ACCA P2 Revsion Pack June 2015

ACCA Paper P2 (International)

Corporate Reporting

Revision Pack

June 2015

P2 CORPORATE REPORTING REVISION PACK

2

The Accountancy College Ltd

All rights reserved. No part of this publication may be reproduced, stored in a

retrieval system, or transmitted, in any form or by any means, electronic,

mechanical, photocopying, recording or otherwise, without the prior written

permission of The Accountancy College Ltd.


3

Must should could

All these sequences are based on the following all taken from the revision kit:-

Must Should Could

Q1 b/s Rose Grange Traveler

Q1 i/s Marchant Ashanti Base

Q1 cfs Angel Warrburt Jocatt

Q2 Themed mix Aron Norman

Savage

Panel

Macaljoy

Q3 Industry mix Cate Verge

Ethan

Greenie

Havana

Q4 current

issues

Jones

Whitebirk

High quality

FI

Transition

Holcombe

But any question from q30 onwards is useful. The earlier questions are good, but

your examiner is a forward thinking man, so earlier questions are often less useful.


4

Four Day Revision Sequence

These are the questions we will do together.

Day Subject Kit Q Exam Q Q Name

1 Financial instruments 44 2(focus) Aron

Pensions 24 2(focus) Savage

Group cfs 77 Dec 2013 1(Groups) Angel

Group B/S 59 1(Groups) Rose

2 Mixed Standards 76 June 2013 3(Mix) Verge

Mixed Standards 69 3(Mix) Ethan

Mixed Standards 52 3(Mix) Cate

Mixed Standards 84 June 2014 3(Mix) Aspire

3 SMEs 58 4(Current) Whitebirk

Current issues Revision pack 4(Current) Godzilla

Integrated reporting 16 4(Current) Jones

Current issues Revision pack 4(Current) GH Articles

4 Group B/S 47 1(Groups) Grange

Groups B/S 74 June 2013 1(Groups) Traveller

Group B/S 87 Dec 2014 1(Groups) Joey


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Two Day Revision Sequence


Day Subject Kit Q Exam Q Q Name



Group B/S 58 1(Groups) Rose



Mixed Standards 68 June 2012 3(Mix) Ethan

Current issues Revision pack 4(Current) Godzilla

Current issues Revision pack 4(Current) GH Articles

Four evening online sequence


Evening Subject Kit Q Exam Q Q Name



2 Group B/S 58 1(Groups) Rose



Mixed Standards 68 June 2012 3(Mix) Ethan

4 Current issues Revision pack 4(Current) Godzilla

Current issues Revision pack 4(Current) GH

Articles


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REVISION FOCUS

The following revision sequence is comprehensive. The questions cover all the

content. But as you are revising remember to go back to the class questions to

ensure that the stuff you learnt in class is accessible to you in the exam. Then

once you are comfortable with all the questions you have done with me, it is time

to turn to the supplementary questions. The effect of this is that there are three

bodies of questions with which you should be intimately familiar. In order of

importance they are:-

(1) the revision questions

(2) the class questions

(3) the supplementary questions.

Supplementary Questions

The above revision sequence is intended to be largely comprehensive. In other

words, there is little new to learn once you have repeated the above and the class

questions until you know them. However, because I have done all the above for

you first, if you limit yourself to the above then you will never have to think for

yourself until you are in the exam.

So, I suggest that all the more recent exam questions since December 2007

(question 30 in the kit) are all valid and will improve your chances of passing P2. It

probably makes sense to work backwards from the more recent questions simply

because of the examiners forward thinking brain being reflected in the exams the

examiner sets. Also it probably makes sense to focus on the narrative questions

from the B section as most students improve most noticeably in their narrative

answers when they apply themselves to these questions as the exam approaches.


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RECENT EXAM CONTENT

Q June 2011 Dec 2011 June 2012 Dec 2012 June 2013 Dec 2013 June 2014 Dec 2014

1

Rose Fairly straight b/s with a foreign sub and transfers

Traveler Straight b/s with segments and ethics

Robby Group B/S with plenty going on, plus a difficult discussion of derecognition

Minny B/S with lots of impairment

Trailer Complex b/s with lots and lots to do

Angel Accessible cfs with plenty to do and solid discussion on cash and ethics.

Marchant Challenging p/l very similar to earlier q Ashanti.

Joey Awkward b/s with sbp and ethics

2

Lockfine First time adoption

Decany Horrid group restructure

William Lovely mix of leases, pensions, sbp & provisions

Coate Messy mix with JV, intangibles and forex.

Verge Lovely mix question with segments revenue and other stuff

Havana Challenging mix question with leases revenue and other stuff.

Aspire Wide ranging mix question with a heavy slant towards currency.

Coatmin Challenging banking mix

3

Alexandra Classic mix question with usual suspects

Scramble Challenging mix with lots of intangibles

Ethan Technical mix of goodwill, dt, FVO and equity

Blackcutt Mix of nca with impairment, provisions and others.

Janne Good mix question with leasing FVM and other stuff

Bental Absolutely rock hard mix on debt reverse acquisitions and hedging!!

Minco Hard mix question with lots to talk about but getting really tough at end.

Kayte Challenging mix in shipping industry

4

Grainger Lovely FI question addressing IFRS9 and current issues

Venue Lovely revenue development

Royan Surprise subject of provisions

Jayach Lovely fvm.

Lizzer Solid current issues question on presentation and clutter

Zack Solid current issues question on judgement and policies

Avco Good question on the mind bending problem of debt v

equity.

Estoil Solid current issue on impairment


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EXAM TIPS

The tips derived from the above are therefore as follows. Tips do not tend to

change much from sitting to sitting because the same stuff stays current in the

examiners mind for years. Use the above table to see if you agree with me. Maybe

you have different gut feelings.

Question Top Tips

1 (groups) Position statement Cash flow statement Performance statement

2 (mix) Usual suspects

3 (mix) Usual suspects

4 (Current Issues) Integrated reporting Equity accounting Framework & Sploci

SMEs Leases Changes Groups (JA + Subs + Associates) Financial instrument impairment (see Q Grainger June 2011) Revenue (see Q Venue December 2011)

But watch out! All the above could be wrong. So make sure you go through all the

revision questions, class questions and supplementary questions. Then you should

still be fine.


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QUESTION SPOTTERS

For those super obsessive question spotters amongst you, here is the full list of

question one formats over recent years:-

Year Sitting Question Subject

2014 D Joey b/s

2014 J Marchant i/s

2013 D Angel cfs

2013 J Trailer b/s

2012 D Minny b/s

2012 J Robby b/s

2011 D Traveler b/s

2011 J Rose b/s

2010 D Jocatt cfs

2010 J Ashanti i/s

2009 D Grange b/s

2009 J Bravado b/s

2008 D Warrburt cfs

2008 J Ribby b/s

2007 D Beth b/s

2007 J Glove b/s

2006 D Andash cfs

2006 J Ejoy i/s

2005 D Lateral b/s

2005 J Jay b/s

2004 D AAP cfs

2004 J Memo b/s

2003 D Largo b/s

2003 J Base i/s

Please feel free to make of that what you will!


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EXAM ADVICE

Here is some very basic exam advice that despite its simplicity is often the

difference between a pass and a fail:

Question selection

This is a tricky but important subject. The hardest question in the B section in

recent past has been the mix question (also known as the industry question or the

analysis question). So try and prepare yourself for all styles of question. Students

during class tend to shy away from the current issues question because of its

narrative content. But try to overcome this as this question is often the easiest on

the paper.

Reading time

Use this to decide which questions to do and in which order. Then allocate your

time on the question paper, so that you know to the very minute when your time is

up on each question.

