Tag: Nepal Financial Reporting Standards (NFRS)

Nepal Financial Reporting Standards (NFRS) are designed as a common global language for business affairs so that company accounts are understandable and comparable within Nepal.

  • Ratios and Financial measures of performance – Ratio analysis

    Ratios and Financial measures of performance – Ratio analysis

    Overview

    Ratios are useful for assessing the performance of a company. When ratios are used to compare different companies, the comparability is affected if companies use different accounting policies to prepare their financial statements. These Ratios summary notes are prepared by mindmaplab team and covering, Ratios revised amendment, the key definitions, full standard with illustrative examples, the financial ratios analysis, accounting ratio, performance ratios, types of ratio analysis, the key and important financial ratios, ratio analysis in management accounting, the use of ratio analysis, including the most important financial ratios to analyze a company. This is actually a financial ratios cheat sheet. This is the Ratio and Trend analysis full text guide; we have also prepared Ratio and Trend analysis pdf version download.

    IAS Standards

    IAS 2 Inventories       

    IAS 7 Statements of cash flows

    IAS 7 Statement of cash flows  – Revisited

    IAS 8 Accounting policies, changes in accounting estimates, and errors

    IAS 10 Events after the reporting period       

    IAS 12 Income taxes 

    IAS 16 Property, plant and equipment          

    IAS 17 Leases

    IAS 19 Employee benefits     

    IAS 20 Accounting for government grants and disclosure of government assistance          

    IAS 21 The effects of changes in foreign exchange rates     

    IAS 23 Borrowing costs        

    IAS 24 Related party disclosures

    IAS 27 Consolidated and separate financial statements        

    IAS 28 Investments in associates and joint ventures 

    IAS 32 Financial instruments: presentation  

    IAS 33 Earnings per share

    IAS 33 Earnings per share – Revisited          

    IAS 36 Impairment of assets 

    IAS 37 Provisions, contingent liabilities and contingent assets        

    IAS 38 Intangible assets

    IAS 40 Investment property

    IFRS Standards

    IFRS 3 Business combinations    

    IFRS 5 Non-current assets held for sale and discontinued operations    

    IFRS 7 Financial instruments: disclosures          

    IFRS 8 Operating segments         

    IFRS 9 Financial instruments      

    IFRS 10 Consolidated financial statements        

    IFRS 11 Joint arrangements         

    IFRS 12 Disclosure of interests in other entities 

    IFRS 13 Fair value measurement 

    IFRS 15 Revenues from contracts with customers          

    IFRS 16 Leases

    IAS 17 VS IFRS 16 Lease – Differences

    Ratio Analysis

    Categories of financial ratios

    Ratios can be divided into five categories:

    Categories of financial ratios

    *Remember that when a ratio is calculated, it is important to compare ‘like with like’.

    Profitability ratios

    This category of ratios measures the performance of the company in terms of the return (profit) earned on the capital employed in the business. These ratios are relevant for measuring the success of management in using the resources and allow customers and suppliers to assess whether the company has the ability to continue operating successfully in the future.

    Return on (total) capital employed (ROCE)

    The return on capital employed ratio measures profit before interest and tax with the total capital employed in the business. It is therefore a measure of the success of the company in making use of its invested capital.

    Profit before interest and tax x 100

    Share capital + reserves + debt capital

    Return on shareholders’ funds (ROSF)

    The return on shareholders’ funds (ROSF) or return on shareholders’ capital (ROSC) measures the return on the capital invested by shareholders.

    In a company with no preference shares and no non-controlling interests, this ratio is calculated as follows:

    Profit before tax x 100

    Share capital + reserves

    When a company has non-controlling interests or preference shares, you need to decide on the most suitable method of calculating the ratio.

    Using ROCE or ROSF – It is not necessary to calculate both these ratios. The ratio that you calculate should be the ratio that is of the greatest interest to the particular user or user group.

    Gross profit percentage

    The gross profit margin is the ratio of gross profit to sales income.

    This ratio should normally remain fairly constant from one year to the next. Even a fairly small change in the ratio might indicate that something of significance has happened.

    Variations between years may be attributable to:

    • a change in sales prices
    • a change in sales mix
    • a change in purchase/production costs
    • an exceptional write-off of inventory

    Gross profit x 100

    Sales

    Overhead percentage

    Overhead percentage ratios measure the ratio of overhead costs to sales revenue. The main overhead costs are administrative expenses and sales and distribution costs.

    The ratio of variable overhead costs to sales revenue should remain constant from one year to the next, unless something of significance happens

    The ratio of fixed overhead costs to sales revenue should decrease as the company grows and increases its annual revenue.

    Overheads x 100

    Sales

    Efficiency ratios

    Cash flow is the lifeblood of an entity. Cash is needed to maintain operations by paying suppliers and employees, and to allow the company to grow.

    The operating cycle (also called the cash cycle) refers to the continuous cycle of business activities, whereby an entity spends cash to acquire materials, labour and other resources, and eventually recovers its cash (with a profit) by selling goods or services to customers and collecting payment.

    Poor working capital management and an inefficient cash cycle mean inadequate cash flows.

    When an entity ties up capital in excessive working capital (inventory and trade receivables) its ROCE will be lower than it should be, and it may need to borrow money to meet its obligations.

    Several working capital efficiency ratios are useful for assessing the efficiency of working capital management and management of the operating cycle/cash cycle.

    Inventory turnover

    Inventory turnover is a measure of how quickly an entity uses its inventory. It is also a measure of how slowly an entity uses its inventory, and how long items are held in inventory before they are eventually used or sold.

    Inventory turnover may be measured as ‘x times a year’.

    Cost of Sales

    Average Inventory

    A low turnover indicates inefficient use of resources. The slower inventory turnover, the greater the risk of obsolescence.

    Inventory turnover may also be measured as an average number of days, rather than as ‘x times a year’.

    Average Inventory x 365

    Cost of Sales

    This calculates the number of days a company takes to sell its average holding of inventory.

    Separate turnover ratios could be calculated for:

    • raw materials
    • work in progress (the production cycle), and
    • finished goods

    Receivables turnover

    It is sometimes called ‘debtor days’ or ‘days sales outstanding’. The receivables turnover ratio is usually measured in days. It is the average time that it takes an entity to collect amounts due from customers.

    Average Trade Receivables x 365

    Credit Sales

    The ratio should ideally use credit sales, but the financial statements do not provide an analysis of sales into cash sales and credit sales. Therefore, total sales must normally be used, and this may produce an unrealistic ratio.

    A change in the ratio from one year to the next may be due to:

    • A change in settlement terms for credit customers, to encourage new business
    • the introduction of debt factoring, which will reduce the average receivables collection period
    • exceptional factors, such as one large new customer being offered extended credit.

    Payables payment period

    It is the average payment period to suppliers. It is normally measured in days.

    Average Trade Payables x 365

    Credit Purchases

    The ratio should ideally use purchases on credit. However, this figure is not available from the financial statements, and the figure for the annual cost of sales should be used instead.

