ACCA P2 (INT) Corporate Reporting - Study text

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On this basis, the accounting treatment becomes:

DR CR

$ $

Saleofproperty

Cash 850,000

Noncurrentassets

440,000

Profitorloss–normalprofit(550,000–440,000)

110,000

Deferredincome(liability)–abnormalprofit(850,000–550,000)

300,000

DR CR

$ $

Paymentofrental

Cash

100,000

Profitorloss–rental

100,000

Profitorloss–amortiseddeferredincome(300,000/10

years)

30,000

Deferredincome

30,000

(b) Sale and finance leaseback

Where the leaseback is a financing arrangement, two treatments could apply.

Treatment 1

As the asset has been sold, the asset should be de-recognised and the proceeds

recorded. It is not appropriate to show a profit on the disposal as the risks and

rewards of ownership revert back to Flow under a finance leaseback. The

substance of the transaction is that there has been no sale and the lessor is

providing finance to the lessee with the asset as security hence the profit of

$410,000 should be deferred and amortised.

On the leaseback, the asset should be re-instated and, as a finance lease, this

would be at the fair value (or the present value of the minimum payments if

lower) of $550,000. The lease payments will be split into repayment of the

capital and the interest. The deferred profit will be amortised over the ten year

lease term.

Treatment 2

It could, however, be argued that the above treatment does not fully reflect the

substance of the transaction as the original owner bears the risks and rewards

of ownership before and after the sale and leaseback. If the risks and rewards

were not transferred from Flow, then it could be argued that the asset should

remain in the books at its original net book value and should not be uplifted to

fair value. There will not be a profit or loss recorded.

The proceeds from the ‘sale’ reflect a financing arrangement secured on the

property and so should be recognised as a liability. The subsequent lease

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payments would again be split into repayment of the capital $850,000 and

interest $150,000 ($1m payments - $850,000 loan).

23 AZ

(a) (i) Usefulness of segmental data

Many entities carry out several classes of business and operate in a

number of countries across the world. Each of these businesses and

geographical segments carries with it different opportunities for growth,

different rates of profit and varying degrees of risk. Some business

segments may be strongly influenced by the health of the economy

whereas other segments may be unaffected by recession. One country

may be experiencing growth; another country may be less stable because

of political events. Awareness of these cultural and environmental

differences is important to investors in order to allow them to fully

understand the performance and position of the entity over the past, its

prospects for the future and the risks that it faces.

IFRS 8 requires that segmental information should be provided to enable

investors to understand the impact that the different segments of a

business may have on the business as a whole. If the user of financial

statements is only provided with figures for the entity as a whole, this

might hide the risks and problems or profits and opportunities of the

underlying business segments. The disaggregated financial information

provided by segmental reporting allows for analytical review on a

segment by segment basis which will provide greater understanding of

the entity’s position and performance and allow a better assessment of

its future.

(ii)

Analysing segments

IFRS 8 defines an operating segment as a component of an entity that

engages in business activities from which it ay earn revenues and incur

expenses, whose operating results are reviewed regularly by the chief

operating decision maker in the entity and for which discrete financial

information is available.

Not every part of a business is necessarily an operating segment or part

of an operating segment. Head office is an example, since head office

does not usually earn revenues. Generally an operating segment has a

segment manager who is directly accountable to and maintains regular

contact with the chief operating decision-maker, to discuss the

performance of the segment.

IFRS 8 requires that entities should report information about each

operating segment that is identified and that exceeds certain

quantitative thresholds for size of revenue, operating profit or loss or

assets. Financial information about operating segments with similar

characteristics can be aggregated.

IFRS 8 sets out the information about each reportable operating segment

that should be disclosed, including total assets, profit or loss, revenue

Answers

from external customers, revenue from sales to other segments, interest

income and expense, depreciation, material items of income or expense

and tax. The amount reported for each item should be the same measure

that is reported for the segment to the chief operating decision maker of

the entity.

IFRS8 applies to quoted companies only.

(b) AZ segmental reporting issues

(i) Fleet of aircraft

The answer to (a) explains how operating segments should be identified.

It seems probable that information is provided separately for aircraft

seat sales and for holiday homes to the chief operating decision maker of

AZ; therefore it seems probable that these should be treated as

reportable operating segments for the purpose of IFRS 8, provided that

they exceed the minimum threshold limits for size (at least 10% of

revenues, or profit or loss, or assets of the reporting entity).

(ii) Aircraft manufacturing plant

IFRS 8 requires that in measuring and reporting segment revenue from

transactions by an operating segment with other segments, inter-

segment transfers should be measured on the basis of the information

provided to the chief operating decision maker. In this case, the

revenues from inter-segment sales should be based on the prices

actually charged.