Time

Perhaps the most important advice of all is stick to the timings of questions. The

examiner actively encourages markers to be very generous with weak answers and

hard on excellent answers. This means if you have 8 out of 10, you are unlikely to

persuade the marker to give away another mark. But in the first few lines of the

next answer, the marker will be keen to give you marks.

Completeness

Closely related to the above is completeness. Make sure you answer 100 marks,

especially those parts of the exam where you feel weak and know you are

guessing. This leads to the next point.

Write anything

Obviously it is always best to write the correct answer. But if you really have no

clue, write something anyway. Not only might you strike lucky and get the answer

correct, you will also find markers are generous even when you are wrong.

Requirements

Really try to answer the requirements. A nice simple answer directly answering the

question will always score higher than irrelevant technical wizardry.

Write clearly

The new online marking has many advantages, but one definite disadvantage is the

quality of the image. Dont worry, image quality is not bad. But its very definitely not the same as looking at the original scripts. This has no negative impact on

clear scripts, but makes scribbled chaotic scrawl even harder to mark.


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Write big

Another down side of online marking is the default image size. Its about A5. That is, the scripts appear on the markers screens at half the original size that you see

when you write the script on exam day. Markers can zoom in, but the functionality

of this is jerky and so many markers like, where possible, to view a virtual page in

its entirety. If you can make this possible for them, they will really appreciate it.

You make this possible by writing big (and clear). Writing does not have to be

enormous, but the classic 8 words per line looks just great on screen.

Alternate lines

This advice only applies to those who know they have a tendency to write small. If

you are that student, then force yourself to write bigger by skipping every alternate

line during your narrative answers.

Number circles

At the top of every page are the number circles. They are for you to communicate

the question you are doing. Use the circles. Markers dont want to guess which question you are answering.

Question per page

When starting a new question always start a new page. You can do this for each

part of each question. I think this helps with clarity, but this is not vital. But every

time you start a new question, you must start a new page.

Blank pages

The online system copes fine with blank pages. Try to keep them minimal, but use

them if you find them useful.

Continuity

Once you start a question, try to finish it. Do the individual parts in any order. So

for example, answering q3b followed by q3a followed by q3d followed by q3c is

perfectly acceptable. But dont throw q4a in the middle of that lot!

Volume

Write as much as you feel comfortable writing. Just make sure you answer all the

questions in full and give the markers sufficient ideas to give you marks. Some

students are unbelievably concise and score good marks in half a booklet (12

pages). Others need three booklets (24+6+6 pages). But if I can be so bold, I

suggest you are looking to fill one booklet (24 pages).

Balance

Try to balance the effort to the number of marks. It is shocking to see the number

of students who write twice as much for their 4 mark answer as they do for their 8

mark answer.

Finally, good luck

Martin


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SMALL AND MEDIUM ENTITIES

But another big political issue is the accounting for SMEs. It is widely accepted that

IFRS are bulky and the presentation of fs using IFRS is a substantial bureaucratic

burden. Large companies are big enough to shoulder this burden, but small and

medium companies feel this expense disproportionately because of their size.

So many countries have utilised a two tier accounting system widely called big

GAAP little GAAP (generally accepted accounting principles). Each country has set

a threshold above which companies are required to produce full fs using full IFRS

(or equivalent) and below which companies are required to produce reduced fs with

less disclosure. This makes SME accounting much cheaper in these countries.

The IASB have until recently ignored this issue. However, following extreme

pressure, they have reviewed the problem and a Standard has resulted. It

proposes that all companies should be able to produce reduced fs, provided they

are not public interest companies (that is, not quoted or offering financial services).

So unless your company is quoted or offering financial services, then it is an SME

and can produce reduced fs.

However, the IFRS for SMEs has been widely criticised because the reduced fs are

very little reduced from the full fs. This means that even if your company qualifies

as SME, you will produce fs just as bulky as would have been required had your

company failed to qualify.

Simplifications

Some of the main simplification in the IFRS for SMEs are as follows:-

(1) Goodwill recognition

Partial method recognition is required (see Basic Groups Chapter).

(2) Goodwill amortisation

Amortisation is required (over 10 years) to avoid the annual impairment test.

(3) PPE Model

Only the cost model is allowed.

(4) Investment Property Model

Only the fair value model is allowed.

(5) Borrowing Costs

The capitalisation of finance cost on PPE is not allowed.

(6) Development

Development is written off like research.

Article

An article here written by the examiner gives more detail.


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ACOUNTING & BUSINESS

The examiner writes monthly for A&B. Here is a selection of potentially relevant

articles.

For more articles by the examiner go to the ACCA CPD webpage and scroll down

picking out the corporate reporting articles. Here is the link:-

http://www.accaglobal.com/gb/en/member/accounting-business/ab-cpd.html

or just search acca cpd.


14

INTEGRATED REPORTING

Here is an article by Graham Holt.

The International Integrated Reporting Council (IIRC) has recently released a

framework for integrated reporting. This follows a three-month global consultation

and trials in 25 countries. The framework establishes principles and concepts that

govern the overall content of an integrated report.

An integrated report sets out how the organisation's strategy, governance,

performance and prospects lead to the creation of value. There is no benchmarking

for the above matters and the report is aimed primarily at the private sector, but it

could be adapted for public sector and not-for-profit organisations.

The primary purpose of an integrated report is to explain to providers of financial

capital how an organisation creates value over time. An integrated report benefits

all stakeholders interested in a company's ability to create value, including

employees, customers, suppliers, business partners, local communities, legislators,

regulators and policymakers, although it is not directly aimed at all stakeholders.

Providers of financial capital can have a significant effect on the capital allocation

and attempting to aim the report at all stakeholders would be an impossible task

and would reduce the focus and increase the length of the report. This would be

contrary to the objectives of the report, which is value creation.

Historical financial statements are essential in corporate reporting, particularly for

compliance purposes, but do not provide meaningful information regarding business

value. Users need a more forward-looking focus without the necessity of companies

providing their own forecasts.

Companies have recognised the benefits of showing a fuller picture of company

value and a more holistic view of the organisation. The International Integrated

Reporting Framework will encourage the preparation of a report that shows their

performance against strategy, explains the various capitals used and affected, and

gives a longer-term view of the organisation. The integrated report is creating the

next generation of the annual report as it enables stakeholders to make a more

informed assessment of the organisation and its prospects.

CULTURE CHANGE

The IIRC has set out a principle-based framework rather than specifying a detailed

disclosure and measurement standard. This enables each company to set out its

own report rather than adopt a checklist approach. The culture change should

enable companies to communicate their value creation better than the often

boilerplate disclosures under International Financial Reporting Standards (IFRS).

The report acts as a platform to explain what creates the underlying value in a

business and how management protects this value. This gives the report more

business relevance than the compliance-led approach currently used. Integrated

reporting will not replace other forms of reporting, but the vision is that preparers

will pull together relevant information already produced to explain the key drivers

of their business's value.


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Information will only be included in the report where it is material to the

stakeholder's assessment of the business. There were concerns that the term

'materiality' had a certain legal connotation, with the result that some entities may

feel they should include regulatory information in the integrated report. However,

the IIRC concluded that the term should continue to be used in this context as it is

well understood.

The integrated report aims to provide an insight into the company's resources and

relationships which are known as the capitals and how the company interacts with

the external environment and the capitals to create value. These capitals can be

financial, manufactured, intellectual, human, social and relationship, and natural

capital, but companies need not adopt these classifications. The purpose of this

framework is to establish principles and content that governs the report, and to

explain the fundamental concepts that underpin them. The report should be

concise, reliable and complete, including all material matters, both positive and

negative, and presented in a balanced way without material error.