    Short-term liquidity ratios

    Short-term liquidity ratios are used to assess the ability of an entity to have sufficient cash, normally from its normal business cycle/cash cycle, to settle payments when they become due.

    The ratios can be used together with information in the statement of cash flows to analyse the liquidity (and cash flows) of the entity.

    Current ratio

    Liquidity comes from current assets, including cash. The need for liquidity comes from the need to settle current liabilities.

    The current ratio is simply a ratio that compares short-term sources of cash (current assets) with short-term needs for cash (current liabilities).

    Current assets

    Current liabilities

    As a very rough guide, an ‘ideal’ current ratio may be 1.5:1 or 2:1. A ratio of less than 1:1 could indicate liquidity problems, because the entity might be unable to obtain cash from normal business activities to settle its current liabilities.

    Quick ratio (acid test ratio)

    Inventory turnover could be very slow. In such cases, inventory is not a liquid asset and will not generate cash within a fairly short period of time in order to pay off the current obligations due in the next month or so.

    The quick ratio or acid test ratio is similar to the current ratio, but it excludes inventory from current assets.

    Current assets (less) Inventory

    Current liabilities

    By eliminating inventory, the quick ratio measures a worst-case-scenario. It can be used to ask the question: Does the entity appear to have sufficient cash and near cash assets (including receivables) to provide the money to settle all current liabilities on time?

    ‘Ideally’ the quick ratio should be about 0.8:1 to 1.0:1.

    Long-term solvency ratios

    A company finances its net assets with a combination of equity and reserves and long-term debt. An entity is ‘high geared’ when a large proportion of its long-term capital is in the form of debt. High financial gearing is seen as a high-risk strategy.

    Gearing’ examines the financing structure of a business and indicates to shareholders the level of financial risk to which the company is exposed because of its long-term capital structure.

    These ratios, and changes in the ratios over time, can help them to assess the credit risk in their investment.

    Gearing ratio

    The gearing ratio (or leverage ratio) is usually calculated as follows:

    Debt or    Debt x 100

    Equity    Equity + Debt

    Debt = Loans + Preference shares 

    Equity = Equity share capital + reserves + non-controlling interest

    Notes on financial gearing

    • A highly geared company, with a substantial proportion of its capital in the form of debt, is seen by investors as ‘more risky’.
    • High gearing is acceptable if it is accompanied by stable annual profits (PBIT) or increasing profits.
    • A highly-geared company may find it more difficult to raise additional debt capital.

    Interest cover

    The interest cover ratio measures the ability of a company to meet its obligations to pay interest on debt (out of its profits).

    The ratio therefore compares profit before interest and tax with the annual interest charges.

    Profit before interest

    Interest

    A high interest cover suggests a sensible financing structure.

    An interest cover of 2 times or less generally indicates that the company might have difficulty paying its interest if there is a fall in its profits.

    Investor ratios

    Four widely-used ratios are:

    1. earnings per share
    2. the P/E ratio
    3. dividend yield
    4. dividend cover

    Dividend yield

    The dividend yield measures the annual cash return (dividends) that equity shareholders are receiving on their investment.

    Net dividend per share + tax credit x 100

    Current market share price

    Where there is no system of tax credits on dividend payments, the figure for dividends is simply the annual cash dividends paid to shareholders.

    Dividend cover

    The dividend cover ratio measures the earnings of a company relative to the size of its dividend payments.

    EPS

    Net dividend per share

    Limitations of financial ratios

    Most of the data for calculating financial ratios comes from the financial statements.

    • The reliability of ratios is therefore affected by the reliability of the financial statements themselves.
    • When ratios are used to compare different companies, the comparability is affected if companies use different accounting policies to prepare their financial statements.
  • IFRS 13 Fair Value Measurement

    IFRS 13 Fair Value Measurement

    Overview

    IFRS 13 Fair Value Measurement – The purpose of IFRS 13 is to: define fair value, set out a single framework for measuring fair value, specify disclosures about fair value measurement. These IFRS 13 summary notes are prepared by mindmaplab team and covering, IFRS 13 revised amendment, the key definitions, full standard with illustrative examples, with IFRS 13 disclosure requirements, IFRS 13 fair value measurement, fair value hierarchy, valuation techniques, IFRS 13 highest and best use method. This is the IFRS 13 full text guide; we have also prepared IFRS 13 pdf version download.

    IAS Standards

    IAS 2 Inventories       

    IAS 7 Statements of cash flows

    IAS 7 Statement of cash flows  – Revisited

    IAS 8 Accounting policies, changes in accounting estimates, and errors

    IAS 10 Events after the reporting period       

    IAS 12 Income taxes 

    IAS 16 Property, plant and equipment          

    IAS 17 Leases

    IAS 19 Employee benefits     

    IAS 20 Accounting for government grants and disclosure of government assistance          

    IAS 21 The effects of changes in foreign exchange rates     

    IAS 23 Borrowing costs        

    IAS 24 Related party disclosures

    IAS 27 Consolidated and separate financial statements        

    IAS 28 Investments in associates and joint ventures 

    IAS 32 Financial instruments: presentation  

    IAS 33 Earnings per share

    IAS 33 Earnings per share – Revisited          

    IAS 36 Impairment of assets 

    IAS 37 Provisions, contingent liabilities and contingent assets        

    IAS 38 Intangible assets

    IAS 40 Investment property

    IFRS Standards

    IFRS 3 Business combinations    

    IFRS 5 Non-current assets held for sale and discontinued operations    

    IFRS 7 Financial instruments: disclosures          

    IFRS 8 Operating segments         

    IFRS 9 Financial instruments      

    IFRS 10 Consolidated financial statements        

    IFRS 11 Joint arrangements         

    IFRS 12 Disclosure of interests in other entities 

    IFRS 13 Fair value measurement 

    IFRS 15 Revenues from contracts with customers          

    IFRS 16 Leases

    IAS 17 VS IFRS 16 Lease – Differences

    Ratio Analysis

    There are many instances where particular IAS / IFRS requires or allows entities to measure or disclose the fair value of assets, liabilities or their own equity instruments.

    Purpose of IFRS 13

    The purpose of IFRS 13 is to:

    • define fair value
    • set out a single framework for measuring fair value
    • specify disclosures about fair value measurement.

    IFRS 13 does not change what should be fair valued nor when this should occur.

    IFRS 13 does not apply to:

    • share based payment transactions within the scope of IFRS 2
    • Leasing transactions accounted for in accordance with IFRS 16 Leases
    • measurements such as net realisable value (IAS 2 Inventories) or value in use (IAS 36 Impairment of Assets) which have some similarities to fair value but are not fair value.

    The IFRS 13 disclosure requirements do not apply to the following:

    • plan assets measured at fair value (IAS 19: Employee benefits)
    • retirement benefit plan investments measured at fair value (IAS 26: Accounting and reporting by retirement benefit plans); and
    • assets for which recoverable amount is fair value less costs of disposal in accordance with IAS 36.

