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PGDBFS 103
International Financial
Accounting and Policy
(IFAP)
Malinda Boyagoda BSc. Business Admin (USJP), ACA, ACMA, CGMA, CPA (Bots)
Tutorial 02 : International
Financial Reporting
Standards
May 2019
1
INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRSs)
IFRSs are the set of most commonly adopted generally accepted accounting principles worldwide.
This module describes and demonstrates the requirements of selected IFRSs and also makes
comparison to US GAAPs to indicate differences and similarities.
The type of differences between US GAAPs and IFRS will include: definition differences, recognition
differences, measurement differences, alternative accounting treatments available, lack of
requirements or guidance, presentation differences, disclosure differences
1. Inventories
IAS 2 Inventories provide more extensive guidance compared to US GAAP, especially with regard to
determination of initial cost of inventory, cost formulae to be used in expensing inventory, subsequent
measurement, disclosures etc.
Recognition: An entity should initially recognise inventory when it has control of the inventory, expects
it to provide future economic benefits, and the cost of the inventory can be measured reliably.
Measurement: Initial measurement of inventories should be at cost. After initial recognition,
inventories should be measured at the lower of cost and net realisable value.
Definition of “Cost” - Cost is defined as all costs of purchase, costs of conversion and other costs
incurred in bringing the inventories to their present location and condition.
Costs of purchase comprise the purchase price, including import duties and other taxes (so far as not
recoverable from the tax authorities), transport and handling costs, and any other directly attributable
costs, less trade discounts, rebates and similar items.
The following costs should be excluded from cost of inventories and recognised as expenses as incurred:
abnormal amounts of wasted materials, labour or other production costs;
storage costs, unless those costs are necessary in the production process prior to a further
production stage;
administrative overheads that do not contribute to bringing inventories to their present
location and condition; and
selling costs.
US GAAP IFRS
A variety of inventory costing methodologies such as
LIFO, FIFO, and/or weighted-average cost are
permitted.
Reversals of write-downs are prohibited.
A number of costing methodologies such as FIFO or
weighted-average costing are permitted. The use of LIFO,
however, is precluded.
Reversals of inventory write-downs (limited to the
amount of the original write-down) are required for
subsequent recoveries.
Inventory measurement
In the past there was a difference between US GAAP and IFRS in that US GAAP referred to the lower of cost or
market whereas IFRS referred to the lower of cost and net realizable value.
The FASB released Accounting Standards Update 2015-11 on July 22, 2015, which eliminated this difference. Now
under both US GAAP and IFRS, inventory is measured at the lower of cost and net realizable value. Net realizable
value is defined as the estimated selling price less the costs of completion and sale.
2
2. Property, Plant and Equipment
Recognition: An item of property, plant and equipment is recognised as an asset if: “it is probable that
future economic benefits associated with the item will flow to the entity; and the cost of the item can be
measured reliably.”
Measurement: Items of property, plant and equipment that qualify for recognition should be initially
measured at cost.
Definition of “Cost”
Cost includes the costs of acquiring or constructing the asset and costs incurred subsequently to add to or
replace part of the asset.
Cost is usually the price paid. The cost of a self-constructed asset is the aggregate of the cost of material,
labour and other inputs used in the construction. The cost of an item of property, plant and equipment
comprises:
The purchase price, including import duties and non-refundable purchase taxes less any trade
discounts and rebates
Directly attributable costs of bringing the asset to the location and condition necessary for it to
be capable of operating in the manner intended by management.
The initial estimate of the costs of dismantling and removing the item and restoring the site on
which it is located (decommissioning obligations) if the obligation is incurred either when the
item is acquired or as a consequence of having used the item during a particular period for
purposes other than to produce inventories during that period.
Borrowing costs on qualifying assets.
An item of property, plant and equipment could be acquired in exchange for another non-
monetary asset. The cost of items acquired as such are measured at fair value.
