IFRS 9: Financials Instrument

 IFRS 9: Financials Instrument

Financial Instrument

  • A contract
  • Gives rise to a financial asset of 1 entity
  • Financial liability/ equity of another entity

FINANCIAL ASSETS

TYPES:

  1. @ fv through P/L (DEFAULT)
    1. INITIAL: FV
    2. SUBSQUENT: FV EXCL TC with fv changes recognised through P/L
  • Held for trading
  1. If Equity & Debt criteria fail
  2. OR Derivatives
    1. Value changes in response to specific underlying items
    2. Financial e.g. interest rate, commodity price, exchange rate, share price
  • Non-financial, not specific to any part of contract
  1. Doesn’t require initial investment or little
  2. Settled at a future date
  1. Movements through P/L
  1. Equity Instrument @ fv through OCI
    1. Entity Elects to classify instrument
  • NOT held for trading (note can sell some BUT not trade)
    1. INITIAL: @ fv & transaction cost
  • SUBSQUENT: FV excl transaction cost
  1. Measure movements through OCI (can end up with a DR bal for equity)
  1. Debt Instrument @ fv through OCI (Debenture that earns interest & sold before maturity date)
    1. Objective: BOTH collect contractual cfs & selling FA
    2. Contractual Terms FA:
  • On specified dates
  • Cfs that are solely payments of Principal & Interest on P amt outstanding
    • INITIAL: @ fv & transaction cost
  1. SUBSQUENT: FV excl transaction cost
  2. Measured @ fv with movements through OCI
  1. @ amortised cost (eg. Debenture earns interest & held to maturity date)
    1. Objective: HOLD FA to collect contractual cfs
    2. Contractual Terms FA:
  • On specified dates
  • Cfs that are solely payments of Principal & Interest on P amt outstanding
    • INITIAL: @ fv & transaction cost
  1. SUBSEQUENT: Amortised Cost
  2. Measured at effective interest rate method

DERECOGNITION ASSETS

Asset no longer on SPF eg reached maturity date/ sold

RULE: when contractual right to cash flows expire

(Proceeds received + Cash + other financial assets received) – (Carrying Amount of A (@disposal date)) = Profit or loss on disposal recognised in P/L

If sold at fv—no profit cause was recognised at that price

FINANCIAL LIABILITIES

TYPES:

  1. At amortised cost (DEFAULT)
  2. @ fv through P/L
    1. Held for trading
    2. Designated
      1. Initial: irrecoverable
      2. Conditions: eliminate/ significantly

reduce acc mismatch

  • FL evaluated on fv
  1. Financial Liabilities from derecognition
  2. Financial Guarantee
  3. Loan commitments
  4. Contingent consideration in a business combination

DERECOGNITION LIABILITIES

Remove from SPF

Liability satisfied, cancelled, expired

Settlement paid – Carrying amount FL = P/L

Capitalisation Issue:

  • General Purpose: Increase the liquidity of company
  • HOW? Increase the no of shares in circulation, thus decreasing share price
  • Theses issue of shares are to existing shareholders Proportionately to shares they have and paid out of reserves
  • INVESTOR:
    • Receive shares no compensation
    • No shares increase but the value of the investment remains the same
  • ISSUER:
    • Reserves become share capital
    • No inflow of capital/resources

DR Reserve

CR Share Capital

RIGHTS Issue:  

  • Advantage to existing shareholders: can take up shares at less than FV

HOW TO APPROACH:

  1. BEFORE rights issue do a fair value adjustment
  2. What if Calc:
    1. Valuation Method to Cal Value of Rights (experiment assumption: all rights were exercised)

Shares             R/s                   Value

Balance (CUM R)         2000                2.40                 4800                after fv adj

Rights                          400                  1.92                 768                  1.92 is exercise right price

Ex Rights                      2400                2.32                 5568                5568/2400 = 2.32

  1. Value regarding existing shares

CUM R val: 2.40 – Ex Rights v: 2.32 = 0.08

0.08 is change in existing rights value

0.08 x 2000 shares = R160

IAS 8: Changes in accounting policy, accounting estimates and errors

IAS 8: Changes in accounting policy, accounting estimates and errors

TESTED IN 3 WAYS:

