is a joint venture
of Capital Contracts (Pvt) Ltd. The two companies are therefore related.
Rathnayake Construction (Pvt) Ltd and Capital Contracts (Pvt) Ltd are not
related simply by virtue of the fact that both are joint venturers in Basin
Builders (Pvt) Ltd. Therefore unless any other relationship exists, they are
not related.
CA Sri Lanka
Leases
2.6 Disclosures
Disclosure is required in respect of the controlling party and parent-subsidiary
relationships, transactions with key management personnel and other related
party transactions.
2.6.1 Controlling party disclosures
Relationships between parents and subsidiaries must be disclosed irrespective of
whether any transactions have taken place between the related parties. An entity
must disclose the name of its parent and, if different, the ultimate controlling
party. This will enable a reader of the financial statements to be able to form a
view about the effects of a related party relationship on the reporting entity.
If neither the parent nor the ultimate controlling party produces financial
statements available for public use, the name of the next most senior parent that
does so shall also be disclosed.
2.6.2 Key management personnel disclosures
An entity should disclose key management personnel compensation in total and
for each of the following categories:
(a)
(b)
(c)
(d)
(e)
454
(a)
(b)
The amount of outstanding balances and their terms and conditions and
details of guarantees given or received
CA Sri Lanka
(c)
(d)
The expense recognised in the period in respect of bad or doubtful debts due
from related parties.
These disclosures should be made separately for each of the following categories:
The parent
Entities with joint control / significant influence over the entity
Subsidiaries
Associates
Joint ventures in which the entity is a venture
Key management personnel of the entity or its parent, and
Other related parties.
Another entity that is a related party because the same government has
control or joint control of or significant influence over the reporting entity
and the other entity.
CA Sri Lanka
(a)
The name of the government and nature of its relationship with the
reporting entity.
(b)
455
QUESTION
Salary Rs
Bonus Rs
Pension Rs
Mr A
1,200,000
300,000
500,000
Mrs B
780,000
260,000
500,000
Mrs C
890,000
400,000
440,000
Mrs D
880,000
380,000
530,000
Mr E
820,000
370,000
420,000
Mr F
790,000
370,000
420,000
Kandy
Moratuwa
Required
Prepare the related party disclosure note for the Columbo Group financial
statements for the year ended 31 December 20X4.
456
CA Sri Lanka
ANSWER
Identification of related parties
The three companies are also related to Galle (assuming that the brother is a
close family member of the director of Columbo)
The loan from Columbo to Mrs C is not a related party transaction as Mrs C
cannot influence Columbo
The transactions between Kandy and Galle are related party transactions
Balances and transactions between Columbo and its subsidiaries, which are
related parties, have been eliminated on consolidation and are not disclosed in
this note.
Trading transactions
During the year, group companies entered into the following transactions with
related parties that are not members of the group:
Rs.
Sale of goods to other related parties
Receipt of services from key management personnel other than
In their capacity as key management personnel
CA Sri Lanka
1,500,000
400,000
457
50,000
Compensation of key management personnel
The compensation of the directors, who are the key management personnel of the
group is set out below in aggregate for each of the categories specified in LKAS 24
Related Party Disclosures.
Rs'000
Short term employee benefits
2,540
1,000
Post employment benefits
3,540
QUESTION
Galle PLC is the parent company of the Galle Group, which operates in the tourism
industry in Sri Lanka. As part of its internal reporting system, Galle PLC records all
transactions with other Group and associated companies. The output of the system
at 31 December 20X3 in respect of the year ended on that date was as follows:
Company
Matara Ltd
Puttalam Ltd
Jaffna Ltd
Badulla Ltd
Vavuniya Ltd
Kagalle Ltd
Relationship
100% subsidiary
80% subsidiary
40% associate
25% associate
30% joint
venture
10% investment
Purchases
Owed to
Sales by
by Galle
Galle PLC
Galle PLC
PLC
at year end
Rs'000
Rs'000
Rs'000
225,000
50,000
160,000
23,000
- 320,000
- 190,000
90,000
5,000
180,000
Owed by
Galle PLC
at year end
Rs'000
65,000
20,000
-
16,000
All transactions with subsidiaries were at group set transfer prices; no such prices
were set for transactions with other companies and the management of the Galle
Group believes that they took place at market prices.
Galle PLC has provided a guarantee to Vavuniya Ltd that remains in place at the
year end.
458
CA Sri Lanka
The Group Finance Director intends to present this output as the related party
disclosure in the Group financial statements for the year ended
31 December 20X3.
Required
Comment on the suggested form of the related party disclosure and redraft for
the Galle Group in accordance with LKAS 24 insofar as you can based on the
information provided.
ANSWER
Disclosure that transactions took place at market prices may only be made
where this claim can be substantiated. This does not appear to be the case
here.
CA Sri Lanka
459
Relationship
Associates
Joint ventures
Sale of goods
Rs'000
90,000
Purchases of goods
Rs'000
510,000
-
QUESTION
On 1 July 20X9, the board of directors of Batara PLC agreed to sell a division of the
business. The division currently has work planned until the end of September
20X9 so the board have agreed to complete the work and then discontinue the
operations of the division. There is an interested buyer for the division but Batara
PLC have stated that the purchase cannot take place until after the work has been
completed and realistically anticipate that a transfer of the division cannot occur
until 31 October 20X9.
Required
Analyse whether the division should be classified as 'held for sale' at 1 July 20X9?
ANSWER
In order to be held for sale an asset must be available for immediate sale in its
present condition and a sale must be highly probable.
At 1 July 20X9 the division is not available for immediate sale in its present
condition and therefore it does not meet the criteria specified in SLFRS 5 as being
held for sale.
The division will only be available for immediate sale in its present condition
when the planned work has been completed. It may meet the criteria on 31
October when the work has been completed.
460
CA Sri Lanka
QUESTION
Timbuktu PLC disposed of its retail division on 31 August 20X9. The results of the
division for the period to disposal are shown below:
Rs Mn
140,655
Revenue
(130,248)
Cost of sales
10,407
Gross profit
(20,059)
Expenses
(9,652)
Loss before tax
(180)
Tax
(9,832)
Loss for the period
The gain on disposal of the retail division amounted to Rs. 24 Mn with a related
tax expense of Rs. 2 Mn.
Required
Advise what amount(s) in respect of discontinued operations should be disclosed
in the statement of profit or loss and other comprehensive income according to
SLFRS 5
ANSWER
A single amount must be presented in the statement of profit or loss and other
comprehensive income comprising the post-tax profit or loss of discontinued
operations and the post-tax gain or loss recognised on the disposal of the
operations. This is calculated as:
Rs Mn
(9,832)
Loss for the period
22,000
Gain on disposal after tax (24-2)
12,168
Profit from discontinued operations
This amount must be further analysed, however this analysis can take place in the
notes to the accounts.
QUESTION
Advise whether the parties mentioned below are related to X, a public limited
company, for the purposes of LKAS 24 Related Party Disclosures:
CA Sri Lanka
(a)
Children of the former wife of the finance director with her new husband
(b)
(c)
(d)
ANSWER
462
(a)
The former wife of the finance director would be considered a related party
if she were financially dependent on the finance director (and so influenced
by him), who is key management personnel of the company, but her children
with her new husband are not, as she is not the finance director's domestic
partner.
(b)
X's sole supplier is not automatically considered a related party, simply due
to X's economic dependence on it.
(c)
Companies are not automatically related simply because they have a director
in common. However, if X's marketing director uses his influence to
encourage trading with B, any transactions would need to be disclosed.
(d)
The shareholder is considered a related party as, with 24% of the votes,
significant influence over X would be possible. As the ex wife to whom the
shareholder pays maintenance is financially dependent on the shareholder
she is considered close family and therefore a related party.
CA Sri Lanka
CHAPTER ROUNDUP
They are measured at the lower of carrying amount and fair value less costs to
sell / distribute.
LKAS 24 requires that related parties are identified and any transactions with
them in the reporting period are disclosed.
This enables users to assess the impact of transactions that may not have taken
place at arms length.
Disclosures are required in respect of the controlling party and parentsubsidiary relationships, transactions with key management personnel and
other related party transactions.
CA Sri Lanka
463
PROGRESS TEST
464
What single amount is disclosed in the statement of profit or loss and other
comprehensive income in respect of discontinued operations?
CA Sri Lanka
(a)
(b)
At the lower of carrying amount and fair value less costs to sell or distribute.
The post-tax profit or loss of discontinued operations and the post-tax gain or loss
recognised on the measurement to fair value less costs of disposal or on the
disposal of the assets or disposal group(s) constituting the discontinued
operation.
An individual that has control or joint control of or significant influence over the
company a member of the key management personnel of the company, or a close
member of the family of the above.
Yes the parent and subsidiary are related parties; the provision of services is a
related party transaction. The fact that a price is not charged is not relevant.
CA Sri Lanka
The asset must be available for immediate sale in its present condition
Its sale must be highly probable (ie significantly more likely than not).
465
466
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter continues from the previous chapter and deals
with two more standards that concentrate on disclosure:
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards
(SLFRS / LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
467
CHAPTER CONTENTS
1 SLFRS 8 Operating Segments
2 LKAS 33 Earnings Per Share
468
CA Sri Lanka
1.2 Scope
The standard is only applicable to entities whose equity or debt securities are
traded on a stock exchange or who are in the process of filing financial statements
for the purpose of issuing instruments.
In group accounts, only consolidated segmental information must be disclosed.
That engages in business activities from which it may earn revenues and
incur expenses (including revenues and expenses relating to transactions
with other items of the same entity)
(b)
(c)
The term 'chief operating decision maker' identifies the function which
allocates resources and assesses the performance of the entity's operating
segments. It does not necessarily refer to an individual.
An operating segment normally has a segment manager who maintains direct
contact with the chief operating decision maker. The segment manager may be
a function rather than an individual.
An entity may have a matrix structure of operations whereby some managers
are responsible for different product and service lines and other managers are
responsible for separate geographical areas. In this case the entity should
determine whether product /service lines or geographical areas are the
operating segments. This decision is based on the core principle that the
purpose of segment disclosures is to allow users to evaluate the nature and
financial effects of the activities in which an entity engages and the economic
environments in which it operates.
CA Sri Lanka
469
If those segments that meet the quantitative threshold do not represent at least
75% of total external revenue, additional segments must be identified (even if
they do not meet the 10% thresholds).
Two or more operating segments below the thresholds may be aggregated to
produce a reportable segment if the segments have similar economic characteristics,
and the segments are similar in a majority of the aggregation criteria above.
Operating segments that do not meet any of the quantitative thresholds may be
reported separately if management believes that information about the segment
would be useful to users of the financial statements.
Operating segments that are not separately reported are combined and their
results disclosed in an all other segments category.
QUESTION
470
Revenue
%
55
8
7
9
8
6
7
100
Profit
%
65
6
8
5
8
6
2
100
Assets
%
58
9
7
7
6
8
5
100
CA Sri Lanka
No two operating segments share all of the SLFRS 8 aggregation criteria. All sales
are made to external customers with the exception of the Secretarial Services
division which makes all of its sales to other internal segments.
Required
Advise how the principles in SLFRS 8 Operating segments for the determination
of a companys reportable operating segments would be applied using the
information given above.
ANSWER
Only the Tax services segment meets the 10% quantitative threshold for a
reportable segment.
This segment only provides 55% of total revenue generated by the Company and
59% (55/93 100%) of external revenue. Therefore additional operating
segments must be identified as reportable.
It may be the case that certain other segments have similar economic
characteristics and meet a majority of the SLFRS 8 aggregation criteria in which
case they may be joined to form a reportable segment.
It may also be the case that the management of AB Professional wish to report the
results of particular segments that dont qualify as reportable in order to provide
useful information to users.
If this is not the case then other operating segments must be designated as
reportable in order to achieve the required 75% of external revenue in reportable
segments.
The logical way to achieve this would be to designate the next largest segments in
terms of revenue until the 75% threshold were achieved.
Risk consultancy provides (9/93 100%) = 10% of external revenue; if this is
reported separately, total external revenue reported becomes 59% + 10% = 69%.
A further segment must be reported. This could be any of Accounting, Legal,
Corporate Finance and PR and Marketing, all of which contribute more than 6%
external revenues.
1.5 Disclosure
1.5.1 General information
CA Sri Lanka
And
And
External revenues
Internal revenues
Interest revenue
Interest expense
Depreciation and amortisation
Material items of income and
expense
Interest in the profit or loss of
associates / joint ventures under
the equity method
Income tax expense or income
Material non-cash items (other
than depreciation and
amortisation)
472
CA Sri Lanka
Car
parts
Rs'000
Motor
vessel
Rs'000
Software
Rs'000
Electronics
Rs'000
Finance
Rs'000
All
other
Rs'000
3,000
5,000
9,500
12,000
5,000
1,000(a)
Intersegment revenues
3,000
1,500
4,500
Totals
Rs'000
35,500
Interest revenue
450
800
1,000
1,500
3,750
Interest expense
350
600
700
1,100
2,750
1,000
1,000
Depreciation and
amortisation
200
100
50
1,500
1,100
2,950
200
70
900
2,300
500
100
4,070
200
200
2,000
5,000
3,000
12,000
57,000
2,000
81,000
300
700
500
800
600
2,900
1,050
3,000
1,800
8,000
30,000
43,850
(a)
(b)
1.5.4 Reconciliations
The total reportable segment amount of the following must be reconciled to the
equivalent entity amount:
CA Sri Lanka
Revenue
Profit or loss
Assets
Liabilities
Other material items of information.
473
Rs'000
39,000
1,000
(4,500)
35,500
Assets
Total assets for reportable segments
Other assets
Elimination of receivable from corporate HQ
Other unallocated amounts
Entity revenues
Rs'000
79,000
2,000
(1,000)
1,500
81,500
474
CA Sri Lanka
4,200
China
3,400
6,500
Japan
2,900
3,500
Other countries
6,000
3,000
35,500
24,000
Total
CA Sri Lanka
475
(A)
Industry
Revenue
External revenue
Result
Segment result
Taxation
Other information
Segment assets
Segment liabilities
Capital expenditure
Depreciation
Retirement benefits
charge
(B)
Geographical
Revenue
Non-current assets
Oil Palm
2014
2013
Rs. '000
Rs. '000
165,702
193,366
165,702
193,366
Investments
2014
2013
Rs. '000
Rs. '000
104,939
51,000
104,939
51,080
Company
2014
2013
Rs. '000
Rs. '000
270,641
244,446
270,641
244,446
109,000
(25,979)
83,021
101,386
(259)
101,127
210,386
(26,238)
184,148
143,036
(34,546)
100,490
44,679
(478)
44201
187,715
(35,024)
152,691
8,888
1,172
747
576
747
576
291
236
291
236
Malaysia
Sri Lanka
Company
2014
2013
2014
2013
2014
2013
Rs. '000
Rs. '000
Rs. '000
Rs. '000
Rs. '000
Rs. '000
166,405
193,366
104,236
51,000
270,641
244,446
1,646,563 1,657,701 3,650,307 3,876,347 5,296,870 5,534,048
476
CA Sri Lanka
2.1 Definitions
The following definitions are included in LKAS 33 and are relevant to the
calculation of basic and diluted earnings per share:
An ordinary share is an equity instrument that is subordinate to all other classes
of equity instruments.
A potential ordinary share is a financial instrument or other contract that may
entitle its holder to ordinary shares.
Dilution is a reduction in earnings per share or an increase in loss per share
resulting from the assumption that convertible instruments are converted, that
options or warrants are exercised, or that ordinary shares are issued upon the
satisfaction of specified conditions.
Antidilution is an increase in earnings per share or a reduction in loss per share
resulting from the assumption that convertible instruments are converted, that
options or warrants are exercised, or that ordinary shares are issued upon the
satisfaction of specified conditions.
Options, warrants and their equivalents are financial instruments that give the
holder the right to purchase ordinary shares.
Rs.
X
(X)
(X)
X
477
The excess that arises where an entity purchases its own preference shares for
more than their carrying amount
Where discontinued operations are presented, basic earnings per share must also
be disclosed for continuing operations. To calculate profits attributable to
ordinary shareholders for this purpose, profits of the discontinued operation must
be deducted from the above calculation.
QUESTION
Pacific Power PLC reported retained profits of Rs. 120 Mn in the year ended
31 December 20X6. The company has the following shares in issue at that date:
50 million ordinary shares
6 million 3% redeemable preference shares
10 million 5% irredeemable cumulative preference shares
Rs. 700,000,000
Rs. 9,000,000
Rs. 60,000,000
Fixed dividends are paid on the preference shares at the relevant coupon rate on
carrying amount.
There have been no issues of shares during the year.
Required
(a)
Calculate the profit attributable to ordinary shareholders for the year ended
31 December 20X6?
(b)
State how might your answer differ if the irredeemable preference shares
were non-cumulative?
ANSWER
(a)
Irredeemable preference share dividend (5% 60,000,000)
Rs'000
120,000
(3,000)
117,000
478
CA Sri Lanka
date on which shares are deemed to be issued for the purposes of the calculation
of the weighted average number of ordinary shares is as follows:
Consideration for share issue
Inclusion date
Cash
Settlement date
Acquisition of an asset
Rendering of services
If a company has 100,000 shares in issue from 1 January 20X4 to 31 March 20X4
and then issues 50,000 further shares in exchange for an immediate payment of
cash, then the weighted average number of shares is:
1 January 31 March
1 April 31 December
25,000
112,500
137,500
This figure is adjusted for events that have changed the number of shares
outstanding without a corresponding change in resources:
Event
Bonus issue
Rights issue
In both cases, the reciprocal of the adjustment factor can be used to re-calculate
the comparative EPS for the previous year.
QUESTION
Typhoon Tea PLC had a profit after tax of Rs. 81 Mn in the year ended
31 December 20X3. This increased to Rs. 83 Mn in the year ended 31 December
20X4. The company had 100 million ordinary shares in issue at 1 January 20X3
and 20X4 and made the following issues in 20X4:
CA Sri Lanka
479
A 1 for 5 rights issue on 1 July 20X4. The market price of one share
immediately before the rights issue was Rs. 16.20; the exercise price was
Rs. 12.50.
Required
What is the basic earnings per share for the year ended 31 December 20X3
and 20X4?
ANSWER
y/e 31 December 20X3 as initially reported
Earnings
Weighted average number of shares
Rs. 81 million
100 million
81,000,000
100,000,000
Rs. 0.81
Earnings
Weighted average number of shares (see below)
83,000,000
Therefore basic EPS
123,188,703
Weighted average number of shares:
Time factor
100 Mn
1.1.X4 28.2.X4
2/12m
10 Mn
Bonus issue
110 Mn
1.3.X4 30.6.X4
4/12m
22 Mn
Rights issue
132 Mn
1.7.X4 31.12.X4
6/12m
Rs. 83 million
123,188,703
Rs. 0.67
Adj 1
11/10
Adj 2
16.20/15.58
No. shares
19,062,901
16.20/15.58
38,125,802
66,000,000
123,188,703
11
10
16.20
15.58
81.00
12.50
93.50
CA Sri Lanka
Therefore 93.50/6
15.58
Rs 0.71
Include:
Convertible loan stock or
convertible preferred shares
Options or warrants
Shares that would be issued on the
satisfaction of conditions resulting
from contractual arrangements such
as the purchase of a business.
Remember that antidilutive potential ordinary shares (ie those that increase
profits more than they increase the number of shares in issue) are not taken into
account in the calculation of diluted EPS.
Diluted earnings per share is calculated as:
FORMULA TO LEARN
Diluted EPS =
The calculation should be performed in steps with each group of dilutive potential
ordinary shares added in turn, starting with the most dilutive.
After each addition, diluted EPS is calculated and the diluted earnings per share
figure is that which is the lowest calculated at any stage.
2.3.1 Profits
The earnings used in diluted EPS are those calculated for basic EPS, adjusted by
the post-tax effect of:
(a)
CA Sri Lanka
481
(b)
Interest recognised in the period for the dilutive potential ordinary shares
(convertible debt)
(c)
An entity may issue a contract that may be settled in either cash or its own
ordinary shares.
Where the method of settlement is at the entitys option, it is assumed that the
contract will be settled in ordinary shares and therefore the resulting potential
ordinary shares are included in the calculation of diluted earnings per share if
they are dilutive.
Where the method of settlement is at the counterpartys option, the more
dilutive of cash settlement and share settlement is used in calculating diluted
EPS.
2.3.4 Question practice
The following questions will refresh your memory as to how different types of
potential ordinary shares are dealt with.
QUESTION
Share options
Adanti PLC has the following results for the year ended 31 December 20X2.
Net profit for year
Weighted average number of ordinary shares
outstanding during year
Average fair value of one ordinary share during year
482
Rs. 30,500,000
10,500,000 shares
Rs. 25
CA Sri Lanka
500,000 shares
Rs. 14
Required
Calculate both basic and diluted earnings per share.
ANSWER
Basic earnings per share
QUESTION
Rs. 7,000,000
280,000
220,000
Alahakoon PLC has 100,000,000 ordinary shares in issue, and also had in issue in
20X4:
(a)
(b)
Rs. 35,000,000 of 12% convertible loan stock, convertible in one year's time
at the rate of 12 shares per Rs. 100 of stock.
ANSWER
1
2
CA Sri Lanka
Rs. 1.75
483
Incremental shares
=
=
20,000,000/100 9
1,800,000
Therefore EPS
=
=
Rs. 2,592,000/1,800,000
Rs. 1.44 so dilutive
Incremental shares
=
=
35,000,000/100 12
4,200,000
Therefore EPS
=
=
Rs. 3,024,000/4,200,000
Rs. 0.72, so dilutive
(b)
QUESTION
484
CA Sri Lanka
price has fluctuated significantly since the acquisition date, recording a low of
Rs. 8.70 and a high at the year-end of Rs. 21.
ANSWER
Where ordinary shares are issuable contingent upon a future event occurring,
these shares are included in the calculation of diluted EPS based on the number of
shares that would be issuable if the end of the period were the end of the
contingency period.
1
The specified level of earnings to be achieved by 1 March 20X5 has not been
achieved by the year end and so the contingently issuable shares are not
included in the calculation of diluted EPS.
The required market price has been achieved at the period end and
therefore the contingently issuable shares are included in the calculation of
diluted EPS.
CA Sri Lanka
(a)
The amounts used as the numerators in calculating basic and diluted EPS,
and a reconciliation of those amounts to the net profit or loss for the period
(b)
485
An entity may present alternative EPS figures if it wishes. However, LKAS 33 lays
out certain rules where this takes place.
(a)
(b)
(c)
The following earnings per share disclosure note is taken from the Citrus Leisure
PLC Annual Report 2012/13.
25 EARNINGS PER SHARE
Basic earnings per share is calculated by dividing the net profit for the year
attributable to equity holders of the parent by the weighted average number of
ordinary shares outstanding during the year. The weighted average number of
ordinary shares outstanding during the year and the previous year are adjusted
for events that have changed the number of ordinary shares outstanding, without
a corresponding change in the resources such as a bonus issue.
Diluted earrings per share is calculated by dividing the net profit attributable to
ordinary share holders by the weighted average number of ordinary shares of
outstanding during the year adjusted for the effects all dilutive potential ordinary
shares.
Group
2013
Rs.
Amounts used as the Numerator
Net Profit attributable to Equity Holders of the
Parent for Basic and Diluted Earnings Per Share
(48,476,717)
2013
Number
2012
Rs.
(6,562,151)
2012
Number
85,150,970
57,679,054
85,150,970
94,183,432
Notice that:
486
CA Sri Lanka
The 2013 loss and weighted average number of shares is the same for both
basic and diluted earnings per share. Therefore there are no dilutive potential
ordinary shares at the 2013 year end. The basic and diluted earnings per share
reported in the financial statements is the same figure.
The 2014 loss for both basic and diluted earnings per share is the same figure,
however the weighted average number of shares is different. This suggests that
the potential ordinary shares may be options or warrants.
QUESTION
You are the financial controller of PD Plantations PLC and have received the
following email from the CEO:
To:
From:
Subject:
Nihinsa Balendran
Vidu Dias
Transactions and earnings per share
Dear Nihinsa
The Board has recently been discussing some financing and other options
available to the company in the future. We are very aware of the importance of
earnings per share to investors and analysts and wed really like to make decisions
that wont affect EPS negatively. With that in mind, please could you advise me of
the impact of the following:
1
We would like to raise cash to fund expansion into a new market. This will
be through some form of debt, possibly convertible debt or possibly
redeemable debt structured as redeemable preference shares.
We are considering rewarding our highest performing staff with a profitrelated bonus scheme. The bonus would be paid in cash.
Our shares are currently trading at a relatively high market price, which
makes them less accessible to individual shareholders. In order to dilute the
market value of a share, we are considering making a bonus issue of shares
to existing shareholders.
Many thanks
Kind regards
Vidu Dias
Required
Draft a reply to Vidu Dias.
CA Sri Lanka
487
ANSWER
To: Vidu Dias
From: Nihinsa Balendran
Re: Transactions and earnings per share
Dear Vidu
Thank you for your email. In reply to your queries about the impact of various
issues on earnings per share, I trust that you will find the details below useful.
I have referred to both basic and diluted earnings per share.
Diluted earnings per share is a worst case scenario the earnings per share
that would be reported if all potential ordinary shares that would reduce
EPS had been issued in the year.
Financing options
488
CA Sri Lanka
A bonus share issue has no effect on profit, however it does increase the number
of shares in existence, so reducing both basic and in turn diluted earnings per
share. This reduction is however superficial the companys performance is no
worse simply as a result of the bonus issue. To reflect this, the effect of a bonus
issue also adjusts the comparative figures, so making them comparable with
current year figures.
I hope that you find this information useful, please do contact me if I can be of any
further help,
Kind Regards
Nihinsa
Tutorial note
Regarding a bonus issue of shares, the following illustration explains why the
reduction in EPS is superficial.
A company makes profits of Rs. 100 Mn in year 1 and year 2. It has 100m shares
outstanding throughout year 1 and at the start of year 2 it makes a 1 for 5 bonus
issue. It therefore has 120m shares outstanding throughout year 2.
