ACCA Strategic Business

Reporting (SBR)
Achievement Ladder
Step 4 Questions & Answers
Strategic Business Reporting Achievement Ladder Step 4

Question 1
Question text
Therfield, a public limited company, operates a national chain of supermarkets. The finance director
requires advice on how to account for the transactions below for the year ended 30 September 20X1.
(a) As well as selling food, on 1 April 20X1, Therfield purchased a ten-year pharmacy licence for $5m
and opened pharmacies in some of its larger stores. As a result, Therfield had to spend $0.5m
training and recruiting pharmacists, $0.3m marketing its new products and $1m fitting out a new
dedicated area of the store for the pharmacy. (5 marks)
(b) Therfield has a policy of upgrading their computers every five years. On 1 October 20X0,
Therfield spent $3m on new hardware, $0.2m on related installation costs, $0.4m on the latest
version of the required operating software (the hardware did not include an operating system)
and $0.1m on word processing and spreadsheet software. From 1 October 20X0 to 1 April 20X1,
the internal IT department developed a new program to incorporate the new pharmaceutical
products at a total cost of $0.3m. (5 marks)
(c) Therfield has a policy of buying up available land in suitable locations outside town centres for
potential development of future stores. Therfield does not have a policy of revaluing its land and
buildings unless they are investment property. At 30 September 20X1 Therfield held:
 Land which had cost $20m which had not yet been developed
 Land on which construction of a new store had started at a total cost of $30m
 Land which Therfield had purchased (at a cost of $8m) but had decided was unsuitable for
development of a store. Instead, during November 20X0, Therfield began development on
the land for the construction of residential property, from which it would earn rental income.
The land had a fair value of $10m at that date. It was not possible to assign a fair value to the
property during the course of construction. Construction was completed on 1 April 20X1 at a
total cost of $30m. The fair value of the land and property at that date was $45m. There was
no change in the fair value of the land and property at the year end. (5 marks)
(d) Historically, Therfield has had a problem with high staff turnover due to low salaries and having to
work evenings and weekends. To encourage better staff retention, on 1 October 20X0, the board
decided to award share options to all 1,000 employees provided they remained in employment
for five years. At 1 October 20X0, 20% of employees were expected to leave over the vesting
period to 30 September 20X5 and as at 30 September 20X1, this had risen to 25%. The fair
value of these options at 1 October 20X0 was $2 and this had risen to $3 by 30 September 20X1.
The number of options per employee is conditional on the average profit over the five years
commencing 1 October 20X0 as follows:
Average profit Number of options
From $1m up to $1.2m 100
Above $1.2m up to $1.4m 120
Above $1.4m up to $1.6m 140
Above $1.6m up to $1.8m 160
Above $1.8m up to $2m 180
Profit for year ended 30 September 20X1 was $1m and profit for the following four years was
forecast to rise by $0.2m a year. The awarding of the options was also conditional on the share
price reaching at least $8 per share by 30 September 20X5. The year-end share price was $6.
(6 marks)
(e) In order to diversify its operations, in the previous financial year Therfield had acquired all of the
equity shares of a small family-run, but well known, high street retailer, on 1 July 20X0. The
family management were retained and the purchase contact included a clause whereby the
purchase consideration would be increased proportionately if certain pre-agreed targets were met
within the first year after the acquisition date.
Goodwill of $5m was recognised on the initial acquisition. This included contingent consideration
with a fair value of $0.7m based on expectations at the time of the acquisition of the likelihood
and amount of the future payment. The same estimate was maintained at the 30 September
20X0 year end as expectations had not changed. By 30 June 20X1 a lower target was actually
met and the amount paid on 30 June 20X1 was $0.2m. (4 marks)
Required
Discuss how the above items should be dealt with in the financial statements of Therfield for the year
ended 30 September 20X1. (Total = 25 marks)
Feedback

Marking scheme
Marks
(a) Pharmacy
Capitalise licence as intangible asset 1
Amortise licence over 10 years 1
Calculation of amortisation 1
Expense training & marketing 1
Capitalise refit as PPE 1
5
(b) Computers
Capitalise new hardware & installation costs as PPE 1
Capitalise operating system as part of hardware (ie PPE) 1
Capitalise non-operating system (word processing/spreadsheet software) as
intangible asset 1
Capitalise $0.3m internally generated as intangible if meet PIRATE criteria 1
Amortisation/depreciation (give credit for using 5 or 10 years) 1
5
(c) Land
Land not developed = PPE (no dep'n) 1
Land under construction = property in course of construction (start dep'n of
property when construction completed) 1
Land & residential property =
– Transfer land from PPE at FV 1
– Recognise construction costs at cost 1
– Recognise gain of $5m on completion in P/L 1
5
(d) Share-based payment
Spread expense over vesting period (5 years) 1
Recognise increase in equity 1
Take into account performance conditions 1
Calculate if average profit criteria met 1
Ignore market conditions 1
Calculation 1
6
(e) Contingent consideration
Accounting treatment in previous year correct – no prior year adjustment 1
Goodwill not adjusted even though within 12 months 1
Goodwill subject to annual impairment test 1
Reduction in amount paid recognised as a gain in profit or loss 1
4

