4. financial accounting ii

8/12/2019 4. Financial Accounting II

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STUDY UNIT FOUR

FINANCIAL ACCOUNTING II

4.1 Employer Accounting for Postemployment Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

4.2 Share-Based Payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64.3 Leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74.4 Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104.5 Other Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124.6 Provisions and Contingencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154.7 Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174.8 Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194.9 Accounting Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224.10 Exchange Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244.11 Joint Ventures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264.12 Business Combinations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274.13 Consolidated and Separate Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294.14 Study Unit 4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

Study Unit 4 is the second of two study units pertaining to financial accounting. It addresses topics

listed or suggested in the CSO that were not covered in the preceding study unit.

Core Concepts

Under a defined benefit plan, the entity is responsible for providing the agreed benefits andtherefore bears actuarial risk and investment risk.

Under defined benefit plan accounting, the employer must estimate the discounted benefitsattributable to the current and prior periods as a result of employee services rendered. Moreover,the employer must determine (1) the fair value of plan assets, (2) total actuarial gains and lossesand the amount to be recognized, (3) past service cost when a plan has been initiated oramended, and (4) any gain or loss after a curtailment or settlement.

Employee share options granted in exchange for services are normally accounted for at the fairvalue of the equity instruments granted by a debit to expense and a credit to equity.

A lease is an agreement by which a lessor (owner) conveys the right to a lessee to use an assetfor an agreed period in exchange for a payment or series of payments. The accounting for leasesis based on the substance of the transaction. A lease may be, in effect, the financing of apurchase or a rental agreement.

The lessee records a finance lease as an asset and a liability at its inception at the fair value of theleased property. The lessors basic entry for a finance lease is to debit a receivable, credit anasset, and credit unearned finance income. But if the lessor is a manufacturer/dealer, sellingprofit or loss is recognized.

The carrying amount of an asset or liability is expected to be recovered (consumed) or settled,respectively. A deferred tax liability or asset ordinarily is recognized when future tax paymentsprobably will differ as a result of such recovery or settlement from what they would have been ifthe recovery or settlement had no tax consequences.

A financial liability is a liability that is a contractual obligation (i) to deliver cash or another financialasset to another entity or (ii) to exchange financial assets or financial liabilities with another entityunder conditions that are potentially unfavorable to the entity. Financial liabilities also includecertain liabilities to deliver the entitys equity instruments.

An equity instrument is a contract that is evidence of a residual interest in an entitys net assets.

A current liability is an obligation that is expected to be settled within the normal operating cycle, isheld to be traded, or is due to be settled within 12 months of the balance sheet date, or the entityhas no conditional right to defer settlement for 12 months. Any other liability is noncurrent.

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Examples of provisions are liabilities for violations of environmental law, nuclear plantdecommissioning costs, warranties, and restructurings.

A contingent liability is not recognized. However, it should be disclosed unless the possibility ofresource outflows is remote. A contingent asset is not recognized but should be disclosed if aninflow of economic benefits is probable.

Bonds are debt instruments. If issued at a premium or discount, they are accounted for using theeffective interest method.

Equity consists of share capital; items of income, expense, gain, or loss reported directly in equity;retained earnings; and possibly, treasury shares.

A change in accounting estimate should be reflected in the financial statements prospectively.

All material prior-period errors must be corrected retrospectively in the first set of financialstatements issued after their discovery.

Accounting policies are specific principles, bases, conventions, rules, and practices adopted by anentity in preparing and presenting financial statements (IAS 8). A voluntary change in accountingpolicy is accounted for by retrospective application.

A functional currency is the currency of an entitys primary economic environment. Thepresentation currency is the currency in which the statements are reported.

When a foreign currency transaction is reported in the functional currency, exchange differencesordinarily are recognized in profit or loss when they arise.

The entitys presentation currency may not be the functional currency. Exchange differencesarising from translation into the presentation currency are recognized separately in equity.

A joint venture is a contractual arrangement whereby two or more parties undertake an economicactivity that is subject to joint control. Joint ventures may be in the form of jointly controlled(1) operations, (2) assets, or (3) entities.

A business combination results when one entity obtains control over the others net assets andoperations.

All business combinations within the scope of IFRS 3 must be accounted for using the purchasemethod.

In a business combination, goodwill is recognized as an asset measured as the excess of costover the net fair value of items recognized.

A parent is an entity that controls at least one other entity (a subsidiary). Ordinarily, it presentsconsolidated statements. Control is the power to govern the financial and operating policies ofan entity so as to obtain benefits from its activities.

An associate is an entity over which the investor exercises significant influence and that is not asubsidiary or a joint venture. An entity usually accounts for an associate using the equitymethod.

4.1 EMPLOYER ACCOUNTING FOR POSTEMPLOYMENT BENEFITS

1. The applicable pronouncement isIAS 19,Employee Benefits. Examples of postemploymentbenefits are pensions and other retirement benefits, life insurance, and medical care. Anarrangement to provide these benefits to employees is a postemployment benefit plan.Such a plan may be a defined contribution plan or a defined benefit plan.

a. Under adefined contribution plan, the entitys maximum legal or constructiveobligation equals its agreed contributions to a fund (a separate entity). The benefitsto be received by employees are determined by thecontributions made(includingany made by the employees) and by theinvestment returns. Accordingly, actuarialrisk and investment risk are borne by the employees.

b. Under adefined benefit plan, the entity is responsible for providing the agreedbenefits and therefore bearsactuarial risk and investment risk.

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c. If amultiemployer planis a defined benefit plan, the entity should use defined benefitplan accounting for its proportionate share of the defined benefit obligation, planassets, and cost. If the information available does not suffice for this purpose, theemployer should account for the plan as a defined contribution plan.

1) Astate plancreated legislatively and operated by a government or other body is

accounted for as a multiemployer plan.2) The employer may pay insurancepremiums to fund the plan. In this case, theemployer should account for the plan as a defined contribution plan.However, it should account for the plan as a defined benefit planif it will havea legal or constructive obligation to pay benefits directly when they are due or tomake additional contributions if the insurer does not pay all future benefits.

2. Defined Contribution Plan Accounting

a. The employer recognizes an expense and a liability for thecontribution payableinexchange for an employees services performed during the period. The amount isdetermined after subtracting any contribution already made.

1) However, if the contribution made exceeds the amount due, the excess is

treated as aprepaid expense.3. Defined Benefit Plan Accounting

a. The employer must estimate the benefits attributable to the current and prior periodsas a result of employee services rendered. Thus, it must makeactuarialassumptions about such variables as employee turnover, mortality, the discountrate, future increases in compensation, the expected rate of return on plan assets,and increases in medical costs.

1) Furthermore, thebenefits must be discountedand determinations must bemade of (a) the fair value of plan assets, (b) total actuarial gains and losses andthe amount to be recognized, (c) past service cost when a plan has beeninitiated or amended, and (d) any gain or loss after a curtailment or settlement.

b. Thedefined benefit obligation (DBO) consists of the present value of future amountsrequired to settle the obligation arising from services provided by employees in thecurrent and prior periods. Theprojected unit credit method should be used todetermine the present value of the DBO, current service cost, and past service cost.

1) Each service periodresults in a unit of benefit, with each unit separatelymeasured to determine the total obligation. Furthermore, theplans benefitformula is used to attribute benefits to service periods. Nevertheless, servicein later years may result in materially greater benefits than in earlier years. Inthis case, benefits should be attributed on a straight-linebasis until the datewhen additional service will no longer create an entitlement to materialincremental benefits.

2) Themeasurementof a postemployment benefit obligation includes

(a) estimates of future salary increases, (b) the benefits defined in the plan,(c) the benefits arising from any constructive obligation beyond the terms of theplan, and (d) estimates of future changes in government benefits that affect thelevel of plan benefits.

3) The possibility that nonvested projected benefitswill not vestis a factor in themeasurement of the DBO, but it does not affect the existence of the obligation.