IFRS 8 also requires that AZ must disclose the basis of accounting for

transactions between reportable segments.

(iii)

Exceptional loss

Items which are unusual in size, nature or incidence and hence where

knowledge of their nature and amount is relevant to a reader’s

understanding of performance are required to be disclosed in the notes

or on the face of the statement of comprehensive income in accordance

with IAS 1.

In addition, IFRS 8 requires disclosure for each reportable segment of

any material items of income or expense that is disclosed in accordance

with IAS1. If the activities of the airline manufacturing plant are a

reportable segment or part of a reportable segment, the loss should

therefore be reported within the segmental information in the financial

statements.

(iv) Discontinued operations

IFRS 8 does not deal with discontinued operations as this is the subject

of IFRS 5

Non-current assets held for sale and discontinued

operations

. IFRS 5 requires the disclosure of the impact of a

discontinued operation, and has strict conditions that must be met when

identifying a discontinued operation.

To be classed as discontinued, IFRS 5 requires that the component of the

entity has been sold in the year or is classified as ‘held for sale’. A

decision by the board and an announcement to the press alone is

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insufficient to be classed as ‘held for sale’. The criteria that must be met

by the end of the reporting period are as follows:

 The asset must be available for immediate sale in its present

condition; and

 The sale must be highly probable. For this to be so the following sub-

conditions must also be met:

−

The appropriate level of management must be committed to the

plan to sell

−

An active programme to locate a buyer must have been initiated

−

The asset is being marketed at a reasonable price, and

−

The sale should be expected to be completed within one year

from the date of classification.

Hence, unless marketing of the holiday business is in progress at a

reasonable price, and sale in the next 12 months is expected, the

operation need not be classified as discontinued. If however, all of the

above criteria are met, then the results of this operation must be

disclosed as a single line on the face of the statement of comprehensive

income together with supporting disclosures in the notes to the

accounts.

(v)

40% investment in Eurocat

IFRS 8 requires that information should be disclosed for each reportable

segment of the entity’s interest in the profit or loss of associates and joint

ventures accounted for by the equity method. In addition, if the

information is provided to the chief operating decision maker of the

entity, for each reportable segment there should be disclosure of the

amount of investment in associates or joint ventures accounted for

under the equity method.

Therefore, AZ must disclose the results of the associate in its segmental

disclosures.

24 EPS

(a) The need to disclose diluted EPS

Many entities issue financial instruments that allow the holder to buy shares

at a price that is less than the market price. Such instruments include

convertible debt, options and warrants. When the holders exercise their rights

and obtain the equity, the original EPS measure will be diluted. This is

because the shares have been issued at below their market price and so will

provide the entity with less cash and so less earnings per share. IAS 33

requires disclosure of both the basic and diluted EPS. The diluted earnings per

share figure is calculated using the current earnings and assuming the worst

dilution arises. This will assist existing and prospective investors with their

investment decisions.

For example, a convertible bond provides the holder with a regular coupon

plus the option to convert the bonds into ordinary shares at during a certain

time frame. Most investors will probably choose to convert rather than to

Answers

redeem their bonds and hence this will affect the EPS. Firstly, the number of

shares in issue will increase; secondly, the earnings will increase because the

coupon will no longer need to be paid. Typically, convertible bonds will be

issued at a low coupon because of the opportunity to take the shares.

Therefore, the impact on earnings is minimal, and the EPS will typically

decrease.

(b)

Calculation of diluted EPS

BasicEPS

$000

Netprofit

Netprofitaftertaxandnon‐controllinginterests $18,000,000

Ordinaryshares

40,000,000

EPS

45cents

It is assumed that the preference dividend is included in finance costs;

therefore the net profit after tax represents total earnings.

In order to determine the diluted EPS, the potential ordinary shares must first

be ranked in order of their dilutive effect.

Dilutiveeffect

Effecton

earnings

$000

Effecton

numberof

ExtraEPS

Options(w1)

nil 400 nil

Convertiblebonds(w2) 804 1,840 0.44

Convertiblepreferenceshares(w3)

160 3,200 0.05

Diluted EPS must be calculated starting with the most dilutive (options) and

finishing with the least dilutive (bonds).



DilutedEPS

Earnings

Ordinary

EPS

$000

cents

BasicEPS 18,000

40,000 45

(i)Options

nil

400

18,000

40,400 44.55c

(ii)Convertiblepreferenceshares 160

3,200

18,160

43,600 41.65

(iii)Convertiblebonds 804

1,840

18,964

45,440 41.70

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The convertible bond is seen to have an anti-dilutive effect and therefore must

be excluded from the calculation, giving a diluted EPS of 41.65. This must be

disclosed alongside the basic EPS in the statement of comprehensive income.

