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University of Sunderland
BA (Honours) Accounting and Financial Management
APC311
International Financial
Reporting
Version 1.0
International Financial Reporting
Published by The University of Sunderland
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The copying, storage in any retrieval system, transmission,reproduction in any form or resale of the course materials or any part thereof without the prior written permission of theUniversity of Sunderland is an infringement of copyright andwill result in legal proceedings.
© University of Sunderland 2007
Every effort has been made to trace all copyright owners ofmaterial used in this module but if any have beeninadvertently overlooked, the University of Sunderland will beplease to make the necessary arrangement at the firstopportunity.
These materials have been produced by the University ofSunderland Business School in conjunction with ResourceDevelopment International.
International Financial Reporting
International Financial Reporting
Contents
How to use this workbook
Introduction
Unit 1
Introduction to and Context of the Course 1
Introduction 1
Summary 10
Review Activities 10
Review Activities Feedback 13
Unit 2
The Regulatory and Conceptual Framework
of International Financial Reporting 17
Introduction 17
Summary 24
Review Activities 24
Review Activities Feedback 25
Appendix 28
Unit 3
The Presentation of Financial Statements (IAS1) I 30
Introduction 30
Summary 40
Review Activities 41
Review Activities Feedback 43
International Financial Reporting
Unit 4
The Presentation of Financial Statements (IAS1) II 46
Introduction 46
Summary 55
Review Activities 55
Review Activities Feedback 58
Unit 5
Accounting for Fixed Tangible Assets 65
Introduction 65
Summary 73
Review Activities 74
Review Activities Feedback 75
Unit 6
Accounting for Intangible Assets 78
Introduction 78
Summary 84
Review Activities 84
Review Activities Feedback 85
Unit 7
Accounting for Leases 88#p#分页标题#e#
Introduction 88
Summary 92
Review Activities 92
Review Activities Feedback 93
International Financial Reporting
Unit 8
Accounting for Provisions, Contingent Liabilities
and Contingent Assets 97
Introduction 97
Summary 104
Review Activities 104
Review Activities Feedback 106
Unit 9
Accounting for Pensions 110
Introduction 110
Summary 115
Review Activities 116
Review Activities Feedback 117
Appendix 121
International Financial Reporting
How to use this workbook
This workbook has been designed to provide you with the course materialnecessary to complete International Financial Reporting by distance learning.At various staged throughout the module you will encounter icons as outlinedbelow which indicate what you are required to do to help you learn.
This Activity icon refers to an activity where you are required to undertake aspecific task. These could include reading, questioning, writing, research,analyzing, evaluating, etc.
This Activity Feedback icon is used to provide you with the informationrequired to confirm and reinforce the learning outcomes of the activity.
It is important that you utilise these icons as together they will provide you withthe underpinning knowledge required to understand concepts and theoriesand apply them to the business and management environment. Try to useyour own background knowledge when completing the activities anddraw thebest ideas and solutions you can from your work experience. If possible,discuss your ideas with other students or your colleagues; this will makelearning much more stimulating. Remember, if in doubt, or you need answersto any questions about this workbook or how to study, ask your tutor.International Financial Reporting
International Financial Reporting
Introduction
LEARINING OUTCOMES:
Welcome to the International Financial Reporting module of BA Accounting
and Financial Management topup
programme. By the end of the course it isexpected that you will be able to:
· Summarise, apply and critically appraise the content and context ofinternational financial reporting standards.
· Discuss and evaluate the contribution of a range of academic literatureto debates surrounding such standards.
· Perform essential knowledge and skills in preparing consolidatedfinancial statements.
· Organise and present material in an appropriate written form and
articulate arguments effectively in assessed work.The course also aims to encourage the development of oral communicationand group working. You will also develop IT skills by use of relevant webresources and the WebCT online course management system.
CONTENT SYNOPSIS:
This module aims to develop and add to your knowledge of the techniques,principles and underlying concepts of international financial accounting andreporting acquired in your previous studies. It also aims to provideopportunities for you to develop certain intellectual and transferable skills. Thiis achieved by providing you with:#p#分页标题#e#
(i) more detailed knowledge of the development and content of a numberof international financial reporting standards and of the effect of theseon the preparation and presentation of corporate financial statements;
(ii) a further opportunity to display and develop intellectual skills of logicalthinking, problem identification, critical analysis and solution, integratingtheory with practice and academic report writing;
(iii) a further opportunity to display and develop transferable skills relatingto verbal and written communication, numeracy and informationhandling, independent and collaborative learning, the use of IT andgeneral business awareness.
International Financial Reporting
TEACHING AND LEARNING METHODS:
This course has been designed around a requirement for a total of 100 hoursof study time. This encompasses selfstudyand assessment time. There arefeatures of this workbook that you need to be aware of before you begin andthese are as follows:
· It is intended to be completed by you at your own pace, wherever andwhenever you wish.
· You should be aware that the workbook contains only an overview ofthe subject. This provides the core of a structured approach to eachtopic that you should develop through your independent learning. It willidentify key points that you will need to develop with essential andsupplementary reading. You will find a reading list at the end of thisintroduction and further suggested readings are provided at the end ofeach unit.
· Each of the units begins with a list of learning objectives. Thesedescribe the skills and knowledge that you should gain from workingthrough the unit. It is important that you make reference to the learningoutcomes as you study in order to ensure that you achieve thenecessary objectives.
· This course is written using a variety of different media in order toassist your learning and it is intended that you don’t just sit readingthrough the written material but also use the website links and multimedia facilities in order to bring the course to life. Most important of allhowever are the activities and exercises, which are spread throughoutthe course material to reinforce your learning. As you work through themodule you will find activities to do. These aim to teach key areas of atopic, give you practice in using the skills or knowledge you havegained, or get you to think about the implications of the topic.
· After each activity you will find some feedback. This not only gives youthe answers, but provides you with further guidance on the topic. Thisis why, however much you may be tempted, you should not omit anactivity. You might miss out on some valuable feedback.
· Each unit ends with some selfassessmentquestions (SAQs) to test
your grasp of key points. By attempting these you will be able to checkwhether you have achieved the learning objectives for that unit. Don’tskip the SAQs or cheat and look ahead at the answers.
· The WebCT module management site provides webbasedsupport foryour independent learning. The site contains electronic copies ofmodule documents, further practical examples, solutions to numericquestions and guides to your further reading. It is also a formal noticeboard for the course. You should, therefore, check the announcementsregularly.#p#分页标题#e#
International Financial Reporting
ASSESSMENTS
This course is formally assessed via a piece of coursework.The coursework will contribute 100% to the final assessment mark for thiscourse. The coursework will be an essay or report format and restricted about3,000 words (no more or less than 10%). A pass mark of the coursework i40%.
REASSESSMENT ARRANGEMENTS
One piece of referred/deferred coursework will be used in the reassessment.
RECOMMENDED READING
Essential Textbook
ACCA study text (2007/08): F7 Financial Reporting (INT) Complete
Text,
Kaplan Publishing.
It is essential that you use this text, working through it alongside the units inthis open learning pack.
Other referenced texts
Alexander, D. & A. Britton, (2004) Financial Reporting, (7th ed.), Thomson
Alexander, D. & A. Britton & A. Jorissen (2007): International Financial
Reporting and Analysis, (3rd ed.), Thomson.
Atrill, P. & E. McLaney, (2002) Financial Accounting for Nonspecialists,
(3rd
ed.) Prentice Hall
Black G., (2003) Students’ Guide to Accounting and Financial ReportingStandards, (9th ed.) Prentice Hall,
Cox, D., D. Meikle & D. Street, (2003) Limited Company Accounts, OsborneBooks
Deegan C. & J. Unerman,(2006) Financial Accounting Theory, European ed.McGraw Hill
Elliott B. & J. Elliott, (2008) Financial Accounting and Reporting, (12th ed.)Prentice Hall
Lewis, R. & D. Pendrill, (2004) Advanced Financial Accounting, (7th ed.),Prentice Hall,
Sutton, T., (2004) Corporate Financial Accounting and Reporting, (2nd ed.),Prentice Hall
International Financial Reporting
Other Materials
Other material may be referenced in particular units; these will include articlesand webbased
resources. These references, along with the above texts, willbe made available in the WebCT.
International Financial Reporting Unit 1 – Introduction to and Context of the Course
Unit 1
Introduction to and Context
of the Course
LEARNING OUTCOMES
After completing this unit you should be able to:
· define corporate governance and explain its relationship to financial
reporting
· explain and give examples of creative accounting
· discuss the pressures that influence the system of corporategovernance
· read and understand published journal articles and critically evaluatethem
INTRODUCTION
Welcome to the first unit of the International Financial Reporting module. Inthis unit we shall look at the system of corporate governance that forms thebackground to financial reporting and at the pressures that operate upon thissystem. As this is the introductory unit of the module, we shall also provideyou with some guidance on how to read the journal articles that you willencounter in this and subsequent units.
Corporate Governance
In order to understand the background to the need for a robust system offinancial reporting we need to take a quick look back through history. NabarroNathanson (2002) describes a series of financial scandals that have, over thecenturies, presented a less than perfect picture of the world of finance. Their#p#分页标题#e#
list includes:
· Tulipmania in Holland in 1637
· the South Sea Bubble in 1720, the UK’s first stock market crash
· the Victorian railway boom of the 1840s
· the Wall Street crash of 1929
International Financial Reporting Unit 1 – Introduction to and Context of the Course
2
· the collapse of Slater Walker in the mid1970s
· three major scandals of the 1990s: the revelations, after his death, ofRobert Maxwell’s financial dealings; the Polly Peck collapse; Barings
Bank
· the collapse of Enron in 2001 and of WorldCom in 2002.
Their list ends in 2002 when their paper was published but no doubt you canadd to it from your reading of world events since then.Financial scandals like those listed above highlight the need for careful reviewof both the role that directors and managers play in corporate affairs and thenature of the financial reports that corporate entities produce for theirshareholders. Such a review was carried out in the UK in 1991 and in 1992the Committee on the Financial Aspects of Corporate Governance producedits report of this review. This report is known as the Cadbury Report (1992).
ACTIVITY
Locate a copy of the Cadbury Report (1992) at the website:
http://www.ecgi.org/codes/documents/cadbury.pdf
How does the report define corporate governance?
FEEDBACK
You should have found from page 14, para 2.5 of the report that it definescorporate governance as: ‘…the system by which companies are directed andcontrolled in the interests of shareholders and other stakeholders…’Financial reporting is the process by which directors meet the accountabilityrequirements of the system of corporate governance: directors report toshareholders regularly on their stewardship, with a system of independentauditing providing a check on the ‘truth and fairness’ of those reports.
Let’s pause for a moment to explore these two groups: shareholders anddirectors.International Financial Reporting Unit 1 – Introduction to and Context of the Course
3
ACTIVITY
In the traditional view of the limited company, the directors and shareholders
can be identified as two distinct groups.
1. How would you rank these two groups in terms of their distance fromdaytodaycompany activity?
2. What relationship does that ranking bear to the level of risk they take incontributing to the company?
3. With which group do you think control of a large company really lies?
FEEDBACK
1. You probably said that the shareholders are more removed from thecompany’s activities. In many cases, they may not even be fully aware
of everything that the company does. Directors, in the form of a Board,act on behalf of the shareholders and are legally responsible for
managing the company so their involvement is a little closer. Thishierarchy can, however, be less clear than our description suggests. In#p#分页标题#e#
a small company it can be compressed, because the owners may alsobe the directors and managers, having more than an ownership
interest. If the hierarchy is of the traditional form, with a large number ofshareholders and with control in the hands of a Board of Directors, thedistance between ownership and control may be great.
2. In theory, the level of risk is in inverse proportion to this ranking, in thesense that shareholders bear all the risk by putting in capital and onlyhaving rights to residual profits. However, they can always sell their
shares and thus rid themselves of the risk.
3. The control in large companies lies with the Board of Directors, who
formulate the company policies that management and employees
execute.
International Financial Reporting Unit 1 – Introduction to and Context of the Course
4
Delegation
of control
Agency Theory
So shareholders own a company; directors control it. The following diagram
shows how the delegation of control by shareholders to directors leads to
those groups having distinct sets of objectives.
The diagram ascribes a label ‘agency theory’ below these two sets of
objectives: we now need to explore what the term ‘agency theory’ means.
ACTIVITY
Think about what we said in the feedback above and suggest how the
objectives of these two groups, shareholders and directors, might differ.
FEEDBACK
The objectives of the shareholder group will be concerned with how to
maximise profits, with dividends and capital gains. You may also have said
that they will look for long term business growth, merger and acquisition, or be
prepared to take risks on projects with high returns.
However, the directors will want to maximise benefits and job security and be
more concerned with short term business performance, perhaps avoiding
mergers, acquisitions and risky projects.
Shareholders Directors
Ownership Control
Objectives Objectives
Company
≠
Agency theory
International Financial Reporting Unit 1 – Introduction to and Context of the Course
5
The relationship between shareholders and management is an example of the
principalagent
relationship, and has given rise to agency theory. You may
have already encountered the concept of agency in your studies of Business
Law. An agent is defined as: a person used to effect a contract between
his/her principal and a third party.
So the owners or shareholders are the principals, the directors and senior
managers are their agents and the third parties are those with whom the
company deals: customers, suppliers, lenders and so on. However, modern
UK company law tends to impose upon the directors of a company the
position of principal when they make contracts with the outside world, with the
company managers as their agents, carrying out their duties under a contract#p#分页标题#e#
of employment with the company.
Agency theory leads to an important problem: what happens when the agentdirectors
have a different view or different agenda from that of the principalowners?
If the goals of the two parties are different or they have a different
view of the risks involved in a course of action, then the maximisation of
shareholder wealth may not be achieved. It is beyond the scope of this
module to explore the solutions to this problem but you should be aware that
agency theory is a contributory factor in our next topic: creative accounting.
Creative Accounting
Creative accounting is a term often used in a pejorative sense; dictionaries
tend to define it using words like ‘exploitation’ or ‘misleading’.
ACTIVITY
Use a search engine such as Google to find a couple of definitions on the
Web.
FEEDBACK
You may have found definitions similar to those from the dictionary that wementioned above. The general interpretation is one of the manipulation offinancial information. While this may be in accord with accounting standards, itcan fail to provide a ‘true and fair view’ of a company’s financial situation.
英國留學作業指導We can define creative accounting as the exercise of (legitimate) choice inaccounting for transactions and events with the motive of improving theperformance and position of the business. For example, the management mayInternational Financial Reporting Unit 1 – Introduction to and Context of the Coursewant to improve ratios such as the earnings per share (EPS) and or thegearing ratios, or they may want to suggest an inefficient stock market.Creative accounting can arise because of the agency relationship in businessthat we referred to earlier or there may be problems with the regulatorframework, gaps in accounting or an underlying assumption of ‘economicconsequences’. Let’s now look at some examples.
Examples of Creative Accounting
At this point in the unit we want you to explore examples of creativeaccounting while at the same time learning how to read a journal articles.
Reading critically is an important skill because in addition to enabling you toincrease your knowledge of the subject, it also ensures that you keep up todate. Work through the next activity carefully; when you read subsequentpapers as you work through the module, try to apply similar questions eachtime. In general, look for and note the following:
· date and authorship
· abstract and/or summary
· objective of the paper
· main points
· authors’ opinions and conclusions
· whether you agree with those conclusions.
ACTIVITY
Using your Athens password, locate the following article:
Tweedie, D. & G. Whittington, (1990) ‘Financial reporting: current problemsand their implications for systematic reform’, Accounting and Business#p#分页标题#e#
Research, Vol. 21, No. 81
As you read the paper by Tweedie and Whittington (1990) ask yourself thefollowing questions and note down the answers:
1. What is the date of the paper?
2. Who are the authors?
3. Is there useful knowledge in the paper’s Introduction and Conclusion?
4. What is the object of the paper?
5. Why have problems in financial reporting arisen?
6. Some detailed considerations of the problems (this is quite difficult tomaster; keep referring back to it as the module progresses):International Financial Reporting Unit 1 – Introduction to and Context of the Course
· What is offbalancesheet financing?
· What (three) examples are given in the paper?
· Why is offbalance
sheet financing problematic for financial
reporting?
· What is goodwill?
· Why is the accounting treatment of goodwill (subsequent to its
calculation) problematic for financial reporting?
· What are complex capital issues?
· Why is accounting for complex capital issues problematic forfinancial reporting?
· Why is accounting for brands problematic for financingreporting?
7. What do the authors believe are the (three) common characteristics ofthese problems?
8. What systematic principles do the authors consider standard setters
might adopt to cope with these?
FEEDBACK
Compare your responses to the questions with ours.
1. The date of the paper is easily found from the reference. It appears inthe winter 1990 volume of the journal Accounting and BusinessResearch.
2. Again, this is easy to find. The authors are David Tweedie and Geoffrey
Whittington. A footnote provides more information (current in 1990)
about the authors: Tweedie was the Chair of the Accounting Standards
Board (ASB) and Whittington was a professor of financial accounting at
the University of Cambridge and an academic advisor to the ASB.
3. The paper’s Introduction provides an overview of the article, includingthe background, purpose and results of the research on which thearticle is based. The Conclusion to the paper summarises the resultsand provides the conclusions of the authors.
4. The object of the paper, as stated in the first paragraph of theintroduction is to examine a number of perceived problems with
financial reporting, identify their common characteristics and thus try toalleviate the problems by providing a set of systematic principles forstandard setters to adopt.
5. Again, you can find this in the introduction. Problems in financialreporting have arisen because recent (in 1990) innovations hadcontradicted the principle of standardisation by either introducing newInternational Financial Reporting Unit 1 – Introduction to and Context of the Coursetypes of contract or transaction that existing standards do not copewith, or by enabling repackaging of transactions that allows them to betreated differently from the manner prescribed by the standards.#p#分页标题#e#
6. The details are as follows:
a) Offbalancesheet financing is company debt finance that is notshown on the face of the balance sheet.
b) The three examples given in the paper are leases, nonsubsidiariesand contingent contracts.
c) Offbalance
sheet financing is problematic for financial reportingbecause it enables the company’s borrowings to be excluded from, forexample, gearing calculations. It can, therefore, give potential investorsand other stakeholders a misleading, incomplete view of the extent ofthe company’s indebtedness.
d) Goodwill, which we shall deal with in detail later in the module, canbe simply defined as the difference between what a company pays foran asset and what it is actually worth.
e) The accounting treatment of goodwill (subsequent to its calculation)is problematic for financial reporting because there is a choice oftreatments: write it off immediately; retain it in the balance sheetpermanently; or retain it but write it off.
f) Complex capital issues arise from the high level of takeover activity inthe capital markets. The article gives several examples such as deepdiscount bonds and convertible loan stocks.
g) Accounting for complex capital issues is problematic for financialreporting because it raises the issue of whether accounting should take
a probabilistic or a historic view of the effects of transactions.
h) Accounting for brands is problematic for financing reporting becauseit is, in effect, part of the problem of accounting for goodwill. Theseparate value of a brand is also difficult to determine.
7. The authors believe that these problems share three commoncharacteristics: the recognition problem of defining the reporting entity;the recognition problem of defining assets, liabilities and othercomponents of accounts; and the measurement problem of thevaluation of assets and liabilities and the extent to which gains in valueare recognised in the profit and loss account.
8. The systematic principles that the authors consider standard setters
might adopt to cope with these characteristics include: avoidance of a
‘fire fighting’ approach that deals with each problem individually;
adoption of a more systematic approach that designs standards to deal
with the issues common to a number of problems. For example,
management could be constrained to conform to higher standards by
user behaviour, and standards should aim to present data relevant to
the economic substance of a firm’s current and past position and
activities rather than its legal form. The authors provide a detailed list of
possible solutions in the body of the article.
International Financial Reporting Unit 1 – Introduction to and Context of the Course
9
Examples of creative accounting can be grouped under four heading:
· the definition or presentation of transactions and events: the
relationship between debt and equity and capital and revenue items#p#分页标题#e#
· recognition issues of assets and liabilities: offbalance
sheet finance,
intangible assets, pension assets/liabilities
· measurement issues: the revaluation of tangible fixed assets, the
amortisation of intangible assets (e.g. goodwill and brands)
· income smoothing: opportunities exist here within accounting for
provisions.
We shall end this first unit by returning to the topic of corporate governance.
ACTIVITY
Using your Athens password, locate the following paper:
Whittington G., (1993) ‘Corporate Governance and the Regulation of Financial
Reporting’, Accounting and Business Research, Vol. 23, No. 91A
This paper examines the topic of our first unit. What does Whittington say are
the four main pressures on the system of corporate governance? Writing in
1993, what is his main conclusion?
FEEDBACK
Whittington (1993) lists the four main pressures as: creative accounting,
business failures, rapid increases in directors’ pay and shortterm
pressures
imposed by the Stock Market. His main conclusion is that regulation is a
natural consequence of these underlying pressures, with selfregulation
as a
transitional phase in the evolution towards enforcement.
