ACCA P2

Corporate Reporting (INT)

June 2015
Sample note

 Lesco Group Limited, April 2016

All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording or otherwise, without the prior written
permission of Lesco Group Limited.

Recommendation of study:
Hello and welcome to our ACCA P2 corporate reporting study.
This paper is challenging to study but easy to pass because if you do Q1 really well
which accounts for 50marks then you can pass this paper easily.
But our recommendation is you should build your basic understanding of the p2
knowledge so that you can use them in the real life as well not just pass this paper.
So:
1, make sure you have gone through all videos and if you have time attend our live
online course to do more questions practice.
2, A separate note for you is required because you can use that to copy the exam
questions answer from our tutors.
3, Practice many recent question is the key to success. In the video tutor has laid out
lots of past exam questions to you and if you practice them after the class and make
sure you do them right then you will be P2 expert. But in the exam and because its an
exam if you havent practiced recent past exam questions from examiner and even
though you are an expert you will still not be as speedy as the one who does. So:
4, We strongly recommend our online students to enroll in our Live Online Course
which tutor will practice more recent past exam questions with you and do more
summary.
If you want to enroll in our live online course and you can contact:
billy@accaapc.com
Best of luck in your coming exam.
Accounting Practice Center (A.P.C)

Content
Chapter1: Introduction to P2 ..........................................................................................................................6
Chapter2 Accounting Standards .....................................................................................................................7
IAS 2 Inventory ............................................................................................................................................8
IAS 8 Accounting policies, changes in accounting estimates and errors...................................................13
IAS10 events after the reporting period ...................................................................................................18
IAS 12 Income taxes ..................................................................................................................................20
IAS16 property, plant &equipment ...........................................................................................................34
IAS 17 leases .............................................................................................................................................46
IAS 18 Revenue Recognition .....................................................................................................................51
IAS 19 Employee Benefits and IFRS 2 Share Based Payment ....................................................................58
IAS 20 Government grants ........................................................................................................................65
IAS 23 borrowing costs..............................................................................................................................68
IAS 24 Related Party Disclosures ...............................................................................................................72
IAS 34 Interim Financial Reporting............................................................................................................76
IAS 36 impairment of assets .....................................................................................................................78
IAS 37 provisions, contingent liabilities and contingent assets ................................................................85
IAS 38 Intangible Assets ............................................................................................................................90
IAS 40 investment property ......................................................................................................................93
IFRS 1 fist time adoption of international financial reporting standards ..................................................97
IFRS 2 Share Based Payment .....................................................................................................................98
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations .................................................103
IFRS 8 Operating Segments .....................................................................................................................108
Financial Instrument [IAS32; IAS 39; IFRS 9; IFRS 7] ...............................................................................112
IFRS 9.......................................................................................................................................................112
IAS32 Compound financial instrument ...................................................................................................117
IAS39 Financial instrument impairment .................................................................................................118
IFRS7 Disclosure about financial instrument ..........................................................................................119
IAS39 Hedge Accounting .........................................................................................................................120
IFRS 10 Consolidated Financial Statements ............................................................................................130
IFRS 11 Joint Arrangements ....................................................................................................................132
IFRS 12 disclosures of interests in other entities ....................................................................................133

IFRS 13 Fair Value Measurement ............................................................................................................136

IAS 41 Agriculture ...................................................................................................................................138
IFRS for SMEs..........................................................................................................................................146
Management Commentary .....................................................................................................................147
Conceptual and regulatory framework ...................................................................................................148
Integrated reporting................................................................................................................................152
Chapter 3 Consolidation .............................................................................................................................154
Basic concepts about consolidation:.......................................................................................................154
Associate (IAS 28 investment in associates) ...........................................................................................174
IAS 21 The effects of changes in foreign exchange rates, .......................................................................192
IAS 7 statement of cash flow...................................................................................................................199

Chapter1: Introduction to P2
P2 is all about application of accounting standards to consolidation FS + solve clients
specific problems.
You need to know the behind idea and theory of accounting standards outlined in the study
note.
You will also need to practice lots of past exam questions to reinforce your understanding
about each accounting standards.
Make sure you do those and certainly you can pass this exam!
Study structure of p2 in this course:
1. Overview
2. Accounting standards
3. Consolidation

Chapter2 Accounting Standards

IAS 2 Inventory

1, Initial measurement
Inventory= quality X value
(Number of inventory purchased X historical cost)*
*Historical cost:
1, Cost of purchase: purchase price, import duties but excluding discounts
2, Cost of conversion relating to production (direct/variable overheads),
E.g., labour costs in factory; (but labor costs relating to marketing department
is not) machinery depreciation
3, Other costs happened necessary to bring the inventory to its intended location and
condition.
e.g., Carriage inwards can be cost. But carriage outwards is expense

2, Subsequent Measurement (valuing closing inventory)

Inventory= quality X value
(Closing inventory X

(using FIFO, WAC))

Lower of cost and net realizable value

Aim: not to overstate the asset (inventory) figure, i.e., be prudent.

For statement of financial position, closing inventory will appear under

current assets and if theres more closing inventory then it will make
statement of financial position look better.
For statement of comprehensive income, if theres more closing inventory,
then therell be less cost of sales then overstate the profit.

3, Where does inventory fit into?

Statement of financial position as at 31 DEC 2014 for Manny company:
Current assets
Inventory

$
8,990

Statement of comprehensive income (extract) for the year ended 31 DEC 2014 for
Manny company:
$
$
Sales revenue
$78,559
Cost of sales
Opening inventory 8,009
Purchase
5,889
-closing inventory
(8,990)
(4,908)
Gross profit
73,651

Journals:
Opening inventory:
DR cost of sales 8,009
CR closing inventory 8,009
Purchases
DR cost of sales 5,889
CR cash/payable 5,889
Closing inventory
DR closing inventory 8,990
CR cost of sales 8,990

10

Q housing department [DEC 2012 Q3 extract]

The local government organization supplements its income by buying and selling
property. The housing department regularly sells part of its housing inventory in the
ordinary course of its operations as a result of changing demographics. Part of the
inventory, which is not held for sale, is to provide housing to low-income employees at
below market rental. The rent paid by employees covers the cost of maintenance of the
property.
(2 marks)

Supplement
Sales of property are in the ordinary course of its operations and are routinely
occurring, then the housing stock held for sale will be classified as inventory per IAS2
inventory.
Low-income employees
The part of the inventory held to provide housing to low-income employees at below
market rental and this is held to provide housing services rather than rentals so cant
be classified as investment property but as property, plant and equipment per IAS16.

