Learning goals Flashcards
(133 cards)
1
Q
What are the current developments in the harmonization of international accounting?
A
- International accounting standards 1973-2001
- IFRS From 2001 and onwards, they take precedence
- Listed companies are required to comply with IAS/IFRS since 2005, it is a national decision to adapt it to non-listed
2
Q
Explain what accounting theory is, who create practical applications of it?
A
- A coherent set of hypothetical, conceptual and pragmatic principles forming the general frame of reference for a field of inquiry.
- Organizations such as the International Accounting Standards Board help create practical applications of accounting theory, and professionals such as CPAs help companies navigate accounting standards.
3
Q
Describe the main attempts to construct an accounting theory
A
Traditional approaches:
- Non-theoretical (Be useful to users, pragmatic)
- Theoretical (Deductive: Basic assumptions are made into logical principles, Inductive: Start with observations and moves into generalized conclusions)
New Approaches:
- Behavioral (Takes human behavior into account and how it relates to decision making)
- Positive (Stakeholders are rational and maximize utility, tries to explain how things are, and not how they should be -> i.e. normative is opposite)
4
Q
Describe and discuss the contents of the IASB Framework (Objectives)
A
Objectives:
- To assist several stakeholders:
=> The Board, in the development/review of IFRS and promoting harmonization
=> National standard-setting bodies, in developing national standards
=> Preparares of financial statements, in applying IFRS
=> Auditors, in forming an opinion (compliance with IFRS)
5
Q
Describe the structure of published financial statemtents under IFRS
A
Balance Sheet (=Statement of financial position): => Assets, Liabilities and Equity
Income statement (=Statement of comprehensive income) => Income and Expenses
6
Q
Describe and discuss the contents of the IASB conceptual Framework (Scope)
A
Scope:
- The “Conceptual Framework” deals with:
=> Objectives of financial reporting
=> Qualitative characteristics of useful financial information
=> Definition, recognition and measurement of the elements from which financial statements are constructed
=> Concepts of capital and capital maintenance
7
Q
Describe and discuss the contents of the IASB Framework (Underlying assumptions, explain them)
A
- Accrual basis (Economic events are recognized by matching revenues to expenses (the matching principle) at the time in which the transaction occurs rather than when payment is made (or received).
- Going concern (Accounting term for a company that has the resources needed to continue to operate indefinitely until a company provides evidence to the contrary)
8
Q
Describe and discuss the contents of the IASB Framework (Principal characteristics)
A
CRUR
Comparability – Comparability enables users to identify and understand similarities in, and differences among, items.
Relevance - Relevant financial information is capable of making a difference in the decisions made by users.
Understandability – Classifying, characterizing and presenting information clearly and concisely.
Reliability - is the concept of only recording those transactions in the accounting system that you can verify with objective evidence.
9
Q
Central issues depreciation
A
- How do we systematically recognize the expensing of the total cost of the asset over time?
- Depreciation is an “allocation issue”
- The depreciation method shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed
10
Q
Explain what depreciation does and does not do (Reasons & Misconceptions)
A
Reasons:
- Results from the matching convention which requires that the corresponding expense needs to be matched with the benefit in each period
- The total expense for the asset’s life is spread over the total beneficial life in proportion to the pattern of benefit
Misconceptions:
- The process of depreciation calculation is not designed to produce meaningful balance sheet (B/S) numbers
- The depreciable amount is the annual charge based on actual or implied assumptions as to the pattern of benefit being derived
11
Q
IAS 16 PPE, what does it cover and what are the three core stages
A
IAS 16 Property, Plant and Equipment outlines the accounting treatment for most types of property, plant and equipment, i.e. non-current asset with definite life:
- Property, plant and equipment is initially measured at its cost
- Subsequently measured either using a cost or revaluation model, and
- Depreciated so that its depreciable amount is allocated on a systematic basis over its useful life.
12
Q
What are the three questions you need to ask before a non-current asset becomes an investment property? (Decision tree)
A
Is the property held for sale in the ordinary course of business?
Is the property owner occupied? (Used in ordinary course of business in production on administration)
Is the property being constructed or developed?
13
Q
Discuss alternative treatments for investment properties, how is it initially measured?