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c. The amount of thedefined benefit liability (DBL)recognized equals the following:

Present value of the DBO at the balance sheet date Unrecognized actuarial gains (losses) Unrecognized past service cost Fair value of plan assets at the balance sheet date

DBL

1) If this amount is negative, it is anasset. However, themaximum amountrecognizable for such an asset is the sum of unrecognized actuarial losses,unrecognized past service cost, and the present value of future refunds fromthe plan or reductions in future contributions.

a) This calculation should not result in gain recognition solely because of anactuarial loss or past service cost in the current period or in lossrecognition solely because of anactuarial gainin the current period.

d. Income (subject to the maximum recognizable for a defined benefit asset) or expenseis recognized for the sum of the following:

1) Current service costis the increase in the present value of the DBO arisingfrom services rendered by employees in the current period.

2) Interest costis the increase in the present value of the DBO becausesettlement is one period closer.

3) Theexpected return on plan assets is determined with regard to marketexpectations for returns on the fair value of plan assets held after allowing foractual contributions paid into, and actual benefits paid out of, the fund.

4) Actuarial gains and lossesrecognized under the corridor approach. Actuarialgains and losses include the effects of changes in actuarial assumptions andadjustments for actual experience different from that previously assumed.Hence, the difference between the actual and expected return on plan assets isan actuarial gain or loss.

a) Theactual return on plan assetsis the difference between the fair valueof plan assets at the beginning and the end of the year adjusted forcontributions and benefits paid.

b) Part of the actuarial gains and losses should be recognized as income orexpense if thenet cumulative unrecognized amountat the close of theprior period exceeds the corridor amount: the greater of 10% of thepresent value of the DBO at that date or 10% of the fair value of planassets at that date.

i) Thedifference between actual and expected returns on planassets for the current period is not included in the corridor amountand is not recognized as part of the minimum expense or income.

c) Theminimum to be recognized equals the amount outside of the

corridor divided by the average expected remaining working life of planparticipants. However, the entity may apply any systematic method thatresults in faster recognition.

d) An entity has the option of recognizing actuarial gains and losses in full inthe period they occur. Recognition isoutside of profit or lossin astatement of changes in equity identified as statement of recognizedincome or expense.




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5) Past service costrecognized. Past service cost is the change in the presentvalue of the DBO related to prior employee service that arises in the currentperiod from the introduction of, or an amendment to, postemployment benefits.It may be positive (benefits increase) or negative (benefits decrease).

a) Past service cost is expensed on astraight-line basis over the average

period until vesting. To the extent it is vested upon introduction of, oramendment to, a plan, past service cost is immediately recognized.

i) Vested benefitsare those earned postemployment benefits owed toan employee that are not contingent upon the employees continuedservice.

6) Curtailment or settlementeffects. A curtailment arises from a reduction incovered employees or an amendment of the plan to reduce benefits for futureservice. A settlement is a transaction that eliminates the DBO for part or all ofplan benefits.

a) When a curtailment or settlement occurs, the gain or loss recognizedencompasses the change in the present value of the DBO, the change inthe fair value of plan assets, and previously unrecognized related

actuarial gains and losses and past service cost.e. Transitional liability. Upon initial adoption of IAS 19, the transitional liability equals

the present value of the DBO, minus the fair value of plan assets, minus any pastservice cost to be recognized in future periods.

1) If this liability isgreater than the liability under the previous accountingpolicy, the entity must make an irrevocable choice regarding recognition of theexcess as part of the defined benefit liability. One choice is immediaterecognition in full as a change in accounting policy. The alternative isstraight-line amortizationof expense over a maximum of 5 years. Ifamortization is chosen, the entity

a) Limits anyassetto be recognized when the DBL is negative to the

maximum amount.b) Limits recognition ofactuarial gains(but not negative past service cost)

under the corridor approach. The actuarial gain that otherwise would berecognized under that approach is limited to the excess of the netcumulative unrecognized actuarial gains over the unrecognizedtransitional liability.

c) Includes the related part of theunrecognized transitional liabilityin thecalculation of a settlement or curtailment gain or loss.

2) If the transitional liability is less than the liability under the previous accountingpolicy, the decrease is immediately recognized as a change in accountingpolicy.




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4.2 SHARE-BASED PAYMENT

1. According toIFRS 2,Share-Based Payment,share-based payment transactions (SBPTs)involvereceipt by the entity of goods or services in return for

a. Itsequity instruments(shares or share options) orb. Amounts based on thepriceof its equity instruments.

2. The SBPTs to which IFRS 2 applies are settled by the entity in one of three ways:

a. Equity settlementby issuing equity instruments of the entity (e.g., shares or shareoptions)

b. Cash settlementby incurring liabilities based on the price or value of the entitysequity instruments

c. Cash or equity settlementat the option of the entity or supplier

3. IFRS 2 applies to all entities. However, it does not apply to issues of shares to gain controlin abusiness combination.

a. It also does not apply to contracts to buy or sell a nonfinancial asset that can besettled net in cash or another financial instrument, or by exchanging financial

instruments, as if the contracts were financial instruments (see IASs 32 and 39).4. Recognition of goods or servicesoccurs when they are received.

a. Equityis credited in an equity-settled SBPT, and a liabilityis credited in acash-settled SBPT.

b. If the goods or services do not meet the asset recognition criteria, anexpenseisdebited.

5. Equity-settled SBPTs. The goods or services and the credit to equity are measured at thefair valueof the goods or services if it is reliably measurable. If it is not, the transaction ismeasured at thefair value of the equity instruments granted. The latter treatment isnormally required for employee share options.

a. If the equity instruments arefully vestedimmediately, the entity recognizes on the

grant datethe full receipt of services and credits equity accordingly.

1) If services are to be received over thevesting period, their fair value isrecognized as the services are rendered.

b. The fair value of equity instruments granted is determined at themeasurement date,which is thegrant date for employee awards. For others, measurement occurswhen the entity obtains the goods or receives the services.

1) Market pricesare the basis for the measurement. If they are not available, avaluation technique should be used that is consistent with generally acceptedvaluation methodologies for financial instruments (e.g., option pricing models).

c. Vesting conditionsconsist of performance conditions (e.g., achieving a specifiedshare price or profit level) and service conditions (e.g., continued employment for a

specified period). Vesting conditions that are not market conditions do not affect theestimate of the fair value of the shares or share options at the measurement date.Vesting conditions affect the number of equity instruments included in themeasurement.

1) Thus, recognition of an amount for goods or services received is based on thebest available estimateof the number of equity instruments expected to vest.This estimate is revised as required by subsequent information. On the vestingdate, the estimate is revised to reflect the number actually vested.

a) No revision is made after the vesting date.




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d. In the rare case in which the fair value of equity instruments (e.g., share options) is notreliably measurable at the measurement date, intrinsic value(fair value of theentitys shares exercise price) may be used to measure the SBPT when the goodsare received or services are rendered. Remeasurement is then necessary at eachreporting date and the date of final settlement. Any change in intrinsic value isrecognized in profit or loss.

6. Cash-settled SBPT. Thefair value of the liability is the basis for measurement. Untilsettlement, the entity remeasures this fair value at each reporting date and at the finalsettlement date, with changes in fair value recognized in profit or loss.

7. Cash alternatives. The entity accounts for the transaction (or its components) as a cash-settled SBPT if, and to the extent that, the entity has incurred a liability to settle in cash (orother assets).

a. It accounts for the transaction (or its components) as an equity-settled SBPT if, and tothe extent that, no such liability has been incurred.

8. Modifications of terms and conditionsmay affect the expense recognized.

a. If thefair value of the new instruments exceeds the fair value of the old (e.g.,

because of potential issuance of additional instruments or a lower exercise price), theadditional amount is expensed over its vesting period. The fair value determined atthe grant date for the original equity instruments is recognized over the remainder ofthe original vesting period.