    IFRS 13 Definition

    1. Fair value – Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e. it is an exit price).

    Note that the fair value is an exit price, i.e. the price at which an asset would be sold.

    1. Exit price – The price that would be received to sell an asset or paid to transfer a liability.
    2. Entry price – The price paid to acquire an asset or received to assume a liability in an exchange transaction.
    3. Unit of account – The level at which an asset or a liability is aggregated or disaggregated in an IFRS for recognition purposes.
    4. Most advantageous market – The market that maximises the amount that would be received to sell the asset or minimises the amount that would be paid to transfer the liability, after taking into account transaction costs and transport costs.
    5. Principal market – The market with the greatest (highest) volume and level of activity for the asset or liability.
    6. Highest and best use – The use of a non-financial asset by market participants that would maximise the value of the asset or the group of assets and liabilities (e.g. a business) within which the asset would be used.
    7. Inputs – The assumptions that market participants would use when pricing the asset or liability, including assumptions about risk, such as the following:
      • the risk inherent in a particular valuation technique used to measure fair value (such as a pricing model); and
      • the risk inherent in the inputs to the valuation technique.

    Measuring Fair value

    Fair value measurement assumes that the asset (liability) is exchanged in an orderly transaction between market participants to sell the asset (transfer the liability) at the measurement date under current market conditions.

    If an active market exists then it will provide information that can be used for fair value measurement.

    If there is no such active market (e.g. for the sale of an unquoted business or surplus machinery) then a valuation technique would be necessary.

    Principal or most advantageous market

    • Fair value measurement is based on a possible transaction to sell the asset or transfer the liability in the principal market for the asset or liability.
    • If there is no principal market fair vale measurement is based on the price available in the most advantageous market for the asset or liability.
    • Unless there is evidence to the contrary, principal market (or failing that, the most advantageous market) is the one in which an entity normally enters into transactions sell the asset or to transfer the liability being fair valued.
    • If there is a principal market for the asset or liability, the fair value measurement must use the price in that market even if a price in a different market is potentially more advantageous at the measurement date.
    • The price in a principle market might either be directly observable or estimated using a valuation technique.

    Transaction costs and Transport costs

    • The price in the principal (or most advantageous) market used to measure the fair value of the asset (liability) is not adjusted for transaction costs.
    • The price in the principal (or most advantageous) market is adjusted for the costs that would be incurred to transport the asset from its current location to that market.

    IFRS 13 Transaction costs and Transport costs EXAMPLE

    Fair value of non-financial assets – highest and best use

    Fair value measurement of a non-financial asset must value the asset at its highest and best use.

    *The current use of land is presumed to be its highest and best use unless market or other factors suggest a different use.

    Valuation Techniques

    An entity must use a valuation technique that is appropriate in the circumstances and for which sufficient data is available to measure fair value, maximising the use of relevant observable inputs and minimising the use of unobservable inputs.

    Quoted price in an active market provides the most reliable evidence of fair value and must be used to measure fair value whenever available.

    Fair value hierarchy

    IFRS 13 establishes a fair value hierarchy to categorise inputs to valuation techniques into three levels.

    Level 1 – Quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date (e.g. Share price quoted on the Stock Exchange).

    Level 2 – Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly (e.g. Quoted price of a similar asset to the one being valued).

    Level 3 – Unobservable inputs for the asset or liability. (e.g. Cash flow projections).

    LIABILITIES AND AN ENTITY’S OWN EQUITY INSTRUMENTS

    General principles

    The fair valuation of an entity’s own equity instrument assumes that market participant to whom the instrument could be transferred would take on the rights and responsibilities associated with the instrument.

    The same guidance that applies to the fair value of assets also applies to the fair value of liabilities and an entity’s own equity instruments including that:

    • an entity must maximise the use of relevant observable inputs and minimise the use of unobservable inputs; and
    • quoted price in an active market must be used to measure fair value whenever available.

    In the absence of an active market there might be an observable market for items held by other parties as assets.

    IFRS 13 Disclosure

    The fair value measurement of assets and liabilities might be recurring or non-recurring.

    • Recurring fair value measurements are those that are required or permitted in the statement of financial position at the end of each reporting period (e.g. the fair value of investment property when the IAS 40 fair value model is used);
    • Non-recurring fair value measurements are those that are required or permitted in the statement of financial position in particular circumstances (e.g. when an entity measures an asset held for sale at fair value less costs to sell in accordance with IFRS 5).

    Disclosures are necessary in respect of each of the above.

    Information must be disclosed to help users assess both of the following:

    • the valuation techniques and inputs used to measure the fair value assets and liabilities on a recurring or non-recurring basis;
    • the effect on profit or loss or other comprehensive income for the period of recurring fair value measurements using significant unobservable inputs (Level 3).
  • IFRS 12 Disclosure of interests in other entities

    IFRS 12 Disclosure of interests in other entities

    Overview

    IFRS 12 Disclosure of interests in other entities – The objective of IFRS 12 is to require companies to disclose information that enables users of their financial statements to evaluate: the nature of, and risks associated with, its interests in other entities; and the effects of those interests on its financial position, financial performance and cash flows. These IFRS 12 summary notes are prepared by mindmaplab team and covering, IFRS 12 revised amendment, the key definitions, full standard with illustrative examples, with IFRS 12 disclosure requirements, IFRS 12 disclosure of interests in other entities, structured entity IFRS 12. This is the IFRS 12 full text guide; we have also prepared IFRS 12 pdf version download.

    IAS Standards

    IAS 2 Inventories       

    IAS 7 Statements of cash flows

    IAS 7 Statement of cash flows  – Revisited

    IAS 8 Accounting policies, changes in accounting estimates, and errors

    IAS 10 Events after the reporting period       

    IAS 12 Income taxes 

    IAS 16 Property, plant and equipment          

    IAS 17 Leases

    IAS 19 Employee benefits     

    IAS 20 Accounting for government grants and disclosure of government assistance          

    IAS 21 The effects of changes in foreign exchange rates     

    IAS 23 Borrowing costs        

    IAS 24 Related party disclosures

    IAS 27 Consolidated and separate financial statements        

    IAS 28 Investments in associates and joint ventures 

    IAS 32 Financial instruments: presentation  

    IAS 33 Earnings per share

    IAS 33 Earnings per share – Revisited          

    IAS 36 Impairment of assets 

    IAS 37 Provisions, contingent liabilities and contingent assets        

    IAS 38 Intangible assets

    IAS 40 Investment property

    IFRS Standards

    IFRS 3 Business combinations    

    IFRS 5 Non-current assets held for sale and discontinued operations    

    IFRS 7 Financial instruments: disclosures          

    IFRS 8 Operating segments         

    IFRS 9 Financial instruments      

    IFRS 10 Consolidated financial statements        

    IFRS 11 Joint arrangements         

    IFRS 12 Disclosure of interests in other entities 

    IFRS 13 Fair value measurement 

    IFRS 15 Revenues from contracts with customers          

    IFRS 16 Leases

    IAS 17 VS IFRS 16 Lease – Differences

    Ratio Analysis

    Introduction to IFRS 12

    IFRS 12 must be applied by a company that has an interest in any of the following:

    1. subsidiaries;
    2. joint arrangements (i.e. joint operations or joint ventures);
    3. associates;
    4. unconsolidated structured entities.

