Part V. Liabilities and equity Liabilities - IAS 37 (provisions) and IFRS for SME par. 21 Provisions * "legal obligation derives from: a contract, legislation" provision is recorded in fin statements where ** "constructive obligation derives from entity's actions where: by an established patter of past practice, published policies the entity has indicated to other parties that it will accept certain responsibilities" an entity has a present bligation (legal* or constructive**) as a result of past event and *** "IAS37 states that an event is porbable if the event is more likely to occu. Practically, this means that if and event has more than 50% likelihood of occuring, then it is probable." it is probable*** that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of obligation Provision is a liability of uncertain timing or amount Measurement the best estimate of the expenditure required to settle the present obligation "if a large population of items is involved, expected values ay be used to measure the required provision." "where time value of money is material, the amount of provision should be discounted to its present value using pre-tax rate. Subsequent unwind of discount is recorded as finance cost in PL." Contingencies Contingent liability a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not whole within the control of the entity or it is a present obligation that arises from past events but it is not recognized because: it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation or the amount of the obligation cannot be measured with sufficient reliability Contingent liability is disclosed in notes to fin statements unless the related outflow of resources embodying economic benefits is remote. Contingent asset Contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurance or non-occurrence of one or more uncertain future events not wholyy within the control of the entity. Contingent asset is disclosed in notes to fin statements unless the related inflow of resources embodying economic benefits is remote. Warranties (legal obligation) "a mnaufacturer gives warrany at the time of sale topurchasers of itproducts. Under the terms of the contract for sale the manufacturer undertakes to make good, by repair or replacement, manufacturing defects that become apparent within given time (e.g. 2 years in CZ) from the date of the sale. On past experience it is probable that there will be some claims." Present obligation as result ofpast event - the obligating event is the sale of the product with warranty (legal obligation) A provision should be recognized for the best estimate of the costs of making good under warranty products sold before BS date. Onerous contract (legal obligation) An onerous contract is a contract in which the aggregate cost required to fulfill the agreement is higher than the economic benefit to be obtained from it Prudence would require that if a future liability is foreseen we shuld recognize it (i.e. provision with uncertain timing) Dr PL Cr Warranty provision https://www.iasplus.com/en/standards/ias/ias37 Restructuring "It inclused sale or termination of business, closure or relocation of a business, change in management structure, fundamental reorganizations. " Provision should be recognized if a constructive obligation exists: detailed formal plan for the restructuring has been identified valid expectation has been raised in those affected thatit will be carried out by either implementing the plan or announcing it to those affected. No obligationb arises for the sale of an operation until the entity is committed to the sale i.e. there is a binding sale agreement. Future repairs or refurbishments some assets require substantial expenditure every few years for major repairs or refurbishments and replacement of major components. Before IAS37 was introduced companies used to created provisions for such future repairs but currently as per IAS37 it is forbidden. Future operating losses No porvision is allowed fr future operating losses. "Equity - there is no specific IFRS for equity; basic guidance can be found in IAS 1, IAS 8, IAS 16, IAS 32 and 39; in IFRS for SME par 22" recognition a. shares are issued before receipt of cash or other assets Share capital e.g. +50 Receivables for shares issued -50 b. cash or other assets have been received before shares are issued Consideration received (bank) Advance received for shares to be issued e.g. +50 measurement a. consideration is received within normal business terms at (FV - transaction costs) b. receipt of consideration is deferred at PV special cases "bonus issue - is an issue of new shares to existing shareholders, in proportion to their existing shareholding, for no cost or consideration. The company receives absolutely no money for it, they’re given away free of charge. By doing this entity reduces market price of its outstanding shares. It also can be considered as reward for loyalty as for each additioanl share every shareholders gets entitlement for dividends (when they will be announced bythe company)" Db Share premium Cr Share capital rights issue (option issue) - issue of options to existing shareholders by using which existing ordinary shareholders can purchase additional ordinary shares with some discount to the fair value of the share in the future. Db Cash Cr Option reserve Db Cash Cr Share capital (Cr Share premium) - if even with discount the new market price of 1 share is still higher than nominal value Db Option reserve Cr Share capital share split - division of issued shares of an entity into a greater number of shares without any further consideration from the shareholders. By doing this entity reduces market price of its outstanding shares => no double entries are required. A memo entry is normally made to reflect the fact that the split has occurred and that the par value has changed proportionally. "treasury