Maximum for the question 25

(a) Pharmacy
The $5m spent on acquiring a licence should be capitalised as an intangible asset as it is
separable (ie it could be sold on) and it arises from legal rights (ie a legal contract), meeting the
IAS 38 Intangible Assets definition. The recognition criteria have also been met as probable
future economic benefits are likely to result from opening the pharmacies and the cost of the
asset can be measured reliably at the $5m paid.
The licence should then be amortised over the period of expected benefits ie the ten-year term of
the licence. As the licence was purchased on 1 April 20X1, six months amortisation are required
ie $0.25m ($5m × 1/10 × 6/12).
The $0.5m spent on training and the $0.3m spent on marketing are specifically prohibited by
IAS 38 from being capitalised. It is very hard to prove that these are controlled resources or that
there will be future economic benefits so these amounts do not meet the IASB Conceptual
Framework definition of an asset. As such, they should be recognised as an expense in profit
or loss.
The $1m refitting costs should be capitalised as property, plant and equipment and then
depreciated over their useful life.
(b) Computers
The $3m spent on new hardware should be capitalised as property, plant and equipment. IAS 16
Property, Plant and Equipment also requires that entities capitalise any costs directly attributable
to bringing the asset to the location and condition necessary for it to operate as intended. Here
the installation costs of $0.2m are required before the computers can be used, and the operating
system needed for the computer to be run should also be capitalised. This brings the total cost to
$3.6m. As the computers are replaced every five years, this should then be depreciated over five
years, giving an annual depreciation of $0.72m ($3.6m/5 years).
As the word processing and spreadsheet software is not an operating system, and therefore not
essential for the hardware to operate, this software should be capitalised separately as an
intangible asset of $0.1m and again amortised over its useful life of five years, ie at $0.02m a
year.
The internally generated software of $0.3m should only be capitalised as an intangible asset if
the following criteria are met:
 Probable economic benefits will be generated
 Intention to complete the project and use the software
 Resources available to complete the development
 Ability to use the software
 Technical feasibility of completing the project
 Expenditure attributable to the development can be measured reliably
Here, the criteria appear to be met as the software was developed to be able to sell
pharmaceutical products which began on 1 April 20X1. The intangible asset should then be
amortised. Its useful life is likely to be the ten year licence as Therfield are likely to transfer this
internally generated software to any replacement hardware it might purchase. This gives
amortisation of $0.015m ($0.3m × 1/10 × 6/12) in the current year.
(c) Land
The land which has not yet been developed should be held as 'property, plant and equipment'
under IAS 16 Property, Plant and Equipment at its cost of $20m. It is not depreciated as land is
considered to have an unlimited useful life.
The land on which construction of a new store had started should be treated as property 'in the
course of construction' at its cost of $30m. Depreciation of the property should not begin until
construction is completed and the asset is available for use. The land should not be depreciated.
 The land on which the residential property has been constructed should be reclassified from
'property, plant and equipment' to 'investment property' at the point at which the development
began, ie in November 20X0. The IAS 40 Investment Property definition is met at that point as
the land is held to earn rentals and for capital appreciation from that date onwards. Therfield has
a policy of carrying investment property at fair value, so before transfer to investment property,
the land should be revalued to its fair value of $10m with the gain of $2m recognised in other
comprehensive income as per IAS 16. The land is then transferred to investment property at its
fair value. As the fair value of the construction costs cannot be measured reliably, they should be
capitalised at their cost of $30m as 'investment property in the course of construction'. On
1 April 20X1 when the property is completed, the property should be transferred to 'investment