A
Initially “At Cost” with Transactions costs included
Cost model => Use IAS 16 with disclosure from IAS 40
Fair value model => Use IAS 40
- Requires continuing reliable valuation
- A gain or loss is recognized in P/L
- The FV shall reflect the market conditions at B/S date
14
Q
Explain the issues involved in determining appropriate treatments for borrowing costs (IAS 23)
A
=> Capitalize: borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset
=> Expense: Recognize other borrowing costs as an expense in the period in which they occurred
15
Q
Methods of providing for depreciation
A
Time-based depreciation methods (Depreciation expense will be determined regardless of the level of activity during the period):
- Straight line method
- Reducing balance method
- Sum of the digits method
Methods-based on activity level (Depreciation expense will be determined in relation to the output produced in the relevant period by the asset or the level of service quantity used)
- Defined as output of the asset
- Defined as service quantity of the asset (usage)
16
Q
Cost model is measured at:
A
+ Cost
– Any accumulated depreciation
– Any accumulated impairment loss
17
Q
Revaluation model is measured at:
A
+ FV at the date of revaluation
– Any subsequent accumulated depreciation
– Any impairment losses
18
Q
Cost model restrictions of usage and adjustments if FV is not equal to CA
A
No restrictions of usage
Adjustments
- Only adjust if there are triggering events for impairment
- If impairment is reversed, its maximum is the prior impairment amount
19
Q
Revaluation model restrictions of usage
A
Restrictions
- FV has to be measured reliably (PPE)
- An active market exists (Intangibles)
20
Q
Revaluation model adjustments if FV is not equal to CA
A
If: FV > CA Increase to FV, the increase should credit OCI and “revaluation surplus”
If: FV
21
Q
Define intangible assets
A
- Identifiable (separable, ability to sell or transfer)
- Non-monetary asset (Controlled and possess future economic benefit)
- Without physical substance
22
Q
Describe, apply and appraise the requirements of IAS 38 relating to intangible assets (Three parts)
A
Intangible assets meeting the relevant recognition criteria are:
- Initially measured at cost
- Subsequently measured at cost or using the revaluation model, and
- Amortised on a systematic basis over their useful lives (unless the asset has an indefinite useful life, in which case it is not amortised, but impaired)
23
Q
IAS 36 Impairment indications (External)
A
External sources of information (USIC, think Utsikt):
- Unusual significant decline in asset’s market value
- Significant changes in the technological, market, economic or legal environment
- Increase in market interest rates or other market rates of return on investments
- CA of the net assets of the entity is more than its market capitalization
24
Q
IAS 36 Impairment of assets seeks to ensure that? Exceptions? When and where are tests required?
A
- An entity’s assets are not carried at more than their recoverable amount (i.e. the higher of fair value less costs of disposal and value in use).
- With the exception of goodwill and certain intangible assets for which an annual impairment test is required
- Entities are required to conduct impairment tests where there is an indication of impairment of an asset, and the test may be conducted for a ‘cash-generating unit’ where an asset does not generate cash inflows that are largely independent of those from other assets.
25
Define goodwill, two main characteristics, interpretation and calculation
Goodwill are future economic benefits arising from assets that are:
- Not capable of being individually identified
- Not separately recognized
Goodwill itself is not an identifiable asset or liability, but a residual amount
Goodwill =
+ FV of the purchase consideration given
- Aggregate FVs of the identifiable assets and liabilities of the acquiree that are recognized on acquisition.
26
Describe, apply and appraise the requirements of IAS 38 relating to research and development
Do not recognize an asset arising from research
=> Expense research when it is incurred
An intangible asset arising from development shall only be recognized if TIE-AAA is fulfilled:
• Technical feasibility
• Intention to complete and sell
• Existence of a market
• Ability to use or sell
• Availability of adequate resources to complete
• Ability to measure costs reliably during development
27
IAS 36 Impairment indications (Internal)
Internal sources of information (PEE):
- Plans to discontinue or restructure the operation to which an asset belongs
- Evidence of obsolescence or physical damage of an asset
- Evidence available from internal reporting that economic performance of an asset is/will be worse than expected
28
Reasons for leases
- No initial cash outlays
- Protection against obsolescence (aging)
- Tax benefits
- Off-balance sheet financing
29
Finance lease accounting treatment (Lessee)
| Recognition, Initial measurement, Subsequent measurement
Recognition of asset and liability at the inception of the lease in the -> balance sheet
Initial measurementat the lower of FV and PV of MLPs
=> PV of MLPs calculated using discount rate = interest rate implicit in the lease. Any initial direct costs of the lessee are added to the recognized amount.