Workings

(1) Options

Number of options 2,000,000

Proceeds from exercise at $1.20/option $2,400,000

Market price of a share $1.5

Effective number of shares at full price ($2.4m/1.5) 1,600,000

Effective number of free shares (2m – 1.6m) 400,000

(2) Convertible bonds

Where more than one conversion rate applies, IAS 33 requires the

calculation to be based on the most advantageous rate to the holder. This

will be in the next year at a rate of 23 shares per $250 nominal value of

bonds. Resulting in an additional 1.84 million shares (20million ×

23/250). Post tax interest saved on conversion = $804,000 (6% × $20m ×

0.67).

(3)

Convertible preference shares

Additional ordinary shares created = 3.2m (2 × 1.6m)

Preference dividend saved = $160,000 (10 × 1.6m)

(c)

Nature of diluted EPS

IAS 33 requires that the instruments be considered in order of their dilutive

effect. If this is ignored then the cumulative preference shares would be

considered before the cumulative bonds and the calculation would give a

diluted EPS of 41.70 instead.

DilutedEPS

$000

cents

Net

profit

Ordinary

EPS

BasicEPS 18,000

40,000 45.00

(i)Option

nil

400

18,000

40,400 44.55

(ii)Convertiblebonds 804

1,840

18,804

42,240 44.52

(iii)Convertiblepreferen ceshares 160

3,200

18,964

45,440 41.70

The impact of ignoring the order of the dilutive effects is that the true dilutive

effect on the EPS figure is not reported. Nevertheless, both of these measures

may be of use to users and it may be helpful to disclose both calculations in

Answers

the financial statements. IAS 33 permits additional measures of EPS to be

provided in the notes to the accounts.

(d)

Share equivalents

The basic EPS is calculated using the number of shares actually in issue, and

does not take account of the other instruments in issue that are share

equivalents and so have a dilutive effect. The view may be taken that the

existing measure of basic EPS is unrealistic as at least some of the share

equivalents will convert into shares and so the basic measure is overstated and

meaningless.

If the basic measure of EPS were to be adjusted, one problem would be to

determine which of the instruments may convert. There would also need to be

a standard definition of share equivalents to ensure that all entities prepare

their calculation in the same manner, in order to achieve comparability. The

possibility of conversion may vary from one organisation to the next and it

would be difficult to factor this into the calculation. For example, the decision

to convert a bond into an ordinary share will depend on the market price of a

share as well as the conversion rate. A change in the market price will affect

the possibility of conversion and hence the EPS, but this will be difficult to

predict and calculations would therefore be unstable.

It is therefore preferable to provide users with both the best case (basic) and

the worst case (diluted) EPS scenarios. The true measure of EPS will be

somewhere in between. The calculation of these two measures can be more

easily prescribed and hence the comparability between organisations can be

more carefully controlled.

25 Universal Solutions

(a) (i) Defined benefit pension scheme

The employees of a defined benefit scheme will be guaranteed a pension

based on their final salary and their number of years of service.

Accordingly, the higher paid the employee is on retirement, and the

longer the length of service:

 the greater the employee’s pension entitlement and

 the greater the liability of the pension fund.

An actuary will advise the company of the cash contributions to be paid

into the plan each year in order to provide the promised pensions. This

is a complicated calculation involving many estimates such as employee

mortality, future increases in salary and expected future investment

returns.

The employer has an open-ended liability to make additional

contributions should there be a deficit in the defined benefit pension

fund. A deficit may arise, for example, if salary levels rise more than

expected or staff turnover reduces, increasing service years.

It will be necessary for the actuary to regularly re-value the pension

fund’s assets and liabilities to assess the surplus or deficit position and

revise the company’s contributions.

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(ii) The basis to be adopted in measuring scheme assets

Assets should be measured at their fair value. For quoted securities, for

example, this means their mid-market price.

(iii)

The basis to be adopted in measuring scheme liabilities

Liabilities should be measured on an actuarial basis (i.e. discounted cash

flow), using the projected unit credit method.

The projected unit method is an accrued benefits valuation method in

which the scheme’s liabilities reflect projected future earnings. To derive

the scheme liabilities, the expected future pension payments should be

discounted at a rate that reflects the time value of money, for example,

using an AA (high quality) corporate bond rate.

(iv)

Actuarial gains and losses

Actuarial gains and losses are deficits or surpluses that arise because:

 events have not coincided with the actuarial assumptions made at

the last valuation (experience gains and losses) or

 the actuarial assumptions have changed.