The performance of the company is identical in both years it makes the same
profits and has the same level of capital available to it.
Basic EPS in year 1 is Rs. 100 Mn/100 Mn shares = Rs. 1
Basic EPS in year 2 is Rs. 100 Mn/120 Mn shares = Rs. 0.83
This doesnt reflect the fact that the performance of the company is identical.
Therefore we adjust the year 1 comparative:
Rs. 1 5/6 (reciprocal of the bonus fraction) = Rs. 0.83.
The same EPS is now reported for both years so demonstrating a comparable
performance.
CA Sri Lanka
489
QUESTION
The Finance Director of Vadugas Industries PLC, a recently listed company, is
applying SLFRS 8 for the first time and has compiled the following information
about operating segments. She has explained that other segments is comprised
of several small diverse businesses, the results of which are deemed so
individually insignificant that the Board does not review them on a regular basis.
The FD is unsure whether the results of all segments need to be reported and has
been told by the CEO that he believes that only Segment B needs to be reported, as
the largest segment.
Revenue
internal
external
Profit before tax
Total assets
Segment
A
Rs Mn
Segment
B
Rs Mn
Segment
C
Rs Mn
60
45
7
16
0
200
8
128
14
20
6
4
145
70
74
12
26
34
14
8
Required
Advise the Finance Director of Vadugas Industries which of the segments are
reportable and explain why SLFRS 8 does not only apply to the largest segment.
ANSWER
SLFRS 8 requires that operating segments are identified and the results of
reportable operating segments disclosed separately.
An operating segment is a segment that engages in business activities to earn
revenues and incur expenses, whose operating results are regularly reviewed by
the chief decision maker and for which discrete financial information is available.
It is assumed that the segments listed meet the definition of operating segments.
Although SLFRS 8 allows for the aggregation of segments with similar
characteristics for the purposes of applying the standard, the other segments are
described as diverse and their results are not regularly reviewed by the Board,
which is assumed to be the chief decision maker. Therefore these other segments
are ignored.
With regard to segments A-D, an operating segment is reportable where its
segment total is 10% or more of total revenue or all segments reporting a profit
(or loss if greater) or assets.
490
CA Sri Lanka
Segment A meets the revenue test with segment revenue of Rs. 105 Mn
Segment B meets the revenue and asset tests with segment revenue of
Rs. 200 Mn and segment assets of Rs. 128 Mn
Segment D meets the revenue and profit before tax tests with segment
revenue of Rs. 215 Mn and profit before tax of Rs. 74 Mn.
QUESTION
Question name
Jaffna Property PLC reported basic and diluted earnings per share in the year
ended 31 December 20X3 of Rs. 1.23 based on 750,000,000 shares outstanding
throughout the period. In the year ended 31 December 20X4, the company made a
profit of Rs. 950 Mn. At the start of January 20X4, by way of a bonus for
performance in 20X3, the company issued 30,000,000 share options to staff. These
have an exercise price of Rs. 10.00. It also made a 3 for 20 bonus issue of shares on
1 October 20X4.
The average price of a Jaffna Property PLC share in 20X4 was Rs. 12.50.
Required
Advise the appropriate presentation of earnings per share and design the
required disclosures for Jaffna Property PLC in respect of earnings per share.
CA Sri Lanka
491
ANSWER
Both basic and diluted earnings per share are disclosed on the face of the
statement of profit or loss and other comprehensive income with equal
prominence:
Statement of profit or loss and other comprehensive income
20X4
Rs'000
950,000
20X3
Rs'000
922,500
Rs 1.10
Rs 1.07
Rs 1.09
Rs 1.07
The following reflects the income and share data used in the earnings per share
computations
20X4
20X3
Amounts used as numerator
Rs'000
Rs'000
Net profit attributable to the equity holders of
950,000
922,500
the company for basic and diluted earnings per
share
Number of ordinary shares used as denominator
No.
No.
862,500,000
750,000,000
Weighted average number of shares in issue
(Basic EPS)
6,000,000
950,000,000
112.5 Mn
862.5 Mn 3/12m
215,625,000
862,500,000
950,000,000/862,500,000
492
Rs 1.10
Rs 950,000,000
CA Sri Lanka
862,500,000
6,000,000
868,500,000
Rs 1.09
Options
24,000,000
6,000,000
Restated comparatives
The comparatives are restated by multiplying by the reciprocal of the
bonus fraction:
Rs. 1.23 20/23 = Rs. 1.07
CA Sri Lanka
493
CHAPTER ROUNDUP
494
Operating segments are reportable when they meet the quantitative threshold
being 10% or more of total entity revenue, profit (or loss if greater) or
assets.
EPS is calculated by dividing the net profit or loss for the period attributable
to ordinary shareholders by the weighted average number of ordinary
shares outstanding during the period.
Basic and diluted EPS are presented in the statement of profit or loss and other
comprehensive income with equal prominence.
CA Sri Lanka
PROGRESS TEST
How does a bonus issue affect the calculation of weighted average number of
shares for the purpose of calculating EPS?
CA Sri Lanka
495
(a)
(b)
(c)
75%
Shares in issue before the bonus issue are multiplied by the bonus fraction which
is number of shares after the issue/number of shares before the issue.
1.
2.
Calculate the individual earnings per share for each group of potential
ordinary shares in order to identify those that are dilutive and those that are
anti-dilutive.
3.
4.
Add the dilutive potential ordinary shares into the DEPS calculation one by
one, starting with the most dilutive.
5.
DEPS is the lowest figure calculated for DEPS after each addition of potential
ordinary shares.
496
On the face of the statement of profit or loss and other comprehensive income (or
statement of profit or loss if presented separately), given equal prominence as
basic EPS.
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter revises the principles of group accounting including
accounting for subsidiaries, associates and joint arrangements.
Subsequent chapters build on these basics and cover more advanced
group accounting topics.
Knowledge Component
1 Interpretation and Application of Sri Lanka Accounting Standards
(SLFRS / LKAS / IFRIC / SIC)
1.1 Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
2.1.1
2.2.1
2.2.2
Evaluate the information provided and identify the existence of joint ventures.
Compile financial statements for joint ventures.
2.3 Investments in
associates
2.3.1
2.1.2
2.3.2
Compile consolidated financial statements for a group with more than two
subsidiaries, sub subsidiaries and foreign subsidiaries.
Recompile a consolidated set of financial statements post acquisition / merger /
divestment
497
CHAPTER CONTENTS
1 Introduction
2 Principles of consolidation
3 SLFRS 3 Business Combinations
4 Preparation of consolidated financial statements
5 Associates and joint arrangements
6 SLFRS 12 Disclosure of Interests in Other Entities
498
CA Sri Lanka
1 Introduction
A parent company prepares consolidated financial statements to include its
subsidiaries. Associates and joint ventures are accounted for using the equity
method. Other investments are financial assets accounted for under LKAS 39.
A group of companies includes a parent company and one or more subsidiaries. It
may also include one or more associates. Five accounting standards are relevant
to group accounting; they are:
CA Sri Lanka
499
These standards are all concerned with different aspects of group accounts, but
there is some overlap between them.
1.1 Definitions
The following definitions are drawn from the standards listed above:
A group is a parent and its subsidiaries. (SLFRS 10)
A parent is an entity that controls one or more entities. (SLFRS 10)
A subsidiary is an entity that is controlled by another entity. (SLFRS 10)
Control an investor controls an investee when the investor is exposed, or has
rights, to variable returns from its involvement with the investee and has the
ability to affect those returns through power over the investee. (SLFRS 10)
Power is existing rights that give the current ability to direct the relevant
activities. (SLFRS 10)
Relevant activities are activities of the investee that significantly affect the
investees returns. (SLFRS 10)
An associate is an entity over which an investor has significant influence that is
neither a subsidiary nor a joint venture. (LKAS 28)
Significant influence is the power to participate in the financial and operating
policy decisions of an investee but is not control or joint control over those
policies. (LKAS 28)
A joint arrangement is an arrangement of which two or more parties have joint
control. (SLFRS 11, LKAS 28)
Joint control is the contractually agreed sharing of control of an arrangement,
which exists only when decisions about the relevant activities require the
unanimous consent of the parties sharing control. (SLFRS 11, LKAS 28)
A joint venture is a joint arrangement whereby the parties that have joint control
of the arrangement have rights to the net assets of the arrangement. (SLFRS 11,
LKAS 28)
A joint operation is a joint arrangement whereby the parties that have joint
control of the arrangement have rights to the assets and obligations for the
liabilities relating to the arrangement. (SLFRS 11)
Further definitions are provided in the relevant Sections of this Chapter.
500
CA Sri Lanka
Criteria
Required treatment in
group accounts
Subsidiary
Control
Full consolidation
Associate
Significant influence
Equity accounting
Joint venture
Joint control
Equity accounting
Investment
As a financial asset
CA Sri Lanka
(a)
(b)
(c)
2 Principles of consolidation
A subsidiary is an entity that is controlled by a parent company; unless the
parent company is an investment entity it must consolidate all subsidiaries.
(2)
Exposure to, or rights to, variable returns from its involvement with the
investee; and
(3)
The ability to use its power over the investee to affect the amount of the
investors returns
If there are changes to one or more of these three elements of control, then an
investor should reassess whether it controls an investee.
2.1.1 Power
Power is defined as existing rights that give the current ability to direct the
relevant activities of the investee. There is no requirement for that power to have
been exercised.
Relevant activities may include:
502
CA Sri Lanka
CA Sri Lanka
503
QUESTION
Identification of subsidiaries
504
AB Co and CD Co establish XY Co, each holding 50% of the voting shares. The
shareholders agreement specifies that:
(a)
(b)
(c)
CA Sri Lanka
EF Bank establishes a special purpose vehicle SP and owns 100% of its shares.
SP simultaneously enters into a trade receivables factoring agreement with PQ
Co. This is the sole purpose of SP. An agreement sets out the terms on which
SP will purchase PQ Cos receivables and EF Bank will provide financing for
that purpose. PQ Co will continue to be responsible for collecting and
managing the receivables and it is required to provide a guarantee that losses
on the transferred receivables will not exceed a certain amount. The shares
held by EF Bank confer voting rights but cannot override the restriction on
SPs activities or invalidate the contract with PQ Co.
Required
Discuss whether control is established in each of these scenarios.
ANSWER
1
Both major capital activities and day to day management activities are likely
to be relevant activities ie affect XY Cos returns. We should therefore
consider which activities have the greatest effect on returns.
If capital activities have the most significant impact (which may be the
case because the stated objective is to achieve capital gains) then AB Co
and CD Co have joint control of XY Co.
If day to day management activities are considered more significant then
AB Co has control because it directs these activities unilaterally.
CA Sri Lanka
EF Bank owns 100% of SP however it is unlikely that the voting rights confer
the ability to direct the relevant activities. This is due to the restrictions on
SPs activities and the factoring agreement. PQ Co is likely to be the entity
that directs the relevant activities of SP because it manages the receivables.
It is therefore likely that PQ Co controls SP.
505
(b)
(c)
(d)
A parent that does not present consolidated financial statements must comply
with the LKAS 27 rules on separate financial statements.
506
CA Sri Lanka
Obtains funds from one or more investors for the purpose of providing those
investor(s) with investment management services;
(b)
Commits to its investor(s) that its business purpose is to invest funds solely
for returns from capital appreciation, investment income or both; and
(c)
CA Sri Lanka
507
The gap between the reporting dates is three months or less, and
(ii)
3.1 Definitions
SLFRS 3 provides a number of definitions including the following:
Acquiree is the business that the acquirer obtains control of in a business
combination.
Acquirer is the entity that obtains control of the acquiree.
Acquisition date is the date on which the acquirer obtains control of the acquiree.
508
CA Sri Lanka
(b)
CA Sri Lanka
Acquirer is
identified
Acquisition date
is determined
509
Assets, liabilities
and NCI of
acquiree are
recognised and
measured
Identifiable assets, assumed liabilities and the noncontrolling interest should be recognised on acquisition.
Some assets or liabilities that were not previously
recognised by the acquiree may be recognised on
consolidation eg internally generated intangible assets.
Goodwill is
recognised and
measured
3.3 Goodwill
Goodwill arises in consolidated financial statements as a consolidation adjustment
and is calculated as:
Rs.
Fair value of consideration transferred
X
Non-controlling interest
X
Less: Fair value of identifiable assets acquired and liabilities
(X)
Assumed
Goodwill
3.3.1 Consideration
Consideration of any form is included in the calculation of goodwill at the
acquisition date fair value. Acquisition costs are not part of consideration; these
are expensed as incurred.
Contingent consideration is included at its acquisition date fair value. The
acquirer may be required to pay contingent consideration in the form of equity or
of a debt instrument or cash. Debt instruments are presented in accordance with
LKAS 32.
Contingent consideration may occasionally be an asset, for example if the
consideration has already been transferred and the acquirer has the right to the
return of part of it, an asset may occasionally be recognised in respect of that right.
Postacquisition, the subsequent accounting for contingent consideration depends
on the circumstances:
510
(a)
(b)
If the change is due to events which took place after the acquisition date, for
example, meeting earnings targets:
CA Sri Lanka
(i)
(ii)
511
The subsidiary company may incorporate fair value adjustments in its own
financial statements; if it does not, fair value adjustments must be made as a
consolidation adjustment.
SLFRS 3 provides guidance on the recognition of certain assets and liabilities as
follows:
Restructuring and future losses
An acquirer should not recognise liabilities for future losses or other costs
expected to be incurred as a result of the business combination.
SLFRS 3 explains that a plan to restructure a subsidiary following an acquisition is
not a present obligation of the acquiree at the acquisition date. Neither does it
meet the definition of a contingent liability. Therefore an acquirer should not
recognise a liability for such a restructuring plan as part of allocating the cost of
the combination unless the subsidiary was already committed to the plan before
the acquisition.
This prevents creative accounting. An acquirer cannot set up a provision for
restructuring or future losses of a subsidiary and then release this to profit or loss
in subsequent periods in order to reduce losses or smooth profits.
Intangible assets
The acquiree may have intangible assets, such as development expenditure. These
can be recognised separately from goodwill only if they are identifiable. An
intangible asset is identifiable only if it:
(a)
(b)
Contingent liabilities
Contingent liabilities of the acquirer are recognised if their fair value can be
measured reliably. A contingent liability must be recognised even if the outflow is
not probable, provided there is a present obligation.
This is a departure from the normal rules in LKAS 37; contingent liabilities are not
normally recognised, but only disclosed.
After their initial recognition, the acquirer should measure contingent liabilities
that are recognised separately at the higher of:
(a)
(b)
512
CA Sri Lanka
QUESTION
Goodwill
You are the financial accountant at SL Traders Ltd. SL Traders Ltd acquired 90%
of the 2 million shares in Columbo Imports Ltd on 31 August 20X2. This is the
latest in a series of acquisitions and SL Traders Ltd has adopted a consistent policy
of measuring the non-controlling interest at fair value.
Consideration provided to the shareholders of Columbo Imports Ltd comprised
Rs. 4.2 Mn cash payable immediately; one share in SL Traders Ltd for every 50
acquired; and Rs. 1 Mn payable on 31 August 20X5 if Columbo Imports achieves a
specified revenue growth. This growth is considered unlikely at the acquisition
date and as such the fair value of contingent consideration at the acquisition date
is assessed as 25% of its face value. The market value of an SL Traders share at
the acquisition date is Rs. 45 and the market value of a Columbo Imports share is
Rs. 3.
You have discovered the following information relevant to Columbo Imports at the
acquisition date:
In its most recent financial statements to 31 July 20X2 the company disclosed
details of an on-going legal case. No provision was made for the possible costs
of Rs. 90,000 as these were not considered probable of payment. This
assessment of the situation remains in place at the acquisition date.
The company has a well-established trade name and logo. Both are registered
with the relevant authorities but are not recognised in Columbo Imports
financial statements. The fair value of the trade name has been assessed as
Rs. 300,000.
CA Sri Lanka
513
514
CA Sri Lanka
Legal fees are acquisition costs and do not form part of consideration.
Reassess whether it has correctly identified all of the assets acquired and all
of the liabilities assumed and must recognise any additional assets or
liabilities that are identified in that review
(ii)
CA Sri Lanka
515
The period during which this work to identify actual values is carried out is known
as the measurement period. It ends on the earlier of:
The date by which the acquirer has received all of the information it was
seeking or learns that the information cannot be obtained, or
12 months after acquisition.
During this period the acquirer may adjust provisional amounts to reflect new
information obtained about facts and circumstances that existed on the
acquisition date. Amounts are adjusted retrospectively, meaning that the goodwill
initially calculated may change.
Any adjustments after the measurement period are recognised only to correct an
error in accordance with LKAS 8.
3.6 Disclosures
An acquirer must disclose information to enable the users of its financial
statements to evaluate the nature and financial effect of a business combination
that occurs during the current period or after the end of the period but before the
financial statements are authorised for issue. This information should include:
The name and a description of the acquiree
The acquisition date
The percentage of voting equity interests acquired
The reasons for the business combination
A qualitative description of the factors that make up the goodwill recognised
The acquisition date fair value of the total consideration transferred and each
major class of consideration
For contingent consideration:
the amount recognised at acquisition
a description of the arrangement
an estimate of the range of outcomes
Details of acquired receivables
Amounts recognised for each class of assets and liabilities acquired
Disclosure in accordance with LKAS 37 for contingent liabilities recognised
The amount of a gain in a bargain purchase and a description of reasons why
the transaction resulted in a gain
516
CA Sri Lanka
Goodwill
Stated capital (of S)
Retained earnings / reserves (of S)
Fair value adjustments
Cost of investment (of P)
Non-controlling interest
CA Sri Lanka
Retained earnings
Goodwill
517
Allocate the relevant share of post acquisition retained earnings and other
reserves to the NCI:
DEBIT
CREDIT
Cancel any intra-group balances (after accounting for cash / goods in transit by
assuming they have been received):
DEBIT
CREDIT
Payables/Loan
Receivables/investment
Retained earnings
Inventory / PPE
518
CA Sri Lanka
QUESTION
You are provided with the following statements of financial position for Lakegala
and Purijjala.
STATEMENTS OF FINANCIAL POSITION AS AT 31 OCTOBER 20X0
Lakegala
Purijjala
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Non-current assets, at net book value
325
70
Plant
200
50
Fixtures
525
120
Investment
200
Shares in Purijjala at cost
Current assets
220
70
Inventory at cost
145
105
Receivables
0
100
Bank
175
465
1,190
295
Equity
700
170
Stated capital
215
50
Retained earnings
915
220
Current liabilities
275
55
Payables
0
20
Bank overdraft
75
275
295
1,190
The following information is also available.
CA Sri Lanka
(a)
(b)
For the purposes of the acquisition, plant in Purijjala with a book value of
Rs. 50 Mn was revalued to its fair value of Rs. 60 Mn. The revaluation was
not recorded in the accounts of Purijjala. Depreciation is charged at 20%
using the straight-line method.
(c)
519
(d)
Purijjala owes Lakegala Rs. 35 Mn for goods purchased and Lakegala owes
Purijjala Rs. 15 Mn.
(e)
(f)
Required
Prepare the consolidated statement of financial position of Lakegala as at
31 October 20X0.
ANSWER
Consolidated statement of financial position at 31 October 20XO
Plant
Total
(W1)
(W2)
(W3)
(W4)
(W5)
Cons.
Rs Mn
325
Rs Mn
70
Rs Mn
395
Rs Mn
10
Rs Mn
Rs Mn
(8)
Rs Mn
Rs Mn
Rs Mn
397
Fixtures
200
50
250
Investment
200
200
(200)
76.5
76.5
Goodwill
Inventory
220
70
290
Receivables
145
105
250
Bank
100
100
250
(9)
1,190
295
1,485
700
170
870
(170)
Retained earnings
215
50
265
(20)
(9)
(5.6)
76.5
(2.4)
275
55
330
20
20
1,190
295
1,485
Payables
Bank overdraft
200
100
Stated capital
NCI
281
(50)
1,304.5
700
(9)
221.4
83.1
(50)
280
20
1,304.5
WORKINGS
1
Calculate goodwill
Goodwill
Rs Mn
Consideration transferred
Fair value of NCI (30% 170,000 Rs 1.50)
Net assets acquired:
Stated capital
Retained earnings at acquisition
FV Adjustment (60 50)
Goodwill
520
Rs Mn
200
76.5
170
20
10
(200)
76.5
CA Sri Lanka
Goodwill
Stated capital
Retained earnings
Plant
Investment
NCI
76.5
170
20
10
200
76.5
9
9
(70% 8m)
5.6
2.4
8
Unrealised profit
The unrealised profit is Rs. 45 Mn 25%/125% = Rs. 9 Mn. The selling
company is Lakegala and therefore the unrealised profit is eliminated by
(Rs Mn):
DEBIT
CREDIT
Retained earnings
Inventory
9
9
Intragroup balances
Purijjala has an intercompany payable balance of Rs. 35 Mn and Lakegala an
intercompany receivable balance of the same amount; Lakegala has an
intercompany payable balance of Rs. 15 Mn and Purijjala an intercompany
receivable balance of the same amount.
These are eliminated by (Rs Mn):
DEBIT
CREDIT
CA Sri Lanka
50
50
521
Revenue
Cost of sales
Administration expenses
Goodwill (CSOFP)
The debit entry is allocated in its entirety to the owners of the parent where the
NCI is measured as a proportion of net assets; it is allocated between the
owners of the parent and the NCI where the NCI is measured at fair value.
Eliminate any unrealised profits by:
DEBIT
CREDIT
Cost of sales/expense
Inventory/PPE (SOFP)
The debit entry is allocated in its entirety to the owners of the parent where the
parent is the selling company; it is allocated between the owners of the parent
and the NCI where the subsidiary is the selling company.
522
CA Sri Lanka
QUESTION
80% of Kalu for Rs. 5 Mn when the carrying amount of the net
assets of Kalu was Rs. 4 Mn.
30 November 20X7 65% of Beira for Rs. 2.6 Mn when the carrying amount of
the net assets of Beira was Rs. 3.35 Mn.
The companies' statements of profit or loss and other comprehensive income for
the year ended 31 March 20X8 were:
Dias
Kalu
Beira
Rs'000
Rs'000
Rs'000
5,000
3,000
2,910
Revenue
(3,000)
(2,300)
(2,820)
Cost of sales
2,000
700
90
Gross profit
(1,000)
(500)
(150)
Administrative expenses
230
Other income
(50)
(210)
Finance costs
1,230
150
(270)
Profit/(loss) before tax
(300)
(50)
CA Sri Lanka
(1)
On 1 April 20X7, Beira issued Rs. 2.1 Mn 10% loan stock to Dias. Interest is
payable twice yearly on 1 October and 1 April. Dias has accounted for the
interest received on 1 October 20X7 only (within other income).
(2)
On 1 July 20X7, Kalu sold a freehold property to Dias for Rs. 800,000 (land
element Rs. 300,000). The property originally cost Rs. 900,000 (land
element Rs. 100,000) on 1 July 20W7. The property's total useful life was
50 years on 1 July 20W7 and there has been no change in the useful life
since. Kalu has credited the profit on disposal to 'Administrative expenses'.
(3)
The property, plant and equipment of Beira on 30 November 20X7 was fair
valued at Rs. 500,000 (carrying amount Rs. 350,000) and was acquired in
April 20X7. The property, plant and equipment has a total useful life of ten
years. Beira has not adjusted its accounting records to reflect fair values. The
group accounting policy is to measure non-controlling interests at the
proportionate share of the fair value of net identifiable assets at acquisition.
523
(4)
All companies use the straight-line method of depreciation and charge a full
year's depreciation in the year of acquisition and none in the year of
disposal. Depreciation on fair value adjustments is time apportioned from
the date of acquisition.
(5)
Dias has accounted for its dividend received from Kalu in 'Other income'.
(6)
Required
Prepare the consolidated statement of profit or loss and other comprehensive
income for Dias for the year ended 31 March 20X8.
ANSWER
Consolidated statement of profit or loss and other comprehensive income of
Dias for the year ended 31 March 20X8
D
B (4/12)
Rs'000
Rs'000
5,000
3,000
Cost of sales
(3,000)
(2,300)
(940)
Gross profit
2,000
700
30
(1,000)
(500)
(50)
Revenue
Admin expense
Other income
230
Finance costs
PBT
Income tax exp
1,230
Total
(W2)
(W3)
(W4)
(W5)
(W6)
Consol
Rs'000
Rs'000
Rs'000
Rs'000
Rs'000
Rs'000
Rs'000
Rs'000
970
8,970
(50)
(70)
150
(90)
-
8,970
(6,240)
(6,240)
2,730
2,730
(63.5)
(1,550)
230
35
(120)
70
(5)
(65)
(40)
(1,683.5)
225
(50)
1,290
1,221.5
(350)
(300)
(50)
(350)
Profit for yr
930
100
(90)
940
871.5
OCI
130
40
40
210
210
TCI
1,060
140
(50)
1,150
1,081.5
Profit:
NCI
Owners of group
930
20
(31.5)
(11.5)
80
(58.5)
951.5
28
(17.5)
10.5
112
(32.5)
1,139.5
105
(12.7)
(1.75)
(50.8)
(3.25)
(12.7)
(1.75)
(50.8)
(3.25)
(25.95)
(40)
(65)
897.45
TCI:
NCI
Owners of group
524
1,060
105
(3.95)
(40)
(65)
1,085.45
CA Sri Lanka
Workings
1
Profits
TCI
Beira
Loss
TCI
Rs'000
20
80
28
112
(31.5)
(58.5)
(17.5)
(32.5)
Pre-acquisition
210
12
= 140
Post-acquisition
(210
12
) = 70
Rs'000
105
(70)
35
The correct journal to record the net Rs. 35,000, and cancel the finance cost
and payable figures in Beiras financial statements is therefore (Rs'000)
DEBIT Payables (CSOFP)
CREDIT Other income
CREDIT Finance costs
105
35
70
525
Sale of property
Unrealised profit
Rs'000
300
(100)
Land Proceeds
Carrying amount
Profit on disposal (in Kalu)
Rs'000
200
500
(640)
(140)
3.5
63.5
Administrative expenses
PPE (CSOFP)
63.5
63.5
150
10
= 15 per annum
4
12
At year end
Rs'000
145
= Rs. 5 Mn
Administrative expenses
PPE (CSOFP)
5
5
The adjustment to profit is allocated between the NCI and the owners of the
parent in the ratio 35%:65%.