Pressures on the System of Corporate Governance
We would say, in conclusion, that there are also pressures on the system of
corporate governance from the increasing divorce of ownership and control
and from a change in the assumed information needs of users towards a
decisionuseful
perspective. There are two issues relevant to financial
reporting:
· content issues relating to creative accounting that appeared not to be
effectively addressed by the audit function or the efficiency of the stock
market
International Financial Reporting Unit 1 – Introduction to and Context of the Course
10
· context issues relating to the nature and effectiveness of the regulation
of accounting in curtailing creative accounting; this presupposes that
regulation of the system is the most appropriate approach.
Summary
In this opening unit of the International Financial Reporting module we have
looked at the system of corporate governance that forms the background to
financial reporting and at the pressures that operate upon this system. We
have looked at examples of creative accounting, one of these pressures. We
also provided some guidance in how to read the journal papers that you will
encounter throughout this module.
You should now try the self assessment questions before starting unit 2.
Review Activities
REVIEW ACTIVITIES 1
1. What is corporate governance?
2. How and why do the objectives of shareholders and directors differ?
3. How do we define creative accounting?
4. What are the main pressures on the system of corporate governance?#p#分页标题#e#
REVIEW ACTIVITIES 2
Case study: Enron
Discuss the key factors and issues and that led to the fall of Enron. Discuss
whether you think the same fraud could happen again.
The Enron scandal was the first in a series of accounting scandals that hit the
world headlines from 200103.
Background
Enron was formed in 1985 and was the first US nationwide gas pipeline
network. The business shifted from core operations towards the energy
trading markets as there was a great deal of money to be made buying and
selling energy contracts.
Enron’s revenues grew significantly; in 2000 its revenue had climbed to $101
billion from less than $10 billion only a decade earlier.
International Financial Reporting Unit 1 – Introduction to and Context of the Course
11
Enron started to unravel as a result of using dishonest accounting techniques.
In 1999 ethical considerations were ignored when the board allowed the chief
financial officer, Andrew Fastow, to create private partnerships that were used
to do business with the company.
In the US, special purpose entity partnerships do not have to be consolidated
if an independent investor holds only 3% of the shares. This meant Enron
were able to hide losses in these types of entity as these partnerships and
special purpose entities were not consolidated into the Enron accounts. They
hide huge losses and large amounts of debt from the shareholders.
Andrew Fastow is said to have made over $30 million personally from the
operation of these partnerships.
In August 2001, the CEO, Jeffrey Skilling, left for undisclosed reasons, and in
the October Enron reported a quarterly loss. In November 2001 the company
announced that it was restated pervious earnings back to 1997 and reducing
them by $568 billion. In December 2001, the company filed for bankruptcy
owing $31.8 billion.
From August 2000, when the share price was $90, Enron executives who
knew of the hidden losses, started to sell off their shares secretly. By August
2001 the share price was down to $42 and yet investors still bought them
thinking the company would bounce back. The longer investors held on to
their shares, the lower the price fell and it was at $15 and the end of October.
Whistleblower
Sherron Watkins, the Enron Vice President of Corporate Development sent a
letter to Kenneth Lay, the founder of Enron and CEO, after Skilling left. She
outlined the issue Enron was facing with the partnerships and suspect
accounting. She copied in a friend at Arthur Andersen who passed it on to the
partner responsible for the Enron audit. The letter did not become public
knowledge until five months after it was written.
Probably the most famous quote from that letter correctly prophesised what
would happen at the company:
‘I am incredibly nervous that we will implode in a wave of accounting#p#分页标题#e#
scandals.’
The Enron audit committee has been criticised for its lack of involvement in
that letter. It should have been members of the audit committee who selected
the legal firm to investigate the allegations. Instead, it was Enron
management, and they decided to send it to the one firm Watkins had asked
them not to, as it had had some involvement in the partnerships in question.
Arthur Andersen knew about the fraud before the audit committee and were
criticised for not telling them. The audit committee only found out about the
scandal on 2 November 2001, when the company’s financial condition was
deteriorating rapidly. Six days later, Enron was restating its accounts.
International Financial Reporting Unit 1 – Introduction to and Context of the Course
12
Additionally, Arthur Andersen appeared to perceive its role as reporting to the
management of Enron and not the audit committee.
Corporate governance
Enron fulfilled many of the requirements for good corporate governance. They
had 13 directors, of whom only two were executives of Enron. The Chairman
and chief executive roles were split and they had independent nonexecutive
directors.
Despite this, decisions made and lapses in corporate governance led to Enron
falling.
In 1999, Fastow had asked for board approval for one of the partnerships; due
to the conflicts of interest involved, approval was contrary to the company’s
code of conduct. The board did not investigate the financial implications and
approved the partnership. From then on Fastow stood to gain from both his
employment in Enron and his special purpose partnership entities.
Subsequent to this, any concerns that were noted about the partnerships or
Andrew Fastow’s earnings were not followed up. Had these concerned been
followed up earlier, the company may not have dissolved as quickly as it did.
As a result of the Enron scandal, the US introduced many new rules on
corporate governance included in the SarbanesOxley
Act. Has this been
around at the time of Enron, it is fairly certain that these partnerships would
not have been approved or the fraud would have been discovered much
quicker.
Fall out Management
Kenneth lay was found guilty of six counts of securities and wire fraud, but
died before he could be sentenced.
Jeffrey Skilling was found guilty of nineteen counts of securities and wire fraud
and was sentenced to 24 years imprisonment. He started his sentence in
December 2006. He was ordered to repay $26 million to the pension fund.
Andrew Fastow was found guilty of 78 counts of fraud, money laundering and
conspiracy. He was sentenced to six years of prison and the forfeiture of
$23.8 million in exchange for testimonies against other Enron officers. He
testified against Lay and Skilling, claiming that they approved of, and directed,#p#分页标题#e#
his use of the partnerships that hid losses and debt.
In total, 19 Enron officers pleaded guilty or were convicted of charges laid
relating to the accounting fraud.
Auditors
The company’s auditor, Arthur Andersen, was convicted of criminal
obstruction of justice charges in 200. This charge arose from the instructions
given to staff to shred documents relating to the Enron audit. Once convicted,
International Financial Reporting Unit 1 – Introduction to and Context of the Course
13
the firm surrendered its right to practise, which ended the firm’s operations.
Arthur Andersen’s conviction was overturned in 2005 because of flaws in the
case. However, Arthur Andersen will not resurface, because the firm lost the
majority of its clients once the Enron case became public.
Commentators have suggested Arthur Andersen’s judgement may have
been compromised because of the large amount of consulting work it did for
Enron, in addition to the audit.
Employees
The bankruptcy of Enron cost 21,000 jobs.
The Enron pension plan suffered huge losses when the Enron share price
collapsed. It is estimated that 62% of the assets in the pension fund were
Enron shares. When the share price was high before scandal ($90 per share
in August 2000) this provided a secure pension fund. After the bankruptcy, the
share price was worthless (less than $0.70 per share).
Review Activities Feedback
REVIEW ACTIVITIES FEEDBACK 1
1. Corporate governance is defined by the Cadbury Report (1992) as the
system by which companies are directed and controlled in the interests
of shareholders and other stakeholders.
2. Shareholders will tend to want to maximise profits, with dividends and
capital gains, and will look for long term business growth, merger and
acquisition, being prepared to take risks on projects with high returns.
However, directors will want to maximise benefits and job security and
will tend to be more concerned with short term business performance,
perhaps avoiding mergers, acquisitions and risky projects. These
objectives differ because of the level of distance that the two groups
have from the daytoday
running of the company, with shareholders
sometimes being more remote.
3. Creative accounting is the exercise of legitimate choice in accounting
for transactions and events with the motive of improving the
performance and position of the business.
4. The main pressures on the system of corporate governance arise from
a number of factors: creative accounting; business failures; rapid
increases in directors’ pay; shortterm
pressures imposed by the Stock
Market; the increasing divorce of ownership and control; and from a
International Financial Reporting Unit 1 – Introduction to and Context of the Course#p#分页标题#e#
14
change in the assumed information needs of users towards a decisionuseful
perspective.
REVIEW ACTIVITIES FEEDBACK 2
The Enron fraud occurred and was allowed to continue because of a serious
break down in internal controls.
There were many factors occurring simultaneously that allowed the fraud go
undetected for so long:
1. The willingness of many Enron executives to turn a blind eye to
fraudulent accounting practices.
2. The lack of respect on the part of the board for the company’s code of
conduct that allowed a breach to occur and then failed to pick up any
further breaches.
3. The complacency of the board in investigating further issues that
concerned them, such as Andrew Fastow’s earnings. He was
fraudulently making money from the company and it was investigated
for some time.
4. The failure of the audit committee to have a proper involvement in the
fraud when it was first highlighted by Watkins’ letter.
5. The failure of Arthur Andersen to consult with the audit committee and
to spot irregularities in the Enron accounts.
One of the surprising aspects of the Enron fraud is that so many members of
the company appeared to know about it, but it took until 2001 before an
employee spoke up about it.
It appears likely that senior management were aware they were acting
fraudulently. A code of conduct was in place at Enron and it was not taken
account of. Some of these employees would have been members of
professional accountancy bodies with their own ethical codes in place. This
did not stop the fraud continuing. Members of Enron’s senior management
team lied to the stock market about the state of the company.
There were significant weaknesses in the system of corporate governance.
The role of directors is to oversee the operation of the company and act as
guardians of the business. The executives of Enron, involved in the
accounting fraud, did not perform their duty. There need to be procedures in
place to ensure that this cannot happen, that executives cannot overrule
procedures in place for the company’s protection. A conflict of interest, as with
Fastow’s partnerships, should have alerted the board to tread carefully rather
International Financial Reporting Unit 1 – Introduction to and Context of the Course
15
than approving the existence of the partnerships and failing to follow up
further queries. The board were complacent in their treatment of this issue by
not making a full investigation before accepting complex business
transactions.
The audit committee also failed to do its duty and were not aware of many of
the issues. They were not sufficiently organised and motivated to question the
company’s operations. It has been said that they were too close to the#p#分页标题#e#
directors and were not sufficiently independent.
It is hoped that corporate fraud on the scale of Enron and Worldcom would not
happen again. The US government responded with the SarbanesOxley
Act,
which provides detailed guidelines as to how the business should operate its
internal controls and the responsibility of the directors and auditors to ensure
that the system works correctly. The SarbanesOxley
Act is strict in its
requirements for directors and auditors to take responsibility for effective
internal control. However, the SEC metaphorically closed the gate after the
horse had bolted. Numerous accounting frauds have come to light since
Enron and, given the strict regulations of SarbanesOxley,
it should serve as a
preventative measure for the future.
References
Committee on the Financial Aspects of Corporate Governance (1992) Report
with Code of Best Practice, [Cadbury Report], London: Gee Publishing.
Nabarro Nathanson (2002) Corporate Governance Futile or Effective? 400
years of financial scandals, London, Nabarro Nathanson.
Recommended Readings
ACCA Study Text Paper 2 Corporate Reporting (International) (2007/08) BPP,
Chapter 7.
Blake, J., O. Amat & J. Dowds, ‘The ethics of creative accounting’, in Ethical
Issues in Accounting, ed. Gowthorpe, C. & J. Blake, Routhledge, 1998
Jones, M., Accounting for Nonspecialists,
chapter 13, Wiley, 2002
Lee, T., A., Financial Reporting and Corporate Governance, Wiley, 2006.
Myddleton, D.R. (2004) Unshackling Accountants, London, Institute of
Economic Affairs. [Available at
http://ideas.repec.org/a/eee/accoun/v40y2005i4p428432.
html ]
Naser, K. & M. Pendlebury, ‘A note on the use of creative accounting’, British
Accounting Review, Vol.24, 1992
International Financial Reporting Unit 1 – Introduction to and Context of the Course
16
Perks, R., Financial Accounting for Nonspecialists,
chapter 8, McGrawHill,
2004
Solomon, J., Corporate Governance and Accountability, Wiley, 2007.
Chapters 14.
Tweedie, D. & G. Whittington, ‘Financial reporting: current problems and their
implications for systematic reform’, Accounting and Business Research, Vol.
21, No. 81, 1990
Whittington, G., ‘Corporate governance and the regulation of financial
reporting’, Accounting and Business Research, Vol.23, No.91A, 1993
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
17
Unit 2
The Regulatory and
Conceptual Framework of
International Financial
Reporting
LEARNING OUTCOMES
After completing this unit you should be able to:
· describe the international regulatory systems for financial reporting
· outline the development of the IASB#p#分页标题#e#
· explain and critically discuss the contents of the IASB framework
· reflect on various international influences on financial reporting
standards and practices in your own country.
· gain some understanding of the notion of ‘true and fair’ view.
INTRODUCTION
Towards the end of unit 1 we reached the point where we saw that a natural
consequence of the various pressures on the system of corporate governance
was regulation. We shall develop this in unit 2 by looking at the development
of the International Accounting Standards Board (IASB) and of the regulatory
and conceptual framework of international financial reporting.
How might we regulate financial reporting?
Financial reporting is, as we have seen, an important part of the international
system of corporate governance. However, there are arguments both for and
against the regulation of financial reporting and recent decades have
witnessed concerns relating to the context and content of financial reporting.
So the first step in this unit is to ask how we might regulate financial reporting.
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
18
ACTIVITY
Before going any further, reflect for a moment on what influences financial
reporting standards and practices in your own country? Is it the market? Is it
the State? The law?
FEEDBACK
Your response to this might be a combination of the following ways that
financial reporting can be regulated:
1. each company might choose its own rules, pressured by the capital
markets
2. associationism: rules are developed by organisations formed to
represent the interests of their members
3. corporatism: rules are developed by organisations that are licensed by
the state and incorporated into a state sponsored system of regulation
4. the state: statutory rules are developed, with an enforcement
mechanism.
Within each of these possible regulation mechanisms there is also the need to
consider how the rules are first created and approved, and then enforced.
Bearing all this in mind, we can say that the most important types of regulation
are the law and accounting standards, and it is the accounting standards that
form the focus of much of our work in this module. It is useful, first of all, to
look briefly at the history of the International Accounting Standards Board
(IASB).
IASB: a history
In 1973 accountancy bodies from nine countries formed the Board of the
International Accounting Standards Committee and until the late 1980s the
Board’s activity involved codifying best practice in a set of International
Accounting Standards, which included many options.
In 1989 the Board published a conceptual framework of international
accounting standards (IASs), the Framework for the Preparation and#p#分页标题#e#
Presentation of Financial Statements and began initial discussion with the
International Organisation of Securities Commissions (IOSCO) regarding the
acceptance of IASs as applicable to the financial statements of crossborder
multinationals. This period also saw the development of a ‘comparability
project’ to eliminate certain options in IASs and/or to incorporate the
expression of a preference (a benchmark treatment).
From 1993 IASs began to be adopted by a number of continental companies
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
19
for their consolidated statements and in 1995 IOSCO and the IASC agreed to
develop a ‘core set’ of IASs. In 1998 certain countries legally allowed the use
of IASs for consolidated statements, and in 2000 IOSCO endorsed the use of
IASs. In 2001 the IASC reformed as the International Accounting Standards
Board (IASB).
ACTIVITY
Look at the website of the IASB at:
http://www.iasb.org/Home.htm
Who were the nine original members?
FEEDBACK
The nine original Board members were: Australia, Canada, France, Germany,
Japan, Mexico, the Netherlands, the UK and the USA.
ACTIVITY
Look again at the IASB website and briefly describe its current structure. You
will find that the site has a diagram showing the relationships between the
different sections.
FEEDBACK
You should have discovered that the reformed IASB consists of:
1. the IASC Foundation, which has two main bodies: the IASB and the
advisory trustees
2. the IASB, which initially adopted extant IASs but issues its own IFRSs
3. the International Financial Reporting Interpretations Committee (IFRIC)
4. the Standards Advisory Council (SAC).
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
20
We referred above to the conceptual framework published by the IASB in
1989. We now need to explore this in more detail.
What is a conceptual framework?
The Financial Accounting Standards Board (FASB) defined a conceptual
framework as ‘… a coherent system of interrelated objectives and
fundamentals that can lead to consistent standards and that prescribes the
nature, function and limits of financial accounting and financial statements…’
(FASB, 1967)
Financial reporting needs such a framework in order to:
1. ensure consistency and coherence in standard setting
2. identify and rank issues, and allow for a proactive
approach to
standard setting
3. encourage ‘rational’ debate
4. aid interpretation of standards by those who prepare and audit
accounts
5. enhance the credibility of financial reporting
6. legitimate the standard setting process.
ACTIVITY
There is a brief summary of the framework at:#p#分页标题#e#
http://www.iasb.org/NR/rdonlyres/E366C16217E44FBE80EB7A506A615138/
0/Framework.pdf
From this, find out what four main areas the framework covers. Return to the
IASB website and find and read about the IASB’s work on the conceptual
framework at:
http://www.iasb.org/Current+Projects/IASB+Projects/Conceptual+Framework/
Conceptual+Framework.htm
Follow the link to the project update and from there, note down the main
objective of financial statements according to the framework.
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
21
FEEDBACK
The framework will need to cover:
1. the objective of financial statements
2. the qualitative characteristics that determine the usefulness of
information in financial statements
3. the definition, recognition and measurement of the elements from
which financial statements are constructed
4. concepts of capital and capital maintenance.
You should have found that, according to the framework, the main objective of
financial statements is to provide financial information about the reporting
entity that is useful to present and potential investors and creditors in making
decisions in their capacity as capital providers. Thus the objective is to provide
information about financial position, performance and changes in financial
position to a range of users, but the priority user is the investor group and the
main purpose is for economic decision making.
From the summary you should also have noticed that the framework states
that financial statements are prepared with the underlying assumptions:
1. the accruals (or matching) basis of accounting
2. that the entity is a going concern.
The qualitative characteristics referred to in the summary are:
1. understandability
2. relevance (including materiality)
3. reliability (including faithful representation; substance over form;
neutrality; prudence; completeness)
4. comparability.
We need to look further at the definition, recognition and measurement of the
elements from which financial statements are constructed, as this will form
much of the material in the rest of the module.
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
22
ACTIVITY
Continue reading the summary document and note down:
1 How the various elements (assets, liabilities, equity, income and expenses)
are defined.
2 The criteria for the recognition of an element.
FEEDBACK
You should have made notes as follows.
1 An asset is defined by the summary as a resource controlled by an
enterprise as a result of past events and from which future economic benefits
are expected to flow to the entity.
A liability is a present obligation arising from past events the settlement of#p#分页标题#e#
which is expected to result in an outflow of resources embodying economic
benefits.
Equity is the residual interest in the assets of the enterprise after deducting all
its liabilities.
Income is defined as increases in equity (other than transactions with the
owners).
Expenses are decreases in equity (other than transactions with the owners).
2 An element should be recognised if it is probable that any future economic
benefit associated with the item will flow to or from the entity, and the item has
a cost or value that can be measured with reliability.
The elements of a set of financial statements must be measured, and here the
choice is between historical cost, current cost, realisable value or present
value.
Let’s now return to our starting point for the unit and consider again the need
for a regulatory framework.
Why a regulatory framework?
There is a need for regulation of financial statements because they need to:
· provide direction
· provide guidance
· ensure quality
· meet users’ requirements.
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
23
The issue of quality is crucial, and can be represented by the concept of the
‘true and fair view’ or ‘fair presentation’.
ACTIVITY
Use your Athens password to access the following journal articles:
Walton, P. Introduction: the true and fair view in British accounting, European
Accounting Review, Vol. 1, 1993.
Read through the paper and as you read, note down the answers to the
following questions:
1 What are the three categories of meaning of ‘true and fair view’ according to
Walton?
2. What does Walton say are the implications for European harmonisation?
3. What is Walton’s general position with respect to the meaning of ‘true and
fair view’?
FEEDBACK
You should have noted that:
1. The three categories of meaning of ‘true and fair view’ according to
Walton are: a legal, residual clause; an independent concept; and a
generally accepted accounting principle (GAAP).
2. According to Walton the implications for European harmonisation,
under the GAAP view, are that each member state had its own ‘true
and fair view’ before the Fourth Directive; that to create a harmonised
true and fair view would require a common GAAP or meaning; and that
the actual words are signifiers and do not really matter.
3. Walton’s general position with respect to the meaning of ‘true and fair
view’ is that it carries both an operational meaning and a potentially
wider political meaning, when accountants are defending or enhancing
their professional status.
Finally, you should note that there are various global standards:#p#分页标题#e#
· The EU regulation imposes endorsed IFRSs on the consolidated
statements of all companies listed in the UK on 1st January 2005.
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
24
· Currently, the US Financial Accounting Standards Board (FASB) and
the IASB are working together on ‘convergence’.
· The aim for 2009 is to eliminate the SEC requirement for foreign private
issuers to reconcile IFRSbased
financial statements to US GAAP.
The goal is harmonisation of national financial reporting frameworks: a
response to the globalisation of business, but whether harmonisation will be
based on a particular view (the conceptual framework) that is appropriate for
other countries remains to be seen.
Summary
In this unit we developed the idea from unit 1 that a natural consequence of
the various pressures on the system of corporate governance was regulation.
We looked at the development of the International Accounting Standards
Board (IASB) and of the regulatory and conceptual framework of international
financial reporting. We also explored the notion of the ‘true and fair view’.
In the appendix to this unit we have provided a list of IFRS and IAS
summaries. The remainder of the module will cover a selection of these.
