From tutorial

Question 1

Describe the standard setting process of the IASB

Answer 1

The standard setting process of the IASB for issuing IFRSs has six stages.

1. Setting the agenda.
2. Planning the project.
3. Developing and publishing the discussion paper.
4. Developing and publishing the exposure draft (ED).
5. Developing and publishing the standard.
6. Procedures involving consultation and evaluation after an IFRS has been issued.

Question 2

Identify the potential benefits of harmonized accounting standards

Answer 2

Potential benefits of a globally accepted set of accounting standards include:
 Using a principles based approach
 Greater comparability
 Reduction in the cost of financial statement preparation
 Greater mobility of staff

Question 3

Explain going concern

Answer 3

The going concern assumption is important in that all measures of performance and financial position, and all classifications in a statement of financial position (current and non-current) implicitly assume that the entity is going to continue

Question 4

Explain accrual basis

Answer 4

The accrual basis assumption is made in the preparation of general-purpose financial reports. Under this assumption, the effects of all transactions and other events are recognized in the accounting records when they occur, rather than when cash or its equivalent is received or paid.

Question 5

Define ‘equity’, and explain why the Conceptual Framework does not prescribe any recognition criteria for equity.

Answer 5

The Framework defines equity as ‘the residual interest in the assets of the entity after deducting all its liabilities’.
There is no need for recognition criteria for equity as it is a residual, determined after recognition criteria are applied to the other elements.

Question 6

What choices of measurement model exist subsequent to PPE being initially recognized?

Answer 6

• Cost model

- Revaluation model

Question 7

What is meant by ‘significant parts depreciation’?

Answer 7

Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately.

Question 8

Explain how revaluation decreases are accounted for under the revaluation model.

Answer 8

Revaluation decrease:
 The decrease shall be recognized in profit or loss.
 But: revaluation decrease debited directly to equity under the heading of revaluation surplus to the extent of any credit balance existing in the revaluation surplus in respect of that asset

Question 9

Explain how revaluation increases are accounted for under the revaluation model.

Answer 9

Revaluation increase:
 The increase shall be credited directly to equity under the heading of revaluation surplus.
 But: revaluation increase in P&L to the extent that it reverses a revaluation decrease of the same asset previously recognized in profit or loss

Question 10

Discuss the importance of a theory of accounting and the link to the existing conceptual framework of the IASB.

Answer 10

Accounting theory should help in providing a frame/reference for accounting behavior
 Framework of the IASB as an attempt to provide an accounting theory
 Consistent basis
 “Universal”

Question 11

Discuss the arguments in favor of the capitalization of borrowing costs as part of the cost of an asset.

Answer 11

Arguments in favor of capitalization are:
 No difference to other costs that do qualify for capitalization
 Accrual/matching concept
 More consistency: companies that construct their own assets vs companies that choose to buy their assets

Question 12

Discuss the arguments against the capitalization of borrowing costs as part of the cost of an asset.

Answer 12

Arguments against capitalization are:
 Interest charging
 Inconsistency
 Difficult determination of the way an asset has been financed
 Capitalization ceases at completion of asset vs. lifetime financing cost of the asset
 More prudent

Question 13

In what circumstances, if any, do you think that regulation should allow the non-depreciation of owned buildings?

Answer 13

If the buildings are current assets, which is quite possible, then depreciation is definitely not logical. For investment properties, we are into the general ‘fair value’ debate, about which strong, and different, views are likely to be found.

Question 14

What is the difference between “research” and “development”?

Answer 14

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

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

Question 15

Why is it easier to recognize intangibles that are acquired in a business combination than those that are internally generated?

Answer 15

 Reliable measurement
 Banned assets
 Research

Question 16

What are some internal indicators of impairment?

Answer 16

 Evidence of obsolescence or physical damage
 Assets becoming idle, plans to discontinue operations, plans to dispose of assets
 Economic performance is worse than expected

Question 17

What are some external and internal indicators of impairment?