3
Subsequent measurement
The ability to revalue assets (to fair value) under IFRS might create significant differences in the carrying
value of assets as compared with US GAAP.
US GAAP IFRS
US GAAP only allows the cost model
to be used to subsequently measure
fixed assets.
IAS 16 allows two options for reporting fixed assets subsequent to its initial
measurement at cost: (1) cost model (2) revaluation model
Cost model – cost less depreciation and any impairment losses.
Revaluation model – measured at fair value on the date of the revaluation.
If chosen, the revaluations must be done often enough for its carrying value
not be significantly different from fair value.
When revaluations are done the entire class of assets need to be re-valued.
Revaluation gains are credited directly to equity through other comprehensive
income.
Revaluation losses are taken to equity up to any previously recorded
revaluation gains. The remainder is expensed to the Income statement.
Revaluation surplus in equity may be transferred to retained earnings once it
is realized (either through use or sale)
Transaction event US GAAP IFRS
Yr 0 Purchase of a fixed asset
for $100,000
Dr PPE 100,000 Dr PPE 100,000
Yr 1 Useful life of the asset
estimated as 10 years
Cost model adopted and the
asset is depreciated at 10%.
PPE $
Cost 100,000
Dep’n (10,000)
NBV 90,000
Revaluation model adopted
PPE $
Cost 100,000
Dep’n (10,000)
NBV 90,000
Yr 2
Assets is revalued at the
end of Yr2 to $96,000.
PPE $
Cost 100,000
Dep’n (20,000)
NBV 80,000
Dr P&L (Dep’n) $10,000
PPE Option 1 Option 2
Cost 120,000 96,000
Dep’n (24,000) -
NBV 96,000 96,000
Dr: PPE - Revaluation gains : $16,000
Cr: Equity – Revaluation surplus : $16,000
Total asset value and equity reported under IFRS is higher by $16,000
4
Y3
PPE $
Cost 100,000
Dep’n (30,000)
NBV 70,000
Dr P&L (Dep’n) $10,000
PPE $
Cost 96,000
Dep’n ($96k/7yrs) (13,714)
NBV 82,286
Dr P&L (Dep’n) $13,714
Annual depreciation charge (and hence the profits of
Yr 3) is less by 3,714 (13,714 – 10,000) under IFRS.
Yr 4 Asset disposed for
$90,000 at the
beginning of Yr 4
Disposal profit = Sale price –
NBV
[$90,000-$70000 = $20,000]
$
Disposal profit (90k – 82,286) 7,714
Transfer of revaluation surplus
from Equity to P&L
16,000
Total credit to P&L 23,714
Profit for the year is $3,714 more under IFRS.
Depreciation
Deprecation is based on estimated useful lives, taking residual value into account. It should reflect
the pattern in which the assets future economic benefits are expected to be consumed.
US GAAP IFRS
US GAAP generally does not require the component
approach for depreciation.
While it would generally be expected that the
appropriateness of significant assumptions within the
financial statements would be reassessed each reporting
period, there is no explicit requirement for an annual
review of residual values.
IFRS requires that separate significant components of
property, plant, and equipment with different economic
lives be recorded and depreciated separately. (e.g. Air
craft hull and engine are depreciated separately)
The guidance includes a requirement to review residual
values and useful lives at each balance sheet date.
5
3. Investment property
Alternative methods or options of accounting for investment property under IFRS could result in
significantly different asset carrying values (fair value) and earnings.
US GAAP IFRS
There is no specific definition of investment property.
The historical-cost model is used for most real estate
companies and operating companies holding
investment-type property.
Investor entities—such as many investment
companies, insurance companies’, and employee
benefit plans that invest in real estate — carry their
investments at fair value.
The fair value alternative for leased property does not
exist.
Investment property is separately defined as property
(land and/or buildings) held in order to earn rentals
and/or for capital appreciation. The definition does not
include owner occupied property, property held for sale
in the ordinary course of business, or property being
constructed or developed for such sale. Properties
under construction or development for future use as
investment properties are within the scope of
investment properties.