  1. Change in Estimate
    1. Prospectively (Current & Future)
  2. Change in Errors
    1. Retrospectively (Comparative periods & Opening balances restated: as if error never made)
  3. Change in Accounting Policy
    1. Only change if 1: required by standard 2: Will make info more relevant & reliable
    2. Can only test 2 WAYS:
      1. Weighted Ave to FIFO or vice versa
      2. IAS 40 Cost Model to Fair Value CANNOT vice versa
    3. Retrospectively (Comparative periods & Opening balances restated: as if error never made)
    4. Disclose properly
      1. Voluntary Change:
        1. Nature of acc policy change
        2. Reason why apply makes more reliable
        3. Each Current & Prior Period Practical amount of adj:
          1. Each fs line item
          2. Basic & diluted earnings per share
        4. Amounts of adj relating to periods before those presented
        5. If retrospective impractical: why, when acc policy applied

LEASES

LEASES

Lessor needs to classify lease as finance         Lessee can use a single accounting or operating.                                                                        model. Don’t need to classify leases.

  1. Identify Lease
  • Is a lease contract if:
    • Right to Control Underlying Asset for a period of time in exchange for consideration
    • On Inception date: earlier of lease/ commitment
  • Separate Components: Lease/ Non-lease via Stand Alone Price
    • Lessee can elect practical expedient
      • Don’t have to separate
      • Will say in question
      • Not available to lessor
  1. At commencement date: Lessee must recognise a right of use asset & lease liability

            DR                  Right of use Asset

            CR                  Lease Liability

EXCEPTION: Lessee can elect Not to apply no 2 where:

  • Short term lease: < 12 m
  • Underlying Asset is Low Value:
    • Low Value When:
      • Lessee can benefit from the asset on own or with resources they already have
      • Underlying Asset is NOT highly dependent on other Assets
    • Initial measurement of a right of use asset: (in books lessee)
      • Initial lease liability
      • Lease PMT’s made at or before commencement date: less lease incentives received
      • Initial Direct Costs incurred by lessee
      • Estimated Cost by lessee for dismantling & restoration of underlying asset (PV!!!)
  • Initial measurement of a lease liability: (in books lessee)
    • @ PV of lease PMT’s that are NOT paid at that date
      • Lease PMT’s include:
        • Fixed payments (incl in substance) less lease incentives receivable (Lessee by lessor)
        • Variable lease PMT’s that depends on an index or rate (if not dependant will be exp)
        • Amounts expected to be payable by lessee under residual value guarantees (at the end of lease)
        • Exercise Price of purchase option if reasonable certain will exercise
        • Penalties paid for terminating a lease if reasonable certain that lessee will exercise this option

Elaborating Residual Value Guarantees:

  • On commencement date Lessor & Lessee agree on residual amount (worth at end)
  • Fair Value estimated at end can differ from residual = need to compare:
    • FV < R then lessee will need to pay difference as final PMT to lessor
    • This amount is the expected payable residual value guarantee (FV) NB
  • If FV > R lessor can decide to sell Asset to 3rd party for this higher amount. Lessee doesn’t need to payback more only gives back asset at residual agreed.

Elaborating on Discounting Rate for purpose calculating PV

  • Rate causes PV of lease PMT’s and the unguaranteed residual value to equal the sum of the fair value of underlying asset and any initial direct costs of lessor.
  • Calculate the interest rate implicit in the lease (ito lessor)
    • PV: fair value of underlying asset at commencement date + initial direct costs incurred by lessor
    • N: lease term
    • PMT: annual payments
    • FV: again from perspective of LESSOR: amount payable under residual value guaranteed by lessee + RVG from initial (on commencement) + Unguaranteed amount residual (JUST THINK ALL THAT LESSOR GETS)
    • I: ???
  • Will use the I rate above to calculate PV of lease liability that is recognised by the LESSEE
    • NB in this cal FV: what the lessee pays!!!!! So if FV< R!!!!

IF lessee did not have knowledge required?

  • Cannot calculate discount rate then use lessees incremental borrowing rate
  • Thus in calc 2 as above calc the lease liability PV: use the incremental borrowing rate also as I
  1. Subsequent Measurement of Right of use Asset
    • Cost Model PPE
      1. CA = Cost – Acc Dep (and impairment loss & adj for re-measurement of lease liability)
      2. Depreciation:
        1. If lease transfers ownership or has a purchase option at end of lease term that is reasonable certain to be exercised. Then dep from commencement date to end useful life.
        2. Else, dep to earlier of end of useful life and end of lease term.
  • Revaluation Model
    1. If Right of Use asset is in a class of PPE that uses revaluation model. Lessee can elect to not use it.
    2. IF the lessee doesn’t own any other assets in the same class of right of use asset. Then MUST use the cost model.
  1. Subsequent Measurement of Lease Liability
    • Increase CA reflects interest on lease liability
    • Decrease CA reflects lease PMT’s made
    • Re-measure CA from re-assessment & modification