5
Dividend income
The dividend from Kalu is eliminated by (Rs'000):
DEBIT
CREDIT
40
40
526
CA Sri Lanka
Impairment losses
(a)
Goodwill
Kalu
Rs'000
Consideration
transferred
Non-controlling
interests
FV net assets at acq'n:
Carrying amount per Q
Fair value adjustment
(W4)
4,000
20%
Rs'000
5,000
800
4,000
-
Beira
Rs'000
3,500
35%
1,225
3,350
150
(4,000)
1,800
(b)
Rs'000
2,600
(3,500)
325
Losses
Goodwill
'Notional' goodwill ( 100%/80%)
( 100%/65%)
Net assets at 31 March 20X7
Recoverable amount
Impairment loss
Allocated to:
'Notional' goodwill
Other assets
Recognised impairment loss:
Recognised goodwill (100 65%)
Other assets (100%)
Kalu
Rs'000
1,800
Beira
Rs'000
325
2,250
500
4,450
6,700
7,040
0
3,300
3,800
3,700
100
100
100
65
Administrative expenses
Goodwill (CSOFP)
65
65
As the NCI is not measured at fair value none of the loss is allocated to
it.
CA Sri Lanka
527
5.1 Associates
At the start of the chapter an associate was defined as an entity over which an
investor has significant influence.
5.1.1 Significant influence
We have also defined significant influence as the power to participate in the
financial and operating policy decisions of the investee but is not control or joint
control over those policies.
If an investor holds 20% or more of the voting power of the investee, it can be
presumed that the investor has significant influence over the investee, unless it
can be clearly shown that this is not the case.
Significant influence can be presumed not to exist if the investor holds less than
20% of the voting power of the investee, unless it can be demonstrated
otherwise.
Significant influence may be evidenced by:
(a)
(b)
(c)
(d)
(e)
(b)
528
otherwise entitled to vote, have been informed about, and do not object
to, the investor not applying the equity method;
(ii)
The equity method is applied from the date on which significant influence
commences and ceases to be applied when the investor ceases to have significant
influence.
5.1.3 The equity method
The equity method is a method of accounting whereby the investment is initially
recognised at cost and adjusted thereafter for the post-acquisition change in the
investors share of the investees net assets. The investors profit or loss includes
its share of the investees profit or loss and the investors other comprehensive
income includes its share of the investees other comprehensive income.
At acquisition
An associate is initially recognised at cost. Cost is notionally allocated to the
fair value of net assets acquired:
Where cost exceeds net assets acquired notional goodwill is included within
the carrying amount. This is not separately recognised.
Where cost is less than net assets acquired, the difference is included as
income in the determination of the investor's share of the associate's profit
or loss in the period in which the investment is acquired.
Statement of financial position
A single figure for investment in associates is shown in the consolidated
statement of financial position. At the time of the acquisition this is stated at
cost. This is subsequently increased or decreased by the groups share of the
total comprehensive income made in the year by the associate.
CA Sri Lanka
529
Practical considerations
If an associate prepares its financial statements to a different reporting date
from that of the group it should prepare additional financial statements to the
group reporting date, or if that is not possible its most recent accounts may be
used for consolidation providing that:
The gap between the reporting dates is three months or less, and
Adjustments are made for the effects of significant transactions or other
events that occur between the reporting dates.
530
CA Sri Lanka
QUESTION
Allice Group acquires 35% of Brandon Co on 1 July 20X6 at a cost of Rs. 16 Mn. At
that date the Equity in Brandon Co was made up of:
A company in the Allice Group sold goods to Brandon Co for Rs. 2.5 Mn,
recognising a margin of 20%. At 31 December 20X7, half of these goods
remained unsold.
2.
CA Sri Lanka
531
ANSWER
Cost
Share of post acquisition retained earnings (30%
(24,670 22,000))
Share of post acquisition movement in revaluation
surplus (30% (7,500 7,000))
Post acquisition share of movement in AFS reserve
(30% (1,200 2,000))
Adjustment for unrealised profit (2,500 20%
30%)
Dividend paid to Allice Group (30% 1,000)
Carrying amount of associate in group SOFP:
Rs'000
16,000
801
150
(240)
(75)
(300)
16.336
Notes:
1.
2.
In terms of the AFS investment reserve, the group should recognise its share
of the Rs. 800,000 fall. The Rs. 500,000 reclassification adjustment is a debit
to Brandons AFS investment reserve and a credit to Brandons retained
earnings. These movements net to zero and so no further adjustment is
required.
532
CA Sri Lanka
A party with joint control can prevent one of the other parties from controlling
the arrangement
An arrangement can still be a joint arrangement even if not all parties have
joint control (some parties may participate rather than have joint control)
Judgement must be applied when assessing whether a party has joint control of
an arrangement.
The existence of a contractual agreement distinguishes a joint arrangement from
an investment in an associate.
Evidence of a contractual arrangement could be in one of several forms.
Contract between the parties
Minutes of discussion between the parties
Incorporation in the articles or by-laws of the joint venture
The contractual arrangement is usually in writing, whatever its form, and it will
deal with the following issues surrounding the joint arrangement.
Its activity, duration and reporting obligations
The appointment of its board of directors (or equivalent) and the voting rights
of the parties
Capital contributions to it by the parties
How its output, income, expenses or results are shared between the parties
It is the contractual arrangement that establishes joint control over the joint
venture, so that no single party can control the activity of the joint venture on its
own.
The terms of the contractual arrangement are key to deciding the form of the joint
arrangement.
QUESTION
1.
2.
CA Sri Lanka
Joint control
51%
30%
19%
533
The facts are the same as in point 2 above, however Company Q has an
option to buy Company Rs shared in GG Co. The option can be exercised by
Company Q at any time in the event that Companies Q and R do not agree on
a decision regarding the relevant activities of GG Co. The option price is not
set so high that the possibility of exercise is remote.
4.
Pacific and Atlantic both have a 24% interest in Southern; the remaining
52% of ordinary voting shares are widely dispersed. Decisions about
relevant activities require a majority of the voting rights and Pacific and
Atlantic have an agreement that they will agree on decisions about relevant
activities.
5.
The facts are the same as in point 4 above, however there is no agreement
between Pacific and Atlantic that they will agree on decisions.
Required
Analyse the scenarios in order to conclude as to whether joint control exists.
ANSWER
534
1.
2.
3.
There is no joint control here; because Company Q can impose its decisions
at any time by exercising its option to purchase Company Rs shares,
Company Q is deemed to have unilateral control. Therefore Company R
should consolidate GG Co as a subsidiary.
4.
Joint control does exist here. Collectively Pacific and Atlantic have control
over Southern. Since there is a contractual agreement for Pacific and Atlantic
CA Sri Lanka
to agree on all decisions, the two entities have joint control and Southern is a
joint arrangement.
5.
CA Sri Lanka
535
Joint operation
Joint venture
The terms of
the contractual
arrangement
Rights to assets
Obligations for
liabilities
536
CA Sri Lanka
Joint operation
Joint venture
Revenues,
expenses, profit
or loss
Guarantees
CA Sri Lanka
Joint Operation
Joint venture
(a)
(b)
(c)
(d)
537
Joint Operation
operation; and
(e)
Joint venture
provides evidence that the net realisable
value of current assets is less than cost or
there is an impairment loss.
Upstream transactions (JV to investor)
Where there is an unrealised gain, the
joint venturers share of gain is not
recognised until the profit is realised.
Where there is an unrealised loss the loss
is recognised immediately if it represents
a reduction in the net realisable value of
current assets or a permanent decline in
the carrying amount of non-current
assets.
QUESTION
Joint operation
Olbas Group has a 30% share of a joint operation Goldmine. Assets, liabilities,
revenue and costs are apportioned on the basis of shareholding.
In the year, Goldmine built an excavation centre in Africa at a cost of Rs. 6 Mn. It
was completed on 1 October 20X4 and is to be dismantled at the end of its life of
ten years. The present value of this dismantling cost to the joint arrangement at 1
October 20X4, using a discount rate of 4%, was Rs. 1.5 Mn.
Goldmine has earned revenue of Rs. 1.3 Mn in the year ended 31 March 20X5. The
terms of the agreement between Olbas Group and the other joint operators
require that Goldmine collects all revenues and distributes these to other joint
operators on an annual basis. At 31 March 20X4, Goldmine had not yet paid the
other joint operators their share of revenue for the year.
In the year ended 31 March 20X5 the joint operation incurred operating costs of
Rs. 0.8 Mn. These were paid by another joint operator and recharged to Olbas
Group. Olbas Group has not yet been charged for its share of the costs for the year.
Required
Calculate what amounts are included in the consolidated statement of financial
position of the Olbas Group for the year ended 31 March 20X5 in respect of the
joint operation?
538
CA Sri Lanka
ANSWER
The Olbas Group must recognise on a line-by-line basis its assets, liabilities,
revenues and expenses plus its share (40%) of the joint assets, liabilities, revenue
and expenses. The following amounts are therefore included in the consolidated
statement of financial position:
Statement of financial position
Non-current assets
Property plant and equipment (W1)
Equity
Retained earnings (W4)
Current liabilities
Trade payables (W2)
Non-current liabilities
Dismantling provision (W3)
(W1)
Property, plant and equipment:
Cost of excavation centre (6m 30%)
dismantling provision (1.5m 30%)
Accumulated depreciation: 2,250/10 6/12m
31 March 20X5 carrying amount
(W2)
Trade payables (to other joint operators):
Revenue 70% 1.3m
Costs 30% 800,000
(W3)
Dismantling provision:
At 1 October 20X4
Finance cost (unwinding of discount): 450 4% 6/12m
At 31 March 20X5
CA Sri Lanka
Rs'000
2,137
28
1,150
459
1,800
450
2,250
(113)
2,137
910
240
1,150
450
9
459
539
QUESTION
Equity accounting
The statements of financial position of Jaipura and its investee companies, Adikari
and Guptha, at 30 September 20X6 are shown below.
STATEMENTS OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20X6
Jaipura
Rs Mn
Non-current assets
Freehold property
Plant and machinery
Investments
Current assets
Inventory
Trade receivables
Cash
Total assets
Equity and liabilities
Equity
Stated capital
Retained earnings
Non-current liabilities
12% loan stock
Current liabilities
Trade payables
Bank overdraft
Total equity and liabilities
540
Adikari
Rs Mn
Guptha
Mn
420
230
240
890
177
97
274
98
65
163
75
40
2
117
60
27
9
96
35
18
1
54
1,007
370
217
200
423
623
50
200
250
40
158
198
320
100
52
12
384
20
120
19
19
1,007
370
217
CA Sri Lanka
Additional information
(a)
(b)
(c)
At the date of acquisition of Adikari, the fair value of its freehold property
was considered to be Rs. 50 Mn greater than its value in Adikari's statement
of financial position. Rs. 30 Mn of this increase related to buildings and the
remainder to land. Adikari had acquired the property ten years previously
and the buildings element is depreciated on cost over 50 years.
(d)
In the year Jaipura sold goods to Guptha of which Guptha had Rs. 15 Mn in
inventory at 30 September 20X6. Jaipura had priced these goods to earn a
profit margin of 20%.
An impairment loss of Rs. 15 Mn is to be recognised on the investment in
Guptha.
The non-controlling interest is measured at fair value. Adikari shares were
trading at Rs. 240 Mn just prior to the acquisition by Jaipura.
(e)
(f)
Required
Prepare the consolidated statement of financial position for the Jaipura Group at
30 September 20X6.
CA Sri Lanka
541
ANSWER
JAIPURA GROUP CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT
30 SEPTEMBER 20X6
J
Total
W1
W2
W3
W4
(i)
W4
(ii)
W4
(iii)
W4
(iv)
Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn
Total
Rs Mn
420
177
597
P&M
230
97
327
Invts
240
240
Ass
GW
890
274
1,164
Inv
75
60
135
135
Tr rec
40
27
67
67
Cash
11
11
117
96
213
213
Total
assets
1,007
370
1,377
St cap
200
50
250
(50)
Ret Egs
423
200
623
(120)
(2.9)
(20)
60
(0.9)
20
623
250
883
757.2
320
100
420
420
Tr Pay
52
20
72
72
O/d
12
12
12
384
120
504
504
1,007
370
1,377
Free
50
643.2
(3.8)
Prop
NCI
Loan
327
(200)
(40)
40
13.8
(0.8)
38
(15)
40
40
1,048.2
1,261.2
200
13.8
(0.8)
(15)
478.1
79.1
1,261.2
WORKINGS
1
542
Rs Mn
200
60
50
120
50
(220)
40
CA Sri Lanka
40
50
120
50
200
60
2.9
0.9
3.8
Investment in associate
(i)
(ii)
CA Sri Lanka
543
6.1 Scope
SLFRS 12 covers disclosures for entities that have interests in:
Subsidiaries
Joint arrangements
Associates, and
Unconsolidated structured entities.
A structured entity is an entity that has been designed so that voting or similar
rights are not the dominant factor in deciding who controls the entity, such as
when any voting rights relate to administrative tasks only and the relevant
activities are directed by means of contractual arrangements. (SLFRS 12)
A structured entity may have some or all of the following features:
Restricted activities
A narrow and well defined objective eg to carry out research and development
activities
Insufficient equity to finance its own activities without support
544
CA Sri Lanka
it shall disclose
it has made in
have the typical
the reasons for
CA Sri Lanka
545
Understand:
The composition of the group, and
The interest that non-controlling interests have in the groups activities
and cash flows.
(b)
Evaluate:
The nature and extent of significant restrictions on its ability to access or
use assets and settle liabilities of the group.
The nature of, and changes in, risks associated with interests in
subsidiaries.
The consequences of losing control of a subsidiary during the reporting
period.
6.3.1Interest that the NCI has in the groups activities and cash flow
For each subsidiary with a material non-controlling interest, the following should
be disclosed:
(a)
(b)
(c)
(d)
(e)
(f)
(g)
546
Significant restrictions on its ability to access or use the assets and settle the
liabilities of the group.
CA Sri Lanka
(b)
The nature and extent to which protective rights of the NCI can significantly
restrict the entitys ability to access or use the assets and settle the liabilities
of the group.
(c)
(b)
Details of any such support provided in the period where there was no
contractual obligation to do so.
(c)
(b)
(c)
(d)
For each joint venture and associate that is material to the reporting entity the
following should be disclosed:
CA Sri Lanka
(a)
(b)
547
(c)
The fair value of the investment in the joint venture or associate (where the
equity method is applied).
(b)
The nature and extent of any significant restrictions on the ability of joint
ventures or associates to transfer funds to the entity.
(b)
(c)
(i)
The date of the end of the reporting period of the joint venture /
associate.
(ii)
The unrecognised share of losses of a joint venture or associate both for the
reporting period and on a cumulative basis.
Commitments that it has relating to its joint ventures separately from the
amount of other commitments
(b)
(b)
548
CA Sri Lanka
The carrying amount (at the time of transfer) of all assets transferred to
those structured entities in the period.
Nature of risks
(a)
(b)
The line items in the statement of financial position in which those assets
and liabilities are recognised.
(c)
The amount that best represents the entitys maximum exposure to loss
from its interests in unconsolidated structured entities including how the
maximum loss is determined.
(d)
An entity should also disclose its intentions to provide financial or other support
to an unconsolidated structured entity, including intentions to assist the
structured entity in obtaining financial support.
These disclosures are not required by investment entities.
QUESTION
Jaffna Co acquired 100% of a private company Ocean Co on 1 September 20X5.
Jaffna Co agreed to pay Rs. 80 Mn in cash, issue 1 of their shares for 5 of Ocean Cos
shares and pay Rs. 10 Mn in two years time. In addition if Ocean Co makes
Rs. 200 Mn profit over the next two years Jaffna Co will pay an additional
Rs. 50 Mn. Profit this year was Rs. 130 Mn and forecasts indicate a similar profit
will be made next year. The fair value of this contingent consideration was
estimated as Rs. 3 Mn at 1 September 20X5. Before the acquisition Jaffna Co had
20 million shares and Ocean Co had 5 million shares. The market value of Jaffna
Co shares were Rs. 250 each and Rs. 360 for Ocean shares.
Assume a discount rate of 5%.
Required
Explain how the above item should be dealt with in the financial statements of
Jaffna Co at the acquisition date, 1 September 20X5.
CA Sri Lanka
549
ANSWER
SLFRS 3 Business combinations states that the cost of a business combination
should be the fair value of the consideration transferred by the acquirer. Any
costs associated with the business combination are expensed (or debited to share
premium if they are share issue costs). The fair value will be measured at
1 September 20X5.
The consideration transferred will be:
Cash
Deferred consideration (Rs 10 Mn 1/1.052)
Contingent consideration
Shares (5 Mn shares/5 Rs 250)
Rs'000
80,000
9,070
3,000
250,000
342,070
Notes:
Only the fair value of the contingent consideration of Rs. 50 Mn is included in the
consideration transferred. As it is unlikely that the conditions will be met, this is
relatively small compared to the potential amount payable as fair value takes into
account the probability of payment.
The deferred consideration must be discounted to its present value of Rs. 9.07 Mn
and shown as a liability. The discount of Rs. 930,000 will be shown as a finance
cost in profit or loss over the 2 years until the full amount becomes payable.
QUESTION
Pasikuda acquired 80% of the ordinary share capital of Sigiriya for Rs. 160 Mn and
40% of the ordinary share capital of Ampara for Rs. 70 Mn on 1 January 20X7
when the retained earnings balances were Rs. 64 Mn in Sigiriya and Rs. 24 Mn in
Ampara. Pasikuda, Ampara and Sigiriya are public limited companies.
550
CA Sri Lanka
416
278
694
99
128
227
80
97
177
457
1,151
343
570
124
301
CA Sri Lanka
On 30 November 20X9 Pasikuda sold some goods to Sigiriya for Rs. 32 Mn.
These goods had originally cost Rs. 22 Mn and none had been sold by Sigiriya
by the year-end. On the same date Pasikuda also sold goods to Ampara for
Rs. 22 Mn. These goods originally cost Rs. 10 Mn and Ampara had sold half
by the year end.
551
Required
Prepare a consolidated statement of financial position for The Pasikuda Group as
at 31 December 20X9.
ANSWER
2
Total
(W1)
(W2)
(W3)
(W4)
(W5)
(W6)
Cons.
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs'000
PPE
220
160
380
12
(9)
383
Investments
230
230
(160)
(70)
Goodwill
24
(15)
Invt in Ass
96.8
96.8
450
160
610
Inventory
384
234
618
(10)
608
Receivables
275
166
441
441
42
10
52
52
1,151
510
1,721
St capital
416
99
515
(99)
Retained
earnings
278
128
406
(64)
(12)
(7.2)
(12.8)
(10)
26.8
326.8
39
(3)
(1.8)
12.8
47
457
343
800
800
1,151
510
1,721
Cash
NCI
Payables
488.8
1,589.8
-
416
1,589.8
Rs Mn
160
39
99
64
12
(175)
Goodwill at acquisition
24
The acquisition consolidation journal is therefore:
DEBIT
Goodwill
Rs. 24 Mn
DEBIT
Stated capital
Rs. 99 Mn
DEBIT
Retained earnings
Rs. 64 Mn
DEBIT
PPE
Rs. 12 Mn
CREDIT Investment
Rs. 160 Mn
CREDIT NCI
Rs. 39 Mn
552
CA Sri Lanka
Goodwill impairment
The goodwill is impaired by Rs. 15 Mn; as the NCI is measured at fair value
this is allocated to the NCI and owners of the parent in proportion to their
shareholdings. It is recorded by;
DEBIT
Retained earnings (80%)
Rs. 12 Mn
DEBIT
NCI (20%)
Rs. 3 Mn
CREDIT Goodwill
Rs. 15 Mn
Rs. 7.2 Mn
Rs. 1.8 Mn
Rs. 9 Mn
12.8m
Rs. 12.8 Mn
Rs. 12.8 Mn
Rs. 10 Mn
Rs. 10 Mn
Investment in associate
(i)
(ii)
Post acquisition profits of (97 24) 40% = Rs. 29.2 Mn are allocated
to the investment in associate by:
DEBIT
Investment in associate
Rs. 29.2 Mn
CREDIT Retained earnings
Rs. 29.2 Mn
Investment in associate
Investments
Retained earnings
Rs. 96.8 Mn
Rs. 70 Mn
Rs. 26.8 Mn
553
CHAPTER ROUNDUP
554
LKAS 28 requires that an associate and joint venture are accounted for using
the equity method. A parent has significant influence over an associate and
joint control over a joint venture.
CA Sri Lanka
PROGRESS TEST
How does SLFRS 3 deal with contingent consideration and contingent liabilities?
What is the journal adjustment in the CSOFP for an unrealised profit in inventory?
CA Sri Lanka
555
556
(a)
(b)
Exposure to, or rights to, variable returns from its involvement with the
investee; and
(c)
The ability to use its power over the investee to affect the amount of the
investors returns
At fair value through profit or loss (with the exception of subsidiaries that provide
services relevant to the normal activities of the investment entity; these are
consolidated as normal).
When the NCI is measured at fair value at acquisition such that goodwill is full
goodwill.
DEBIT retained earnings CREDIT inventory (where the parent company is the
seller) or DEBIT retained earnings (group %) DEBIT NCI (NCI %) CREDIT
inventory (where the subsidiary is the seller).
Cost plus (or minus) the investors share of total comprehensive income since
acquisition less dividends paid or declared to the investor less impairment losses.
Whether it has control, significant influence or joint control over an entity and
whether a joint arrangement is a joint venture or a joint operation.
CA Sri Lanka
CHAPTER
INTRODUCTION
A parent company may achieve control of a subsidiary in stages rather than in one
transaction. Goodwill arises only where control is achieved, and its calculation takes into
account the previously held interest.
Similarly, a parent company may dispose of part of an investment rather than the whole
shareholding. In this case, the disposal calculation takes into account the retained interest.
Both of these topics are new at KC1 level.
Knowledge Component
1 Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
2
2.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
accounting/reporting
2.1.1
Compile consolidated financial statements for a group with more than two
subsidiaries, sub subsidiaries and foreign subsidiaries.
2.1.2
557
CHAPTER CONTENTS
1 Step acquisitions
2 Disposals
1 Step acquisitions
Business combinations achieved in stages (step or piecemeal acquisitions) can
result in a company being an investment in equity instruments, an associate
and then a subsidiary over time.
A parent company may acquire a controlling interest in the shares of a subsidiary
as a result of several successive share purchases, rather than by purchasing the
shares all on the same day. Business combinations achieved in stages may also be
known as 'piecemeal acquisitions'.
558
CA Sri Lanka
A previously held equity interest, say 35%, accounted for as an associate under
LKAS 28, is increased to a controlling interest of 50% or more.
Business combinations in which control is maintained:
A controlling interest in a subsidiary is increased, say from 60% to 80%.
Business combinations where control is achieved are treated in the same way,
but business combinations where control is maintained are not.
CA Sri Lanka
559
QUESTION
(b)
(c)
ANSWER
(a)
Rs Mn
480
150
160
300
450
(750)
40
560
CA Sri Lanka
(b)
(c)
QUESTION
Goodwill
Stated capital
Retained earnings
Profit or loss
Investment
Non-controlling interest
Rs. 40 Mn
Rs. 300 Mn
Rs. 450 Mn
Rs. 40 Mn
Rs. 600 Mn
Rs. 150 Mn
Associate to subsidiary
It acquired a further 40% in 20X7 for cash consideration of Rs. 122 Mn. On
this date fair value of the net assets of Arattana was Rs. 284 Mn and the
previously held interest had a fair value of Rs. 88 Mn.
Between 20X5 and 20X7, Arattana retained profits of Rs. 20 Mn and recognised a
revaluation surplus of Rs. 5 Mn.
It is group policy to measure the non-controlling interest as a proportion of net
assets.
Required
CA Sri Lanka
(a)
(b)
561
ANSWER
(a)
80
7.5
(87.5)
0.5
Gain
(b)
Rs Mn
88
Goodwill on consolidation
Rs Mn
122
88
85.2
295.2
(284)
11.2
Consideration
Fair value of previously held interest
NCI (284m 30%)
Fair value of net assets
Goodwill
Journal
DEBIT
DEBIT
CREDIT
CREDIT
CREDIT
CREDIT
Goodwill
Stated capital / reserves
Cash
Investment
Profit or loss
NCI
Rs. 11.2 Mn
Rs. 284 Mn
Rs. 122 Mn
Rs. 87.5 Mn
Rs. 0.5 Mn
Rs. 85.2 Mn
562
CA Sri Lanka
QUESTION
Acquiring control
Opalagala acquired 25% of Talawatta on 1 January 20X1 for Rs. 2,020 Mn when
Talawatta's reserves were standing at Rs. 5,800 Mn. The fair value of Talawatta's
identifiable assets and liabilities at that date was Rs. 7,200 Mn. Both Opalagala
and Talawatta are stock market listed entities.
At 31 December 20X1, the fair value of Opalagala's 25% stake in Talawatta was
Rs. 2,440 Mn.
A further 35% stake in Talawatta was acquired on 30 September 20X2 for
Rs. 4,025 Mn giving Opalagala control over Talawatta. The fair value of
Talawatta's identifiable assets and liabilities at that date was Rs. 9,400, the fair
value of a 25% and 40% shareholding were Rs. 2,875 Mn and Rs. 4,600 Mn
respectively, and Talawatta's reserves stood at Rs. 7,800 Mn.
For consistency with the measurement of other group held shares, Opalagala
holds all investments in subsidiaries and associates as available-for-sale (fair
value through other comprehensive income) in its separate financial statements
as permitted by SLFRS 10 Consolidated financial statements.
At 31 December 20X2, the fair value of Opalagala's 60% holding in Talawatta was
Rs. 7,020 Mn (and total cumulative gains recognised in other comprehensive
income in Opalagala's separate financial statements amounted to Rs. 975 Mn).