shares - an entity's own repurchased shares. By doing this entity increases market price of its outstanding shares (the share count is permanently reduced, which causes the remaining shares present in circulation to represent a larger percentage of shareholder ownership, including dividends and profits)" Db Share capital Cr Cash distributions to shareholders a. monetary distributions Db Retained earnings or Share premium Cr Cash b. nonmonetary distributions Db Retained earnings or Share premium Cr PPE - at FV convertible debt (bond) - can be eitherredeemed for cash or converted into ordinary shares at maturity. Convertible bonds are a type of compound financial instrument with characteristics of both liability and equity. liability and equity components needs to be separated principle as debt compoment - needs to be recorded at amortized cost as fin liability (i.e. by discounting the future cash flows of the bonds (interest and principle) at the rate of a similar debt instrument) option to convert principle into ordinary shares as equity component - needs to be recorded as derivative (equity) i.e. at FVTPL where FV is initially measured as difference between the present value of the liability component of the convertible bond (as mentioned above) and the total proceeds from the issue of such bond. It is residual approach. Db Cash Cr Fin liability - convertable bond at PV Cr Equity - embaded conversion option as balancing figure BONUS issue ##### Sheet/List 2 ##### https://www.accaglobal.com/us/en/technical-activities/technical-resources-search/2018/october/IFRS15-revenue-recognition-steps.html Part VI. Revenue & deferred income tax Revenue - IFRS 15 (replaced IAS18 Revenue and IAS 11 Construction contracts) and IFRS for SME par. 23 general info "new standard specifies how and when a company will recognize Revenue as well as requiring them to provide users of fin statements with more informative, relevant disclosures. This standard provides a single, principles-based 5-step model to be applied to contracts with customers. Its main objective is to report the nature, amount, timing and undertainty of revenue and cash flows arising from a contract with customer." definitions revenue is income arising in the course of an entity's ordinary activities. income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity other than those relating to contributions from equity participants. a contract is an agreement betweent two or more parties that creates enforceable rights and obligations. a customer is a party that has contracted with an entity to obtain goods or services that are an output of entity's ordinary activities in exchange for consideration. recognition - 5-step approach. The effect of this approach is that revenue is recognized when control over the goods or services promised in the contract is provided. 1. Identify the contract "Contract can have a written and non-written form or be implied (contract may not be limited to goods or services explicitly mentioned in a contract, but also include those expected to be delivered due to business practices or statements made)" "Should be approved by parties, and have a commercial basis" Should create enforceable rights and obligations between parties Should have a consideration established taking into account ability and intention to pay New contracts may arise when terms of existing contracts are modified "New contract arises as a result of modifications if a new performance obligation is added to a contract. If a customer orders additional units at a later date, the additional order is considered distinct, even if the order is for identical goods" "Continuation of an existing contract arises when no distinct goods or services are provided as part of the modification. For example: a customer negotiates a discount in relation to units already delivered, for example due to unsatisfactory quality or service relating to the delivered units only." 2. Identify separate performance obligations "A performance obligation is a distinct promise to transfer specific goods or services, distinct from other goods or services" Performance obligation is distinct when its fulfilment is separable from other obligations in the contract – goods or services offered are not integrated or dependent on other goods or services provided already under the contract; the obligation provides goods or services rather than only modifies goods or services already provided The following are examples of circumstances which do not give rise to a performance obligation: providing goods at scrap value activities relating to internal administrative contract set-up "Identifying performance obligations may result in unbundling contracts into performance obligations, or combining contracts into a performance obligation, to recognise revenue correctly." "Unbundling a contract may apply when incentives are offered at the time of sale, such as free servicing or enhanced warranties. In this case servicing and warranties are performance obligations that are distinct and revenue relating to them needs to be recognised separately from the goods or services promised on the contract to which they relate." Circumstances which could result in contracts being combined it is negotiated as a package with a single commercial objective consideration for one contract depends on the price or performance of the other contract 3. Determine the transaction price Transaction price is the most likely value the entity expects to be entitled to in exchange for the promised goods or services supplied under a contract "May include significant financing components and incentives and non-cash amounts offered (all are knows as variable amounts of consideration), which affect how revenue is recognised" "may arise as a result of discounts, rebates, refunds, credits, concessions, incentives, performance bonuses, penalties, and contingent