Investment property is initially measured at cost
(transaction costs are included). Thereafter, it may be
accounted for on a historical-cost basis or on a fair
value basis as an accounting policy choice. When fair
value is applied, the gain or loss arising from a change
in the fair value is recognized in the income statement.
The carrying amount is not depreciated.
The election to account for investment property at fair
value may also be applied to leased property.
4. Impairment of assets
An asset cannot be carried in the balance sheet at more than its recoverable amount.
An impairment review compares the asset’s recoverable amount with its carrying value. If the
recoverable amount is lower, the asset is impaired and should be written down to the recoverable
amount.
IAS 36 applies to the impairment of all assets, unless specifically excluded from the standard’s scope.
Assets that are excluded include: Inventories, Deferred tax assets, financial assets that are included
within the scope of IFRS 9, Investment property that is measured at fair value, Biological assets related
to agricultural activity measured at fair value.
US GAAP IFRS
US GAAP requires a two-step impairment test and
measurement model as follows:
Step 1—The carrying amount is first compared with
the undiscounted cash flows. If the carrying amount
is lower than the undiscounted cash flows, no
impairment loss is recognized.
Step 2—If the carrying amount is higher than the
undiscounted cash flows, an impairment loss is
measured as the difference between the carrying
amount and fair value.
IFRS uses a one-step impairment test.
The carrying amount of an asset is compared with the
recoverable amount.
The recoverable amount is the higher of
(1) the asset’s fair value less costs of disposal or
(2) the asset’s value in use.
Fair value less costs of disposal represents the price that
would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market
6
Fair value is defined as the price that would be
received to sell an asset in an orderly transaction
between market participants at the measurement
date (an exit price).
participants at the measurement date less costs of
disposal.
Value in use represents entity-specific future pretax
cash flows discounted to present value by using a
pretax, market-determined discount rate.
If a reversal of an impairment loss has occurred IAS
36 allows the reversal to be recognized in the income
statement.
US GAAPs do not allow previously recognized
impairment losses to be reversed.
Example – calculation of impairment losses
Assume an asset with following characteristics:
Carrying amount 50,000
Selling price 40,000
Cost of disposal 1,000
Expected future cash flows 55,000
Present value of expected future cash flows 46,000
IFRS – IAS 36
Recoverable amount = higher of; net selling rice and value in use
= higher of : (40,000-1,000) or 46,000
= 46,000
Impairment = Carrying amount less recoverable amount = 50,000 – 46,000 = 4,000.
US GAAP
Carrying value = $50,000
Expected future cash flows (undiscounted) = $ 55,000
Expected future cash flows exceed the carrying amount, therefore, no impairment is recognized.
7
5. Intangible assets
An intangible asset is defined as “an identifiable non-monetary asset without physical substance”.
The key characteristics of an intangible asset are that it:
is a resource controlled by the entity from which the entity expects to derive future
economic benefits;
lacks physical substance;
is identifiable to be distinguished from goodwill.
Examples of intangible assets – computer software costs, patents, copy rights, franchises, customer
loyalty, import quotas, brands
An intangible asset could be acquired in following ways:
i. Purchased from an external party. [e.g. a patent right purchased from its owner]
ii. Acquired in a business combination [e.g. Brand name of a subsidiary acquired by the
parent)
iii. Internally generated intangibles [e.g. loyalty of its own customers / value of the company’s
own brand name]
Purchased intangibles
Purchased intangible assets should be measured on initial recognition at cost.
Its useful life is assed as finite (e.g. a 5 year copy right) or infinite (e.g. brand name).
Finite intangibles – cost is amortised on a systematic basis over the useful life.
Infinite life – No amortization. Asset is assessed for impairment annually.
Intangible assets acquired in a business combination
The cost of an intangible asset acquired in a business combination is its fair value at the acquisition date.