Must accrue for interest if YE & PMT are not the same

Presentation

  1. Statement of Financial Position

20X17            20X16

Assets          

            Non-Current Assets

Right of use Asset

Equity & Liabilities

            Non-current Liabilities

            Lease Liability

Current Liabilities

Short-term portion of lease liability

  1. Statement of Profit or Loss

20X17            20X16

            Other expenses

            (including depreciation on RUA &

Any non-lease component exp)

            Net Finance Cost

(20X17: AMRT 2)

(20X16: AMRT 1)

 

  1. Notes for year ended

            Lease contracts in which the company is the lessee

            Right of use asset

Office equipment

20X17            20X16

Carrying Amount at the beginning of year

Additions

Depreciation

Re-measurement of the Lease Liability

Carrying Amount at the end of the year

Income & expenses related to leases

20X17            20X16

Expenses

Depreciation- Office Building

Maintenance Expense

IAS 36

IAS 36

How?

Compare Carrying Amount (Calc IAS16) > Recoverable Amount = Impairment Loss (p/l OR COS OR Rev deficit)

At END of Reporting Period:

  1. Test indications (annually)
    • Intangible asset with indefinite useful life
    • Intangible asset not yet available for use
    • Goodwill acquired
  2. if indications apply cal Recoverable Amount

Indications:

External:

  • Assets value ↓ more than usual
  • Changes in market, tech, economy eg Competitor stealing market
  • Market Interest Rates/ Other Market Rates ↑ affect discount rate*-value in use
  • CA of net assets > Market Capitalism

Internal:

  • Evidence of obsolescence/damage
  • Asset is planned to become idle, discontinue, restructure operation, dispose A before expected date
  • Evidence that economic performance will be worse than estimated

Indications Apply: Cal RA as HIGHER OF:

  1. Fair value (given) – Cost to sell (location + condition)

Cost to sell examples: legal costs, stamp duty, dismantling cost

  1. Value in use F Cashflow – P Cashflow excl finance cost & tax

NB After you have the impairment loss there may be a change in estimate

  • Can be eg useful life, dep method, rate
  • Change Applies from FUTURE periods.
  • Therefore if you change in March 2014 – use old dep for rest of 2014…get impairment loss nd CA then:
  • 2015 calc dep on new estimate: DEP = new CA – new Residual    NB if u hav an impairment loss

Remaining UL                              the CA new

Reversal: ( other comprehensive income ( Rev Surplus)/ other income)

  • Must hav had a previous impairment loss & LIMITED by it
  • Impairment on goodwill CANNOT be reversed
  • Impairment no longer exists / may have decreased
  • For above to occur there must have been an estimate that changed
  • Changed: fvC2S to value in use, for Value in use… disc/ cash flow change, fv- change in cost/fv
  • Assess indications:
    • External opposite to above
    • Internal : costs incurred to improve/enhance A + restructure the operation
      • Economic performance expected to be better

IAS 16: Property, plant and equipment

The following is a summary of what I have learned from IAS 16 in FRK 201:

Recognition
Initial Recognition

In paragraph 6, along with other definitions, the standard defines property, plant and equipment as;
– tangible assets,
– that are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes, and
– are expected to be used during more than one period.

Recognition requirement states that it must be probable that future economic benefits are expected to flow to the entity and that the cost thereof can be measured reliably.

property, plant and equipment can be recognised in the financial statements of an entity when the above definition and recognition requirements have been met.

1.       Components of property, plant and equipment

Par 43-47
When each separate component of property, plant and equipment is significant enough, they can each be recognised and depreciated separately.

2.       Spare parts

Par 8
Spare parts, stand-by or servicing equipment can be capitalised to property, plant and equipment if they meet the definition of property, plant and equipment, otherwise, they will be recognised as inventory in the financial statements of the entity.

3.       Safety and environmental costs

Par 11
These costs do not directly increase the future economic benefits that flow to the entity, but it does enable the property, plant and equipment item to produce future economic benefits in excess. After the carrying amount of the property, plant and equipment item has increased due to these costs, they need to be reviewed for impairment loss under IAS 36. This stops the entity form overstating their property, plant and equipment every time they capitalise safety and equipment costs.

Carrying amount + safety and environmental costs = new increased carrying amount
New increased carrying amount compare to the recoverable amount, adjust the new carrying amount with the impairment loss (recoverable amount –  new carrying amount) to accurately disclose the carrying amount and to ensure that it is not overstated.