Answer 17

 Significant decline in market value
 Significant changes in the technological, market, economic or legal environment in which the entity operates
 Increases in market interest rates
 The carrying amount of the entity’s assets exceeds the entity’s market capitalization

Question 18

What is a cash generating unit?

Answer 18

A CGU is the smallest identifiable group of assets that generates cash inflows largely independent of the cash flows from other assets or groups of assets.

Question 19

How are impairment losses accounted for in relation to cash generating units?

Answer 19

 Reduce the carrying amount of any goodwill allocated to the CGU
 Allocate any balance of loss to the other assets of the CGU pro rata on the basis of their carrying amounts

Question 20

Leases are classified on the basis of ‘substance over form’. What does this criterion mean?

Answer 20

The IFRS Conceptual Framework in paragraph 35 states that ‘if information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that they are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. The substance of transactions or other events is not always consistent with that which is apparent from their legal or contrived form’.

Question 21

Leases are classified on the basis of ‘substance over form’, how does it relate to the capitalization of finance leases?

Answer 21

if ‘in substance’ substantially all of the risks and rewards incident with ownership are transferred from the lessor to the lessee the arrangement is giving rise to a finance lease.

Question 22

What are ‘minimum lease payments’?

Answer 22

Minimum lease payments = (i) Payments over the lease term
+ (ii) Guaranteed residual value
+ (iii) Bargain purchase option
- (iv) Contingent rent
- (v) Reimbursement of costs paid by the lessor

Question 23

Explain the required classifications of cash flows under IAS 7

Answer 23

Cash flows must be classified into:

• Cash flows from Operating activities
• Cash flows from Investing activities
• Cash flows from Financing activities

Question 24

Operating activities

Answer 24

Are the principal revenue-producing activities of an entity and any other activities that do not fall within investing and financing activities.

Question 25

Investing activities

Answer 25

Are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Question 26

Financing activities

Answer 26

Are activities that result in changes in the size and composition of the equity capital and borrowing of an entity.