Under both IAS 38 and US GAAP intangibles such as patents, trademarks and customer lists acquired in a
business combination should be recognized as an asset apart from goodwill.
Its useful life is assed as finite or infinite.
Internally generated intangibles
The cost of an internally generated intangible asset that meets the recognition criteria is the sum of
directly attributable expenditure incurred to create, produce and prepare the asset so that it is capable of
operating in the manner intended by management.
Examples of internally generated intangible assets: computer software costs, patents, copy rights,
franchises, import quotas, mining licenses.
8
US GAAP IFRS
In general, both research costs and
development costs are expensed as incurred,
making the recognition of internally generated
intangible assets rare.
However, separate, specific rules apply in
certain areas. For example, there is distinct
guidance governing the treatment of costs
associated with the development of software for
sale to third parties.
Costs associated with the creation of intangible assets are
classified into research phase costs and development
phase costs.
(1) Costs in the research phase are always expensed.
(2) Costs in the development phase are capitalized, if all of the
following six criteria are demonstrated:
The technical feasibility of completing the intangible asset
The intention to complete the intangible asset
The ability to use or sell the intangible asset
How the intangible asset will generate probable future
economic benefits (the entity should demonstrate the
existence of a market or, if for internal use, the usefulness
of the intangible asset)
The availability of adequate resources to complete the
development and to use or sell it
The ability to measure reliably the expenditure attributable
to the intangible asset.
Development Expenditures on internally generated brands,
publishing titles, customer lists, and items similar in substance
cannot be distinguished from the cost of developing the
business as a whole. Therefore, such items are not recognized as
intangible assets.
Development costs initially recognized as expenses cannot be
capitalized in a subsequent period.
Revaluation model
US GAAP IFRS
Revaluation of intangible assets is not allowed. IAS 38 Allows the use of the revaluation model for intangible
assets with finite lives, but only if the intangible asset has a
price that is available on an active market (a condition rarely
met in practice).
Application of the revaluation model and accounting for
revaluation gains/losses is similar to PPE.
9
6. Borrowing costs
Prior to the revision of IAS 23 – Borrowing costs in 2007, it provided two methods of accounting for
borrowing costs.
1. Benchmark treatment: expense all borrowing costs in the period incurred.
2. Allowed alternative treatment: capitalize borrowing costs to the extent they are attributable to the
acquisition, construction or production of a qualifying asset (an asset that takes a substantial
period to get ready for tis intended use/sale); other borrowing costs are expensed as incurred.
Adoption of the benchmark treatment was not acceptable under US GAAP. Under the IASB-FASB
convergence project, IAS 27 was revised in 2007, whereby the benchmark treatment was eliminated.
Borrowing costs under IFRS are broader and can include more components than interest costs under US
GAAP. E.g. IAS 23 specifically includes foreign exchange gains/losses on foreign currency borrowings.
7. Leases
The objective of IAS 17 is to prescribe, for lessees and lessors, the appropriate accounting policies and
disclosures to apply in relation to leases.
A lease is defined as an agreement whereby the lessor conveys to the lessee in return for a payment or
series of payments the right to use an asset for an agreed period of time.
Classification of leases
All leases must be classified as either finance leases or operating leases. The classification of leases
under IAS 17 is based on the extent to which risks and rewards incidental to ownership of a leased asset
lie with the lessor or the lessee.
Examples “risks” - possibilities of losses from idle capacity, technological obsolescence,
variations in return, because of changing economic conditions.
Examples “rewards” - expectation of profitable operation over the asset’s life and of gain from
the appreciation in value of the asset’s residual value
A finance lease is defined as “... a lease that transfers substantially all the risks and rewards incidental
to ownership of an asset”. Thus, a finance lease is an arrangement that has the substance of a financing
transaction for the lessee to acquire effective economic ownership of an asset.
An operating lease is “... a lease other than a finance lease”.
The following examples of situations, individually or in combination, would normally lead to a lease being
classified as a finance lease:
The lease transfers ownership of the asset to the lessee by the end of the lease term.