    The objective of IFRS 12 is to require companies to disclose information that enables users of their financial statements to evaluate:

    • the nature of, and risks associated with, its interests in other entities; and
    • the effects of those interests on its financial position, financial performance and cash flows.

    Significant judgements and assumptions

    A company must disclose information about significant judgements and assumptions it has made in determining:

    • that it has control of another entity;
    • that it has joint control of an arrangement or significant influence over another entity; and
    • the type of joint arrangement (i.e. joint operation or joint venture) when the arrangement has been structured through a separate vehicle.

    Interests in subsidiaries

    A company must disclose information that enables users of its consolidated financial statements:

    • to understand the composition of the group and the interest that non-controlling interests have in the group’s activities and cash flows; and
    • to evaluate the consequences of changes in its ownership interest in a subsidiary that do not result in a loss of control and of losing control of a subsidiary during the reporting period.

    When the financial statements of a subsidiary used in the preparation of consolidated financial statements are as of a date or for a period that is different from that of the consolidated financial statements, a company must disclose the date of the end of the reporting period of the financial statements of that subsidiary the reason for using a different date or period.

    Non-controlling interests

    A company must disclose for each of its subsidiaries that have non-controlling interests that are material to the reporting entity:

    • the name and the principal place of business of the subsidiary
    • the proportion of ownership interests held by non-controlling interests
    • the profit or loss allocated to non-controlling interests of the subsidiary during the reporting period

    Interests in joint arrangements and associates

    A company must disclose information that enables users of its financial statements to evaluate:

    • the nature, extent and financial effects of its interests in joint arrangements and associates,
    • the nature of, and changes in, the risks associated with its interests in joint ventures and associates.

    Nature, extent and financial effects of interests in joint arrangements and associates

    A company must disclose:

    • the name and the nature of the entity’s relationship with the joint arrangement or associate.
    • the principal place of business and the proportion of ownership interest or participating share held by the entity.
    • The method used for measurement (equity method or at fair value).

    Risks associated with an entity’s interests in joint ventures and associates

    A company must disclose:

    • commitments that it has relating to its joint ventures
    • contingent liabilities incurred relating to its interests in joint ventures or associates

    Structured entities

    Structured entity – An entity that has been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements.

    A structured entity might be consolidated or unconsolidated depending on the results of the analysis of whether control exists.

    Consolidated structured entities

    • A company must disclose the terms of any contractual arrangements that could require the parent or its subsidiaries to provide financial support to a consolidated structured entity.
    • A company must also disclose any support given where there is no contractual obligation and any intention to provide financial or other support to a consolidated structured entity.

    Unconsolidated structured entities

    A company must disclose information that enables users of its financial statements:

    • to understand the nature and extent of its interests in unconsolidated structured entities; and
    • to evaluate the nature of, and changes in, the risks associated with its interests in unconsolidated structured entities.
  • IFRS 11 Joint arrangements

    IFRS 11 Joint arrangements

    Overview

    IFRS 11 Joint arrangements – A joint arrangement has the following characteristics: The parties are bound by a contractual arrangement; and the contractual arrangement gives two or more of those parties joint control of the arrangement. These IFRS 11 summary notes are prepared by mindmaplab team and covering, IFRS 11 revised amendment, the key definitions, full standard with illustrative examples, with IFRS 11 disclosure requirements. This IFRS 11 is a guide for dummies as well as for professionals. This is the IFRS 11 full text guide; we have also prepared IFRS 11 pdf version download.

    IAS Standards

    IAS 2 Inventories       

    IAS 7 Statements of cash flows

    IAS 7 Statement of cash flows  – Revisited

    IAS 8 Accounting policies, changes in accounting estimates, and errors

    IAS 10 Events after the reporting period       

    IAS 12 Income taxes 

    IAS 16 Property, plant and equipment          

    IAS 17 Leases

    IAS 19 Employee benefits     

    IAS 20 Accounting for government grants and disclosure of government assistance          

    IAS 21 The effects of changes in foreign exchange rates     

    IAS 23 Borrowing costs        

    IAS 24 Related party disclosures

    IAS 27 Consolidated and separate financial statements        

    IAS 28 Investments in associates and joint ventures 

    IAS 32 Financial instruments: presentation  

    IAS 33 Earnings per share

    IAS 33 Earnings per share – Revisited          

    IAS 36 Impairment of assets 

    IAS 37 Provisions, contingent liabilities and contingent assets        

    IAS 38 Intangible assets

    IAS 40 Investment property

    IFRS Standards

    IFRS 3 Business combinations    

    IFRS 5 Non-current assets held for sale and discontinued operations    

    IFRS 7 Financial instruments: disclosures          

    IFRS 8 Operating segments         

    IFRS 9 Financial instruments      

    IFRS 10 Consolidated financial statements        

    IFRS 11 Joint arrangements         

    IFRS 12 Disclosure of interests in other entities 

    IFRS 13 Fair value measurement 

    IFRS 15 Revenues from contracts with customers          

    IFRS 16 Leases

    IAS 17 VS IFRS 16 Lease – Differences

    Ratio Analysis

    Introduction

    • A controlling interest in an investee results in an investment (a subsidiary) which is consolidated.
    • A fairly small interest in the equity shares of another company would give no influence of any kind and such investments are treated as follows:
    • The shares are shown in the statement of financial position as long-term assets (an investment) and valued in accordance with IFRS 9; and
    • Any dividends received for the shares are included in profit or loss for the year as other income.
    • Still other investments might result in joint control or significant influence. The rules for accounting for these are given in:
    • IFRS 11 Joint Arrangements: and
    • IAS 28 Investments in Associates and Joint ventures.

    IFRS 11 Definitions

    Joint arrangement – A joint arrangement is an arrangement of which two or more parties have joint control.

    Joint control – is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control.

    Separate vehicle – A separate vehicle is a separately identifiable financial structure, including separate legal entities or entities recognised by statute, regardless of whether those entities have a legal personality.

    Joint arrangements

    A joint arrangement has the following characteristics:

    1. The parties are bound by a contractual arrangement; and
    2. The contractual arrangement gives two or more of those parties joint control of the arrangement.

    A party to a joint arrangement is an entity that participates in a joint arrangement, regardless of whether that entity has joint control of the arrangement.

    Contractual arrangement

    • Any contractual arrangement will usually be evidenced in writing, between the parties.
    • A joint arrangement might be structured through a separate vehicle.
    • Any contractual arrangement sets out the terms upon which the parties participate in the activity that is the subject of the arrangement and would generally deal with such matters as:
    1. the purpose, activity and duration of the joint arrangement.
    2. how the members of the board of directors, of the joint arrangement, are appointed.
    1. the decision-making process (the matters requiring decisions from the parties, the voting rights of the parties and the required level of support for those matters).
    1. the capital or other contributions required of the parties.
    2. how the parties share assets, liabilities, revenues, expenses or profit or loss relating to the joint arrangement.