Review Activities
REVIEW ACTIVITIES 1
In this unit we want you to check your progress by exploring the ‘true and fair
view’ concept.
1. How would you define this term?
2. Where is the term used most frequently?
3. What is the historical development of the concept?
4. Why is a ‘true and fair’ view required?
5. How is the ‘true and fair’ view achieved?
6. What is the relationship between ‘true and fair’ and harmonization?
REVIEW ACTIVITIES 2
In financial reporting it is essential to ensure that information is communicated
in a manner which can be understood by the recipients of the report. In
addition, it is of the utmost importance that company reports do not become
overburdened
with unnecessary detail and that the costs of collecting and
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
25
publishing the information are kept within reasonable bounds.
What is the reasoning behind this statement and what are the implications?
Review Activities Feedback
REVIEW ACTIVITIES FEEDBACK 1
1. “The concept of ‘true and fair view’ has never been officially defined, and it
has been argued that a definition would neither be possible nor desirable, as
the principle is dynamic” (Evans, 2003: pp312).
2 The term is used most frequently in auditor’s reports in financial statements.
3. The concept has been developed in the UK based on three basic ideas#p#分页标题#e#
(Chastney, 1975; Walton, 1991; Evans, 2003):
a legal residual clause;
an independent concept;
generally accepted accounting principles.
4 A ‘true and fair’ view is required to achieve “the objective of financial
statements which is to provide information about the financial position,
performance and changes in financial position of an enterprise that is useful to
a wide range of users in making economic decisions.” (ISAB: IAS Framework,
2001)
5 The ‘true and fair view’ can be reflected by four qualitative characteristics in
financial reporting:
· relevance
· reliability
· comparability
· understandability
6 In assessing the relationship between ‘true and fair’ and harmonization think
about the following points:
(1) each member state has its own true and fair view before the
harmonization;
(2) in order to create a harmonized true and fair view, there is a need to
change to a common GAAP and construct a common meaning of the
true and fair view;
(3) the actual words used in understanding the true and fair view do not matter;
what is important is how the true and fair view is signified.
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
26
REVIEW ACTIVITIES FEEDBACK 2
1. It is important that published financial statements are not seen to be
mere statements of data produced for no purpose. The financial
statements should include useful information that should be readily
available to those who have a right to receive and use such
information.
2. If the financial reports are communicated to the relevant users it is
essential that the reports are in a form such that their content can be
readily understood. There is little point in sending complicated financial
statements containing details expressed in technical accounting jargon
to nonaccountant
users. Such reports should be simplified, possibly by
summarising the full financial statements, with explanations in ‘plain’
language. This is particularly important when attempting to provide
financial information to employees. A complicated report will go unread.
3. With the development of IASs and increasingly complex local statutory
and regulatory requirements, the financial reports of larger companies
have become formidable documents. Some believe that the reports of
companies have become so detailed that only those with an accounting
background can use such documents.
However, the answer may not be to simplify such reports. What
constitutes ‘unnecessary detail’ is a matter of subjective judgement and
some vital information may be lost if detail is removed or – worse – the
details provided could be misinterpreted or taken out of context. There#p#分页标题#e#
is a fine dividing line between detailed statements that provide a true
and fair view and overdetailed
statements that a reader cannot use
without a great deal of time and effort. As yet the optimum level of
reporting has to be agreed, but the accounting profession is likely to
continue in its endeavour to make corporate reports valuable by
meeting the various user needs.
4. This is an application of the costbenefit
principle. In some countries
companies are permitted to send summary financial statements to
shareholders, who do not elect to receive the full financial statements,
thereby reducing the not inconsiderable cost of printing and distributing
full financial statements to all shareholders, many of whom cannot fully
understand such statements and therefore derive no benefit from their
receipt. It is unlikely that the cost of collecting the information is
particularly relevant. Much of the detail is required for internal
management reporting purposes; the incremental cost related to
collecting information to meet additional external reporting
requirements is not likely to be significant. Often the problem of
confidentiality means that much more information is available internally
than will ever be made available externally.
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
27
The development of more ‘userfriendly’
published accounts will
continue and the accounting profession may be forced to change its
current position if it is to have credibility as a useful, relevant profession
in the future. The service provided by the publication of financial reports
must be relevant to the environment in which it exists.
Recommended Readings
Chastney, J.G. (1975), ‘True and Fair View – History, Meaning and the Impact
of the 4th Directive’, Occasional Paper 6, Institute of Chartered Accountants in
England and Wales, London, .
Evans, L. (2003) ‘The true and fair view and the ‘fair presentation override of
IAS1’, Accounting and Business Research, Vol. 33, No. 4
Evans, L. (2004) ‘Problems with fairness’, Accountancymagazine.com
October
FRC, (2005) The implications of the accounting and auditing standards for the
‘true and fair view’ and auditors’ responsibilities, August [Available at
http://www.frc.org.uk/press/pub0854.html]
Parker, R. H. & C. W. Nobes, (1991) ‘True and Fair: UK Auditors’ View’,
Accounting and Business Research, Autumn.
Walton, P. (1993) Introduction: the true and fair view in British accounting,
European Accounting Review, Vol. 1.
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
28
Appendix
IFRS and IAS summaries#p#分页标题#e#
Framework Technical
Summary *
IFRSs:
IFRS 1 Firsttime
Adoption of International Financial Reporting Standards
IFRS 2 Sharebased
Payment
IFRS 3 Business Combinations
IFRS 4 Insurance Contracts
IFRS 5 Noncurrent
Assets Held for Sale and Discontinued Operations
IFRS 6 Exploration for and evaluation of Mineral Resources
IFRS 7 Financial Instruments: Disclosures *
IFRS 8 Operating Segments
IAS 1 Presentation of Financial Statements *
IAS 2 Inventories
IAS 7 Cash Flow Statements *
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
IAS 10 Events After the Balance Sheet Date
IAS 11 Construction Contracts
IAS 12 Income Taxes
IAS 16 Property, Plant and Equipment *
IAS 17 Leases *
IAS 18 Revenue
IAS 19 Employee Benefits *
IAS 20 Accounting for Government Grants and Disclosure of Government
Assistance
IAS 21 The Effects of Changes in Foreign Exchange Rates
International Financial Reporting Unit 2 – The Regulatory and Conceptual Framework
29
IAS 23 Borrowing Costs *
IAS 24 Related Party Disclosures
IAS 26 Accounting and Reporting by Retirement Benefit Plans
IAS 27 Consolidated and Separate Financial Statements
IAS 28 Investments in Associates
IAS 29 Financial Reporting in Hyperinflationary Economies
IAS 31 Interests in Joint Ventures
IAS 32 Financial Instruments: Presentation *
IAS 33 Earnings per Share
IAS 34 Interim Financial Reporting
IAS 36 Impairment of Assets *
IAS 37 Provisions, Contingent Liabilities and Contingent Assets *
IAS 38 Intangible Assets *
IAS 39 Financial Instruments: Recognition and Measurement *
IAS 40 Investment Property
IAS 41 Agriculture
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
30
Unit 3
The Presentation of
Financial Statements
(IAS 1) I
LEARNING OUTCOMES
After completing this unit you should be able to:
· explain the nature and purpose of a balance sheet
· analyse the presentation of a balance sheet
· discuss the accounting conventions of financial statements
· interpret a balance sheet
· evaluate the limitations of a balance sheet.
INTRODUCTION
This is where we begin to look closely at the International Accounting
Standards. In this and the next unit we shall focus on IAS1, the standard that
deals with the presentation of financial statements. In this unit we shall
concentrate on the balance sheet.
Begin by reading through the technical summary of IAS1.
ACTIVITY
Download the technical summary from:
http://www.iasb.org/NR/rdonlyres/80B373BFBB1645ABB3F78385CD4979EA/
0/IAS1.pdf
What is the general scope of the standard according to the summary?#p#分页标题#e#
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
31
FEEDBACK
From the summary you can see that IAS 1 covers:
The term ‘entity’ is used throughout without the concept being made explicit.
1. the components of financial statements: balance sheet, income
statement etc.
2. aspects such as fair presentation and compliance with IFRS, the ‘going
concern’ and ‘accrual’ basis of accounting, consistency of presentation,
materiality and aggregation; offsetting; comparative information
3. the structure and content of financial statements
4. the basis for conclusions
5. guidance on implementation.
You can see from IAS1 that the three basic financial statements are:
· the balance sheet, showing the accumulated wealth of the entity at the
end of the accounting period. It is a statement at one point in time and
can be regarded as a snapshot of the entity’s position.
· the income statement, showing the profit (or loss) generated over the
period. It is a record over time rather a snapshot of one moment.
· a cash flow statement showing cash movements over the period.
All three statements provide an overall picture of the financial health of the
entity.
ACTIVITY
An illustration of financial statements produced in accordance with IFRS can
be found at:
http://www.kpmgifrg.com/pubs/pub_ifst.cfm
You may want to download this document.
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
32
The relationship between the statements can be summarised in the following
diagram:
1 2 3
Accounting period
In this unit we shall concentrate on the balance sheet.
The Balance Sheet
As we mentioned earlier, the purpose of the balance sheet is to set out the
financial position of a business at a particular moment in time. It is therefore a
position statement showing a picture of financial strength (or weakness) with,
on one hand, the assets of the business and on the other, claims (liabilities)
against the business.
There is an important distinction to be made when discussing either assets or
liabilities and that is between those that are current and those that are noncurrent.
Assets
A current asset is one that is bought or acquired for nonpermanent
use in the
business. Alexander et al (2007) describe a current asset as having the
following features:
· it is expected to be realised in, or is held for sale or consumption in, the
normal course of the operating cycle of the business
· it is held primarily for trading purposes
· it is expected to be realised within twelve months of the balance sheet
date
Balance#p#分页标题#e#
sheet
Balance
sheet
Balance
sheet
Income
statement
Income
statement
Cash flow
statement
Cash flow
statement
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
33
· it is cash, or the equivalent of cash, that is not restricted in its use.
All other assets are classified as noncurrent
assets.
ACTIVITY
Using the above definition, decide whether the following balance sheet items
are current or noncurrent
assets and give the reason for your response:
1. Money owed to the business by customers
2. Premium bonds held by a small business
3. Office furniture owned by a travel agent
4. Office furniture owned by a manufacturer of office furniture
FEEDBACK
1. Money owed to a business by its customers (debtors) will be a current
asset because the business will expect payment soon after the balance
sheet date.
2. Premium bonds held by a small business are noncurrent
because they
will be held as an investment and are, presumably, not expected to be
realised within twelve months of the balance sheet date.
3. Office furniture owned by a travel agent is noncurrent.
It is not
intended for sale.
4. On the other hand, office furniture owned by a manufacturer of office
furniture is intended for sale, and in the balance sheet of that company
it will be part of the inventory and as such, a current asset.
We shall look at the further classification of noncurrent
assets in later
units.
Liabilities
In the classification of assets the term ‘current’ is used almost in the sense of
the current of a flowing river, to contrast with the fixed or permanent nature of
noncurrent
assets such as equipment and buildings. However, when we refer
to current liabilities we are using the term in the sense of ‘happening now’ to
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
34
contrast with the longterm
nature of some liabilities of a business. So, current
liabilities are:
· those that the business incurs from day to day
· expected to be settled in the normal course of the business operating
cycle and within twelve months of the balance sheet date
· primarily trading debts of the business.
All other liabilities should be classified as noncurrent
liabilities.
ACTIVITY
Using the above definition, decide whether the following balance sheet items
are current or noncurrent
liabilities and give the reason for your response:
1. Trade creditors who are owed money for supplies
2. Accrued expenses such as electricity and telephone bills
3. A bank overdraft#p#分页标题#e#
4. A loan secured on company assets
5. Monies owed to shareholders.
FEEDBACK
Your response should have been that items 1 to 3 are all current liabilities
because of their shortterm
nature. The secured loan and the shareholders’
funds are longterm
liabilities and are therefore not current.
Major items in the balance sheet
Of course a balance sheet is far more complex than our distinction between
current and noncurrent
assets and liabilities would so far suggest
ACTIVITY
From the document at:
http://www.kpmgifrg.com/pubs/pub_ifst.cfm
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
35
or from other sources, draw up your own list of the components of a balance
sheet. Bear in mind that not every component will appear in every balance
sheet.
FEEDBACK
From an overview of a range of balance sheets from different business
entities you should have drawn up a list similar to this:
1. Property, plant and equipment
2. Investment property
3. Intangible assets (we shall define these later in the module)
4. Financial assets
5. Inventories (sometimes called stock and workinprogress)
6. Trade debtors and other receivables (provisions)
7. Cash and cash equivalents
8. Trade creditors and other payables (accruals)
9. Tax liabilities and assets
10.Provisions
11.Financial liabilities
12.Minority interests
13.Issued capital and reserves
There is also a wealth of additional information in most balance sheets. Key
items will be subject to further classification and analysis, for example:
· tangible/intangible assets: see IAS 16 Property, Plant and Equipment
· the subclassifications
of inventories: see IAS 2 Inventories
· operating leases or finance leases: see IAS 17
· borrowing costs shown as an expense or capitalised: see IAS 23.
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
36
You will also have noticed the often substantial notes to the financial
statements.
The Balance Sheet Equation
One way of looking at a balance sheet is to conceptualise it as an equation. A
mathematical equation states that everything on the left is equal to everything
on the right; a modern balance sheet says that the total of everything in the
top section is equal to the total of everything in the bottom section. Let’s
explore this using a series of simple examples in which no goods are sold but
the asset and liability situation of the business changes.
Let’s assume that a trading entity starts as a small business with €4,000 of the
owner’s own money. At this point, it is easy to see that €4,000 in a bank#p#分页标题#e#
represents what the business is worth, since the business owes nothing. The
balance sheet ‘equation’ is therefore:
Bank = Capital
€4,000 = €4,000
ACTIVITY
Rewrite the equation after each of the following transactions:
1. The owner spends €1,000 of the money on a van.
2. The owner then obtains stock on credit of €2,000.
3. The owner introduces some more capital in the form of a computer at a
cost of €3,000.
FEEDBACK
The equation will change at each step as follows:
1. After the owner spends €1,000 of the money on a van (another asset),
the equation becomes:
Bank + Van = Capital
€3,000 + €1,000 = €4,000
2. After obtaining the stock on credit the equation is a little different, since
there is now a liability in the form of the supplier of the stock, but the
balance on the capital account remains the same:
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
37
(Bank + Van + Stock) Creditor
= Capital
(€3,000+ €1,000 + €2,000 ) €
2,000 = €4,000
3. After the further injection of capital the equation becomes:
( Bank + Van + Stock + Computer ) Creditor
= Capital
(€3,000 + €1,000 + €2,000 + €3,000 ) €
2,000 = €7,000
In this last step the net worth of the business increased because of the
introduction of new capital; whatever happens to one side of the net worth
equation also affects the other side.
In addition, following mathematical principles, the equations can be
manipulated. The last one would be exactly the same if it had been expressed
as:
Bank + Van + Stock + Computer = Capital + Creditor
€9,000 = €7,000 + €2,000
We can summarise this in the following diagram:
Assets = Capital + Liabilities
OR
Assets Liabilities
= Capital
Noncurrent
assets
+ Current
assets
= Capital + Noncurrent
liabilities
+ Current
liabilities
OR
Noncurrent
assets
+ Current
assets
Capital
Noncurrent
liabilities
= Current
liabilities
The balance sheet is not without its limitations. It provides us with a snapshot
of the strength (or weakness) of the business at one point in time but this
means that inevitably:
· it can provide no details of what happened during the period
· it can give little information about performance and cash flows during
the period
· being composed of historical data it may be seen as being of little use
for the future.
The balance sheet focuses on the resources that go into and out of the
business and we need to be aware that the valuation of some of those#p#分页标题#e#
resources may be subjective. This will become apparent when we look at
topics like depreciation and the valuation of inventory.
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
38
Our last section in this unit deals with the accounting concepts that underpin
financial statements.
Accounting Concepts
The recording of accounting information and the preparation of accounts has
always been governed by a number of accounting concepts that may relate to
the ethics of the profession, the rules of measurement of financial transactions
or the rules that govern the content of financial statements. In brief, these
concepts are as follows.
Entity
The business is, for the purpose of accounting, a separate legal entity from its
owners. In English law a limited company is a separate legal person but the
accounting concept also applies to the financial statements of a sole trader, in
that personal financial matters are kept separate. In the event of bankruptcy,
this is no longer the case but this topic is not within the scope of this module.
Time interval
Financial statements are prepared at regular intervals. This is usually, though
not always, annually.
Duality
Every transaction has a twofold
effect, one is credited, the other debited. For
example, when the entity sells goods on credit the sales account is credited
and the customer’s account is debited.
Money Measurement
Financial accounting, as the term suggest, can only deal with items capable of
being expressed in money terms.
Accruals
Transactions and events are recognised when they occur, not when cash is
received or paid for them. If the entity has consumed electricity but not paid
for it at the date of the balance sheet, this consumption is included in the
expenses of the profit and loss account and shown as an accrual on the
balance sheet.
Going Concern
Financial statements are prepared on the assumption that the business will
continue trading.
Consistency
Consistency of presentation of the accounts should be retained from one
period to the next.
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
39
Materiality and Aggregation
Material items should be shown separately, but immaterial items may be
aggregated with amounts of a similar nature.
Offsetting
Assets should be shown separately from liabilities, and income from
expenses. There should be no offsetting.
Comparative Information
Comparative information for the previous period should be shown alongside
that for the current period.
ACTIVITY
Refer to the IAS1 technical summary document that you downloaded earlier
and look for mention of any of the above concepts. Use the checklist below to#p#分页标题#e#
indicate which are mentioned:
Entity
Time interval
Duality
Money measurement
Accruals
Going concern
Consistency
Materiality and aggregation
Offsetting
Comparative information
FEEDBACK
You should have discovered that the following concepts are explicitly covered:
Time interval
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
40
Accruals
Going concern
Consistency
Materiality and aggregation
Offsetting
Comparative information
The term ‘entity’ is used throughout without the concept being made explicit.
Summary
In this unit we began to look at IAS1, the standard that covers the
presentation of financial statements. We concentrated on the balance sheet
and defined its nature and purpose: it is a snapshot of an entity setting out its
financial position at one moment in time. We distinguished between the
current and noncurrent
nature of assets and liabilities. In the case of assets
the term ‘current’ refers to their permanence or lack of it, while in the case of
liabilities it refers to their shortor
longterm
nature.
In the unit we also looked at an overview of the structure of a balance sheet
and at the various accounting conventions that govern the presentation of
financial statements.
You should now try the self assessment question before going on to unit 4.
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
41
Review Activities
REVIEW ACTIVITIES 1
Phoenix plc’s trial balance at 30 June 2008 was as follows:
€000 €000
Freehold land 2,400
Other property, plant and
equipment 1,800 (depreciation)540
Furniture and fittings 620 (depreciation)360
Inventories (30 June 2007) 1,468
Sales revenue 6,465
Administrative expenses 1,126
Ordinary shares of €1 each 4,500
Investments (noncurrent)
365
Revaluation reserve 600
Development cost 415
Share premium 500
Receivables 947
Payables 592
Cost of goods sold 4,165
Distribution costs 669
Dividend received 80
Profit and loss account 488
Bank 150
14,125 14,125
Corporation tax for the year is estimated at €122,000.
Insofar as the information permits, prepare the balance sheet as at 30th June
2008 in accordance with international financial reporting standards (IFRS).
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
42
REVIEW ACTIVITIES 2
Small Limited is a quoted company with an authorised share capital of
$250,000, consisting of ordinary shares of $1 each. The company prepares its#p#分页标题#e#
accounts as on 31 March in each year and the trial balance, before final
adjustments, extracted on 31 March 2005 showed:
$ $
Equity share capital, issued and fully paid 200,000
Retained earnings as on 1 April 2004 61,000
6% loan notes (secured on leasehold factory) 60,000
Leasehold factory:
Cost at beginning of year 200,000
Accumulated depreciation at beginning of year 76,000
Plant and machinery:
Cost at beginning of year 80,000
Accumulated depreciation at beginning of year 30,000
Additions to plant in year 10,000
Payables and accrued expenses 170,000
Inventory as on 31 march 2005 160,000
Receivables 100,000
Prepayments 80,000
Balance at bank 90,000
Profit for the year (subject to any items below) 111,000
Sale proceeds of plant 12,000
720,000 720,000
You ascertain that:
The loan notes are repayable at par by six equal annual drawings starting on
31 December 2005.
Annual depreciation is calculated as to:
(1) Leasehold factory – 2% on cost
(2) Plant and machinery – 20% reducing balance on NBV as at 31 March
2004 plus additions less disposals in the year
(3) Plant disposed of originally cost $16,000. Accumulated depreciation is
$3,200.
(4) Inventory has been valued consistently at the lower of cost and net
realisable value.
(5) A dividend of 20% was declared in May 2005.
You are required to prepare in a form suitable for publication and in conformity
with the provisions of IAS1 (revised), the balance sheet as on 31 March 2005.