1) For apost-vesting-period modification, recognition of the additional amount isimmediate.

2) When the new instruments have alower fair valuethan the old, the modificationis not considered. The original fair value is expensed.

b. Cancelations and settlementsof equity instruments accelerate the vesting period.Thus, unrecognized amounts areexpensed immediately.

1) Payments made are deemed to be repurchases of equity instruments (deduc-tions from equity). But any payment exceeding its fair value is expensed.

c. Replacementequity instruments are accounted for as if a modification of the originalgrant had been made. Their fair value is measured at thegrant date. The fair valueof the instruments canceled is measured at the cancelation date, minus any cashpayment made that is treated as a deduction from equity.

4.3 LEASES

1. Aleaseis an agreement by which a lessor (owner) conveys the right to a lessee to use anasset for an agreed period in exchange for a payment or series of payments. Theaccounting for leases is based on thesubstance of the transaction. A lease may be, ineffect, the financing of a purchase or a rental agreement.

2. Lessee accounting for finance leases. A lease may be classified as either a finance leaseor an operating lease by a lessee. Afinance leasetransfers substantially all of the risksand rewards of ownership of the asset to the lessee.

a. A finance lease should be accounted for by the lessee as the acquisition of an assetand the incurrence of a liability. In subsequent periods, the lessee should depreciatethe asset and recognizefinance (interest) expenseon the liability. Depreciationshould be consistent with the accounting policy for owned assets. Absent areasonable certainty that the lessee will own the asset at the end of the lease term, itshould be fully depreciated over the shorter of the useful life or the lease term.




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b. Finance leases are presented as items of property, plant, and equipment in thebalance sheet, that is, as tangible assets.

3. A lease is classified at its inception. It is normally classified as a finance lease if, forexample,

a. The lease provides for thetransfer of ownershipof the leased asset by the end of

the lease term.1) Leases of land and buildingsare subject to the same rules as leases of other

assets. However,landordinarily has an indefinite economic life. Thus, ifownership does not pass to the lessee at the end of the lease term, the lease isnormallynot a finance leasebecause substantially all of the risks and rewardsof ownership will not be transferred. In that case, theland leaseis anoperating lease. Thebuildingselement may be a finance or an operatinglease.

a) Moreover, the land and buildings elements are usually analyzedseparately. Minimum lease paymentsare allocated to them inproportion to the relative fair values of the leasehold interests.

b. The lease contains abargain purchase option; i.e., the lessee has the option topurchase at a price expected to be sufficiently below the fair value of the exercisedate that, at the leases inception, exercise is reasonably certain.

c. Thelease termis for the major part of the economic life of the leased asset.

d. Thepresent value of the minimum lease payments is at least substantially all of thefair value of the leased asset at the inception of the lease.

e. The leased asset is such that it can be used only by the lessee without majormodification.

4. Other factorsalso may indicate classification as a finance lease:

a. Lessor losses from cancelation of the lease are borne by the lessee.b. The lessee bears the risk of fluctuations in the fair value of the residual value.c. The lessee may renew the lease at a rent substantially below the market rent.

5. The lessee records a finance lease as an asset and a liability at its inception at thefairvalue of the leased property(not to exceed the present value of the minimum leasepayments).

a. Thediscount factorused to calculate present value is the interest rate implicit in thelease (if practicable to determine). Theimplicit rateis the discount rate that equates(1) the fair value of the leased asset at the leases inception plus the lessors initialdirect costs with (2) the sum of the present values of the minimum lease paymentsand the unguaranteed residual value. The alternative is to use the lesseesincremental borrowing rate.

6. The lesseesminimum lease payments include required payments (excluding contingentrent and costs for services and taxes to be paid by and reimbursed to the lessor) during the

lease term and the amount of a bargain purchase option.

a. If no bargain purchase option exists, the minimum lease payments equal the sum ofthe minimum payments payable over the lease term and any amounts guaranteed bythe lessee or by a party related to the lessee.

b. From thelessors perspective, the minimum lease payments (absent a bargainpurchase option) include the residual value guaranteed by the lessee, a party relatedto the lessee, or a financially capable third party unrelated to the lessor or lessee.




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7. Aperiodic lease payment has two components: the finance charge and the reduction ofthe outstanding liability. This charge should be allocated so that a constant periodic rate ofinterest is maintained on the diminishing liability balance. Under the effective-interestmethod, the appropriate interest rate is applied to the carrying amount of the lease liabilityat the beginning of the interest period to calculate finance expense.

a. The portion of the minimum lease payment greater than the finance expense reducesthe balance sheet liability for the finance lease.

8. Lessor accounting for finance leases. Lessors also classify most leases as either anoperating or a finance lease.

a. Under a finance lease, the lessor recognizes a net receivable equal to thenetinvestment in the lease: gross investment(minimum lease payments from thelessors perspective plus unguaranteed residual value) discounted at the interestrate implicit in the lease.

1) Unearned finance incomeequals the difference between the gross investmentand the net investment in the lease. Finance income is recognized so as toprovide a constant periodic rate of return on the carrying amount of the netinvestment. Thus, lease payments (minus costs for services) are applied toreduce the principal and the unearned finance income.

2) Theinitial direct costsof entering into a finance lease, e.g., commissions andlegal fees, are included in the initial measurement of the lease receivable.Thus, they must be allocated over the lease term, not expensed as incurred.However, this rule does not apply tomanufacturer or dealer lessors. Theirinitial direct costs are expensed when selling profit is recognized.

b. When amanufacturer or dealerlessor accounts for a finance lease, selling profit orloss is recognized in income as if an outright sale had occurred. If the rate is lowerthan the commercial rate, the selling profit (sales revenue cost of sale) is limited tothe amount resulting from using the commercial rate.

1) The initial direct costs are expensed at the leases inception.

2) Sales revenue is the fair value of the asset or, if lower, the present value of theminimum lease payments based on a commercial interest rate.

3) The cost of sale equals the cost or carrying amount of the leased property minusthe present value of the unguaranteed residual value.

c. The following are the basic lessor entries:

Lessor not a Manufacturer/Dealer Manufacturer/DealerLease payments Cost of sale XXX

receivable XXX Asset XXXAsset XXX

Lease payments receivable XXXUnearned finance Sales revenue XXX

income XXX Unearned finance income XXX

9. Operating leasesdo not meet the criteria for classification as finance leases. They do nottransfer substantially all the risks and rewards of ownership.

a. Under an operating lease, the lessee records no liability except for rental expenseaccrued at the end of an accounting period. Thus, an operating lease is a form ofoff-balance-sheet financing. The lessor continues to recognize and depreciate anasset, and a manufacturer or dealer lessor recognizes no selling profit.




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b. Rent is reported as expense or income by the lessee or lessor on a straight-line basisunless another systematic basis is representative of, respectively, the time pattern ofthe users benefit or the time pattern in which the use benefit from the asset isreduced.

c. Ifinitial direct costsare incurred for an operating lease, the lessor adds them to thecarrying amount of the leased asset.

10. Asale-leasebackinvolves the sale by the owner and a lease of the asset back to the seller.In a sale-leaseback transaction, if the lease qualifies as a finance lease, any excess of theproceeds over the carrying amount is deferred and amortized by the seller-lessee over thelease term.

a. If the sale-leaseback results in an operating lease, and the transaction is clearly at fairvalue, profit or loss is recognized immediately.

1) If the sale price is below fair value, profit or loss is recognized immediatelyunless a loss is to be offset by future lease payments at less than market price.In that case, the loss is amortized proportionately to the lease payments overthe assets period of use.

2) If the sale price exceeds fair value, the excess over fair value is amortized overthe assets period of use.

b. If the sale-leaseback gives rise to an operating lease and the fair value is below thecarrying amount, a loss equal to the difference is recognized immediately.