Subsequent recognition

1.   Day to day servicing and replacement costs

Everytime property, plant and equipment costs are incurred, the entity must identify whether these costs meet the definition of property, plant and equipment and the recognition requirement before they can be capitalised to property, plant and equipment.

Par 12 states that the day to day costs are not to be capitalised as they are seen as repair and maintenance expenditure that is expensed in the Statement of Profit and Loss and Other Comprehensive Income.

Par 13 states that when parts of property, plant and equipment are replaced, the carrying amount of the replaced part must be derecognised and the cost of the new replacement is to be recognised. This prevents overstatement of property, plant and equipment in the financial statements. The cost of the present replacement can be used as an indicator of what the cost of replacement was at the time of initial recognition. This ‘deemed carrying’ amount must then be derecognised.

Par 67-72
A property, plant and equipment item can be derecognised either at the disposal of the item or when no future economic benefits are expected to flow to the entity form that specific item anymore. The proceeds received form realisation of this item is deducted from the carrying amount of this item.

 

2.  Major inspection costs

Par 14
These major inspections are necessary to ensure that the asset can continue in a condition to operating optimally. Major inspection costs get treated the same way as replacements.
The cost of the new inspection is capitalised to property, plant and equipment and the carrying amount of the previous inspection must be derecognised to prevent overstatement.

Measurement
Initial measurement

COST

Par 15 – 17
All property, plant and equipment items are initially measured at cost price
The cost price includes the purchase price, purchase duties, non refundable taxes and other deductible rebates and discounts. Basically, all the costs that are necessary to incur in order to bring the property, plant and equipment item to the condition and location to ensure that it is capable of being used in the manner intended by management.

1.       Dismantling, removing and restoration costs

As per Par 16 where the elements of what costs comprise are listed, these costs are also to be included in the cost of the property, plant and equipment item on initial measurement.

Only when there is a current obligation that exists for the entity to incur these costs – when the requirements of IAS 37 are met – does the entity capitalise these costs to the property, plant and equipment item.

Dismantling costs can be seen as a provision (IAS 37 apply) = current obligation
(cost price + dismantling cost) – residue value

Dismantling costs not seen as a provision for future expenditure (IAS 37 not apply) = no current obligation at initial measurement.
cost price – (residue value-dismantling cost)

*The depreciable amount in both instances stay the same
*Depreciation expense in both instances stay the same
*But cost prices differ, thus the carrying amounts will differ

 

2.       Incidental operations

Par 20
When the property, plant and equipment item has reached it’s current location and condition that will allow it to be capable of use as intended by management, then further costs thereon should not be capitalised ( a loss made on the use thereof, relocating and reorganising costs or costs incurred when the asset is not used to its full potential).
Par 21
Costs that are in connection to construction and development of the property, plant and equipment item, but is not necessary to get the item to its current condition and location to be used as intended by management = incidental operations – the costs and income thereof has nothing to do with the costs of the property, plant and equipment and it will be taken through to profit and loss like normal income and expenditure.

 

3.       Self-constructed assets

Par 22
When property, plant and equipment are used to construct other property, plant and equipment items, these new item’s cost will be determined the same way according to IAS 2 as inventories are valued.

For example, Machine A with a current year depreciation expense of R120 000 constructs Machine B for 2 months during the current financial year at a cost of R50 000.
Thus Machine B’s costs will be as  follows:

R50 000 + (R120 000 x 2/12) = R70 000
[Because IAS 2 states that the depreciation of the machine used to construct the inventory forms part of the cost of that inventory]

 

4.       Deferred settlement

The cost of the property, plant and equipment item must be the cash price equivalent, but when settlement/payment is deferred beyond normal payment terms, the interest amount which is the difference between FV and PV should not be included in the cost of the item.

 

5.       Exchange transactions

New property, plant and equipment can be bought by exchanging it for another. The new property, plant and equipment item must be measured at fair value when acquired, unless:
– the exchange lacks economic substance
– or if the fair value cannot be determined = in which case the cost price of the new item received will then be the carrying amount of the asset given up.
All other amounts given up during this exchange transaction (like extra cash) is capitalised to the fair value/ carrying amount.