Subsequent measurement (during the lease term):
=> Each lease payment should be allocated between
- A reduction of the obligation and
- The finance charge
Aim: produce a constant periodic rate of interest on the remaining balance of the obligation over the amortization period
30
Major problems of IAS 17
- IAS 17 makes it difficult for investors and others to get an accurate picture of a company’s lease assets and liabilities, particularly for industries such as the airline, retail and transport sectors
- The distinction between operating leases (disclosed in the notes) and finance leases (reported on the balance sheet) made it difficult for investors to compare companies
- Investors have to estimate the effects of a company’s off balance sheet lease obligations, which in practice often led to overestimating the liabilities arising from those obligations
31
Understand and contribute to ongoing debates concerning the treatment of leases in financial statements (Problem and Solution)
- Problems in IAS 17 (Difficulties in assessing companies due to off-balance sheet leases) have led to a new standard IFRS 16, published January 2016, in effect 1 January 2019
- Main changes:
The main changes in the new standard concern the lessee
- IFRS 16 requires the lessee to report all leases on the balance sheet as assets and liabilities
- Thus, the classification as either operating or finance lease is eliminated for the lessee and they are instead all treated as finance leases
32
Strong indicators for Finance lease
- Transfer of ownership to the lessee by the end of the lease term
- Bargain purchase option exists
- The lease term is for the major part of the economic life of the asset
- PV of MLPs amounts to at least substantially all of the FV of the asset
- Leased asset is of such a specialized nature that only the lessee can use it without major modifications
33
Operating lease accounting treatment (Lessee)
Recognition of an expense in the income statement
- On a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefit
- Yearly rental expense = Minimum rent under the lease divided equally over the years+ Any contingent rent relating to that year
=> No other measurement since only in income statement
34
Finance lease accounting treatment (Lessor)
| Recognition, Initial measurement, Subsequent measurement
Recognition of a receivable
Initial measurementat an amount equal to the net investment in the lease
Subsequent measurement
- A lessor aims to allocate finance income over the lease term on a systematic and rational basis
- This income allocation is based on a pattern of reflecting a constant periodic return on the lessor’s net investment outstanding in respect of the finance lease
- Lessor’s net investment = Accounts receivable = PV of all lease payments + ung. RV
- Lease payments relating to the accounting period (excl. costs for services) are applied against the gross investment in the lease to reduce both the principal and the unearned finance income
- Gross investment = Net investment + Σ interest income
35
Operating lease accounting treatment (Lessor)
- The asset subject to the operating lease is, in substance over form, a non-current asset of the lessor
- Such an asset should be depreciated on a basis consistent with the lessor‘s policy for similar assets
- IAS 16 (PPE) or IAS 38 (Intangible Assets) will apply
- IAS 36 (Impairment) will need to be considered
- Lease income (excluding receipts for services provided such as insurance and maintenance) is recognized in income on a straight line basis over the lease term
36
Identify the need for a statement of cash flows
- Shows the financial health of a company since it shows the CASH itself ENTERING the business
- Through Accrual Accounting, revenue is gained when the sale is made, and not the COMPLETE transaction!
37
Describe the requirements of IAS 7, Statement of Cash Flows, components and definitions
Five components In the cash flow statement:
- CF from Operating activities (Business activities):
The principle revenue producing activities. All activities that do not classify as investing or financing activities.
- CF from Financing activities (Debt and Debt repayments)
Activities that result in changes in the size and composition of the equity capital and borrowings of the enterprise
- CF from Investing activities (Purchasing & Selling asset)
The acquisition and disposal of long-term assets and investments not included in cash equivalents
- Cash Equivalents:
Short-term, highly liquid, risk free investments (Less than 90 days)
- Cash
38
Calculation in a statement of cash flows
+ Cash flow from operating activities
+ Cash flow from investing activities
+ Cash flow from financing activities
=
Net increase/decrease in cash/cash equivalents
----------------
+ Cash/cash equivalents at the beginning of the year
=
Cash/cash equivalents at the end of the year
39
What are the methods for cash flow statements, which one is problematic
Free choice for companies to use either the direct or the indirect method
The direct method (Cumbersome, requires to match every transaction)
The indirect method (Easy, show net profit with a few adjustments)
40
Discuss IAS 2 requirements relating to inventories (Cost formulas allowed)
- The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs
- The costs of other inventories shall be measured by FIFO or weighted average
41
Define construction contracts and give examples
A contract specifically negotiated for the construction of
=> An asset or
=> A combination of assets that are closely interrelated or interdependent in terms of design, technology and function or their ultimate purpose or use.