KEY COMPONENTS

Integrated reporting is built around the following key components:

Organisational overview and the external environment under which it operates.

Governance structure and how this supports its ability to create value.

Business model.

Risks and opportunities and how they are dealing with them and how they affect

the company's ability to create value.

Strategy and resource allocation.

Performance and achievement of strategic objectives for the period and outcomes.

Outlook and challenges facing the company and their implications.

The basis of presentation needs to be determined, including what matters are to be

included in the integrated report and how the elements are quantified or evaluated.

The framework does not require discrete sections to be compiled in the report, but

there should be a high-level review to ensure that all relevant aspects are included.

The linkage across the above content can create a key storyline and can determine

the major elements of the report, such that the information relevant to each

company would be different.

An integrated report should provide insight into the nature and quality of the

organisation's relationships with its key stakeholders, including how and to what

extent the organisation understands, takes into account and responds to their

needs and interests. Furthermore, the report should be consistent over time to

enable comparison with other entities.

An integrated report may be prepared in response to existing compliance

requirements; for example, a management commentary. Where that report is also

prepared according to the framework or even beyond the framework, it can be

considered an integrated report. An integrated report may be either a standalone

report or be included as a distinguishable part of another report or communication.

For example, it can be included in the company's financial statements.


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NATURE OF VALUE

The IIRC considered the nature of value and value creation. These terms can

include the total of all the capitals, the benefit captured by the company, the

market value or cashflows of the organisation, and the successful achievement of

the company's objectives. However, the conclusion reached was that the framework

should not define value from any one particular perspective, because value depends

upon the individual company's own perspective. It can be shown through

movement of capital and can be defined as value created for the company or for

others. An integrated report should not attempt to quantify value, as assessments

of value are left to those using the report.

Many respondents felt that there should be a requirement for a statement from

those 'charged with governance' acknowledging their responsibility for the

integrated report in order to ensure the reliability and credibility of the integrated

report. Additionally it would increase the accountability for the content of the

report.

The IIRC feels that the inclusion of such a statement may result in additional

liability concerns, such as inconsistency with regulatory requirements in certain

jurisdictions and could lead to a higher level of legal liability. The IIRC also felt that

the above issues might result in a slower take-up of the report and decided that

those 'charged with governance' should, in time, be required to acknowledge their

responsibility for the integrated report, while at the same time recognising that

reports in which they were not involved would lack credibility.

There has been discussion about whether the framework constitutes suitable

criteria for report preparation and for assurance. The questions asked concerned

measurement standards to be used for the information reported and how a

preparer can ascertain the completeness of the report.

FUTURE DISCLOSURES

There were concerns over the ability to assess future disclosures, and

recommendations were made that specific criteria should be used for measurement,

the range of outcomes and the need for any confidence intervals to be disclosed.

The preparation of an integrated report requires judgment, but there is a

requirement for the report to describe its basis of preparation and presentation,

including the significant frameworks and methods used to quantify or evaluate

material matters. Also included is the disclosure of a summary of how the company

determined the materiality limits and a description of the reporting boundaries.

The IIRC has stated that the prescription of specific key KPIs (key performance

indicators) and measurement methods is beyond the scope of a principles-based

framework. The framework contains information on the principle-based approach

and indicates that there is a need to include quantitative indicators whenever

practicable and possible. Additionally, consistency of measurement methods across

different reports is of paramount importance. There is outline guidance on the

selection of suitable quantitative indicators.


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A company should consider how to describe the disclosures without causing a

significant loss of competitive advantage. The entity will consider what advantage a

competitor could actually gain from information in the integrated report, and will

balance this against the need for disclosure.

Companies struggle to communicate value through traditional reporting. The

framework can prove an effective tool for businesses looking to shift their reporting

focus from annual financial performance to long-term shareholder value creation.

The framework will be attractive to companies who wish to develop their narrative

reporting around the business model to explain how the business has been

developed.


18

EQUITY ACCOUNTING

Here is another article by Graham Holt

With IAS 28 now in force, its a good time to consider how it affects you. But be

prepared not everything in the standard is as cut and dried as might be hoped,

says Graham Holt

In May 2011, the International Accounting Standards Board (IASB) issued a new

version of IAS 28, Investments in Associates and Joint Ventures, that requires both

joint ventures and associates to be equity-accounted. The standard is effective from

1 January 2013 and entities need to be aware of its implications, although the EU

has endorsed IAS 28 from 1 January 2014.

An associate is an entity in which the investor has significant influence, but which is

neither a subsidiary nor a joint venture of the investor. 'Significant influence' is the

power to participate in the financial and operating policy decisions of the investee,

but not to control those policy decisions. It is presumed to exist when the investor

holds at least 20% of the investee's voting power. If the holding is less than 20%,

the entity will be presumed not to have significant influence unless such influence

can be clearly demonstrated. A substantial or majority ownership by another

investor does not preclude an entity from having significant influence.

Loss of influence

An entity loses significant influence over an investee when it loses the power to

participate in the financial and operating policy decisions of that investee. The loss

of significant influence can occur with or without a change in absolute or relative

ownership levels.

A joint venture is defined as a joint arrangement where the parties in joint control

have rights to the net assets of the joint arrangement. Associates and joint

ventures are accounted for using the equity method unless they meet the criteria to

be classified as 'held for sale' under IFRS 5, Non-current Assets Held for Sale and

Discontinued Operations.

On initial recognition, the investment in an associate or a joint venture is

recognised at cost, and the carrying amount is increased or decreased to recognise

the investor's share of the profit or loss of the investee after the date of acquisition.

IFRS 9, Financial Instruments, does not apply to interests in associates and joint

ventures that are accounted for using the equity method.

Instruments containing potential voting rights in an associate or a joint venture are

accounted for in accordance with IFRS 9 unless they currently give access to the

returns associated with an ownership interest in an associate or a joint venture. An

entity's interest in an associate or a joint venture is determined solely on the basis

of existing ownership interests and, generally, does not reflect the possible exercise

or conversion of potential voting rights.


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Investments in associates or joint ventures are classified as non-current assets

inclusive of goodwill on acquisition and presented as one-line items in the

statement of financial position. The investment is tested for impairment in

accordance with IAS 36, Impairment of Assets, as single assets, if there are

impairment indicators under IAS 39, Financial Instruments: Recognition and

Measurement.

The entire carrying amount of the investment is tested for impairment as a single

asset - that is, goodwill is not tested separately. The recoverable amount of an

investment in an associate is assessed for each individual associate or joint

venture, unless the associate or joint venture does not generate cashflows

independently.

IFRS 5 applies to associates and joint ventures that meet the classification criteria.

Any portion of the investment that has not been classified as held for sale is still

equity-accounted until the disposal. After disposal, if the retained interest continues

to be an associate or joint venture, it is equity-accounted.

Under the previous version of the standard, the cessation of significant interest or

joint control triggered remeasurement of any retained investment even where

significant influence was succeeded by joint control. IAS 28 now requires that any

retained interest is not remeasured. If an entity's interest in an associate or joint

venture is reduced but the equity method continues to be applied, then the entity

reclassifies to profit or loss the proportion of the gain or loss previously recognised

in other comprehensive income relative to that reduction in ownership interest.

Consolidation parallels

The IASB states that many of the procedures appropriate for equity accounting are

similar to those for consolidation of entities and the concepts used in accounting for

the acquisition of a subsidiary are also applicable to the acquisition of an associate

or joint venture.