4.4 INCOME TAXES

1. Objective. The carrying amount of an asset or liability is expected to be recovered(consumed) or settled, respectively. UnderIAS 12,Income Taxes, a deferred tax liability orasset ordinarily is recognized when future tax payments probably will differ as a result ofsuch recovery or settlement from what they would have been if the recovery or settlementhad no tax consequences.

a. Thetax consequencesof transactions and other events are accounted for in thesame way as the transactions and other events. For example, if the transactions andother events are included in the income statement or directly in equity, the related taxeffects also are included in the income statement or directly in equity.

2. Income taxesare all domestic and foreign taxes on taxable profits. Tax expense or taxincomefor the period consists of current and deferredcomponents.

a. Current taxis the tax payable or recoverable regarding taxable profit or tax loss.

1) Taxable profit or tax lossis calculated based on tax law.

b. Deferred tax expense or incomeis the sum of the changes in the deferred tax assetsand deferred tax liabilities. For example, this amount reflects changes relating to theorigination or reversal of temporary differences, changes in tax rates, and imposition

of new taxes. Thus, the decrease in a deferred tax asset or an increase in a deferredtax liability increases deferred tax expense.

c. Aliabilityis recognized for the unpaid amount of current tax for current and priorperiods. Anassetis recognized to the extent the amount paid exceeds the amountdue. An asset also is recognized for the benefit of a tax loss carryback that recoverscurrent tax of a prior period.




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d. Adeferred tax liability (DTL)is an amount of income taxes payable in the future withregard to a taxable temporary difference. Adeferred tax asset (DTA) is an amountof income taxes recoverable in the future with regard to a deductible temporarydifference or the carryforward of unused tax losses or credits.

1) The difference between the carrying amount of an asset or liability for financial

statement purposes and its tax base is atemporary difference (TD). Ataxable (deductible) TD results in taxable (deductible) amounts in the futurewhen the carrying amount of the asset or liability is recovered or settled.

a) Butcash flowsare notaffected by the basis of accountingused toprepare the financial statements. Accordingly, whether the financialstatements are prepared based on the tax basis, the cash basis, oraccounting principles generally accepted in a given country, cash flowsshould be the same.

2) Thetax baseis the amount attributed for tax purposes to an asset or liability.The tax base of an assetis the amount deductible against future taxableeconomic benefits when the assets carrying amount is recovered. The taxbase of aliabilityis the portion of the carrying amount that will not be

deductible against future taxable economic benefits for tax purposes. The taxbase of revenue received in advance (a liability) is the portion of the carryingamount taxable in the future.

3) EXAMPLE: An entity acquires an asset that it depreciates for tax purposesusing an accelerated method and for financial reporting purposes using thestraight-line method. In the early years, the asset is depreciated more quicklyfor tax purposes than for financial reporting purposes. This temporarydifference reverses in later years. Hence, in the early years, actual taxespayable will be less than tax expense reported in the financial statements, anda deferred tax liability will be recognized. By the end of the assets useful life,cumulative actual taxes paid will equal cumulative reported tax expense, so thedeferred tax balance will be zero.

3. ADTL is recognized for most taxable TDs. However, no DTL is recognized when it resultsfrom the initial recognition ofgoodwillor goodwill for which amortization is not taxdeductible. The reason is that the recognition of a DTL would increase goodwill.

4. ADTAis recognized for most deductible TDs and for the carryforwardof unused tax lossesand credits, but only to the extent it isprobablethat taxable profit will be available to permitthe use of those amounts.

5. Measurement. Acurrent tax liability or asset for the current and prior periods is theamount to be paid to, or recovered from, the taxation authorities, based on tax laws andrates enacted or substantively enacted as of the balance sheet date.

a. ADTA or DTLis measured at theratesexpected to apply when it is realized orsettled, based on tax laws and rates enacted or substantively enacted as of thebalance sheet date. If different rates apply to different taxable profit levels, a DTA orDTL is measured based on the average rates expected to apply in the periods whenthe TDs are expected to reverse.

b. Thetax rateor tax basemay vary with the manner of recovery or settlement. Forexample, one tax rate may apply if an asset is sold immediately, and another mayapply if it is to be recovered through continued use.

c. Deferred tax items arenot discounted.

d. ADTA is reviewedat the balance sheet date to determine whether it is probable thatsufficient taxable profit will be available to permit the benefit of the DTA to be used.Any resulting reduction in the DTA may subsequently be reversed to the extent theavailability criterion is satisfied.




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6. Recognition. Current tax and deferred tax are included in profit or loss as income orexpense. However, a tax that arises from a transaction or event recognized directly inequity is itself debited or credited directly to equity.

a. Thecarrying amountof a deferred tax item may change even though the amount ofthe related TD has not changed, for example, because of a change in a tax law or

rate, a reassessment of recoverability of a deferred tax asset, or a change in theexpected manner of recovery.

7. Presentation. Tax assets and liabilities are presented separately in the balance sheet fromother assets and liabilities, and deferred tax items are reported separately from current taxitems. An entity that distinguishes between current and noncurrent items should notclassify deferred tax items as current.

a. Current tax itemsshould beoffsetgiven a legally enforceable right and an intent tosettle on a net basis or to realize the asset and settle the liability at the same time.

b. Deferred tax itemsshould beoffsetgiven a legally enforceable right, provided theamounts relate to taxes imposed by the same tax authority.

c. Tax expense or tax income forprofit or loss from ordinary activitiesis reported onthe income statement.

4.5 OTHER LIABILITIES

1. UnderIAS 32,Financial Instruments: Disclosure and Presentation, afinancial liabilityis aliability that is a contractual obligation (i) to deliver cash or another financial asset toanother entity or (ii) to exchange financial assets or financial liabilities with another entityunder conditions that are potentially unfavorable to the entity. The definition of a financialliability also extends to a liability that is a nonderivative contract that may be settled by theentitys delivery of a variable number of its equity instruments. Moreover, the definition of afinancial liability includes a liability that is a derivative contract settleable in the entitys ownequity instruments butnot by exchanging a fixed amount of cash or another financial assetfor a fixed number of the entitys equity instruments.

a. Liabilities, for example, deferred revenue and liabilities under operating leases,commodity futures contracts, and most warranties, that are to be settled bytransferring nonfinancial assets or rendering services are not financial liabilities.

b. Noncontractual liabilities, such as income taxes payable, are not financial liabilities.

c. Acontingent obligationmay satisfy the definition of a financial liability. For example,afinancial guaranteeis a contract arising from a past transaction or event and istherefore classified as a financial liability even though the requirement to perform iscontingent upon the debtors future default.

d. Anequity instrumentis a contract that is evidence of a residual interest in an entitysnet assets.

e. Liability v. equity. Whether a financial instrument, or its components, is a liability, an

asset, or an equity item depends on its substance, not its legal form, at the time ofinitial recognition and on the definitions of those elements.

1) For example, if the issuer must redeem preference (preferred) shares, or if theholder has a right to redemption, and the amount and date of redemption arefixed or determinable, the shares are liabilities. Moreover, such a contractualobligation may be established indirectly, as when an optional redemption isrendered highly likely by the circumstances.




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a) When a derivative gives one party a choice of settlement alternatives, it isa financial asset or liability unless all alternatives result in an equityinstrument.

2) Compound instruments. If a financial instrument has both equity and liabilitycomponents, they are presented separately in the issuers balance sheet. Anexample is a bond convertible to ordinary (common) shares of the issuer. Thisinstrument is equivalent to the separate issuance of debt with an earlysettlement clause and ordinary (common) share warrants or to the issuance ofdebt with detachable warrants.

3) Treasury sharesare subtracted from equity. No gain or loss is recognized inprofit or loss on transactions in an entitys own equity instruments.