Examples: bridge, building, dam, pipeline, road, ship, tunnel, construction of refineries
42
Important notions to revenue
- Revenue is gross inflow, i.e. before the deduction of any expenses
- We must also assume that this inflow is to the enterprise (although not specifically stated in definition)
- Revenue results from ORDINARY activities => Distinguishes revenue from other gains (Gains = “Other items that meet the definition of income and may, or may not, arise in the ordinary activities of an enterprise”)
- Revenue gives rise to an increase in equity
43
Critically appraise IAS 18 in relation to revenue recognition
- There are inconsistencies and weaknesses in existing revenue recognition standards
- There are several revenue recognition models
- Too many number of requirements to which preparers of financial statements must refer
44
Possible methods to determine the value of the inventory
- Unit cost
- First in, first out (FIFO)
- Last in, first out (LIFO)
- Weighted average
- Base inventory
45
Discuss IAS 2 requirements relating to inventories (Measurement, how is it calculated)
Measurement at lower of: Cost and net realizable value (NRV)
Where:
NRV=
+ Estimated selling price in the ordinary course of business
– estimated costs of completion
– estimated costs necessary to make the sale
Cost=
+ Costs of purchase
+ Cost of conversion
+ Other costs incurred in bringing the inventory to the present location and condition
46
Discuss IAS 2 requirements relating to inventories (Measurement - What is not included in costs)
* Abnormal amounts of waste
* Storage costs
* Administrative overhead
* Selling costs
47
What are the two types of construction contracts
Fixed price contract = contractor agrees to a fixed contract price or a fixed rate per unit of output
Cost plus contract = contractor is reimbursed for allowable or otherwise defined costs, plus a percentage of these costs or a fixed fee
48
What happens if the contract cover the construction of a number of assets
In these cases: Each asset must be treated as a separate contract if:
=> Separate proposals have been submitted for each asset and
=> Each asset has been subject to separate negotiations and the contractor and customer have been able to accept or reject that part of the contract relating to each asset and
=> The costs and revenues of each asset can be identified
49
A group of contracts may in substance be a single construction contract and is required to be treated as such when?
- The group of contracts is negotiated as a single package
- The contracts are so clearly interrelated that they are in effect part of a single project with an overall profit margin
- The contracts are performed concurrently or in a continuous sequence
50
Contract revenue
initial amount of revenue agreed in contract + variations in contract work + claims + incentive payments
51
What are the three types of contract costs
- Costs relating directly to the specific contract (Material costs)
- Costs that are attributable to the contract activity in general and can be allocated to the contract (Insurance)
- Other costs specifically chargeable to the customer under the terms of the contract (Administrative for which REIMBURSEMENT IS SPECIFIED in contract, if not, do not include)
52
What costs are not included in contract costs
- General admin. costs for which REIMBURSEMENT IS NOT specified in the contract
- Selling costs
- R&D costs for which reimbursement is not specified in the contract
- Depreciation of idle plant and equipment that is not used in a particular contract
53
Which method should be used to calculate construction contracts if the outcome can be measured reliably? If it cannot?
If reliably:
=> Percentage-of-Completion method (%Finished/Total cost)
If not reliably:
- Cost to cost method ((Incurred cost/Total Cost)*E(Sales))
- Effort extended method (Surveys of work performed)
- Units of delivery (Best estimate of physical completion)
54
What type of transactions does revenue arise from
- Sale of goods
- Rendering of services
- The use by others of the entity’s assets yielding interest, royalties (=Use of long-term assets, e.g. franchise) and dividends
55
Revenue recognition: Sale of Goods
1) It is probable that the economic benefits associated with the transaction will flow to the enterprise
2) The amount of revenue can be measured reliably
3) The enterprise has transferred to the buyer the significant risks and rewards of ownership of the goods
4) The enterprise retains neither continuing managerial involvement to the degree usually associated with ownership, nor effective control over the goods sold
5) The costs incurred or to be incurred in respect of the transaction can be measured reliably
56
Revenue recognition: Rendering of Services
1) It is probable that the economic benefits associated with the transaction will flow to the enterprise
2) The amount of revenue can be measured reliably
3) The stage of completion of the transaction at the B/S date can be measured reliably
4) The cost incurred for the transaction and the costs to complete the transaction can be measured reliably
57
Revenue recognition: “The use by others of the entity’s assets yielding interest, royalties and dividends”, on what basis shall these items be recognized
1) It is probable that the economic benefits associated with the transaction will flow to the enterprise
2) The amount of revenue can be measured reliably
Basis:
=> Interestshall be recognized using the effective interest method (IAS 39)
=> Royalties shall be recognized on an accrued basis in accordance with the substance of the relevant agreement
Dr.Accrued revenue Cr. Revenue
=>Dividends shall be recognized when shareholders’ right to receive the payment is established
58
Revenue recognition: Barter transactions
The revenue in these transactions can only be reliably measured by REFERENCE to NON-BARTER transactions that:
- Involve advertising similar to the advertising in the barter transaction,
- Occur frequently,