11

Q Internal plc [DEC 2012 Q2 modified]

Internal plc receives lots of certificate from government (free) which can be sold to
other companies. But these certificates are not sold as at the year end.
Required:
How to account for them?
(2 marks)

Answer:
Treatment:
Initial measurement [government grant]
DR inventory
CR deferred income
On sale of certificate
DR deferred income
CR cost of sales (become inventory)
Then
DR cash/receivable
CR inventory
DR/CR I/S (balancing figure)

12

IAS 8 Accounting policies, changes in accounting estimates and errors

If the company is going to use another accounting policy this year and find an error
relating to last years account then the company should adjust for this year and last
years financial statements. (Retrospective adjusting)
If the company is going to use another accounting estimate this year and the company
should adjust for current year financial statements and future one.(prospective
adjusting)
But how to determine whether this is a change in accounting policy or estimate?
Well, if theres a change in
Measurement basis of the figure, e.g., value the inventory using FIFO but now
use weighted average method; use replacement cost rather than historic cost.
Recognition basis of the figure, e.g., recognize as an expense before but now for
asset(e.g., IAS 23 borrowing costs)
Presentation basis of the figure, e.g., recognize the depreciation expense into
cost of sales now rather than in administrative expenses before.
You are going to change in the accounting policy only if:
1, a change in laws / accounting standards and you are required to do so;
2, gives a fairer presentation to the users of FS.
And anything that is not changing the measurement, recognition or presentation of
figures are deemed to be a change in accounting estimate such as:
Allowance for receivables;
Useful life/ depreciation method of the non-current assets;
Warranty provision relating to return of goods from customers.
An

error may happen if theres a

Misuse of the accounting standard last year;
Fraud happened last year;
Omit some figures in last years account.

13

Accounting Summary:

Changes in accounting policy this year:

Assume it happens in last year as well and of course this year happens;
Adjust for last year closing retained earnings taken into account in the changes to be
brought forward in this years statement of changes in equity.
Material prior period errors found:
Correct last years material errors;
Adjust for last year closing retained earnings taken into account in the error effect to
be brought forward in this years statement of changes in equity.
Changes in accounting estimate:
Use the new one to continue the calculation.

14

Q Account Ltd (accounting policy and accounting estimate)

1, Account Ltd charged interest expenses incurred from the construction of tangible
non-current assets to the income statement before but now it capitalizes the interest
as an addition to the cost of tangible non-current asset as per IAS 23 borrowing costs.
2, Account Ltd depreciate the machine using the reducing balance basis method at 30%
but now it use the new depreciation method over 10 years.
3, Account Ltd shows overhead expenses within cost of sales before but now it shows
under administrative expense.
4, Account Ltd has previously measured inventory at weighted average cost but now it
uses FIFO method.
Required:
Whether the above transactions are a change in accounting policy or accounting
estimate.

15

Q Martin Construction (change in accounting policy)

Martin Construction incurs significant finance costs on its financing for the
construction of supermarkets. Its chosen accounting policy to date has been
expense the finance costs as incurred. The final accounts for the year ended 31
December 2012, and the 2013 draft accounts, reflect this policy and show the
following.

Profit before interest and tax

Finance costs
Profit before tax
Income tax expense
Profit after tax
Retained earnings B/F:

2013
$000
8,700
(2,500)
6,200
(1,900)
4,300
26,050

2012
$000
6,200
(1,750)
4,450
(1,400)
3,050
23,000

The directors of Martin Construction have now decided to change the accounting
policy in 2013 to 16 capitalization of finance costs per IAS23. Martin Construction
incurs no finance costs other than those related to the construction of the
supermarkets.
Martin Construction paid a dividend of $1m during the year ended 31 December
2013.
Required:
Show how the change in accounting policy will be reflected in the income statement
and statement of changes in equity for the year ended 31 December 2013.

16

Q JJK (prior period errors)

During the year 2013 JJK Ltd discovered certain items that had been included in
inventory at 31 DEC 2012 at a value of $2.5m but they had been in fact sold before the
year end.
The income statement below for JJK for 2012 and 2013 are as follows:
2013

2012

Sales

52,100

48,300

Cost of sales

(33,500)

(30,200)

Gross profit

18,600

18,100

Tax expense

(4,600)

(4,300)

Profit after tax

14,000

13,800

The retained earnings at 1 Jan 2012 were $11.2million.

Required:
Show the 2013 income statement with comparative figures and the retained earnings
for each year.

Q Giant (changes in accounting estimate)

Giant Ltd has an asset which was purchased for $80,000 on 1 January 2005 when its
useful life was estimated to be ten years with a residual value of $10,000. A straight
line depreciation policy was selected. On 1 January 2011 the directors reviewed the
useful life of the asset and found that it had a remaining life of eight years.
Required:
Calculate the NBV as at 31 December 2011?

17

IAS10 events after the reporting period

Time line:

Audit
report
signed

FS
authorized
to issue

YR end

YR start

This is the event happened between financial statement year end and the financial
statements are authorized to be issued to the shareholders to be discussed at the AGM
(annual general meeting).
They will be either adjusting events or non-adjusting events
Magical way to distinguish the adjusting events and non-adjusting events:
Is it because of this event then it will affect the figure as at the year end?

-Adjusting events
Change in judgments, estimate or assumptions after the year end.
e.g., 1, inventory sold at a loss? Change in assumptions that closing inventory should be
valued at the lower of cost and net realizable value (IAS 2);
2, Customers go bankruptcy so that recoverability of the receivable balance at the
year-end has been changed.
3, If company is involved in going concern problems after the year end and because
the financial statement should be prepared under going concern basis and now
this is changed.

-Non-adjusting events
Theres no link between financial statement figures at the year end and events after the FS
year end.
e.g., 1, fire destroyed the inventory after the year end (cants predict!)
2, dividends are declared after the year end or share issues after the year end (no
link between figures and events)

18

Example: (Orange Ltd) (IAS 10 events after the reporting period)

John has asked you to identify the following events happened in orange Ltd of whether
theyre adjusting or non-adjusting events between the accounting year end of 31
December 2013 and 31 March 2014:
1. Major acquisition of a competitor announced on 17 January 2014.
2. Inventory is sold for a price significantly lower than the original cost on 5 January
2014.
3. The bankruptcy of a major customer on 9 February 2014.
4. A Major fire happened in a warehouse, destroying two thirds of the companys
inventory on 27 February 2014.
5. You discovered a material sales ledger fraud on 29 January 2014 that took place
throughout the financial year.
6. 100,000 ordinary shares issued on 1 March 2014.
7 Dividends were announced on 30 January 2014.

19

IAS 12 Income taxes

In this session, well be looking at

Current tax
Deferred tax

20

Basic Idea:
In the statement of comprehensive income:

Sale revenue
Cost of sales
Gross profit
Expenses
Profit before tax
Tax expense (@30%)
Profit after tax

$
1,000
(300)
700
(100)
600
(50)
550

You can see although tax rate is 30% but we use 30%Xprofit before
tax which does not equal to 50, why?
The reason being within the tax expense there are 3 components:
(mnemonics: CPD)
Current tax payable (based on last year taxable profit)
Provision (under/ (over))
Deferred tax movement
Because of permanent and temporary difference which leads to the
difference in taxable profit calculation and accounting profit calculation.
Permanent differences are the amounts which represent income or expense
for accounting purposes but are not taxable/allowable for tax purposes.
Example: client entertaining.
Temporary differences are amounts which represent income or expense for
accounting purposes and tax purposes but in difference periods. Example:
depreciation and capital allowances.
Notice: The deferred tax transfer is not cash flow!!!
Before we look at deferred tax, why not start off by looking at
current taxation? (This is what you have already learnt in F3, just a
recap.)