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
43
Review Activities Feedback
REVIEW ACTIVITIES FEEDBACK 1
Phoenix PLC Balance sheet as at 30 June 2008
€000 €000
Noncurrent
assets
Property, plant and equipment 3,920
Intangible assets 415
Financial assets 365
4,700
Current assets
Inventories 1,468
Trade and other receivables 947
Cash 150
2,565
Current liabilities
Trade and other payables 592
Current tax payable 122
714
Net current assets 1,851
Net assets 6,551
Equity
Issued Share capital
4,500
Other reserves 1,100
Retained earnings 951
6,551
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
44
REVIEW ACTIVITIES FEEDBACK 2
Small Limited
Balance sheet as at 31 March 2005
$ $
Assets
Noncurrent
assets
Property, plant and equipment 157,760
Current assets
Inventories 160,000
Trade receivables 100,000
Prepayments 80,000
Cash at bank 90,000
430,000
Total assets 587,760
Equity and liabilities
Capital and reserves#p#分页标题#e#
Share capital 200,000
Retained earnings 157,760
357,760
Noncurrent
liabilities
6% loan notes 50,000
Current liabilities
Trade and other payables 170,000
Current portion of 6% loan notes 10,000
180,000
Total equity and liabilities 587,760
Statement of changes in equity for the year ended 31 march 2005
Share capital Retained earnings
Total
$ $ $
Balance at 31 March 2004 200,000 61,000 261,000
Net profit for the period 96,760 96,760
Balance at 31 march 2005 200,000 157,760 357,760
Workings
(W1) Depreciation $ $
Leasehold factory 2% of $200,000 4,000
Plant and machinery
NBV b/d 50,000
Additions 10,000
Disposals at NBV (12,800)
International Financial Reporting Unit 3 – The Presentation of Financial
Statements (IAS 1) I
45
Depreciation 20% x 47,200 9,440
13,440
(W2) Disposal of plant
Proceeds 12,000
Cost 16,000
Less: depreciation 3,200
12,800
800
(W3) Profit for year per list of balances 111,000
Less: depreciation (4,000 + 9,440) 13,440
Loss on sales (W2) 800
14,240
96,760
References and Recommended Readings
Alexander D., Britton A. & Jorissen, A. (2007) International Financial
Reporting and Analysis, (3rd ed.) London, Thompson.
Atrill P. and McLaney E. (2006): Accounting and Finance for NonSpecialists,
(5th edition), Prentice Hall, Chapters 2 & 3.
Berry A. and Jarvis R. (2006): Accounting in a business content, (4th edition),
Thomson, Chapters 3 & 4.
Collier P. M. (2006): Accounting for managers – interpreting accounting
information for decisionmaking,
(2nd edition), Wiley, chapter 8.
Dyson J. R. (2007): Accounting for nonaccounting
students, (7th edition),
Prentice Hall, Chapters 1, 2 & 6.
Jones M. (2006): Financial Accounting, John Wiley & Sons, Chapters 4 & 6.
Mclaney E. and Atrill P. (2008): Accounting An
Introduction, (4th edition),
Prentice Hall, chapters 2 & 3.
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
46
Unit 4
The Presentation of
Financial Statements
(IAS1)II
LEARNING OUTCOMES
In this unit we continue our work on IAS1 and look at the other major financial
statements: the income statement and the cash flow statement. After
completing this unit you should be able to:
· describe the nature and purpose of an income statement and cash flow
statement
· discuss their format and presentation
· explain the key issues for preparing the statements
· comply with the main accounting conventions
· prepare an income statement and cash flow statement.
INTRODUCTION
In the previous unit we saw that the income statement and the cash flow#p#分页标题#e#
statement form a link in that they show, respectively, the profit (or loss)
generated and the cash movements over the period between any two
successive balance sheets.
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
47
1 2 3
Accounting period
Let’s look at each of them in turn.
Income Statement
The purpose of the income statement, according to IAS1, is to measure and
report how much profit (wealth) the business has generated over a period. It is
therefore an instrument for measuring performance. It will show:
the total revenue generated during the period
the total expenses incurred in generating that revenue
the difference between them, which is the profit or loss for the period.
You will recall that in the previous unit we explored the balance sheet
equation, which is, at its most basic:
Assets = Capital + Liabilities
Since the profit or loss made over an accounting period adds to or reduces
the capital account, we can rewrite this as:
Assets = (Capital + Profit) + Liabilities; or
Assets = (Capital + (Revenue – Expenses)) + Liabilities
Balance
sheet
Balance
sheet
Balance
sheet
Income
statement
Income
statement
Cash flow
statement
Cash flow
statement
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
48
ACTIVITY
In the previous unit you carried out an activity changing the balance sheet
equation. It finished like this:
Assets = Capital + Liabilities
€9,000 = €7,000 + €2,000
During the next accounting period this business makes a profit of €5,000,
which will be added to the capital account. How might it be reflected in the
other components of the equation to make it balance?
FEEDBACK
The profit has been generated throughout the period through the use of both
assets and liabilities of the business. For example, stock has been used and
replaced; creditors paid and new liabilities incurred; and fixed assets will have
depreciated. These changes are reflected in the accounts, so that the assets
and the liabilities figures will also change.
Let’s now look at the key elements of an income statement.
Key Elements of the Income Statement
It is convenient to think of an income statement as consisting of three parts:
· the revenue, that is, the sales of the entity, also referred to as the
turnover
· the cost of sales during the period
· other key elements.
Revenue (Sales or Turnover)
IAS 18 defines revenue as ‘the gross inflow of economic benefits during the
period arising in the course of the ordinary activities of the enterprise’. In order#p#分页标题#e#
to report income as revenue it must be earned during the period: the work
must be completed, or be realised and verifiably measured. If it has been
completed, this increases the likelihood of conversion into cash.
Cost of Sales
The cost of goods sold during the period is determined by adding together the opening
stock and purchases during the period, then deducting closing stock.
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
49
Other Key Elements
These might include:
· gross profit, being the sales less the cost of sales
· any other operating income
· distribution costs: transport, postage etc.
· administration expenses: light, heat etc.
· other operating expenses
· profit from operating activities, obtained by deducting all the expenses
from the gross profit
· notes to the income statement.
The format of an income statement can be seen from the document that you
downloaded in the previous unit.
ACTIVITY
Look at the illustration of financial statements that you downloaded from:
http://www.kpmgifrg.com/pubs/pub_ifst.cfm
Use the list above as a checklist to identify the components of the income
statement. There is no feedback to this activity.
Before we look at cash flow statements, we shall say a little more about the
term ‘profit’. The term ‘profit’ has been mentioned several times and it is
important that you realise two factors:
· it is not the same as cash
· its calculation is rarely simple.
These points are illustrated in the next activity.
ACTIVITY
1. Imagine that you are involved in running a social venture where you
have to raise some money, such as a sports club or charity. A series of
fund raising events raises €1,000 worth of income during a month. Why
might not all of this income be donated to the club/charity?
2. A retailer wants to know how much profit she has made during a single
month. However, she has electricity and telephone bills that cover
threemonth
periods and rates that cover six month periods. On the last
day of the month she takes delivery of some stock, but does not have
to pay for it for another month. She makes sales on credit and does not
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
50
receive the cash until two months have passed. How does she know
how much profit has been made during the month?
FEEDBACK
1. Not all of the income is donated to the club/charity because there may
be expenses to pay out of the money during the month, such as the
hire of the room where the events took place, refreshments for any
helpers, printing costs for sponsorship forms and advertising posters.#p#分页标题#e#
There might have been other things you can think of, but the point is
that the cash received is not the same as the profit made on a venture.
The profit made is the income less the expenses.
2. In order to calculate profit it is necessary to deduct expenses related to
the venture from the income, as you saw in the first scenario. However,
the income for a given period must have set against it only the
expenses for that same period. This is the basic accounting convention
of accruals (also known as matching) and it requires a variety of
adjustments to be made to the figures in a trial balance before an
income statement can be produced that will provide the profit for a
particular period. The retailer in our scenario will need to adjust her
expenses.
The other financial statement that we have to deal with is the cash flow
statement.
Cash Flow Statement
The cash flow statement is a primary financial statement showing the
movement of cash, and cash equivalents, over a period. It is regulated by IAS
7.
ACTIVITY
Download a technical summary of IAS7 from:
http://www.iasb.org/NR/rdonlyres/8C5325269CE749B684BB446BEDA65541/
0/IAS7.pdf
1. What are the objectives of the cash flow statement?
2. How are ‘cash’ and ‘cash equivalents’ defined in IAS7?
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
51
FEEDBACK
1. The objectives of the cash flow statement are to provide information
about the historical changes in cash and cash equivalents; classify
cash flows from various business activities; and provide information for
users to enable them to assess the ability of the entity to generate cash
and cash equivalents and assess the timing and certainty of this
generation.
2. Cash is defined as ‘cash on hand and demand deposits’. Cash
equivalents are defined as ‘short term, highly liquid investments that
are readily convertible to known amounts of cash and which are subject
to an insignificant risk of changes in value’. Examples of cash
equivalents are treasury bills and money market funds.
IAS7 requires the cash flows from three areas of activity to be shown:
· operating activities
· investing activities
· financing activities.
· These are added together to show the net changes in cash and cash
equivalents. Let’s look at these three areas.
Cash Flows from Operating Activities
These include cash flowing:
· in from the sale of goods and rendering of services
· in from revenues of royalties, commissions etc.
· out via payments to suppliers and employees
· in and out via receipts or payments of income taxes or contracts held
for dealing or trading purposes.#p#分页标题#e#
Cash Flows from Investing Activities
These include cash flowing in/out from:
· receipts or payments from disposal or acquisition of fixed assets
· receipts from interests in joint ventures or payments to joint ventures or
the acquisition of equity or debt instruments in other enterprises
· receipts or payments from/to loans to other parties
· payments to other financial instruments: futures, forward options or
swaps.
Cash Flows from Financing Activities
These include cash flowing in/out from:
· the issue of shares and other equity instruments
· payments to the owners to acquire or redeem the enterprise’s shares
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
52
· the proceeds of issuing loans, notes, bonds and other shortand
longterm
borrowings
· repayments of amounts borrowed.
IAS7 describes two methods of showing the cash flows:
· the direct method: this shows gross cash receipts and payments
· the indirect method: this starts with the pretax
profit and adjusts it for
the effects of noncash
charges and credits, deferrals/accruals of
past/future operating cash flows and income or expenses associated
with investing or financing cash flows.
IAS 7 encourages the direct method, but the indirect method is an alternative
option. We shall use an example showing operating activities of an entity as
an illustration of both methods.
Direct Method
€
Cash received from customers
Cash payments to suppliers
Cash paid to and on behalf of
employees
Other cash payments
X
(X)
(X)
(X)
Net cash inflow from operating
activities
X
Indirect Method
€
Profit before tax
Adjustments for:
Depreciation
Investment income
Interest expense
Operating profit before working
capital changes
Increase in inventory
Increase in trade receivables
Increase in trade payables
Cash generated from operations
Interest paid
Income taxes paid
X
X
(X)
X
X
(X)
(X)
X
X
(X)
(X)
Net cash inflow from operating
activities
X
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
53
The same statement, shown the two different ways, might be as follows:
Direct method Indirect method
€
Cash received from customers
15,424
Cash payments to suppliers
(5,824)
Cash paid to and on
behalf of employees
(2,200)
Other cash payments
(511)
€
Profit before tax
6,022
Depreciation charges#p#分页标题#e#
899
Increase in inventory
(194)
Increase in receivables
(72)
Increase in payables
234
Net cash inflow
from operating activities
6,889
Net cash inflow
from operating activities
6,889
ACTIVITY
Compare the two methods, as illustrated above and note down what you see
as the advantages and disadvantages of each. Which do you prefer?
FEEDBACK
The direct method has a number of advantages in that it provides extra
information for users and shows the true cash flows involved in the trading
operations. However, the extra information is obtained as a cost. The indirect
method shows the ‘quality’ of earnings and incurs a low cost in obtaining the
information but it lacks information on the trading cash flows.
The IASC encourages the use of the direct method but the indirect method is
acceptable. However, in Australia and New Zealand the direct method has
been mandatory since 1992; the indirect method is not allowed. In the UK and
USA both are optional. You may want to think about what happens in your
country.
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
54
There are some differences between IAS7 and the UK accounting standard
FRS1. IAS7 is similar to FRS1 before its revision in 1996. The current FRS1
has eight headings whereas IAS7 requires only three. Also, IAS7 includes
cash and cash equivalents whereas FRS1 requires cash only (shortterm
investments are reported separately).
ACTIVITY
What do you think are the consequences of these differences?
FEEDBACK
1. The use of different headings makes it more difficult to compare cash
flow statements of UK GAAP adopted companies with those of
IASs/IFRSs based companies.
2. The different definition of cash and cash equivalent includes/excludes
some items to be recognised in the cash flow statement. Therefore, we
will have different cash flow statements for the same company if it
adopts a different accounting standard.
Usefulness and Limitations of the Cash Flow
Statement
The cash flow statement is useful in that it:
· enables users to make decisions based on a forecast of future cash
flows
· shows the relationship between profitability and cashgenerating
ability
· has uses in the research and analysis of assessment models
· shows liquidity, viability, and adaptability, in conjunction with the
balance sheet
· is less difficult to ‘manipulate’ than the balance sheet.
ACTIVITY
Bearing in mind those advantages, what would you say are the limitations of a
cash flow statement?
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II#p#分页标题#e#
55
FEEDBACK
A cash flow forecast shows historical information, which is not a necessity in
forecasting future cash flows, and there are still possibilities for the
manipulation of cash flows. Cash flow is for short term survival; profit is for
long term survival, so a negative cash flow does not always mean that there is
a problem. After all, a huge cash balance may indicate bad management.
Summary
In this unit we continued looking at IAS1 and at the other major financial
statements: the income statement and the cash flow statement. We outlined
the nature, purpose and contents of an incomes statement. Using IAS7 we
looked at the two methods for constructing a cash flow statement and
considered their advantages and disadvantages. We also considered how IAS
7 differed from the corresponding UK FRS and looked at the usefulness and
limitations of the cash flow statement.
Review Activities
REVIEW ACTIVITIES 1
1. Using the information in Phoenix plc’s trial balance at 30 June 2008
given in the self assessment question for unit 3, insofar as it permits,
prepare the income statement for the year ended 30 June 2008.
2. The draft financial statements of Max Plc for the year ended 31
December 2008 are as follows:
Income statement for the year ended 31 December 2008
€
Sales revenue
30,650
Cost of sales (26,000)
Gross
profit 4,650
Depreciation (450)
Administration & selling expenses (950)
Interest expenses (400)
Investment income (dividends received) 500
Profit
before tax 3,350
Income tax expense (120)
Profit
for the year 3,230
International
Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
56
Balance sheet as at 31 December
2008 2007
€ € € €
Assets
Cash and cash equivalents 490 160
Accounts receivable 1,800 1,200
Inventory 1,000 1,950
Longterm
investments 2,500 2,500
Property, plant & equipment at cost 3,810 1,910
Accumulated depreciation (1,510) (1,060)
Property,
plant & equipment net 2,300 850
Total
assets 8,090 6,660
Shareholders’
equity
Share capital 1,200 1,100
Share premium 300 150
Retained earnings 3,410 1,380
Total
shareholders’ equity 4,910 2,630
Liabilities
Trade payables 250 1,890
Interest payable 230 100
Income taxes payable 400 1,000
Longterm
debt (including finance leases) 2,300 1,040
Total
liabilities 3,180 4,030
Total
equity and liabilities 8,090 6,660
Dividends
paid were €1,200.
Prepare a cash flow statement for the year ended 31 December 2008 using
the indirect method illustrated in IAS 7 (i.e. starting the cash flow statement#p#分页标题#e#
with the profit before tax).
REVIEW ACTIVITIES 2
The summarised balance of Pearson at 31 December 20X4 and 20X5 are as
follows:
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
57
20X5 20X4
£ £
Property at cost 130,000 110,000
Plant and machinery at cost 151,000 120,000
Fixtures and fittings at cost 29,000 24,000
Inventory 51,000 37,000
Receivables 44,000 42,800
Government stock (not qualified as cash equivalents) 4,600 Cash
at bank 11,400 200
421,000
334,000
Equity share capital 150,000 100,000
Share premium 35,000 15,000
Retained profits 56,000 21,500
Loans 30,000 70,000
Deferred tax 18,000 11,000
Payables 53,000 36,500
Bank overdraft 14,000
Tax payable 10,000 8,000
Depreciation on plant & machinery 54,000 45,000
Depreciation on fixture and fittings 15,000 13,000
421,000
334,000
The following information is relevant:
(i) There had been no disposal of property in the year.
(ii) A machine tool which had cost £8,000 (in respect of which £6,000
depreciation had been provided) was sold for £3,000, and fixtures
which had cost £5,000 (in respect of which depreciation of £2,000 had
been provided) were sold for £1,000. Profits and losses on those
transactions had been included in operating profit.
(iii) The income statement charges in respect of tax were: current income
taxes £12,500; deferred tax £9,500.
(iv) The premium paid on redemption of loans was £2,000, which has been
written off to the income statement.
(v) A dividend of £10,000 was paid during the year.
(vi) Interest received during the year was £450. Interest charged in the
income statement for the year was £6,400. Accrued interest of £440 is
included in payables at 31 December 20X4 (nil at 31 December 20X5).
You are required to prepare a cash flow statement for the year ended 31
December 20X5 by using indirect method, in accordance with IAS 7.
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
58
Review Activities Feedback
REVIEW ACTIVITIES FEEDBACK 1
Phoenix plc: Income Statement for year ended 30.6.2008
€000
Sales revenue 6,465
Cost of sales 4,165
Gross profit 2,300
Distribution cost (669)
Administration expense (1,126)
Operating profit 505
Dividend received 80
Profit before taxation 585
Tax expense 122
Profit for the year 463
Movement of noncurrent
assets:
Freehold Other Fixtures
Total
land PPE Fittings
Balance b/f 2,400 1,800 620
4,820
Accumulated depreciation:
Balance b/f _____ 540 360 900#p#分页标题#e#
NBV at 30.6.2008 2,400 1,260 260
3,920
Movement on Reserves
Share premium Revaluation P&L
Balance b/f 500 600 488
Retained profit for year ___ ____ 463
Balance c/f 500 600 951
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
59
Question 2
Cash flow statement for the year ended 31 December 2008
Workings € €
Cash flow from operating activities
Net profit before tax 3,350
Adjustments for
Depreciation (i.s.) 450
Investment income (i.s.) (500)
Interest expense (i.s) 400
Operating
profit before working capital changes 3,700
Increase in trade receivables (1) (600)
Decrease in inventories 950
Decrease in trade payables (1,640)
Cash
generated from operations 2,410
Interest paid (2) (270)
Income taxes paid (3) (720)
Net
cash from operating activities
1,420
Cash flows from investing activities
Purchase of property, plant & equipment(4) (1,900)
Dividends received 500
Net
cash used in investing activities (1,400)
Cash flows from financing activities
Proceeds from issue of shares 250
Proceeds from longterm
borrowings 1,260
Dividends paid (1,200)
Net
cash used in financing activities 310
Net
increase in cash and cash equivalent 330
Cash and cash equivalent at beginning of period 160
Cash
and cash equivalent at end of period 490
Workings
(1) trade receivables
Opening balance 1,200
Movement during the period 600
International
Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
60
Closing balance 1,800
(2) interest paid
Opening balance 100
Interest expense (income statement) 400
Interest paid (270)
Closing
balance 230
(3) income taxes
Opening balance 1,000
Income taxes expense 120
Income taxes paid (720)
Closing
balance 400
(4) property, plant and equipment – cost
Opening balance 1,910
Purchase 1,900
Closing
balance 3,810
(5) retained earnings
Opening balance 1,380
Profit for the year (Income statement) 3,230
Dividend paid (1,200)
Closing
balance 3,410
REVIEW ACTIVITIES FEEDBACK 2
Cash flow statement for the year ended 31 December 20x5
Workings £ £
Cash flows from operating activities
Net profit before tax (7) 66,500
Adjustments for:
Depreciation (15,000+4,000) (3) (4) 19,000
Loss on sale of plant (5) 1,000
Interest received (450)
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
61
Interest charged 6,400
Premium on loan redemption 2,000#p#分页标题#e#
Operating
profit before working capital changes 94,450
Increase in inventories (51,000 – 37,000) (14,000)
Increase in receivables (44,000 – 42,800) (1,200)
Increase in payables (53,000 – (36,500 – 440)) 16,940
Cash
generated from operations 96,190
Interest paid (6,400 + 440) (6,840)
Income taxes paid (6) (13,000)
Net cash from operating activities 76,350
Cash flows from investing activities
Purchase of property, plant and equipment (2) (69,000)
Proceeds of sale of plant and equipment (5) 4,000
Purchase of government stock (4,600)
Interest received 450
Net cash used in investing activities (
69,150)
Cash flows from financing activities
Proceeds of issue of shares (50,000+20,000) 70,000
Repayment of loans (40,000+2,000) (42,000)
Dividends paid (10,000)
Net cash from financing activities 18,000
Net
increase in cash and cash equivalent 25,200
Cash and cash equivalents at 1 January 20X5 (13,800)
Cash
and cash equivalents at 31 December 20X5 11,400
Workings
(1) Plant and machinery account – cost
Balance at 31/12/20X4 120,000
Disposal (8,000)
Purchased during the year 39,000
Balance
at 31/12/20X5 151,000
(2) Fixture and fittings account – cost
Balance at 31/12/20X4 24,000
Disposal (5,000)
Purchased during the year 10,000
International
Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
62
Balance at 31/12/20X5 29,000
Fixed assets – purchased summary:
Property 20,000
Plant and machinery 39,000
Fixtures and fittings 10,000
69,000
(3) Plant and machinery account – depreciation
Balance at 31/12/20x4 45,000
Disposal during the year (6,000)
Charged for the year 15,000
Balance
at 31/12/20x5 54,000
(4) Fixtures and fittings account – depreciation
Balance at 31/12/20x4 13,000
Disposal during the year (2,000)
Charged for the year 4,000
Balance
at 31/12/20x5 15,000
(5) Noncurrent
assets disposals account
Plant cost 8,000
Fittings cost 5,000
Plant depreciation (6,000)
Fittings depreciation (2,000)
Cash proceeds:
Plant (3,000)
Fittings (1,000)
Loss
on sale 1,000
(6) Tax
Balance at 31/12/20x4
Deferred tax 11,000
Income tax 8,000
Income statement
Deferred tax 9,500
Income tax 12,500
41,000
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
63
Cash paid for the year (13,000)
Balance
at 31/12/20x5
Deferred tax 18,000
Income tax 10,000
(7) Income statement
As the profit before tax is required, reconstruct the income statement.#p#分页标题#e#
Income statement
£ £
Profit before tax 66,500
Taxation
Income tax 12,500
Deferred tax 9,500
(
22,000)
Profit
for the year 44,500
Retained
profit brought forward 21,500
Profit for the year 44,500
Dividends paid (10,000)
Retained
profit carried forward 56,000
International Financial Reporting Unit 4 – The Presentation of Financial
Statements (IAS1) II
64
Recommended Readings
These are the same as for unit 3.