 

Subsequent measurement
Par 29

CHOICE

The entity can now choose to measure their property, plant and equipment after recognition either on the cost model or on the revaluation model. Whichever model the entity chooses, it is to be applied to their accounting policy per class of property, plant and equipment items. The model that the entity chooses must also accurately represent the manner of how the item is being used (deprecated)

Cost model
1.       Change in accounting estimates

Par 50 + 51, 60 + 61
The entity may change the residue value and the useful life of a property, plant and equipment item any time it needs a review. These estimates are based on current facts and circumstances at the time of acquisition of the asset and therefore economic circumstances may change leading to these estimates that need to be reviewed.

This change in accounting estimates are not seen as an error and IAS 8 applies that states that these changes must be recognised prospectively – form the current period and thereon future periods.

So if the entity acquires a property, plant and equipment item at the beginning of 20X1, and it’s residue value and useful life changes during 20X3, the following steps are to be taken to account for this change accurately:

1.       Determine the depreciable amount of the item as it would be initiated before the changes.

2.       Determine the initial depreciation expense per year as it would be before any changes.

3.       Determine the carrying amount of this item at the beginning of 2013 before any changes occur.

4.       Use this carrying amount as the ‘new’ cost of the item for the beginning of 20X3.

5.       Determine the new depreciable amount for 20X3:
‘New’ cost – new residue value for the change made

6.       Determine the new depreciation expense for this current year in 20X3:
New depreciable amount  divided by the REMAINING amount of the new useful life (total new useful life – years already used before changes made)

7.       This new depreciation will be the expense for 20X3 and onwards as this change in accounting estimates are to be applied prospectively (IAS 8).

Different methods of depreciation used according to this Standard:
– Straight line method
– Reducing balance method
– Units of production method

Revaluation model

Par 31-42
Property, plant and equipment will initially be recognised at cost (ALWAYS) and the subsequent to that the entity can recognise the assets according to the revaluation model.

Revaluation amount: Fair value @ date of revaluation – accumulated depreciation – accumulated impairment losses on this item.
This ‘change’ in accounting policy (from initial measurement at a cost to revaluation for subsequent measurement) will be treated according to IAS 16 and NOT IAS 8.

Net replacement cost:
Fair value of an asset already used
Gross replacement cost:
New item’s fair value

NB! Par 35 states that when we use the revaluation model, we must eliminate the accumulated depreciation and accumulated impairment losses against the GROSS replacement cost  of the asset  so that it can from then on be carried in the books of the entity at the NET replacement cost ( whereon the revaluation will be made)

1.       Revaluation SURPLUS or DEFICIT

Par 39-40
Net replacement cost (revalued amount) > carrying amount at the date of revaluation
= revaluation SURPLUS à Other Comprehensive Income in SPL and SCE
Net replacement cost (revalued amount) < carrying amount at the date of revaluation
= revaluation DEFICIT à Profit and Loss as an expense

BUT

When there is a surplus during the first revolution on that asset and then during a subsequent revaluation, a deficit occurs, this deficit must first be set off against the surplus, thus debiting the surplus in OCI in the SPL and SCE before the remaining deficit can be debited to the P/L as an expense.

Likewise, if a deficit is achieved initially and then a surplus in the subsequent year, then the surplus must first be offset against the deficit but crediting this deficit in the P/L before the remaining surplus can go to OCI.

 

2.       The realisation of revaluation surplus

This realisation is only available is a surplus arises and not for a deficit.
The revaluation surplus can be realised to Retained Earnings either when it is derecognised once off when sold OR as it is being used.
When it is being realised as the asset is used, the amount goes directly in equity as a line item in the Statement of Changes in Equity.

This amount of surplus to be realised as it is being used for a specific period can be determined by following these steps:

a)       Depreciation for the year from the date of revaluation

b)      Depreciation for the year is the item wasn’t revealed

c)       The difference between a) and b) will give us the revaluation surplus to be realised according to use.

 

3.       Derecognition

Par 67-71
A property, plant and equipment item will be derecognised either when it is being disposed of or when the entity can no longer expect any future economic benefits to flow from the item to the entity.
According to this standard, the amount to be derecognised when the item is disposed of is the carrying amount of disposal deducted by the proceeds from disposing of it with must be the cash price equivalent. This is seen one economic event and the net effect must be disclosed with will be the profit or loss.

Par 68+71 states that a profit or loss can be realised from this disposal of the asset.

Par 65-66
When a 3rd party compensates the entity for an impairment loss, this amount will be disclosed as a separate economic event in the SPL along with other such events like the cost incurred to restore or construct the asset or day to day servicing costs.