21

Current tax:
Companies have to pay tax on taxable profits. The tax charge is normally ESTIMATED
at the end of the financial year and charged to the statement of comprehensive income,
and paid in the following year.
The double entry for taxation would be:
DR Taxation expense
(Statement of comprehensive income)
CR Taxation liability
(Statement of financial position)
The double entry for when the tax is paid a few months later:
DR Taxation liability
(Statement of financial position)
CR Bank
(Statement of financial position)
Since the amount paid is likely to differ from the estimated tax charge originally
recognized, a balance will be left on the taxation liability account being an under or
over provision of the tax charge.

22

Example of Current tax: (Tracy Ltd)

Tracy Ltd estimated last years tax charge to be $250,000 at on December 2011.
On 1 March 2012, Tracy Ltd settled their income tax bill and paid cash to the tax
authorities of $255,000.
On 31 December 2012 Tracy Ltd estimated that this years income tax charge to be
$270,000.
On 1 March 2013 Tracy Ltd settled their income tax bill and paid cash to the tax
authorities of $265,000.
Required:
Show how this should be accounted for in the books of The Tracy Ltd, showing
Journal entries

Answer:
2011: (expense don't have to recognize in this years SOCI)
DR tax expense 250,000
CR tax liability 250,000
2012:
DR tax expense 5,000
CR tax liability 5,000 (under provision)
DR tax liability
CR bank
DR tax expense
CR tax liability

255,000
255,000
270,000
270,000

2013:

DR tax liability 5,000 (over provision)

CR tax expense 5,000
DR tax liability 265,000
CR tax expense 265,000

23

Deferred tax

What is deferred tax?

Illustrate with an example:

Imagine you have a building with a carrying value of $1000. During the year you have
revalued this building to $1,100 then you make a profit from it of $100 which is not
realized yet.
DR NCA 100
CR revaluation reserve 100
So for the tax mans perspective, because you will somehow in the future realized this
profit when sold so they may require you to provide for a future tax obligation (deferred
tax) of $100Xtax rate although you are not paying money now but you will in the
future.

Concept:
So we know that deferred tax is a future obligation to be settled by company depending
on the future tax law. So deferred tax does not necessarily fulfill the liability definition
(present obligation).
Deferred tax arises because of temporary differences (TD). Temporary difference is the
difference between CV and TB.

DT=TD* X CT%
*TD=CV - TB
TD: Temporary difference between carrying value and tax base
CV: Carrying value of asset/liability.
TB: tax base in the tax mans book. (In real practice we will try to refer to
different tax regulations to calculate the tax base)

24

DT: Deferred tax liability/asset

CT%: Corporation tax rate

Deferred tax is a future liability recognized today. And deferred tax is based on
temporary difference (timing difference between accounting and tax law). So the
amount we owe to the tax authority will be finally paid back to them in the subsequent
years.

Q: (formula)
Opening deferred tax (DT) 60
Closing temporary difference (TD) 200
CT rate 35%

Required:
Deferred tax movement.
Answer:
Deferred tax movement= closing DT-opening DT
=200X35%-60
=10

25

Why do we need deferred tax?

1, Accruals Concept
Because we know assets represent present value of future economic inflows from using
it. That means from using this asset company can generate into future operating
profits. And we know profits are taxed by tax authority. So we need to match the future
operating profits with future tax expenses. And the future tax expenses being
discounted back to todays value is called deferred tax. So this is according to Accruals
concept (Matching principle).
For liability which represents present value of future economic cash outflows from
settling the obligation. That means when settle the liability the company has to incur
cash outflows which will save us tax. In order to match the future cash outflow to tax
future tax savings we need to provide for present value of future tax savings. Again,
according to Accruals concept (matching principle).

2, Reduce distortion in profit figure

See Example in Thomas.

Basic Deferred tax Example: (Thomas)

Thomas acquired a non-current asset costing $2,000 at the start of year 1. It is being
depreciated straight line over 4 years. Corporation tax rate is 25%. The capital
allowances granted on this asset are:
Year
1
2
3
4

Capital allowances
800
600
360
240

The company expects to make a profit before tax of 3,000 in these 4 years.

Required:
1, calculate PAT for these 4 years (ignoring deferred tax)
2, calculate PAT for these 4 years (including deferred tax)
3, Show double entry for deferred tax movement and where do they fit into statement
of financial position.
4, Show how deferred tax will eventually become 0.
26

5, Explain the conceptual basis within deferred tax.

How to determine the carrying value and tax base?

DT=TDXCT%
DT=CV-TB

Carrying value: (CV)

Value in the statement of financial position (asset or liability)
Asset: positive
Liability: negative
If you are given income and expenses then substitute them in asset and liability

Income: positive
Liability: negative
And if you are given equity figure, then its CV=0.

Tax Base: (TB)

If its:
Taxed in future= 0
Not taxed in future= CV

27

Expansion of tax base:

This would be very difficult as you see the IAS 12 has listed out all of the procedures to
determine tax base for the item. In the real practice which is quite different from the
exam, depending which country you are in, you will be given lots of rules of the future
amount which is deductible or taxable.
But in the exam, your examiner will clearly state whether:
Itll have future tax consequences or will be taxed in the future, or allow
cost in full
Will be taxed= 0
It has been included in the taxable profit or loss or has been taxed or will not
be taxed
Will not be taxed= CV

Table:
Asset:
Tax base of an asset is the amount that will be deductible for tax purposes against any
taxable economic benefits that will flow to the entity when it recovers the carrying value of
the asset. Where those economic benefits are not taxable, the tax base of the asset is the
same as its carrying amount.
Taxed future?
-0
Not taxed future?-CV

Liability
The tax base of liability will be its carrying amount, less any amount that will be deducted
for tax purposes in relation to the liability in future periods
Taxed future? [CV-CV=0]
Not taxed future? [CV-0]

In summary, irrespective of asset or liability, if its: (exam trick)

Taxed in future= 0
Not taxed in future= CV

28

Q practice (Deferred tax)

Required:
Calculate the deferred tax.
1. Accelerated capital allowances (ACA)
LEKO Ltd purchased a building at the year start for $200,000. The life of the building is
20 years and there is no residual value and one year has gone. Capital allowances are
allowed at 40% for the year. Corporation tax rate is 30%.

2. Revaluation
Jim purchased a building at the year start for $900,000. The life of the building is 10
years and there is no residual value. Capital allowances are allowed at 40% for the year.
At the year end the building is revalued to $950,000. Corporation tax rate is 30%.

3. Development
Feikon Company spends $15million on a development project which will lead to three
years of sales including the current year. The tax man allows this cost in full as incurred.
Corporation tax rate is 30%.

4. Provisions
Environmental provision $60million
Corporation tax rate 30%
Tax man recognizes environmental costs as the cash flow.

5. Tax losses
The tax man is carrying forward losses of $100million. Corporation tax rate is 30% and
the company is considered to be generating into profits in the future.

6. Trade receivables

29

Trade receivables have a carrying amount of $10,000. The related revenue has already
been included in taxable profit. Corporation tax rate is 30%
A loan receivable has a carrying amount of $1m. The repayment of the loan will have
no tax consequences. Corporation tax rate is 30%.