The lessee has the option to purchase the asset at a price that is expected to be sufficiently
lower than the fair value at the date the option becomes exercisable for it to be reasonably
certain, at the inception of the lease, that the option will be exercised.
The lease term is for the major part of the economic life of the asset, even if title is not
transferred.
10
At the inception of the lease, the present value of the minimum lease payments amounts to at
least substantially all of the fair value of the leased asset.
The leased assets are of a specialised nature such that only the lessee can use them without
major modifications being made.
The following situations, individually or in combination, could also lead to a finance lease classification:
If the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne
by the lessee.
Gains or losses from the fluctuation in the residual’s fair value fall to the lessee (for example,
in the form of a rent rebate equalling most of the sales proceeds at the end of the lease).
The lessee has the ability to continue the lease for a secondary period at a rent that is
substantially lower than market rent.
Lease classification example:
On 1 Jan 2010 ABC entered into lease with XYZ for a pre-owned airplane, and the terms of the
lease are as follows:
a) Lease term – 7 years
b) Annual lease payments of $3,000 due on Dec 31
c) Fair value of the airplane at inception of the lease is $20,000
d) Airplane has a 10 year remaining economic life
e) Estimated residual value is $5,124.
f) ABC has the option to purchase the airplane at the end of the lease term for $8,000
g) Implicit interest rate of the lease is 5%
h) Ownership is not transferred at the end of the lease term
i) The lease may not be extended.
Should this lease be classified as finance lease or operating lease?
11
Finance lease indicator Indicator present?
Transfers ownership of the asset to the
lessee at the end of the lease term.
The lessee bargain purchase option
The lease term is for the major part of
the economic life of the asset.
The present value of the minimum
lease payments amounts to at least
substantially all of the fair value of
the leased asset.
The leased assets are of a specialised
nature such that only the lessee can
use them without major modifications
being made.
The lease transfers ownership of the
asset to the lessee by the end of the
lease term.
The lessee has the option to purchase
the asset at a price that is expected to
be sufficiently lower than the fair
value.
The leased assets are of a specialised
nature
Conclusion
12
Accounting for finance leases
A finance lease should be recorded in a lessee’s balance sheet both as an asset and as an obligation to pay
future rentals. At the commencement of the lease term, the sum to be recognised both as an asset and as a
liability should be the lower of the fair value of the leased asset and the present value of the minimum
lease payments.
Leased assets and leased liabilities are presented separately and gross in the balance sheet.
In calculating the present value of the minimum lease payments, the discount factor is the interest rate
implicit in the lease (i.e. the rate that will discount the future lease rentals to the fair value of the leased
asset at inception), if this is practicable to determine, if not, the lessee’s incremental borrowing rate shall
be used.
An asset leased under a finance lease should be depreciated over the shorter of the lease term and its
useful life, unless there is a reasonable certainty that the lessee will obtain ownership of the asset by the
end of the lease term, in which case it should be depreciated over its useful life.
An entity applies IAS 36 to determine whether a leased asset has become impaired in the same way as for
assets that are owned by the entity.
Accounting for operating leases
Operating leases should not be capitalised. Lease payments made under operating leases should be
recognised as an expense on a straight-line basis over the lease term, unless another systematic basis is
more representative of the time pattern of the user’s benefit.
The requirement to spread the lease payments on a straight-line basis over the lease term applies even if
the payments are not made on such a basis.
Accounting for sale and leaseback transactions - Finance leasebacks
A finance leaseback is essentially a financing operation for the seller. The seller/lessee never disposes of
the risks and rewards of ownership of the asset, and so it should not recognise a profit or loss on the sale.
Any apparent profit (that is, the difference between the sale price and the previous carrying value) should
be deferred and amortised over the lease term. This treatment will have the effect of adjusting the overall
charge to the income statement, for the depreciation of the asset, to an amount consistent with the asset’s
carrying value before the leaseback.