CA Sri Lanka
563
Talawatta
Rs Mn
10,200
40,720
50,920
7,450
58,370
7,600
7,600
2,200
9,800
800
7,900
8,700
1,100
9,800
Neither
564
CA Sri Lanka
Required
Prepare the consolidated statement of profit or loss and other comprehensive
income and statement of financial position of the Opalagala Group as at 31
December 20X2 assuming that the 25% interest in Talawatta allowed Opalagala
significant influence over the financial and operating policy decisions of Talawatta.
ANSWER
(a)
OPALAGALA GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT
31 DECEMBER 20X2
Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn
O
T
W4
W6
W3i
W3ii W3iii
38,650
7,600
800
PPE
7,020
Invt
(975)
500
355 (6,900)
2,100
Gwill
12,700
2,200
C Assets
58,370
9,800
10,200
800
(800)
S. Cap
40,720
7,900 (975)
Reserves
500
355 (7,800) (40)
4,600
40
NCI
7,450
1,100
Liabilities
58,370
9,800
Rs Mn
Total
47,050
2,100
14,900
64,050
10,200
40,660
4,640
8,550
64,050
CA Sri Lanka
565
1,303
32
1,570
40
Workings
1
Group structure
Opalagala
1.1.20X1
30.9.20X2
25%
+ 35% = 60%
Rs. 2,020 Mn Rs. 4,025 Mn
Rs. 5,800 Mn Rs. 7,800 Mn
Cost
Pre-acq'n reserves
Talawatta
2
Timeline
1.1.X2
SPLOCI
30.9.X2
Had 25%
associate
31.12.X2
Consolidate
3/12
Acquired 35%
25% + 35%
= 60% Subsidiary
Consol in
SOFP with
40% NCI
Equity accounting
In Os statement of financial position the investment in T is carried at fair
value; for the purposes of group accounting it is carried (until 30 September
20X2) at cost plus 25% of post-acquisition reserves movements.
Therefore at 30 September 20X2, the carrying amount for group purposes is:
Rs Mn
Cost
Share of post acquisition
increase in reserves (25% x (7,800 5,800)
Carrying amount
566
2,020
500
2,520
CA Sri Lanka
(i)
For group purposes therefore, the fair value increase since acquisition
is reversed by:
DEBIT
CREDIT
Reserves
Investment
975
975
Of this, the Rs. 555 Mn recognised in the year as OCI is also reversed in
the statement of profit or loss and other comprehensive income.
(ii)
Investment
Reserves
500
500
Goodwill
On gaining control, goodwill is measured as:
Rs Mn
Consideration transferred
Non-controlling interests
FV of O's previously held equity interest
Fair value of identifiable net assets
Stated capital
Reserves
Fair value adjustment (W5)
Rs Mn
4,025
4,600
2,875
800
7,800
800
(9,400)
2,100
2,100
800
7,800
567
DEBIT PPE
CREDIT Investment (4,025 + 2,875)
CREDIT NCI
5
800
6,900
4,600
Movement
Rs Mn
At year end
31.12.X2
Rs Mn
800
Non-controlling interests
The NCI is allocated its share of post-acquisition profits and OCI by (Rsm):
DEBIT Reserves (40% 400 3/12)
40
CREDIT NCI 40
In the statement of profit or loss and other comprehensive income, amounts
allocated to the NCI are:
Profit (40% 320 3/12)
OCI (40% 80 3/12)
Rs. 32 Mn
Rs. 8 Mn
CA Sri Lanka
QUESTION
P owns 70% of S, a company with net assets of Rs. 250 Mn. The carrying amount of
the non-controlling interest is Rs. 75 Mn. P acquires an additional 15% interest
from the non-controlling interest for Rs. 40 Mn.
Required
What journal entry is required to recognise the increased shareholding in the
consolidated financial statements of P?
ANSWER
Fair value of consideration
Decrease in NCI net assets at acquisition date (15% Rs 250 Mn)
Adjustment to parents equity
Rs Mn
(40)
37.5
(2.5)
Non-controlling interest
Equity (controlling interest)
Cash
QUESTION
Rs. 37.5 Mn
Rs. 2.5 Mn
Rs. 40 Mn
P acquired 80% of S in 20X5 for Rs. 300 Mn. On that date the fair value of the
identifiable net assets of S was Rs. 310 Mn and the fair value of the non-controlling
interest was Rs70m. Between the acquisition date in 20X5 and 30 June 20X7, S
made total comprehensive income of Rs. 34 Mn. On 30 June 20X7, P increased its
shareholding in S to 90%. Rs. 36 Mn was paid as consideration for the additional
10% shareholding. The NCI on the acquisition was measured at fair value.
Required
What journal entry is required to recognise the increased shareholding in the
consolidated financial statements of P on 30 June 20X7?
ANSWER
In this question the NCI is measured at fair value and therefore part of the initial
goodwill on acquisition is attributable to the NCI. NCI goodwill forms part of the
adjustment journal on the step acquisition.
CA Sri Lanka
569
NCI goodwill is included within the carrying amount of the NCI and therefore the
simplest way to calculate the required adjustment on 30 June 20X7 is to calculate
the NCI (including its share of net assets and goodwill) at that date and use this as
the basis for calculating the decrease in the NCI.
NCI at 30 June 20X7
NCI at acquisition
NCI share of post-acquisition total comprehensive income (20%
Rs 34 Mn)
NCI at 30 June 20X7
Rs Mn
70
6.8
76.8
Rs Mn
Adjustment to parents equity
(36)
Fair value of consideration
38.4
Decrease in NCI net assets at acquisition date (10/20% Rs 76.8 Mn)
2.4
Adjustment to parents equity
This is recorded by:
DEBIT
CREDIT
CREDIT
Non-controlling interest
Equity (controlling interest)
Cash
Rs. 38.4 Mn
Rs. 2.4 Mn
Rs. 36 Mn
2 Disposals
A parent company may dispose of a full or partial shareholding. In some cases,
control is retained. The accounting treatment depends on the level of
disposal.
570
CA Sri Lanka
In both cases this figure is calculated as the fair value of consideration received
less the carrying amount of the subsidiary disposed of. The difference between the
two gain (or loss) figures is due to the different carrying amount of a subsidiary in
each set of financial statements.
If the gain (or loss) is material, it should be disclosed separately.
2.2.1 Gain or loss in parent companys financial statements
This is calculated as:
Fair value of consideration received
Carrying amount of investment disposed of
Gain / (loss) on disposal
Rs.
X
(X)
X/(X)
Rs.
X
(X)
X/(X)
The two gains figures are related, as the following example demonstrates.
CA Sri Lanka
571
Rs Mn
370
(305)
65
The difference between the two gains figures is Rs. 75 Mn. This is equal to the
group share of the Rs. 100 Mn post acquisition increase in reserves of Floor Dcor
- 75% Rs. 100 Mn = Rs. 75 Mn.
2.2.4 Preparation of consolidated financial statements
Where a full disposal has taken place in the accounting period:
Consolidated statement of financial position
The subsidiarys assets and liabilities are not recognised
There is no non-controlling interest
Retained earnings include either:
The group share of the reserves movement in the subsidiary between the
acquisition and disposal date plus the group gain (or loss) on disposal, or
The parent company gain or loss on disposal.
572
CA Sri Lanka
The parent companys gain or loss on disposal is calculated in the same way
as that described in section 2.2.1.
The group gain or loss on disposal is calculated to take into account the fair
value of the retained shareholding.
CA Sri Lanka
A realised gain or loss on the shares that have been sold, and
573
Rs Mn
420
220
580
(58)
(522)
118
The calculation can be set out differently to show the split of the gain between the
realised and unrealised amounts:
On sale
On FV
of 60%
of 30%
Rs Mn
Rs Mn
420
220
Fair value (of consideration received)
(348)
(174)
Carrying amount (60%/30% 580)
72
46
Gain
2.3.3 Preparation of consolidated financial statements
Where a subsidiary to associate disposal has taken place in the accounting period:
Consolidated statement of financial position
The interest in the associate is equity accounted based on the year end
shareholding. The cost of the investment is taken to be the fair value of the
interest retained at the disposal date and this is subsequently increased by the
group share of post-acquisition retained total comprehensive income.
574
CA Sri Lanka
QUESTION
Yala Co, the parent company of Yala Group bought 100% of the voting share
capital of Sinharaja Co on its incorporation on 1 January 20X2 for Rs. 160 Mn.
Sinharaja Co earned and retained Rs. 240 Mn from that date until
31 December 20X7. At that date the statements of financial position of the
company and the group were as follows.
Sinharaja Consolidated
Yala Group
(excluding
Co
S Co)
Rs Mn
Rs Mn
Rs Mn
160
Investment in Sinharaja
500
1,500
Assets
1,000
500
1,500
1,160
Stated capital
Retained earnings
Liabilities
400
560
200
1,160
160
240
100
500
400
800
300
1,500
ANSWER
The gain or loss on disposal in the books of the parent company is calculated as
follows:
Parent company
Rs Mn
440
Fair value of consideration received
(96)
Carrying amount of investment (60% 160)
344
Profit on sale
CA Sri Lanka
575
(400)
240
Notes:
1
The group gain can be split into the amount attributable to the disposal of
Rs. 440 Mn (60% 400 Mn) = Rs. 200 Mn and the amount attributable to
the fair value uplift of the retained portion Rs. 200 Mn (40% 400 Mn) =
Rs. 40 Mn.
The gain attributable to the disposal is Rs. 144 Mn less than the parents gain
on disposal. As previously, this amount is equal to the profits made between
acquisition and disposal date that are attributable to the disposed of
shareholding:
Acquisition
Retd
earnings
Rs 0
Disposal
Profits for period between acquisition and disposal Rs 240 Mn
60% profits (attributable to disposed of shareholding) Rs 144 Mn
40% profits (attributable to retained shareholding) Rs 96 Mn
Retd
earnings
Rs 240 Mn
Investment in S
Assets
Stated capital
Retained earnings
Liabilities
576
Y Co
Rs Mn
160
1,000
S Co
Rs Mn
1,160
400
560
200
1,160
500
160
240
100
500
W1
Rs Mn
(160)
500
W2
Rs Mn
200
440
(500)
(160)
240
(100)
Consol
Rs Mn
200
1,440
1,640
400
1,040
200
1,640
CA Sri Lanka
Workings
(W1) For consolidation purposes, the cost of the investment in the subsidiary in Y
Cos books is initially cancelled against the stated capital of S Co by (Rs Mn):
DEBIT
CREDIT
Stated capital
Investment in S
160
160
Assets (cash)
Investment in ass
Liabilities
Assets
Retained earnings
440
200
100
500
240
The credit to retained earnings is also reported as the gain on disposal in the
consolidated statement of profit or loss.
Tutorial note
An alternative approach to the preparation of the consolidated statement of
financial position, and the approach that would be taken in subsequent years
assumes that Yala Co has recorded the disposal by:
DEBIT
CREDIT
CREDIT
Cash
Investment
Retained earnings
440
96
344
(ii)
Investment in S
(i)
W2
Consol
Rs Mn
Rs Mn
Rs Mn
Rs Mn
96
40
64
200
1,440
1,440
1,504
1,640
Stated capital
400
400
Retained earnings
904
Liabilities
200
200
1,504
1,640
Assets
CA Sri Lanka
Y Co
96
40
1,040
577
The parent companys gain or loss on disposal is calculated in the same way
as that described in section 2.2.1.
The group gain or loss on disposal is calculated in the same way as that
described in section 2.3.1.
(X)
(X)
* Note. This line is only required where non-controlling interests are measured at
fair value at the date of acquisition (ie where there is an increase in the noncontrolling interest share of goodwill already recognised).
578
CA Sri Lanka
(51)
(9)
4
Cash
Equity
NCI (Rs. 51 Mn + 9 Mn)
Rs. 56 Mn
Rs. 4 Mn
Rs. 60 Mn
579
proceeds and the carrying amount of the investment disposed of. The resulting
gain or loss is recognised in profit or loss.
QUESTION
Disposal of a subsidiary
P Co, part of the P Group bought 80% of the share capital of S Co for Rs. 324 Mn on
1 October 20X5. At that date S Co's retained earnings balance stood at Rs. 180 Mn.
The statements of financial position at 30 September 20X8 and the summarised
statements of profit or loss to that date are given below. (There is no other
comprehensive income.)
P Group
S Co
Rs Mn
Rs Mn
360
270
Non-current assets
324
Investment in S Co
370
370
Current assets
1,054
640
Equity
540
180
Stated capital
414
360
Retained earnings
100
Current liabilities
100
1,054
640
Profit before tax
Tax
Profit for the year
153
(45)
108
126
(36)
90
No entries have been made in the accounts for any of the following transactions.
Assume that profits accrue evenly throughout the year.
It is the group's policy to value the non-controlling interest at its proportionate
share of the fair value of the subsidiary's identifiable net assets.
Ignore taxation.
Required
Prepare the consolidated statement of financial position and statement of profit
or loss at 30 September 20X8 in each of the following circumstances. (Assume no
impairment of goodwill.) In each case calculate the group gain or loss on disposal.
580
(a)
(b)
P Co sells one quarter of its holding in S Co for Rs. 160 Mn on 30 June 20X8.
(c)
CA Sri Lanka
ANSWER
(a)
Group
Rs Mn
360
0
0
1,020
1,380
540
740
0
100
1,380
PBT
Tax
Att.to:
Owners of
parent
NCI
P Co
Rs Mn
153
(45)
108
S Co
Rs Mn
126
(36)
90
(W3)
Rs Mn
182
Group
Rs Mn
461
(81)
380
108
72
182
362
18
18
380
Workings
1
Timeline
1.10.X7
30.9.X8
P/L
Subsidiary all year
Group gain on
disposal not sub at y/e
CA Sri Lanka
581
Consideration transferred
NCI (20% 360)
Acquired: (180 + 180)
Consolidation adjustment journal (Rs Mn):
DEBIT Goodwill
36
DEBIT Stated capital
180
DEBIT Retained earnings
180
CREDIT Investment
324
CREDIT NCI
72
(W3) Non-controlling interest
36
36
Rs Mn
650
540
36
(108)
(468)
182
582
650
108
100
36
182
270
370
CA Sri Lanka
(b)
Timeline
1.10.X7
30.6.X8
30.9.X8
P/L
Subsidiary all year
20% NCI 9/12
CA Sri Lanka
583
=9
40.5
160
(103.5)
56.5
160
103.5
56.5
584
Group
Rs Mn
360
0
250
710
1,320
540
680
0
100
1,320
CA Sri Lanka
Timeline
1.10.X7
30.6.X8
30.9.X8
P/L
Subsidiary (80% 9/12)
IEI 3/12
Sells =
40% of S Co
IEI in SOFP
Group gain
on disposal
CA Sri Lanka
540
36
(108)
Rs Mn
340
250
(468)
122
585
Cash
Investment
NCI
Liabilities (of S)
Non-current assets (of S)
Current assets (of S)
Goodwill
Retained earnings
340
250
108
100
270
370
36
122
QUESTION
P has owned a 70% holding in S for many years. During the year ended
31 December 20X6, it decided to dispose of 15% of S's shares to aid other
expansion plans. The shares were put up for sale on 28 February 20X6, a
purchaser was found on 31 March 20X6 and the legal documentation was
completed by 30 April 20X6. P paid a significant premium for its interest in S and
goodwill was recognised amounting to Rs. 80 Mn. Due to some market difficulties
this was written down to Rs. 65 Mn 2 years ago. It has not been necessary to
recognise any further impairment losses.
The group policy is to measure non-controlling interests at their proportionate
share of the fair value of the acquiree's identifiable net assets.
Required
Discuss how this transaction would affect the consolidated statement of profit or
loss and other comprehensive income of the P Group for the year ended
31 December 20X6 and the consolidated statement of financial position at that
date.
ANSWER
Consolidated statement of profit or loss and other comprehensive income
Disposal of 15% of the shares in S leaves a 55% holding which means that P still
retains control of S. Consequently, S's income and expenses are consolidated in
full for the whole period as they were under the control of P throughout the
period.
The non-controlling interests in S have changed during the year and this change in
ownership occurred legally on 30 April 20X6. Consequently the NCI will be
allocated 30% of profits and other comprehensive income arising in the first 4
months of the year, and 45% for the final 8 months of the year.
586
CA Sri Lanka
QUESTION
Polonnaruwa PLC acquired 25% of the shares in Dambulla Ltd on 1 January 20X3
by issuing one million shares with a fair value of Rs. 200 each. Polonnaruwa PLC
did not exercise significant influence over Dambulla, and accounted for the
investment at cost. At 1 January 20X3 the net assets of Dambulla Ltd had a
carrying amount of Rs. 690 Mn and a fair value of Rs. 710 Mn.
On 1 May 20X4, Polonnaruwa PLC bought a further 60% of the share capital of
Dambulla by issuing a further two million shares with a fair value of Rs. 250 each.
At that date the net assets of Bismuth had a carrying amount of Rs. 750 Mn and a
fair value of Rs. 775 Mn. The difference between book and fair value is due to land
held at cost Rs. 25 Mn below its fair value. The non-controlling interest at
1 May 20X4 had a fair value of Rs. 100 Mn, and the 25% interest already held by
Polonnaruwa had a fair value of Rs. 205 Mn.
Polonnaruwa measures the non-controlling interest at fair value.
Required
(a) What goodwill figure is recognised in the consolidated statement of financial
position at 31 December 20X3, in accordance with SLFRS 3, Business
Combinations?
(b) What journal entries are required to record the acquisition?
CA Sri Lanka
587
ANSWER
Goodwill is not calculated until control is gained on the second acquisition. At
this date the calculation includes the fair value of the retained interest as follows:
Rs Mn
FV of consideration transferred (2m x Rs 250)
500
NCI at fair value
100
FV of retained interest
205
(775)
FV of net assets of Dambulla
Goodwill
30 Mn
The first consolidation journal recognises the disposal of the existing interest in
Dambulla and its purchase at fair value:
DEBIT Investment
205
CREDIT Investment (Rs. 200 x 1m)
200
CREDIT Gain (P/L)
5
The second consolidation journal records goodwill on acquisition as follows
(Rsm):
DEBIT
Goodwill
30
DEBIT
Land
25
DEBIT
Share capital / reserves
750
CREDIT Investment (205 + 500)
705
CREDIT NCI
100
588
CA Sri Lanka
CHAPTER ROUNDUP
In all cases the parent company gain or loss on disposal is the difference between
the fair value of consideration and the carrying amount (usually cost) of the
investment disposed of.
In a full disposal, the group gain on disposal is the difference between the fair
value of consideration and the recognised net assets and goodwill of the
subsidiary.
CA Sri Lanka
589
PROGRESS TEST
590
How is the group gain on disposal calculated when control of a subsidiary is lost
but a non-controlling shareholding is retained?
CA Sri Lanka
C and D. In both of these cases control is achieved where it did not previously
exist.
DEBIT
CREDIT
DEBIT/CREDIT
NCI
Cash
Equity
X
X
X
CREDIT
DEBIT/CREDIT
DEBIT
NCI
Equity
Cash
X
X
X
Consideration received
Fair value of retained interest
Net assets disposed of (net assets + goodwill
NCI interest)
Gain / loss
CA Sri Lanka
X
X
X
(X)
X
X
X
(X)
X
591
592
CA Sri Lanka
CHAPTER
INTRODUCTION
Complex groups involve sub-subsidiaries; the basic consolidation procedures seen in your earlier studies should still be
applied.
In questions about complex groups and reorganisations, it is very helpful to sketch a diagram of the group structure, as
we have done. This clarifies the situation and it should point you in the right direction: always sketch the group
structure as your first working and double check it against the information in the question.
Knowledge Component
1 Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
2
2.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
2.1.1
Compile consolidated financial statements for a group with more than two
subsidiaries, sub subsidiaries and foreign subsidiaries.
2.1.2
593
CHAPTER CONTENTS
1 Vertical groups
2 D-shaped groups
3 Group reorganisations
1 Vertical groups
A vertical group exists where a parent has a subsidiary and that subsidiary
has its own subsidiary. The effective group holding in the sub-subsidiary must
be calculated and used in the consolidation workings.
1.1 Introduction
The following group structure shows a vertical group:
P
80%
S
75%
SS
594
CA Sri Lanka
80%
S
60%
SS
QUESTION
Effective interest
Top owns 60% of the equity of Middle Co, which owns 75% of the equity of
Bottom Co. What is Top Co's effective holding in Bottom Co?
CA Sri Lanka
595
ANSWER
Top owns 60% of 75% of Bottom Co = 45%.
(b)
If S did not control SS prior to joining the group, it will be the date on which S
acquired control of SS.
Determining the acquisition date of SS is important when identifying the preacquisition reserves of the sub-subsidiary.
CA Sri Lanka
110,000
60,000 shares in SS Co
70,000
60,000
80,000
Current assets
305,000
305,000
240,000
Equity and liabilities
Equity
80,000
100,000
100,000
Stated capital
195,000
170,000
115,000
Retained earnings
275,000
270,000
215,000
30,000
35,000
25,000
Payables
305,000
305,000
240,000
P Co acquired its 80% shareholding in S Co on 1 July 20X4 when the reserves of
S Co stood at Rs. 40 Mn; and
S Co acquired its 60% shareholding in SS Co on 1 July 20X5 when the reserves of
SS Co stood at Rs. 50 Mn.
It is the group's policy to measure the non-controlling interest at acquisition at its
proportionate share of the fair value of the subsidiary's net assets.
Required
Prepare the draft consolidated statement of financial position of P Group at
30 June 20X7.
Note. Assume no impairment of goodwill.
Solution
This is two acquisitions from the point of view of the P group:
In 20X4, the group buys 80% of S.
In 20X5 S (which is now part of the P group) buys 60% of SS.
CA Sri Lanka
597
W2(ii)
Rs Mn
W3(i)
Rs Mn
W3(ii)
Rs Mn
16
(88)
W4
Rs Mn
(22)
(100)
(50)
(26)
(33.8)
78
26
33.8
Consol
Rs Mn
410
24
210
644
80
330.2
(22)
143.8
90
644
Workings
1
Group structure
P
1.7.20X4
80%
S
1.7.20X5
60%
SS
Goodwill
In this working, the cost of each investment from a group perspective is
compared with the effective group interest acquired.
Note that:
598
The NCI in net assets at acquisition is based on the 52% NCI calculated
above
CA Sri Lanka
P in S
Rs'000
Rs'000
Consideration transferred
Non-controlling interests
120,000
(20%
140,000)
28,000
100,000
40,000
S in SS
Rs'000
(80%
110,000)
(52%
150,000)
Rs'000
88,000
78,000
100,000
50,000
(140,000)
(150,000)
8,000
16,000
24,000
(i)
(ii)
Rs. 8 Mn
Rs. 100 Mn
Rs. 40 Mn
Rs. 120 Mn
Rs. 28 Mn
Goodwill
Stated capital
Retained earnings
Investment
NCI
Goodwill
Stated capital
Retained earnings
Investment
NCI
Rs. 16 Mn
Rs. 100 Mn
Rs. 50 Mn
Rs. 88 Mn
Rs. 78 Mn
(ii)
CA Sri Lanka
599
Retained earnings
NCI
NCI
Investment
Rs. 22 Mn
Rs. 22 Mn
The retained earnings figures on the respective dates of acquisition are the same,
but on the date P Co purchased its holding in S Co, the retained earnings of SS Co
were Rs. 60 Mn.
It is the groups policy to measure the non-controlling interest at its proportionate
share of the fair value of the subsidiarys net assets.
Required
Prepare the draft consolidated statement of financial position of P Group at
30 June 20X7.
Note. Assume no impairment of goodwill.
SOLUTION
In this example, SS Co only became part of the P group on 1 July 20X5, not on
1 July 20X4.
Therefore only the retained earnings of SS Co arising after 1 July 20X5 are
included in the post-acquisition reserves of P Co group.
600
CA Sri Lanka
W3(ii)
W4
Rs Mn Rs Mn
(22)
639.2
80
325.4
(28.6)
28.6
Consol
Rs Mn
410
19.2
210
(22)
143.8
90
639.2
WORKINGS
1
Group structure
P
1.7.20X5
80%
S
1.7.20X4
60%
SS
CA Sri Lanka
601
Goodwill
P in S
Rs'000
Consideration transferred
Non-controlling interests
Rs'000
120,000
(20%
140,000)
28,000
100,000
40,000
S in SS
Rs'000
Rs'000
(80%
110,000)
(52%
160,000)
88,000
83,200
100,000
60,000
(140,000)
(160,000)
8,000
11,200
14,000
(i)
(ii)
Rs. 8 Mn
Rs. 100 Mn
Rs. 40 Mn
Rs. 120 Mn
Rs. 28 Mn
Goodwill
Stated capital
Retained earnings
Investment
NCI
Goodwill
Stated capital
Retained earnings
Investment
NCI
Rs. 11.2 Mn
Rs. 100 Mn
Rs. 60 Mn
Rs. 88 Mn
Rs. 83.2 Mn
(ii)
602
CA Sri Lanka
Retained earnings
NCI
NCI
Investment
Rs. 22 Mn
Rs. 22 Mn
P Co
Rs'000
S Co
Rs'000
SS Co
Rs'000
105,000
125,000
180,000
120,000
80,000
305,000
110,000
70,000
305,000
60,000
240,000
80,000
195,000
275,000
30,000
305,000
100,000
170,000
270,000
35,000
305,000
100,000
115,000
215,000
25,000
240,000
CA Sri Lanka
603
W3(ii)
W4
Consol
Rs Mn Rs Mn Rs Mn
410
27
(22)
210
647
80
330.2
(33.8)
33.8
(22)
146.8
90
647
WORKINGS
1
Group structure
P
1.7.20X4
80%
S
1.7.20X5
60%
SS
604
CA Sri Lanka
Goodwill
P in S
Rs'000
Rs'000
Consideration
transferred
Non-controlling
interests
120,000
S in SS
Rs'000
Rs'000
(80%
110,000)
29,000
Fair value of
identifiable net assets
acquired:
Stated capital
Retained earnings
100,000
40,000
88,000
80,000
100,000
50,000
(140,000)
(150,000)
9,000
18,000
27,000
(i)
(ii)
Rs. 9 Mn
Rs. 100 Mn
Rs. 40 Mn
Rs. 120 Mn
Rs. 29 Mn
Goodwill
Stated capital
Retained earnings
Investment
NCI
Goodwill
Stated capital
Retained earnings
Investment
NCI
Rs. 18 Mn
Rs. 100 Mn
Rs. 50 Mn
Rs. 88 Mn
Rs. 80 Mn
(ii)
CA Sri Lanka
605
Retained earnings
NCI
NCI
Investment
Rs. 22 Mn
Rs. 22 Mn
QUESTION
Sub-subsidiary
210
80
3
Plant and machinery
310
180
3
Investments in
subsidiaries
110
6.2
Shares, at cost
3.8
Loan account
10
12.2
Current accounts
120
22.2
606
CA Sri Lanka
Antelope Co
Rs Mn
Rs Mn
Current assets
Inventories
Receivables
Cash at bank
170
140
60
Yak Co
Rs Mn Rs Mn
20.5
50
16.5
370
800
Equity and liabilities
Equity
Stated capital
Retained earnings
200
379.6
15
1
4
87
289.2
100
129.2
579.6
Current liabilities
Trade payables
Due to Antelope Co
Due to Yak Co
Taxation
160.4
60
Zebra Co
Rs Mn Rs Mn
20
23
10
(1)
229.2
40.2
12.8
9
0.8
0.6
12.6
220.4
800
60
289.2
14
23
Antelope Co acquired 75% of the shares of Yak Co in 20X1 when the credit balance
on the retained earnings of that company was Rs. 40 Mn. No dividends have been
paid since that date.