- Represent a predominant number of transactions and amount when compared to non-barter transactions to provide advertising that is similar to the advertising in barter transactions,
- Involve cash and/or another form of consideration (e.g. marketable securities) that has a reliably measurable FV, and
- Do not involve the same counterparty as in the barter transaction
59
Revenue measurement, if received instantly, or after a time
Measurement of revenue: At FV of the consideration received or receivable
When revenue is received after a period of time
=> The nominal amount of revenue needs to be discounted
Discount rate to be used:
- The prevailing rate for a similar instrument of an issuer with a similar credit rating, or
- A rate of interest that discounts the nominal amount of the instrument to the current cash sales price of the goods or services
60
IFRS 15 on “Revenue from contracts with customers”, which IAS will it replace, what is its main objectives and key principles
To be applied from 2017 onwards
- This standard will replace IAS 11 (construction contracts) and IAS 18 (revenue)
Main objectives:
- Remove inconsistencies in revenue recognition
- Provide a single recognition model
- Simplify preparation of financial statements
Key principles:
- Revenue is recognized on transfer to the customer
- Measured at transaction price
61
True or false: The scope of IFRS 15 covers all revenue transactions
False
| => It excludes: Leases, Financial instruments and insurance contracts
62
What is "transaction price" in terms of IFRS 15
The transaction price is the amount to which an entity expects to be entitled in exchange for the transfer of goods and services. When making this determination, an entity will consider past customary business practices.
63
What are the five steps in IFRS 15 revenue recognition
1. Identify the contract(s) with a customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations in the contract
5. Recognise revenue when (or as) the entity satisfies a performance obligation
64
Describe the key principle IAS 37 (Provisions, Contingent liabilities, Contingent assets) attempts to address
The key principle established by the Standard is that a provision should be recognised only when there is a liability i.e. a present obligation resulting from past events. The Standard thus aims to ensure that only GENUINE obligations are dealt with in the financial statements – planned future expenditure, even where authorised by the board of directors or equivalent governing body, is excluded from recognition.
65
Define provisions, when is it recognized?
A liability of uncertain timing or amount
Recognition of a provision if the three are fulfilled (tree):
- An entity has a present obligation (legal or constructive) as a result of past events,
- It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and
- A reliable estimate can be made of the amount of the obligation
66
For measuring a provision, the entity should?
- Take risks and uncertainties into account
- Discount the provision, where the effect of the time value of money is material
- Take future events into account, when there is sufficient objective evidence that they will occur
- Not take gains from expected disposal of assets into account
67
Executory contracts
Are contracts under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent
68
Onerous contract
A contract is unerous if:
Unavoidable costs of meeting obligations under the contract > Economic benefits expected to be received under the contract
If a contract is onerous, recognize the present obligation under the contract and measure it as a provision
69
Define contingencies
Is an unforeseen event that may or may not happen.
70
Define Obligating event, what does its constituents derive from
Event that creates legal or constructive obligation that results in an entity having no realistic alternative to settling the obligation
Legal obligation derives from:
- Contract (through its explicit or implicit terms),
- Legislation, or
- Other operation of law
Constructive obligation derives from an entity’s actions where by an established pattern of:
- Past practice,
- Published policies, or
- A sufficiently specific current statement,
(i. e. the entity has indicated to other parties that it will accept certain responsibilities)
71
For measuring a provision, what are the two concepts used?
Best estimate concept: The amount recognized as a provision shall be the best estimate of the expenditure required to settle the present obligation at the balance sheet (B/S) date
Present value of future expenditures: Used if the effect of time value of money is considerable
72
A constructive obligation to restructure only arises when an entity:
- Has a detailed FORMAL PLAN for the restructuring identifying at least the business or part of business concerned, the principal locations affected, the location, function and approx. number of employees who will be compensated for termination of their services, the expenditures that will be undertaken, when the plan will be implemented
- And restructures by starting to implement that plan or announcing its main features to those affected by it.
73
A restructuring provision, what does it include, what does it not include
Include:
- Direct expenses arising from the restructuring
- The expenses are necessarily entailed (and not related with ongoing activities)
Does not include:
- Retaining or relocating of staff
- Marketing
- Investment in new systems
- Investments in distribution networks
74
IAS 37 (Provisions) effectively bans
- Big bath accounting = Provision is recorded in a year with high profits to inflate future profits
- Creation of provisions where no obligation to a liability exists
- The use of provisions to smooth profits
75
Contingent liability
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 recognized because:
- It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation or
- The amount of the obligation cannot be measured reliably.