4) Interest, dividends, losses, and gainsrelated to a financial liability arereported as income or expense in profit or loss. Distributions on an equityinstrument are debited directly to equity. Accordingly, dividends on sharesclassified as liabilities are items of expense, and gains and losses on theirredemption or refinancing also are included in profit or loss. The effects ofredemption or refinancing of an equity instrument, however, are includeddirectly in equity.

a) Transaction costsnecessary to an equity transaction are deducted fromequity.

f. Typical financial liabilities include trade accounts payable, notes payable, loanspayable, and bonds payable.

g. Financial assets and liabilities are notoffsetabsent a legal right and an intent to settlenet or to realize the asset or settle the liability at the same time.

2. Acurrent liabilityis an obligation that is expected to be settled within the normal operatingcycle, is held to be traded, or is due to be settled within 12 months of the balance sheetdate, or the entity has no conditional right to defer settlement for 12 months. Any otherliability is noncurrent.

a. Some current liabilities are included in the working capital employed in the normaloperating cycle, e.g., trade payables and accrued employee operating costs.

b. Current liabilities not settled within the normal operating cycle include the current partof interest-bearing debt, dividends, income taxes, and bank overdrafts.

c. Refinancing. Financial liabilities due to be settled within 12 months should continueto be classified as current. This treatment applies even if (1) the original termexceeded 12 months and (2) an agreement to refinance, or reschedule payments, ona long-term basis is completed after the balance sheet date and before the financialstatements are authorized for issue.

1) An entity that (a) expects and (b) has discretion (c) to refinance or roll over theliability (d) under anexistingloan agreement (e) classifies it as noncurrent.

d. Obligations callable because of breach. A debtor may breach a long-term

borrowing agreement, making the debt payable on demand.1) The liability should be reclassified as current even if the lender has agreed, after

the balance sheet date and before the authorization of the financial statementsfor issue, not to demand payment.

2) But the liability is noncurrent if the lender agrees before the balance sheet dateto allow at least a 12-month grace period to rectify the breach. This periodmust end at least 12 months after the balance sheet date.




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3. The most common financial liabilities areaccounts payableor trade payables, which areobligations to sellers that are incurred when an entity purchases inventory, supplies, orservices on credit. These liabilities arise when the goods or services have been receivedor supplied and have been invoiced or formally agreed with the supplier.

a. Short-term liabilities, such as accounts payable, are usually not interest bearing

(unless the accounts are not settled when due) and are usually not secured bycollateral.

b. Thegross methodrecords purchases and accounts payable without regard topurchase discounts available, for example, cash discounts for early payment.

1) Purchases and accounts payable may be accounted for using the gross methodor the net method.

a) In a periodic system, purchase discounts taken are credited to a contrapurchases account and closed to cost of goods sold. In a perpetualsystem, they are credited to inventory.

2) Thenet methodrecords purchases and accounts payable at the cash(discounted) price. The advantage of the net method is that it isolates purchasediscounts lost, which are treated as financing charges.

c. The timing of recognition of accounts payable may depend on theshipping terms,that is, whether title and risk of loss pass at the point of shipment or at the ultimatedestination.

4. Accrued expenses. Ordinarily, accrued expenses are liabilities for goods or servicesreceived or supplied, but not paid, invoiced, or formally agreed with the supplier, thatotherwise meet the recognition criteria in the current period. They are accounted for usingbasic accrual entries.

a. Reversing entriesmay be used to facilitate accounting for accrued expenses in thenext period. For example, if wages payable are accrued at year-end (the adjustingentry is to debit wages expense and credit wages payable), the reversing entry at thebeginning of the next period is to debit the liability and credit wages expense. If the

reversing entry is made, no allocation between the liability and wages expense isneeded when wages are paid in the subsequent period (the entry will simply be todebit wages expense and to credit cash).

1) Ifaccrual entries are reversed, all expenses paid in the next period can becharged to expense.

2) Ifreversing entries are not made, either of the following methods is used in thenext period:

a) The liability is debited when the accrued expense is actually paid. Forexample, the first wages payment of the year will be accounted for bydebiting wages expense and wages payable and crediting cash. Thus,this entry will differ from subsequent entries recording the payment ofwages.

b) Payments are recorded by debiting expense for the full amounts paid. Atyear-end, the liability is adjusted to the balance owed at that date. Forexample, if the liability for accrued wages has decreased, the adjustingentry will be to debit wages payable and credit wages expense.

b. If an entity fails to accrue expenses at year-end, income is overstated in that periodand understated in the next period (when they are paid and presumably expensed).

1) Moreover, expenses incurred but unpaid and not recorded result in understatedaccrued liabilities and possibly understated assets (for example, if the amountsshould be inventoried). In addition, working capital (current assets currentliabilities) will be overstated, but cash flows will not be affected.




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5. Taxes payable. Accounting for deferred income taxes is explained in Subunit 4.4.Employment-related taxes, such as unemployment tax and withholding tax, are expensesincurred as employees earn wages, but they are paid only periodically. Accordingly,liabilities should also be accrued for these expenses as well as for wages earned but notpaid.

a. Property taxes are usually accrued over the tax authoritys fiscal period.b. Purchase taxes may be levied on certain goods and services. Ordinarily, the tax ispaid by the customer but is collected and remitted by the seller periodically.

6. Short-term employee benefitsexpected to be paid as a result of service rendered duringthe period ordinarily should be recognized as an expense and a liability (accrued expense).

a. Forshort-term compensated absences, the timing of recognition depends onwhether the benefitsaccumulate. If they accumulate, the expected cost isrecognized when services are rendered that increase the employees entitlement tofuture compensated absences.

b. The obligation is recognized whether it is vesting (the employee is entitled to a cashpayment for an unused entitlement upon leaving the entity) or not vesting, and theamount should not be discounted. It equals the additional amount expected to bepaid as a result of the unused accumulated entitlement at the balance sheet date.

7. Deferred revenues. If the recognition criteria are not met, advance receipts are treated asliabilities (deferred revenues). Recognition is deferred until the obligation is partly or whollysatisfied, that is, when the increase in future economic benefits becomes reliablymeasurable.

a. Cash received in advance may initially be credited to a deferred revenue (liability)account. At the end of the accounting period, revenue is recognized by a debit todeferred revenue and a credit to revenue. However, a reversing entry is notappropriate if advance receipts are initially credited to a deferred revenue (apermanent or real account).

4.6 PROVISIONS AND CONTINGENCIES

1. Provisionsare defined in IAS 37,Provisions, Contingent Liabilities, and Contingent Assets,as liabilities of uncertain timing or amount that are not covered by another Standard andthat do not result from financial instruments carried at fair value, from executory contracts(unless onerous), or from insurance contracts with policyholders. Examples of provisionsare liabilities for violations of environmental law, nuclear plant decommissioning costs,warranties, and restructurings.

a. Provisions differ from trade payables and accruals because of their greateruncertainty. They differ from contingent liabilities because they are presentobligations that meet the recognition criteria. Contingencies are possible obligationsor do not meet the recognition criteria.

b. Recognitionof provisions is appropriate when (1) the entity has a legal orconstructive present obligation resulting from a past event (called an obligatingevent), (2) it is probable that an outflow of economic benefits will be necessary tosettle the obligation, and (3) its amount can be reliably estimated.

1) Apast eventleads to a present obligationif the entity has no realisticalternative to settlement.

2) For purposes of IAS 37,probablemeans more likely than not. Moreover, apast event is deemed to result in a present obligation if, given all the availableevidence, it is more likely than not that a present obligation exists.




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3) Alegal obligationis based on a contract, legislation, or other operation of law.

4) Aconstructive obligationresults when the entity has indicated to other parties,e.g., by an established pattern of practice or by published policies, that itaccepts certain responsibilities and has created a valid expectation of fulfillingthem.

2. Acontingent liabilityis a possible obligation arising from past events. Its existence will beconfirmed only by uncertain future events not wholly within the entitys control. A liabilityalso is contingent if it does not meet the recognition criteria.

a. For example, if the entity and other parties are jointly and severally liable on anobligation, the amount expected to be paid by the other parties is a contingentliability.

b. A contingent liability is not recognized. However, it should be disclosed unless thepossibility of resource outflows is remote. Disclosuresinclude estimated financialeffects, any uncertainties related to timing or amount, and the possibility ofreimbursement.