 

Presentation and disclosure

Please see the entry on this website, “#008 Google Classroom Assignment’, where a model of the financial statement of an entity is created. Here I show the disclosure and presentation of the effect of this Standard. See where I have marked “IAS 16”.

IFRS 15, Revenue from Contracts with Customers

Please see the Model Financial Statements for more detail of this standard applied to financial statements.

The following is just a basic summary of IFRS 15 that I made for myself to help me study:

  1. Identifying the contract
  • Definition of a contract – an agreement between two or more parties that creates enforceable rights and obligations.

 

 

 

 

  • Requirements are:

– The parties to the contract have approved the contract and are committed to performing their obligations.

-The entity can identify each party’s rights regarding the goods or services to be transferred.

-The entity can identify the payment terms for the goods or services to be transferred.

-The contract has commercial substance.

-It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.

2.Identifying performance obligations

  • a good or service (or a bundle of goods or services) – distinct:
    – the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer

– the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract

  • a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer:

– performance obligation satisfied over time

same method used to measure the entity’s progress towards complete satisfaction of the performance obligation.

3. Determining the transaction price

  • Transaction price – is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties.
  • Significant financing component:
    Time value of money – entity shall adjust the promised amount of consideration if the timing of payments agreed to by the parties to the contract (either explicitly or implicitly) provides the customer or the entity with a significant benefit of financing the transfer of goods or services to the customer. Finance income is not recognised as revenue, show separately!
  • Practical expedient – an entity need not adjust the promised amount of consideration for the effects of a significant financing component if the entity expects, at contract inception, that the period between when the entity transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less.
  • Calculate the transaction price on either

– the expected value method: sum of probability-  weighted amounts in a range of possible consideration amounts; or

– The most likely amount: single most likely amount in a range of possible consideration amounts (ie the single most likely outcome of the contract).

4. Allocating the transaction price to performance obligations

  • Stand-alone selling prices – Determine the stand-alone selling price at contract inception of the distinct good or service underlying each performance obligation in the contract and allocate the transaction price in proportion to those stand-alone selling prices.
  • Discount – allocate a discount proportionately to all performance obligations in the contract unless there is observable evidence that the entire discount relates to only one or more performance obligations.

5. Satisfying performance obligations

  • Control – ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset, as well as to prevent other entities from directing the use of, and obtaining the benefits from that asset.
  • Satisfied over time, if either:
    – the customer simultaneously receives and consumes the benefits provided;

– the entity’s performance creates or enhances an asset; or

– the entity’s performance does not create an asset with an alternative use to     the entity

  • Specified point in time – indicators of the transfer of control:
    – The entity has a present right to payment for the asset

– The customer has legal title to the asset

– The entity has transferred physical possession of the asset

– The customer has the significant risks and rewards of ownership of the asset – The customer has accepted the asset

Consolidations Chapter 9: Interim acquisition

A parent might acquire the interest at a date other than the beginning or end of the financial year (like in the case of chapter 1-3 and 8 of Consolidations). In which case the equity will have to be determined at the acquisition date.
The principle stands that all the equity of the subsidiary that accumulated up to the date when the parent acquired the controlling interest, should be shown in the at-acquisition journal entry and eliminated against the investment in the subsidiary by means of a consolidation journal.

  • The main trick when working with the interim acquisition is to take out the income and expenses that relate to the pre-acquisition period (from beginning of reporting period until the date of acquisition) so that only the profit that relates to the post-acquisition period (from the date of acquisition until the end of the reporting period) of the subsidiary is left over and used further in the Analysis of Equity.
  • That means that each income and expense item must be carefully evaluated to determine to which period it relates. It can be stated that the income and expenses are equally distributed, then only the fraction of the year relating to the pre-acquisition period will be eliminated of that specific item.
  • This elimination of the income and expenses, sales and cost of sales related to the pre-acquisition, is done in the at-acquisition consolidations journal.
  • At-acquisition consolidations journal portraying the elimination of income and expenses, sales and cost of sales that should not form part of the at-acquisition equity of the subsidiary:
  Dr Cr
Ordinary Share Capital – Opening balance (S) x  
Retained earnings – Opening Balance (S) x  
Revenue (S) x  
       Cost of Sales (S)   x
       Other expenses (S)   x
       Income tax expense (S)   x
       Investment: S Limited (P)   x
       Non-Controlling Interest (SCE)   x
Goodwill (SFP) x  

 

  • Only the profit amount for the post-acquisition period is left over and with that, the retained earnings opening balance of the trial balance of S is added to get the total retained earnings at acquisition.
  • Next, each amount in the Consolidated Statement of Profit or Loss and Other Comprehensive Income will be adjusted as follows after the above mentioned is taken into account:

100%P + 100%S – a pre-acquisition fraction of the amount – intra-group transaction

  • Assets and liabilities in the Consolidated Statement of Financial Position are not affected by this adjustment between the pre – and post-acquisition period, only those items that relate to profit in the Consolidated Statement of Profit or Loss and Other Comprehensive Income.
  • It is also possible that the gross income may not be distributed evenly throughout the year as it is assumed with most of the income and expense items unless otherwise stated.