76
Disclose for each class of contingent liability:
- A brief description of the nature
- An estimate of its financial effect
- An indication of the uncertainties relating to the amount or timing of outflow
- The possibility of any reimbursement
77
Contingent asset
A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.
78
Disclose for each class of contingent asset:
- A brief description of the nature
| - An estimate of its financial effect
79
Describe a financial instrument
is defined as “any contract that gives rise to a financial asset of one enterprise and a financial liability or equity of another enterprise” (IAS 32 and 39).
80
Define the scope of IASs regarding financial instruments
Apply to all entities and financial instruments except (selection):
- Subsidiaries, associates and joint ventures (IAS 27)
- Consolidated and Separate Financial Statements (IAS 28)
- Rights and obligations under leases (IAS 17)
- Financial instruments issued by the entity that meet the definition of an equity instrument in IAS 32 (including options and warrants
81
Outline three key events in the history of accounting for financial instruments
1995: IAS 32 (Presentation of financial instruments)
1998: IAS 39 in order to meet the IOSCO agreement and it took a cautious approach (complex requirements for hedging)
July 2014: Publication of the final version of IFRS 9, replaces effective from January 2018
82
Financial assets can be classified in 4 categories
- Financial asset at FV through P/L
- Held-to-maturity investments
- Loans and Receivables
- Available-for-sale
83
Financial liabilities can be classified in 2 categories:
- Financial liability at FV through P/L
| - Other financial liabilities
84
Define Regular way contracts, when is recognition permitted?
Contracts for the purchase or sale of financial assets that require delivery of the assets within a regular time frame.
For these contracts, recognition is permitted at either:
- Trade date
- Settlement date
(but the policy chosen must be applied consistently)
85
Offsetting of a financial asset and a financial liability can only occur if?
- There is a legally enforceable right to offset and
- If the enterprise intends to settle on a net basis and
- If the enterprise intends to realize the asset and settle the liability simultaneously
86
Define derecognition, when can it occur?
Derecognition means removing a financial asset/liability from the balance sheet (B/S) when the contractual obligation is discharged, cancelled or expires.
Can occur when:
1) Substantially all risks and rewards have been transferred
2) Control has been transferred (Do only use this second criterion if no clear conclusion under 1))
87
Main criticism of IAS 39 (Financial instruments)
Information available:
- Lack of understanding by users of the significance of financial instruments on an enterprise’s financial performance, position and CFs -> due to the growth in the variety of FI available
- Often off-B/S, i.e. FI were not recognized
- Financial risk profile changed -> today: Excessive gains or losses depending on how prices of FI move
Measurement practice
- Historical cost does not always provide relevant or consistent information -> Fair values could provide more relevant information
- But: Where should the unrealized gains or losses be reported? P/L or OCI?
88
Define Hedge accounting
- Offsetting the (potential) loss on one item against the (potential) gain on another
- The loss or gain on the hedging arises from changes in FVs or cash flows
- IAS 39 permits the use of hedging where derivatives are designated as the hedge instrument but only permits non-derivatives to hedge a foreign currency risk
89
What are the three kinds of hedges in Hedge accounting
Fair value hedges:
=> Gain or loss from remeasuring the hedging instrument at FV and the hedged item is immediately recognized in P/L
CF hedges:
=> The portion of the gain or loss on the hedging instrument which is determined to be an EFFECTIVE hedge should be recognized in equity (OCI)
=> The INEFFECTIVE portion of the gain or loss is recognized in P/L
(A hedge is “effective” if expected changes in the hedged item are almost fully offset by changes in the hedging instrument (range of 80-125%))
Foreign entity investment hedges / Foreign currency hedge:
=> Similar to cash flow hedges, but more specific
90
Criticism of the Incurred Loss‐Model (IAS 39)
-> Loan loss allowance does not consider expected losses (“too little too late“)
-> Front loading of interest
-> Comparability is limited due to heterogenous
impairment techniques
91
Objective of the Expected Loss‐Model (IFRS 9)
-> Loan loss allowance considers expected losses
-> Credit‐adjusted effective interest rate for financial assets
that are credit‐impaired on initial recognition
-> Increased comparability of financial statements
92
Explain how short‐term employee benefits have to be accounted for
An entity is required to recognize a LIABILITY where an employee has provided a service, and EXPENSE when the entity consumes the economic benefits of employee service
=> Dr. Pension expense Cr. Pension contribution payable
93
Explain the purpose and function of actuarial cost or funding methods (projections)
=> The employer has an obligation to pay further contributions if the fund is unable to pay members’
benefits. It is therefore important that calculations are correct so they can cover pension expenses.