Question 27

What are the 6 criterion that has to be evaluated within R&D

Answer 27

```  Technical feasibility  Intention to complete and sell  Existence of a market  Ability to use or sell  Availability of resources  Ability to measure costs reliably (TIE-AAA) ```

Question 28

What are the strong indicators for Finance lease

Answer 28

o Transfer of ownership to the lessee by the end of the lease term o Lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the FV at the date of the option (i.e. a bargain purchase option exists) o The lease term is for the major part of the economic life of the asset o PV of MLPs amounts to at least substantially all of the FV of the asset o Leased asset is of such a specialized nature that only the lessee can use it without major modifications

Question 29

Discuss why capitalization of outlays may not provide relevant information about the intangible assets held by an entity.

Answer 29

 There is no necessary link between capitalized costs and expected future benefits  Time gap  Correlation gap

Question 30

Discuss why managers may prefer to expense outlays on intangibles rather than capitalize them.

Answer 30

 Managers prefer to inflate future profits  Investors generally consider write-offs as one-time items, of no consequence for valuation  Immediate expensing obviates the need to provide explanations in case of failure  Cost and benefit  Lack of relevance of capitalized numbers  Volatility

Question 31

Discuss the main problem related to the current standard IAS 17 for leases

Answer 31

 Off-balance sheet accounting  Asset/Liability missing for lessee  Biased picture of company regarding solvency

Question 32

Compare and contrast the impact on the reported profit and asset value for an accounting period of the first-in, first-out method and the weighted average method.

Answer 32

The key issue for discussion in this question is the relevance and reliability of financial information produced under each method. - FIFO values the asset at the latest price and includes the earliest purchases in inventory and thus in times of rising prices may defer losses to the next accounting period and may overstate assets. - Weighted average ‘smooths’ the impact of price rises across income and asset values but may mask problems with obsolescence.

Question 33

Why is the lower of cost and net realizable value rule used in the accounting standard? Is it permissible to revalue inventory upwards? If so, when?

Answer 33

Rationale => ‘assets should not be carried in excess of amounts expected to be realized from their sale or use’. Inventory cannot be revalued upwards unless there has been a previous write down. Under no circumstances can inventory be valued beyond its original cost.

Question 34

Revenue recognition criteria for the sale of goods

Answer 34

a) The entity has transferred to the buyer the significant risks and rewards of ownership of the goods; b) The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; c) The amount can be reliably estimated d) It is probable that the economic benefits associated with the transaction will flow to the entity; and e) The costs (to be) incurred in respect of the transaction can be measured reliably.

Question 35

Revenue recognition criteria for the rendering of services.

Answer 35

a) The amount of revenue can be measured reliably; b) It is probable that the economic benefits associated with the transaction will flow to the entity; c) The stage of completion of the transaction at the end of the reporting period can be measured reliably; and d) The costs incurred for the transaction and the costs to complete the transaction can be measured reliably.

Question 36

Define a contingency

Answer 36

In plain English a contingency is an unforeseen event that may or may not happen

Question 37

contingent liability

Answer 37

=> “A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or => A present obligation that arises from past events but is not recognised because: i. it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or ii. the amount of the obligation cannot be measured with sufficient reliability.”

Question 38

What are the characteristics of a provision?

Answer 38

The characteristics of a provision are that it is a liability where there is uncertainty as to either the timing of settlement or the amount to be settled.

Question 39

What are the recognition criteria for provisions?

Answer 39

a) an entity has a present obligation (legal or constructive) as a result of a past event; b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and c) a reliable estimate can be made of the amount of the obligation.

Question 40

At what point would a contingent liability become a provision?

Answer 40

If it becomes probable that an outflow of economic benefits will be required for an item previously dealt with as a contingent liability, a provision is recognized in the financial statements in the period in which the change in probability occurs.

Question 41

Identify three reasons why the net realizable value may be below their cost

Answer 41

 Inventories are damaged  Inventories are wholly or partially obsolete  Selling prices have declined below cost

Question 42

If the net realizable value is below cost, what journal entries should a company take?

Answer 42

The inventory value should be reduced by passing the following entry: (DATE): DR Inventory write-down CR Inventory

Question 43

Illustrate and discuss the effects on the statement of comprehensive income and statement of financial position from using the different cost assumptions available to value closing inventory.

Answer 43

 FIFO: COGS based on lower prices, higher profit, higher inventory  WAC: COGS based on higher prices, lower profit, lower inventory (Weighted average cost)

Question 44

The percentage-of-completion method for the valuation of construction contracts. Discuss the advantages and disadvantages of this method