Consolidations Chapter 8: Preference Shares

The following notes are made on important principles and concepts I have learned in this chapter:

  1. Preference share capital is share capital that has preference over the other share capital of an entity. The share capital in chapter 1-4 only consisted of ordinary share capital.
  2. These preference shares get their dividends paid out first, have no voting rights like in the case of ordinary shares and their dividends are based on an annual fixed percentage.
  3. Preference shares can either be
  • Cumulative – preference shareholders are entitled to the dividends even if the entity does not declare preference dividends for that specific period (can be in arrears for previous years not declared); or
  • Non-Cumulative – preference shareholders are not entitled to the dividends if the entity does not declare preference dividends for that specific period (cannot be in arrears for previous years not declared).
  1. Preference share capital has its own Analysis of Equity.
  2. In the Analysis of Equity, the preference share capital will only have retained earnings at-acquisition date if the preference shares are cumulative and are in arrears form BEFORE the date of acquisition.
  3. The preference share capital will also only have retained earnings in the ‘since’-period (from date of acquisition until the beginning of the current period) in the Analysis of Equity if the preference shares are cumulative and are in arrears DURING this ‘SINCE’-period.
  4. The profit attributable to the preference share capital in the CURRENT period in the Analysis of Equity is the amount of dividends declared for that specific period.
  5. When distributing the profit for the current period for ordinary shares, the profit (dividend) attributable to preference shares (see point 7 above) must first be taken out of the subsidiary’s total profit so that the remaining profit can go to the parent’s and Non-Controlling Interest’s ordinary shareholders.
  6. Point 8 is because of the fact that preference shares have a preference over others to get their dividend – form the profit for the year – first (see point 1 and 2).
  7. Most of the extra calculations from introducing the preference shares are done in the Analysis of Equity – Preference Share Capital, these amounts are then used just like in the case of the Analysis of Equity – Ordinary Share Capital to calculate correct end-balances to be disclosed in the Consolidated Financial Statements of the Group, already shown in the Consolidations Chapter 1-3 entry on this e-portfolio.
  8. At-acquisition journal entry:
  Dr Cr
Preference Share Capital – Opening Balance (S) x  
Goodwill x  
        Investment in S Ltd (P)   x
        Non-Controlling Interest (SCE)   x

 

Consolidations Chapter 4: Intra-group transactions

The following important notes are made during this chapter:

  1. Only the transactions made between the parent and the subsidiary must be eliminated via a journal entry.
  2. Transactions between the parent and other entities or the subsidiary and other entries are not classified as intra-group and should not be eliminated.
  3. Only intragroup transactions must be eliminated between the parent and subsidiary that do not affect profit or loss.

Elimination of possible intra-group transactions:

Dividends

Only declared, not paid:

  Dr Cr
Other income (P) (SCI) x  
Non-Controlling Interest (SCE) x  
      Dividends declared (S) (SCE)   X

 

  Dr Cr
Shareholders fo dividends (S)(SFP) x  
      Dividends receivable (P) (SFP)   x

 

Declared AND paid

  Dr Cr
Other income (P) (SCI) x  
Non-Controlling Interest (SCE) x  
      Dividends declared/paid (S) (SCE)   X

 

Rent

  Dr Cr
Other Income/ Rent Income (Lessor P or S) (SCI) x  
      Other Expenses/ Rent expense (Lessee P or S) (SCI)   x

 

Loans

  Dr Cr
Finance income (Lender P or S) (SCI) x  
      Finance Cost (Borrower P or S) (SCI)   x
     
Loans due (Borrower P or S) (SFP) x  
      Loans granted (Borrower P or S) (SFP)   x

 

Management/ Administration fees

  Dr Cr
Other Income/ Management fees received                  (Service provider P or S) (SCI) x  
      Other Expenses/ Management fees paid                      (Service receiver P or S) (SCI)   x

 

Other intra-group transactions and balances that must be eliminated are the followings that are explained in further chapters:

  • Sales of inventories
  • Debtors and creditors
  • Property, plant and equipment

 

Consolidations Chapter 1-3

As seen in the above picture, I would like to compare Business Combinations to the all familiar game that we all played as kids known as Pacman. Often businesses with more capital and in need to expand in the most cost-effective way will ‘eat’smaller entities’ assets and absorb their liabilities in order to gain a controlling interest through the acquisition of shares so that they can affect the returns that they get from these entities for their own benefits. The acquirers act as Pacman, eating and using the acquiree’s equity.