property', and both the land and property should be remeasured to their fair value of $45m,
resulting in a gain of $5m ($45m – $(10m + 30m)) recognised in profit or loss. As the fair value of
the land and property has not changed at the year end, there is no further gain or loss to
recognise.
(Tutorial note. If Therfield's accounting policy was to carry investment property at cost, the land
need not be revalued to fair value before transfer from PPE to investment property.)
(d) Share-based payment
This is an equity-settled share-based payment. An expense should be recorded in profit or loss,
spread over the vesting period of five years with a corresponding increase in equity.
It should be measured at the fair value at the grant date ie $2. The year-end estimate of total
leavers over the five-year vesting period (25%) should be removed in the calculation of the
expense as they will never be able to exercise their share options.
There are two other vesting criteria here:
 The average profit, which should be taken into account because it is a performance criterion.
The average profit for the next five years is $1.4m ([$1m + $1.2m + $1.4m + $1.6m +
$1.8m]/5 years), resulting in 120 options per employee.
 The share price, which should not be taken into account because it is a market condition
which is already factored into the fair value. So the fact that the share price target of $8 has
not been met by the year end does not need to be taken into account.
The expense and the corresponding increase in equity for year ended 30 September 20X1 is
calculated as follows:
= 1,000 employees × 75% employees remaining × 120 options × $2 FV × 1/5 vested
= $36,000
(e) Contingent consideration
The contingent consideration was originally recognised as a liability of $0.7m at the date of the
acquisition in the previous year, based on estimates of fair value at that time. This was correct
and no prior period adjustment is necessary.
The adjustment to the amount paid is within 12 months of the acquisition. However, the
adjustment arose as a result of conditions that arose after the acquisition date and therefore
goodwill is not adjusted and remains at $5m.
However, the goodwill is subject to an annual impairment test and the recoverable amount of the
business may have been affected by the failure to meet targets.
On 30 June 20X1 the liability is eliminated and the $0.5m reduction in the liability is treated as a
post-acquisition gain (due to the change in accounting estimate) and recognised in profit or loss.
Question 2
Question text
Pennsylvania, a public limited company, set up a funded defined benefit pension plan for its
employees many years ago. The following information has been provided by the actuary for the year
ended 30 September 20X7:
(i) The present cost in terms of future pensions of employee service during the year is $90m. This
has been determined using the projected unit credit method.
(ii) The present value of the obligation to provide benefits to current and former employees has been
calculated as $2,280m at 30 September 20X7 and the fair value of plan assets was $2,270m at
the same date.
(iii) The market yield on high quality corporate bonds of a similar maturity to the pension obligations
relevant to the year was 5%.
The following has been extracted from the financial records:
(i) The present value of the defined benefit obligation was $2,100m at 30 September 20X6 and the
fair value of the plan assets was $2,200m at the same date.
(ii) Pensions paid to former employees during the year amounted to $70m.
(iii) Contributions paid into the plan during the year as decided by the actuary were $88m.
With effect from 1 October 20X6, the company amended the plan to increase pension entitlement for
employees. The additional cost of improvement in benefits was calculated by the actuary to be
approximately $60m at 1 October 20X6.
Required
(a) Prepare the notes to the statement of profit or loss and other comprehensive income and
statement of financial position required by IAS 19 Employee Benefits for the defined benefit
pension plan of Pennsylvania.
Note. Ignore any deferred tax effects and assume that pension payments and the contributions
into the plan were paid on 30 September 20X7. (17 marks)
(b) Discuss critically the conceptual basis for the presentation and recognition of remeasurements of
defined benefit pension plan assets and obligations and past service costs in the statement of
profit or loss and other comprehensive income (8 marks)
(Total = 25 marks)
Feedback