7. Accrued expense
Current liabilities include accrued expenses with a carrying amount of $1,000. The
related expense will be deducted for tax purposes on a cash basis.
Current liabilities include accrued expenses with a carrying amount of $2,000. The
related expense has already been deducted for tax purposes.
Current liabilities include accrued fines and penalties with a carrying amount of $100.
Fines and penalties are not deductible for tax purposes.

8. Loan payable
A loan payable has a carrying amount of $1m. The repayment of the loan will have no
tax consequences.

30

Q Kasare (Deferred tax)

This question comes from Q2 of you P2 pilot paper. Note this version has been
updated to reflect the latest version of accounting standards.
The following statement of financial position relates to Kesare Group, a public limited
company, at 30 June 2006.

$000
Assets
Non-current assets:
Property, plant and equipment
Goodwill
Other intangible assets
Financial assets (cost)

10,000
6,000
5,000
9,000
30,000

Current assets
Trade receivables
Other receivables
Cash and cash equivalents
Total assets

7,000
4,600
6,700
18,300
48,300

Equity and liabilities

Equity
Share capital
Other reserves
Retained earnings
Total equity

9,000
4,500
9,130
22,630

Non-current liabilities
Long term borrowings
Deferred tax liability
Employee benefit liability
Total non-current liabilities

10,000
3,600
4,000
17,600

Current liabilities
Current tax liability
Trade and other payables
Total current liabilities
Total liabilities
Total equity and liabilities

3,070
5,000
8,070
25,670
48,300

31

The following information is relevant to the above statement of financial position:

(i) The financial assets are classified as 'investments in equity instruments' but are
shown in the above statement of financial position at their cost on 1 July 2005. The
market value of the assets is $10.5 million on 30 June 2006. Taxation is payable on the
sale of the assets. As allowed by IFRS 9, an irrevocable election was made for changes
in fair value to go through other comprehensive income (not reclassified to profit or
loss).
(ii) The stated interest rate for the long term borrowing is 8 per cent. The loan of $10
million represents a convertible bond which has a liability component of $9.6 million
and an equity component of $0.4 million.
The bond was issued on 30 June 2006.
(iii) The defined benefit plan had a rule change on 1 July 2005, giving rise to past
service costs of $520,000. The past service costs have not been accounted for.
(iv) The tax bases of the assets and liabilities are the same as their carrying amounts
in the draft statement of financial position above as at 30 June 2006 except
for the following:
(1)
Property, plant and equipment
Trade receivables
Other receivables
Employee benefits

$000
2,400
7,500
5,000
5,000

(2) Other intangible assets were development costs which were all allowed for tax

purposes when the cost was incurred in 2005.

(3) Trade and other payables includes an accrual for compensation to be paid to

employees. This amounts to $1 million and is allowed for taxation when paid.
(v) Goodwill is not allowable for tax purposes in this jurisdiction.
(vi) Other adjustments
Kesare buys a sub just after year end. The sub has inventory as at cost of $60,000,
but fair value of $65,000. All the inventory is still in inventory a few days later at the
year end.
Kesare bought a foreign sub for $500,000, measured in the parental home currency
in the second year. The subsidiary has grown to $570,000 because of net profits of
$70,000 that the sub has retained. The withholding tax rate is 60%. Show the deferred

32

tax implication at 30June2007.

The company had granted 20million options in the scheme and they are all expected
to vest at the end of the fourth year. The fair value of the options at the grant date was
$10 and the current intrinsic value of each is $8. Show the deferred tax implication at
30June2007.
Kesare is leasing plant under a finance lease over a five year period. The asset was
recorded at the present value of the minimum lease payments of $12 million at the
inception of the lease which was 31 May 2005. The asset is depreciated on a straight
line basis over the five years and has no residual value. The annual lease payments are
$3 million payable in arrears on 1 June and the effective interest rate is 8% per annum.
The directors have not leased an asset under a finance lease before and are unsure as
to its treatment for deferred taxation. The company can claim a tax deduction for the
annual rental payment as the finance lease does not qualify for tax relief.
(vii) Assume taxation is payable at 30%.

Required
(a) Discuss the conceptual basis for the recognition of deferred taxation using the
temporary difference approach to deferred taxation. (5 marks including)
(b) Calculate the deferred tax liability at 30 June 2006 after any necessary
adjustments to the financial statements showing how the deferred tax liability would
be dealt with in the financial statements. (Assume that any adjustments do not affect
current tax. Candidates should briefly discuss the adjustments required to calculate
deferred tax liability.) (30 marks)
(Total = 35 marks)

33

IAS16 property, plant &equipment

1, Initial measurement:
Capital expenditure
Capital expenditure is the costs of acquiring non-current assets.
According to IAS 16 the following costs may be capitalized in the statement of financial
position on acquisition of a non-current asset:
(Mnemonic: IIIID)
Initial cost (purchase price)
Import duty not refundable (if asset is bought from other country)
Installation costs
Intended use relating costs (lawyer, surveyor costs)
Delivery costs
Finance cost (IAS 23 see F7 & P2)

Revenue expenditure
Revenue expenditure is expenditure on maintaining the capacity of noncurrent assets.
Costs that are regarded as revenue expenditure should be expensed in the statement
of comprehensive income and may not be capitalized according to IAS 16 are:
(Mnemonic: RIM)
Repairs expenses
Insurance expenses
Maintenance expense
After weve purchased the non-current asset the accountant needs to record that
non-current asset into the non- current asset register.
A non-current asset register is generally maintained in the finance department.
Companies can purchase specifically designed packages or a register can simply be
maintained on an Excel spreadsheet.
And this is used to reconcile the NCA in the NCA register to the individual asset in place,
ie, an example of control procedure by company.
34

Sample of Non-current asset register:

Asset type

Machine

Date purchased

Description

Drink

1 July 2013

Cost

Depreciation

Carrying

Disposal

value

proceeds

Disposal date

$7m

machine
Year ended 31 DEC 2013

$700,000

$6.3m

Year ended 31 DEC 2014

$3m

Jan-2014

2, Subsequent measurement
Cost model: cost-accumulated depreciation*=carrying value
Depreciation method should be reviewed each year to see whether or not it is
reasonable. A change in depreciation method should be treated as a change in
accounting estimate and prospective adjusting method according to IAS 8 should be
applied. I.e., disclose the depreciation method in the note of the financial statements.
Revaluation Model: revalued amount
*Depreciation
*Revaluation
*Disposal
*Impairment [IAS 36] (see F7 & P2)
*Non-current asset held for sale & discontinued operations [IFRS5] (see F7 & P2)

[Note]:
IAS 16 the test was whether the expenditure was Capital or Revenue e.g. an
improvement could be capitalized but maintenance or repair could not be capitalized.
The following circumstances should be capitalized:

35

(Mnemonics: LOSE)
L: Life extension
O: major overhaul cost
S: separate component, e.g., new engine for an aircraft
E: energy saving, e.g., improving production capacity
Basic idea:
1, economic benefits are excessed
2, component treated separately
3, major overhaul cost

*Revaluation Model:

1, Depreciation:
Basic Idea:
Depreciation is the charge to the statement of comprehensive income to reflect the use
of an asset in a period and this is based on ACCRUALS CONCEPT which applies the cost
of using the asset to the statement of comprehensive income for the same period as
the revenue earned from the asset.
Methods of depreciation
1, straight line basis depreciation:
Idea: An equal amount is charged in every accounting period over the life of the asset.
Calculation:
Depreciation per year = original cost estimated residual value
Estimated useful life
Or