    Joint control

    IFRS 11 states that decisions about the relevant activities require unanimous consent of all parties that collectively control the arrangement.

    It is not necessary for every party to the arrangement to agree in order for unanimous consent to exist.

    IFRS 11 Types of joint arrangements

    There are two types of joint arrangement. A joint arrangement is either a joint operation or a joint venture.

    1. Joint operation – A joint operation is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. Those parties are called joint operators.
    2. Joint venture – A joint venture is a joint arrangement where the parties that have joint control of the arrangement have rights to the net assets of the arrangement. Those parties are called joint venturers.

    *Investors may or may not establish a joint arrangement as a separate vehicle.

    • IFRS 11 says that if a joint arrangement is not structured through a separate vehicle it MUST be a joint operation.
    • If a joint arrangement is structured through a separate vehicle it could be a joint operation or a joint venture.

    *For a joint arrangement to be a joint venture, it is the separate vehicle that must have the rights to the assets and the obligations to the liabilities with the investor only having an interest in the net assets of the entity. If an investor has a direct interest in specific assets and direct obligation for specific liabilities of the separate vehicle then the joint arrangement is a joint operation.

    Accounting for joint operations and joint ventures

    Joint operations

    A joint operator must recognise the following in its own financial statements:

    1. its assets, including its share of any assets held jointly;
    2. its liabilities, including its share of any liabilities incurred jointly;
    3. its revenue from the sale of its share of the output arising from the joint operation;
    4. its share of the revenue from the sale of the output by the joint operation; and
    5. its expenses, including its share of any expenses incurred jointly.

    Joint ventures

    A joint venturer must recognise its interest in a joint venture as an investment and account for it using the equity method in accordance with IAS 28 Investments in Associates and Joint Ventures.

  • IFRS 10 Consolidated Financial Statements

    IFRS 10 Consolidated Financial Statements

    Overview

    IFRS 10 Consolidated Financial Statements – Guidance on the process of consolidation is set out in two standards, IFRS 3 Business Combinations and IFRS 10 Consolidated Financial Statements. IFRS 10 explains that a business under the control of another is a subsidiary and the controlling entity is the parent. These IFRS 10 summary notes are prepared by mindmaplab team and covering, IFRS 10 revised amendment, the key definitions, full standard with illustrative examples, IFRS 10 investment entity, IFRS 10 control, IFRS 10 exemption from consolidation, objective of IFRS 10, IFRS 10 special purpose entities, with IFRS 10 disclosure requirements. This IFRS 10 is a guide for dummies as well as for professionals. This is the IFRS 10 full text guide; we have also prepared IFRS 10 pdf version download.

    IAS Standards

    IAS 2 Inventories       

    IAS 7 Statements of cash flows

    IAS 7 Statement of cash flows  – Revisited

    IAS 8 Accounting policies, changes in accounting estimates, and errors

    IAS 10 Events after the reporting period       

    IAS 12 Income taxes 

    IAS 16 Property, plant and equipment          

    IAS 17 Leases

    IAS 19 Employee benefits     

    IAS 20 Accounting for government grants and disclosure of government assistance          

    IAS 21 The effects of changes in foreign exchange rates     

    IAS 23 Borrowing costs        

    IAS 24 Related party disclosures

    IAS 27 Consolidated and separate financial statements        

    IAS 28 Investments in associates and joint ventures 

    IAS 32 Financial instruments: presentation  

    IAS 33 Earnings per share

    IAS 33 Earnings per share – Revisited          

    IAS 36 Impairment of assets 

    IAS 37 Provisions, contingent liabilities and contingent assets        

    IAS 38 Intangible assets

    IAS 40 Investment property

    IFRS Standards

    IFRS 3 Business combinations    

    IFRS 5 Non-current assets held for sale and discontinued operations    

    IFRS 7 Financial instruments: disclosures          

    IFRS 8 Operating segments         

    IFRS 9 Financial instruments      

    IFRS 10 Consolidated financial statements        

    IFRS 11 Joint arrangements         

    IFRS 12 Disclosure of interests in other entities 

    IFRS 13 Fair value measurement 

    IFRS 15 Revenues from contracts with customers          

    IFRS 16 Leases

    IAS 17 VS IFRS 16 Lease – Differences

    Ratio Analysis

    International accounting standards and group accounts

    The following standards relate to accounting for investments:

    • IFRS 3 Business combinations
    • IFRS 10 Consolidated financial statements
    • IFRS 11 Joint Arrangements
    • IAS 27 Separate financial statements
    • IAS 28 Investments in associates and joint ventures

    Guidance on the process of consolidation is set out in two standards, IFRS 3 Business Combinations and IFRS 10 Consolidated Financial Statements.

    Introduction to IFRS 10

    IFRS 10 explains that a business under the control of another is a subsidiary and the controlling entity is the parent.

    IFRS 10 covers the on-going rules related to consolidation. It is IFRS 10 that requires:

    1. that the financial statements of Parent and Subsidiary be prepared using uniform accounting policies;
    2. the consolidated assets, liabilities, income and expenses are those of the parent and its subsidiaries added on a line by line basis;
    3. the elimination of unrealised profit on intra group transactions; and
    4. the cancellation of intra group balances.
    5. IFRS 10 explains how to account for disposals.

    IFRS 10 Definitions

    Control – An investor controls an investee when:

    1. it is exposed, or has rights, to variable returns from its involvement with the investee; and
    2. it has the ability to affect those returns through its power over the investee.

    Non-controlling interest (NCI) – the equity in a subsidiary not attributable to a parent.

    The non-controlling interest may be stated as either:

    • a proportionate share of the identifiable assets acquired and liabilities assumed; or
    • at fair value as at the date of acquisition

    Consolidated financial statements – The financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity.

    The requirement to prepare consolidated accounts

    An entity that is a parent must present consolidated financial statements. There is an exception to this rule.

    A parent need not present consolidated financial statements if (and only if) it meets all of the following conditions:

    1. The parent itself (X) is a wholly-owned subsidiary, with its own parent (Y).
    2. Alternatively, the parent (X) is a partially-owned subsidiary, with its own parent (Y), and the other owners of X are prepared to allow it to avoid preparing consolidated financial statements.
    3. The parent’s debt or equity instruments are not traded in a public market.
    4. The parent does not file its financial statements with a securities commission for the purpose of issuing financial instruments in a public market.
    5. The parent’s own parent, or the ultimate parent company (for example, the parent of the parent’s parent), does produce consolidated financial statements for public use that comply with International Financial Reporting Standards.

    The following might be given as spurious justification for failing to consolidate a particular subsidiary:

    1. The subsidiary’s activities are dissimilar from those of the parent, so that the consolidated financial statements might not present the group’s financial performance and position fairly.
    2. Obtaining the information needed would be expensive and time-consuming and might delay the preparation of the consolidated financial statements.
    3. The subsidiary operates under severe long-term restrictions, so that the parent is unable to manage it properly.