payments" variable consideration is only recognised when it is highly probable that there will not be a significant reversal in the cumulative amount of revenue recognised to date no revenue is recognised if the vendor expects goods to be returned "instead a provision matching the asset is recognised at the same time as the asset, with an adjustment to cost of sales" the restriction results in a later recognition of revenue and profit (once there is certainly the goods will not be returned) in comparison with current accounting variable consideration is measured by reference to two methods "expected value for the contract portfolio (for a large number of contracts), or" single most likely outcome amount (if there are only two potential outcomes) Adjustments for the effects of the time value of money (a ‘financing component’): "if a financing component is significant, IFRS 15 requires an adjustment to be made for the effect of implicit financing" cash received in advance from buyer – vendor to recognise finance cost and increase in deferred revenue cash received in arrears from buyer – vendor to recognise finance income and reduction in revenue no adjustment for a financing component is needed if payment is settled within one year of goods or services transferred no adjustment for a financing component is needed if payment is settled within one year of goods or services transferred consideration is variable and the amount or timing depends on factors outside of parties’ control the difference between the consideration and cash selling price arises for other non-financing reasons (ie performance protection) 4. Allocate transaction price to performance obligations Allocation is based on the standalone selling price of goods or services forming that performance obligation "Allocation of transaction price may include allocation of discounts, which are applied:" "on a proportionate basis to all performance obligations based on the stand-alone selling price of each performance obligation (observable or estimated), or" "to specific performance obligations only, if" observable evidence exists evidencing that the discount relates to those specific obligations only; and Contract modifications may require reassessment how consideration is allocated to performance obligations. 5. Recognise revenue when each performance obligation is satisfied. "The point of revenue recognition is the point when performance obligation is satisfied, per each distinctive obligation" May result in revenue recognition at a point in time or over time Recognition over time applies when: "the customer simultaneously receives and consumes the asset/service as the vendor performs the service, or" "the vendor’s performance creates or enhances an asset (for example, work in progress) that is controlled by the customer as the work progresses." How to recognise revenue over time: "output method - direct measurement of the value of goods or services transferred to date for example per surveys of completion to date, appraisals of results achieved, milestones reached, units produced/delivered; or" "input method - based on measures such as resources consumed, costs incurred (but see below re contract set up costs), number of hours per time sheets or machine hours, which are directly related to the vendor's performance" "The vendor’s performance creates an asset, when:" the asset has no alternative use to the vendor: "the vendor is restricted from using the asset for any other purpose other than selling it to that specific customer, for example" "the asset is manufactured to specific specifications or delivery time, meaning that from the point of commencement of asset creation, it is clear the asset is for a specific customer" "the entity cannot practically or contractually sell the asset to a different customer as it would be practically and contractually prohibitive (for example would require a costly rework, selling at a reduced price, or if customer can prohibit redirection)" "no such practical or contractual limitations would apply if the entity production is that of identical assets in bulk, and those assets are interchangeable" the vendor has an enforceable right to be paid for work completed to date "the vendor does not have an enforceable right to pay when, for example:" terms of contract allow customer to cancel or modify the contract the customer can pay an amount other than the value of the asset or service created to date (ie compensation only) "Capitalisation of costs associated with a sale contract (for example bidding costs, sales commission)" "Only incremental costs of obtaining a contract (which would not have been incurred if the contract had not been obtained) to be considered, for example:" direct sales commissions payable if contract is awarded - include costs of running a legal department proving an across-business legal support function - exclude Capitalise – if expected to be recovered (contract will generate profits) Amortise on a basis that is consistent with the transfer of the goods or services specified in the contract Deferred income tax - IAS 12 and IFRS fo SME par. 29 general info: deferred tax is tax that is payable in the future in respect of taxable temporary differences "temporary differences - differences between the carrying amount of an asset (or liability) within BS and its tax base ie the amount at which the asset (or liability) is valued for tax purposes by the relevant tax authority. Taxable temporary differences are those on which tax will be charged in the future when the asset (or liability) is recovered (or settled)." "Within financial statements, non-current assets with a limited economic life are subject to depreciation. However, within tax computations, non-current assets are subject to capital allowances (also known as tax depreciation) at rates set within the relevant tax legislation. Where at the year-end the