However, it is not always appropriate to apply IFRS 10, Consolidated Financial

Statements, or IFRS 3, Business Combinations. There is disagreement over whether

equity accounting is a one-line consolidation or a valuation approach. When an

associate is impairment-tested, it is treated as a single asset and not as a collection

of assets as would be the case under acquisition accounting.

Additionally as associates and joint ventures are not part of the group, not all of the

consolidation principles will apply in the context of equity accounting.

There is no definition of the cost of an associate or joint venture in IAS 28. There is

debate over whether costs should be defined as including the purchase price and

other costs directly attributable to the acquisition such as professional fees and

other transaction costs. It might be appropriate to include transaction costs in the

initial cost of an equity-accounted investment, but IFRS 3 would require these to be

expensed if they relate to the acquisition of businesses. IFRS 9 includes directly

attributable transaction costs in the initial value of the investment.


20

IAS 28 states that profits and losses resulting from 'upstream' and 'downstream'

transactions between an investor (including its consolidated subsidiaries) and an

associate or joint venture are recognised only to the extent of the unrelated

investors' interests in the associate or joint venture. Upstream transactions are

sales of assets from an associate to the investor and downstream transactions are

sales of assets by the investor to the associate.

Elimination

There is no specific guidance on how the elimination should be carried out but

generally in the case of downstream transactions any unrealised gains should be

eliminated against the carrying value of the associate. In the case of upstream

transactions any unrealised gains could be eliminated either against the carrying

value of the associate or against the asset transferred.

The standards are currently unclear on whether this elimination also applies to

unrealised gains and losses arising on transfer of subsidiaries, joint ventures and

associates. An example would be where an investor sells its subsidiary to its

associate and the question would be whether part of the gain on the transaction

should be eliminated.

There is an inconsistency between guidance dealing with the loss of control of a

subsidiary and the restrictions on recognising gains and losses arising from sales of

non-monetary assets to an associate or a joint venture. IFRS 10 requires

recognition of both the realised gain on disposal and the unrealised holding gain on

the retained interest. In contrast, IAS 28 requires gains or losses on the sale of a

non-monetary asset to an associate or a joint venture to be recognised only to the

extent of the other party's interest.

The IASB accordingly issued an exposure draft in December 2012 stating that any

gain or loss resulting from the sale of an asset that does not constitute a business

between an investor and its associate or joint venture should be partially

recognised. However, any gain or loss arising from the sale of an asset that does

constitute a business between an investor and its associate or joint venture should

be fully recognised.

IFRS 3 defines a business as an integrated set of activities and assets that is

capable of being conducted and managed for the purpose of providing a return

directly to investors or other owners, members or participants.

Under the equity method, the investment is initially recognised at cost and adjusted

to recognise the investor's share of the profit or loss and other comprehensive

income (OCI) of the investee. Additionally, the investment is reduced by

distributions received from the invest.

However, IAS 28 is silent on how to treat other changes in the net assets of the

investee in the investor's accounts, which might include:

issues of additional share capital to parties other than the investor;

buybacks of equity instruments from shareholders other than the investor;

writing of a put option over the investee's own equity instruments to other

shareholders;

purchase or sale of non-controlling interests in the investee's subsidiaries'

equity-settled share-based payments.


21

Inconsistent

The IASB proposed in an exposure draft issued in November 2012 that an investor's

share of certain net asset changes in the investee should be recognised in the

investor's equity. The draft contains an alternative view by one board member who

believes the amendment to be inconsistent with the concepts of IAS 1 and IFRS 10,

and would cause serious conceptual confusion. This board member believes this

short-term solution would not improve financial reporting and would undermine a

basic concept of consolidated financial statements.

The draft notes that an investor may discontinue the use of the equity method for

various reasons including where the investment in the investee becomes a

subsidiary or a financial asset. The draft proposes that an investor should reclassify

to profit or loss the cumulative amount of other net asset changes previously

recognised in the investor's equity when an investor discontinues the use of the

equity method for any reason.


22

REALIGNING THE FRAMEWORK

By Graham Holt

Graham Holt examines the discussion paper on the conceptual framework for

financial reporting issued by the IASB in July

In July 2013 the International Accounting Standards Board (IASB) issued a

discussion paper on a new version of its conceptual framework, which provides the

fundamental basis for development of International Financial Reporting Standards

(IFRS).

The discussion paper gives users and preparers of financial statements an

opportunity to offer input into the direction of financial reporting standards. The

paper sets out the fundamental principles of accounting necessary to develop

robust and consistent standards. While it lacks the immediacy of other IASB

proposals, it will nevertheless be a significant long-term influence on the direction

that accounting standards will take.

The paper introduces revised thinking on the reporting of financial performance, the

measurement of assets and liabilities, and presentation and disclosure. The paper

proposes that the primary purpose of the framework - which underpins the

accounting standards - is to identify consistent principles that the IASB can use in

developing and revising those standards. The framework may also help in

understanding and interpreting the standards.

The IASB framework was originally published in the late 1980s. In 2010 two

chapters of a new framework were issued: Chapter 1, The Objective of General

Purpose Financial Reporting, and Chapter 3, Qualitative Characteristics of Useful

Financial Information. There are no plans for a fundamental reconsideration of

these chapters. The concept of a reporting entity is not considered in the discussion

paper because the exposure draft of 2010 is to be used, with related feedback, in

developing guidance in this area.

The discussion paper proposes to redefine assets and liabilities as:

An asset is a present economic resource controlled by the entity because of past

events.

A liability is a present obligation of the entity to transfer an economic resource

because of past events.

An 'economic resource', it should be noted, is a right, or other source of value, that

is capable of producing economic benefits.

Currently the definitions of assets and liabilities require a probable expectation of

future economic benefits or resource outflow. The IASB's initial view is that the

definitions of assets and liabilities should not require an expected or probable inflow

or outflow as it should be sufficient that a resource or obligation can produce or

result in a transfer of economic benefits. Thus, a guarantee could qualify as a

liability even though the obligation to transfer resources is conditional. However,

the measurement of an asset or liability will be affected by the potential outcome.

The IASB still believes that a liability should not be defined as limited to obligations

that are enforceable against the entity.


23

Under the discussion paper, constructive obligations would qualify as liabilities.

Liabilities would not arise where there is an economic necessity to transfer an

economic resource unless there is an obligation to do so. Thus a group

reconstruction would not necessarily create a liability.

However, the IASB believes that certain avoidable obligations could qualify as a

liability - for example, directors' bonuses depending on employment conditions. No

decision has been made on whether the definition of a liability should be limited to

obligations that the entity has no practical ability to avoid or should include

conditional obligations resulting from past events.

The discussion paper sets out that the framework's definition of control should be in

line with its definition of an asset. An entity controls an economic resource if it has

the present ability to direct the resource's use so as to obtain economic benefits

from it. The exposure draft on revenue recognition uses the phrase 'substantially

all' when referring to benefits from the asset but the IASB feels this phrase in this

context would be confusing as an entity would recognise only the rights which it

controls. For example, if an entity has the right to use machinery on one working

day per week, then it should recognise 20% of the economic benefits (assuming a

five-day working week) as it does not have all or substantially all of the economic

benefits of the machinery.

The discussion paper proposes that equity remain defined as being equal to assets

less liabilities. However, the paper does propose that an entity be required to

present a detailed statement of changes in equity that provides more information

regarding different classes of equity, and the transfers between these different

classes.

The distinction between equity and liabilities focuses on the definition of a liability.

The current guidance on the difference between equity and liability is complicated.

The paper identifies two types of approach: narrow equity and strict obligation.

The narrow equity approach treats equity as being only the residual class issued,

with changes in the measurement of other equity claims recognised in profit or loss.