94
Define actuarial assumptions, give examples, and discuss their impact on the pension cost and pension benefit obligation
Actuarial assumptions are an entity’s best estimates of the variables that will determine the ultimate cost of providing post-employment benefits.
Examples & Impact:
Demographics: Mortality (earlier death means short pension), retirement ages (working longer benefits the system), length of service (same company contributes more)
Financial assumptions: Discount rates (higher rates mean higher risk), salary and benefit levels, expected rate of return on plan assets (low return will make it difficult to pay, especially with inflation)
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Define the concept of total pension cost according to IAS 19
Under a defined benefit scheme the exact total amount of the benefit is known only:
=> At the moment of retirement
=> When the pensioner dies
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Calculate a defined benefit liability/asset according to IAS 19
+PV of the defined benefit obligation (DBO) at B/S date
-FV of plan assets at B/S date
=Net defined liability/asset
-Past service cost not recognized
= Defined benefit liability/asset recognized on B/S
Note:
=> If amount is positive DBL
=> If amount is negative DBA
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General idea of IAS 19 (Employee benefit)
The cost of providing employee benefits should be recognized in the period in which the benefit is
earned by the employee, rather than when it is paid or payable
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Types of employee benefits
- Short-term employee benefits (Settled within 12 months)
- Post-employment benefits (E.g. pensions)
- Termination benefits
- Other long-term employee benefits (E.g. sabbatical leave)
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What are the two kinds of pension plans
- A defined contribution plan:
Entity pays fixed contributions to a fund and have no legal or constructive obligation if the benefit amount is insufficient. (I.e. EMPLOYEES bear the risk)
- Defined benefit plans:
The entity has an obligation to provide the agreed benefits to current and former employees. (I.e. EMPLOYER bear the risk)
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Different types of defined benefit plans
- The final pay plan:
In which the benefits are calculated as a percentage of the final salary before retirement
- The final average pay plan:
Where the benefits are calculated as percentage of the average salary of the last 3-5 years before retirement
The career average pay plan:
In which the benefits are related to the average salary someone has earned during his career
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Actuarial risk
Benefits will be less than expected
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investment risk (Pension plans)
Assets invested will be insufficient to meet expected benefits
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Past service cost
Is the change in the PV of the DBO for employee service in prior periods, resulting in the current period from the introduction of, or changes to, post-employment benefits or other long-term employee benefits.
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Termination benefits result from:
An employee’s decision to accept an offer of benefits in exchange for the termination of employment (Voluntary)
Or an entity’s decision to terminate an employee’s employment (Non-Voluntary)
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Three types of share-based payment transactions
a) equity-settled share-based payment transactions
b) cash-settled share-based payment transactions
c) share-based payment transactions with cash alternatives
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Define Equity-settled share-based payment transactions
Transactions, in which the entity receives goods or services as consideration for equity instruments of the entity (incl. shares or share options)
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Advantages of segmental reporting
- Some additional information
- Information about major customers and the possible dependency on them
- Comparison between different segments possible
- Internal information about the structure of a company
- Better understanding of financial statements in general
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Describe what is meant by an operating segment
An operating segment is a component of an entity:
=> That engages in business activities from which it may earn revenues and incur expenses (incl. revenues and expenses related to transactions with other components of the same entity),
=> Whose operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and
=> For which discrete financial information is available.