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
65
Unit 5
Accounting for Fixed
Tangible Assets
LEARNING OUTCOMES
In this and the next two units we shall focus on one aspect of the balance
sheet: assets. We shall look first at fixed, tangible assets and in units 6 and 7
at intangible assets.
After completing this unit you should be able to:
· distinguish and describe key definitions of fixed tangible assets (FTA)
· describe the IAS requirements of FTA with respect to:
o recognition and derecognition
o measurement
o presentation
o disclosure
o disposal
o impairment.
INTRODUCTION
Fixed tangible assets are an important element in the balance sheet and their
management can provide opportunity for creative accounting. The relevant
regulations are:
· IAS 16: Property, Plant and Equipment (PPE)
· IAS 23: Borrowing Cost
· IAS 36: Impairment of Assets
· IAS 20: Government grants
· IAS 40: Investment Properties.
We shall focus on the first three of these standards but you should ensure that
you are familiar with all the standards relating to fixed, tangible assets.
We begin with definitions.
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
66
Definitions
The IAS Framework document (para. 49a) defines an asset as a resource
controlled by an entity as a result of past events and from which economic
benefits are expected to flow. In unit 3 we drew a distinction between current
and noncurrent
assets in that a current asset is one that is bought or acquired
for nonpermanent
use in the business, whereas all other assets are noncurrent
assets. We went on to expand on the meaning of ‘current’ by linking it
to permanence so that a current asset is not permanent: it is expected to be
sold or consumed in the normal course of the operating cycle of the business,
normally within twelve months of the balance sheet date. A noncurrent
asset,
on the other hand, was permanent.
We now need to introduce a new descriptor for these noncurrent
assets and
refer to them as fixed. A fixed asset is, therefore, one that an entity intends to#p#分页标题#e#
use within the business, over an extended period, in order to assist in its daily
operating activities. It is not bought with the intention of immediate resale. We
can refine this definition further and refer to:
· fixed tangible assets: these have physical substance
· fixed intangible assets: these are invisible, for example computer
software, copyrights, brands, long term investments, etc.
ACTIVITY
Using the above definition, decide whether the following balance sheet items
are fixed, tangible assets or fixed, intangible assets and give the reason for
your response:
1 Motor vehicles
2 Land
3 Computer software
4 Computers
5 Goodwill
6 Brands
FEEDBACK
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
67
The motor vehicles, land and computers are all tangible assets because they
are visible. The software, brands and goodwill are all intangible, invisible fixed
assets.
IAS requirements
IAS 16 governs the accounting treatment of property, plant and equipment
(PPE), items that will appear in most balance sheets.
ACTIVITY
Download a copy of the technical summary of IAS 16 from
http://www.iasb.org/NR/rdonlyres/C10C23816B524C4A92D47874C40040D0/
0/IAS16.pdf
Read through the summary and answer the following questions:
1 When is a tangible fixed asset recognized in the balance
sheet?
2 How is it to be valued
(a) initially?
(b) subsequently?
FEEDBACK
You should have found the following:
1 A tangible fixed asset is recognized in the balance sheet when
there is sufficient evidence that a future inflow or outflow of
benefit will occur, and when the cost of the asset can be
measured at a monetary amount with sufficient reliability.
2 (a) Initially, a fixed tangible asset should be valued in the balance sheet at
cost, that is, its purchase price plus any directly attributable costs of bringing
the asset into working condition for its intended use. The purchase price
includes: cost of purchase, import duties and nonrefundable
purchase taxes.
Directly attributable costs are those that would have been avoided if the
expenditure on the asset had not been made. They include, where applicable:
cost of site preparation, initial delivery and handling costs, installation costs,
professional fees of architects and engineers, and the costs of dismantling
and removing the asset and restoring the site where it was located.
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
68
(b) Subsequently a fixed tangible asset is measured using one of two
alternative approaches: cost or revaluation.
Note that historical cost accounting of fixed tangible assets is rejected by IAS
16. The two alternative approaches can be defined as follows.#p#分页标题#e#
Cost Model
The cost model measures the asset and shows it in the balance sheet using
its recognised initial cost less any accumulated depreciation and any
accumulated impairment losses. We shall look at deprecation in due course.
Revaluation Model
The revaluation model uses the fair value of the asset at the date of
revaluation less any subsequent accumulated depreciation and subsequent
accumulated impairment losses.
Fair value is defined as follows:
· The asset can be exchanged between a knowledgeable, willing buyer
and a knowledgeable, willing seller in an arm’s length transaction.
· In the case of land and building, the market value is determined by
professional qualified valuers, or the value that is available on the open
market.
· In the case of plant and equipment, if market value is not available due
to their specialised nature, the assets should be valued at their
depreciated replacement cost by using appropriate, specific price
indices.
When an item of PPE is revalued, the entire class of PPE should be revalued.
The carrying values of assets will be changed; this will affect gearing ratios
and, potentially and eventually, retained earnings.
When accounting for revaluations, any surplus is directly credited. Any
decrease is recognised as an expense. In the case of disposals, there is a
transfer to retained earnings from the revaluation surplus.
Depreciation
We mentioned deprecation earlier. This is an important part of the
measurement of fixed, tangible assets.
ACTIVITY
Refer again to the technical summary of IAS 16. How does it define
depreciation and the depreciable amount?
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
69
FEEDBACK
IAS 16 defines deprecation as the systematic allocation of the depreciable
amount over the asset’s useful life. The depreciable amount is the asset’s cost
less its realisable value.
The selection of the depreciation method is based on the expected pattern of
the economic benefits of the asset. It may be straight line, reducing balance or
the units of production (usage) method. We want you to revise your
knowledge of these methods in the following series of activities.
Straight line
Straight line depreciation divides the loss on value of the asset evenly over its
expected life. Any scrap value the asset may have at the end of its life is
deducted from its original cost and the result is divided by the number of years
the entity expects to use the item. The result is the annual depreciation charge
to the profit and loss account.
ACTIVITY
Calculate the annual straight line depreciation charge on:
1 A car bought for €10,000 to be used for 4 years and with a scrap value of#p#分页标题#e#
€2,000.
2 A machine bought for €15,000 with an expected life of 5 years but no scrap
value.
FEEDBACK
1. The car would be depreciated each year by €(10,000 2,000)/
4 = €2,000
2. The machine would be depreciated each year by €15,000/5 = €3,000
Reducing Balance
This method applies the same percentage rate deduction to the value of the
asset at the end of each year.
ACTIVITY
Use the reducing balance method to work out the depreciation on an asset
costing €20,000 at a rate of 25% over the first 5 years.
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
70
FEEDBACK
The calculation would be:
Year 1: 25% x €20,000 = €5,000 leaving a yearend
value of €15,000
Year 2 25% x €15,000 = €3,750 leaving a yearend
value of €11,250
Year 3 25% x €11,250 = €2,813 leaving a yearend
value of €8,437
Year 4 25% x €8,437 = 2,109 leaving a yearend
value of €6,328
Year 5: 25% x €6,328 = €1,582 leaving a yearend
value of €4,746
Usage Method
This method uses rate of usage or output, such as car mileage or machine
hours, to determine the depreciation. If, for example, a vehicle has an
expected lifetime mileage of 150,000 miles the deprecation is then allocated
pro rata depending on the mileage covered in each year. If it was expected to
travel 50,000 miles in year 1 then 1/3 of the depreciable amount is charged in
year 1.
ACTIVITY
Calculate the proportions of the depreciable amount on a vehicle with an
expected lifetime mileage of 140,000 miles if it is expected to do 20,000 miles
in year 1 and 30,000 miles in year 2.
FEEDBACK
The annual proportions will be:
Year 1: 20/140 or 1/7
Year 2: 30/140 or 3/14
Of course, once a method of depreciation is chosen, it should be used
consistently.
We have two more standards to cover in this unit: IAS23 and IAS36.
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
71
IAS 23 Borrowing cost
Borrowing costs are the interest and other costs incurred by an entity in
connection with the borrowing of funds. Their benchmark treatment is that
they should all be recognised as an expense of the period in which there are
incurred but, alternatively, they may be capitalised if they are directly
attributable to the acquisition, construction, or production of a qualifying asset.
In other words, they are treated as part of the cost of the asset.
ACTIVITY
Download the technical summary of IAS 23 at the site below, and note down
the definition of a ‘qualifying asset’.
http://www.iasb.org/NR/rdonlyres/189CA2974D7E482680BC35876874AD44/
0/IAS23.pdf#p#分页标题#e#
FEEDBACK
A qualifying asset is one that necessarily takes a substantial period of time to
get ready for its intended use or sale.
‘Directly attributable’ costs are those that could have been avoided if the
expenditure on the qualifying asset had not been made.
IAS 36 Impairment
Earlier in the unit we talked about the need to depreciate fixed, tangible assets
using one of two models, cost or revaluation. Assets are shown in the balance
sheet at their carrying value, and this is done on the assumption that the entity
is a going concern and that there will be future periods in which expenses like
depreciation can be allocated to the income statement. We do not usually
need to compare the carrying value of an asset at a point in time with, say, its
value if it were to be auctioned or sold in some other way. But what if this
carrying value is in excess of the current market value of the asset? IAS 36
was developed to provide guidance so that an entity can ensure that its assets
are carried at no more than their recoverable value. If they are, they are said
to be impaired.
Note that the following assets are excluded from the impairment rules of IAS
36:
· inventories (IAS 2)
· deferred tax assets (IAS 12)
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
72
· assets arising from employee benefits (IAS 19)
· investment property measured at fair value (IAS 40)
· noncurrent
assets classified as held for sale (IFRS 5).
ACTIVITY
Download the technical summary of IAS 36 at the site below and note down
how recoverable amount’ is defined and how an impaired asset is recognised
http://www.iasb.org/NR/rdonlyres/A288C7817D394988BA719AB77A263BA0/
0/IAS36.pdf
FEEDBACK
The recoverable amount of an asset is the higher of its net selling price, that
is, its fair value less selling costs, and its value in use. The net selling price is
obtained from a binding sale agreement at the current market price less costs
of disposal, from available and reliable information in pricing the assets. Value
in use is defined as the present value of future cash flows expected to be
derived from the asset. Cash inflows and outflows are derived from the use of
the asset and its ultimate disposal, with a suitable discount rate to these cash
flows.
Assessment of impairment should be conducted at each balance sheet date.
An impaired asset is recognised from external and internal information. For
example, externally the asset’s market value may have declined more than
expected, there may have been an adverse effect from changes of business
environment or the carrying amount is more than the market capitalisation.
Internally, there may be evidence of obsolescence or damage to the asset,#p#分页标题#e#
changes in the way the asset is used may have occurred or be imminent, or
there may be evidence that the economic performance of the asset is, or will
be, worse than expected.
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
73
When an impaired asset is recognised there is an impairment loss: the
recoverable amount is less than the carrying value so the asset must be
written down to its recoverable amount. This is illustrated in the following
diagram:
An impairment loss is recognised immediately as an expense in the income
statement. If the asset has any revaluation surplus, the impairment loss can
be offset against the surplus. Depreciation is adjusted for future periods to
reflect the reduced carrying amount.
The impairment of intangible fixed assets such as goodwill is dealt with in unit
6.
Summary
This was the first of three units in which we focus on the assets shown in the
balance sheet. We concentrated on fixed assets, defining them and
distinguishing between tangible and intangible fixed assets. We looked at
three IASs: 16, dealing with property, plant and equipment; 23, dealing with
borrowing costs; and 36 dealing with impairment of assets.
Recoverable
amount
Impaired
Carrying
amount
Value in use
Fair value less
Higher costs to sell
Higher
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
74
Review Activities
REVIEW ACTIVITIES 1
Trent is a quoted company and purchased equipment on 30th June 2006. The
following costs were associated with the purchase:
Item £
Cost of equipment 150,000
Marketing research expenses 3,000
Import duties 500
Delivery and handling costs 100
Professional fees 150
Workers’ training costs 1,000
Installation costs 1,500
Provisions of dismantling in future 300
The useful life of the equipment is 5 years and no residual value.
(i) What is the value of the equipment according to IAS16?
Trent borrowed £100,000 to finance the above equipment on 30th June
2006. The total interest incurred in the year to 31st December 2006
was £10,000. The equipment was brought into use in Trent’s business
operations on 1st October 2006.
(ii) What are accounting treatments of the above borrowing costs
according to IAS 23?
Due to changes of technology, the recoverable amount of the
equipment is valued at £100,000 on 31st December 2006.
(iii) What are implications of above event for the financial statements of
Trent on 31st December 2006?
REVIEW ACTIVITIES 2
The objective of IAS 36 Impairment of Assets is to ensure that noncurrent
assets and goodwill are recorded in the financial statements at no more than#p#分页标题#e#
their recoverable amount, and that any resulting impairment loss is measured
and recognized on a consistent basis.
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
75
Required:
(1) Explain the reasons why the International Accounting Standard
Committee felt it necessary to introduce IAS 36 Impairment of assets.
(2) Explain the reasoning behind the definition of recoverable amount
contained within IAS 36.
Review Activities Feedback
REVIEW ACTIVITIES FEEDBACK 1
(i) 150,000+500+100+150+1,500+300 = 152,550
Dr Fixed assets 152,550
Cr Cash 152,550
(ii) 5,000 expensed and 5,000 capitalised: initial value of the equipment is
157,550
Dr Expense – interest 5,000
Fixed assets – interest 5,000
Cr Interest payable/cash 10,000
(iii) first year depreciation = 157,550/5 = 31,510; carrying value is 126,040.
impairment loss = 126,040 – 100,000 = 26,040 a) offset against surplus
b) recognised as expense immediately. Depreciation for 2007 is
25,000.
Dr Expense – depreciation 31,510
Cr Fixed assets depreciation
31,510
Carrying value = 157,550 – 31510 = 126,040
Impairment loss = 126,040 – 100,000 = 26,040
a) offset against surplus
Dr Evaluation surplus – impairment loss 26,040
Cr Fixed assets – impairment loss 26,040
b) expensed
Dr Expense – impairment loss 26,040
Cr Fixed assets – impairment loss 26,040
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
76
Depreciation
Dr Expense – depreciation 25,000
Cr Fixed assets – depreciation 25,000
REVIEW ACTIVITIES FEEDBACK 2
(1) IAS 36 was issued in response to a number of perceived problems
It is accepted practice that a noncurrent
asset should not be carried in
financial statements at more than its recoverable amount, i.e. the
higher of the amount for which it could be sold and the amount
recoverable from its future use. However, there was very little
authoritative guidance as to how the recoverable amount should be
identified or measured.
There was uncertainty as to how diminutions should be presented in
the financial statements. For example, were they to be treated as
additional depreciation (which affected profits) or as downward
revaluations (which might not)?
As a result of these problems, accounting practice was often
inconsistent and there was a like that impairment might occur without
being recognized in the financial statements
(2) IAS 36 defines recoverable amount as the higher of fair value less
costs to sell (i.e. net selling price) and value in use. Net selling price is
the amount obtainable from the sale of an asset in an arm’s length#p#分页标题#e#
transaction between knowledgeable, willing parties, less the costs of
disposal. Value in use is the present value of estimated future cash
flows expected to arise from the continuing use of an asset and from its
disposal at the end of its useful life.
The rational behind these definitions is that, when a noncurrent
asset
becomes impaired, the decision must be made whether to continue to
use it or to sell it. This decision is based on the cash flows that can be
generated by following each course of action, so that an entity will not
continue to use the asset if it can realize more cash by selling it and
vice versa. This means that when an asset is stated at the higher of bet
selling price and value in use, it is recorded at its greatest value to the
entity.
International Financial Reporting Unit 5 – Accounting for Fixed Tangible Assets
77
Recommended Readings
ACCA Paper P2 Study Text: Corporate Reporting (International), BPP
Learning Media, 2008, Chapter 21.
Alexander, D. & Britton, A. (2004): Financial Reporting, 7th edition, Chapter
27
Alexander, D., Britton, A. & Jorissen, A. (2007): International Financial
Reporting and Analysis, 3rd edition, Chapter 23.
Elliott, B. & J. Elliott (2008): Financial Accounting and Reporting, 12th edition,
Chapter 26.
Gowthorpe, C. (2003): Business Accounting and Finance for NonSpecialists,
Chapter 11
Gowthorpe C. (2005): Financial Accounting for NonSpecialists,
2nd edition,
Thomson, Chapters 7 & 10.
Jones, M. (2006): Financial Accounting, Wiley, Chapters 4 & 8.
International Financial Reporting Unit 6 – Accounting for Intangible Assets
78
Unit 6
Accounting for Intangible
Assets
LEARNING OUTCOMES
This is the second of our three units dealing with assets. In this unit we shall
look at how the IAS deals with intangible assets.
After completing this unit you should be able to:
· give basic definitions of intangible assets and goodwill
· outline the IAS requirements relating to intangible assets and goodwill
in financial statements with respect to recognition, measurement,
presentation and disclosure
· describe the impairment of assets
· apply your knowledge to practical cases
· debate the existing accounting treatments of intangible assets and
goodwill.
INTRODUCTION
Intangible assets and goodwill are important items in the balance sheet but
are susceptible to some forms of creative accounting by management. We
need to pay particular attention, therefore, to the requirements of three IAS:
· IAS 38: Intangible Assets
· IFRS: 3 Purchased Goodwill
· IAS 36: Impairment of Assets
We mentioned intangible assets briefly in the previous unit. In IAS 38 an#p#分页标题#e#
intangible asset is defined as an identifiable, nonmonetary
asset without
physical substance. Examples include computer software, patents, licences,
copyrights, import quotas and franchises. Goodwill is also an intangible asset
and it is defined in IFRS 3 as future economic benefits arising from assets that
are not capable of being individually identified and separately recognised.
International Financial Reporting Unit 6 – Accounting for Intangible Assets
79
There is an important distinction to be made between internally generated
goodwill and purchased goodwill in that internally generated goodwill is not an
asset.
Let’s look at the three standards in turn.
IAS 38 Intangible assets
IAS 38 covers the recognition, measurement, disposal and disclosure of
intangible assets.
Recognition
In order for an asset to be recognised as intangible, three criteria must be
met: identifiability, controllability and reliable measurability.
ACTIVITY
Download the technical summary of IAS 38 at the site below and note down
the identifiability criteria in its definition of an intangible asset.
http://www.iasb.org/nr/rdonlyres/149d67e267694e8f976d6babeb783d90/
0/ias38.pdf
FEEDBACK
You should have found that an intangible asset is identifiable if it can be
separated and sold, transferred, licensed, rented or exchanged, either
individually or as part of a package. It must arise from contractual or other
legal rights, regardless of whether those rights are transferable or separable
from the entity or from other rights and obligations
The controllability criterion refers to the power to obtain future economic
benefits from the asset and the reliability criterion to whether its cost can be
measured, both initially and reliably.
If the recognition criteria are not met, the expenditure should be recognised as
an expense when it is incurred.
Research and development, which is often regarded as an intangible asset, is
internally generated. If an entity cannot distinguish the development phase
from an internal project, it should treat the expenditure for that project as if it
were incurred in the research phase only, charging all research costs as
International Financial Reporting Unit 6 – Accounting for Intangible Assets
80
expenses. Development costs are capitalised only after the technical and
commercial feasibility of the asset for sale or use have been established.