3. Acontingent assetis a possible asset arising from past events and the existence of whichwill be confirmed only by uncertain future events not wholly within the entitys control. An

example is a potential recovery on a legal claim with an uncertain outcome.

a. Acontingent asset is not recognized but should be disclosed if an inflow ofeconomic benefits is probable. Disclosures include a description of the contingentasset and an estimate of its financial effects.

4. Measurement. A provision is measured in accordance with the best estimateof theamount needed to settle the obligation. The best estimate is the pre-tax amount that anentity would rationally pay to settle the obligation at the balance sheet date or to transfer itto a third party at that date.

a. If the population of items being measured is large, anexpected valuecomputation isappropriate. However, even if a single obligation is being estimated, a range ofoutcomes, not just the single most likely outcome, is considered.

b. Risks and uncertaintiesare considered in calculating the best estimate, but theyshould not result in deliberate overstatement.

c. The measurement should be at thepresent valueof the outflows needed to settle theobligation if the effects of discounting are material.

d. The settlement amount may include the effects offuture eventsif sufficient objectiveevidence of their occurrence is available.

e. Gains on disposalof assets are not anticipated in measuring the provision.

5. An expected reimbursementof an amount required to settle a provision is recognized onlyif receipt of the reimbursement isvirtually certain. In this case, the expectedreimbursement is recognized as a separate asset.

a. The debit to expense for a provision is net of a recognized reimbursement.

b. Reimbursements may result from, for example, insurance, indemnity clauses incontracts, or suppliers warranties.

6. A provision is adjusted at the balance sheet date to the current best estimate. If therecognition criteria are no longer met, the provision is reversed.

a. If a present value measurement has been made, the periodic increase resulting fromthe reduction in the discount period is treated as a borrowing cost.

7. Future operating lossesare not an appropriate basis for a provision.




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8. Anonerous contractis one for which the unavoidable costs of performance exceed theexpected benefits. The unavoidable costs equal the least net cost of terminating thecontract.

a. The present obligation of an onerous contract is treated as a provision.

b. An example of an onerous contract is a noncancelable lease of a factory building that

cannot be sublet after the entity has moved its operations to a new site.9. Arestructuringis a program planned and controlled by management that materially

changes the scope of a business or the way it is conducted, for example, selling a line ofbusiness, relocating activities from one region or country to another, eliminatingmanagement layers, or fundamentally reorganizing the entity. A provision for restructuringis recognized when the recognition criteria are satisfied.

a. If the following conditions are met, a constructive obligation to restructure is created:

1) The entity has a detailed formal plan.

2) A valid expectation has been raised in those affected because the entity hasbegun implementation of the plan or has announced its main features.

b. However, no obligation is created relative to the sale of an operation unless a binding

sale agreement has been reached.c. The restructuring provision includes only thedirect expendituresof restructuring, that

is, those necessary to the restructuring and not associated with ongoing activities.

1) The provision excludes such costs as marketing, retraining employees,relocating employees, and new systems. It also excludes identifiable futureoperating losses up to the date of the restructuring and any gains on anexpected disposal of assets.

4.7 BONDS

1. Bonds are debt instruments within the scope ofIAS 39,Financial Instruments: Recognitionand Measurement. When bonds are issued on an interest payment date, the entry is todebit cash and credit bonds payable. Any difference is debited to a discount or credited toa premium. Ifbondsare issued at a discount or a premium, theeffective interest methodof amortization should be used (unless the results of another method are not materiallydifferent). Under this method, interest expense changes every period, but the interest rateis constant.

a. Price. Bonds are sold at the sum of the present values of the maturity amount and theinterest payments (if interest-bearing). The difference between the nominal amountand the selling price of bonds is either a discount or a premium.

1) Bonds are sold at adiscountwhen they sell for less than the nominal amount,that is, when the contract (stated) interest rate is less than the market (effective)interest rate.

2) Bonds are sold at apremium(in excess of the nominal amount) when the statedrate exceeds the effective rate.

3) The bond discount or premium should appear as a direct deduction from, oraddition to, the nominal amount of the bond payable.

b. When bonds are issuedbetween interest payment dates, the price includes accruedinterest.

c. Interest expenseis equal to the carrying amount of the bond at the beginning of theperiod times the yield (market) interest rate.




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d. Interest paidremains constant and is equal to the nominal amount of the bond timesthe stated rate.

e. The difference between interest expense and interest paid is thediscount orpremium amortization.

1) When bonds are carried at a discount, interest expense exceeds interest (cash)

paid.Interest expense $XXX

Discount on bonds payable $XXXCash XXX

2) When bonds are carried at a premium, interest (cash) paid exceeds interestexpense.

Interest expense $XXXPremium on bonds payable XXX

Cash $XXX

f. For bondsissued at a discount, the carrying amount will increase as the discount isamortized. The result is a higher interest expense for each interest payment period.

Because the discount amortized is the excess of an increasing interest expense overthe constant amount of interest paid, the amortization will increase with eachpayment.

g. For bondsissued at a premium, the carrying amount will decrease as the premium isamortized. The result is a lower interest expense for each interest payment period.Because the premium amortized is the excess of the constant amount of interest paidover a decreasing amount of interest expense, the premium amortization also willincrease with each payment.

h. The periodicreduction of the discount (premium) will cause the carrying amount ofthe bonds to be higher (lower) than the carrying amount at the previous period-end.At the maturity date, the discount or premium will be fully amortized to zero, and thecarrying amount will be equal to the face value of the bonds.

2. Transaction costs, such as issue costs, are included in the initial measurement of financialliabilities, such as bonds. These liabilities are subsequently measured at amortized cost.

a. Issue costsare incurred to bring a bond to market and include printing and engravingcosts, legal fees, accountants fees, underwriters commissions, registration fees, andpromotional costs.

b. Although the effective interest method is theoretically superior, issue costs arecustomarily amortized using the straight-line method.

3. Compound instruments. The initial total carrying amount of convertible debt or of debtinstruments issued withdetachable share purchase warrants (the proceeds) should beallocated between the debt instruments and the equity feature, and these debt and equitycomponents should be separately accounted for. The total assigned initially to the

instrument as a whole is the fair value of the whole.a. The amount assigned to theliabilitycomponent is the fair value of a similar

standalone liability.

b. The amount assigned to theequitycomponent is the excess of the fair value of thecompound instrument over the fair value of the liability component.

c. Transaction costsare allocated on the same basis as the proceeds.




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4.8 EQUITY

1. Equity consists of share capital; items of income, expense, gain, or loss reported directly inequity; retained earnings; and, possibly, treasury shares.

Share capital:

Preference (preferred) shares XXXShare premium XXX XXXOrdinary (common) shares XXXShare premium XXX XXX

Total share capital XXX

Reserves:

Revaluation surplus XXXForeign currency translation adjustment XXX

Total reserves XXX

Retained earnings:

Retained earnings appropriated for... XXX

Unappropriated retained earnings XXXTotal retained earnings XXX

Treasury shares (at cost) (XXX)Total equity XXX

2. Share capital(issued capital) represents investments by owners in exchange for shares.

a. One share capital account shows thepar or stated valueof all shares outstanding (ifshares have no par or stated value, the amount received is given).

1) Amounts for each class of share capital, such as ordinary (common) andpreference (preferred) shares, are usually separately listed.

b. Share premiumconsists of the sources of issued capital in excess of par or statedvalue. These sources may include

1) Amounts in excess of par or stated value received for the entitys shares2) Debits for receipts less than par or stated value3) Amounts attributable to treasury share transactions4) Transfers from retained earnings upon the issuance of share dividends

c. Direct transaction costsare subtracted from equity.