Illustration – Sale and lease back
Entity A owns a freehold interest in a building. Entity A sells the building to bank B and leases it back for a
period of 20 years. This is believed to be a major part of the building’s economic life. The main facts about
the building and the lease are as follows:
Book value of the building $700,000
Sales proceeds $1,000,000
Lease rentals years 1 - 20 $88,218
Interest rate implicit in lease 7%
Present value of minimum lease payments $1,000,000
13
The leaseback of the building is for a major part of the building’s economic life, and so the lease should be
treated as a finance lease. Entity A will therefore record the following double entries:
On sale:
Dr Cash $1,000,000
Cr Building $700,000
Cr Deferred income $300,000
to recognise the sale of the building.
Dr Assets held under finance lease $1,000,000
Cr Finance lease creditor $1,000,000
to set up the finance leased asset and liability.
Years 1-20:
Dr Deferred income $15,000
Cr Profit & loss $15,000
to release the deferred income over the lease term (C300,000/20).
Dr Depreciation $50,000
Cr Assets held under finance lease $50,000
to recognise depreciation on the leased asset (C1,000,000/20).
Dr Interest (profit & loss) X
Dr Finance lease creditor (88,218 − X)
Cr Cash 88,218
to record rentals paid.
Operating leases – Disclosures
Lessees shall make the following disclosures for operating leases:
The total of future minimum lease payments under non-cancellable operating leases for each of the
following periods:
a) not later than one year;
b) later than one year and not later than five years;
c) later than five years.
US GAAPS require disclosure of the amount to be paid in each of the next 5 years (year 1 to 5) by year, as
well as the amount to be paid later than 5 years as a single amount.
14
US GAAP vs IFRS
US GAAP IFRS
The guidance for leases (ASC 840, Leases) applies
only to property, plant, and equipment.
Although the guidance is restricted to tangible
assets, entities can analogize to the lease guidance
for leases of software.
The scope of IFRS lease guidance (IAS 17, Leases) is not
restricted to property, plant, and equipment. Accordingly, it
may be applied more broadly (for example, to some intangible
assets and inventory).
The guidance under ASC 840 contains four specific
criteria for determining whether a lease should be
classified as an operating lease or a capital lease by
a lessee. The criteria for capital
lease classification broadly address the following
matters:
Ownership transfer of the property to the
lessee
Bargain purchase option
Lease term in relation to economic life of the
asset
Present value of minimum lease payments in
relation to fair value of the leased asset
The criteria contain certain specific quantified
thresholds such as whether the lease term equals or
exceeds 75% of the economic life of the leases asset
(“75% test”) or the present value of the minimum
lease payments equals or exceeds 90% of the fair
value of the leased property (“90% test”).
The guidance under IAS 17 focuses on the overall substance of
the transaction.
Lease classification as an operating lease or a finance lease
(i.e., the equivalent of a capital lease under US GAAP) depends
on whether the lease transfers substantially all of the risks and
rewards of ownership to the lessee.
Although similar lease classification criteria identified in US
GAAP are considered in the classification of a lease under
IFRS, there are no quantitative breakpoints or bright lines to
apply (e.g.,90%).
Under IFRS there are additional indicators/potential
indicators that may result in a lease being classified as a
finance lease. For example, a lease of special-purpose assets
that only the lessee can use without major modification
generally would be classified as a finance lease. This would
also be the case for any lease that does not subject the lessor to
significant risk with respect to the residual value of the leased
property.
Under ASC 840, land and building elements
generally are accounted for as a single unit of
account, unless the land represents 25% or more of
the total fair value of the leased property.
Under IAS 17, land and building elements must be considered
separately, unless the land element is not material.
This means that nearly all leases involving land and buildings
should be bifurcated into two components, with separate
classification considerations and accounting for each
component.
The lease of the land element should be classified based on a
consideration of all of the risks and rewards indicators that
apply to leases of other assets.