Under the strict obligation approach, all equity claims are classified as equity with

obligations to deliver cash or assets being classified as liabilities. Any changes in

the measurement of equity claims would be shown in the statement of changes in

equity.

If the latter approach were adopted, certain transactions (eg the issuance of a

variable number of equity shares worth a fixed monetary amount) currently classed

as liabilities would not be so designated because they do not involve an obligation

to transfer cash or assets.

The IASB has come to the view that the objective of measurement is to contribute

to the faithful representation of relevant information about the resources of the

entity, claims against the entity and changes in resources and claims, and about

how efficiently and effectively the entity's management and governing board have

discharged their responsibilities to use the entity's resources. The IASB believes

that a single measurement basis may not provide the most relevant information for

users.


24

When selecting the measurement basis, the information that measurement will

produce in both the statement of financial position and the statement of profit or

loss and other comprehensive income (OCI) should be considered. Further, the

selection of a measurement of a particular asset or a particular liability should

depend on how that asset contributes to the entity's future cashflows and how the

entity will settle or fulfil that liability.

NARROW AND BROAD

The current framework does not contain principles to determine the items to be

recognised in profit or loss, and in OCI and whether, and when, items can be

recycled from OCI to profit or loss. In terms of what items would be included in

OCI, the paper proposes two approaches: 'narrow' and 'broad'.

Under the narrow approach, OCI would include bridging items and mismatched

remeasurements. OCI would be used to bridge a measurement difference between

the statement of financial position and the statement of profit or loss. This would

include, for example, investments in financial instruments with profit or losses

reported through OCI. Mismatched remeasurements occur when the item of income

or expense represents the effects of part of a linked set of assets, liabilities or past

or planned transactions. It represents their effect so incompletely that, in the

opinion of the IASB, the item provides little relevant information about the return

the entity has made on its economic resources in the period.

An example is a cashflow hedge where fair value gains and losses are deferred in

OCI until the hedged transaction affects profit or loss. The paper suggests that

under the narrow OCI approach, an entity should subsequently have to recycle

amounts from OCI to profit or loss; and under the mismatched remeasurements

approach the amount should be recycled when the item can be presented with the

matched item.

The issue that arises here is that, under the narrow approach, the treatment of

certain items would be inconsistent with current IFRS - eg revaluation gains and

losses for property, plant and equipment.

The paper also sets out a third category - 'transitory remeasurements'. These are

remeasurements of long-term assets and liabilities that are likely to reverse or

significantly change over time. These items would be shown in OCI - for example,

the remeasurement of a net defined pension benefit liability or asset. The IASB

would decide in each IFRS whether a transitory remeasurement should be

subsequently recycled. However, the IASB has not yet determined which approach

it will use.


25

RECOGNITION

Recognition and derecognition deals with the principles and criteria for assets and

liabilities to be included or removed from an entity's financial statements. The

paper sets out to bring this into line with the principles used in IASB's current

projects. It proposes that assets and liabilities should be recognised by an entity,

unless that results in irrelevant information, the costs outweigh the benefits, or the

measure of information does not represent the transaction faithfully enough.

Derecognition is not currently addressed in the framework and the paper proposes

derecognition should occur when the recognition criteria are no longer met. The

question for the IASB is whether to replace the current concept based on the loss of

the economic risks and benefits of the asset with the concept based on the loss of

control over the legal rights comprised in the asset. A concept based on control

over the legal rights could result in several items going off balance sheet.

Proposed revisions to the disclosure framework include the objective of the primary

financial statements, the objective of the notes to the financial statements,

materiality and communication principles. The IASB has also identified both short-

term and long-term steps for addressing disclosure requirements in existing IFRS.

These proposals are an attempt to make the conceptual framework a blueprint for

developing consistent, high-quality, principles-based accounting standards. It is

important that there is dialogue about the whole of IFRS and for the IASB to

achieve buy-in to its core principles by enabling constituents to help shape the

future of IFRS.


26

SPLOCI

This is essentially an extension of the framework article by Graham Holt

The purpose of the statement of profit or loss and other comprehensive income

(OCI) is to show an entity's financial performance in a way that is useful to a wide

range of users so they may attempt to assess the future net cash inflows of an

entity. The statement should be classified and aggregated in a manner that makes

it understandable and comparable.

International Financial Reporting Standards (IFRS) currently require that the

statement be presented as either one statement, being a combined statement of

profit or loss and other comprehensive income, or two statements, being the

statement of profit or loss and the statement of other comprehensive income. An

entity has to show separately in OCI, those items which would be reclassified

(recycled) to profit or loss and those items which would never be reclassified

(recycled) to profit or loss. The related tax effects have to be allocated to these

sections.

Profit or loss includes all items of income or expense (including reclassification

adjustments) except those items of income or expense that are recognised in OCI

as required or permitted by IFRS.

Reclassification adjustments are amounts recycled to profit or loss in the current

period that were recognised in OCI in the current or previous periods. An example

of items recognised in OCI that may be reclassified to profit or loss are foreign

currency gains on the disposal of a foreign operation and realised gains or losses on

cashflow hedges. Those items that may not be reclassified are changes in a

revaluation surplus under IAS 16, Property, Plant and Equipment, and actuarial

gains and losses on a defined benefit plan under IAS 19, Employee Benefits.

However, there is a general lack of agreement about which items should be

presented in profit or loss and in OCI. The interaction between profit or loss and

OCI is unclear, especially the notion of reclassification and when or which OCI items

should be reclassified.

A common misunderstanding is that the distinction is based on realised versus

unrealised gains. This lack of a consistent basis for determining how items should

be presented has led to an inconsistent use of OCI in IFRS. It may be difficult to

deal with OCI on a conceptual level since the International Accounting Standards

Board (IASB) is finding it difficult to find a sound conceptual basis.

However, there is urgent need for some guidance around this issue.

Opinions vary, but there is a feeling that OCI has become a 'dumping ground' for

anything controversial because of a lack of clear definition of what should be

included in the statement. Many users are thought to ignore OCI as the changes

reported are not caused by the operating flows used for predictive purposes.


27

Financial performance is not defined in the Conceptual Framework, but could be

viewed as reflecting the value the entity has generated in the period and this can

be assessed from other elements of the financial statements and not just the

statement of comprehensive income. Examples would be the statement of

cashflows and disclosures relating to operating segments. The presentation in profit

or loss and OCI should allow a user to depict financial performance, including the

amount, timing and uncertainty of the entity's future net cash inflows and how

efficiently and effectively the entity's management have discharged their duties

regarding the resources of the entity.

There are several arguments for and against reclassification. If reclassification

ceased, there would be no need to define profit or loss, or any other total or

subtotal in profit or loss, and any presentation decisions can be left to specific

IFRSs. It is argued that reclassification protects the integrity of profit or loss and

provides users with relevant information about a transaction that occurred in the

period. Additionally, it can improve comparability where IFRS permits similar items

to be recognised in either profit or loss or OCI.

Those against reclassification argue that the recycled amounts add to the

complexity of financial reporting, may lead to earnings management, and the

reclassification adjustments may not meet the definitions of income or expense in

the period as the change in the asset or liability may have occurred in a previous

period.

The original logic for OCI was that it kept income-relevant items that possessed low

reliability from contaminating the earnings number.

Markets rely on profit or loss and it is widely used. The OCI figure is crucial because

it can distort common valuation techniques used by investors, such as the

price/earnings ratio. Thus, profit or loss needs to contain all information relevant to

investors. Misuse of OCI would undermine the credibility of net income. The use of

OCI as a temporary holding for cashflow hedging instruments and foreign currency

translation is non-controversial.