Yak Co acquired 80% of the shares in Zebra Co in 20X3 when there was a debit
balance on the retained earnings of that company of Rs. 3 Mn.
Subsequently Rs. 0.5 Mn was received by Zebra Co and credited to its retained
earnings, representing the recovery of an irrecoverable debt written off before the
acquisition of Zebra's shares by Yak Co.
During the year to 31 March 20X4 Yak Co purchased inventory from Antelope Co
for Rs. 20 Mn which included a profit mark-up of Rs. 4 Mn for Antelope Co. At
31 March 20X4 one half of this amount was still held in the inventories of Yak Co.
Group accounting policies are to make a full allowance for unrealised intra-group
profits.
It is the group's policy to measure the non-controlling interest at its proportionate
share of the fair value of the subsidiary's net assets.
Required
Prepare the draft consolidated statement of financial position of Antelope Co at
31 March 20X4.
CA Sri Lanka
607
ANSWER
Consolidated statement of financial position of the Antelope Group at
31 March 20X4
Property
P&M
Goodwill
Invt in
Subs
Shares
Loan
Current a/c
Current
assets
Inventories
Receivables
Cash
Stated
capital
Retained
earnings
NCI
Payables
Due to A
Due to Y
Taxation
A
Rs Mn
100
210
Y
Rs Mn
100
80
Z
W2(i)
Rs Mn Rs Mn
3
5
(110)
W2(ii)
Rs Mn
W3
Rs Mn
W4
W5
Rs Mn Rs Mn
W6
Rs Mn
0.15
110
10
6.2
3.8
12.2
(4.65)
170
140
60
800
200
20.5
50
16.5
289.2
100
15
1
4
23
10
(100)
(10)
379.6
129.2
(1)
(40)
2.5
160.4
60
800
40.2
12.8
7
289.2
0.8
0.6
12.6
23
(1.55)
(3.8)
(22.2)
35
(22.9)
22.9
Consol
Rs Mn
200
293
5.15
(2)
203.5
191
80.5
973.15
200
(2)
445.4
(1.55)
(13.4)
(12.6)
59.35
201.4
67
973.15
WORKINGS
1
Group structure
A
20X1
75%
Y
20X3
Effective interests in Z:
A Group (75% 80%) = 60%
NCI
= 40%
80%
Z
608
CA Sri Lanka
Goodwill
A in Y
Rs Mn
Consideration transferred
Non-controlling interests
110
35
(25% 140)
Y in Z
Rs Mn
Rs Mn
Rs Mn
(75% 6.2)
(40% x 7.5)
100
40
4.65
3
10
(2.5)
(140)
(7.5)
0.15
5.15
(i)
(ii)
Rs. 5 Mn
Rs. 100 Mn
Rs. 40 Mn
Rs. 110 Mn
Rs. 35 Mn
Goodwill
Stated capital
Retained earnings
Investment
NCI
Goodwill
Stated capital
Retained earnings
Investment
NCI
Rs. 0.15 Mn
Rs. 10 Mn
Rs. 2.5 Mn
Rs. 4.65 Mn
Rs. 3 Mn
(ii)
Rs. 22.9 Mn
Rs. 22.9 Mn
609
NCI
Investment
Rs. 1.55 Mn
Rs. 1.55 Mn
Unrealised profit
Rs. 4 Mn = Rs. 2 Mn
This is eliminated by:
DEBIT
CREDIT
Retained earnings
Inventories
Rs. 2 Mn
Rs. 2 Mn
Intercompany balances
Receivable amounts (3.8 Mn + 10 Mn + 12.2 Mn)
Payable amounts (12.8 Mn + 0.6 Mn + 12.6Mn)
26 Mn
26 Mn
Rs. 13.4 Mn
Rs. 12.6 Mn
Rs. 3.8 Mn
Rs. 22.2 Mn
610
Step 1
Step 2
Step 3
Step 4
Step 5
CA Sri Lanka
Step 6
Step 7
Reserves working. Include the group share of subsidiary and subsubsidiary post-acquisition retained earnings (effective holdings
again).
Step 8
Step 9
2 D-shaped groups
A D-shaped group exists where a parent company has both a direct and an
indirect ownership interest in a sub-subsidiary. Again the effective group
holding in the sub-subsidiary is important when preparing the consolidated
financial statements.
2.1 Introduction
The following group structure shows a D-shaped group:
P
80%
S
10%
75%
SS
CA Sri Lanka
611
10%
75%
15%
(NCI direct)
SS
60%
10%
30%
100%
612
QUESTION
D shaped group
The draft statements of financial position of Hulk Co, Molehill Co and Pimple Co as
at 31 May 20X5 are as follows.
Hulk Co
Molehill Co
Pimple Co
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Assets
Non-current assets
60
Tangible assets
90
60
Investments in
Subsidiaries (cost)
90
Shares in Molehill Co
42
25
Shares in Pimple Co
115
42
205
102
60
40
50
40
Current assets
245
152
100
Equity and liabilities
Equity
100
50
50
Stated capital
50
20
Revaluation surplus
32
25
45
Retained earnings
195
102
75
Non-current liabilities
12% loan
Current liabilities
Payables
CA Sri Lanka
195
10
112
75
50
245
40
152
25
100
(a)
Hulk Co acquired 60% of the shares in Molehill on 1 January 20X3 when the
balance on that company's retained earnings was Rs. 8 Mn (credit).
(b)
Hulk acquired 20% of the shares of Pimple Co and Molehill acquired 60% of
the shares of Pimple Co on 1 January 20X4 when that company's retained
earnings stood at Rs. 15 Mn.
(c)
(d)
(e)
613
Required
Prepare the consolidated statement of financial position of Hulk Co as at 31 May
20X5.UESTION
ANSWER
Consolidated statement of financial position of the Hulk Group at
31 May 20X5
H
M
P
W2(i) W2(ii)
W3
W4
Consol
Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn
90
60
60
210
Tangible
assets
55.2
13.8
69
Goodwill
Invts in
subsidiaries
90
(90)
Molehill
25
42
(50.2)
(16.8)
Pimple
40
50
40
130
Current
assets
245
152
100
409
100
50
50
(50) (50)
100
Stated capital
50
20
(8)
62
Revaluation
surplus
45
32
25
(8) (15)
(14)
65
Retained
earnings
23.2
28.6
22
(16.8)
57
NCI
10
10
12% loan
50
40
25
115
Payables
245
152
100
409
WORKINGS
1
Group structure
Hulk
60%
(NCI direct)
40%
Molehill
60%
(NCI direct)
614
20%
Pimple
20%
CA Sri Lanka
Note. Pimple comes into Hulk's control on 1 January 20X4. As the investments in
Pimple by Hulk and Molehill both happened on the same date, only one goodwill
calculation is needed in respect of Pimple.
Consideration transferred
direct
indirect
Non-controlling interests
(58m 40%)/(65m 44%)
Fair value of NA acquired
Share capital
Retained earnings
Rs Mn
Rs Mn
25
(60% 42)
23.2
25.2
28.6
50
15
50
8
(58)
55.2
(65)
13.8
69
(i)
(ii)
Rs. 55.2 Mn
Rs. 50 Mn
Rs. 8 Mn
Rs. 90 Mn
Rs. 23.2 Mn
CA Sri Lanka
Goodwill
Stated capital
Retained earnings
Investment
NCI
Goodwill
Stated capital
Retained earnings
Investment
NCI
Rs. 13.8 Mn
Rs. 50 Mn
Rs. 15 Mn
Rs. 50.2 Mn
Rs. 28.6 Mn
615
(ii)
= Rs. 8 Mn
Rs. 14 Mn
Rs. 8 Mn
Rs. 22 Mn
NCI
Investment
Rs. 16.8 Mn
Rs. 16.8 Mn
3 Group reorganisations
Changes in direct ownership (ie internal group reorganisations) can take many
forms. With the exception of divisionalisation, internal reorganisations do not
affect the consolidated financial statements, but they will affect the accounts
of individual companies within the group.
Groups will reorganise on occasions for a variety of reasons.
616
(a)
A group may want to float a business to reduce the gearing of the group. The
holding company will initially transfer the business into a separate company.
(b)
(c)
The group may 'reverse' into another company to obtain a stock exchange
quotation.
CA Sri Lanka
(d)
After
shareholders
S1
After
P
S1
S2
S2
CA Sri Lanka
617
Stated capital
Revaluation surplus
Retained earnings
It appears that S1 cannot make a distribution of more than Rs100m. If, however, S1
makes a distribution in kind of its investment in S2, then the revaluation surplus
can be treated as realised.
It is not clear how P should account for the transaction. The carrying value to S2
might be used, but there may be no legal rule. P will need to write down its
investment in S1 at the same time. A transfer for cash is probably easiest, but there
are still legal pitfalls as to what is distributable, depending on how the transfer is
recorded.
There will be no effect on the group financial statements as the group has stayed
the same: it has made no acquisitions or disposals.
S1
S3
618
After
P
S2
S1
S2
S3
CA Sri Lanka
The problem of an effective distribution does not arise here because the holding
company did not buy the subsidiary. There may be problems with financial
assistance if S2 pays less than the fair value to purchase S3 as a prelude to S1
leaving the group.
Before
P
S1
S2
S1
S2
If S1 paid cash for S2, the transaction would be straightforward (as described
above). It is unclear whether P should recognise a gain or loss on the sale if S2 is
sold for more or less than carrying value. S1 would only be deemed to have made a
distribution (avoiding any advance tax payable) if the price was excessive.
Where a share for share exchange takes place, it must be recorded so as to
preserve the book value of the transferred investment.
Example
Axim Co has two 100% subsidiaries, Beyin and Ketan. The statements of financial
position at 31 December 20X5 are as follows.
Axim Co
Beyin Co
Ketan Co
Group
Rs Mn
Rs Mn
Rs Mn
Rs Mn
1,000
Investment in Beyin Co
500
Investment in Ketan Co
1,500
1,375
1,500
4,375
Net assets
3,000
1,375
1,500
4,375
2,500
1,000
500
2,500
Stated capital
500
375
1,000
1,875
Retained earnings
3,000
1,375
1,500
4,375
Axim Co wants to transfer Ketan Co to Beyin Co.
CA Sri Lanka
619
Solution
Beyin Co issues 250,000 shares in exchange for Axim Co's investment in Ketan Co.
The carrying amount of Axims investment in Ketan is Rs. 500 Mn therefore this is
the amount that the investment is transferred at and this is recorded as the
increase in Beyins stated capital. The statements of financial position are now as
follows.
Axim Co
Beyin Co
Ketan Co
Group
Rs Mn
Rs Mn
Rs Mn
Rs Mn
1,500
Investment in Beyin
500
Investment in Ketan
1,500
1,375
1,500
4,375
Net assets
3,000
1,875
1,500
4,375
2,500
1,500
500
2,500
Stated capital
500
375
1,000
1,875
Retained earnings
3,000
1,875
1,500
4,375
3.5 Divisionalisation
This type of transaction involves the transfer of businesses from subsidiaries
into just one company. The businesses will all be similar and this is a means of
rationalising and streamlining. The savings in administration costs can be quite
substantial. The remaining shell company will leave the cash it was paid on an
intragroup balance as it is no longer trading. The accounting treatment is
generally straightforward.
QUESTION
The A Group has three wholly owned subsidiaries, B, C and D. The directors of the
A Group have decided to restructure its internal ownership as follows:
Before
A
After
A
Required
Discuss why the A Group might wish to restructure the group in this way and how
it might go about effecting the transaction.
620
CA Sri Lanka
ANSWER
Possible reasons for such a reorganisation include:
Combining the businesses of D and C into one business
Cost savings by running D and C, which may have economies of scale, together
To allow the management of D to manage C's business rather than the
management of B
Potential tax advantages, such as loss relief, or channelling dividend payments
through D which may operate in a tax regime with lower taxes
To allow B to be sold off from the group without selling D
To allow B to become a dormant company.
The reorganisation could be achieved by B selling its shares in C to D. Any profit
or loss on such a sale would be an unrealised one from the group point of view and
would require elimination in the group financial statements. However, if C were
sold at a loss, this would imply that an impairment test should be done to ensure
its value is not overstated.
Another possibility is for the sale to occur through an intercompany account
which remains outstanding, ie a receivable in B's books and a payable in D's books
for the purchase consideration. An advantage of this is that it does not strip D of
assets, and would be particularly sensible if the plan is for B to become a dormant
company.
B would be unable to transfer its investment in C as a dividend to D as D is a fellow
subsidiary rather than its parent. However, B could potentially pay a dividend in
specie (ie a dividend paid in assets other than cash) to A of the shares in C and A
could then pass that investment to its subsidiary D as a capital injection (DEBIT
investment in C, CREDIT Share capital, in D's books), which would have a potential
advantage of increasing D's share capital if this were considered desirable.
QUESTION
A acquired 60% of B on 1 January 20X3. One other party holds 40%. There is a
contractual agreement between the two parties to undertake an economic activity
that is subject to joint control. Each party is entitled to a share of net profit in
proportion to ownership and the same share of the proceeds of the realisation of
net assets in the event of the business being wound up.
A acquired 60% of C on 1 March 20X1 and C acquired 30% of D on 1 April 20X4.
A acquired 80% of E on 1 August 20X4. E has been acquired with a view to be sold.
CA Sri Lanka
621
Required
Propose what accounting treatment should be adopted for B,C,D and E in the
consolidated statement of profit or loss and other comprehensive income for the
A group for the year ended 31 December 20X4. State any relevant SLFRS.
ANSWER
B would be considered a joint arrangement under SLFRS 13 Joint Arrangements
due to the contractual agreement to undertake an economic activity that is subject
to joint control. SLFRS 13 distinguishes between joint arrangements that are 'joint
operations' (where the venturers have direct rights to the assets and liabilities of
the joint arrangement and 'joint ventures' (where the venturers have rights to the
net assets). In this case, as the venturers are entitled to a proportionate share of
the realisation of the net assets, the arrangement would be classed as a joint
venture. LKAS 28 Investments in Associates and Joint Ventures requires the equity
method to be used for accounting for joint ventures in the consolidated financial
statements. Under the equity method the group's 60% share of B's profit for the
year would be shown on one line (before group profit before tax). Similarly, the
group's 60% share of each item of B's other comprehensive income for the year
would be shown separately.
Group structure
A
1.1.X3
60%
B
1.3.X1 60%
C
80%
E
1.8.X4
1.4.X4 30%
D
C is controlled by A and therefore would be classed as a subsidiary under
SLFRS 10 Consolidated Financial Statements. 100% of all income and
expenses would be consolidated in order to present the financial
performance of the group as a single economic entity. A 40% non-controlling
interest will be shown in profit for the year and total comprehensive income
for the year.
D is an indirect associate. A controls C and therefore A can control C's 30%
of D. A is presumed to exert significant influence over the operating and
622
CA Sri Lanka
CA Sri Lanka
623
CHAPTER ROUNDUP
624
A vertical group exists where a parent has a subsidiary and that subsidiary
has its own subsidiary. The effective group holding in the sub-subsidiary must
be calculated and used in the consolidation workings.
A D-shaped group exists where a parent company has both a direct and an
indirect ownership interest in a sub-subsidiary. Again the effective group
holding in the sub-subsidiary is important when preparing the consolidated
financial statements.
Changes in direct ownership (ie internal group reorganisations) can take many
forms. With the exception of divisionalisation, internal reorganisations do not
affect the consolidated financial statements, but they will affect the accounts
of individual companies within the group.
CA Sri Lanka
PROGRESS TEST
B Co owns 60% of the equity of C Co which owns 75% of the equity of D Co. What
is the total non-controlling interest percentage ownership in D Co?
P Co owns 25% of R Co's equity and 75% of Q Co's equity. Q Co owns 40% of R
Co's equity. What is the total non-controlling interest percentage ownership in R
Co?
CA Sri Lanka
625
B
60%
C
75%
D
Non-controlling interest = 25% + (40% of 75%) = 55%
4
P
75%
25%
(NCI direct)
25%
40%
35%
(NCI direct)
626
CA Sri Lanka
CHAPTER
INTRODUCTION
A statement of cash flows is key to understanding the liquidity position
of a company. At KC1 level, your existing knowledge is extended to
include the preparation of a consolidated statement of cash flows.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
627
CHAPTER CONTENTS
1 Individual company statement of cash flows
2 Consolidated statement of cash flows
3 Current developments
1.1 LKAS 7
The general requirements of the standard are as follows:
The objective of LKAS 7 is to provide information to users of financial statements
about the ability of an entity to generate cash and cash equivalents, as well as
indicating the cash needs of the entity.
A statement of cash flows should be presented as an integral part of the financial
statements of an entity.
All types of entity are required by the Standard to produce a statement of cash
flows.
Definitions provided by the standard include the following:
Cash comprises cash on hand and demand deposits.
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.
Cash flows are inflows and outflows of cash and cash equivalents.
628
CA Sri Lanka
Treasury bills
Equity investments
CA Sri Lanka
629
Certain cash flows may be classified as cash flows from operating activities,
investing activities or financing activities. Such cash flows include interest and
dividends:
Interest and dividends paid
630
Rs Mn
1,560
(480)
(790)
290
120
410
CA Sri Lanka
CA Sri Lanka
631
QUESTION
The financial statements of Meepitiya Models (Pvt) Ltd for the year ended
31 December 20X4 are set out below.
Meepitiya Models (Pvt) Ltd
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20X4
Rs'000
7,740
Revenue
(5,290)
Cost of sales
2,450
Gross profit
50
Release of government grant
(67)
Provision for warranties
(91)
Distribution costs
(164)
Administrative expenses
2,178
(320)
Finance cost
1,858
Profit before taxation
(368)
Taxation
1,490
Profit for the year
(180)
Other comprehensive income: property revaluation
1,310
Total comprehensive income
632
CA Sri Lanka
Cash in hand
Total assets
9,332
Equity and liabilities
Equity:
Stated capital
Revaluation reserve
Retained earnings
Non-current liabilities:
Loan stock
Redeemable preference shares
Finance lease obligation
Deferred tax
Provision for warranties
Government grant
Current liabilities:
Trade payables
Finance lease obligation
Government grant
Bank overdraft
Taxation
Total equity and liabilities
20X3
Rs'000
3,024
3,100
900
615
425
90
8,154
500
220
3,600
390
400
2,340
1,375
1,200
140
325
474
250
1,560
1,200
120
240
407
300
350
390
50
106
352
9,332
320
480
50
347
8,154
CA Sri Lanka
(a)
(b)
Equipment with a fair value of Rs. 60,000 was acquired under a finance lease
during the year.
633
(c)
Finance costs include loan stock interest of Rs. 110,000, finance lease
interest of Rs. 35,000 and a redeemable preference share dividend of
Rs. 95,000.
Required
(a)
Prepare the statement of cash flows for Meepitiya Models (Pvt) Ltd for the
year to 31 December 20X4.
ANSWER
Meepitiya Models (Pvt) Ltd
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20X4
Rs'000
Cash flows from operating activities
Profit before tax
Finance cost
Depreciation charge
Non cash income grant release
Increase in warranty provision
(Increase)/decrease in inventories
(Increase)/decrease in receivables
Increase/(decrease) in payables
Cash generated from operating activities
Interest paid
Dividends paid (W1)
Tax paid (W2)
Net cash from operating activities
Cash flows from investing activities
Payments to acquire property, plant and equipment (W3)
Payments to acquire intangible non-current assets
(3,342 3,100)
Payments to acquire long-term investments (1,200 900)
Payments to acquire short-term investments
Net cash used in investing activities
Cash flows from financing activities
Issue of stated capital (500-390)
Finance lease capital repayments (W4)
Repayment of loan stock (1,560 1,375)
Net cash used in financing activities
634
Rs'000
1,858
320
280
(50)
67
(5)
(65)
30
2,435
(320)
(230)
(278)
1,607
(856)
(242)
(300)
(200)
(1,598)
110
(130)
(185)
(205)
CA Sri Lanka
Rs'000
Increase in cash and cash equivalents
Cash and cash equivalents b/f
Cash and cash equivalents at c/f
Rs'000
(196)
90
(106)
Workings
1
Dividends paid
Retained earnings b/f
Profit for the year
Dividends paid (balance)
Retained earnings c/f
Rs'000
3,024
(180)
(280)
60
856
3,480
CA Sri Lanka
Rs'000
587
368
(278)
677
3,600
Tax paid
Balance b/f (240 + 347)
Statement of profit or loss
Tax paid (balancing figure)
Balance c/f (325 + 352)
Rs'000
2,340
1,490
(230)
Rs'000
600
60
(130)
530
635
Investing activities
Financing activities
Operating or investing
activities
Loan
636
20X4
Rs Mn
45
S Co
20X3
Rs Mn
60
20X4
Rs Mn
80
20X3
Rs Mn
30
CA Sri Lanka
During 20X4, P Co made a loan to S Co of Rs. 30 Mn. The first repayment is due in
20X5.
Required
What financing cash flow should be reported in respect of loans in the
consolidated statement of cash flows?
Solution
Proceeds of loan issue S Co
Repayment of loan P Co
Intercompany loan
Net proceeds from issue of loan
Rs Mn
50
(15)
35
(30)
5
(X)
X
(X)
CA Sri Lanka
X
(X)
X
637
QUESTION
The following are extracts of the consolidated results for Jaffna Co for the year
ended 31 December 20X8.
CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE
INCOME (EXTRACT)
Rs Mn
90
Group profit before tax
(30)
Income tax expense
60
Profit for the year
Profit attributable to:
Owners of the parent
Non-controlling interest
CONSOLIDATED STATEMENT OF FINANCIAL POSITION (EXTRACT)
2017
Rs Mn
300
Non-controlling interest
45
15
60
20X8
Rs Mn
306
Required
Calculate the dividend paid to the non-controlling interest.
ANSWER
Non-controlling interest in net assets b/f
Profit attributable to NCI
Non-controlling interest in net assets c/f
Cash dividend paid
638
Rs Mn
300
15
(306)
9
CA Sri Lanka
QUESTION
The following are extracts of the consolidated results of Pripon Co for the year
ended 31 December 20X8.
CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE
INCOME (EXTRACT)
Rs Mn
150
Group profit before tax
30
Share of associate's profit after tax
180
75
Tax (group)
105
Profit after tax
CONSOLIDATED STATEMENT OF FINANCIAL POSITION (EXTRACTS)
20X7
Rs Mn
264
Investment in associate
20X8
Rs Mn
276
Required
Calculate the dividend received from the associate in the year.
ANSWER
Investment in associate b/f
Profit after tax of associate
Investment in associate c/f
Cash dividend received
CA Sri Lanka
Rs Mn
264
30
(276)
18
639
QUESTION
Pacific Stone Co is a 40 year old company producing garden statues carved from
marble. 22 years ago it acquired a 100% interest in a marble importing company,
Kandy Stone Imports Co. In 20W9 it acquired a 40% interest in a competitor,
Columbo Ornaments Co and on 1 January 20X7 it acquired a 75% interest in
Garden Furniture Designs. The draft consolidated accounts for the Pacific Stone
Group are as follows.
DRAFT CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER
COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20X7
Rs Mn
Rs Mn
4,455
Operating profit
1,050
Share of profit after tax of associate
600
Income from long-term investment
(450)
Interest payable
5,655
Profit before taxation
Tax on profit
1,173
Income tax
Deferred taxation
312
Tax attributable to investment income
135
(1,620)
4,035
Profit for the year
Attributed to:
640
3,735
300
4,035
CA Sri Lanka
3,000
3,300
Investments in associates
1,230
1,230
Long-term investments
11,730
16,455
Current assets
3,000
5,925
Inventories
3,825
5,550
Receivables
5,460
13,545
Cash
25,020
12,285
24,015
41,475
Equity and liabilities
Equity
Stated capital
12,285
20,469
7,500
10,335
Retained earnings
19,785
30,804
Total equity
345
Non-controlling interest
19,785
31,149
Non-current liabilities
510
2,130
Obligations under finance leases
1,500
4,380
Loans
90
39
Deferred tax
2,049
6,600
Current liabilities
840
1,500
Trade payables
600
720
Obligations under finance leases
651
1,386
Income tax
120
90
Accrued interest and finance
charges
3,726
2,181
24,015
41,475
CA Sri Lanka
641
Note
1
Rs Mn
495
96
84
336
(204)
(51)
756
(189)
567
300
867
825
42
867
Loans were issued at a discount in 20X7 and the carrying amount of the
loans at 31 December 20X7 included Rs. 120 Mn representing the finance
cost attributable to the discount and allocated in respect of the current
reporting period.