    Investment entities exemption

    An investment entity might take shares in another entity in order to make gains through dividends or capital appreciation, not to become involved in business of that entity.

    An investment entity must not consolidate the entities that it controls but it must measure them at fair value through profit or loss in accordance with IFRS 9 Financial Instruments.

    An entity is an investment entity only if it meets all of the following criteria:

    1. Its only substantive activities are investing in multiple investments for capital appreciation, investment income (dividends or interest), or both.
    2. It has made an explicit commitment to its investors that its purpose of investment is to earn capital appreciation, investment income (dividends or interest), or both.
    3. Ownership in the entity is represented by units of investments, such as shares or partnership interests, to which proportionate shares of net assets are attributed.
    4. The funds of its investors are pooled so that they can benefit from professional investment management.
    5. It has investors that are unrelated to the parent (if any), and in aggregate hold a significant ownership interest in the entity.
    6. Substantially all of the investments of the entity are managed, and their performance is evaluated, on a fair value basis.
    7. It provides financial information about its investment activities to its investors.

    Group financial statements – Disposals

    IFRS 10 Consolidated Financial Statements contains rules on accounting for disposals of a subsidiary.

    Accounting for a disposal is an issue that impacts the statement of profit or loss.

    There are two major tasks in constructing a statement of profit or loss for a period during which there has been a disposal of a subsidiary:

    1. The statement of profit or loss must reflect the pattern of ownership of subsidiaries in the period.
    2. When control is lost, the statement of profit or loss must show the profit or loss on disposal of the subsidiary.

    The rules in IFRS 10 cover full disposals and part disposals.

    Full disposals

    Profit or loss on disposal

    IFRS 10 specifies an approach to calculating the profit or loss on disposal.

    This approach involves comparing the asset that is recognised as a result of the disposal (i.e. the proceeds of the sale) to the amounts that are derecognised as a result of the disposal.

    IFRS 10 Profit or loss on disposal

    The calculation of profit or loss on disposal must be supported by several other calculations. These are:

    • the goodwill arising on acquisition, which in turn needs the net assets of the subsidiary at the date of acquisition; and
    • the net assets of the subsidiary at the date of disposal, which in turn needs a calculation of the equity reserves at the date of disposal.

    Part disposals

    When a parent makes a part disposal of an interest in a subsidiary it will be left with a residual investment. The accounting treatment for a part disposal depends on the nature of the residual investment. Whether part disposal:

    • results in loss of control
    • does not results in loss

    Part disposal with loss of control

    If a part disposal results in loss of control the parent must recognise a profit or loss on disposal in the consolidated statement of profit or loss.

    IFRS 10 Part disposal with loss of control

    Part disposal with no loss of control

    A part disposal which does not result in loss of control is a transaction between the owners of the subsidiary. In this case the parent does not recognise a profit or loss on disposal in the consolidated statement of profit or loss. Instead the parent recognises an equity adjustment.

    The double entry to record the equity adjustment is:

    Cash                                                                      Dr.

    Non-controlling interest (new)                                 Cr.

    Retained earnings                                                           Cr.

  • IFRS 9 Financial Instruments

    IFRS 9 Financial Instruments

    Overview

    IFRS 9 Financial Instruments – The rules on financial instruments are set out in three accounting standards: IFRS 9 Financial Instruments, IAS 32 Financial instruments: Presentation, IFRS 7 Financial instruments: Disclosure. IFRS 9 applies to all financial assets and liabilities except for those specifically scoped out of the standard. These IFRS 9 summary notes are prepared by mindmaplab team and covering, IFRS 9 revised amendment, the key definitions, full standard with illustrative examples, the sppi test, IFRS 9 impairment, expected credit loss (ecl) IFRS 9, lifetime ecl, hedge accounting, expected credit loss, impairment of financial assets, poci IFRS 9, financial assets at amortized cost, sicr IFRS 9, compound financial instruments IFRS 9 with IFRS 9 disclosure requirements. This IFRS 9 is a guide for dummies as well as for professionals. This is the IFRS 9 full text guide; we have also prepared IFRS 9 pdf version download.

    IAS Standards

    IAS 2 Inventories       

    IAS 7 Statements of cash flows

    IAS 7 Statement of cash flows  – Revisited

    IAS 8 Accounting policies, changes in accounting estimates, and errors

    IAS 10 Events after the reporting period       

    IAS 12 Income taxes 

    IAS 16 Property, plant and equipment          

    IAS 17 Leases

    IAS 19 Employee benefits     

    IAS 20 Accounting for government grants and disclosure of government assistance          

    IAS 21 The effects of changes in foreign exchange rates     

    IAS 23 Borrowing costs        

    IAS 24 Related party disclosures

    IAS 27 Consolidated and separate financial statements        

    IAS 28 Investments in associates and joint ventures 

    IAS 32 Financial instruments: presentation  

    IAS 33 Earnings per share

    IAS 33 Earnings per share – Revisited          

    IAS 36 Impairment of assets 

    IAS 37 Provisions, contingent liabilities and contingent assets        

    IAS 38 Intangible assets

    IAS 40 Investment property

    IFRS Standards

    IFRS 3 Business combinations    

    IFRS 5 Non-current assets held for sale and discontinued operations    

    IFRS 7 Financial instruments: disclosures          

    IFRS 8 Operating segments         

    IFRS 9 Financial instruments      

    IFRS 10 Consolidated financial statements        

    IFRS 11 Joint arrangements         

    IFRS 12 Disclosure of interests in other entities 

    IFRS 13 Fair value measurement 

    IFRS 15 Revenues from contracts with customers          

    IFRS 16 Leases

    IAS 17 VS IFRS 16 Lease – Differences

    Ratio Analysis

    Introduction to Financial Instruments

    The rules on financial instruments are set out in three accounting standards:

    1. IFRS 9 Financial Instruments
    2. IAS 32 Financial instruments: Presentation
    3. IFRS 7 Financial instruments: Disclosure

    IFRS 9 applies to all financial assets and liabilities except for those specifically scoped out of the standard.

    Examples of scope exclusions are:

    • investment in a subsidiary
    • lease receivables
    • entity’s own equity
    • Financial guarantees are accounted for (as a financial liability) under IFRS 9 unless the entity has “previously asserted explicitly” that it regards such contracts as insurance contracts. In this case the entity can elect to apply IFRS 4: Insurance Contracts or IFRS 9 on a contract by contract basis.
    • Contracts to buy or sell non-financial items are not financial assets or liabilities.

    * If the contract can be net settled it is within the scope of the standard.

    IFRS 9 defines net settlement very widely with the result that many derivatives on non-financial items are within the scope of the standard. Thus IFRS 9 says that a contract is net settled in either of the following circumstances:

    1. when the ability to net settle is not explicit in the terms of the contract, but the entity has a practice of net settling similar contracts;
    2. when an entity has a practice of taking delivery of the underlying and selling it within a short period after delivery for the purpose of generating a profit from short-term fluctuations in price or dealer’s margin.
    3. when the terms of the contract permit either party to settle it net; or
    4. when the non-financial item that is the subject of the contract is readily convertible to cash.