However, other treatments such as the policy of IFRS 9 to allow value changes in

equity investments to go through OCI, are not accepted universally.

US GAAP will require value changes in all equity investments to go through profit or

loss. Accounting for actuarial gains and losses on defined benefit schemes are

presented through OCI and certain large US corporations have been hit hard with

the losses incurred on these schemes. The presentation of these items in OCI would

have made no difference to the ultimate settled liability, but if they had been

presented in profit or loss the problem may have been dealt with earlier. An

assumption that an unrealised loss has little effect on the business is an incorrect

one.

The discussion paper on the Conceptual Framework considers three approaches to

profit or loss and reclassification. The first approach prohibits reclassification. The

other approaches, the narrow and broad approaches, require or permit

reclassification. The narrow approach allows recognition in OCI for bridging items or

mismatched remeasurements, while the broad approach has an additional category

of 'transitory measurements' (for example, remeasurement of a defined benefit

obligation), which would allow the IASB greater flexibility. The narrow approach

significantly restricts the types of items that would be eligible to be presented in

OCI and gives the IASB little discretion when developing or amending IFRSs.


28

A bridging item arises where the IASB determines that the statement of

comprehensive income would communicate more relevant information about

financial performance if profit or loss reflected a different measurement basis from

that reflected in the statement of financial position. For example, if a debt

instrument is measured at fair value in the statement of financial position, but is

recognised in profit or loss using amortised cost, then amounts previously reported

in OCI should be reclassified into profit or loss on impairment or disposal of the

debt instrument.

The IASB argues that this is consistent with the amounts that would be recognised

in profit or loss if the debt instrument were to be measured at amortised cost.

A mismatched remeasurement arises where an item of income or expense

represents an economic phenomenon so incompletely that presenting that item in

profit or loss would provide information that has little relevance in assessing the

entity's financial performance. An example of this is when a derivative is used to

hedge a forecast transaction; changes in the fair value of the derivative may arise

before the income or expense resulting from the forecast transaction.

The argument is that before the results of the derivative and the hedged item can

be matched together, any gains or losses resulting from the remeasurement of the

derivative, to the extent that the hedge is effective and qualifies for hedge

accounting, should be reported in OCI. Subsequently those gains or losses are

reclassified into profit or loss when the forecast transaction affects profit or loss.

This allows users to see the results of the hedging relationship.

The IASB's preliminary view is that any requirement to present a profit or loss total

or subtotal could also result in some items being reclassified. The commonly

suggested attributes for differentiation between profit or loss and OCI

(realised/unrealised, frequency of occurrence, operating/non-operating,

measurement certainty/uncertainty, realisation in the short/long-term or outside

management control) are difficult to distil into a set of principles.

Therefore, the IASB is suggesting two broad principles, namely:

Profit or loss provides the primary source of information about the return an entity

has made on its economic resources in a period. To support profit or loss, OCI

should only be used if it makes profit or loss more relevant.

The IASB feels that changes in cost-based measures and gains or losses resulting

from initial recognition should not be presented in OCI and that the results of

transactions, consumption and impairments of assets and fulfilment of liabilities

should be recognised in profit or loss in the period in which they occur. As a

performance measure, profit or loss is more used, although there are a number of

other performance measures derived from the statement of profit or loss and OCI.


29

IFRS FOR SMES

Here is an article by Graham Holt.

The principal aim when developing accounting standards for small- to medium-sized

enterprises (SMEs) is to provide a framework that generates relevant, reliable and

useful information, which should provide a high-quality and understandable set of

accounting standards suitable for SMEs. In July, the International Accounting

Standards Board (IASB) issued IFRS for Small and Medium-Sized Entities (IFRS for

SMEs). This standard provides an alternative framework that can be applied by

eligible entities in place of the full set of International Financial Reporting Standards

(IFRS).

IFRS for SMEs is a self-contained standard, incorporating accounting principles

based on existing IFRS, which have been simplified to suit the entities that fall

within its scope. There are a number of accounting practices and disclosures that

may not provide useful information for the users of SME financial statements. As a result, the standard does not address the following topics:

Earnings per share

Interim financial reporting

Segment reporting

Insurance (because entities that issue insurance contracts are not eligible to use the standard)

Assets held for sale.

In addition, there are certain accounting treatments that are not allowable under

the standard. Examples are the revaluation model for property, plant and

equipment and intangible assets, and proportionate consolidation for investments in

jointly controlled entities. Generally, there are simpler methods of accounting

available to SMEs than the disallowed accounting practices. The standard also

eliminates the 'available-for-sale' and 'held-to maturity' classifications of IAS 39, Financial Instruments: Recognition and Measurement.

All financial instruments are measured at amortised cost using the effective interest

method, except that investments in non-convertible and non-puttable ordinary and

preference shares that are publicly traded, or whose fair value can otherwise be

measured reliably, are measured at fair value through profit or loss. All amortised

cost instruments must be tested for impairment. At the same time, the standard

simplifies the hedge accounting and derecognition requirements. However, SMEs can also choose to apply IAS 39 in full.


30

The standard also contains a section on transition, which allows all of the

exemptions in IFRS 1, First-Time Adoption of International Financial Reporting

Standards. It also contains 'impracticability' exemptions for comparative

information and the restatement of the opening statement of financial position. As a

result of the above, IFRS require SMEs to comply with less than 10% of the volume of accounting requirements applicable to listed companies.

What is an SME?

There is no universally agreed definition of an SME. No single definition can capture

all the dimensions of a small- or medium-sized enterprise, nor can it be expected to

reflect the differences between firms, sectors, or countries at different levels of

development. Most definitions based on size use measures such as number of

employees, balance sheet total, or annual turnover. However, none of these

measures apply well across national borders. IFRS for SMEs is intended for use by

entities that have no public accountability (ie, their debt or equity instruments are not publicly traded).

Ultimately, the decision regarding which entities should use IFRS for SMEs stays

with national regulatory authorities and standard-setters. These bodies will often

specify more detailed eligibility criteria. If an entity opts to use IFRS for SMEs, it

must follow the standard in its entirety it cannot cherry pick between the requirements of IFRS for SMEs and the full set.

The IASB makes it clear that the prime users of IFRS are the capital markets. This

means that IFRS are primarily designed for quoted companies and not SMEs. The

vast majority of the world's companies are small and privately owned, and it could

be argued that full International Financial Reporting Standards are not relevant to

their needs or to their users. It is often thought that small business managers

perceive the cost of compliance with accounting standards to be greater than their

benefit. Because of this, the IFRS for SMEs makes numerous simplifications to the

recognition, measurement and disclosure requirements in full IFRS. Examples of these simplifications are:

Goodwill and other indefinite-life intangibles are amortised over their useful lives,

but if useful life cannot be reliably estimated, then 10 years.

A simplified calculation is allowed if measurement of defined benefit pension plan obligations (under the projected unit credit method) involve undue cost or effort.

The cost model is permitted for investments in associates and joint ventures.

The main argument for separate SME accounting standards is the undue cost

burden of reporting, which is proportionately heavier for smaller firms. The cost of

applying the full set of IFRS may simply not be justified on the basis of user needs.

Further, much of the current reporting framework is based on the needs of large

business, so SMEs perceive that the full statutory financial statements are less

relevant to the users of SME accounts. SMEs also use financial statements for a

narrower range of decisions, as they have less complex transactions and therefore

less need for a sophisticated analysis of financial statements. Therefore, the disclosure requirements in the IFRS for SMEs are also substantially reduced.


