Tricky Tutorials: Groups, Financial Instruments, Provisions, Warranties Flashcards
How does IAS 32 determine an obligation to repay in cash? Or through an issue of shares?
Cash: As a liability
Shares: Equity - split accounting part debt/part equity
What are the accounting entries for the issue of convertible debt?
Dr Cash (amount received) Cr Liability Cr Equity (balancing figure in SOFP)
How do you figure out the liability value component in the accounting entries for convertible debt?
Value liability component: Discount cash flows (interest and repayment that you could be obliged to pay) to present value using market rate of interest (that just applies to debt)
- Using the rate without the option to convert
How is a liability subsequently classified?
Classified as ‘other financial liability’
How is convertible debt subsequently measured?
Measured at amortised cost at an effective rate = market rate for normal debt (rate of interest without the conversion)
How do you build back up the debt from present value to what is owed?
Unwinding:
Balance b/f x rate of interest without the conversion - (cash which is the cash x interest on debt) = balance c/f
How is unwinding interest expense presented in the accounts?
Dr Finance Cost (interest)
Cr Liability
How is the coupon interest (the netted off balance) presented in the accounts?
Dr Liability
Cr Bank
How do you present convertible debt in the FS at y/e?
SOCI: Interest expense from the unwinding
SFP = Current liability; Convertible Debt: Balance C/F at the end of the year
Equity; Equity Option: Equity balancing figure from initial accounting entries
When is a provision recognised?
- There is a present obligation (legal or constructive) as a result of a past event that occurred before the year end
- It is probable that an outflow of economic benefits will result. Probable assumed as more than 50%
- A reliable estimate of the amount can be made
What is a constructive obligation?
Based on a company’s behaviour: If a company markets themselves as environmentally friendly, they might be responsible to pay for environmental damage even if it is not a legal obligation
Should you always provide a provision for damage?
The damage must be done rather than planned
How do you account for a dismantling provision on acquisition?
- On building, capitalise the provision as part of the non-current asset (as obligation present at acquisition date) = Provision x (1/1+interest rate to the power of the number of years of UL left)
- Then add this discounted PV to the initial NCA cost
How do you account for a dismantling provision at year-end?
Depreciate NCA:
Dr Depreciation Expense (SPL)*
Cr Acc Depreciation (SFP)
* assume straight-line if not specified
Unwind the liability: Depreciate the NCA Dr Finance Cost (SPL) (Provision PV x interest %) Cr Provision (SFP)
How do you present a dismantling provision in the FS extracts?
SOCI
Depreciation of NCA
Finance Costs (the unwound liability)
SFP:
PPE
Provisions (in the year of building put initial PV and the unwinding for one year)
If there had been damage that a company had a legal obligation to rectify before year-end, how would you account for this?
Future costs of rectification x percentage damaged x 1/(1+discount rate)to the power of UL remaining
Then with that number:
Dr SPL (ongoing use of the area) Cr Provision
How do you account for a warranty for large populations of similar items?
For large populations of similar items, the company will use expected values to calculate the provision:
E.g. Company sells conservatories under warranties. At y/e 31 Dec X2, management estimate that there is:
- 70% chance that no faults will be found with goods under warranty
- 20% chance that faults will cost £4m to resolve
- 10% chance that the cost of resolving faults will be £10m
Provision = (£0 x 70%) + (£4m x 20%) + (£10m x 10%) = £1.8m
Should you account for a legal provision in this example?
Company T is being sued by a former employee who was injured at work in Nov X2. At the y/e 31 Dec X2, lawyers estimate that there is:
- a 70% chance that there will be no case to answer
- a 20% chance that damages will cost £4m
- a 10% chance that the costs will be £10m
Present obligation? Yes, the obligation even was the injury which occurred before the year-end
Past event? Yes, the injury occurred before the year-end
Probable outflow? no - in an isolated case such as this we go with the most likely outcome. It is more likely than not (70%) that no amounts will be paid
Although no provision will be recognised, the likelihood of outflow is possible so the case will be disclosed as a contingent liability
What is deferred cash?
When the parent company agrees to pay to subsidiary shareholders at a later date
How do you account for deferred cash in the parent company’s individual FS initially?
Dr Investment (SFP) Cr Liability (SFP)
Discount the future cash payment to present value
How do you treat deferred cash at year end?
- Unwind the discount at year-end: check how much unwinding needs to be done as this is a cumulative position
- Record the unwinding figure in the parent company’s individual financial statements:
Dr Finance Cost (SPL)
Cr Liability (SFP) - No impact on group investment or on goodwill
- Watch-out if company is acquired part-way through year as you should only unwind from the acquisition date
How do you approach this question:
A Ltd acquired 100% of the share capital of B Ltd on 1 January 20X6 and agreed to pay cash of £375k on 31 Dec 20X7.
The relevant discount rate is 7%.
A Ltd have not recorded anything in their financial statements for this transaction.
- Figure out the PV using the discount factor/rate =
Cash x 1(1+discount rate)to the power of years after the acquisition date
Dr Investment
Cr Liability - Unwind the discount for the end of the first-year using the interest rate
e.g. 327,540 x 7% = 22,928
Dr Finance Cost 22,928
Cr Liability 22,928 - Closing Liability for the year = PV + Unwinding discount
4. Group Consolidated statement of profit or loss: Finance Cost (the unwound discount)
- Consolidated statement of financial position:
Current Liabilities
Deferred Consideration (closing liability for the year) - Parent workings:
Goodwill
Deferred Consideration (PV at acquisition date)
Group Retained Earnings
Unwinding (finance costs) (the unwound discount)
Who issues shares when they are part of consideration for acquiring another company? How should you record them?
- When one company buys another, and shares are part of the consideration, these are shares issued by the parent company to the subsidiary’s shareholders
- Record based on the parent company’s share price at the acquisition date, regardless of whether the shares are issued at acquisition or in the future
- Fair price is regardless of when they are issued.
How do you account for shares issued at acquisition date?
Parent company’s statement: shares issued at acquisition date
Dr Investment (market value of share x n.o shares)
Cr Share capital (nominal value x n.o shares)
Cr Share premium (Balancing figure)