cumulative depreciation charged and the cumulative capital allowances claimed are different, the carrying value of the asset (cost less accumulated depreciation) will then be different to its tax base (cost less accumulated capital allowances) and hence a taxable temporary difference arises." example: 2 https://www.accaglobal.com/in/en/student/exam-support-resources/fundamentals-exams-study-resources/f7/technical-articles/deferred-tax.html 1 The movement in the deferred tax liability in the year is recorded in the statement of profit or loss where: increase in liability => increase in tax expense in PL decrease in liability => decerase tax expense in PL 3 Example 2: FA with acquisition price 600 useful life 3 years acc. Dep-n method linear => 200 annual acc. Dep. Charge tax dep. Method 600 in 1st year of useful life 20X1 20X2 20X3 Total EBT " 1,000 " " 1,000 " " 1,000 " " 3,000 " Acc. Dep-n charge 200 200 200 600 Tax. Dep-n charge -600 - - -600 Tax base 600 " 1,200 " " 1,200 " " 3,000 " Current tax expense at 30% (PL) 180 360 360 900 NBV or CA (acc. Value of asset) 400 200 - 600 Tax basis (tax value of asset) - - - - Temporal difference 400 200 - 600 4 Db PL Db Deferred tax liability Differed tax liability (BS) 120 60 - 180 Cr Deferred liability (BS) Cr PL Deferred tax expense (PL) 120 -60 -60 - Total tax expense to PL 300 300 300 900 EBT " 1,000 " " 1,000 " " 1,000 " " 3,000 " Tax expense at 30% -300 -300 -300 -900 EAT 700 700 700 " 2,100 " for assets Acc. Value > Tax base => DTL 5 Acc. Value < Tax base => DTA for liabilities Acc. Value > Tax base => DTA Acc. Value < Tax base => DTL 6 Revaluation of non-current assets and deferred tax "When an NCA is revalued to its current value within the financial statements, the revaluation surplus is recorded in equity (in a revaluation reserve) and reported as other comprehensive income. While the carrying value of the asset has increased, the tax base of the asset remains the same and so a temporary difference arises. Tax will become payable on the surplus when the asset is sold and so the temporary difference is taxable. Since the revaluation surplus has been recognised within equity, to comply with matching, the tax charge on the surplus is also charged to equity. " Asset with acquisition price of 2k and useful life of 4 years (example above) was revalued to 2.5k at the end of 2d year ##### Sheet/List 3 ##### IAS 21 and IFRS for SME par. … recognition Entity level "functional currency - the currency of the primary economic environment in which the entity operates. Since transactions are initially recorded in an entity’s functional currency, the results and financial position would need to be retranslated where this differed to the presentation currency " determinants This currency should be the one in which transactions (purchases/inputs and sales/outputs) are normally denominated (primary factors) and in which the entity normally generates and spends cash (secondary factors) All transactions in currencies other than the functional currency are treated as transactions in foreign currencies. "Once decided on, the functional currency does not change unless there is a change in the underlying nature of the transactions and relevant conditions and events" "presentation currency - the currency in which the financial statements are presented. An entity can present its financial statements in any currency. If the presentation currency differs from the functional currency, the financial statements are retranslated into the presentation currency. If the financial statements of the entity are not in the functional currency of a hyperinflationary economy, then they are translated into the presentation currency as follows:" Assets and liabilities (including any goodwill arising on the acquisition and any fair value adjustment) - at the closing spot rate at the date of that balance sheet Income statements - at the spot rate at the date of the transactions (average rates are allowed if there is no great fluctuation in the exchange rates) All exchange differences are recognised in a separate component of equity (OCI) Group level "At the group level, various entities within a multinational group will often have different functional currencies. The functional currency is identified at entity level for each group entity. Each group entity translates its results and financial position into the presentation currency of the reporting entity." "When preparing group accounts, the financial statements of a foreign subsidiary should be translated into the presentation currency of the Group. Any goodwill and fair value adjustments are treated as assets and liabilities of the foreign entity, and therefore retranslated at each balance sheet date at the closing spot rate." Exchange differences on intra-group items are recognised in profit or loss "When a foreign operation is disposed of, the cumulative amount of the exchange differences in equity relating to that foreign operation is recognised in profit or loss when the gain or loss on disposal is recognised." measurement initial spot ER (approximate rate can be used) subsequent monetary amounts - should be reported using the closing rate. Any differences should be reported in PL except differences arising on monetary items that form part of the reporting entity’s net investment in a foreign operation - these differences are reported in equity (OCI) non-monetary items - any differences should be reported in equity (OCI) measured at historical cost should be reported using the exchange rate at the date of the transaction. "measured at fair value, however, should be reported at the rate that existed when the fair values were determined." "Def: net investment in a foreign operation - monetary items receivable from, or payable to, a foreign operation for which settlement is neither planned nor likely to occur in the foreseeable future (12 months)"