Required
Prepare a consolidated statement of cash flows for the Pacific Stone Group for the
year ended 31 December 20X7 as required by LKAS 7, using the indirect method.
There is no need to provide notes to the statement of cash flows.
642
CA Sri Lanka
ANSWER
PACIFIC STONE GROUP
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED 31 DECEMBER 20X7
Rs Mn
Cash flows from operating activities
Net profit before tax
Adjustments for:
Depreciation (W1)
Profit on sale of plant
Share of associate's profits
Investment income
Interest payable
Operating profit before working capital changes
Increase in trade and other receivables (5,550 3,825 84)
Increase in inventories (5,925 3,000 96)
Increase in trade payables (1,500 840 204)
Cash generated from operations
Interest paid (W2)
Income taxes paid (W3)
Net cash from operating activities
Cash flows from investing activities
Purchase of subsidiary undertaking (W4)
Purchase of property, plant and equipment (W5)
Proceeds from sale of plant
Dividends from investment (600 135)
Dividends from associate (W6)
Dividends paid to non-controlling interest (W7)
Net cash used in investing activities
Cash flows from financing activities
Issue of ordinary share capital (W8)
Issue of loan notes (W9)
Capital payments under finance leases (W10)
Dividends paid (3,735 + 7,500 10,335)
Net cash from financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at 1.1.X7
Cash and cash equivalents at 31.12.X7
CA Sri Lanka
Rs Mn
5,655
975
(300)
(1,050)
(600)
450
5,130
(1,641)
(2,829)
456
1,116
(300)
(750)
66
294
(3,255)
1,500
465
750
(144)
(390)
7,359
2,760
(810)
(900)
8,409
8,085
5,460
13,545
643
Workings
1
Depreciation charges
Balance b/f
Charge for year
Rs Mn
300
3,600
3,900
Interest
Discount
Interest paid
Accrued interest c/f
3
450
540
Rs Mn
651
39
1,485
51
2,226
Purchase of subsidiary
Cash received on acquisition
Less cash consideration
Cash inflow
644
Rs Mn
90
Taxation
Cash outflow
INTEREST PAYABLE
Rs Mn
120 Accrued interest b/f
300
120 Expenses
540
Rs Mn
336
(42)
294
CA Sri Lanka
B/f
On acquisition
Leased
Cash additions
6
NON-CONTROLLING INTEREST
Rs Mn
144 Balance b/f
345 Profit for year
On acquisition
489
Rs Mn
750
3,300
4,050
Rs Mn
Nil
300
189
489
Rs Mn
12,285
825
7,359
20,469
Balance c/f
CA Sri Lanka
9,000
10,500
Non-controlling interest
Dividend paid
Balance c/f
1,500
Rs Mn
LOAN NOTES
Rs Mn
Balance b/f
Finance cost
4,380 Cash inflow
4,380
Rs Mn
1,500
120
2,760
4,380
645
10
Cash outflow
C/f
Current
Long-term
QUESTION
FINANCE LEASES
Rs Mn
B/f
810 Current
Long-term
720 New lease commitment
2,130
3,660
Rs Mn
600
510
2,550
3,660
The following are extracts from the financial statements of Bentota PLC and one of
its wholly owned subsidiaries, Hikkaduwa Ltd, the shares in which were acquired
on 31 October 20X2.
STATEMENTS OF FINANCIAL POSITION
Bentota
and subsidiaries
Hikkaduwa
31 December
31 December
31 October
20X2
20X1
20X2
Rs Mn
Rs Mn
Rs Mn
4,764
3,685
694
2,195
2,175
7,001
5,860
694
Current assets
Inventories
1,735
1,388
306
Receivables
2,658
2,436
185
43
77
4,436
3,901
498
11,437
9,761
1,192
Stated capital
5,112
4,776
400
Retained earnings
2,540
2,063
644
7,652
6,839
1,044
Non-current assets
Property, plant & equipment
Goodwill
Investment in associates
42
Equity
646
CA Sri Lanka
Bentota
and subsidiaries
Non-current liabilities
Loans
Hikkaduwa
31 December
31 December
31 October
20X2
20X1
20X2
Rs Mn
Rs Mn
Rs Mn
1,348
653
111
180
1,459
833
1,915
1,546
Bank overdrafts
176
343
235
200
2,326
2,089
148
11,437
9,761
1,192
Deferred tax
Current liabilities
Payables
148
Rs Mn
546
Finance costs
Share of profit of associates
120
666
126
540
Attributable to:
Owners of the parent
540
0
Non-controlling interests
540
The following information is also given:
CA Sri Lanka
(a)
(b)
(c)
The cost on 31 October 20X2 of the shares in Hikkaduwa was Rs. 1,086 Mn
comprising the issue of Rs. 695 Mn unsecured loan stock at par, 120,000
ordinary shares at a value of Rs. 2,800 Mn and Rs. 55 Mn in cash.
647
(d)
(e)
Total dividends paid by Bentota (the parent company) during the period
amounted to Rs. 63 Mn.
Required
Prepare a statement of cash flows for the Bentota Group for the year ended
31 December 20X2 using the indirect method.
Notes to the statement of cash flows are not required.
ANSWER
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20X2
Rs Mn
Cash flows from operating activities
Profit before taxation
Adjustments for:
Depreciation
Share of profit of associates
Interest expense
Rs Mn
666
78
(120)
624
(37)
(41)
221
767
(160)
607
648
(48)
(463)
100
(411)
CA Sri Lanka
Rs Mn
Cash flows from financing activities
Dividends paid
Rs Mn
(63)
(63)
133
(266)
(133)
Workings
1
78
4,764
4,842
Goodwill
b/f
Acquisition of H
(1,086 (1,044 100%))
3
Rs Mn
GOODWILL
Rs Mn
42 Impairment losses
c/f
42
Rs Mn
0
42
42
Rs Mn
100
2,195
2,295
Rs Mn
4,776
336
5,112
CA Sri Lanka
649
Cash paid
c/f current tax
deferred tax
QUESTION
Rs Mn
200
180
126
506
The following draft group financial statements relate to Pacific Palm a public
limited company.
PACIFIC PALM GROUP STATEMENT OF FINANCIAL POSITION AS AT 30
NOVEMBER
20X2
20X1
Rs Mn
Rs Mn
Assets
Non-current assets
Property, plant and equipment
327
254
Investment property
8
6
Goodwill
48
68
Intangible assets
85
72
Investment in associate
54
650
CA Sri Lanka
Non-current liabilities
Long-term borrowings
Deferred tax
Long-term provisions: pension liability
Total non-current liabilities
Current liabilities
Trade payables
Current tax payable
Total current liabilities
Total liabilities
Total equity and liabilities
20X2
Rs Mn
20X1
Rs Mn
67
35
25
127
71
41
22
134
144
33
177
304
1,015
55
30
85
219
874
CA Sri Lanka
2.0
(7.0)
(6.0)
(11.0)
37.0
38.0
10.0
48.0
651
Rs Mn
Total comprehensive income attributable to
Owners of the parent
Non-controlling interest
27.0
10.0
37.0
Balance at 1
December 20X1
Shares issued
Dividends
Rights issue
Acquisitions
Total
comprehensive
income for the
year
Balance at 30
November 20X2
Stated
capital
Rs Mn
275
Retained
earnings
Rs Mn
324
Financial
asset
reserve
Rs Mn
4
Revaluation
surplus
(PPE)
Rs Mn
16
15
15
(5)
(5)
290
32
351
Total
Rs Mn
619
2
6
(7)
9
27
656
Noncontrolling
interest
Rs Mn
36
Total
equity
Rs Mn
655
(13)
2
20
15
(18)
2
20
10
55
37
711
652
CA Sri Lanka
The fair value of the identifiable net assets of Sandy Beach, excluding
deferred tax assets and liabilities, at the date of acquisition comprised the
following.
Rs Mn
Property, plant and equipment
15
Intangible assets
18
Trade receivables
5
Cash
7
The tax base of the identifiable net assets of Sandy Beach was Rs. 40 Mn at
1 January 20X2. The tax rate of Sandy Beach is 30%.
(ii)
(iii) Pacific Palm purchased a research project from a third party including
certain patents on 1 December 20X1 for Rs. 8 Mn and recognised it as an
intangible asset. During the year, Pacific Palm incurred further costs, which
included Rs. 2 Mn on completing the research phase, Rs. 4 Mn in developing
the product for sale and Rs. 1 Mn for the initial marketing costs. There were
no other additions to intangible assets in the period other than those on the
acquisition of Sandy Beach
(iv) Pacific Palm operates a defined benefit scheme. The current service costs for
the year ended 30 November 20X2 are Rs. 10 Mn. Pacific Palm enhanced the
benefits on 1 December 20X1. The total cost of the enhancement is Rs. 2 Mn.
The net interest on net plan assets was Rs. 8 Mn for the year and Pacific Palm
recognises remeasurement gains and losses in accordance with
LKAS 19.
(v)
Pacific Palm owns an investment property. During the year, part of the
heating system of the property, which had a carrying amount of Rs. 0.5 Mn,
was replaced by a new system, which cost Rs. 1 Mn. Pacific Palm uses the fair
value model for measuring investment property.
(vi) Pacific Palm had exchanged surplus land with a carrying amount of
Rs. 10 Mn for cash of Rs. 15 Mn and plant valued at Rs. 4 Mn. The transaction
has commercial substance. Depreciation for the period for property, plant
and equipment was Rs. 27 Mn.
(vii) Goodwill relating to all subsidiaries had been impairment tested in the year
to 30 November 20X2 and any impairment accounted for. The goodwill
impairment related to those subsidiaries which were 100% owned.
(viii) Deferred tax of Rs. 1 Mn arose in the year on the gains on available for sale
financial assets.
CA Sri Lanka
653
(ix) The associate did not pay any dividends in the year.
Required
Prepare a consolidated statement of cash flows for the Pacific Palms Group using
the indirect method under LKAS 7 Statements of cash flows.
ANSWER
PACIFIC PALM GROUP STATEMENT OF CASH FLOWS FOR YEAR ENDED 30
NOVEMBER 20X2
Rs Mn
Rs Mn
Cash flows from operating activities
Profit before taxation
59.0
Adjustments for:
Depreciation
27.0
Amortisation (W1)
17.0
Impairment of goodwill (W1)
31.5
Profit on exchange of land*: 15 + 4 10
(9.0)
Gain on investment property* (W1)
(1.5)
Loss on replacement of investment property
0.5
Gain on revaluation of held for trading financial assets
(Sandy Beach fair value on derecognition less fair
value at 1 December 20X1: 5 4)
(1.0)
Retirement benefit expense (W7)
4.0
Cash paid to defined benefit plan (W3)
(7.0)
Share of profit of associate (per question)
(6.0)
6.0
Interest expense (per question)
120.5
Decrease in trade receivables (W4)
56.0
Decrease in inventories (W4)
23.0
89.0
Increase in trade payables (W4)
Cash generated from operations
288.5
(6.0)
Interest paid
(16.5)
Income taxes paid (W3)
Net cash from operating activities
266
Cash flows from investing activities
Acquisition of subsidiary, net of cash acquired: 15 7
(8.0)
Acquisition of associate (W1)
(48.0)
Purchase of property, plant and equipment (W1)
(98.0)
Purchase of investment property (per question)
(1.0)
Purchase of intangible assets (W6)
(12.0)
Purchase of investments in equity instruments (W1)
(5.0)
15.0
Proceeds from sale of land
(157)
Net cash used in investing activities
654
CA Sri Lanka
Rs Mn
Cash flows used in financing activities
Proceeds from issue of share capital (W2)
Repayment of long-term borrowings (W3)
Rights issue to non-controlling shareholders (from SOCIE)
Dividends paid (from SOCIE or (W2))
Dividends paid to non-controlling interest shareholders
(from SOCIE or (W2))
Net cash used in financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at the beginning of the year
Cash and cash equivalents at the end of the year
Rs Mn
0.0
(4.0)
2.0
(5.0)
(13.0)
(20)
89
143
232
*Note. The statement of profit or loss and other comprehensive income in the
question shows 'gains on property' of Rs. 10.5 Mn, which need to be added back to
profit in arriving at cash generated from operations. This is made up of Rs. 1.5 Mn
gain on investment property (W2) and Rs. 9 Mn gain on the exchange of surplus
land for cash and plant (Note (vi) of the question. The double entry for the
exchange is:
DEBIT
DEBIT
CREDIT
CREDIT
Cash
Rs. 15 Mn
Plant
Rs. 4 Mn
Land
Rs. 10 Mn
Profit or loss
Rs. 9 Mn
Separate from this, also shown in W2, is an impairment loss on the old heating
system, for which the double entries are:
CA Sri Lanka
DEBIT
CREDIT
Rs. 0.5 Mn
DEBIT
CREDIT
Rs. 1 Mn
Rs. 0.5 Mn
Rs. 1 Mn
655
Workings
1
Assets
PPE
b/f
P/L
OCI
Dep'n/ Amort'n/
Impairment
Acquisition of
sub/assoc
Non-cash
additions
Disposals/
derecognition
Cash
paid/(rec'd)
c/f
Rs Mn
254
Investment
property
Rs Mn
6.0
1.5
Goodwill
Rs Mn
68.0
(7)
(27)
(31.5)
15
(W5)
Intangible
assets
Rs Mn
72
Associate
Rs Mn
0
6
Financial
assets
Rs Mn
90
1
3*
(17)
11.5
18
48
4
(10)
(0.5)
(5)
98
1.0
0.0
327
8.0
48.0
(W6)
12
(0)
85
54
94
Equity
Stated
capital
Rs Mn
275
b/f
P/L
OCI
Acquisition of subsidiary
Rights issue (5 40%)
Cash (paid)/rec'd
c/f
Retained
earnings
Rs Mn
324
NCI
Rs Mn
36
38
(6)
10
15
0
290
20
2
(13) *
55
(5) *
351
* Note. Cash flow given in question, but working shown for clarity.
3
Liabilities
b/f
P/L
OCI
Acquisition of subsidiary
Cash (paid)/rec'd
c/f
656
Long-term
borrowings
Rs Mn
71
(4)
67
Tax
payable
Rs Mn
(41 + 30)
71.0
11.0
1.0
(W5) 1.5
(16.5)
(35 + 33)
68.0
Pension
liability
Rs Mn
22
(W7) 4
6
(7)
25
CA Sri Lanka
b/f
Acquisition of subsidiary
... Increase/(decrease)
c/f
5
Rs Mn
128
(23)
105
Trade
receivables
Rs Mn
113
5
(56)
62
Trade
payables
Rs Mn
55
89
144
Rs Mn
30.0
20.0
5.0
55.0
45.0
(1.5)
(43.5)
11.5
Intangible assets
The research costs of Rs. 2 Mn and the marketing costs of Rs. 1 Mn are
charged to profit or loss for the year.
The Rs. 8 Mn cost of the patents and the Rs. 4 Mn development costs =
Rs. 12 Mn are cash outflows to acquire intangible assets.
Pension costs
The total net pension cost charged to profit or loss is:
Current service cost
Past service cost (recognised immediately)
Net interest income on plan assets
Rs Mn
10
2
(8)
4
2.5 Disclosure
LKAS 7 requires disclosure of non-cash transactions, components of cash and cash
equivalents and other disclosures
Non-cash investing and financing transactions such as a bonus issue of shares
should be disclosed in the financial statements in a way that provides all
relevant information about these investing and financing activities. This
CA Sri Lanka
657
Restrictions on the use of, or access to, any part of cash equivalents
(b)
(c)
Cash flows that increased operating capacity, compared to cash flows that
merely maintained operating capacity
658
CA Sri Lanka
2014
6,449,484
4,861
401,092
1,865
2013
2,052,435
1,528
58,719
118,161
1,940
6,857,302
2,232,783
Cash and cash equivalents includes the following for the purpose of the Statement
of Cash Flows.
CASH AND CASH EQUIVALENTS
Cash at bank
Bank overdrafts
6,857,302
2,232,783
(801,204) (3,445,702)
6,056,098
(1,212,919)
(b)
(c)
(d)
The amount of the assets and liabilities other than cash or cash equivalents
in the subsidiaries or other businesses over which control is obtained or lost,
summarised by each major category.
Disclosures (c) and (d) are not required in respect of subsidiaries controlled by
investment entities and measured at fair value through profit or loss.
CA Sri Lanka
659
QUESTION
Critically evaluate LKAS 7's approach to statements of cash flows of reconciling
the movement in cash and cash equivalents.
ANSWER
Cash is defined by LKAS 7 as 'cash on hand and demand deposits'. Cash
equivalents are 'short-term, highly liquid investments that are readily convertible
to known amounts of cash and which are subject to insignificant risk of changes in
value'.
LKAS 7 amalgamates these two concepts together and shows the movement in the
statement of cash flows. This is effectively treating cash equivalents as if they
were pure cash, reinforced by the naming of the statement of cash flows, which
refers only to cash.
One could argue that this is misleading to the user of the financial statements as
short-term bonds and other investments of up to 3 months maturity from the
reporting date are treated as if they are liquid cash, which is not the case. The
breakdown of cash and cash equivalents is shown in a note to the statement of
cash flows. A more transparent alternative might be to show such investments as
inflows and outflows of pure cash under 'Investing activities', and to reconcile
therefore to the movement in pure cash.
QUESTION
On 1 February 20X3, P Group acquired 70% of a subsidiary S Co. Purchase
consideration was 100,000 shares issued at their market price of Rs. 225 plus
Rs. 300 Mn in cash. At the acquisition date the statement of financial position for
S Co was as follows:
Rs Mn
570
PPE
120
Inventories
170
Trade receivables
85
Cash and cash equivalents
945
200
Stated capital
515
Reserves
715
150
Trade payables
80
Income taxes payable
945
660
CA Sri Lanka
(b)
(c)
Assuming that:
The NCI in net assets of P Group at 1 January 20X3 was Rs. 604 Mn
The NCI in net assets of P Group at 31 December 20X3 was Rs. 850 Mn
The NCI in total comprehensive income for the year ended 31 December
20X3 was Rs. 241.5 Mn
Trade receivables
20X3
Rs Mn
540
20X2
Rs Mn
430
ANSWER
(a)
Cash to acquire S Co
Cash acquired with S Co
Net payment to acquire S Co
(b)
CA Sri Lanka
Rs Mn
(300)
85
215
661
(c)
Rs Mn
604
241.5
214.5
(850)
210
NCI b/f
NCI in TCI
Acquisition of S (715 x 30%)
NCI c/f
Dividends paid to the NCI
(d)
Rs Mn
110
(170)
60
3 Current developments
ED/2014/6 Disclosure Initiative proposes changes to IAS 7 (LKAS 7)
Long-term
borrowings
Lease liabilities
Long-term debt
20X1
1,040
Cash flow
250
1,040
(90)
160
Non-cash changes
Acquisition New leases
200
200
900
900
20X2
1,490
810
2,300
662
CA Sri Lanka
CHAPTER ROUNDUP
CA Sri Lanka
663
PROGRESS TEST
664
CA Sri Lanka
To provide users of financial statements with information about the entity's ability
to generate cash and cash equivalents, and the entity's cash needs
All entities
The net profit or loss for the period is adjusted for non-cash items; changes in
inventories, receivables and payables from operations; and other items resulting
from investing or financing activities.
Cash flows from acquisitions and disposals are presented separately under
investing activities.
CA Sri Lanka
665
666
CA Sri Lanka
CHAPTER
INTRODUCTION
Where a company acquires a subsidiary that reports its results in a foreign currency, the financial
statements of the subsidiary must be translated prior to consolidation.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
1.2
Level B
1.2.1
1.2.2
1.2.5
1.3.1
1.3.2
1.3.3
1.2.3
1.2.4
1.3
Level C
Advise on the application of Sri Lanka Accounting Standards in solving complicated matters.
Recommend the appropriate accounting treatment to be used in complicated circumstances
in accordance with Sri Lanka Accounting Standards.
Evaluate the outcomes of the application of different accounting treatments.
Propose appropriate accounting policies to be selected in different circumstances.
Evaluate the impact of the use of different expert inputs to financial reporting.
Advise appropriate application and selection of accounting/reporting options given under
standards.
Design the appropriate disclosures to be made in the financial statements.
667
CHAPTER CONTENTS
1 LKAS 21 The Effects of Changes in Foreign Exchange Rates
2 LKAS 29 Financial Reporting in Hyperinflationary Economies
The first of these aspects was considered in Chapter 3; the second is considered in
this chapter.
1.1 Definitions
The following definitions are relevant:
Foreign operation A subsidiary, associate, joint venture or branch of a reporting
entity, the activities of which are based or conducted in a country or currency
other than those of the reporting entity.
Net investment in a foreign operation. The amount of the reporting entity's
interest in the net assets of that operation.
668
CA Sri Lanka
The currency that mainly influences sales prices for goods and services
(often the currency in which prices are denominated and settled).
(b)
(c)
The currency that mainly influences labour, material and other costs of
providing goods or services (often the currency in which prices are
denominated and settled).
The currency in which funds from financing activities (raising loans and
issuing equity) are generated.
(b)
CA Sri Lanka
(a)
(b)
Whether transactions with the parent are a high or a low proportion of the
foreign operation's activities.
(c)
Whether cash flows from the activities of the foreign operation directly affect
the cash flows of the parent and are readily available for remittance to it.
(d)
Whether the activities of the foreign operation are financed from its own
cash flows or by borrowing from the parent.
669
Where the functional currency of a foreign operation is different from that of the
group, the results of the operation must be translated.
Assets
Closing rate
Pre-acquisition stated
capital and retained
earnings
Note 1
Note 2
Liabilities
Closing rate
Note 1
Post acquisition retained earnings are translated as a balancing figure for ease. If
this balance were calculated it would include the profit of the operation for each
year since acquisition translated at the average rate for those years. In an exam
situation where a subsidiary was acquired many years ago, this is impracticable.
Note 2
An exchange difference arises on the translation of the financial statements. LKAS
21 requires that this is recognised as other comprehensive income and taken to a
separate reserve in equity.
The foreign exchange reserve therefore includes exchange differences arising on
translation of the financial statements for each year since acquisition.
Again in an exam situation the calculation of this reserve on a cumulative basis
when a subsidiary was acquired many years ago is impracticable. Therefore the
foreign exchange reserve and post-acquisition retained earnings are usually
combined for exam purposes and calculated as a balancing figure.
Note 3
Although items in the statement of profit or loss and other comprehensive income
are translated at the spot rate on the date on which each transaction took place,
670
CA Sri Lanka
LKAS 21 allows the use of an average rate for the period provided that this does
not fluctuate too much.
1.3.1 Example: Translation of financial statements
The abridged financial statements of Europa Co, an 80% subsidiary of a Sri Lankan
company, Lanka Imports Ltd appear below.
DRAFT STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X9
Europa Co
'000
Assets
PPE
Plant at cost
Less depreciation
Current assets
Inventories
Receivables
500
(200)
300
200
100
300
600
100
280
380
110
110
600
Revenue
Expenses
Profit before tax
Tax
Retained profit
Europa Co
'000
250
(160)
90
(20)
70
Europa Co was acquired by Lanka Imports Ltd on 1 January 20X9 when its
retained earnings were 210,000.
CA Sri Lanka
671
Exchange rates:
Required
Translate the financial statements of Europa Co.
Solution
SUMMARISED STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER 20X9
PPE
Inventories
Receivables
Stated capital
Retained earnings pre Acq
Retained earnings post Acq
Long-term loans
Current liabilities
'000
300
200
100
600
100
210
70
110
110
600
Rate
175
175
175
168
168
Balance
175
175
Rs Mn
52.5
35
17.5
105
16.8
35.28
14.42
19.25
19.25
105
672
Opening net
assets
Closing net
assets
310,000
70,000
380,000
CA Sri Lanka
Closing net
assets
310,000
70,000
380,000
168
Rs 52,080,000
170
+
Rs 11,900,000
175
Rs 66,500,000
In this case the translated opening net assets plus the translated profit for the year
amount to less than the translated closing net assets. Therefore there is an
exchange gain of the difference, in this case Rs. 2.52 Mn (66.5 52.08 11.9)
If, however, we translate the separate elements of the equation all at the closing
exchange rates, the equation does hold:
Opening net
assets
Closing net
assets
310,000
70,000
380,000
175
Rs 54,250,000
175
+
Rs 12,250,000
175
=
Rs 66,500,000
(X)
X
X/(X)
(X)
X
X/(X)
X/(X)
Remember that this is the exchange difference for the current year. It is:
Reported as an item of other comprehensive income that may be reclassified to
profit or loss, and
Accumulated in a separate reserve in equity.
CA Sri Lanka
673
Rs'000
(52,080)
54,250
Rs'000
2,170
(11,900)
12,250
350
2,520
674
Rs Mn
42.5
(27.2)
(3.4)
11.9
2.52
14.42
CA Sri Lanka
Rs Mn
52.5
35
17.5
105
16.8
35.28
11.9
2.52
19.25
19.25
105
Lanka Imports Ltd has owned Europa Co for one year and therefore:
The balance of post-acquisition retained earnings is equal to the translated
profit for the year
The balance on the foreign exchange reserve is equal to the exchange difference
for the year.
Remember that you will not be able to split these reserves easily where a foreign
operation was acquired several years prior to the reporting date and therefore it
is acceptable to merge them. You should, however, calculate the exchange
difference for the year when preparing a statement of profit or loss and other
comprehensive income.