Answer 44

 Smoothens the profit over the life of the contract rather than taking all profit at the end of the contract life  Depends on reliable assessment by management of percentage complete  Depends on a subjective judgement by management on the future outcome of the contract.

Question 45

The percentage-of-completion method for the valuation of construction contracts. Appraise whether it results in useful information for users.

Answer 45

Useful information will be provided if the percentage completion method provides relevant, reliable, understandable and comparable information to users. This is where the discussion should center.

Question 46

The IAS 18 method of revenue recognition proves that accountants are prudent. Discuss.

Answer 46

Prudence is now regarded as an overriding principle. Accountants are required to be free from bias, including any prudent bias. However, management has to take decisions on:  What constitutes the ordinary activities of the enterprise  Whether or not significant risks and rewards of ownership have been transferred to a buyer  Whether the amount of revenue involved can be measured reliably, i.e. can its fair value be determined  If it is probable that economic benefits associated with the transaction (sale) will flow to the enterprise  Whether the costs in respect of the transaction can be reliably measured  At what stage a particular service has reached in its delivery

Question 47

How is present value related to the concept of a liability?

Answer 47

The risks and uncertainties surrounding the events and circumstances should be taken into account in reaching the best estimate of a provision. IAS 37 requires provisions to be discounted to present value where the effect of discounting is material (paragraph 45). The discount rate used must be a pre-tax rate that reflects the time value of money and the risks specific to the liability. (To avoid double-counting, where the estimates of future cash flows have been adjusted for risk then the discount rate should not also reflect the particular risk (paragraph 47). In practical terms it is often difficult to determine reliably a liability-specific discount rate.)

Question 48

What is the key characteristic of a present obligation?

Answer 48

The key characteristic of a present obligation is if the entity has no realistic alternative but to make the sacrifice of economic benefits to settle the obligation.

Question 49

What is a financial instrument?

Answer 49

A financial instrument is ‘any contract that gives rise to a financial asset of one enterprise and a financial liability or equity of another enterprise’ (IAS 32 and IAS 39).

Question 50

Describe the main risks that pertain to financial instruments.

Answer 50

The main risks include: market risk, credit risk and liquidity risk.

Question 51

What are the four categories for financial instruments and how are they accounted for?

Answer 51

 Hold-to-maturity (HTM): Amortized costs using effective interest rate  Loans and receivables: Amortized costs using effective interest rate  FVTPL: Changes in FV in P/L  Available for sale: Changes in FV in OCI

Question 52

Describe the three categories of financial asset under IFRS 9. How is each category accounted for?

Answer 52

Debt instruments – measured at amortized cost if they meet the “business model” and “characteristics of the asset” tests. If they don’t meet these tests they must be measured at fair value through profit or loss (FVTPL). Derivatives – FVTPL Equity instruments – at FVTPL if held-for-trading. Otherwise the entity may elect to measure them at FVTPL or at fair value through equity. In the latter case all fair value movements must go to equity and no recycling to profit or loss is permitted.

Question 53

Categorize in one of the four categories specified in IAS 39: Loans receivable (holder)

Answer 53

Financial asset – Loans and receivables

Question 54

Categorize in one of the four categories specified in IAS 39: Loans payable (issuer)

Answer 54

Financial liability – Financial liability

Question 55

Categorize in one of the four categories specified in IAS 39: Ordinary shares of the issuer

Answer 55

Equity instrument of the issuer – Categorization not applicable (scoped out of IAS 39)

Question 56

Categorize in one of the four categories specified in IAS 39: Redeemable preference shares of the issuer, redeemable at any time at the option of the holder

Answer 56

Financial liability - financial liability

Question 57

Identify which of the four categories specified in IAS 39: Forward exchange contract

Answer 57

Fair value through profit or loss

Question 58

Identify which of the four categories specified in IAS 39: 5-year government bond paying interest of 5%

Answer 58

Held-to-maturity investment, measured at amortized cost.

Question 59

Identify which of the four categories specified in IAS 39: Trade accounts receivable

Answer 59

Loans and receivables, measured at amortized cost.

Question 60

Identify which of the four categories specified in IAS 39: Trade accounts payable

Answer 60

Financial liabilities, measured at amortized cost.

Question 61

Identify which of the four categories specified in IAS 39: Mandatory converting notes paying interest of 6% (the notes must convert to a variable number of ordinary shares at the expiration of their term)

Answer 61

Held-to-maturity investment, measured at amortized cost

Question 62

Identify which of the four categories specified in IAS 39: Investment in a portfolio of listed shares held for capital growth

Answer 62

Available-for-sale investment, measured at fair value with changes in fair value through equity

Question 63

Identify which of the four categories specified in IAS 39: Investment in a portfolio of listed shares held for short-term gains

Answer 63

Held-for-trading; at fair value through profit or loss

Question 64

Identify which of the four categories specified in IAS 39: Borrowings of $1 million, carrying a variable interest rate