Accordingly, a land lease would be classified as a finance lease
if the lease term were long enough to cause the present value
of the minimum lease payments to be at least substantially all
of the fair value of the land.
In determining whether the land element is an operating or a
finance lease, an important consideration is that land normally
has an indefinite economic life.
15
IFRS 16 Leases - IASB / FASB Convergence project
The IASB published IFRS 16 Leases in January 2016 with an effective date of 1 January 2019. The new
standard requires lessees to recognise nearly all leases on the balance sheet which will reflect their right to
use an asset for a period of time and the associated liability for payments.
Under existing rules, lessees account for lease transactions either as operating or as finance leases,
depending on complex rules and tests which, in practice, these result in all or nothing being recognised on
balance sheet for sometimes economically similar lease transactions.
The impact on a lessee’s financial reporting, asset financing, IT, systems, processes and controls is
expected to be substantial. Many companies lease a vast number of leased items, including cars, offices,
equipment, power plants, retail stores, cell towers, aircrafts etc.
Therefore, lessees will be greatly affected by the new leases standard. The lessors’ accounting largely
remains unchanged
The distinction between operating and finance leases is eliminated for lessees, and a new lease asset
(representing the right to use the leased item for the lease term) and lease liability (representing the
obligation to pay rentals) are recognised for all leases (except for the exempted short term leases and low
value asset leases)
Lessees should initially recognise a right-of-use asset and lease liability based on the discounted payments
required under the lease.
The new standard will affect virtually all commonly used financial ratios and performance metrics such as
gearing, current ratio, asset turnover, interest cover, EBITDA, EBIT, operating profit, net income, EPS,
ROCE, ROE and operating cash flows. These changes may affect loan covenants, credit ratings and
borrowing costs, and could result in other behavioral changes. These impacts may compel many
organisations to reassess certain ‘lease versus buy’ decisions.
16
DISCLOSURE AND PRESENTATION STANDARDS
8. Statement of cash flows
IAS 7 requires all entities to prepare a cash flow statement as an integral part of their financial statements
for each period for which financial statements are presented.
Cash flows must be classified and reported according to the activity which gave rise to them. There are three standard activities:
operating activities;
investing activities; and
financing activities.
Cash flows from operating activities
IAS 7 defines operating activities as “the principal revenue-producing activities of the entity and other
activities that are not investing or financing activities”.
Examples of cash flows that are expected to be classified as operating activities:
receipts from the sale of goods and the rendering of services;
payments to suppliers for goods and services;
payments to and on behalf of employees;
payments and refunds of income taxes
Where an entity deals or trades in securities, this is equivalent to inventory in a retail entity, and this
activity will be treated as an operating activity. Similarly, financial institutions will classify cash flows in
relation to loan advances to customers within operating activities.
Operating cash flows could be reported using either the direct method or the indirect method. The
standard encourages, but does not require, reporting entities to use the direct method.
Cash flow from investing activities
IAS 7 defines ‘investing activities’ as “the acquisition and disposal of long-term assets and other
investments not included in cash equivalents”.
Examples of cash flows expected to be classified as investing activities:
Payments to acquire long-term assets (e.g. property, plant and equipment)
Receipts from sales of long-term assets.
Payments to acquire equity or debt instruments of other entities.
Receipts from the sale of equity or debt instruments of other entities held as investments.
Advances and loans made to other parties (other than those made by a financial institution).
Receipts from the repayment of advances and loans made to other parties (other than those received by a financial institution).
17
Cash flow from financing activities
IAS 7 defines ‘financing activities’ as “activities that result in changes in the size and composition of the
contributed equity and borrowings of the entity”.
Examples of the cash flows expected to be classified as arising from financing activities:
receipts from the issue of shares or other equity instruments;
payments to acquire or redeem the entity’s shares;
receipts from the issue of debentures or other borrowings;
repayments of amounts borrowed;
Interest and dividend cash flows
IAS 7 does not dictate how dividends and interest cash flows should be classified, but rather allows an entity to determine the classification appropriate to its business.