CA Sri Lanka
(i)
(ii)
675
78,900
41,664
120,564
12,700
16,500
29,200
149,764
20,000
82,364
102,364
30,000
17,400
149,764
CA Sri Lanka
Solution
Consolidated statement of financial position at 31 December 20X9
PPE
Invt in E
Inventories
Receivables
Stated capital
Retained
earnings
NCI
Loans
Current
liabilities
LI Ltd
Rs'000
78,900
41,664
12,700
16,500
149,764
20,000
82,364
E Co
Rs'000
52,500
(W1)
Rs'000
(W2)
Rs'000
(41,664)
35,000
17,500
105,000
16,800
49,700
(16,800)
(35,280)
(2,884)
10,416
2,884
Group
Rs'000
131,400
47,700
34,000
213,100
20,000
93,900
30,000
17,400
19,250
19,250
13,300
49,250
36,650
149,764
105,000
213,100
Revenue
Expenses
Tax
Retained profit
Exchange diff
TCI
Profit attributable to:
Owners of parent (80%)
NCI (20%)
TCI attributable to:
Owners of parent
NCI
CA Sri Lanka
LI Ltd
Rs'000
71,400
(58,900)
(2,050)
10,450
E Co
Rs'000
42,500
(27,200)
(3,400)
11,900
2,520
14,420
Group
Rs'000
113,900
(86,100)
(5,450)
22,350
2,520
24,870
10,450
9,520
2,380
19,970
2,380
10,450
11,536
2,884
21,986
2,884
677
Workings
(W1) Goodwill on acquisition
Cost of investment
NCI 20% (100 + 210)
Net assets at acquisition
Stated capital
Retained earnings
Goodwill
'000
rate
62
168
(100)
(210)
nil
168
168
Rs'000
41,664
10,416
(16,800)
(35,280)
nil
Stated capital
16,800
DEBIT
Retained earnings
35,280
CREDIT
Investment
41,664
CREDIT
NCI
10,416
CREDIT
NCI
2,884
2,884
Note that in this example, since Europa was purchased in the current year, this
reallocation is equal to the TCI attributable to the NCI as disclosed in the
consolidated statement of profit or loss and other comprehensive income.
1.4.2 Goodwill
Goodwill arising on the acquisition of a foreign subsidiary is considered to be a
foreign asset. It is:
1.
2.
3.
4.
678
CA Sri Lanka
'000
248
93
(100)
(210)
31
31
rate
168
168
Rs'000
41,664
15,624
168
168
168
175
(16,800)
(35,280)
5,208
5,425
217
679
Where the NCI is measured at fair value and therefore has an interest in
goodwill the exchange difference is allocated between the owners of the parent
and the NCI in proportion to their ownership interest.
Where the NCI is measured as a proportion of net assets the exchange
difference is allocated to the parent only.
QUESTION
Redraft the consolidated financial statements for the Lanka Imports Group for the
year ended 31 December 20X9 assuming that:
(i)
(ii)
ANSWER
Consolidated statement of financial position at 31 December 20X9
PPE
Invt in E
Goodwill
Inventories
Receivables
Stated
capital
Retained
earnings
NCI
Loans
Current
liabilities
680
LI Ltd
Rs'000
78,900
41,664
E Co
Rs'000
52,500
(W1)i
Rs'000
(41,664)
6,048
(W1)ii
(W2)
Rs'000
Group
Rs'000
131,400
5,796
47,700
34,000
218,896
20,000
(252)
12,700
16,500
149,764
20,000
35,000
17,500
105,000
16,800
(16,800)
82,364
49,700
(35,280)
(176)
(2,884)
93,724
16,464
(76)
2,884
30,000
19,250
19,272
49,250
17,400
149,764
19,250
105,000
36,650
218,896
CA Sri Lanka
(ii)
CA Sri Lanka
'000
248
98
(100)
(210)
36
36
rate
168
168
Rs'000
41,664
16,464
168
168
168
175
(16,800)
(35,280)
6,048
6,300
252
Goodwill
6,048
DEBIT
Stated capital
16,800
DEBIT
Retained earnings
35,280
CREDIT
Investment
41,664
CREDIT
NCI
16,464
Goodwill
CREDIT
CREDIT
252
176.4
75.6
681
CREDIT
NCI
2,884
2,884
QUESTION
Comprehensive question
Share capital
Horana
Rs Mn
Mazini
U'000
5,297
4,000
203
2,400
3,000
7,900
7,000
2,000
2,250
Pre-acquisition reserves
Post-acquisition reserves
Loans
682
1,125
4,400
2,825
6,400
6,200
1,500
800
7,900
7,000
CA Sri Lanka
Revenue
Cost of sales
Gross profit
Operating expenses
Profit before tax
Income tax expense
Profit for the year
Horana
Rs Mn
Mazini
U'000
12,000
(7,000)
5,000
(3,025)
1,975
(500)
1,475
5,700
(2,470)
3,230
(570)
2,660
(760)
1,900
Rs to Units
45
43
40
38
Required
Prepare the consolidated statement of profit or loss and other comprehensive
income and statement of financial position for the Horana Group for the year
ended 31 December 20X7.
You should work to the nearest Rs Mn.
CA Sri Lanka
683
ANSWER
STATEMENTS OF FINANCIAL POSITION AT 31 DECEMBER 20X7
Horana
Mazini
(W3)i
(W3)ii
(W4)
Group
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
Rs Mn
5,297
160
5,457
203
(203)
Goodwill
Current assets
Share capital
Pre-acquisition
reserves
Post-acquisition
reserves
NCI
Loans
97
(12)
85
2,400
120
2,520
7,900
280
8,062
2,000
101
(101)
51
(51)
2,000
4,400
96
6,400
248
1,500
32
1,532
7,900
280
8,062
(12)
46
(29)
29
4,455
75
Revenue
Cost of sales
Gross profit
Operating expenses
Profit before tax
Income tax expense
Profit for the year
OCI
Exchange loss
TCI
Profit attributable to:
Owners of parent
NCI
684
Horana
Rs Mn
12,000
(7,000)
5,000
(3,025)
1,975
(500)
1,475
Mazini
Rs Mn
217
(94)
123
(22)
101
(29)
72
(W3)
Rs Mn
Group
Rs Mn
12,217
(7,094)
5,123
(3,047)
2,076
(529)
1,547
(7)
1,475
(9)
63
(16)
1,531
1,475
NCI
50
22
1,525
22
CA Sri Lanka
Horana
Rs Mn
TCI attributable to:
Owners of parent
NCI
1,475
Mazini
Rs Mn
44
19
(W3)
Rs Mn
(7)
Group
Rs Mn
1,512
19
Mazini
Rate
Units'000
Mazini
Rs Mn
4,000
40
160
Current assets
3,000
40
120
7,000
280
Share capital
2,250
45
101
Pre-acquisition reserves
1,125
45
51
Post-acquisition reserves
2,825
96
6,200
Loans
800
248
40
280
7,000
Mazini
Units'000
Revenue
Cost of sales
Gross profit
Operating expenses
Profit before tax
Income tax expense
Profit for the year
OCI exchange difference (W2)
TCI
5,700
(2,470)
3,230
(570)
2,660
(760)
1,900
32
Rate
Mazini
Rs Mn
38
38
217
(94)
123
(22)
101
(29)
72
(9)
63
38
38
CA Sri Lanka
185 Mn
172 Mn
(13 Mn)
685
Profit :
At AR: 1,900,000 38
At CR: 1,900,000 40
Gain
Net loss
72 Mn
76 Mn
4 Mn
(9 Mn)
(W3) Goodwill
Consideration transferred
Non-controlling interests (30% 3,375)
Share capital
Retained reserves
(ii)
Units'000
4,500
1,012
(2,250)
(1,125)
Rate
45
45
45
45
Rs Mn
203
46
(101)
(51)
2,137
2,137
2,137
45
43
40
97
(5)
92
(7)
85
Goodwill
DEBIT
Share capital
DEBIT
Retained earnings
CREDIT
NCI
CREDIT
Investment
97
101
51
46
203
CREDIT
Goodwill
12
12
Of this amount the Rs. 7 Mn loss arising in the year is recognised as other
comprehensive income.
(W4) Allocation of post acquisition profits to NCI
Mazini has made post acquisition profits of Rs. 96 Mn (including cumulative
exchange differences on retranslation of its financial statements). 30% of this is
allocated to the NCI by (Rs Mn):
686
DEBIT
CREDIT
NCI
29
29
CA Sri Lanka
2 LKAS 29 Financial
Economies
Reporting
in
Hyperinflationary
CA Sri Lanka
(b)
The general population regards monetary amounts not in terms of the local
currency but in terms of a relatively stable foreign currency. Prices may be
quoted in that currency.
(c)
Sales and purchases on credit take place at prices that compensate for the
expected loss of purchasing power during the credit period, even if the
period is short.
(d)
Interest rates, wages and prices are linked to a price index, and
(e)
CA Sri Lanka
Other non-monetary items are restated by applying a general prices index from
the date of acquisition (or revaluation where relevant) to the reporting date.
2.3.2 Example: Restating non-monetary assets
An entity operating in a hyperinflationary economy where the currency is the Bitt
acquired land for B100,000 when the price index was 200. At the reporting date
the price index is 900 and therefore the restated value of the land is:
B100,000 900/200 = B450,000
2.3.3 Statement of profit or loss and other comprehensive income
All amounts of income and expense are restated in terms of measuring units
current at the reporting date. Therefore all amounts are restated by applying the
change in the general prices index from the dates when the items of income and
expenditure were initially recorded.
2.3.4 Gain or loss
The restatement of the financial statements will result in a gain or loss known as
the gain or loss on net monetary position. This is included in profit or loss.
CA Sri Lanka
689
2.5 Taxes
The restatement of financial statements in accordance with LKAS 29 may result in
differences between the carrying amount of items and their tax bases. These
differences result in deferred tax amounts in accordance with LKAS 12.
2.6 Disclosure
LKAS 29 requires the following disclosures:
The fact that the financial statements and the corresponding figures for
previous periods have been restated for the changes in the general purchasing
power of the functional currency and, as a result, are stated in terms of the
measuring unit current at the end of the reporting period.
Whether the financial statements are based on a historical cost approach or a
current cost approach.
The identity and level of the price index at the end of the reporting period and
the movement in the index during the current and the previous reporting
period.
CA Sri Lanka
QUESTION
Singhe, a listed company whose functional currency is the Rupee has recently
purchased a foreign subsidiary Lion. The functional currency of Lion is the crown.
Singhe purchased 75% of the ordinary share capital of Lion on 1 September 20X5
for 80 million crowns. The fair value of the net assets at that date was 100 million
crowns. At the year-end the goodwill was tested for impairment and this review
indicated that it had been impaired by 2 million crowns.
The exchange rates were as follows:
1 September 20X5
1 : 2.5
31 December 20X5
1 : 2.1
Crowns to Rs
Single chose to measure the non-controlling interests in Lion at fair value at the
date of acquisition. The fair value of the non-controlling interests in Lion on
1 September 20X5 was 26 million crowns.
The directors are unsure how to treat the subsidiary in the consolidated accounts
of Singhe.
Required
(a)
(b)
ANSWER
(a)
CA Sri Lanka
691
Goodwill
Consideration transferred
Non-controlling interests (at fair value)
Less: Fair value of net assets at acquisition
Goodwill at acquisition
Impairment losses
Exchange gain/(loss) (balancing figure)
Goodwill at year end
Crowns Mn
80.0
26.0
(100.0)
6.0
(2.0)
4.0
Rate
Rs Mn
2.5
2.1
2.1
15
(4.2)
(2.4)
8.4
692
CA Sri Lanka
QUESTION
Polina owns 75% of the shares of a foreign subsidiary, Santana which has the
functional currency of the Pret. The subsidiary was acquired on 1 January 20X3 at
a cost of Pret 90 Mn and on that date the retained earnings of Santana were
Pret 70 Mn.
The abbreviated statements of financial position of Polina and Santana at
31 December 20X3 were as follows:
Polina
Santana
Rs'000
Pret'000
238,500
Investment in Santana
320,000
98,000
Other assets
558,500
98,000
50,000
10,000
Stated capital
233,500
76,000
Retained earnings
283,500
86,000
275,000
12,000
Liabilities
558,500
98,000
Notes:
1.
2.
3.
31 December 20X3
Required
Prepare the abbreviated consolidated statement of financial position for the
Polina Group at 31 December 20X3.
CA Sri Lanka
693
ANSWER
Consolidated statement of financial position
Inv in S
Goodwill
Other assets
St capital
Retained
earnings
FX reserve
NCI
Liabilities
P
Rs Mn
238.5
320
558.5
50
233.5
S (W1)
Rs Mn
264.6
264.6
26.5
201.58
275
558.5
4.12
32.4
264.6
(W4)
Rs Mn
(238.5)
79.5
(W5)
Rs Mn
1.5
(W6)
Rs Mn
(26.5)
(185.5)
1.5
(4.02)
53
Stated capital
FX reserve
Retained earnings
Liabilities
Santana
Pret'000
98,000
98,000
10,000
Exchange
Rate
2.7
76,000
86,000
12,000
98,000
Cons.
Rs Mn
81
584.6
665.6
50
247.06
(1.03)
1.03
3.09
58.05
307.4
665.6
2.65
(W2)
(W3)
2.7
Santana
Rs'000
264,600
264,600
26,500
4,120
201,580
232,200
32,400
264,600
FX Reserve
Opening net assets (80 Mn) at opening rate (2.65)
Opening net assets (80 Mn) at closing rate (2.7)
Gain
Profit for the year (6 Mn) at average rate (2.68)
Profit for the year (6 Mn) at closing rate (2.7)
Gain
Total gain
694
4.02
(W7)
Rs Mn
Translation of Santana
Other assets
Total
Rs Mn
238.5
584.6
823.1
76.5
435.0
8
4.12
307.4
823.1
Rs 212 Mn
Rs 216 Mn
4 Mn
Rs 16.08 Mn
Rs 16.2 Mn
0.12 Mn
4.12 Mn
CA Sri Lanka
Rs'000
XR
Rs Mn
Consideration transferred
Non-controlling interest (25% (10 + 70))
Net assets acquired
Stated capital
Retained earnings
90
20
2.65
2.65
238.5
53
10
70
2.65
2.65
26.5
185.5
Goodwill at acquisition
30
2.65
79.5
DEBIT
Goodwill
Rs. 79.5 Mn
DEBIT
Stated capital
Rs. 26.5 Mn
DEBIT
Retained earnings
Rs. 185.5 Mn
CREDIT
Investment
Rs. 238.5 Mn
CREDIT
NCI
Rs. 53 Mn
Goodwill retranslation
Goodwill is a group asset and must be retranslated based on the closing rate.
It is retranslated to Pret 30 Mn 2.7 = Rs. 81 Mn. This is recorded by;
DEBIT
Goodwill
CREDIT
Retained earnings
Rs. 1.5 Mn
Rs. 1.5 Mn
None of the exchange difference is allocated to the NCI as the full goodwill
method is not used.
6
CA Sri Lanka
DEBIT
Retained earnings
CREDIT
NCI
Rs.4.02 Mn
Rs. 4.02 Mn
695
696
DEBIT
CREDIT
NCI
Rs. 1.03 Mn
Rs. 1.03 Mn
CA Sri Lanka
CHAPTER ROUNDUP
Assets and liabilities in the statement of financial position are translated at the
closing rate; pre acquisition stated capital and reserves are translated at the
acquisition date rate; post acquisition reserves include cumulative exchange
differences on translation.
CA Sri Lanka
697
PROGRESS TEST
698
What additional factors must management take into account when determining
the functional currency of a foreign operation that is part of a group?
How are monetary items adjusted in the financial statements of an entity that
operates in a hyperinflationary economy?
CA Sri Lanka
(a)
(b)
Whether transactions with the parent are a high or a low proportion of the
foreign operation's activities.
(c)
Whether cash flows from the activities of the foreign operation directly affect
the cash flows of the parent and are readily available for remittance to it.
(d)
Whether the activities of the foreign operation are financed from its own
cash flows or by borrowing from the parent.
As assets / liabilities of the group and therefore they are retranslated at the period
end.
When the NCI is measured at fair value and therefore goodwill is full goodwill.
Monetary items are not restated as they are already expressed in terms of the
monetary unit current at the end of the reporting period.
CA Sri Lanka
699
700
CA Sri Lanka
CHAPTER
INTRODUCTION
The SLFRS for SMEs was covered at KB1 level in some detail. In this chapter we revise which entities
can use the SLFRS, the contents of the standard and the differences between the SLFRS for SMEs and full
SLFRS. We also consider why certain topics are not included in the SLFRS for SMEs.
This chapter also considers first-time adoption of SLFRS. The relevant standard is SLFRS 1, which is new
at this level.
Knowledge Component
1
Interpretation and Application of Sri Lanka Accounting Standards (SLFRS /
LKAS / IFRIC / SIC)
1.1
Level A
1.1.1
1.1.2
1.1.3
1.1.4
1.1.5
1.1.6
1.1.7
701
CHAPTER CONTENTS
1 Eligibility to use the SLFRS for SMEs
2 Content of the SLFRS for SMEs
3 Comparison with full SLFRS
4 SLFRS 1 First-time adoption of SLFRS
5 SLFRS 14 Regulatory Deferral Accounts
CA Sri Lanka
QUESTION
An entity can only use the SLFRS for SMEs if it does not have public accountability.
Explain which entities do not have public accountability.
ANSWER
An entity has public accountability if:
CA Sri Lanka
(a)
(b)
703
2.1 Introduction
The SLFRS for SMEs is a single document of 230 pages that is designed to address
the accounting concerns of smaller, private entities whilst taking into account
cost-benefit considerations.
The SLFRS for SMEs is a standalone standard with a single exception: Entities may
choose to apply LKAS 39 rather than the financial instruments section of the
SLFRS for SMEs. Other than this, entities are not allowed to mix and match the
requirements of the SLFRS for SMEs with those of full SLFRS.
2.2 Contents
The SLFRS for SMEs has 35 chapters, which cover individual topics that may be
relevant to entities without public accountability. They are:
1
20 Leases
Statement of comprehensive
income and income statement
23 Revenue
24 Government grants
25 Borrowing costs
26 Share-based payment
27 Impairment of assets
704
28 Employee benefits
CA Sri Lanka
29 Income tax
13 Inventories
31 Hyperinflation
14 Investments in associates
16 Investment property
34 Specialised activities
CA Sri Lanka
705
3.1 Overview
In comparison to full SLFRS, the SLFRS for SMEs:
Contains equivalent guidance on certain topics
Omits certain topics because they are not relevant to typical SMEs
706
CA Sri Lanka
3.2 Comparison
The following table explains the SLFRS for SME requirements that differ from
those within full SLFRS.
SLFRS for SMEs as compared to full SLFRS
Financial
statement
presentation
Financial
instruments
CA Sri Lanka
707
Property,
plant and
equipment
Intangible
assets other
than goodwill
Business
combinations
and goodwill
Under the SLFRS for SMEs transaction costs form part of the
cost of an acquisition.
Contingent consideration is included as part of the cost of the
acquisition if it is probable of payment and the fair value can
be measured reliably.
Goodwill is assumed to have a finite life (presumed 10 years)
and is amortised.
Goodwill is tested for impairment only if there is an indicator
of impairment.
Government
grants
No guidance is provided in the SLFRS for SMEs on nonmonetary government grants, government assistance or the
repayment of government grants.
Borrowing
costs
Employee
benefits
708
CA Sri Lanka
Foreign
currency
translation
Specialised
activities
For biological assets the cost model is used unless the fair
value is readily determinable without undue cost and effort.
Note that although the SLFRS for SMEs has no guidance on assets held for sale, a
plan to dispose of an asset is identified as an indicator of impairment by the
standard.
CA Sri Lanka
709
They relate to topics or accounting policy options in full SLFRS that are omitted
or simplified in the SLFRS for SMEs, or
They are not considered appropriate based on users needs and cost-benefit
considerations. In particular some disclosures in full SLFRS are more relevant
to investment decisions in public capital markets than the transactions and
other events and conditions encountered by a typical SME.
710
CA Sri Lanka
31.12.20X8
31.12.20X9
Transition
date
Preparation of an opening SLFRS statement of financial position typically involves
adjusting the amounts reported at the same date under previous GAAP.
All adjustments are recognised directly in retained earnings (or, if appropriate,
another category of equity) not in profit or loss.
4.2.1 Estimates
Estimates in the opening SLFRS statement of financial position must be consistent
with estimates made at the same date under previous GAAP even if further
information is now available (in order to comply with LKAS 10).
4.2.2 Transition process
(a)
Accounting policies
The entity should select accounting policies that comply with SLFRSs
effective at the end of the first SLFRS reporting period.
These accounting policies are used in the opening SLFRS statement of
financial position and throughout all periods presented. The entity does not
apply different versions of SLFRS effective at earlier dates.
(b)
(c)
CA Sri Lanka
711
(d)
(e)
Measurement
Value at which asset or liability is measured may differ under SLFRS.
For example, discounting of deferred tax assets/liabilities is not allowed
under SLFRS.
4.2.3 Main exemptions from applying SLFRS in the opening SLFRS statement
of financial position
(a)
(b)
Business combinations
For business combinations prior to the date of transition to SLFRS:
(i)
(ii)
For items requiring a cost measure for SLFRS, the carrying value at the
date of the business combination is treated as deemed cost and
SLFRS rules are applied from thereon.
(iii) Items requiring a fair value measure for SLFRS are revalued at the date
of transition to SLFRS.
(iv) The carrying value of goodwill at the date of transition to SLFRS is the
amount as reported under previous GAAP.
(c)
Employee benefits
Unrecognised actuarial gains and losses can be deemed zero at the date of
transition to SLFRS. LKAS 19 is applied from then on.
(d)
712
CA Sri Lanka
(e)
4.2.4 Disclosure
(a)
(b)
CA Sri Lanka
(a)
(b)
Proper planning. This should take place at the overall project level, but a
detailed task analysis could be drawn up to control work performed.
(c)
(d)
(e)
(f)
713
(g)
Physical resourcing. The need for IT equipment and office space should
be properly assessed.
(h)
Process review. Care should be taken not to perceive the change as a oneoff quick fix. Any change in future systems and processes should be
assessed and properly implemented.
(i)
(b)
(c)
(d)
High standards of corporate governance and audit. This is all the more
important in the transition period, especially where there is resistance to
change.
Overall, there are significant advantages to the widespread adoption of SLFRS, but
if the transition is to go well, there must be a realistic assessment of potential
challenges.
CA Sri Lanka
under local GAAP, users may find them hard to understand, and consequently of
little relevance.
4.4.2 Presentation
Many developed countries have legislation requiring set formats and layouts for
financial statements. SLFRS demands that presentation is in accordance with LKAS
1 Presentation of financial statements, but this standard allows alternative forms of
presentation. In choosing between alternatives, companies tend to adopt the
format that is closest to preview GAAP, even if this is not necessarily the best
format.
4.4.3 Concepts and interpretation
Although later LKAS and SLFRS are based to an extent on the Conceptual
Framework, there is no consistent set of principles underlying them. The
Conceptual Framework itself is being revised, and there is controversy over the
direction the revision should take. Consequently, preparers of accounts are likely
to think in terms of the conceptual frameworks if any that they have used in
developing local GAAP.
Where SLFRS themselves give clear guidance, this may not matter, but where
there is uncertainty, preparers of accounts will fall back on their traditional
conceptual thinking.
4.4.4 Choice of accounting treatment
Although many so-called 'allowed alternatives' have been eliminated from SLFRS
in recent years, choice of treatment remains. For example, LKAS 16 Property, plant
and equipment gives a choice of either the cost model or the revaluation model for
a class of property, plant or equipment.
It could be argued that choice is a good thing, as companies should be able to
select the treatment that most fairly reflects the underlying reality. However, in
the context of change to SLFRS, there is a danger that companies will choose the
alternative that closely matches the approach followed under local GAAP, or
the one that is easier to implement, regardless of whether this is the best
choice.
4.4.5 Inconsistency in recognition or measurement methods
As well as the broader choice of which accounting model to adopt (cost or
revaluation, and so on), SLFRS allows further choice on recognition and
CA Sri Lanka
715
(b)
Many issues are perhaps addressed for the first time, for example sharebased payment
(c)
(d)
(e)
5.1 Definitions
Rate-regulated activities are an entitys activities that are subject to rate
regulation.
Rate regulation is a framework for establishing the prices that can be charged to
customers for goods or services and that framework is subject to oversight and/or
approval by a rate regulator.
716
CA Sri Lanka
CA Sri Lanka
20X0
20X1
20X2
917
1,124
1,079
(39)
(39)
15
717
Rs Mn
Net amount charged to customers
in respect of current year
Actual supply costs of current year
Net amount of (under)/over
recovery of costs for the year
20X0
20X1
20X2
917
1,034
1,085
1,040
1,055
980
45
75
(117)
718
CA Sri Lanka
CA Sri Lanka
719
LKAS 36 Impairment of
Assets
SLFRS 3 Business
Combinations
SLFRS 5 Non-current
Assets Held for Sale and
Discontinued Operations
SLFRS 10 Consolidated
Financial Statements
LKAS 28 Investments in
Associates and Joint
Ventures
720
CA Sri Lanka
QUESTION
The SLFRS for SMEs is designed to address the accounting concerns of smaller,
private entities whilst taking into account cost-benefit considerations.
Required
Explain why CA Sri Lanka allows small private entities to apply the SLFRS for
SMEs rather than requiring them to apply full SLFRS.
ANSWER
There are several reasons why the SLFRS for SMEs was introduced rather than
requiring smaller, private entities to apply full SLFRS. These include the
following:
Full SLFRS are designed to meet the needs of large, listed companies. They
cover matters such as complex financial instruments and share-based
payments that are not relevant to smaller, private entities.
If a company adopts full SLFRS, it is required to comply with all of the
requirements of the accounting standards. This compliance places a heavy
reporting burden on smaller entities, and as stated, many of the specific
requirements of standards, and in cases full standards are not relevant to these
entities.
SMEs can be viewed as specialised entities and information that is relevant and
useful to their particular users should be reported in their financial statements.
The main users of the financial statements of companies reporting under full
SLFRS are capital markets, whereas the main users of SME financial statements
are tax authorities, lenders and the owner-managers. In many cases these
parties have limited accounting knowledge and therefore simplified recognition
and measurement criteria are more appropriate.
For many smaller companies the cost of complying with SLFRS would exceed
the benefits received.
QUESTION
You are the financial controller of Ceylon Property (Pvt) Ltd, which owns a
number of properties that its leases out to small businesses. The company
operates it head office from the top floor of one of these properties. The company
is also involved in the continued development of properties to lease out, generally
CA Sri Lanka
721
funded through bank loans. The company applies the SLFRS for SMEs. You have
recently appointed a new assistant who has no knowledge of the SLFRS for SMEs,
having previously been employed at a company that applied full SLFRS.