Answer 64

Financial liability, measured at amortized cost.

Question 65

Discuss why the standard-setters first set rules on presentation and disclosure of financial instruments before tackling recognition and measurement. Do you think the earlier creation of IAS 32 assisted in the development of IAS 39?

Answer 65

Standard-setters first set rules on disclosure before tackling measurement in the hope of gaining useful information from the disclosures to assist in determining measurement rules. The disclosures would have helped to identify the types of financial instruments and associated risks in the market and so would have assisted the standard-setters in the development of IAS 39.

Question 66

Identify and discuss the main criticisms of accounting for financial instruments that emerged during the financial crisis

Answer 66

The main criticisms were: 1. The complexity of the standards 2. Difficulties in determining fair values in illiquid or inactive markets 3. Delayed recognition of impairment losses 4. Off-balance sheet entities

Question 67

Who bears the risk in a defined benefit plan?

Answer 67

The employer has an obligation to pay further contributions if the fund is unable to pay members’ benefits and hence, bears the risk.

Question 68

Who bears the risk in a defined contribution plan?

Answer 68

Employees bear the risk of low or negative returns and the employer is not directly affected by the poor performance of the fund.

Question 69

Explain what the ‘management approach’ used in IFRS 8 means.

Answer 69

The management approach means that the segment information is based on what is reported internally to the Chief Operating Decision-Maker (CODM). Whatever the CODM uses to measure and assess the operating segment is what is disclosed externally under IFRS 8. The only item that must be disclosed is “a measure” of segment result.

Question 70

What is the earnings per share ratio used for?

Answer 70

The earnings per share ratio is used to compare the after-tax profit available to ordinary shareholders of an entity on a per share basis, with that of other entities.

Question 71

Basic earnings per share

Answer 71

‘Basic’ earnings per share is a ratio of the profit (or loss) attributable to ordinary shareholders, and the weighted average number of ordinary shares outstanding during the relevant reporting period

Question 72

Diluted earnings per share

Answer 72

‘Diluted’ earnings per share is a ratio which recognizes the potential dilutive effect of the basic earnings per share ratio from the assumption that the entity’s convertible securities are converted, its warrants or options are exercised, or that its contingently issuable shares are issued.

Question 73

Where are the basic and diluted earnings per share ratios presented in a set of financial statements?

Answer 73

The basic and diluted earnings per share ratios must be presented in an entity’s statement of profit or loss and other comprehensive income (IAS 33, paragraph 66), even if the amounts are negative (IAS 33, paragraph 69).

Question 74

Classify the events below as adjusting events or non-adjusting events according to IAS 10: A lawsuit alleging damages suffered from an accident that occurred after the balance sheet date

Answer 74

Non-adjusting event

Question 75

Classify the events below as adjusting events or non-adjusting events according to IAS 10: A bankruptcy of a customer that occurs after the balance sheet date

Answer 75

Provision for bad debts

Question 76

Classify the events below as adjusting events or non-adjusting events according to IAS 10: At year-end, management has the intention to decide upon the implementation of a restructuring plan. After the balance sheet date but prior to the issuance date of the company’s financial statements, management approves and announces the plan.

Answer 76

Recognition and measurement criteria of IAS 37 were not met.

Question 77

Classify the events below as adjusting events or non-adjusting events according to IAS 10: Shortly after the balance sheet date a survey of an item of property, plant and equipment revealed significant structural problems with the asset

Answer 77

Adjusting event

Question 78

Segment disclosures are widely regarded as some of the most useful disclosures in financial statements because of the extent to which they disaggregate financial information into meaningful and often revealing groupings. Discuss this assertion by reference to the objectives of financial reporting by segments.

Answer 78

Many entities operate in different geographical areas or provide products or services that are subject to differing rates of profitability, opportunities for growth, future prospects and risks. Disaggregation into meaningful and often revealing groupings assists users to better understand the entity’s past performance, to better assess the entity’s risks and returns, and make more informed judgements about the entity as a whole.

Question 79

Discuss the concerns raised about IFRS 8 from users when it was first introduced (instead of IAS 14)

Answer 79

Users were concerned with: - Lack of prescription (i.e. comparability) compared to IAS 14 - Information disclosed externally might be reduced because of the lack of prescription as to what has to be disclosed under IFRS 8. - Management might manipulate the disclosed information by reporting “non-GAAP” measures that could cause the segment results to appear more favorable than if the IFRS profit were reported for each segment.

Question 80

Discuss the concerns raised about IFRS 8 from preparers when it was first introduced (instead of IAS 14)

Answer 80

- Preparers felt that the management approach would better help them reflect to users the way they (preparers) manage the business and thus that the IFRS 8 approach would be a better reflection of the business’s performance as seen through the eyes of management.