It is generally accepted that dividends received and interest paid or received in respect of a financial institution’s cash flows will be classified as operating activities, but the classification is not so clear cut for other entity types.
The standard allows the following presentation for interest and dividends received and paid, provided that the presentation selected is applied on a consistent basis from period to period:
Interest and dividends received in operating or investing activities.
Interest and dividends paid in operating or financing activities.
9. Events after the reporting period
IAS 10 applies to the accounting and disclosure of events that happen between the balance sheet date and
the date when the financial statements are authorised for issue.
IAS 10 distinguishes between events that require changes in the amounts to be included in the financial
statements (‘adjusting events’) and events that only require disclosure (‘non-adjusting events’). The
classification of an event depends on whether it provides additional information about conditions already
existing at the balance sheet date, or it indicates conditions that arose after the balance sheet date.
Adjusting event - an event that provides additional evidence relating to conditions that existed at the
balance sheet date.
Example:
The settlement of a court case after the balance sheet date that confirms that the entity had a present
obligation at the balance sheet date
A non-adjusting event - an event that arises after the balance sheet date that is indicative of conditions
that arose after the balance sheet date
An entity discloses the nature of the event, and an estimate of its financial effect, for each material
category of non-adjusting event.
Example:
The destruction of a major production plant by fire after the balance sheet date.
Commencing major litigation arising solely out of events that occurred after the balance sheet date.
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10. Related party disclosures
IAS 24’s objective is to ensure that financial statements contain the disclosures necessary to draw
attention to the possibility that the reported financial position and results might have been affected by the
existence of related parties and by transactions and outstanding balances, including commitments, with
them.
‘Related parties’ of an entity includes:
Persons with control or joint control over the reporting entity;
Persons with significant influence over the reporting entity; or
Members of the key management personnel of the reporting entity or of a parent of the reporting entity.
Members of the same group (e.g. fellow subsidiaries of a group)
11. Earnings per share
Earnings per share (EPS) is a ratio that is widely used by financial analysts, investors and other users to
gauge an entity’s profitability and to value its shares. Its purpose is to indicate how effective an entity has
been in using the resources provided by the ordinary shareholders, and to assess the entity’s current net
earnings. EPS also forms the basis for calculating the ‘price-earnings ratio’, which is widely used by
investors and analysts to value shares.
IAS 33 prescribes the principles for the determination and presentation of EPS.
IAS 33 applies to the following entities:
Those whose ordinary shares are traded in a public market (e.g. a domestic or foreign stock
exchange).
Those that file, or are in the process of filing, financial statements with a securities
commission or other regulatory body for the purpose of issuing ordinary shares in a public
market (that is, not private placements).
Basic EPS should be calculated by dividing the profit or loss for the period attributable to the parent
entity’s ordinary equity holders by the weighted average number of ordinary shares outstanding during
the period.
12. Operating segments
The core principle (and objective) of IFRS 8 is to require an entity to disclose information that enables users
of the financial statements to evaluate the nature and financial effects of the business activities in which the
entity engages and the economic environments in which it operates
IAS 33 applies to the following entities:
Those whose ordinary shares are traded in a public market.
Those that file, or are in the process of filing, financial statements with a securities commission or
other regulatory body for the purpose of issuing ordinary shares in a public market.
An operating segment is defined as a component of an entity:
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that engages in business activities from which it could earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity);
whose operating results are regularly reviewed by the entity’s CODM to make decisions about resources to be allocated to the segment and assess its performance; and
for which discrete financial information is available.
An entity should disclose information about reportable segments, to enable users of the financial statements
to evaluate the nature and financial effects of the business activities in which the entity engages and about
the economic environments in which it operates.
Specified amounts that should be disclosed relating to each reportable segment o revenues from external customers; o inter-segment revenue; o interest revenue; o interest expense; o depreciation and amortisation; o income tax expense or income; and o material non-cash items other than depreciation and amortisation