    Definitions

    Financial Instrument – A financial instrument is a contract that gives rise to both:

    • a financial asset in one entity, and
    • a financial liability or equity instrument in another entity.

    Financial Asset – A financial asset is any asset that is:

    • cash;
    • an equity instrument of another entity;
    • a contractual right – to receive cash or another financial asset from another entity; or to exchange financial assets or financial liabilities with another entity.

    Financial Liability – A financial liability is any liability that is a contractual obligation:

    • to deliver cash or another financial asset to another entity; or
    • to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity.

    Amortised cost – The amount at which the financial asset or financial liability is measured at initial recognition minus the principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount and, for financial assets, adjusted for any loss allowance.

    Credit loss – The difference between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive (i.e. all cash shortfalls), discounted at the original effective interest rate.

    Lifetime expected credit losses – The expected credit losses that result from all possible default events over the expected life of a financial instrument.

    12-month expected credit losses – The portion of lifetime expected credit losses that represent the expected credit losses that result from default events on a financial instrument that are possible within the 12 months after the reporting date.

    Derivatives

    A derivative is a financial instrument with all three of the following characteristics:

    1. Its value changes in response to a specified underlying (interest rate, commodity price, exchange rate etc.); and
    2. It requires no or little initial investment; and
    3. It is settled at a future date.

    Categories of derivatives

    Derivatives can be classified into two broad categories:

    1. Forward arrangements (commit parties to a course of action)
      • Forward contracts
      • Futures
      • Swaps
    2. Options (Gives the option buyer a choice over whether or not to exercise his rights under the contract).

    Forward arrangements

    Forward contracts

    A forward contract is a contract to buy or sell a specified amount of a specified item (commodity or financial item) on a specified date at a specified price. it has zero fair value at the date it is entered into. Over the life of the contract its fair value will depend on the spot exchange rates and the time to the end of the contract.

    Futures

    They can be traded. A company can enter into a futures contract and then may make a gain or a loss on the market just like any other traded item. If a company holds futures, they might be an asset or a liability at any particular date.

    Swaps

    A swap is an agreement between parties to exchange cash flows related to an underlying obligation. The most common type of swap is an interest rate swap. A swap might be recorded as an asset or liability at any particular date.

    Options

    The holder of the option has entered into a contract that gives it the right but not the obligation to buy (call option) or sell (put option) a specified amount of a specified commodity at a specified price.

    Holding an option is therefore similar to an insurance policy: it is exercised if the market price moves adversely.

    The option holder is required to pay a sum of money (a premium) to the option seller. This premium is paid when the option is arranged, and non-refundable if the holder later decides not to exercise his rights under the option.

    From the point of view of the holder the option will only ever be recorded as an asset. At initial recognition this would be the amount of the premium.

    Using derivatives

    A company can enter into a transaction involving a derivative for one of two reasons:

    1. to speculate, and hope to make a profit from favourable movements in rates or prices; or
    2. to hedge (protect) against exposure to a particular risk.

    *Speculating in derivatives may expose entities to huge risks, if expectations do not come true and the price of the underlying item moves the ‘wrong way’.

    Initial recognition and measurement of financial instruments

    A financial instrument should initially be measured at fair value. This is usually the transaction price. If the transaction price differs from the fair value a gain or loss would be recognised on initial recognition.

    Transaction costs – Incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or financial liability. The accounting treatment for transaction costs depends on how the instrument is subsequently measured.

    IFRS 9 accounting treatment for transaction costs

    Financial instruments measurement methods

    The two measurement methods required by IFRS 9 are:

    1. Amortised cost
    2. Fair value

    Amortised cost method

    Amortised cost is a measurement technique that can be applied to both financial assets and financial liabilities.

    IFRS 9 specifies that interest (to be recognised in profit and loss each year) should be calculated using the effective rate, which is calculated on initial recognition. Therefore, the amortised cost as calculated at each period end is always the present value of the future cash flows discounted at the effective rate.

    Amortisation table of a financial liability (from the borrower’s viewpoint):

    IFRS 9 Amortisation table of a financial liability (from the borrower viewpoint)

    Amortisation table of a financial asset (from the lender’s viewpoint):

    IFRS 9 Amortisation table of a financial asset (from the lender’s viewpoint)

    *The only difference is the naming of the balances (amortised cost for financial liabilities and gross carrying amount for financial assets).

    The final carrying amount for a financial asset carried at amortised cost is in fact made up of two balances being the gross carrying amount of the financial asset less the loss allowance.

    The lender would show the following amounts in its financial statements at each year end (where figures for a loss allowance have been made up):

    IFRS 9 loss allowance

    * The recognition of a loss allowance results in a lower value in the books of the lender to that in the books of the borrower for the same instrument.

    Amortised cost and credit-impaired assets

    An entity might purchase or issue a credit-impaired financial asset. A financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred.

    Such financial assets might need to be carried at amortised cost.

    Fair value

    Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e. it is an exit price).

    IFRS 13 defines an active market as a market in which transactions for the asset (liability) take place with sufficient frequency and volume to provide pricing information on an on-going basis.

    Valuation techniques

    IFRS 13 requires that one of three valuation techniques must be used:

    1. market approach
    2. cost approach
    3. income approach

    *Quoted price in an active market provides the most reliable evidence of fair value and must be used to measure fair value whenever available.

    Classification and measurement of financial assets

    Financial assets must be classified into one of three categories on initial recognition. This classification of a financial asset drives its subsequent measurement. The three categories are:

    1. financial assets at amortised cost;
    2. financial assets at fair value with gains and losses recognised in other comprehensive income (described as fair value through OCI or FVOCI); or
    3. financial assets at fair value with gains and losses recognised in profit or loss (described as fair value through P&L or FVPL).

    The classification is based on an assessment of the business model followed for holding the financial asset and the cash flow characteristics of the asset.

    Reclassification

    Reclassification of financial assets after initial recognition is required when an entity changes its model for managing financial assets. It is not allowed in any other circumstance.

    Financial assets at amortised cost

    A financial asset is measured at amortised cost if both of the following conditions are met:

    1. the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows; and
    2. the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

    Financial assets at fair value through OCI (FVOCI)

    A financial asset is measured at fair value through OCI if both of the following conditions are met:

    1. the asset is held within a business model whose objective is achieved by both holding and collecting contractual cash flows and selling the financial assets; and
    2. the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

    Disposal of financial assets measured at fair value through OCI

    A financial asset in this category might be sold. When this occurs, the accumulated gain or loss previously recognised in OCI in respect of the asset is reclassified to P&L.

    (Note that this only applies to financial assets that are debt instruments. It does not apply to those investments in equity in respect of which an entity has made an irrevocable decision to measure at fair value through OCI).

    Financial assets at fair value through P&L (FVPL)

    All other financial assets must be measured at fair value through P&L.