Required
Explain to your assistant the main differences between the SLFRS for SMEs and
full SLFRS that are relevant to property owned by Ceylon Property (Pvt) Ltd.
ANSWER
Ceylon Property (Pvt) Ltd is an investment property company and therefore the
accounting treatment applied to investment property should be considered.
The SLFRS for SMEs requires that all investment property is recognised initially at
cost and then measured at fair value, if this can be reliably measured without
undue cost or effort. The choice available in full SLFRS to apply either the fair
value or cost model is therefore removed. Under the SLFRS for SMEs the cost
model is applied only if the fair value of investment property cannot be
determined without undue cost or effort.
As regards the property with mixed use (part investment property and part
owner-occupied property), the SLFRS for SMEs requires that the property is
separated for accounting purposes. The floor occupied by Ceylon Property is
therefore accounted for as PPE and those lower floors rented out are accounted
for as investment property. The exception to this rule is where the fair value of the
investment property component cannot be measured reliably without undue cost
or effort. In this case the whole property is accounted for as PPE. This treatment
differs slightly from LKAS 40, which requires that the owner-occupied and
investment components are accounted for separately if they could be sold or
rented separately. Where this is not the case, the entire property is investment
property if the part that is owner occupied is insignificant. Otherwise the entire
property is owner-occupied property.
Where investment property is constructed using loan finance, borrowing costs
arise. Under LKAS 23 eligible borrowing costs on qualifying assets (including
investment property) must be capitalised. The SLFRS for SMEs applies a different
treatment and requires all borrowing costs to be expensed as they arise.
As discussed above, the head office (and possibly the whole property within which
it is found) is classified as PPE. LKAS 16 requires that this is initially measured at
cost and subsequently measured using either the revaluation or the cost model.
The SLFRS for SMEs differs in its treatment of PPE: it requires that all PPE is
measured using the cost model ie held at cost less accumulated depreciation less
accumulated impairment losses. In addition the SLFRS for SMEs takes a more
722
CA Sri Lanka
relaxed approach to the review of estimates; where LKAS 16 requires that residual
value, useful life and depreciation method are reviewed at each reporting date, the
SLFRS for SMEs requires that such a review is only performed where there are
indicators that these have changed since the last reporting date.
CA Sri Lanka
723
CHAPTER ROUNDUP
724
SMEs are defined by reference to the fact that they are entities that do not have
public accountability. Specified Business Entities are not eligible to use the
SLFRS for SMEs.
The SLFRS for SMEs is a standalone SLFRS that simplifies the recognition and
measurement requirements of full SLFRS and reduces the disclosure
requirements.
The SLFRS for SMEs mirrors the requirements of full SLFRS in some cases,
however in most cases it simplifies recognition, measurement and disclosure
requirements of full SLFRS.
SLFRS 1 provides guidance to entities applying SLFRS for the first time.
CA Sri Lanka
PROGRESS TEST
In what areas do the requirements of the SLFRS for SMEs reflect exactly those of
full SLFRS?
How do the requirements of the SLFRS for SMEs differ from full SLFRS in respect
of borrowing costs?
Where an entity adopts the SLFRS for SMEs, which single full LKAS/SLFRS may it
use instead of the relevant chapter of the SLFRS for SMEs?
What accounting topics are not covered in the SLFRS for SMEs?
CA Sri Lanka
725
726
The SLFRS for SMEs requires them to be expensed; full SLFRS require
capitalisation of eligible borrowing costs relating to a qualifying asset.
LKAS 39
Fair value/previous GAAP revaluation may be used as a substitute for cost at date
of transition to SLFRS.
CA Sri Lanka
CHAPTER
INTRODUCTION
This chapter revises analysis techniques that will be familiar to you from
your KB1 Study Text. At KC1 level you are expected to be able to link
financial information including ratios in order to understand and
appraise an entitys financial position and performance.
Knowledge Component
3
Analysis, Interpretations and Communication of Financial Results
3.1
Internal financial
statement analysis
3.1.1
3.2
External financial
statements analysis
trend analysis
3.2.1
3.2.2
727
CHAPTER CONTENTS
1 Introduction and analysis techniques
2 Common-size analysis
3 Ratio analysis
4 Other matters
728
CA Sri Lanka
1.2 Comparatives
It must be remembered that financial analysis requires comparison. Raw data or
data manipulated into a ratio is useless without the same data or ratio for a
previous period or another company to compare it to.
1.3 Linkages
It is important when performing financial analysis to link parts of the financial
statements together. For example if you see an increase in loans outstanding in
the statement of financial position you would reasonably expect to see an increase
in finance costs in the statement of profit or loss. It is also, however, important to
understand why an expected link may not be evident. In this case finance costs
may not have increased and this could be explained by the fact that the additional
loan finance was secured at the period end and hence no finance costs had
accrued by the reporting date. Equally it is important to read and understand any
background information that could help your understanding. In this case
background information may explain that the entity that you are appraising has
recently been subject to an acquisition and is now part of a group. You may
therefore suggest that finance costs have not increased alongside an increase in
loans outstanding because the financing is an intercompany interest-free loan.
QUESTION
Linking information
You are about to review the financial statements of a company that manufactures
and sells fruit juices to supermarkets. All sales are on credit. You have been
advised that sales volumes have increased by 20% in the last year, so meaning
that idle capacity in the manufacturing process is greatly reduced.
CA Sri Lanka
(a)
What effect would you expect this information to have on balances in the
financial statements?
(b)
What reasons might explain why balances have not moved as you would
anticipate when compared to the previous year?
729
ANSWER
Balance
(a) Expected
movement
Revenue
Increase by 20%
Cost of
sales
Increase
proportionately to
revenue (20%)
Expenses
Increase
Noncurrent
assets
730
CA Sri Lanka
Inventory
Increase
Trade
receivables
Increase
proportionately to
revenue (20%)
Trade
payables
Increase
proportionately to
revenue (20%)
CA Sri Lanka
731
732
CA Sri Lanka
QUESTION
The following property, plant and equipment disclosure is taken from the financial
statements of a marketing company:
Cost
b/f
Additions
Disposals
C/f
Depreciation
b/f
Depreciation
charge
Disposals
c/f
Carrying
amount c/f
Carrying
amount b/f
Freehold
Buildings
Rs'000
5,600
5,600
Fixtures and
Fittings
Rs'000
780
780
IT equipment
5,600
624
52
163
145
40
70
5,600
676
104
(30)
278
302
110
100
156
487
80
Rs'000
650
(70)
580
Motor vehicles
Rs'000
120
90
210
What issues can you identify about the future of this company by the information
provided?
ANSWER
Buildings
The buildings are fully depreciated, which indicates that they are old. They may
require expenditure in terms of updating, repairs and maintenance.
The property has a carrying amount of nil however is likely to have a
substantial market value; it may be available as security for loan finance.
Fixtures and fittings
Fixtures and fittings have a carrying amount of Rs. 104,000 and are depreciated
at Rs. 52,000 per annum. Therefore they are close to the end of their useful life
and likely to need replacing. How will this be financed? Fixtures and fittings are
likely to be office furniture and so on expenditure could be delayed if
necessary.
CA Sri Lanka
733
IT Equipment
IT equipment is likely to be core to running a professional services
organisation. The useful life appears to be approximately 4 years which
appears appropriate.
Just over 10% of the equipment (based on cost) has been sold in the year and
has not been replaced. The asset sold was less than half way through its useful
life. These facts could indicate problems in the business a reduction in level of
business, a need for cash etc.
The disposal of IT equipment could however be linked to a change in focus of
the business; new replacement IT equipment may have been acquired by way
of operating lease.
Motor vehicles
The company operates in the area of professional services; it is therefore
unclear how motor vehicles will contribute to generating revenue. The vehicles
are likely to be cars provided to staff as benefits.
There has been heavy expenditure on vehicles in the year however this
expenditure is unlikely to provide the return that similar expenditure in other
parts of the business could have generated.
734
CA Sri Lanka
735
3 Ratio analysis
The calculation of ratios can help with the analysis of financial statements; ratios
can be grouped as relevant to profitability, solvency, liquidity, efficiency and
investors interests.
This section concentrates on reminding you of the calculation of ratios and the
considerations when analysing specific ratios. You should refer to your KB1 Study
Text for a more comprehensive discussion of each ratio. At the end of the section
is a full question for you to attempt.
Return on
Equity
Gross profit
margin
PBIT margin
736
PBIT
Capital employed *
Gross profit
Revenue
PBIT
Revenue
Affected by:
Selling prices
Product mix
CA Sri Lanka
Net profit
margin
Net asset
turnover
Revenue
Capital employed *
* Capital employed is total assets less current liabilities (or shareholders equity
plus non-current liabilities).
Remember to look for linkages when analysing profitability, for example, gross
profit margin may have increased significantly, however this does not indicate a
good performance if it is the result of an increased selling price and volumes and
so revenue are reduced.
Gearing
ratio
(leverage)
Interest
cover
Total debt
Total assets
PBIT
Finance cost
737
Current
ratio
Quick ratio
(Acid test
ratio)
Current assets
Current liabilities
Trade receivables
365
Revenue
738
CA Sri Lanka
Accounts
payable
payment
period
Trade payables
365
Cost of sales
Inventory
turnover
period
Inventory
365
Cost of sales
Receivables
collection
period
Payables
payment
period.
The operating cycle indicates the levels of financing that a company requires as it
gives the average number of days that a company is out of pocket from the day on
which it paid its supplier until the day on which its customer pays the company.
Where a company has cash problems, it should aim to reduce its operating cycle
by:
Reducing the amount of time it holds inventory for;
Shortening terms offered to customers / collecting amounts owed on time; and
Negotiating increased terms with suppliers / using the full terms offered by
suppliers.
CA Sri Lanka
739
Dividend
cover
EPS
Dividend per equity share
P/E ratio
Share price
EPS
Indicates confidence in a
company.
Dividend
yield
3.6 Stakeholders
When performing financial analysis, the reasons for performing it and the
audience for which it is for should be considered. Where an exam places you in a
scenario, always consider what type of analysis and which ratios are relevant to
that scenario. Focus on the needs of the stated user and avoid calculating all
possible ratios if you do not think that they are relevant.
For example, when assessing possible investment opportunities for an individual
investor, efficiency ratios should not be calculated; these are of more interest to
management when assessing the operations of a company.
740
CA Sri Lanka
QUESTION
You are the chief accountant of Blue Mountain Ltd, a listed Sri Lankan company.
The managing director has provided you with the financial statements of Blue
Mountain Ltds main competitor, Garten GmbH, a German company. He finds
difficulty in reviewing these statements in an unfamiliar format, presented below.
GARTEN GmbH
STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X5 (in million)
31.3.X5
31.3.X4
31.3.X5
31.3.X4
ASSETS
CAPITAL AND
LIABILITIES
Capital and
Tangible noncurrent assets
reserves
950
750
1,000
750
Land
Stated capital
750
500
Buildings
200
150
200
200
Plant
Legal reserve
1,950
1,400
Profit & loss
590
300
b/fwd
Profit & loss for
185
290
year
1,925
1,540
Current assets
NET WORTH
150
120
Inventory
180
100
Trade receivables
Payables
20
200
170
150
Cash
Trade payables
420
180
150
350
Taxation
75
50
Other payables
425
350
Prepayments and
accrued income
50
70
Prepayments
2,350
1,890
2,350
1,890
CA Sri Lanka
741
GARTEN GmbH
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED 31 MARCH 20X5 (in million)
20X5
20X4
20X5
EXPENSES
INCOME
Operating expenses:
Operating
income:
740
400
1,890
Purchase of raw
Sale of goods
materials
produced
Variation in
Variation in
inventories
inventory of
90
40
120
thereof
finished goods
and WIP
190
125
75
Taxation
Other operating
income
500
285
2,085
Wages
Total operating
income
Valuation
adjustment
on non-current
assets:
200
150
depreciation
Valuation
adjustment
on current assets:
30
20
amounts written
off
Other operating
50
40
expenses
Total operating
1,060
1,800
expenses
Financial expenses
100
50
Interest
Total financial
100
50
expenses
1,900
1,110
2,085
TOTAL EXPENSES
TOTAL INCOME
185
290
Balance: PROFIT
2,085
1,400
2,085
SUM TOTAL
20X4
1,270
80
50
1,400
1,400
1,400
Required
Prepare a report for the managing director:
(a)
742
CA Sri Lanka
(b)
Explaining why a direct comparison of the results of Blue Mountain Ltd and
Garten GmbH may be misleading.
(7 marks)
(Total = 25 marks)
ANSWER
To:
From:
Date:
Re:
(a)
Managing Director
An Accountant
xx.xx.xx
GARTEN GmbH
20X4
1,270
20X5
1,890
%
Increase
(decrease)
49
400
40
440
285
150
20
40
(80)
740
90
830
500
200
30
50
(120)
89
75
33
50
25
50
855
415
32%
50
1,490
400
21%
75
(4)
50
Cash flows
Share capital issued
Increased payables
Increased accruals
Profit ploughed back (185 + 200)
million
200
75
20
385
680
750
Net inventory
30
80
860
CA Sri Lanka
180
743
Current ratio
Current assets
=
Current liabilities
Quick ratio
Current assets Inventory
=
Current liabilities
20X4
20X5
100
365
1,270
= 29 days
180
365
1,890
= 35 days
420+70
350
= 1.4
350+50
425
= 0.94
100+200+70
350
= 1.06
180+20+50
425
= 0.59
Commentary
(i)
Material costs and labour costs have risen at an alarming rate in 20X5
and to a certain extent other costs have also increased substantially.
These increases are far greater than the increase in revenue. A lack of
co-ordination of production to sales has created a substantial build up
of finished goods in inventory.
(ii)
744
The length of credit period given to customers has increased (if all
sales are on credit). While trading conditions may make this slip in
credit control a necessity, it is regrettable that the company cannot
obtain the same more relaxed terms from its suppliers; this would
balance out working capital requirements, at least to some extent.
CA Sri Lanka
A direct comparison of the results of Blue Mountain Ltd and Garten GmbH
may be misleading for the following reasons.
(i)
It is unlikely that the two companies follow the same, or even similar,
accounting policies, for example on inventory valuation, depreciation,
valuation of land and buildings etc. Also, the general approach to
receivables recoverability may be more or less prudent in Germany
than under Blue Mountain Ltds approach. These policies would have to
be investigated to discover whether comparison is really feasible.
(ii)
Garten GmbH's payables are not split between short and long term, ie
those due within one year and in more than one year (if any). Gearing
ratios cannot be calculated, and the current and quick ratios calculated
in (a) are of limited value.
(vi) The statement of profit or loss and other comprehensive income does
not show a figure of gross profit making it difficult to compare margins.
CA Sri Lanka
745
4 Other matters
Financial analysis does not provide definitive answers or conclusions; it does,
however identify areas that should be investigated in further detail.
A set of financial statements do not usually provide sufficient information for full
analysis of a companys position and performance. This is in part because,
although extensive, SLFRS disclosures do not provide all information that an
analyst may require. It is also the case that there are a number of limitations of
financial analysis as described in this chapter.
746
Accounting policies
and practices
Calculation of ratios
Historic financial
statements
Window dressing
Related party
transactions
Seasonality
CA Sri Lanka
747
QUESTION
Extracts from the financial statements of a commercial catering company for the
years ended 31 December 20X3 and 20X4 are as follows:
20X3
20X4
Rs'000
Rs'000
13,200
13,800
Revenue
(4,620)
(5,220)
Cost of sales
8,580
8,580
Gross profit
4,488
5,244
PBIT
800
8,000
8,800
Share capital
Retained earnings
Revaluation reserve
800
9,000
4,000
13,800
ANSWER
20X3
8,580/13,200 100%
= 65%
4,488/13,200 100%
= 34%
13,200/8,800
= 1.5
4,488/8,800
= 51%
20X4
8,580/13,800 100%
= 62%
5,244/13,800 100%
= 38%
13,800/13,800
= 1.0
5,244/13,800
= 38%
The gross margin has fallen from 65% to 62%, however the absolute gross profit
is constant at Rs. 8.58 Mn. The fall in margin may be explained by:
a drop in selling price in order to achieve increased sales volume;
an increase in the cost of sales;
a change in sales mix.
Given that the company operates in catering, it may be that a contributing factor
will be food inflation resulting in increased costs of raw produce.
748
CA Sri Lanka
Although the gross margin has decreased, the operating profit margin has
increased. The company may have managed its costs well, or achieved some cost
cutting. This may have been achieved through economies of scale associated with
the increased volume production eg for packaging. Alternatively, 20X3 may have
included a large one off expense (or 20X4 a large one off item of income) which
has distorted the ratios.
Asset turnover and ROCE
Both asset turnover and ROCE have decreased significantly. This is the result of an
increase in net assets. The majority of this increase is due to the revaluation
surplus of Rs. 4 Mn. Stripping this out, the ROCE for 20X4 is 54% (5,244/9,800)
and the asset turnover 1.4 (13,800/9,800). These values are more in line with
20X3 amounts, with a slight decrease in asset turnover and slight increase in
ROCE. The increase in ROCE is driven by the increase in operating profit margin as
discussed above.
QUESTION
Lankagoods, a grocery chain, reports the following amounts in its financial
statements for the years ended 31 December 20X3 and 20X4:
Inventory
Receivables
Cash
Payables
20X3
Rs'000
550
45
12
1,850
20X4
Rs'000
585
20
8
1,960
Calculate the current and quick ratios for both years and comment on them.
ANSWER
Current ratio
Quick ratio
CA Sri Lanka
20X3
550+ 45+12
1,850
= 0.33:1
20X4
585+20+8
1,960
= 0.31:1
45+12
1,850
= 0.03:1
20+8
1,960
= 0.01:1
749
At first glance, these ratios are alarming and indicate that Lankagoods has
considerable liquidity problems, which have worsened in the current year.
However, taking into account the nature of the companys business activities as a
grocery chain, the very low ratios may be acceptable. Characteristics of the retail
industry, and large grocery chains in particular are:
High levels of inventory;
No trade receivables (customers are not allowed goods on credit);
Low cash balances (since cash is invested in non-current assets);
Very high payables (powerful grocery chains are notorious for pushing the
credit of their suppliers).
In order to make a full assessment, industry averages should be obtained.
750
CA Sri Lanka
CHAPTER ROUNDUP
The calculation of ratios can help with the analysis of financial statements; ratios
can be grouped as relevant to profitability, solvency, liquidity, efficiency and
investors interests.
CA Sri Lanka
751
PROGRESS TEST
752
If there is an increase in PPE in the statement of financial position, what else might
you expect in the financial statements?
Gross profit margin has increased steadily over the last 3 years; what factors
might explain this?
CA Sri Lanka
PBIT/Capital employed
CA Sri Lanka
753
754
CA Sri Lanka
Index
756
CA Sri Lanka
Index
A
Accounting estimates, 84
Accounting policies, 81, 706
Accounting profit, 298
Accounting standards, 5
Accounts payable payment period,
739
Accounts receivable collection period,
738
Acquiree, 508
Acquirer, 508
Acquisition date, 508
Acquisition method, 509
Actuarial gains and losses, 393
Adjusting events, 258
Agricultural activity, 225
Agriculture produce, 225
Amortised cost, 345
Annual improvements, 13
Antidilution, 477
Asset, 136
Asset ceiling, 392, 404
Associate, 316, 500
Associates, 528
Available-for-sale financial assets
(AFS), 344
B
Basic earnings per share, 477
Biological asset, 225
Biological transformation, 225
Borrowing costs, 105
Business combination, 509
C
Carrying amount, 103, 119, 157
Cash, 628
Cash equivalents, 628
Cash flow hedge, 361, 362
Cash flows, 628
Cash-generating unit, 164, 165
Cash-settled share-based payment,
410, 417
CA Sri Lanka
D
Date of effective control, 596
Deductible temporary differences,
300
757
Index
E
Effective interest method, 345
Effective interest rate, 345
Embedded derivatives, 356
Employee benefits, 391
Environmental reporting, 41
Equity instrument, 334
Equity method, 529
Equity-settled share-based
payment, 410
Equity-settled share-based payments,
411
Errors, 85
Events after the reporting period,
257
Exchange difference, 672
Exposure drafts, 10
758
F
Fair value, 24, 103, 118, 157, 185,
221, 393, 410, 443, 509
Fair value hedge, 360, 361
Fair value model, 122
Finance lease, 182, 190
Financial asset, 333, 343
Financial assets at fair value through
profit or loss (FVTPL), 343
Financial instrument, 333
Financial liability, 333, 351
Financing activities, 629
Fixed price contract, 215
Foreign currency, 93
Foreign currency transactions, 87
Foreign operation, 668
Forgivable loans, 221
Functional currency, 669
G
Gearing ratio, 737
Global Reporting Initiative, 50
Going concern, 74, 260
Goodwill, 167, 509, 510
Government, 221
Government assistance, 221, 223
Government grants, 221, 222, 226
Grant date, 410
Grants related to assets, 221
Grants related to income, 221
Gross investment in the lease, 194
Gross profit margin, 736
Group, 500
Group reorganisations, 616
Guaranteed residual value, 185
H
Harvest, 225
Hedge accounting, 358
Hedge effectiveness, 358
Hedge of a net investment in a
foreign operation, 361
Hedged item, 358
Hedging, 358
Hedging instrument, 358
CA Sri Lanka
Index
I
IAS 32 Financial instruments:
presentation, 334
IAS 39, 341
IAS 40 fair value model, 119
IASB, 8
Identifiable, 509
IFRIC 1 Changes in Existing
Decommissioning, Restoring and
Similar Liabilities, 254
IFRIC 2 Members Shares in Cooperative Entities and Similar
Instruments, 339
IFRIC 4 Determining whether an
Arrangement contains a Lease, 200
IFRIC 5 Rights to Interests arising
from Decommissioning, Restoration
and Environmental Rehabilitation
Funds, 255
IFRIC 6 Liabilities Arising from
Participating in a Specific Market
Waste Electrical and Electronic
equipment, 253
IFRIC 7, 690
IFRIC 9 Reassessment of Embedded
Derivatives, 357
IFRIC 12 Service Concession
Arrangements, 279
IFRIC 13 Customer Loyalty
Programmes, 283
IFRIC 15 Agreements for the
Construction of Real Estate, 284
IFRIC 17 Distributions of Non-cash
Assets to Owners, 80
IFRIC 18 Transfers of Assets from
Customers, 286
IFRIC 19 Extinguishing Financial
Liabilities with Equity Instruments,
382
IFRIC 20 Stripping Cost in the
Production Phase of a Mine, 215
CA Sri Lanka
J
Joint arrangement, 500, 528, 532
Joint control, 500, 532
Joint operation, 500, 535
Joint venture, 316, 500, 535
K
Key management personnel, 451
L
Lease, 182
Lease term, 184
Lessee accounting, 186, 190
Lessor accounting, 188, 194
Liability, 243
Limitations of financial analysis, 746
Liquidity ratios, 737
759
Index
M
Manufacturer and dealer leases, 196
Market condition, 411
Materiality, 91
760
N
Net asset turnover, 737
Net defined benefit liability
(asset), 392
Net interest on the net defined
benefit liability (asset), 393
Net investment in a foreign
operation, 668
Net investment in the lease, 194
Net realisable value, 212
New top holding company, 617
Non-adjusting events, 258
Non-controlling interest, 509, 511
Non-current assets held for
sale/distribution, 441
Non-financial reporting, 40
O
Offsetting, 338
Onerous contract, 243, 248
Operating activities, 629
Operating cycle, 739
Operating lease, 182, 186
Operating segment, 469
Options, warrants and their
equivalents, 477
Ordinary share, 477
Other long-term employee
benefits, 391
Owner-occupied property, 118
P
P/E ratio, 740
Parent, 500
Past service costs, 403
Performance condition, 411
Performance obligation, 288
Plan assets, 392
CA Sri Lanka
Index
Q
Qualifying asset, 105
Quick ratio, 738
R
Rate regulation, 716
Rate regulator, 717
Rate-regulated activities, 716
Ratio analysis, 728, 736
Recently issued standards, 11
Reclassification of financial assets,
347
Recoverable amount, 157
Regulatory deferral account
balance, 717
Regulatory Framework, 2
Reimbursement, 246
Related party, 450
Related party transactions, 451,
453
Relevant activities, 500
Remeasurements, 393, 400
Rendering of services, 270
Reportable segments, 470
Research and development, 141
Restructuring, 248
CA Sri Lanka
Retrospective application, 82
Retrospective restatement, 85
Return on Capital Employed, 736
Return on Equity, 736
Return on plan assets, 393
Revaluation model, 108
Revenue, 268, 288
Royalties, 269
S
Sale and leaseback transactions, 197
Sale and repurchase, 275
Sale of goods, 270
SEC Regulations, 3
Separate financial statements, 501
Service condition, 410
Service cost, 393
Settlement, 393
Settlement options, 337
Share option, 410
Share-based payment
arrangement, 409
Short-term employee benefits, 391
SIC-27 Evaluating the Substance of
Transactions in the Legal Form of a
Lease, 199
SIC 29 Disclosure Service
Concession Arrangements, 282
SIC 31 Barter Transactions involving
Advertising Services, 287
SIC 32 Intangible Assets Website
Costs, 147
Significant influence, 500, 528
SLFRS 2 Share-based payments, 409
SLFRS 3 Business Combinations, 508
SLFRS 4 Insurance Contracts, 373
SLFRS 5 Non-Current Assets Held for
Sale and Discontinued Operations,
440
SLFRS 6 Exploration for and
Evaluation of Mineral Resources, 230
SLFRS 7 Financial Instruments:
Disclosures, 376
SLFRS 8 Operating Segments, 468
SLFRS 12 Disclosure of Interests in
Other Entities, 544
761
Index
T
Tax, 93
Tax base, 300
762
U
Unearned finance income, 194
Unguaranteed residual value, 185,
194
Useful life, 104
V
Valuation techniques, 28
Value in use, 157
Vertical groups, 594
Vertical trend analysis, 728
Vest, 410
Vesting conditions, 410
Vesting period, 410
CA Sri Lanka