For example, if the actuary forecast that investment returns were going

to be 7% in a year, but in fact the return actually achieved was only 5%,

this would give rise to an actuarial deficit.

(b) Workings

Pensionfund Companyposition

Assets Liabilities Expense

Statement

of

financial

position

$ $ $ $

Openingbalance1JanuaryYear4

1,000 1,000

0

Interestcost(12%×1,000)

120 120 

Currentservicecost

100 100 

Expectedreturn(8%×1,000)

(80) 

Netexpensetocompany

(140)

Contributionstothepensionfund

140

140

Benefitspaidout

(95)



–

–––

–

––––––––––––––––

–

–––

–

–––

–

––––––––––––––––

–

–––

–––––––––––––––––––––

–

–––

Amountsrecordedbycompany

1,125 1,125

0

Actuarialdifference(balance)

25 75

(50)



–

–––

–

–––––––––––––––

–

–––

–

–––

–

––––––––––––––––

–

–––

–––––––––––––––––––––

–

–––

Closingbalance31DecYear4 1,150 1,200

(50)



–

–––

–

––––––––––––––––

–

–––

–

–––

–

––––––––––––––––

–

–––

–––––––––––––––––––––

–

–––

Answers

Answers:

(i) The charge to profit or loss for the year to 31

December Year 4 is $140.

(ii) There is no net pension surplus or deficit recorded by the company as at

31 December Year 4.

(iii) There is an actuarial loss at 31 December Year 4 of $50. Under IAS 19

there are three possible accounting treatments of this:

1. Immediate recognition in profit or loss

2. Immediate recognition in the statement of changes in equity

3. Deferred recognition under the corridor approach. This would

involve recognition, starting in the following period of any

amount of the actuarial loss falling outside the corridor (the

greater of 10% of opening assets liabilities). The recognition may

be spread over the estimated service lives of the employees.

In March 2008 the IASB issued a Discussion Paper in response to recognition

that financial information about post-employment benefit promises is

unsatisfactory and lacks transparency. A particular concern was the way in

which IAS 19 allows entities to delay the recognition of gains or losses on

defined benefit schemes due to the ‘smoothing features’ that it permits. A

consequence of the smoothing features of IAS 19 is that there may be

misleading figures about liabilities in the statement of financial position.

The Discussion Paper therefore proposed that all changes in the value of plan

assets and liabilities should be recognised in the period when they occur (and

there should be no deferral of gains or losses through smoothing).

26 IFRS 2

(a) (i) The need for accounting standard regulation

Share options are often granted to employees at an exercise price that is

higher than the market price of the shares. Therefore, the options have

no intrinsic value to the company and, prior to the issue of IFRS 2, these

transactions were not generally recognised until such time as the shares

were issued. This approach could be seen as resulting in a distortion of

reported results between accounting periods and leaving liabilities

unrecorded.

In addition, the subject of accounting for share-based payments contains

a number of other contentious issues, notably relating to the

measurement principles to be applied in recognising the transactions. If

employees agree to stay until their options vest, the organisation must

recognise the service they will provide in return, but how should this be

valued?

IFRS 2 was therefore issued in February 2004 to provide comprehensive

guidance on these matters.

PaperP2: Corporate reporting (International)

(ii) The three types of share based payments

These can be summarised as follows:

Category Features

Equity-settled share-

based payment

transactions

The entity pays for goods or services by

issuing equity instruments in the form of

shares or share options.

Cash-settled share-based

payment transactions

The entity incurs a liability for goods or

services and the settlement amount is

based on the price (or value) of the entity’s

shares or other equity instruments.

Share based payments

with cash alternatives

Transactions where an entity acquires

goods or receives services and either the

entity or the supplier can choose payment

to be a cash amount based on the price (or

value) of the entity’s shares or other equity

instruments, or equity instruments of the

entity.

(b) (i)

Assuming all options vest

31DecemberYear5

Profitandloss

Equity

Expectedoutcome(atgrantdatevalue)

500employees×100options×$15fairvalue 750,000

3yearstovest ×1/3

Year1charge 250,000

Balancecarriedforward

250,000

31DecemberYear6

Expectedoutcome(atgrantdatevalue)

500×100×$15 750,000

×2/3

Recognisedbytheyearend 500,000

Minusexpensepreviouslyrecognised (250,000)

Year2charge

250,000

Balancecarriedforward

500,000

31DecemberYear7

Actualoutcome(atgrantdatevalue)

500×100×$15 750,000

Minusexpensepreviouslyrecognised (500,000)

Year3charge

250,000

Balanceatendofyear3

750,000

ACCA P2 (INT) Corporate Reporting - Study text - 2010 (Emile Woolf)

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