Measurement
Initial measurement of an intangible asset is at cost. Subsequent
measurement may be made using either a cost or a revaluation model:
· a cost model measures the asset at initial cost less any amortisation
and impairment losses
· a revaluation model measures the asset at a revalued amount (based
on fair value) less any subsequent amortisation and impairment losses,#p#分页标题#e#
only if fair value can be determined by reference to an active market.
Subsequent measurement also depends on whether intangible assets have a
finite or an indefinite life. Intangible assets have a finite life where they are of
benefit to the entity for a limited period (say 20 years). The cost less residual
value should be amortised over that life and:
· the amortisation method should reflect the pattern of benefits, using the
straight line method if the pattern cannot be determined reliably
· the amortisation charge is recognised as a profit or loss
· the amortisation period should be reviewed at least annually
· the asset should also be assessed for impairment by IAS 36.
An intangible asset has an indefinite life where there is no foreseeable limit to
the period over which the asset is expected to generate net cash inflows for
the entity. An intangible asset with indefinite useful life should not be
amortised. The useful life should be reviewed each reporting period to see if
there is a change of the indefinite life into a finite life.
Subsequent expenditure is to be recognised as an expense when it is incurred
and capitalised only insofar as this expenditure will enable the asset to
generate future economic benefits in excess of its originally assessed
standard of performance. The expenditure must be measured and attributed
to the asset reliably.
Disposal
An intangible asset is no longer recognised as such either on disposal, or
when no future economic benefits are expected from its use or disposal. If
there are gains or losses on disposal, the difference between the net disposal
proceeds and carrying amount is to be recognised in the profit and loss
account, but gains should not be classified as revenue.
Disclosure
The standard requires the following information to be disclosed:
· the useful life or amortisation rate of the asset
· the amortisation method
International Financial Reporting Unit 6 – Accounting for Intangible Assets
81
· the gross carrying amount
· accumulated amortisation and impairment losses
· the basis for determining that an intangible has an indefinite life
· any other relevant details.
IFRS3 Purchased goodwill
Goodwill may be either internally generated or purchased. We have already
noted that internally generated goodwill should not be regarded as an asset.
Purchased goodwill is regulated by IFRS 3 Business Combinations, rather
than IAS 38 Intangible Assets.
ACTIVITY
Locate IFRS 3 on the following site and find the definition of purchased
goodwill.
http://www.iasb.org/NR/rdonlyres/73E562FEF5814DD48365B17E228955C9/
0/IFRS3.pdf
FEEDBACK
You should have seen in point (f) that purchased goodwill is the excess of the#p#分页标题#e#
cost of the business combination over the acquirer’s interest in the net fair
value of the identifiable assets, liabilities and contingent liabilities.
As with intangible assets we need to look at recognition, measurement and
disclosure.
Recognition and measurement
Purchased goodwill should be recognised as an asset by the acquirer from
the acquisition date. It is initially measured as we defined it in the feedback to
the last activity.
Suggested actions for subsequent measurement include:
· keeping the goodwill in the balance sheet unchanged
· writing off the cost of the goodwill directly to reserves in the year of
acquisition
· writing off the cost of the goodwill directly to the income statement in
the year of acquisition
· amortising the goodwill over its expected life
· not amortising goodwill, but checking it annually for impairment.
International Financial Reporting Unit 6 – Accounting for Intangible Assets
82
ACTIVITY
How might these suggestions impact upon financial statements? Note down
your ideas.
FEEDBACK
1. Keeping goodwill in the balanced sheet unchanged will have no impact
on the financial statements, but it will not be a reflection of the true
value of goodwill.
2. Writing off the cost directly to reserves on acquisition will have no
impact on the income statement, but will affect the volatility of reserves
in the balance sheet.
3. Writing off the cost directly to the income statement will not impact on
the balance sheet, but will affect the volatility of the income statement.
4. Amortising goodwill over its expected life will smooth out the financial
statements, but the economic useful life and the amortisation rate are
subjective. Also this will be no reflection of its true value.
5. Checking goodwill annually for impairment will be a reflection of its true
value, but there is possible volatility of the income statement.
IFRS 3 prohibits the amortisation of the purchased goodwill but it should be
tested for impairment at least annually in accordance with IAS 36 Impairment
of Assets.
Negative goodwill occurs where the acquirer's interest in the net fair value of
the acquired identifiable net assets exceeds the cost of the business
combination. Negative goodwill must be recognised immediately in the income
statement as a gain.
Disclosure
The acquirer must disclose the following:
· names and descriptions of the combining entities or businesses
· acquisition date
· cost of the combination
· amounts recognised at the acquisition date for each class of the
acquiree's assets and liabilities
· amount of any negative goodwill recognised in profit or loss
· any other relevant details.#p#分页标题#e#
International Financial Reporting Unit 6 – Accounting for Intangible Assets
83
IAS 36 Impairment of assets
We began to look at this IAS in the previous unit. You will recall that an asset
is impaired when its carrying amount exceeds its recoverable amount. The
objective of the standard is to ensure that assets are carried at no more than
their recoverable amount, and to define how recoverable amount is
calculated. This is the higher of its net selling price and its value in use. We
also saw how these were defined.
ACTIVITY
Return to your copy of IAS 36 that you obtained for your work in the previous
unit and note down when and how goodwill is tested for impairment.
FEEDBACK
Goodwill should be tested for impairment annually. To test for impairment,
goodwill must be allocated to each of the acquirer's cashgenerating
units, or
groups of cashgenerating
units. If the recoverable amount of the unit exceeds
the carrying amount of the unit, the goodwill is not impaired. If the carrying
amount of the unit exceeds the recoverable amount of the unit, there is an
impairment loss.
The order of reducing the carrying amount of the assets of the unit is as
follows:
· first, reduce the carrying amount of any goodwill allocated to the cashgenerating
unit (or group of units)
· then reduce the carrying amounts of the other assets of the unit (or
group of units) pro rata.
The carrying amount of an asset should not be reduced below the highest of:
· its fair value less costs to sell (if determinable)
· its value in use (if determinable)
· zero.
Note that reversal of an impairment loss for goodwill is prohibited by IAS 36.
Impairment losses should be recognised in the income statement and the
following aspects of impairment should be disclosed:
· the events and circumstances resulting in the impairment loss
· amount of the loss
· nature and segment to which an individual asset relates
· in the case of a cash generating unit, a description, amount of
impairment loss by class of assets and segment
International Financial Reporting Unit 6 – Accounting for Intangible Assets
84
· if the recoverable amount is fair value less costs to sell, disclose the
basis for determining fair value
· if the recoverable amount is value in use, disclose the discount rate.
Summary
In the second of our three units dealing with assets we have looked at how the
IAS deal with intangible assets. We gave the basic definitions of intangible
assets and goodwill and outlined the IAS requirements for the presentation of
intangible assets and goodwill in financial statements with respect to
recognition, measurement, presentation and disclosure. We expanded on the#p#分页标题#e#
material from the previous unit on impairment and described the impairment of
goodwill.
Review Activities
REVIEW ACTIVITIES 1
ERT’s carrying value of its net assets on 31st December 2008 was €1m
including goodwill €250,000, property, plant and equipment €450,000
(including €315,000 for land and buildings, and €135,000 for plant and
equipment), and inventory €50,000. Due to an adverse change in its business
environment, the fair value of ERT’s net assets at the year end was €700,000.
1. Discuss implications, with suitable computations, of the above event for the
financial statements of ERT on 31st December 2008.
2. How can accountants manipulate the financial statements in terms of
intangible assets and goodwill?
REVIEW ACTIVITIES 2
Calver Ltd has the following noncurrent
assets, which are stated at their
carrying amounts at 31 December 20x1:
$m $m
Intangible assets
Goodwill 70
Tangible assets
Land and buildings 320
Plant and machinery 110
430
500
Because these assets are used to produce a specific product, it is possible to
identify the cash flows arising from their use. The management of Calver
believes that the value of these assets may have become impaired, because
International Financial Reporting Unit 6 – Accounting for Intangible Assets
85
a major competitor has developed a superior version of the same product. As
a result, sales are expected to fall.
The following additional information is relevant:
· The land and buildings are carried at a valuation. $60 million of
revaluation surplus exists as at 31 December 20x1. All other noncurrent
assets are carried at historical cost.
· The goodwill does not have a market value. It is estimated that the land
and buildings could be sold for $270 million and the plant and
machinery could be sold for $50 million, net of direct selling costs.
· The value in use of the assets has been calculated at $385 million.
Required:
(1) Calculate the impairment loss that will be recognised in the accounts of
Calver.
(2) Explain how this loss will be treated in the financial statements for the
year ended 31 December 20x1.
Review Activities Feedback
REVIEW ACTIVITIES FEEDBACK 1
1.
€ € €
Goodwill 250,000 (250,000) Land
and building 315,000 (35,000) 280,000
Plant and equipment 135,000 (15,000) 120,000
Inventory 50,000 50,000
Other 250,000 250,000
1,000,000 (300,000) 700,000
· The total value of the business is reduced by €300,000.
· Goodwill of €250,000 is eliminated, leaving €50,000.
· The values of the fixed assets are reduced by €50,000 pro rata.
· Depreciation values are changed (decreased) and then profit#p#分页标题#e#
increased.
· Disclosure requirements should also be noted.
2.
Accountants can manipulate the financial statements in the areas of intangible
assets as follows:
a) identification of intangible assets
b) definite and indefinite useful life
c) length of a finite useful life and amortisation method
d) identification of research and development phase
International Financial Reporting Unit 6 – Accounting for Intangible Assets
86
Accountants can manipulate the financial statements in areas of goodwill by:
a) allocating goodwill into cashgenerating
units
b) determining recoverable amounts by using net selling price and
value in use
c) determining events and reasons for impairment loss
REVIEW ACTIVITIES FEEDBACK 2
(1) Impairment loss
$m
Carrying amount 500
Recoverable amount (385)
Impairment loss 115
Recoverable amount is value in use as this is higher than net selling
price.
Workings
$m
Goodwill Land
and buildings 270
Plant and machinery 50
Net selling price 320
(2) How the loss will be treated
The impairment loss must be allocated to the various noncurrent
assets in
the following order: first, goodwill; second, to other assets on a prorata
basis.
Before Impairment After
impairment loss impairment
$m $m $m
Goodwill 70 (70) Land
and buildings 320 (33) 287
Plant and machinery 110 (12) 98
500 (115) 385
Because the land and buildings have been revalued, the impairment is
recognised in equity to the extent of any credit balance existing in revaluation
surplus in respect of those assets. We have here a $60m revaluation surplus
and an applicable $33m impairment loss, and therefore the whole of the
impairment of $33 million may be charged against the revaluation reserve.
The impairment must be separately disclosed on the face of the statement of
changes in equity.
The remainder of the impairment loss ($82million) must be recognised in the
income statement for the year. It must be included within operating profit
International Financial Reporting Unit 6 – Accounting for Intangible Assets
87
under the appropriate line headings and may also need to be disclosed as an
exceptional item.
In the notes to the financial statements, the loss on the land and buildings is
treated as a downward revaluation and included within the revalued carrying
amount of noncurrent
assets. The remaining impairment loss (on goodwill
and plant and machinery) is treated as additional depreciation. The cost of the
assets is not reduced.
Workings
The impairment loss of $115m must first be allocated to the goodwill ($70m).
This leaves $45m to be allocated prorata
to the other assets.
Loss on land and buildings = 320/430 * $45m = $33m#p#分页标题#e#
Loss on plant and machinery = 110/430 * $45m = $12m
Recommended Readings
Alexander, D., A. Britton, and A. Jorissen (2007) International Financial
Reporting and Analysis, 3rd Edition, London: Thomson Learning, Chapter: 13.
Black G. (2003) Students’ Guide to Accounting and Financial Reporting
Standards, 9th Edition, London: Prentice Hall, Chapter: 4.
Elliott, B. and J. Elliott (2008) Financial Accounting and Reporting, 12th
Edition, London: Financial Times/Prentice Hall, Chapter: 17 (ER).
Grinyer, J. R., A. Russell, & M. Walker (1990) “The Rationale for Accounting
for Goodwill” The British Accounting Review, Vol.22 (3), pp. 223235.
Lewis, R. & D. Pendrill (2004) Advanced Financial Accounting, 7th Edition,
London: Prentice Hall, Chapters: 5, 6 and 13.
Paterson, R. (2002) ‘Straining Goodwill’, Accountancy vol 129, Iss 1306 p101
Simmonds A. & SleighJohnson
N. (2003) ‘Business CombinationsFundamentally
Impaired’, Accountancy, vol 131, Iss 1318 p100
International Financial Reporting Unit 7 – Accounting for Leases
88
Unit 7
Accounting for Leases
LEARNING OUTCOMES
In the third of our units dealing with the assets in the balance sheet we shall
consider one of the most important items in financial statements: leases. After
completing this unit you should be able to:
· describe and distinguish basic definitions of the different types of
leases
· describe the requirements of IAS 17, the standard dealing with leases,
with regard to: classification, accounting treatment by the lessee,
accounting treatment by the lessor and disclosure
· discuss the implications of different accounting treatments of leases on
financial statements.
INTRODUCTION
We are devoting a unit to the topic of leases because of their association with
the complex topic of offbalance
sheet finance. This refers to the financing of
an entity’s activities in such a way that some of the financing may, legally, be
missing from the balance sheet. The management view of leases can,
therefore, lead to some creative accounting so there is a need to be aware of
the relevant regulations contained in IAS 17.
ACTIVITY
Download and read the technical summary of IAS 17 from the site below and
note down the two basic types of lease.
http://www.iasb.org/NR/rdonlyres/B8ABE9AA8F5B4301866EED2D423504E7/
0/IAS17.pdf
International Financial Reporting Unit 7 – Accounting for Leases
89
FEEDBACK
A lease is an agreement whereby the lessor conveys to the lessee, in return
for a payment or series of payments, the right to use an asset for an agreed
period of time. The two basic types are the finance lease and the operating
lease.
IAS 17 defines a finance lease as one that transfers substantially all the risks#p#分页标题#e#
and rewards incidental to ownership of an asset.
An operating lease is any lease other than a finance lease.
IAS17
The objective of IAS17 is to describe, for lessees and lessors, the appropriate
accounting policies and disclosures that apply in relation to finance and
operating leases. In scope it applies to all leases, except lease agreements
for:
· minerals, oil and natural gas
· licensing agreements for films, videos, plays, patents, copyrights and
similar items.
The standard has various requirements relating to the classification of leases,
the accounting treatment by lessee, the accounting treatment by lessor and
disclosure.
Classification
The IAS 17 classification of leases is based on the substance of a transaction
rather than its form. A finance lease is classified as such if:
· the lease transfers ownership of the asset to the lessee by the end of
the lease term
· the lessee has the option to purchase the asset at a price that is
expected to be sufficiently lower than fair value at the date the option
becomes exercisable such that, at the inception of the lease, it is
reasonably certain that the option will be exercised
· the lease term is for the major part of the economic life of the asset,
even if title in the leased asset(s) is not transferred
· at the inception of the lease, the present value of the minimum lease
payments amounts to at least substantially all of the fair value of the
leased asset(s)
· the leased assets are of a specialised nature such that only the lessee
can use them without major modifications being made.
Other situations that might lead to a lease being classified as a finance lease
are:
International Financial Reporting Unit 7 – Accounting for Leases
90
· in the event of cancellation by the lessee, s/he bears the lessor’s
associated losses
· gains/losses from fluctuations in the fair value of the residual, for
example a rent rebate, fall to the lessee
· the lessee is able to continue to lease the asset for a secondary period
at a rent substantially lower than the market rent.
Accounting by Lessees
The accounting principles for finance leases are as follows:
· At the start of the lease term, the lease itself should be recorded, as an
asset and a liability, at the lower of the fair value of the asset and the
present value of the minimum lease payments (i.e. discounted at the
interest rate implicit at the lease, or else at the enterprise’s incremental
borrowing rate)
· Finance lease payments should be apportioned between the finance
charge and the reduction of the outstanding liability (i.e. the finance
charge is to be allocated so as to produce a constant periodic rate of#p#分页标题#e#
interest on the remaining balance of the liability).
· The depreciation policy of leased assets should be consistent with that
for owned assets. If there is no reasonable certainty that the lessee will
obtain ownership at the end of the lease, the asset should be
depreciated over the shorter of the lease term or the life of the asset.
The accounting principle for operating leases is that the lease payments
should be recognised as an expense in the income statement over the lease
term on a straightline
basis, unless another systematic basis is more
representative of the time pattern of the user’s benefit.
Accounting by Lessors
The accounting principles for finance leases are as follows:
· At the start of the lease term, the lessor should record a finance lease
in the balance sheet as a receivable, at an amount equal to the net
investment in the lease.
· The lessor should recognise finance income based on a pattern
reflecting a constant periodic rate of return on the lessor’s net
investment outstanding in respect of the finance lease.
The accounting principles for operating leases are:
· Assets should be presented in the balance sheet of the lessor
according to the nature of the asset.
· Lease income should be recognised over the lease term on a straight
line basis, unless another systematic basis is more representative of
the time pattern in which use benefit is derived from the leased asset is
diminished.
International Financial Reporting Unit 7 – Accounting for Leases
91
· The asset should be depreciated on a basis consistent with the lessor’s
policy for similar assets.
· Relevant IASs 16, 38 and 36 need to be considered.
· Costs (depreciation included) which are incurred in earning the lease
income are recognised as an expense.
Sale and Leaseback Transactions
In the case of a finance lease any excess of proceeds over the carrying
amount is deferred and amortised over the lease term.
In the case of an operating lease:
· If the transaction is clearly carried out at fair value: the profit or loss
should be recognised immediately.
· If the sale price is above fair value: the excess over the fair value
should be deferred and amortised over the period of use.
· If the sale price is below fair value: profit or loss should be recognised
immediately, except if a loss is compensated for by future rentals at
below market price, the loss should be amortised over the period of
use.
· If the fair value at the time of the transaction is less than the carrying
amount: a loss equal to the difference should be recognised
immediately.
Disclosure
The disclosure requirements are shown in the following table:#p#分页标题#e#
Lessees Lessors
Finance
lease
Carrying amount of asset
Amount of minimum lease
payments at balance sheet date
and the present value thereof for
certain time period
Contingent rent recognised as an
expense
General description of significant
leasing arrangements, including
contingent rent provisions,
renewal or purchase options, and
restrictions imposed on dividends,
borrowings, or further leasing
Gross investment and
present value of minimum
lease payments receivable
for future certain time period
Unearned finance income
Contingent rent recognised
in income
Unguaranteed residual
values
General description of
significant leasing
arrangements
Operating
lease
Amounts of minimum lease
payments at balance sheet date
under noncancellable
operating
lease for certain time period
Lease and sublease payments
recognised in income for the
period
Contingent rent recognised as an
expense
Amounts of minimum lease
payments at balance sheet
date under noncancellable
operating leases in the
aggregate and for certain
time period
Contingent rent recognised
as in income
General description of
International Financial Reporting Unit 7 – Accounting for Leases
92
General description of significant
leasing arrangements, including
contingent rent provisions,
renewal or purchase options, and
restrictions imposed on dividends,
borrowings, or further leasing
significant leasing
arrangements
Summary
In this unit we have concentrated on IAS 17 the standard that deals with
leases. We defined the different types of lease and looked at the IAS 17
requirements with regard to the accounting treatment by the lessee and the
lessor of both types.
Review Activities
REVIEW ACTIVITIES 1
White Ltd., a company whose yearend
is 31 December, leased a machine
from Red Ltd. in January 2007. Under the terms of the lease White is to make
4 annual payments of €10,000 payable in advance. White has the right to
continue to lease the asset after the end of the primary period for as long as it
wishes at a nominal rent (ignored for calculation purpose). The lease asset
could have been purchased for cash at the start of the lease for €35,000.
White estimates that the asset will have a useful life of 5 years and no residual
value. The company normally depreciates such assets on a straightline
basis.
The rate of interest implicit in the lease is 9.7%.
1. Prepare the profit and loss account and balance sheet entries for 5
years from January 2007 of White under IAS 17.
2. Explain how White might use leases in its creative accounting attempts.#p#分页标题#e#
REVIEW ACTIVITIES 2
Talent entered into a leasing agreement with Lessor on 1 October 20x5. This
involves a specialised piece of manufacturing machinery which was
purchased by Lessor to Talent’s specifications.
The contract involves an annual payment of $1,200,000 at the start of each
year for five years. At the start of the lease the present value of the minimum
lease payments was calculated in accordance with the rules contained in IAS
17 and found to be $4,100,000. The fair value of the machinery as at the
commencement of the contract was $4,680,000.
Talent is responsible for the maintenance of the machinery and is required to
insure it against accidental damage.
International Financial Reporting Unit 7 – Accounting for Leases
93
The machinery would normally be expected to have a useful life of
approximately seven years.
Talent depreciates its tangible fixed assets on the straight line basis.
You are required:
(1) Explain whether you agree with Talent’s decision to classify its
lease agreement with Lessor as an operating lease.
(2) Assuming that the lease agreement is to be treated as a finance
lease instead of an operating lease, with an implied interest rate of
14.2% per annum, calculated the changes which would be required
in the following figures:
· Net profit for the year ended 30 September 20x6
· Fixed assets as at 30 September 20x6
· Current liabilities as at 30 September 20x6
· Longterm
liabilities as at 30 September 20x6
(3) It has been suggested that the same lease agreement
can be treated as an operating lease by the lessee
and as a financial lease by the lessor (or vice versa).