3. The termreserveis used in the Framework to refer to capital maintenance adjustments andappropriations of retained earnings. However, in IAS 1 and in this text, it also applies toitems recognized directly in equity.

a. Reserves must be presented on theface of the balance sheet. Disclosures thatmust be made in the notes or on the face of the balance sheet include the nature andpurpose of each reserve within equity.

4. Retained earningsis accumulated profit or loss. It is increased by profit and decreased byloss, dividends, and certain transactions in treasury shares.

a. An entity mayappropriateretained earnings to, for example, comply with a bondindenture, retain assets, anticipate losses, or meet legal restrictions.

1) The appropriation limits dividends but does not set aside assets. Moreover, anysuch transfer is excluded from the determination of profit or loss.




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5. Treasury sharesare the entitys own equity instruments reacquired for various purposes,e.g., mergers, options, or share dividends.

a. After treasury shares are reacquired by the issuer or a consolidated subsidiary, theyarelegally available to be reissuedeven if the intention is to cancel them.

b. The acquisition of treasury shares results in adirect change in equity. Furthermore,

no gain or loss is recognized in the income statement for any transfer of treasuryshares, for example, a sale, other issuance, or cancelation. The considerationreceived also is recorded as a direct change in equity.

1) Recognition of gain or losson treasury share transactions isnot allowedbecause they represent a shifting of interests among shareholders. Thus, theFramework defines income to exclude contributions from equity participantsand expense to exclude distributions to equity participants.

c. Disclosure. Treasury shares are a subtraction from equity on the balance sheet, andthe amounts of reductions in equity are disclosed in the notes or on the face of thebalance sheet. Whether the entity or its subsidiary holds treasury shares obtainedfrom a party able to exercise significant influence or control also should be disclosed.

1) The effect of treasury shares is disclosed on the balance sheet or in the notes forall categories of equity. Theacquisition cost of treasury sharesmay bepresented in various ways.

a) A single line item may be presented as an adjustment to equity for the totalcost.

b) An amount equal to par value, if any, may be reported as a subtractionfrom share capital, with adjustments made to other categories of equity(e.g., share premium and retained earnings) for the effects of premiumsor discounts.

c) An adjustment may be made to each category of equity.

d. The entitys cost of acquiring arightto purchase treasury shares is a directsubtraction from equity.

e. Under thecost method, the entry to recognize treasury shares is a debit to treasuryshares and a credit to cash.

1) When the treasury shares are subsequently reissued for cash at a price inexcess of acquisition cost, the difference is credited to share premium fromtreasury share transactions.

2) If the treasury shares are subsequently reissued for an amountless thanacquisition cost, the difference is debited to share premium from treasuryshare transactions. If this account has a zero balance, the debit is to retainedearnings.

3) Treasury shares accounted for at cost reduce total equity.

f. Thepar value method treats the acquisition of treasury shares as a constructive

retirement and the resale as a new issuance. Upon acquisition, the entry originallymade to issue shares is reversed by offsetting the appropriate share capital account,e.g., ordinary (common) shares, with treasury shares at par value and removing theshare premium recorded when the shares were originally issued.

1) Any difference between theoriginal issuance priceand the reacquisitionpriceis ordinarily adjusted through share premium accounts and retainedearnings. Premiumsare credited to share premium from treasury sharetransactions, anddiscountsare debited to the same account but only to theextent of prior premiums. If the credit balance in the account is insufficient toabsorb the discount,retained earningswill be debited for the remainder.




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2) Reissuanceremoves the treasury shares at par value and reestablishes sharepremium for any excess of the reissuance price over par value. If thereissuance price is less than par, the debit is to a share premium account or toretained earnings.

3) Treasury shares stated at par is a direct reduction of the appropriatesharecapital account.

6. Uponissuance of shares, cash is debited, the appropriate class of share capital is creditedfor any par or stated value, and the difference is credited to share premium.

a. Shares may be issued in exchange forservices or propertyas well as for cash. Thetransaction should be recorded at the more clearly determinable of the fair values ofthe shares or the property or services received.

b. Donated assets. Contributions received seem to be within the definition of income,i.e., increases in economic benefits that result in increases in equity, other than thosefrom contributions by equity participants. They are measured atfair value.

1) However, a contribution of treasury shares is, in effect, a transfer of equityinstruments among owners, not a gain or loss by the entity.

7. Retirement. When shares are retired, cash (or treasury shares) is credited. Theappropriate class of share capital account is debited for any par or stated value. Sharepremium is debited to the extent it exists from the original issuance. Any remainder isdebited to retained earnings or credited to premium from share retirement.

a. No gain or loss is reported on transactions in an entitys own shares. However, thetransfer of nonmonetary assets in exchange for shares requires recognition of anyholding gain or loss on the nonmonetary assets.

8. Cash dividendscannot be rescinded. Thus, when they are declared, a liability to owners iscredited and retained earnings is debited, resulting in a decrease in retained earnings.

a. When cash dividends are paid, the dividends payable account is debited and cash iscredited. Hence, at the payment date, retained earnings is not affected.

b. If dividends on preference (preferred) shares arecumulative, dividends in arrears andthe preference (preferred) dividends for the current period must be paid beforeordinary (common) shareholders may receive dividends. Dividends in arrears are nota liability until they are declared and are not recognized in the financial statements.

c. If preference (preferred) shares areparticipating, they may share equally in a cashdividend after a basic return has been paid to holders of both ordinary (common) andpreference shares at the rate for the preference shares. The remainder is allocated,for example, in proportion to the par values of the outstanding shares.

d. If dividends are declared after the balance sheet date, no liability for those dividends isrecognized as of that date.

9. Property dividends. A nonreciprocal transfer of nonmonetary assets to owners should berecorded at the fair value of the asset transferred on the declaration date. If the property

has appreciated, it should first be written up to fair value and a gain recognized.10. Liquidating dividendsare repayments of capital. They are distributions in excess of

retained earnings. Because the effect is to decrease share capital, share premium isdebited first to the extent available before other equity accounts are charged.

11. Ashare dividendprovides evidence to the shareholders of their interest in retainedearnings without distribution of cash or other property. Share dividends are accounted foras a reclassification of shareholders equity, not as liabilities.

a. The recipient of a share dividend should not recognize income. After receipt of thedividend, the shareholder has the same proportionate interest in the entity and thesame total carrying amount as before the declaration of the share dividend.




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12. Share splitsare issuances of shares that do not affect any aggregate par value of sharesissued and outstanding or total equity.

a. No entry is made for share splits, and no transfer from retained earnings to sharecapital occurs, but a memorandum change of any par value or stated value is made.

13. Rights. In a rights offering, each shareholder is issued a certificate or warrantthat is a call

option to buy a certain number of shares at a fixed price. If the rights are exercised, theissuer will reflect the proceeds received as an increase in share capital at par value orstated value, if any, with any remainder credited to share premium.

a. However, if the rights previously issued without consideration are allowed tolapse,share capital is unaffected.

b. Until the issue date, the shares typically traderights-on. After the issue date, theshares usually tradeex-rightsbecause the rights can be sold separately.

c. The recipient of share rights mustallocate the carrying amount of the shares ownedbetween those shares and the rights based on their relative fair values. The portionof the price allocated to the rights increases (decreases) the discount (premium) onthe investment.

d. Transaction costs of redeeming share rights reduce equity.

4.9 ACCOUNTING CHANGES

1. According toIAS 8,Accounting Policies, Changes in Estimates, and Errors, achange inaccounting estimateadjusts the carrying amount of an asset or liability or theconsumption of an asset. It results from reassessing the status and expected benefits andobligations related to assets and liabilities. It is based on new information and is not anerror correction. The effect of a change in estimate is included inprofit or lossin theperiod of change (if the change affects that period only) or in the period of change and infuture periods (if the change affects both the current and future periods). A change inaccounting estimate should be reflected in the financial statements prospectively.

a. Examples of estimatesare (1) uncollectible receivables, (2) inventory obsolescence,(3) service lives and residual values of depreciable assets, (4) warranty costs,(5) periods benefited by a deferred cost, and (6) recoverable mineral reserves.

b. If distinguishing between a change in estimate and a change in accounting policy isdifficult, the change is accounted for as a change in estimateand properlydisclosed.

c. A change in an accounting estimate does not result in a change in its incomestatement classification.

d. If the change in accounting estimate results in changes in assets, liabilities, or equity,the change is recognized by adjusting the carrying amount of each related item in theperiod of change.