31

Differing approaches

Those who argue against different reporting requirements for SMEs say the system

could lead to a two-tier system of reporting. Entities should not be subject to

different rules, which could give rise to different 'true and fair views'.

There were a number of approaches that could have been taken to developing

standards for SMEs. An alternative could have been for generally accepted

accounting principles for SMEs to have been developed on a national basis, with

IFRS focusing on accounting for listed company activities. However, the main issue

here would be that the practices developed for SMEs may not have been consistent

and may have lacked comparability across national boundaries. Also, if an SME

wished to later list its shares on a capital market, the transition to IFRS could be

harder.

Under another approach, the exemptions given to smaller entities would have been

prescribed in the mainstream accounting standard. For example, an appendix could

have been included within the standard, detailing those exemptions given to

smaller enterprises. Yet another approach would have been to introduce a separate

standard comprising all the issues addressed in IFRS that were relevant to SMEs.

As it stands

IFRS for SMEs is a self-contained set of accounting principles, based on full IFRS,

but simplified so that they are suitable for SMEs. The standard has been organised

by topic with the intention that the standard is user-friendlier for preparers and

users of SME financial statements. IFRS for SMEs and full IFRS are separate and

distinct frameworks.

Therefore, the standard for SMEs is by nature not an independently developed set

of standards. It is based on recognised concepts and pervasive principles and it

allows easier transition to full IFRS if the SME later becomes a public listed entity.

In deciding on the modifications to make to IFRS, the needs of the users have been

taken into account, as well as the costs and other burdens imposed upon SMEs by

the IFRS.

Relaxation of some of the measurement and recognition criteria in IFRS had to be

made in order to achieve the reduction in these costs and burdens. Some disclosure

requirements are intended to meet the needs of listed entities, or to assist users in

making forecasts of the future. Users of financial statements of SMEs often do not

make these kinds of forecasts.

Small companies pursue different strategies, and their goals are more likely to be

survival and stability rather than growth and profit maximisation. The stewardship

function is often absent in small companies, with the accounts playing an agency

role between the owner-manager and the bank.

Where financial statements are prepared using the standard, the basis of

presentation note and the auditor's report will refer to compliance with IFRS for

SMEs. This reference may improve SME's access to capital. The standard also

contains simplified language and explanations of the standards.


32

The IASB has not set an effective date for the standard because the decision as to

whether to adopt IFRS for SMEs is a matter for each jurisdiction.

In the absence of specific guidance on a particular subject, an SME may, but is not

required to, consider the requirements and guidance in full IFRS dealing with

similar issues. The IASB has produced full implementation guidance for SMEs.

IFRS for SMEs is a response to international demand from developed and emerging

economies for a rigorous and common set of accounting standards for smaller and medium-sized enterprises that is much easier to use than the full set of IFRS.

It should provide improved comparability for users of accounts while enhancing the

overall confidence in the accounts of SMEs, and reduce the significant costs involved in maintaining standards on a national basis.


33

LEASES

As we wait for a definitive leasing standard, Graham Holt explores the original 2013

exposure draft and the current state of play

Leasing is an important activity for many organisations with the majority of leases

not currently reported on a lessees statement of financial position. The existing

accounting models for leases require lessees and lessors to classify their leases as

either finance leases or operating leases and to account for those leases differently.

The existing standards have been criticised for failing to meet the needs of users of

financial statements because they do not always provide a faithful representation of

leasing transactions.

The exposure draft (ED), Leases (May 2013), attempted to solve the lease

accounting problem by requiring an entity to classify leases into two types type A

and type B and recognise both types on the statement of financial position. The

ED was the result of a joint project by the International Accounting Standards

Board (IASB) and the US Financial Accounting Standards Boards (FASB) (the

boards).This article sets out the current deliberations of the boards as at the end of

2014 and, therefore, as such, the final leasing standard may vary from the

discussions below.

The ED sets out that type A leases would normally mean that the underlying asset

is not property, while type B leases mean that the underlying asset is property.

However, the entity classifies a lease other than a property lease as type B if the

lease term is for an insignificant part of the total economic life of the asset; or the

present value of the lease payments is insignificant relative to the fair value of the

underlying asset at the leases commencement date.

Conversely, the entity classifies a property lease as type A if the lease term is for

the major part of the remaining economic life of the underlying asset; or the

present value of the lease payments accounts for substantially all of the fair value

of the underlying asset at the commencement date. At this date, the lessee

discounts the lease payments using the rate the lessor charges the lessee, or if that

rate is unavailable, the lessees incremental borrowing rate.

The lessee recognises the present value of lease payments as a liability. At the

same time it recognises a right-of-use (ROU) asset equal to the lease liability, plus

any lease payments made to the lessor at or before the commencement date, less

any lease incentives received from the lessor; and any initial direct costs incurred

by the lessee. After the commencement date, the liability is increased by the

unwinding of interest and reduced by lease payments made to the lessor.

A lessee will recognise in profit or loss, for type A leases, the unwinding of the

discount on the lease liability as interest and the amortisation of the ROU asset

and, for type B leases, the lease payments will be recognised in profit or loss on a

straight-line basis over the lease term and reflected in profit or loss as a single

lease cost.

Following the feedback received on the ED, the FASB still remains supportive of the

dual-model approach to bringing leases on to the statement of financial position.


34

Under this approach, a lessee would account for most existing finance leases as

type A leases and most existing operating leases as type B leases. Both type A and

B leases result in the lessee recognising a ROU asset and a lease liability. However,

the IASB has stated that feedback on the 2013 ED indicates that the dual model is

too complex and, therefore, has opted currently for a single lessee model that is

easy to understand. The IASB decided on a single approach for lessee accounting

where a lessee would account for all leases as type A leases.

The boards decided that a lessor should determine lease classification (type A or

type B) on the basis of whether the lease is effectively a financing or a sale, rather

than an operating lease. A lessor would make that determination by assessing

whether the lease transfers substantially all the risks and rewards incidental to

ownership of the underlying asset. A lessor will be required to apply an approach

substantially equivalent to existing International Financial Reporting Standards

(IFRS) finance lease accounting to all type A leases.

A lease is currently defined by the boards as a contract that conveys the right to

use an asset for a period of time in exchange for consideration. An entity would

determine whether a contract contains a lease by assessing whether the use of the

asset is either explicitly or implicitly specified and the customer controls the use of

the asset. The definition of a lease does not require the customer to have the ability

to derive the benefits from directing the use of an asset.

The boards have decided that the leases guidance should not include specific

requirements on materiality and retain the recognition and measurement

exemption for a lessees short-term leases (12 months or less) with the IASB

specifically favouring a similar exemption for leases of small assets for lessees.

The boards have decided that, when determining the lease term, an entity should

consider all relevant factors that may affect the decision to extend, or not to

terminate, a lease. The lease term should only be reassessed when a significant

event occurs or there is a significant change in circumstances that are within the

control of the lessee. A lessor should not be required to reassess the lease term.

Only variable lease payments that depend on an index or a rate should be included

in the initial measurement of leases and the IASB has determined that

reassessment of variable lease payments would only occur when the lessee re-

measures the lease liability for other reasons. A lessor will not be required to

reassess variable lease payments that depend on an index or a rate.

The definition of the discount rate remains unchanged as the rate implicit in the

lease, as does the requirement for a lessee to reassess the discount rate only when

there is a change to either the lease term or the assessment of whether the lessee

is (or is not) reasonably certain to exercise an option to purchase the asset.

A lease modification for both a lessee and a lessor should be accounted for as a

new lease, separate from the original lease, when:

the lease grants the lessee an additional right-of-use not included in the original

lease, and

the additional right-of-use is priced commensurate with its standalone price in the

context of that particular contract.