Explain how this could be and briefly describe the
problems which this might indicate in the setting and
enforcement of accounting standards.
Review Activities Feedback
REVIEW ACTIVITIES FEEDBACK 1
a) Profit and loss account entries
Year Depreciation Finance charge Total
2007 7,000 2,425 9,425
2008 7,000 1,690 8,690
2009 7,000 885 7,885
2010 7,000 7,000
2011 7,000 7,000
35,000
5,000 40,000
Balance sheet entries
Assets held under finance leases
Year Cost Acc. Depr. NB value
2007 35,000 7,000 28,000
2008 35,000 14,000 21,000
2009 35,000 21,000 14,000
2010 35,000 28,000 7,000
2011 35,000 35,000 International
Financial Reporting Unit 7 – Accounting for Leases
94
Obligations under finance leases
Year Ob. at year start Capital repayment Ob. at year end
2007 35,000 7,575 27,425
2008 27,425 8,310 19,115
2009 19,115 9,115 10,000
2010 10,000 10,000 Workings
Year Capital sum Rental paid capital sum finance charge (9.7%)
capital sum
during period at period end#p#分页标题#e#
€ € € € €
2007 35,000 10,000 25,000 2,425
27,425
2008 27,425 10,000 17,425 1,690
19,115
2009 19,115 10,000 9,115 885
10,000
2010 10,000 10,000 Total
rental finance charge capital
repayments
€ € €
2007 10,000 2,425 7,575
2008 10,000 1,690 8,310
2009 10,000 885 9,115
2010 10,000 10,000
40,000
5,000 35,000
Depreciation
= 35,000/5 = €7,000
b) The following points should form the basis of your answer:
· omission may allow management to present figures that give a ‘better’
picture of the entity
· this allows for calculation of lower gearing ratio and higher ROCE and
interest cover.
· this may influence users’ view of the entity and their decisionmaking.
International Financial Reporting Unit 7 – Accounting for Leases
95
REVIEW ACTIVITIES FEEDBACK 2
(1) The critical issue is whether the lease transfers the risks and rewards
associated with ownership to the lessee. The following facts suggest that it
does:
· The asset was purchased to the lessee’s specifications.
· The lessee is responsible for all repairs and maintenance.
· The lessee is responsible for the asset’s security and maintenance.
· The lease runs for virtually all of the asset’s useful life and, therefore,
subjects the lessee to the risks of technical obsolescence.
All of the above suggest that the lease is a finance lease. This is not
necessarily conclusive in this case because the term of the lease runs for
most of the asset’s life, but there will still be two years of potential at the
end of the lease.
(2) Change in net profit $000
Decrease in lease payments
1,200
Increase in depreciation (820)
Increase in financial charges
(412)
Net change (32)
Change in fixed assets
Present value of lease
4,100
Depreciation (820)
Net increase 3,280
Liabilities
Present value of lease
4,100
First instalment (1,200)
2,900
Interest
412
3,312
Lease payment due next year
1,200
Interest (300)
Lease liability due within one year 900
Lease liability due after one year 2,412
(3) The definition of finance and operating leases requires a subjective
decision to be taken about the extent to which risks and rewards have
been transferred to the lessee. This means that it is quite possible for
two accountants to form different opinions about the same contract.
A number of lessors have been accused of attempting to design lease
terms that appear to breach the spirit of IAS 17. These create sufficient
doubt about the transfer of risks and rewards that lessees can justify#p#分页标题#e#
International Financial Reporting Unit 7 – Accounting for Leases
96
their treatment as operating leases. The lessors could, therefore, treat
the lease correctly as a finance lease while the lessees classify them
as operating leases.
It will always be difficult for standardsetters
to regulate the activities of
prepares. If they provide detailed definitions then there will be much
less scope for misunderstandings or abuses of any flexibility.
Unfortunately, this will also make it possible to structure a transaction in
such a way that it falls outside the scope of the definition.
Such differences will tend to undermine the standard setting process.
Users will complain that standards which permit undue flexibility are a
contradiction in terms.
Recommended Readings
ACCA Study Text Paper 2 Corporate Reporting (International) (2007) BPP,
Chapter 10.
Alexander, D., A. Britton, and A. Jorissen (2007) International Financial
Reporting and Analysis, 3rd Edition, London: Thomson Learning, Chapter: 15.
Elliott, B. and J. Elliott (2008) Financial Accounting and Reporting, 12th
Edition, London: Financial Times/Prentice Hall, Chapter: 16.
International Financial Reporting Unit 8 – Accounting for Provisions, Contingent
Liabilities and Contingent Assets
97
Unit 8
Accounting for Provisions,
Contingent Liabilities and
Contingent Assets
LEARNING OUTCOMES
After completing this unit you should be able to:
· explain how IAS 37 defines and recognises provisions, contingent
liabilities and contingent assets
· explain how these items are to be measured
· discuss how IAS 37 deals with creative accounting.
INTRODUCTION
In unit 8 we look at some the items in financial statements that are, by their
nature, less certain. These items are provisions, contingent assets and
contingent liabilities.
ACTIVITY
Begin by downloading and reading IAS 37 at:
http://www.iasb.org/NR/rdonlyres/81F9095630094346B72711119816C992/
0/IAS37.pdf
What is the objective of this IAS?
FEEDBACK
The objective of the standard is to ensure that appropriate recognition criteria
and measurement bases are applied to provisions, contingent liabilities and
contingent assets and that sufficient information is disclosed in the notes to
International Financial Reporting Unit 8 – Accounting for Provisions,
Contingent Liabilities and Contingent
Assets
98
the financial statements to enable users to understand their nature, timing and
amount. The timing is especially important.
The principle of IAS 37 is that a provision should be recognised only when
there is a liability on the part of the entity. Thus, only genuine obligations are
dealt with in the financial statements and planned future expenditure is#p#分页标题#e#
excluded from recognition.
Let’s look at the definitions first.
ACTIVITY
From the standard, complete the table of definitions below this activity box.
Term Definition
Accrual Income that is due or a cost that is incurred during an
accounting period but which has not been received or paid.
Provision
Liability A present obligation as a result of past events whose
settlement is expected to result in an outflow of resources.
Contingent
liability
Contingent
asset
FEEDBACK
Your table should look like this:
Term Definition
Accrual Income that is due or a cost that is incurred during an
accounting period but which has not been received or paid.
Provision A liability of uncertain timing or amount.
Liability A present obligation as a result of past events whose
settlement is expected to result in an outflow of resources.
Contingent
liability
A possible obligation depending on whether some uncertain
future event occurs
A present obligation but payment is not probable or the amount
cannot be measured reliably.
Contingent
asset
A possible asset that arises from past events, and whose
existence will be confirmed only by the occurrence or nonoccurrence
of one or more uncertain future events not wholly
within the control of the enterprise.
International Financial Reporting Unit 8 – Accounting for Provisions, Contingent
Liabilities and Contingent Assets
99
ACTIVITY
How does the standard say that a provision is to be recognised?
FEEDBACK
An enterprise must recognise a provision if, and only if:
1. a present obligation (legal or constructive) has arisen as a result of a
past event (the obligation event)
2. payment is probable
3. the amount can be estimated reliably.
The core elements of a provision are that:
· it is an obligation
· the obligation arises from past events
· the obligation exists independently of the entity’s future actions
· the enterprise has no realistic alternative but to settle the obligation.
We need to give a closer definition of the meaning of some of the terms used
by the standard. These are:
· ‘probable’ transfer of economic benefits
· reliable estimate
· constructive obligations.
‘Probable’ transfer of economic benefits
‘Probable’ means that the event is more likely to occur than not to occur, that
is, that the probability is more than 50%. The probability should be based on
the population as a whole, rather than one single item.
A contingent liability means that there is a less than 50% probability of transfer
of economic benefits.
‘Reliable estimate’
A reasonable estimate of a range of outcomes is almost always possible but#p#分页标题#e#
when it is not, no provision is recognised. The liability is disclosed as a
contingent liability
A provision should be used only for expenditures for which the provision was
originally recognised.
Constructive obligation
This is an obligation that derives from an entity’s actions where:
International Financial Reporting Unit 8 – Accounting for Provisions,
Contingent Liabilities and Contingent
Assets
100
· by an established pattern of past practice, published policies or a
sufficiently specific current statement, the entity has indicated to other
parties that it will accept certain responsibilities; and
· as a result, the entity has created a valid expectation on the part of
those other parties that it will discharge those responsibilities.
ACTIVITY
Look again at the standard and note down how a provision is to be measured.
FEEDBACK
A provision should be the best estimate of the expenditure required to settle
the present obligation at the balance sheet date. Oneoff
events, such as
environmental cleanup
and the settlement of a lawsuit, are measured at the
most likely amount. Large populations of events, such as warranties and
customer refunds, are measured at a weighted expected value of all possible
outcomes. The discounted present value considers the time value of money
and the risks specific to the liability.
Provisions are subject to remeasurement;
they should be reviewed and
adjusted at each balance sheet date. If the outflow is no longer probable,
reverse the provision to income.
Some examples of provisions are shown in the following table:
Provision Treatment
Business closure or
reorganisation
Accrue a provision only after a detailed
formal plan is adopted and announced
publicly. A Board decision is not enough.
Warranty Accrue a provision. The past event is the
sale of defective goods.
Land contamination Accrue a provision if the company’s policy is
to clean up, even if there is no legal
requirement to do so. The past event is the
obligation and public expectation created by
the company’s policy.
Customer refunds Accrue s provision if the established policy
is to give refunds. The past event is the
customer’s expectation, at time of purchase,
that a refund would be available.
Offshore oil rig must be
removed and sea bed restored
Accrue a provision when the rig is installed.
The provision should be added to the cost
of the asset
International Financial Reporting Unit 8 – Accounting for Provisions, Contingent
Liabilities and Contingent Assets
101
CPA firm’s staff training No provision should be made because there
is no obligation to provide the training.#p#分页标题#e#
A retail store is selfinsured
for
fire loss
No provision should be made until there is
an actual fire. There is no past event.
A selfinsured
restaurant where
people were poisoned, lawsuits
are expected and €10,000
estimated by lawyers.
Accrue a provision. The past event is the
injury to customers.
ACTIVITY
Consider the following scenarios and decide whether a provision should be
made in the 2006 financial statements in each case.
Scenario 1:
The board of an entity decided to close down a division on 12 December
2006. The accounting date of the entity is 31 December. Before 31 December
2006, the decision was not communicated to any of those affected and no
other steps were taken to implement the decision.
Scenario 2:
As in scenario 1, the board of an entity decided to close down a division on 12
December 2006 and the accounting date of the entity is 31 December. The
board in this case had agreed a detailed closure plan on 20 December 2006
and the details were given to customers and employees.
FEEDBACK
Scenario 1:
No provision should be made because the decision was not publically
announced and communicated with any related stakeholders of the entity.
Scenario 2:
Accrue a provision because the board publically announced the decision to
the related stakeholders of the entity such as customers and employees.
Therefore, a constructive obligation has arisen.
ACTIVITY
International Financial Reporting Unit 8 – Accounting for Provisions,
Contingent Liabilities and Contingent
Assets
102
Return to the standard and note down how a contingent liability is defined.
FEEDBACK
The standard defines a contingent liability as a present obligation that arises
from past events but is not recognised, because either it is not probable that a
transfer of economic benefits will be required to settle the obligation, or the
英國留學作業指導amount of the obligation cannot be measured with sufficient reliability.
Contingent liabilities should not be recognised in financial statements but they
should be disclosed via:
· a brief description of the nature of the contingent liability
· an estimate of its financial effect
· an indication of the uncertainties that exist
· the possibility of any reimbursement.
An example of a contingent liability is the transfer fees payable in football:
‘…Under the terms of certain contracts with other football clubs in respect of
player transfers, certain additional amounts would be payable by the Group if
conditions as to future team selection are met. The maximum that could be
payable is £1,200,000…’ [From Manchester United Plc Annual Report 2003]#p#分页标题#e#
ACTIVITY
Return to the standard and note down how a contingent asset is defined.
FEEDBACK
The standard defines a contingent asset as one that arises from past events
and whose existence will be confirmed by the occurrence of one or more
uncertain future events not wholly within the entity’s control.
A contingent asset should be disclosed where an inflow of economic benefits
is probable and is to be recognised only when the realisation of the related
economic benefits is virtually certain.
International Financial Reporting Unit 8 – Accounting for Provisions, Contingent
Liabilities and Contingent Assets
103
Measurement rules
Estimates of provisions and contingencies are subject to the judgement of the
entity’s management, who will use their experience of similar transactions. It is
clear that provisions and contingencies will be open to aspects of creative
accounting, such as ‘big bath’ accounting. There may be the creation of
provisions where no obligation to a liability exists or the over estimation of
provisions that are later reversed.
ACTIVITY
By reading relevant literature and your own resources, define and comment
on the term ‘big bath’ accounting.
Useful articles are:
Crichton, J. (1998) ‘Pull the Plug on the Big Bath Scam’, Accountancy, vol
122, Iss 1262, p75
Kirk, R. (1999) ‘Has the ‘big bath’ finally spring a leak?’ Management
Accounting May p6062
Paterson, R. (2003) In a holestill
digging’, Accountancy, vol 132, Iss 1319
p98
FEEDBACK
The objective of ‘big bath’ accounting is to maximize loss. Big bath accounting
mainly occurs in the following circumstances:
1. When in the case of a (onetime)
heavy loss that cannot be avoided,
the firm’s management may choose to maximize the loss in the current
accounting period.
2. When there is an executive handover, especially when the prior CEO
was dismissed for poor performance.
3. When the annual accounts will be cleaned up before or after an
acquisition, a merger or other form of business cooperation. In the
current accounting period, there will be large asset write downs and
increased provisions in order to enhance the future performance of the
firm.
International Financial Reporting Unit 8 – Accounting for Provisions,
Contingent Liabilities and Contingent
Assets
104
Disclosure
Two features of disclosure are addressed by the standard:
· There should be a reconciliation of provisions with an opening balance,
additions, amount of the provision used (that is, amounts charged
against the provision), amount of the provision released (reversed), and
the closing balance.
· Each class of provision should be disclosed as to nature, timing,#p#分页标题#e#
uncertainties and reimbursement.
Summary
In unit 8 we looked provisions, contingent assets and contingent liabilities. We
saw how IAS 37 defines and recognises these items, defines how they should
be measured and how they are disclosed.
Review Activities
REVIEW ACTIVITIES 1
BBA plc is drawing up its accounts for the year ending 31st December 2007.
Advise the company on the accounting treatment of the following items. State
clearly the criteria adopted for arriving at your decisions.
i. The company is planning to acquire a new asset on the 1st January for
€140,000.
ii. The company has been informed that an asset acquired for €10,000
and with a useful economic life of 5 years will require its motor replaced
annually at a cost of €500.
iii. The Public Health Inspector notified BBA on 1 December 2007 that the
company was required to pay a penalty of €10,000 for a minor breach
of health and safety laws
iv. A regular and reputable customer complained on the 10th December
2007 that a consignment of deliveries, invoiced at €140,000, was
defective. To defend the company’s reputation, BBA’s usual policy is to
make a refund of 125 per cent of the value of any defective products.
v. A claim for damages, at €40,000, is received from a customer on 7th
December 2007 in respect of injuries sustained within the company
premises on 29th November 2007. The legal advisers are of opinion
that the company will be held liable for an amount probably of around
€20,000 because of failure to display a ‘wet floor’ sign
vi. A customer has claimed €25,000 as the cost of items damaged
because of negligence of BBA’s workforce. Negligence of the workers
has been established. BBA will be able to realised €10,000 by
disposing of the damaged goods.
vii. BBA has cancelled, with effect from 30.9.2007, a franchise it had
granted to BBC Ltd. BBC Ltd has filed legal action claiming liquidation
damages in a sum of €500,000, and further putative damages of
International Financial Reporting Unit 8 – Accounting for Provisions, Contingent
Liabilities and Contingent Assets
105
€600,000. The legal opinion is that because BBA did not have sufficient
grounds for premature termination of the franchise, it will be liable for
the liquidation damages, and the award of any punitive damages
depends on the attitude that the court adopts.
viii. BBA has been extracting oil offshore over several years. New
legislation passed in the year requires the company to remove the rig
and restore the seabed when extraction is completed. These activities
are expected to cost €3 million.
REVIEW ACTIVITIES 2
Rowsley is a diverse group with many subsidiaries. The group is proud of its#p#分页标题#e#
reputation as a ‘caring’ organisation and has adopted various ethical policies
towards it employees and the wider community in which it operates. As part of
its Annual Report, the group publishes details of its environmental policies,
which include setting performance targets for activities such as recycling,
controlling emissions of noxious substances and limiting use of nonrenewable
resources.
The finance director is reviewing the accounting treatment of various items
prior to the signing of the accounts for the year ended 31 March 20x5. All four
items are material in the context of the accounts as a whole. The accounts are
to be approved by the directors on 30 June 20x5.
i. On 15 February 20x5 the board of Rowsley decided to close down a
large factory. The board is trying to draw up a plan to manage the
effects of the reorganisation, and it is envisaged production will be
transferred to other factories, all of which are some distance away. The
factory will be closed on 31 August 20x5, but at 31 March this decision
had not yet been announced to the employees or to any other
interested parties. Costs of the reorganisation have been estimated at
$45 million.
ii. During December 20x4 one of the subsidiary companies moved from
Aytoun to Beetown in order to take advantage of regional development
grants. It holds its main premises in Aytoun under an operating lease,
which runs until 31 March 20x7. Annual rentals under the lease are $10
million. The company is unable to cancel the lease, but it has let some
of the premises to a charitable organisation at a nominal rent. The
company is attempting to rent the remainder of the premises at a
commercial rent, but the directors have been advised that the chances
of achieving this are less than 50%.
iii. During the year to 31 March 20x5, a customer started legal
proceedings against the group, claiming that one of the food products
that it manufactures had caused several members of his family to
become seriously ill. The group’s lawyers have advised that this action
will probably not succeed.
iv. The group has an overseas subsidiary that is involved in mining
precious metals. These activities cause significant damage to the
International Financial Reporting Unit 8 – Accounting for Provisions,
Contingent Liabilities and Contingent
Assets
106
environment, including deforestation. The company expects to
abandon the mine in eight years time. The mine is situated in a country
where there is no environmental legislation obliging companies to
rectify environmental damage and it is very unlikely that such
legislation will be enacted within the next eight years. It has been
estimated that the cost of cleaning the site and replanting
the trees will
be $25 million if the replanting#p#分页标题#e#
were successful at the first attempt, but
it will probably be necessary to make a further attempt, which will
increase the cost by a further $5 million.
Required:
Explain how each of the items (1) to (4) above should be treated in the
consolidated accounts for the year ended 31 March 20x5.
Review Activities Feedback
REVIEW ACTIVITIES FEEDBACK 1
(i) The obligation to transfer €140,000 of resources for an asset is not a
present obligation arising from a past transaction. It is expected to arise next
year from a proposed transaction. Therefore it has not satisfied the criteria to
be recognised and accounted for as a liability as at the end of the financial
year.
(ii) The need to replace the motor for the asset at €500 is not a present
obligation because it could be avoided by future action e.g. by replacing the
asset as a whole you avoid the need to replace the motor. Hence it does not
satisfy the criteria for classification as a liability. The appropriate accounting
treatment is to treat the €500 as a period cost to be written off each year as
the motor is replaced, and to depreciate the remainder of the asset’s cost over
it useful economic life.
(iii) The penalty of €10,000 is a present obligation. The obligating event giving
rise to it is the breach of the health and safety laws. There is a legal obligation
to pay this penalty and its amount is reliably established. Therefore the
penalty of €10,000 should be accounted for as an accrued liability.
(iv) With regard to the defective pastries there is an accrued liability of
€17,500 (being 125 per cent of the €14,000 sales price of the product). The
obligating event is the sale of defective pastries. There is a present
(constructive) obligation to pay because by her past practice she has created
a valid expectation that she would. The amount is reliably established.
(v) The failure to take reasonable precautions for customer safety (namely not
displaying a ‘wet floor’ sign) is the obligating event. The transfer of economic
benefits to discharge the present obligation to pay appears probable. The
judgment of the court serves only to crystallise the amount and not to
determine whether there is a payment necessary. The expert advice is that
€20,000 may become payable. Since, until the judgment the is no certainty on
the amount and considering the degree of uncertainty involved, a provision
should be made for €20,000 as a best estimate.
International Financial Reporting Unit 8 – Accounting for Provisions, Contingent
Liabilities and Contingent Assets
107
(vi) Since negligence on the part of the contractor’s workers has been
established, the contractor has a present obligation at balance sheet date to
transfer €25,000 for the damaged goods. There is no uncertainty on the#p#分页标题#e#
amount. Therefore €25,000 should be accounts for as an accrued liability
rather than as a provision. The assumption of the liability entitles the company
to a corresponding future economic benefit of the amount expected to be
realised by disposing of the damaged goods for €10,000. But FRS 12
prohibits the recognition of such a gain until it is realised. Hence the profit for
the year is reduced by €25,000.