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2. Allmaterial prior-period errors must be corrected retrospectively in the first set of financialstatements issued after their discovery. This may be done by restating the comparativeamounts for the prior periods when the error occurred. If the error occurred prior to the firstperiod presented, the opening balances for the first period presented are restated.

a. Amaterial erroris one that could, individually or collectively, affect the decisions of

users of the financial statements.b. Typical errorsare mistakes in mathematical calculations, in the application ofaccounting policies, or in factual interpretation. Other examples are fraud or simpleoversight. Such errors are usually recognized in current-period profit or loss.

1) However, in rare circumstances, errors may be of such magnitude that theyrender prior-period statements unreliable, for example, because of recognitionof material work-in-progress and receivables related to fraudulent contracts.

c. Comparative informationshould be restated if practicable.

1) If it is impracticable to determineperiod-specific effects, opening balances arerestated for the earliest period for which retrospective application is practicable.

2) If thecumulative effectof the error cannot practicably be determined in the

current period, the comparative information must be stated prospectively tocorrect the error from the earliest date practicable.

3) Impracticablemeans that the entity cannot apply a requirement after makingevery reasonable effort.

3. Accounting policies. Accounting policies are specific principles, bases, conventions,rules, and practices adopted by an entity in preparing and presenting financial statements(IAS 8). To facilitate comparison of an entitys financial information over time, the sameaccounting policies ordinarily are followed consistently.

a. Achange in accounting policyis indicated only if the result will be reliable andmore relevantinformation or if it is required by a standard or interpretation.

1) A change in policy has not been made when a policy is chosen to account forevents or transactionsdiffering in substancefrom prior events or transactionsor for events or transactions that have not previously occurredor that werenot material.

2) The adoption of a policy to carry property, plant, and equipment or intangibleassets atrevalued amountsis treated in accordance with the revaluationprovisions of specifically applicable Standards rather than as a change inpolicy.

3) A change in accounting policy pursuant to anew standard or interpretationshould be accounted for in accordance with its transition provisions. Absenttransitional guidance or if a change isvoluntary, the change is appliedretrospectively.

a) Retrospective application means adjusting the opening balances of equity

(e.g., retained earnings) for the first period presented and restating othercomparative amounts.

b) Retrospective application is not done if it isimpracticable to determineperiod-specific effects or the cumulative effect. Accordingly,retrospective application to a prior period is impracticable unless thecumulative effects on the opening and closing balance sheets for theperiod are practicably determinable. (See item 2.c. above for thetreatment.)




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4. Error analysis. The analysis of accounting errors addresses such issues as whether anerror affects prior-period financial statements, the timing of error detection, whethercomparative statements are presented, and whether the error is counterbalancing.However, if the error is material, it must be corrected retrospectively.

a. Anerror affecting prior-period statementsmay or may not affect profit or loss. For

example, misclassifying an item as a gain rather than a revenue does not affectincome and is readily correctable. No adjustment is required.

b. An error that affects prior-period profit or loss is counterbalancingif it self-correctsover two periods. For example, understating ending inventory for one period (and thebeginning inventory of the next period) understates the profit or loss and retainedearnings of the first period but overstates the profit or loss and retained earnings ofthe next period by the same amount (assuming no tax changes). However, despitethe self-correction, the financial statements remain misstated. They should berestated if presented comparatively in a later period.

1) An example of anoncounterbalancing erroris a misstatement of depreciation.Such an error does not self-correct over two periods. Thus, an adjustment willbe necessary.

2) In principle, a counterbalancing error requires no correcting entry if detectionoccurs two or more periods afterward (assuming no tax changes). Earlierdetection necessitates a correcting entry.

4.10 EXCHANGE RATES

1. IAS 21,The Effects of Changes in Foreign Exchange Rates, applies to foreign currencytransactions and balances, translation of the results and financial position of foreignoperations included in the entitys statements, and translation of results and financialposition into a presentation currency.

a. Aforeign currencyis any currency that is not the functional currency of the entity.

b. Aforeign operationis a subsidiary, associate, joint venture, or branch whoseactivities are not in the reporting entitys currency or country.

c. Afunctional currencyis the currency of an entitys primary economic environment.

d. Thepresentation currencyis the currency in which the statements are reported.

e. Theclosing rateis thespot exchange rate(rate for immediate delivery) at thebalance sheet date.

2. Aforeign currency transactionis denominated in or requires settlement in a foreigncurrency. Initial recognitionin thefunctional currencyis at the spot exchange ratebetween the functional and foreign currencies at the transaction date (or at anapproximation, such as an average, if rates do not vary materially).

a. At the balance sheet date,monetary itemsare translated at theclosing rate.

1) Nonmonetary items measured at historical costare translated at the rate onthe transaction date.

2) Nonmonetary items measured at fair valueare translated at the rates whenthe fair values were measured.




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b. Anexchange differencearises when a given amount of one currency is translatedinto another currency at different exchange rates.

1) Exchange differences ordinarily are recognizedin profit or losswhen theyarise, that is, upon

a) Settlement of a monetary item or

b) Translation of a monetary item at a rate different from the rate at which itwas (1) initially recognized during the period or (2) translated in previousfinancial statements. Thus, the exchange difference recorded in a periodis based on the change in rates for that period.

2) A gain or loss on anonmonetary itemmay be recognized in profit or loss ordirectly in equity. Any exchange component is accounted for in the same wayas the nonexchange component.

3) An exchange difference with respect to a monetary item that is part of anetinvestment in a foreign entity(a share of its net assets) is recorded directlyin equityin the consolidated statements until disposal of the investment.

a) Upon recognition or gain or loss on disposal of the net investment, the

cumulative amounts are recognized in profit or loss.3. Achange in the functional currency is accounted for prospectively.

4. If the functional currency is not that of a hyperinflationary economy,translation to adifferent presentation currencyis done as follows:

a. Assets and liabilities for each balance sheet presented are translated at theclosingrateas of its date.

b. Income and expenses for each income statement presented are translated at theexchangerates at the transaction dates(but an average rate may be used unlessrates fluctuate greatly).

c. Exchange differences are recognizedseparately in equity.

5. If the functional currency is that of ahyperinflationary economy, translation to a different

presentation currency is at the closing ratefor the most recent balance sheet forallamounts.

a. If an entitys functional currency is that of ahyperinflationary economy, the financialstatements must first be restatedbefore being translated into the presentationcurrency. UnderIAS 29,Financial Reporting in Hyperinflationary Economies, thesestatements should be stated in terms of the measuring unit current at the balancesheet date. This approach is necessary whether the statements are presented on thehistorical-cost or current-cost basis.

6. Goodwillfrom acquisition of a foreign operation and anyfair value adjustmentsto carryingamounts of assets and liabilities are assets and liabilities of the foreign operation. They arestated in the operations functional currency and translated at the closing rate (see 4.and 5. above).




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4.11 JOINT VENTURES

1. IAS 31,Interests in Joint Ventures, applies to reporting by venturers and investors of jointventure assets, liabilities, income, and expenses.

a. Ajoint ventureis a contractual arrangement whereby two or more parties undertakean economic activity that is subject to joint control.

1) Aventureris a party to the venture who has joint control.

2) Aninvestoris a party to the venture who lacks joint control.

3) Controlis power over the policies of an economic activity that permits thecontrolling party to obtain benefits.

2. Jointly Controlled Operations

a. In this type of joint venture, the ventur

4. financial accounting ii

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