= % X cost
36

2, reducing balance basis depreciation

Idea: at the start of year we charge more depreciation and at the end of the year we
charge less depreciation given the fact that machine will be less efficient at the end of
its life, i.e., less revenue can be earned so less expenses matched against with it.
Calculation:
Depreciation per year = % X carrying value

Dr Depreciation expense
Cr Accumulated depreciation

Journal
(Statement of comprehensive income)
(Statement of financial position)
Financial statements
$

Noncurrent assets
Property, plant & equipment(note1)

184,490

Note1:
Cost

Accumulated

Carrying value

depreciation
Non-current assets:
Property

150,000

(12,000)

138,000

Motor vehicles

45,000

(11,250)

33,750

Plant & Machinery

26,000

(13,260)

12,740

221,000

(36,510)

184,490

37

2, revaluation

Basic Idea:
As time goes by initial costs of asset may be very different from their market value.
Eg, if a company purchased a property 35 years ago and therefore subsequently
charged depreciation for 35 years, it would be safe to assume that the carrying value
of the asset would be significantly different from todays market value.
If revaluation policy per IAS 16 may be adopted (i.e. the business has a choice), and if
so the following rules must be applied per the standard: (mnemonic: CRRR)
1, No Cherry picking (If a company chooses to revalue an asset they must revalue all assets in that category.)
2, Regular (Revaluations must be regular but IAS 16 doesn't specify how often)
3, Revalued amount (Subsequent depreciation must be based on the revalued amounts.)
4, Revaluation Reserve (Gains from revaluations are taken to revaluation reserve rather than retained earnings
unless they are sold)

Calculation:
Revalued amount
CV of asset on revaluation date
Revaluation gain/(loss)

DR Asset cost
DR Accumulated depreciation
CR Revaluation reserve

$
X
(X)
X/(X)

Journal
(Statement of financial position)
(Statement of financial position)
(Statement of financial position)

38

3, Disposal
Basic Idea
An asset should be removed from the statement of financial position on disposal or
when it is withdrawn from use and no future economic benefits are expected from its
disposal
Calculation
$
Cash sale/part exchange

CV of asset at disposal date

(X)

Profit/(loss) on disposal

X/(X)

Journal
(Mnemonic: CAP)
1, C: Cost Removal
DR Disposals
CR Non-current asset Cost
2, A: Accumulated Depreciation Removal
DR Accumulated Depreciation
CR Disposals
3, P: Proceeds to be dealt with in cash/part exchange
In cash:
DR Bank
CR Disposals
Part exchange:
DR Asset Cost
CR Bank

39

Example: [BOOKET ltd] (basic issues of IAS 16)

CR disposals
(Copy answer from tutor in your own note)
John is the CEO of BOOKET ltd which specializes in providing drinks for customers and
it has a year end of 31 December each year. John is thinking about the investment
opportunity so that the company can have a higher amount of revenue. So he starts to
think about investing his money into one asset and On 1 Jan10 he purchased a
drink machine A from other country to manufacture the drinks costing $25,000 and
the estimated useful life for this is 3 years.

Cost of machine A includes:

Initial cost
Import tax(not refundable)
Installation costs
Intended use cost(Surveyor cost)
Delivery cost

$
20,000
2,000
500
500
2000

After running the machine for a while John decides to pay for the insurance costs for
the machine of $300 given that he is afraid of this machine having problems and also
he pays for $400 for the maintenance cost for this machine as well.
The drink machine A is depreciated using 25% reducing balance basis.
On 1 April 2013John decided to dispose of the drink machine A for $5,000 because
he thought this machine is out of date and not efficient at all.
On 1 May 2012 John bought a building to expand his business at a cost of $45,000 with
a useful life of 50 years. And the building has a scrap value of $5,000 at the end of the
50 year.
This building is to be depreciated using 2% per year straight line basis.

40

On 1 Jan 2013 the building had been revalued by a qualified value Paul and the
valuation is $150,000. John would like to incorporate this valuation in the financial
statements for the year ended 31 DEC 2013. And John estimated that the
remaining useful life of the building will be 35 years.
Because John was having financial difficulties in his business so On 1 Jan 2015 John
sold this building for $500,000.

John bought a Toyota Corolla

costing $15,000.

for the use within company several years ago

On 31 DEC2014 the corolla was exchanged for the Toyota RV4.

At the date of exchange the Corrollas value was $3,400 and the dealership gave a
part-exchange allowance of $1,500. The Toyota RV4 has a list price of $18,000.
John forgot to record the building into the non-current asset register and asks you to
prepare the non-current asset register for him.

41

Required:
1, What is an asset? Is drink machine A an asset?
2, What is capital and revenue expenditure?
And how should John treat the insurance costs and maintenance costs?
3, What is the idea behind depreciation
And what types of methods there are to depreciate assets?
4, Why did John use reducing balance basis to depreciate the drink machine A rather
than use straight line basis?
Calculate the depreciation expense for drink machine A for this 3 years?
Show the journal of depreciation expenses for drink machine A and the ledger
account.
5, Explain the concept of disposal;
Calculate the gains/losses on disposal;
Show the journal for the disposal of Machine A and how this should be recorded in the
ledger account.
6, Calculate the depreciation expenses for the building for the year ended 31th DEC
2012
And show the journal and the ledger account for this.
7, What are the principles behind revaluation of assets?
Show the journal of the revaluation and the ledger account.
8, What is the new depreciation expense after the revaluation?
9, Show the profit/loss after the disposal of the building and the journal + ledger
account relating to that.
10, calculate the profit/loss arising on disposal
Show the journal entries to record the disposal and complete the disposals ledger
account.
11, Record the building into the non-current asset register.

42

Q June2010 Q1 (VI) (IAS16)

(vi) Ashanti owned a piece of property, plant and equipment (PPE) which cost $12
million and was purchased on 1 May 2012. It is being depreciated over 10 years on the
straight-line basis with zero residual value. On 30 April 2013, it was revalued to $13
million and on 30 April 2014, the PPE was revalued to $8 million. The whole of the
revaluation loss had been posted to other comprehensive income and depreciation has
been charged for the year. It is Ashantis company policy to make all necessary
transfers for excess depreciation following revaluation.

Answer:
Cost [1.5.2012]
Depreciation(12/10yrs)
CV @1.5.2013
Revaluation reserve [bal]
Revalued at 1.5.2013
Depreciation[13/9yrs]
CV@1.5.2014
Impairment of PP&E
Revalued @1.5.2014
DR RR (2.2-0.2) 2
DR I/S (bal) 1.6
CR PP&E 3.6

12
(1.2)
10.8
2.2
13
(1.4)
11.6
(3.6)
8

Excess depreciation=excess RR (2.2)

9years
=0.2
DR RR 0.2
CR RE 0.2

43

Q June2011 Q1 (5) extract

Rose purchased plant for $20 million on 1 May 2007 with an estimated useful life of six
years. Its estimated residual value at that date was $14 million. At 1 May 2010, the
estimated residual value changed to $26 million. The change in the residual value has not
been taken into account when preparing the financial statements as at 30 April 2011.