Chapter 1-3 of Consolidations is covered in FRK100, therefore, the following work is assumed knowledge and my reflection on what I have learned is a revision of 2017.

Basic concepts and definitions I have learned:

Minority passive investments

  • Share investments that are purchased only for the purpose of generating future economic benefits – dividend income or capital gains. Due to the small ownership percentage and/or very limited contractual rights, the investor can not influence the economic activities of the entity in order to affect returns.
  • If these investments are less than 12 months they are disclosed as current assets, but more than 12 months, then they are disclosed as non-currents assets.

Minority active investments

  • Share investments and/or other limited contractual rights to exert significant influence, but not control, over the activities of the entity in order to affect returns earned by the investor.
  • These investments are disclosed as non-current assets.

 

Majority active investments

  • Share investments and/or other limited contractual rights to direct the economic activities of the investee to influence the level of returns earned by the investor.
  • Influences in the economic activities of the investee can be on the policy-making level and on the day-to-day operational level.
  • The element of control is present, not only influence.
  • This is presumed to be a business combination by IFRS.

Business Combination (according to IFRS 3, Business Combinations, Appendix A)

  • “a transaction or other event in which an acquirer obtains control of one or more businesses”

Control (IFRS 10, Appendix A and IFRS 3, Appendix A)

  • A situation in which “an investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee”

Power

  • Refers to the rights held by the investor, which are either
    – voting rights through ownership of shares; or
    – contractual rights

A Business (according to IFRS 3, Business Combinations, Appendix A)

  • “an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors and other owners, members and participants”

Wholly-owned Subsidiary

  • Refers to a company whose entire share capital is held by a single controlling company (the parent).

 

At-acquisition

  • The date at which the acquirer(parent) acquires a controlling interest in the acquiree (subsidiary).
  • The assets and liabilities of the subsidiary at acquisition are eliminated against the investment of the parent (and of the non-controlling interest if not wholly owned).
  • Goodwill or a gain on bargain purchase is the purpose of this elimination in the at-acquisition journal.

 

Gain on bargain purchase

  • This gain is created when the acquirer pays an amount less than the fair value on the acquisition date of the identifiable assets and liabilities of the subsidiary.
  • This discount is recognised as an income in the parent’s Statement of Profit and Loss and Other Comprehensive Income.

Goodwill

  • This is created when the acquirer pays an amount more than the fair value on the acquisition date of the identifiable assets and liabilities of the subsidiary.
  • The goodwill amount is recognised in the parent’s Statement of Financial Position under Non-Current Assets.

Non-Controlling Interest (IFRS 10, Consolidated Financial Statements, Appendix A)

  • “the equity in the subsidiary not directly or indirectly attributable to the parent”
  • Amount of controlling interest of the Non-Controlling Interest is shown as a percentage in relation to the subsidiary (just as in the parent’s case too).
  • The Non-Controlling Interest can be measured at either fair value of proportionate of share at the at-acquisition date.

It is important to remember that the parent and subsidiary are separate legal entities but one reporting entity.

I personally enjoy using the Analysis of Equity method to determine specific amounts needed when compiling the consolidated financial statements of a group.

The following is the basic format of the  Analysis of Equity:

    Parent 70% 30%
Analysis of Equity of Subsidiary Total At-acquisition Since-acquisition Non-Controlling Interest
At-acquisition        
Share capital      
Retained Earnings      
Total equity (net assets)     ­-  
Goodwill/ Gain on bargain purchase A    
Consideration +

Non-Controlling Interest

    ­- B
 
Since-acquisition        
From the date of acquisition until the beginning of the current period        
Retained earnings (@-TB)   H C
Current period        
Profit for the year   F D
Dividends paid   G E
 
Total   J I

 

When compiling the Consolidated Financial Statements of a group, the following principle is extremely important to apply, thereafter the above amounts marked with the letters A-J will be used to adjust the amounts accordingly so that the correct amounts are disclosed in the Consolidated Financial Statements :

100%P + 100%S