(vii) The obligating event is the premature cancellation of the franchise, which
took place on 30.9.X0. Hence at balance sheet date there is an obligation to
transfer economic benefits in the future, arising from a past transaction and in
accordance with legal opinion the transfer of economic benefits is probable. A
reliable estimate of the amount is made for liquidated damages at €500,000
taking into account the element of uncertainty in the amount a provision is
made for €500,000 rather than accounting for it as an accrued liability.
Because the obligation to pay any punitive damages is yet to be confirmed by
an uncertain event (court’s verdict) the claim for punitive damages is reported
as a contingent liability.
(viii) The obligating event is the continuation of oil extraction. Since legislation
has been passed, the transfer of economic benefits is certain. The company
would have experience of such decommissioning in other countries and
therefore would be in a position to estimate with reasonable certainty the
expenses that decommissioning would involve. Therefore it will have to
account for the decommissioning expenses of €3m as a provision. The cost of
decommissioning gives the company access to future economics benefits
arising from sale of oil extracted. Thus the amount may be capitalised and
amortised over the years during which the future benefits are expected to
arise.
REVIEW ACTIVITIES FEEDBACK 2
In all four cases, the key issue is whether or not a provision should be
recognised. Under IAS 37, a provision should only be recognised when:
a) there is a present obligation as a result of a past event
b) it is probable that a transfer of economic benefits will be required to
settle the obligation
c) a reliable estimate can be made of the amount of the obligation
Factory closure
As the factory closure changes the way in which the business is conducted (it
involves the relocation of business activities from one part of the country to
another) it appears to fall within the IAS 37 definition of a restructuring.
The key issue here is whether the group has an obligation to incur
expenditure in connection with the restructuring. There is clearly no legal
obligation, but there may be a constructive obligation. IAS 37 states that a
constructive obligation only exists if the group has created valid expectations#p#分页标题#e#
International Financial Reporting Unit 8 – Accounting for Provisions,
Contingent Liabilities and Contingent
Assets
108
in other parties, such as employees, customers and suppliers, that the
restructuring will actually be carried out. As the group is still drawing up a
formal plan for the restructuring and no announcements have been made to
any of the parties affected, there cannot be an obligation to restructure. A
board decision alone is not sufficient. Therefore no provision should be made.
If the group starts to implement the restructuring or makes announcements to
those affected before the accounts are approved by the directors it may be
necessary to disclose the details in the financial statements as required by
IAS 10 Events after the balance sheet date. This will be the case if the
restructuring is of such importance that nondisclosure
would affect the ability
of the users of the financial statements to reach a proper understanding of the
group’s financial position.
Operating lease
The lease contract appears to be an onerous contract as defined by IAS 37
(i.e. the unavoidable costs of meeting the obligations under it exceed the
economic benefits expected to be received under it).
Because the company has signed the lease contract there is a clear legal
obligation and the company will have to transfer economic benefits (pay the
lease rentals) in settlement. Therefore the group should recognise a provision
for the remaining lease payments. The group may recognise a corresponding
asset in relation to the nominal rentals currently being received, if these are
virtually certain to continue. (In practice, it is unlikely that his amount is
material.) As the chances of renting the premises at a commercial rent are
less than 50%, no further potential rent receivable may be taken into account.
The financial statements should disclose the carrying amount at the balance
sheet date, a description of the nature of the obligation and the expected
timing of the lease payments and the amount of any expected rentals
receivable from subletting.
If an asset is recognised in respect of any rentals
receivable, this should also be disclosed.
Legal proceedings
It is unlikely that the group has a present obligation to compensate the
customer and therefore no provision should be recognised. However, there is
a contingent liability. Unless the possibility of a transfer of economic benefits
is remote, the financial statements should disclose a brief description of the
nature of the contingent liability, an estimate of its financial effect and an
indication of the uncertainties relating to the amount or timing of any outflow.
Environmental damage
It is clear that there is no legal obligation to rectify the damage. However,
through its published policies, the group has created expectations on the part#p#分页标题#e#
of those affected that it will take action to do so. There is therefore a
constructive obligation to rectify the damage and a transfer of economic
benefits is probable.
The group must recognise a provision for the best estimate of the cost. As the
most likely outcome is that more than one attempt at replanting
will be
needed, the full amount of $30 million should be provided. The expenditure
will take place some time in the future, and so the provision should be
International Financial Reporting Unit 8 – Accounting for Provisions, Contingent
Liabilities and Contingent Assets
109
discounted at a pretax
rate that reflects current market assessments of the
time value of money and the risks specific to the liability.
The financial statements should disclose the carrying amount at the balance
sheet date, a description of the nature of the obligation and the expected
timing of the expenditure. The financial statements should also give an
indication of the uncertainties about the amount and timing of the expenditure.
Recommended Readings
ACCA Study Text Paper 2 Corporate Reporting (International) (2007) BPP,
Chapter 9.
Alexander, D., A. Britton, and A. Jorissen (2007) International Financial
Reporting and Analysis, 3rd Edition, London: Thomson Learning, Chapter: 19.
Crichton, J. (1998) ‘Pull the Plug on the Big Bath Scam’, Accountancy, vol
122, Iss 1262, p75
Kirk, R. (1999) ‘Has the ‘big bath’ finally spring a leak?’ Management
Accounting May p6062
Paterson, R. (2003) In a holestill
digging’, Accountancy, vol 132, Iss 1319
p98
Stolowy H. And Lebas M. J. (2006): Financial Accounting and Reporting a
global perspective, second edition, Thomson, Chapter 12.
International Financial Reporting Unit 9 – Accounting for Pensions
110
Unit 9
Accounting for Pensions
LEARNING OUTCOMES
In this final unit we focus on the accounting treatment of pensions, as
described in IAS19. After completing this unit you should be able to:
· define and categorise the different types of pension
· apply the recommended accounting treatment of defined contribution
plans and defined benefit plans.
INTRODUCTION
The objective of IAS19 is to prescribe the accounting and disclosure
recommendations for employee benefits, so we need to begin by looking at
the standard.
ACTIVITY
Download a copy of the technical summary of IAS19 from the site below and
note down what the standard requires the entity to recognise.
http://www.iasb.org/NR/rdonlyres/C561FAFB2E4E41B8A6D7FB7E92070ED8/
0/IAS19.pdf
FEEDBACK
The standard requires an entity to recognise that there is a liability when an
employee has provided service in exchange for employee benefits to be paid#p#分页标题#e#
in the future; and an expense when the entity consumes the economic benefit
arising from service provided by an employee in exchange for employee
benefits. Thus the principle is that the cost of providing employee benefits
should be recognised in the period in which the benefit is earned by the
employee, rather than when it is paid or payable, in other words, the matching
concept.
International Financial Reporting Unit 9 – Accounting for Pensions
111
IAS 19 applies to employee benefits such as:
· wages and salaries
· paid vacation and sick leave
· profit sharing plans
· bonuses
· housing benefits
· medical and life insurance, and of course
· pension benefits.
Let’s look further at the nature of pensions.
ACTIVITY
Two forms of pension are defined by IAS19. Note down the essential
difference between them.
FEEDBACK
The standard describes defined contribution plans and defined benefit plans.
Defined contribution plans, also called money purchase plans, are those in
which the employer undertakes to make certain contributions each year,
usually a stated percentage of salary. Defined benefit plans, also called final
salary plans, are those in which the employees will, on retirement, receive a
pension based on the length of service and salary, usually final salary or an
average of the last few years’ salary.
Defined Contribution Plans
The characteristics of a defined contribution plan are that:
· the employer will contract to pay a certain contribution to an
employee’s pension fund, for example, 5% of their annual salary
· the employer has no legal or constructive obligations to make further
payments
· the final amount of the pension to be received by the employee will
depend on the investment performance of the fund assets.
ACTIVITY
The payroll costs of a company in a particular year are €3million. The
company makes pension contributions of 5% of employees’ salaries, paying
€10,000 monthly. What will the entries in the profit and loss account and
balance sheet be at the year end?
International Financial Reporting Unit 9 – Accounting for Pensions
112
FEEDBACK
The profit and loss account will show the pension costs of €3,000,000 x 5% =
€150,000. The balance sheet will show the amount actually paid, €10,000 x
12 months = €120,000 and the year end liability of €30,000.
Defined Benefit Plans
The characteristics of a defined benefit plan are that:
the employer will enter into a contract to finance a pension of a certain
amount, for example, 1% of the employee’s final salary for each year of
service
the exact amount to be paid on the employee’s pension entitlement is#p#分页标题#e#
uncertain, being dependent on salary level on retirement, length of service,
interest rates, discount rate and future investment returns.
ACTIVITY
An employee’s pension benefit is payable on termination of service and is
equal to 1% of final salary for each year of service. His salary in year 1 is
€10,000 and is assumed to increase at 7% (compound interest) each year.
The discount rate is 10%. What is the pension obligation of the employer if
this employee is expected to leave at the end of year 5? (A NPV table is given
at the end of the unit.)
FEEDBACK
The obligations are as follows:
Year 1 2 3 4 5
Salary
(7% increase) 10,000 10,700 11,449 12,250 13,100
Benefit
attributed to 131 131 131 131 131
current year (1% of final year)
Benefit
attributed to 0 131 262 393 524
previous years
Benefit attributed 131 262 393 524 655
to current and previous years
Opening obligation 0 89* 196 324 476
International Financial Reporting Unit 9 – Accounting for Pensions
113
(PV of benefit attributed to
previous years)
Interest at 10% 0 9 20 33 48
Current service 89 98 108 119 131
cost (PV of benefit
attributed
to current year)
Closing obligation 89 196 324 476 655
(PV of benefit attributed to
current and prior years)
Balance Sheet Values
The present value of the defined benefit obligation at the balance sheet date
is determined by:
· interest costs
· actuarial gains and losses
· past service cost
· the effect of any plan curtailments or settlements.
Costs arise for a pension plan as a result of improving the plan or when a
business introduces a plan in the first instance. Past service costs include the
extra liability in respect of previous years’ service by employees: the effect of
plan amendments that increase or reduce benefits for past service and
estimates of benefit improvements as a result of actuarial gains.
A pension plan asset is valued at the market value of the pension fund at the
balance sheet date, determined by:
· expected return on plan assets
· contributions to the pension fund in current year
· actuarial gains and losses.
Actuarial gains and losses arise from the experienced adjustments of an
actuary. They are the differences between actuarial assumptions and actual
experience, such as:
· unexpectedly low or high rates of employee turnover
· the effect of changes in the discount rate
· differences between the actual return on plan assets and the expected
return on plan assets.
International Financial Reporting Unit 9 – Accounting for Pensions
114
The changes may be either in the present value of the defined benefit#p#分页标题#e#
obligations, or in the market value of the plan assets.
ACTIVITY
Look at the example below:
Pension plan assetsPension plan obligations
€ €
Opening balance 1,000 1,000
Interest 150
Current service cost 200
Expected return 100
Contributions 150
Benefits paid out (150) (150)
Gains (balancing figure) 400
Losses (balancing figure) 800
Closing
balance 1,500 2000
A net actuarial loss of €400 (800 – 400) – what is accounting treatment?
FEEDBACK
There are two possible treatments:
1) The company could recognize the portion of the net actuarial loss in
excess of 10% of the greater of the present value of the defined benefit
obligation or the fair value of the plan assets. The actuarial loss is €400. The
limit of the corridor is 10% of €2000 (i.e. €200) as the present value of the
obligation is greater than the fair value of the plan assets. The difference is
€200 (i.e. €400 €
200). If we assume the length of the employee service is 10
years, €40 may be recognized in the current year’s profit or loss.
2) The actuarial loss can be recognized in full in the statement of
recognized income and expense (SRIE). Accordingly, the €400 loss can be
recognized in the statement. This loss cannot be recycled through the income
statement and should be added to retained earnings.
If actuarial gains and losses exceed 10% of the greater of the present value of
the defined benefit obligation or the market value of the plan assets, a portion
of that net gain or loss is required to be recognised immediately as income or
expense. The portion recognised in the excess divided by the expected
average remaining lives of the participating employees. If gains/losses are
below the 10% limits, they need not be recognised, although the firm may
choose to do so. This is known as the 10% corridor approach.
International Financial Reporting Unit 9 – Accounting for Pensions
115
SRIE Approach – IAS 19 (revised 2004)
A revision to IAS 19, issued by the IASB in 2004, allows actuarial gains and
losses to be recognised in full immediately in a Statement of Recognised
Income and Expense (SRIE). This is similar to the requirements of the UK
standard, FRS 17 Retirement Benefits.
ACTIVITY
Read the briefing on FRS 17 provided at the following site:
http://www.pensionadvice.ltd.uk/s2/main/pensionpages/FRS%2017%20Std%2
0Life.pdf
What do you consider to be the advantages and/or disadvantages of the SRIE
approach?
FEEDBACK
The advantages include:
1) The transparency of actuarial gains and losses is improved; the quality
of disclosure is high.
2) There is no direct impact on the income statement. This avoids the
volatility of profit and loss figures.#p#分页标题#e#
3) It is not necessary to take into account unrecognized actuarial gains
and losses in the coming years, as all gains and losses are recognized in
SRIE.
However, there is a disadvantage in the direct impact on equity, a possible
volatility of the equity of the entity.
Summary
In our final unit we focused on the accounting treatment of pensions, as
described in IAS19. We noted the different types of pension, defined
contribution and defined benefit plans. We also looked at the accounting
treatment of these types.
International Financial Reporting Unit 9 – Accounting for Pensions
116
Review Activities
REVIEW ACTIVITIES 1
AAA Company operates a defined benefit pension scheme on behalf of its
employees. The company operates an annual review of funding in conjunction
with their actuaries who have supplied the following information:
At 31 Dec 2004 At 31 Dec 2005
€ €
Present value of pension
Scheme liabilities 7,000 12,000
Market value of pension
Plan assets 7,000 15,000
To advise the company the actuary has made the flowing assumptions:
Expected return on plan assets 10%
Discount rate (interest rate)
used to determine pension plan liabilities 15%
Current service cost €4650
Contributions to the pension plan €5000
Benefits paid out €2000
The estimated length of employee service is 10 years.
Illustrate how with IAS 19 (revised 2004) AAA Company would account for its
pension costs.
REVIEW ACTIVITIES 2
A, a public limited company, operates a defined benefit plan. A full actuarial
valuation by an independent actually revealed that the value of the liability at
31 May 20x0 was $1,500 million. This was updated to 31 May 20x1 by the
actuary and the value of the liability at that date was $2,000 million. The
scheme assets comprised mainly bonds and equities and the fair value of
these assets was as follows:
31 May 20x0 31 May
20x1
$m $m
Fixed interest and index linked bonds 380 600
Equities 1,300 1,900
Other investments 290 450
1,970 2,950
International Financial Reporting Unit 9 – Accounting for Pensions
117
The scheme had been altered during the year with improved benefits arising
for the employees and this had been taken into account by the actuaries. The
increase in the actuarial liability in respect of employee service in prior periods
was $25 million (past service cost). The increase in the actuarial liability
resulting from employee service in the current period was $70 million (current
service cost). The company had not recognized any net actuarial gain or loss
in the income statement to date.
The company had paid contributions of $60 million to the scheme during the
period. The company expects its return on the scheme assets at 31 may 20x1#p#分页标题#e#
to be $295 million and the interest on pension liabilities to be $230 million.
The average expected remaining working lives of the employees is 10 years
and the net cumulative unrecognized gains at 1 June 20x0 were $247 million.
Required:
Explain the main accounting requirements of IAS 19 Employee Benefits with
respect to pensions and describe the particular problems which IAS 19
creates in respect of defined benefit schemes, such as the one operated by A.
Calculate the amount which will be shown as the net plan asset in the balance
sheet of A as at 31 May 20x1, showing a reconciliation of the movement in the
plan surplus during the year and a statement of those amounts which would
be charged to operating profit.
Review Activities Feedback
REVIEW ACTIVITIES FEEDBACK 1
Balance sheet extract
€
Pension plan assets 15,000
Pension plan liabilities 12,000
Net
pension assets (3000)
Profit and loss account extract
€ €
Current service cost (4650)
Interest cost (15%*7,000) (1050)
Expected return on the assets (10%*7,000) 700
Actuarial gains and losses
Pension plan assets Pension plan liabilities
€ €
Opening balance 7,000 7,000
Interest 1050
Current service cost 4650
Expected return 700
Contributions 5000
Benefits paid out (2000) (2000)
International Financial Reporting Unit 9 – Accounting for Pensions
118
Gains (balancing figure) 4300
Loss (balancing figure) 1300
Closing
balance 15000 12000
There is a net actuarial gain of €3000.
10% corridor approach
10% of 15000 is 1500; 10% of 12000 is 1200. €3000 is higher than €1500.
IAS 19 (revised 2004) requires the net actuarial gains to be portioned and to
be recognized as a gain in the income statement if it falls within the 10%
corridor test. €1500 (€3000 – €1500) will be portioned according to the length
of employees’ service left in the company. Therefore, €1500/10 = €150
Profit and loss account extract
€ €
Current service cost (4650)
Interest cost (15%*7,000) (1050)
Expected return on the assets (10%*7,000) 700
Actuarial gains 150
Alternatively, €3000 is recognized in SRIE (SRGL)
REVIEW ACTIVITIES FEEDBACK 2
IAS 19 regards the cost of providing a pension as part of the cost of obtaining
the services of its work force, even though that pension might not be paid until
some time in the relatively distant future.
IAS 19 requires that the cost of the pension should be recognized on a
systematic and rational basis over the period during which the company
benefits from the employee’s services. Thus, the IAS requires the application
of the matching concept so that the full cost of an employee’s pension is#p#分页标题#e#
charged to the profit and loss account during that person’s period of service.
Under a defined benefit scheme, the employees are entitled to a pension
which is likely to be based on their salary at the time of their retirement. A
defined benefit scheme creates a potential liability which is related to a variety
of unknown factors: salaries at time for retirement, life expectancy after
retirement, probability of death in service, etc. this creates a potential liability
which is extremely difficult to measure. Companies must normally seek advice
from actuaries, experts in statistics and investment who specialize in this type
of field.
Given this requirement, it is possible that the charge to the profit and loss
account will not be the same as the amount of the company’s annual
contribution. In particular, some basis has to be found for accounting for the
effects of surpluses or deficits form investments or changes in the expected
value of the future pension commitments.
31 May 20x1
$m
International Financial Reporting Unit 9 – Accounting for Pensions
119
Present value of the obligation 2,000
Fair value of plan assets (2,950)
Net surplus in plan 950
Unrecognized actuarial gains (692)
Net plan asset 258
Workings
(W1) $m
Unrecognized actuarial gains at 1 June 20x0 247
Actuarial gain/(loss) – obligation (2,0001,500)
(500)
Actuarial gain/(loss) – plan assets (2,9501,970)
980
Net contributions in year (30)
Actuarial gain recognized (5)
Unrecognized actuarial gain 31 May 20x1 692
Net contributions in year is:
Contributions 60
Net charge to income (25)
Actuarial gain (5)
30
(W2) The actuarial gain will be recognized as follows: $m
Net unrecognized gain 247
Limits of 10% corridor
(greater of 10% of 1,500 or 10% of 1,970) (197)
Excess 50
Amortization is therefore (50/10 years) 5
Charge to income statement
Current service cost 70
Past service cost 25
Interest on liabilities 230
Actuarial gain recognized (5)
Return on scheme assets (295)
Net charge to income statement 25
Movement in plan surplus
Opening surplus – asset 1,970
liability
(1,500)
470
Unrecognized actuarial gain (247)
Opening net surplus 223
Expense as above (25)
Contributions 60
Closing net surplus in plan 258
International Financial Reporting Unit 9 – Accounting for Pensions
120
Recommended Readings
ACCA Study Text Paper 2 Corporate Reporting (International) (2007)
BPP, Chapter 6.
Alexander, D., A. Britton, and A. Jorissen (2007) International
Financial Reporting and Analysis, 3rd Edition, London: Thomson
Learning, Chapter: 21.
Cearns, K. (1998) ‘Accounting for Employee Benefits’, Accountancy,#p#分页标题#e#
vol 122, Iss 1259, p889
Cearns, K. (1998) ‘Accounting for Employee Benefits 2’, Accountancy,
vol 122, Iss 1260, p658
Clark, P. (1998) ‘Counting the Cost of Pensions’, Accountancy, vol
121, Iss 1255, p701
Mills, R. (2006) ‘Defined Benefit Schemes: a guide to IAS19’,
Accountancy Ireland, June, vol 38(3) p1618
Stolowy H. And Lebas M. J. (2006): Financial Accounting and
Reporting a
global perspective, second edition, Thomson, Chapter
12.
International Financial Reporting Unit 9 – Accounting for Pensions
121
Appendix
Net Present Value Table
Year 1% 2% 3% 4% 5% 6% 7% 8% 9%
10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926
0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857
0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794
0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735
0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681
0.650 0.621
6 0.942 0.888 0.837 0.790 0.746 0.705 0.666 0.630
0.596 0.564
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583
0.547 0.513
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540
0.502 0.467
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500
0.460 0.424
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463
0.422 0.386
Note: 89 = 131*0.683;