Answer:
Cost (1.5.07)
Cum depreciation (1.5.10)
(20-1.4)/6 X3

20
(9.3)
10.7

New depreciation: (10.7-2.6) /3 =2.7

Old depreciation (10.7-1.4)/3=3.1
Save depreciation
=0.4
DR PPE 0.4
CR RE 0.4

44

Q Dec2011 Q1 extract
Traveler acquired a new factory on 1 December 2010. The cost of the factory was $50
million and it has a residual value of $2 million. The factory has a flat roof, which needs
replacing every five years. The cost of the roof was $5 million. The useful economic life
of the factory is 25 years. No depreciation has been charged for the year. Traveler
wishes to account for the factory and roof as a single asset and depreciate the whole
factory over its economic life. Traveler uses straight-line depreciation.

Answer:
Depreciation
Roof (5m/5yrs)
Factory(50-5-2)/25yrs

1m
1.72m
2.72m

DR I/S 2.72
CR NCA 2.72

45

IAS 17 leases

Introduction
You want to have a photocopier and you have two choices:
1, you can buy it and then you become the owner of the photocopier;
2, you can lease it from the lessor and then you would become the lessee.
Long term-finance lease
Short term-operating lease
But the key to differentiate between them is not just the time length it takes but rather
substance over form.
IAS 17 leases describes two types (forms) of leases:
*Finance lease: lease that transfers the risks and rewards of the asset from the
lessor to the lessee.
*Operating lease: any leases other than finance lease.

5 scenarios
So the substance over form concept behind it can be summarized as follows:
IAS 17 prescribes there are 5 common scenarios that the lease is a finance lese. (one
of them fulfilled then its a finance lease and if none of them fulfills then its an
operating lease.)
1, ownership of asset has been transferred from lessor to lessee.
2, lessee has the option to purchase asset at a price which is sufficiently lower than its
FV.
3, lease term is almost the same as the major part of economic life of asset.
(IFRS doesn't specify the period but US GAAP has given us guidance of >75 %.)
4, at the start of the lease, PV of minimum lease payment is close to FV of asset. (again,
IFRS doesn't specify the percentage but US GAAP has given us a guidance of >90%.)
5, leased assets are specified nature and can only be used by lessee and they can be
used by others if any significant modification to assets occurs.

46

Risks and rewards

But the idea behind it is when the majority risks and rewards has been transferred from
the lessor to lessee then its considered to be a finance lease.
So the typical risks and rewards may include:

Risks:
Costs of repairing, maintaining and insuring the assets.
Risk of obsolescence
Risks of losses from idle capacity of the asset (if machine breaks down then lessee
bears the loss)

Rewards:
Use of assets for almost all of its useful life.
Use of the assets is not disrupted.

Accounting Treatment:
In P2, you are required to know the accounting treatment for both lessor and
lessee.

Lessee
Finance lease:
Initial measurement
Subsequent measurement

DR PPE
CR lease liability
PPE:
DR I/S-depre expense
CR accumulated
depreciation

Lessor
DR lease receivable
CR lease asset

Lease liability:
DR lease liability
DR I/S-finance cost
CR cash

DR cash (from lessee)

CR lease receivable
CR I/S-interest income

Expense the lease

Expense the lease revenue

payment on a straight line

received on a straight line basis

basis

DR cash
CR I/S

DR I/S
CR cash

Keep the assets in FS and

Operating lease:

depreciates it.

DR I/S-depreciation expense
CR accumulated depreciation

47

Sale and leaseback transaction:

Sale and finance leaseback:

Sell asset and lease for most/all of useful life

Profit on sale is spread over the lease period
Sale element of transaction
DR cash (sale proceeds)
CR PPE (CV)
CR/DR deferred income (gain on sale-release over lease term)

Lease element of transaction

DR PPE (PV of min lease payment)
CR lease liability

Sale and operating lease back:

(a) Sale as fair value:
Derecognize the asset at sale date and take the profit immediately to income
statement.
SP=FV>CA

(b) Sale above fair value:

Defer the additional gain and spread over the lease period.
SP>FV>CV

(c) Sell below fair value:

If the seller is short of cash and therefore has to sell at a loss take the WHOLE
loss to the income statement on disposal.
If the seller has the benefit of below market rentals for the lease of the asset
then defer the loss over the lease period.
SP<FV>CV

48

Q: Finano (finance lease)

Finano has the option of buying a drinking machine for a cash price of $14,276 or
leasing it on a financial lease paying $5,000 at the end of every year for 4 years and
the present value of minimum lease payment is $14,275 as well. The rate of
interest implicit in the lease arrangement is 15% per annum.
Finano plans to buy a very sophisticated egg machine to expand its business. Two
advertisements appear in the local newspaper for the egg machine at $11,000.
Finano negotiates the price down to $10,425, and it will pay $2,500 immediately
on 1 January 2013, with 4 more instalments on the anniversary of signing the
agreement. The implicit rate of interest is 10% per annum.

Required:
Show how the company should account for this lease in its Income Statement and
Statement of Financial Position for the drinking machine and egg machine for the year
ended 31 Dec2013.

Q: Opera (operating lease)

Opera has taken out an operating lease on its photocopier paying a non-refundable
deposit of $3,000 to John. The lease is for three years with annual payments of $5,000
after which the photocopier goes back to the lessor John. The photocopier has a useful
economic life of five years.

Required:
Show how the photocopier will be accounted for in the Statement of Financial Position
and Income Statement of Opera, at end of year 1.

49

Q: Finco Ltd [sale and leaseback]

Finco Ltd has 4 sale and leaseback transactions during the year which can be shown as
follows:
Description

1, sale and finance lease back

2, sale at fair value operating lease back
3, sale at overvalue and operating lease back
4, sale at undervalue and operating lease
back

Sale
proceeds
$m
50
80
85
65

Fair value
$m
50
80
65
85

Book(carrying)
value
$m
32
55
70
60

Required:
Show how to deal with the above transactions.

50

IAS 18 Revenue Recognition

Revenue recognition criteria:

When do we actually recognize the sales revenue during a transaction?
Mnemonics: [SIRRR]
S: Stage of completion-(refer to service rendering)
I: Managerial Involvement
R&R: risks and rewards has been transferred from seller to buyer
R: revenue and expense can be reliably measured

Sale and repurchase:

When determining whether to recognize revenue you must look at whether risks and
rewards of the asset have been transferred and if yes then revenue should be
recognized.

Sale of service:
If the service is provided for a period and then when you receive cash from buyer, you
DR cash but since you havent provided for the service and hence you CR deferred
income and when you provide service subsequently then you DR deferred income and
CR Sales revenue according to the service period.