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Explain the criteria for the determination of a reportable segment
A reportable segmentis an operating segment:
=> For which segment information is required to be disclosed by the standard
= > Which meets a certain quantitative threshold:
- Reported Revenue > 10% of combined revenue
- Absolute amount of P/L > 10% combined profit/loss
- Assets > 10% of all operating assets
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Explain the difference between an adjusting event and a non-adjusting event
Adjusting events after the reporting date
= Those that provide evidence of conditions that
existed at the reporting date (Adjust financial statement)
Non-adjusting events after the reporting date= Those that are indicative of conditions that arose subsequent to the reporting date (Disclose in notes, nature and financial effect)
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Define basic earnings per share
EPS 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
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Describe the contents and appraise the statement IAS 33 on earnings per share
The Basic and Diluted EPS ratios must be presented in an entity’s statement of P/L and Other comprehensive income (OCI), even if the amounts are negative
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What are the two Interim financial reporting methods under IAS 34
1) Integral approach
- Interim accounting principles and practices are not always the same as annual reporting principles and practices (e.g. special accruals and deferrals)
2) Discrete approach
- Same accounting principles and practices used for interim reporting and annual reporting
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Disadvantages of segmental reporting
- Costs for providing information
- Company might not want to disclose information for all segments
- Difficult to compare one segment with a competitor that might have differently defined segments
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Individual operating segments might be aggregated for reporting purposes if the segments have similar
economic characteristics and are similar in each of the following aspects:
=> The nature of the products or services,
=> The nature of the production processes,
=> The type or class of customer for their products or services,
=> The methods used to distribute their products or provide their services, and
=> If applicable, the nature of the regulatory environment, e.g. banking, insurance, public utilities
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The “management approach” used in IFRS 8
Means 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
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Segmental reporting: Information about major customers
If revenues from transactions with a single external customer amount to ≥ 10% of an entity’s revenues, the entity shall disclose that fact, the total amount of revenues from each such customer, and the identity of the segments reporting the revenues.
118
Define diluted earnings per share
Diluted EPS the entity’s convertible securities are converted,
=> its warrants/options are exercised, or
=> its contingently issuable shares are issued.
119
Identify the need for additional statements to be included in a reporting package
Not all information needs are satisfied by the general purpose financial statements
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The role of financial reporting in corporate governance, how does it contribute to OECD CG guidance
To provide information to shareholders and other stakeholders about the company’s financial position, financial performance and future prospects
Contribution: Disclosure and transparency
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Threats to adherence to the Code of Ethics
- Self-interest
- Self-review
- Advocacy
- Familiarity
- Intimidation
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Components of an Annual Report (Part 1)
Part 1 = Business Reporting
- Key financial information
- Letters from the President, CEO and CFO to the shareholders
- Report of the BoD, governance issues
- Management report: Review of operations, personnel, R&D, environmental issues, non-financial information
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Components of an Annual Report (Part 2)
Part 2 = Financial Statements
- The consolidated statements
- The parent company individual accounts
- The audit report
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Possible additional statements
1) Value added statement, i.e. wealth created (=Sales-Resources given to other parties not connected with the enterprise)
2) Employment reports (e.g. age, sex, locations etc)
3) Management commentary (explains the main trends and factors underlying the development)
4) Statement of future prospects (forward-looking info)
5 Mission statement
6) Social and environmental report
7) R&D report
8) Overview of key financial figures
9) Corporate responsibility report
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Contents of Management commentary
- Nature of the business
- Objectives and strategy
- Key resources, risks and relationships
- Results and prospects
- Performance measures and indicators
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Contents Corporate responsibility report
- Corporate governance
- Forward-looking information
- Environmental performance
- Respect for labor rights
- Health and safety practices
- Community economic development and social impact
- Respect for human rights
- Payments to governments
- Stakeholder engagement
- Supply chain management
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Triple bottom line (TBL)
Is a concept whereby companies voluntarily take on board:
- Economic: Covering financial and non-financial information as we currently have in annual
reports
- Environmental: Effect of the products/services on the environment
- Social: Covering values, ethics and relationships with various stakeholders
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According to Carroll (1991)’s pyramid, companies have 4 types of responsibility:
1st The economic responsibility to be profitable
2nd The legal responsibility to play by the rules
3rd The ethical responsibility to do what is right
4th The philanthropic responsibility to contribute
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The issues corporate governance is meant to address
- Principal-agent problem
- Limited incentives for shareholders to perform their monitoring responsibilities
- The large size and complexity of corporate entities enables institutional arbitrage
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International Integrated Reporting Council (IIRC), what is it and what is its objective
- A global coalition of regulators, investors, companies, standard setters, the accounting profession and NGOs
- The key objective of Integrated Reporting is to demonstrate the linkages between an organization’s strategy, governance and financial performance and the social, environmental and economic context within which it operates
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Integrated report
A concise communication about how an organization’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long-term
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Fundamental principles of IESBA (International Ethics Standards Board for Acccountants) Code of Ethics
- Integrity
- Objectivity
- Professional competence and due care (continious training)
- Confidentiality
- Professional behavior (Comply with laws and do not discredit profession in any way)
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Give a few examples of "Safeguards" against threats to adherence to the Code of Ethics
- Strong internal controls
- Appropriate disciplinary processes
- The employing organization’s ethics and conduct programs
- Recruitment procedures in the employing organization emphasizing the importance of employing high caliber competent staff