35

In terms of the initial direct costs for both lessors and lessees, they should include

only incremental costs that would not have incurred if the lease had not been

executed. These include commissions or payments made to existing tenants to

obtain the lease. A lessor in a type A lease should include initial direct costs in the

initial measurement of the lease receivable and they should be taken into account

in determining the rate implicit in the lease.

A lessor in a type A lease who recognises selling profit at lease commencement

should recognise initial direct costs as an expense. A lessor in a type B lease should

expense such costs over the lease term on the same basis as lease income. A

lessee should include initial direct costs in the initial measurement of the right-of-

use asset and amortise those costs over the lease term.

The guidance in the ED has been retained for sale and leaseback transactions with

a sale having to meet the requirements of a sale as set out in IFRS 15. A buyer-

lessor should account for the purchase of the underlying asset consistent with the

guidance that would apply to the purchase of any non-financial asset.

This article sets out the deliberations of the IASB/FASB as regards lease accounting

at the end of December 2014. The IFRS is due for publication in 2015, but it seems

that the FASB and IASB will have differing views on several recognition and

measurement issues when the IFRS is finally published. There may yet however be

further changes of opinion.

Graham Holt is director of professional studies at the accounting, finance and

economics department at Manchester Metropolitan University Business School

The FASB reThe FASB remains supportive of the dual-model approach to bringing

leases on to the statement of financial position mains supportive of the dual-model

approach to bringing leases on to the statement of financial position


36

CHANGES

By Graham Holt

The introduction of a new accounting standard or a change in an accounting

standard can have a significant impact on an entity from an internal as well as an

external perspective. As a result, the International Accounting Standards Board

(IASB) has recently agreed to conduct an effects analysis before publishing any

International Financial Reporting Standard (IFRS).

When the IASB issues a new or significantly amended IFRS, it changes the way in

which financial statements show particular transactions or events. Changes in

reporting requirements always come with a cost.

The IASB uses discussion papers and the basis for conclusions to explain the steps

taken to ensure that a proposed IFRS has taken into account the costs and benefits

of the new reporting practice that it introduces.

WHATS THE IMPACT?

The IASB considers a variety of matters prior to the issue of a standard. These

matters include how the changes improve the comparability of financial information

and the assessment of the effect on an entitys future cashflows.

Further considerations include whether the changes will result in better economic

decision-making, the likely compliance costs for preparers, and the potential cost

for users of extracting the data.

On application of the new IFRS, investors will be provided with different information

on which to base their decisions. Investors assessment of how management has

discharged its stewardship responsibilities could be changed as could the cost of the

entitys capital. This, in turn, could affect how investors vote at a shareholder

meeting or influence their investment decisions. New financial reporting

requirements may call for the disclosure of information that is of competitive

advantage to third parties, which would be a cost to the entity.

A change in an accounting standard could result in some entities no longer

investing in certain assets or change how they contract for some activities. For

example, the comment letters on the exposure draft on leases suggest that some

entities would change their leasing arrangements if operating leases had to be

shown on the balance sheet with adverse economic impacts including the loss of

thousands of jobs.

Further IFRS-based financial statements are used in contracts or regulation.

Banking agreements often specify maximum debt levels or financial ratios that refer

to figures prepared in accordance with IFRS. New financial reporting requirements

can affect those ratios, with potential breach of contracts. Many jurisdictions have

regulation that restricts the amount that can be paid out in dividends, by reference

to accounting profit. Further, some governments use IFRS numbers for statistical

and economic planning purposes and the data as evidence for constraints on

profitability in regulated industries.


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Taxation is often calculated on the profit measured for financial reporting purposes.

Where IFRS is used as the basis for income tax, a change in a standard can affect

the tax base. The economic consequences of the link of accounting with tax

liabilities can be significant. If the US Financial Accounting Standards Board (FASB)

were no longer to permit use of the last-in first-out (LIFO) method, companies

using LIFO would have to pay income taxes sooner because of the higher cost of

sales under LIFO. The impact has been estimated to be greater than US$80bn if the

tax law was not changed. However, neither the FASB nor the IASB base accounting

policy decisions on tax consequences.

Some jurisdictions require an impact assessment before a new standard, or an

amendment to a standard, is incorporated into the law. Such a review may take

into account the increased administrative burden on entities in that country or its

consistency with local company law.

FINANCIAL STATEMENTS

On a micro level, where new and revised pronouncements are applied for the first

time, there can be an impact on the drafting of the financial statements. The

financial statements will need to reflect the new recognition, measurement and

disclosure requirements. For example IFRS 10, Consolidated financial statements,

was amended for annual periods beginning on or after 1 January 2014. This

amendment provides an exemption from consolidation of subsidiaries for entities

that meet the definition of an investment entity, such as some investment funds.

Instead, such entities measure their investment in certain subsidiaries at fair value

through profit or loss in accordance with IFRS 9, Financial instruments, or IAS 39,

Financial instruments: recognition and measurement. The consequences of this

amendment will be far-reaching for those entities.

IAS 8, Accounting policies, changes in accounting estimates and errors, contains a

general requirement that changes in accounting policies are fully retrospectively

applied. However, this does not apply where there are specific transitional

provisions. For example, when first applying IFRS 15, Revenue from contracts with

customers, entities should apply the standard in full for the current period,

including retrospective application to all contracts that were not yet complete at the

beginning of that period.

For prior periods, the transition guidance allows entities an option to either:

apply IFRS 15 in full to prior periods (some limited practical expedients are

available)

retain prior period figures as reported under the previous standards, recognising

the cumulative effect of applying IFRS 15 as an adjustment to the opening balance

of equity as at the date of the beginning of the current reporting period.

Further, IAS 8 requires the disclosure of a number of matters about the new IFRS.

These include the title of the IFRS, the nature of the change in accounting policy, a

description of the transitional provisions, and the amount of the adjustment for

each financial statement line item that is affected.


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Additionally, IAS 1, Presentation of financial statements, requires a third statement

of financial position to be presented if the entity retrospectively applies an

accounting policy, restates items or reclassifies items, and those adjustments had a

material effect on the information in the statement of financial position at the

beginning of the comparative period.

IAS 33, Earnings per share, requires basic and diluted earnings per share (EPS) to

be adjusted for the impacts of adjustments resulting from changes in accounting

policies accounted for retrospectively, and IAS 8 requires the disclosure of the

amount of such adjustments. Where there are new accounting policies, the impact

on the interim financial statements will not be as great as on the year-end

accounts. However, IAS 34, Interim financial reporting, requires disclosure of the

nature and effect of any change in accounting policies and methods of computation.

ENTITY ASSESSMENT

The entity itself should prepare an impact assessment relating to the introduction of

any new IFRS. There may be significant changes to processes, systems and

controls, and management should communicate the impact to investors and other

stakeholders. This would include plans for disclosing the effects of new accounting

standards that are issued but not yet effective, as required by IAS 8. Audit

committees have an important role in overseeing implementation of any new

standard in their organisations.

For example, under IFRS 15, an entity may need to evaluate its relationships with

contract counterparties to determine whether a vendor-customer relationship

exists. Existing revenue recognition policies will also need to be evaluated to

determine whether any contracts within the scope of IFRS 15 will be affected by the

new requirements.

Where a new standard requires significantly more disclosures than current IFRS,

the entity may want to understand whether it has sufficient information to satisfy

the new disclosure requirements or whether new systems, processes and controls

must be implemented to gather such information and ensure its accuracy. The

entity should choose a path to implementation and establish responsibilities and

deadlines. This may help to determine th

ACCA P2 Revsion Pack June 2015

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