51

Q June2009 Q3 (iii) [IAS 18]

Vehicle sales [sale and repurchase]
Case1:
Carpart sells vehicles on a contract for their market price (approximately $20,000 each)
at a mark-up of 25% on cost. The expected life of each vehicle is five years. After four
years, the car is repurchased by Carpart at 20% of its original selling price. This price
is expected to be significantly less than its fair value. The car must be maintained and
serviced by the customer in accordance with certain guidelines and must be in good
condition if Carpart is to repurchase the vehicle.
Case2:
The same vehicles are also sold with an option that can be exercised by the buyer two
years after sale. Under this option, the customer has the right to ask Carpart to
repurchase the vehicle for 70% of its original purchase price. It is thought that the
buyers will exercise the option. At the end of two years, the fair value of the vehicle
is expected to be 55% of the original purchase price. If the option is not exercised, then
the buyer keeps the vehicle.
Carpart also uses some of its vehicles for demonstration purposes. These vehicles are
normally used for this purpose for an eighteen-month period. After this period, the
vehicles are sold at a reduced price based upon their condition and mileage.
Required:
Comment on the above accounting issues. (10 marks)

Answer:
Revenue recognition criteria:
S: Stage of completion-(refer to service rendering)
I: Managerial Involvement
R&R: risks and rewards has been transferred from seller to buyer
R: revenue and expense can be reliably measured
Case1:
Carpart should recognize revenue on the sale of the vehicle.
The car can be repurchased by Carpart at 20% of its original selling price which is
significantly less than fair value and it needs to be maintained in good condition.
Hence risks (bad quality, theft) and rewards (ownership) have been transferred to the
customer.

52

Case2:
Carpart has not transferred the significant risks and rewards of ownership at the date
of the transaction
Because the repurchase period is less than substantially all of the vehicles economic
life (only two years into the five year life).
And the repurchase price is at 70% of the original purchase price greater than the fair
value, which is 55% of the original price and hence its certain that customer will ask
the seller to repurchase it back.
Before the option expires, the vehicles must be accounted for as operating leases.
Lessor:
Lessor should recognize the asset in its financial statement and depreciate it (remove
from inventory):
DR assets under operating lease
CR inventory
Lessor should also recognize cash received and corresponding liability and release it to
match with rental income:
DR cash
CR rental received in advance (liability and released to rental income) [30%]
CR long term liability [70%]
Release advance rental received:
DR rental received in advance (liability)
CR I/S (rental income over 2 years)

Demonstration vehicles
The demonstration vehicles should be removed from inventory and recognised as
PP&E.
Because they will be used by business for demonstration purpose for more than 1
accounting period.
Hence company should depreciate them.

53

June 2010 Q1 (v) [IAS 18]

They can be moved to inventory if business decides to sell them and hence depreciation
would be ceased.
(v) Ashanti sold $5 million of goods to a customer who recently made an
announcement that it is restructuring its debts with its suppliers including Ashanti. It is
probable that Ashanti will not recover the amounts outstanding. The goods were sold
after the announcement was made although the order was placed prior to the
announcement. Ashanti wishes to make an additional allowance of $8 million against
the total receivable balance at the year end, of which $5 million relates to this sale.

Required:
Show how the above transaction can be dealt with.

Answer:
DR I/S (sales revenue) 5
CR receivable 5
DR I/S (admin expense) 3
CR allowance for doubtful debts 3

54

June2011 Q3 (b) [IAS 18]

(b) Alexandra enters into contracts with both customers and suppliers. The supplier solves
system problems and provides new releases and updates for software. Alexandra provides
maintenance services for its customers. In previous years, Alexandra recognized revenue
and related costs on software maintenance contracts when the customer was invoiced,
which was at the beginning of the contract period. Contracts typically run for two years.
During 2010, Alexandra had acquired Xavier Co, which recognized revenue, derived from a
similar type of maintenance contract as Alexandra, on a straight-line basis over the term of
the contract. Alexandra considered both its own and the policy of Xavier Co to comply with
the requirements of IAS 18 Revenue but it decided to adopt the practice of Xavier Co for
itself and the group. Alexandra concluded that the two recognition methods did not, in
substance, represent two different accounting policies and did not, therefore, consider
adoption of the new practice to be a change in policy.
In the year to 30 April 2011, Alexandra recognized revenue (and the related costs) on a
straight-line basis over the contract term, treating this as a change in an accounting
estimate. As a result, revenue and cost of sales were adjusted, reducing the years profits
by some $6 million.

Required:
Comment on the above accounting issues. (5 marks)
Answer:
(b)

Revenue has two models under IAS18:At = revenue at a point in time is recognized at the point in time that risks and
rewards transfer (goods)
Over = revenue over a period is recognized over that periodService

So when Alexandra recognized revenue in full at the start of contract and this is not
correct but instead it should recognize the revenue and related costs over a period.

The new treatment, and the one used to date by Xavier Co, is the correct accounting
treatment under IAS 18

According to IAS 8 changes in an accounting estimate result from changes in

circumstances, new information or more experience, this was not the case here.

This is a prior period error, which must be corrected retrospectively. This involves
restating the opening balances for that period so that the financial statements are
presented as if the error had never occurred.

55

June2013 Q2 (b) [IAS 18]

(b) Verge entered into a contract with a government body on 1 April 2011 to undertake
maintenance services on a new railway line. The total revenue from the contract is $5
million over a three-year period. The contract states that $1 million will be paid at the
commencement of the contract but although invoices will be subsequently sent at the
end of each year, the government authority will only settle the subsequent amounts
owing when the contract is completed. The invoices sent by Verge to date (including $1
million above) were as follows:
Year ended 31 March 2012 $28 million
Year ended 31 March 2013 $12 million
The balance will be invoiced on 31 March 2014. Verge has only accounted for the initial
payment in the financial statements to 31 March 2012 as no subsequent amounts are
to be paid until 31 March 2014. The amounts of the invoices reflect the work
undertaken in the period. Verge wishes to know how to account for the revenue on the
contract in the financial statements to date.
Market interest rates are currently at 6%.
Required:
Comment on the above accounting issues. (6 marks)

56

Answer:
(b)
Recognition
Recognition of revenue should meet the following criteria:
Economic inflow would probably flow into the entity.
The amount can be reliably measured.
Measurement
The measurement of revenue to be recognized should meet with the following criteria:
* Revenue should be measured based on stage of completion, ie, relating to period
to provide service.
* There is no managerial involvement over the goods or service by seller;
* Risks and rewards of goods or services have been transferred from seller to buyer;
* The amount can be reliably measured.
Construction contract
The contract could be interpreted as a construction contract especially given segment
3 is called railway construction. A construction contract is a contract specifically
negotiated for construction. So if directors interpret the maintenance contract as
construction then construction accounting would apply.
Fair value
IAS18 refers to fair value but IAS11 does not.
Treatment
Years

CF

DF @6%

PV

2011-2012

1 + 1.8

1/1.06^2

2.6

2012-2013

1.2

1/1.06^1

1.13

Unwinding2011-2012
So int income(2012-2013)
1.6X6%(we should have
had 1.8 income but only
recognize 1.6 so unwind
it.)

0.96

Current issue
The above is a fantastic illustration of why the IASB have a development project on
revenue. It is exactly this kind of inconsistency of revenue recognition dependent upon
interpretation that has motivated the IASB to try to develop a comprehensive revenue
standard.