Marking scheme

Marks
(a) Defined benefit expense 4
Remeasurement gains/losses in OCI 2
Changes in obligation 5
Changes in plan assets 3
Net pension liability/asset in SOFP – 20X7 2
– 20X6 1
Maximum 17

(b) Definitions – 1 mark each 2

Remeasurement of assets – 1 mark per valid point, max 2
Remeasurement of obligations – 1 mark per valid point, max 2
Profit or loss vs other comprehensive income 2
Past service costs 1
Available 9
Maximum 8

Maximum for the question 25

Top tips. To answer part (a), you need to know the proformas – if you had problems with this part of
the question, go back to Chapter 4 of the SBR Workbook and learn the proformas.
Part (b) is a written discussion of IAS 19 in context of the Conceptual Framework. You must be
prepared to discuss the strengths and weaknesses of any examinable IAS/IFRS in the context of the
Conceptual Framework and the proposed revisions to the Conceptual Framework under Exposure
Draft ED/2015/3 – May 2015.
Easy marks. These are available for part (a) if you know your proformas.

(a) NOTES TO THE STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME
DEFINED BENEFIT EXPENSE RECOGNISED IN PROFIT OR LOSS
FOR THE YEAR ENDED 30 SEPTEMBER 20X7
$m
Current service cost 90
Past service cost 60
Net interest cost [from SOFP notes 108 – 110] (2)
148
OTHER COMPREHENSIVE INCOME (ITEMS THAT WILL NOT BE RECLASSIFIED TO
PROFIT OR LOSS): REMEASUREMENTS OF DEFINED BENEFIT PLANS
$m
Remeasurement gain on defined benefit obligation 8
Remeasurement loss on plan assets (excluding amounts in net (58)
interest)
(50)
 NOTES TO THE STATEMENT OF FINANCIAL POSITION
NET DEFINED BENEFIT LIABILITY/(ASSET) RECOGNISED IN THE STATEMENT OF
FINANCIAL POSITION
30 September 30 September
20X7 20X6
$m $m
Present value of defined benefit liabilities 2,280 2,100
Fair value of plan assets (2,270) (2,200)
Net defined benefit plan liability/(asset) 10 (100)
CHANGES IN THE PRESENT VALUE OF THE DEFINED BENEFIT OBLIGATION
$m
Opening defined benefit obligation at 1 October 20X6 2,100
Past service cost 60
Interest cost [(2,100 × 5%) + (60 × 5%)] 108
Current service cost 90
Benefits paid (70)
(Gain) on remeasurement recognised in OCI (balancing figure) (8)
Closing defined benefit obligation at 30 September 20X7 2,280
Note. The past service costs of $60m are included in the opening pension obligation for the
purpose of calculating interest cost as the benefits were awarded on 1 October 20X6.
CHANGES IN THE FAIR VALUE OF PLAN ASSETS
$m
Opening fair value of plan assets at 1 October 20X6 2,200
Expected return on plan assets (2,200 × 5%) 110
Contributions 88
Benefits paid (70)
(Loss) on remeasurement recognised in OCI (balancing figure) (58)
Closing fair value of plan assets at 30 September 20X7 2,270
(b) The IASB's Conceptual Framework for Financial Reporting defines income as 'increases in
economic benefits during the accounting period in the form of inflows or enhancements of assets
or decreases in liabilities that result in increases in equity, other than those relating to
contributions from equity participants' (para. 4.25(a)).
Expenses are defined as 'decreases in economic benefits during the accounting period in the
form of outflows or depletions of assets or incurrences of liabilities that result in decreases in
equity, other than those relating to distributions to equity participants' (para. 4.25(b)).
Only items that meet the definition of income or expenses should be recognised in the statement
of profit or loss and other comprehensive income following the Conceptual Framework.
Gains and losses on plan assets are divided between the interest applied to the asset element of
the net pension obligation or asset and a 'correction' of this (the remeasurement) to ensure that
overall the actual return is reported in the statement of comprehensive income. Under current
accounting rules the interest element is recognised in profit or loss while the 'correction'
(difference between actual return and interest applied) is recognised in other comprehensive
income. The logic for this split is that the interest element shows the financing effect of paying for
benefits in advance or arrears. However, under the Conceptual Framework, there is no
conceptual basis for this split. The standard could also be criticised for reporting estimated
figures in profit or loss, while reporting the difference to arrive at the actual return in other
comprehensive income.
Remeasurement gains and losses on pension obligations arise from differences between
actuarial assumptions and the experience of what has actually happened, and changes in
actuarial assumptions relating to the future. IAS 19 Employee Benefits uses the 'projected unit
credit method' for recognition of pension obligations, which means that future anticipated
increases in salary (and therefore pension) based on years worked to date are included. One
could argue that this approach does not comply with the Conceptual Framework because those
increases have not been earned yet and therefore do not relate to the period. Indeed, they may
never be earned (or payable) if the employee does not work for the same company for his or her
whole working life.
Similarly, under IAS 19 past service costs are recognised immediately in profit or loss when the
plan amendment occurs on the grounds that they represent an increase in a liability and therefore
meet the definition of an expense. However, in some circumstances, employees must work a
minimum service period before being entitled to the enhanced benefits. In such circumstances it
could be argued that the obligation does not increase for employees who have not yet completed
the minimum service period until those benefits are earned and therefore should be recognised
as an increase in the obligation (and expense) as they are earned rather than immediately.
Another issue is whether actuarial gains and losses should enter into the calculation of profit or
loss for the year, or be reported in other comprehensive income. The Conceptual Framework
itself does not make this distinction, but IAS 19 requires them to be recognised in other
comprehensive income. IAS 1 Presentation of Financial Statements requires an entity to
recognise all items meeting the definition of income or expense in profit or loss unless an IFRS
requires or permits otherwise, ie it is the 'default' location (para. 88).
The Exposure Draft on the Conceptual Framework provides guidance on whether to present
income and expenses in profit or loss or in other comprehensive income (ED/2015/3: paras.
7.19–7.27).
The statement of profit or loss shows the return an entity has made on its economic resources
during the period and provides information that is helpful in assessing future cash flows and
management's stewardship of the entity's resources. As such, all items of income and expense
will be shown in profit or loss unless relating to the remeasurement of assets and liabilities –
these would normally be shown in other comprehensive income. This guidance is consistent with
the approach already adopted in IAS 19.