57

IAS 19 Employee Benefits and IFRS 2 Share Based Payment

Some companies will offer benefit to its employees. These benefits may include:
1, Short term benefit: (accounting: expense and liability)
Monetary benefit:
Wages and salary
Paid sick leave
Compensated absence.
Non-monetary salary:
Medical care, housing, cars etc
2, Long term benefit: shares (IFRS2), bonus, etc. (Accounting: easier than pension
accounting. Only to show costs, asset and liability if company has invested their money
in other instrument before paying for cash)
3, Termination benefit: redundancy payments; early retirement payments etc.
(accounting: expense and liability)
4, Post-employment benefit: pensions etc. (EXAM POINT!)
Talking about pensions therere two types of pensions within p2 exam.
They are defined contribution scheme and defined benefit scheme (well talk about
those below)

58

1, Defined contribution scheme

The company doesn't guarantee the final payment to employees.
Company and employee will put the money into the scheme run by the trustee each
year and when employees retire then they get the money which is not fixed (defined).
If the trustee did a bad job, e.g., invest money into shares and suffered a loss then
company didn't have enough money to pay off to the employee then company will have
no further obligation for those money.
Risk is not born by the company but by the employee.
The accounting for this is to DR I/S CR cash each year.
Accounting: DR I/S CR Cash (income statement charge would equal to cash paid.)
Company does not recognize the asset and liability in their account because they have
transferred all the risks and rewards of these to the trustee or agent.

Example: Doc Ltd

Doc ltd makes contributions to the pension fund of employees at a rate of 10% of gross
salary. The gross salary total is $3m for the year.
Total contributions made by Doc Ltd is $200,000.
Required: Show the double entry relating to the above transaction.
Answer:
DR P/L-expense (10%X$3m) $300,000
CR cash $200,000
CR Accrual $100,000

59

2, Define benefit scheme

The company will guarantee the amount of money paid to employees when they retire
and this will be based on number of years that employee has worked for company and
the final salary as well.
The company will put money into the pension scheme each year to create pension
asset (e.g., buying shares etc.) to be paid off to employees (settle pension liability)
when employees get retired.
The question is whether company will have sufficient pension asset to pay off the
pension liability? So the company will employ an actuary to value the pension asset and
liability each money and any deficit occurred would require the company to put money
into it again.
Dose the company recognize the asset and liability in its financial statements? Well the
answer is yes because the company hasn't transferred the risks and rewards to the
trustee because company has to paid off to settle the pension liability even if the
trustee has done a bad job (e.g., lose money into its assets.)
And this is according to substance over form.
The actuary would value the pension asset and liability based on a number of
assumptions:
Level of investment return from pension assets
Number of income/outgoing employees etc.

60

The accounting for this is to separate assets and liabilities. (Remain in companys
account)

Disclosure:
Asset

Liability

b/f bal

b/f bal

Return on asset

Interest cost

Contributions in

Service cost

Benefits out

Benefits out

Actuarial gains/losses

Actuarial gains/losses

c/f bal

c/f bal

Accounting:

b/f bal (c/f from last year by actuary)

Return on asset(discount rate X b/f) DR asset CR I/S

Interest cost (discount rate X b/f): DR I/S CR liability

Contributions in (company putting money in): DR asset CR cash (only cash item)

Service cost (including current & past service cost: employees work for you and you
have to pay for them): DR I/S CR liability
Current service cost: This is expense you need to pay for because employee has
provided service to you in the current year.
Past service cost: This is expense you need to pay for because there is
amendment or curtailment of the pension plan.
Curtailment

and

settlement

gains/losses:

This arises when

significant

reductions are made to the number of employees covered by the plan or the
benefits promised to them. DR/CR P/L
CR/DR Pension Liability

Benefits out (money paid to those retired): DR liability CR asset

c/f(by actuary then b/f to next year)

Actuarial gains/losses:
Gain: DR liability CR OCI
Loss: DR OCI CR liability

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Q Mini Ltd (short term benefit, similar to termination benefit)

The employees of Mini Ltd are entitled to a 10 days compensated absence in the year
costing $10,000.
Required:
So how does the company deal with this transaction?
(i) Supposing the cash is not paid at the year end
(ii) Company pays for the employees in the next year.

Q BBQ [Introductory Q on defined benefit scheme]

This is a defined benefit scheme relating to BBQ Ltd.
$m
Opening PV of pension obligation

990

Closing PV of pension obligation

1100

Opening FV of pension asset

1000

Closing FV of pension asset

1190

Current service cost

130

Pension benefits paid

150

Contribution paid by company

Discount rate

90
10%

BBQ Ltd has anther defined contribution scheme in which it pays $30m each year end.
Required:
Show how to account for the above pension schemes:
1, showing the disclosures of the defined benefit scheme and financial statement
effects relating to it.
(5marks)
2, Journals relating to it.
(2marks)
3, show the treatment relating to defined contribution scheme.

(1mark)

62

Q Mal (past Q Macaljoy Rewritten [IAS 19])

Mal, a public limited company, is a leading support services company which focuses on
the Human Resource Management industry.
The company would like advice on how to treat certain items under IAS 19 Employee
benefits. The company operates the Mal Pension Plan B which commenced on 1
November 2012 and the Mal Pension Plan A, which was closed to new entrants from
31 October 2012, but which was open to future service accrual for the employees
already in the scheme. The assets of the schemes are held separately from those of the
company in funds under the control of trustees. The following information relates to the
two schemes.
Mal Pension Plan A
The terms of the plan are as follows.
(i)Employees contribute 6% of their salaries to the plan.
(ii)Mal contributes, currently, the same amount to the plan for the benefit of the
employees.
(iii)On retirement, employees are guaranteed a pension which is based upon the
number of years service with the company and their final salary.
The following details relate to the plan in the year to 31 October 2013:
Present value of obligation at 1 November 2012
Present value of obligation at 31 October 2013
Fair value of plan assets at 1 November 2012
Fair value of plan assets at 31 October 2013
Current service cost
Pension benefits paid
Total contributions paid to the scheme for year to 31 October 2013

$m
200
240
190
225
20
19
17

Mal Pension Plan B

Under the terms of the plan, Mal does not guarantee any return on the contributions
paid into the fund. The companys legal and constructive obligation is limited to the
amount that is contributed to the fund. The following details relate to this scheme:
$m
Fair value of plan assets at 31 October 2013
21
Contributions paid by company for year to 31 October 2013
10
Contributions paid by employees for year to 31 October 2013
10
The interest rate for Plan A is 5%.

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The Mal Pension Plan A is wound up at the year end. The market value of the plan
assets is unchanged by the curtailment. But the liability is affected. The employees
departing the scheme agree to receive the plan assets in full plus a further payment of
$16m. The cash was paid just before the year end.
1 year later, Mal has a new defined benefit pension scheme with new employees. This
scheme is in surplus with an asset value of $100m and a liability value of $85m. And
because the asset exceeds the liability, it is expected that in the future it will be
possible to reduce contributions into the scheme.
The present value of the reductions in future contributions is only $10m.
Required:
(a) Discusses the nature of and differences between a defined contribution plan and
a defined benefit plan with specific reference to the companys two schemes.
(10 marks)
(b) Shows the accounting treatment for the two Mal pension plans for the year ended
31 October 2013 under IAS 19 Employee benefits (revised 2011). (7 marks)
(c)Show how to account for the curtailment in the financial statements. (3marks)
(d) Show the effect of the above asset ceiling on the current financial statements.
(3marks)

64