    Subsequent measurement of financial assets at fair value through other comprehensive income

    • Only the fair value movement is recognised in other comprehensive income. Interest income, foreign exchange gains and losses and impairment are recognised in profit or loss.
    • The fair value adjustment in OCI will always be the accumulated difference between the fair value and the amortised cost of the bond at the year end.

    Irrevocable designations

    On initial recognition of a financial asset that would otherwise be measured at amortised cost or at fair value through OCI a company can make an irrevocable decision to designate them as at fair value through P&L.

    Investments in equity instruments are measured at fair value through P&L.

    Overview of classification of financial assets

    IFRS 9 classification of financial assets

    Interaction of IFRS 9 and IAS 21

    Debt instruments are monetary items.

    IAS 21 requires the retranslation of foreign currency monetary items to the closing rate at each reporting date. Any exchange difference arising is recognised in the statement of profit or loss.

    Classification and measurement of financial liabilities

    All financial liabilities are classified (on initial recognition) as subsequently measured at amortised cost with specific exceptions including:

    • Derivatives that are liabilities at the reporting date; and
    • Financial liabilities that might arise when a financial asset is transferred but this transfer does not satisfy the derecognition criteria.

    Reclassification of a financial liability after initial recognition is not allowed.

    Irrevocable designation

    A company is allowed to designate a financial liability as measured at fair value through profit or loss. This designation is irrevocable and can only be made if:

    • it eliminates or significantly reduces a measurement or recognition inconsistency; or
    • this would allow the company to reflect a documented risk management strategy.

    Where this designation is used, the part of the change in fair value due to a change in the entity’s own credit risk must be recognised in other comprehensive income.

    Financial guarantee contracts

    A financial guarantee within the scope of IFRS 9 is a financial liability. It is initially measured at its fair value. At subsequent reporting dates it is measured at the higher of:

    1. the amount of the loss allowance; or
    2. the amount initially recognised (amortised to recognise income in accordance with IFRS 15: Revenue from Contracts with Customers if appropriate).

    Impairment of financial assets

    Impairment of most non-current assets is covered by IAS 36. IAS 36 operates an incurred loss model.

    Impairment of financial instruments is dealt with by IFRS 9. IFRS 9 contains an expected loss model.

    • The expected loss model applies to all debt instruments (loans, receivables etc.) recorded at amortised cost or at fair value through OCI. It also applies to lease receivables (IFRS 16) and contract assets (IFRS 15).
    • The aim of the expected loss model is that financial statements should reflect the deterioration or improvement in the credit quality of financial assets held by an entity. This is achieved by recognising amounts for the expected credit loss associated with financial assets.

    General approach

    This approach must be applied to financial assets measured at amortised cost and financial assets measured at fair value through OCI. Any impairment losses on financial assets measured at fair value through profit and loss are automatically recognised in profit or loss.

    For those financial assets to which the general approach applies, a loss allowance measured as the 12-month expected credit losses is recognised at initial recognition.

    The expected credit loss associated with the financial asset is then reviewed at each subsequent reporting date and remeasured as necessary.

    • If there is no significant increase in credit risk the loss allowance for that asset is remeasured to the 12-month expected credit loss as at that date.
    • If there is a significant increase in credit risk the loss allowance for that asset is remeasured to the lifetime expected credit losses as at that date. This does not mean that the financial asset is impaired. The entity still hopes to collect amounts due but the possibility of a loss event has increased.
    • If there is credit impairment, the financial asset is written down to its estimated recoverable amount. The entity accepts that not all contractual cash flows will be collected and the asset is impaired.

    Basis for estimating credit losses

    Credit loss is measured as the present value of the difference between:

    • the contractual cash flows that are due to an entity under the contract; and
    • the cash flows that the entity expects to receive.

    Expected credit losses are a probability-weighted estimate of credit losses (i.e. the present value of all cash shortfalls) over the expected life of the financial instrument.

    A cash shortfall is the difference between the cash flows that are due in accordance with a contract and the cash flows that an entity expects to receive.

    Credit loss can arise even if the entity expects to be paid in full later than when contractually due.

    Determining significant increases in credit risk

    At each reporting date, an assessment is needed about whether the credit risk on a financial instrument has increased significantly since initial recognition.

    This assessment compares the risk of a default occurring as at the reporting date with the risk of a default occurring as at the date of initial recognition.

    Accounting for the loss allowance: financial assets at amortised cost

    The movement on the loss allowance is recognised in profit or loss.

    The loss allowance balance is netted against the financial asset to which it relates on the face of the statement of financial position.

    The loss allowance does not affect the recognition of interest revenue. Interest revenue is calculated on the gross carrying amount (i.e. without adjustment for credit losses).

    Accounting for the loss allowance: financial assets at FVOCI

    There is no separate loss allowance account for financial assets at fair value through OCI. Any impairment on these assets is automatically recognised in OCI as part of the fair value adjustment.

    A second double entry is then made to recognise the movement in the loss allowance in profit or loss with the other side of the entry in OCI.

    Credit impairment

    A financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred. Evidence that a financial asset is credit-impaired include (but is not limited to) observable data about the following events:

    • significant financial difficulty of the issuer or the borrower;
    • a breach of contract, such as a default or past due event;
    • the lender has granted to the borrower a concession for economic or contractual reasons relating to the borrower’s financial difficulty that the lender would not otherwise have considered:
    • it is becoming probable that the borrower will enter bankruptcy or other financial reorganisation;
    • the disappearance of an active market for that financial asset because of financial difficulties; or
    • the purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses.

    A financial asset might become credit impaired after initial recognition. If an entity revises its estimates of receipts it must adjust the gross carrying amount of the financial asset to reflect actual and revised estimated contractual cash flows. The financial asset must be remeasured to the present value of estimated future cash flows from the asset discounted at the original effective rate.

    Future revenue recognition

    Interest is recognised in the future by applying the effective rate to the new amortised cost (after the recognition of the impairment loss).

    Impairment loss double entry

    The impairment loss is charged to profit or loss taking into account the balance on the loss allowance account already recognised for the asset.

    Other issues

    Embedded derivatives

    A non-derivative contract might include terms that cause some of its cash flows to behave in the same way as those of a derivative. Such a contract is described as being a hybrid. A hybrid is made up of two components, a host and an embedded derivative.

    It may be necessary to separate the embedded derivative from its host and account for each separately. The result is that the embedded derivative would be measured at fair value though profit and loss.

    Whether an embedded derivative is separated, depends on whether its host is an asset within the scope of IFRS 9, and if not, whether certain criteria are met.

    Hosts which are financial assets within the scope of IFRS 9

    An embedded derivative embedded in a financial asset host that is within the scope of IFRS 9 is not separated. The normal rules of classification and accounting would apply to such a contract.

    Other hybrid contracts (financial assets outside the scope of IFRS 9 and financial liabilities)

    If a hybrid contract contains a host that is not an asset within the scope of IFRS 9, an embedded derivative must be separated from the host and accounted for as a derivative if, and only if:

    1. the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host
    2. a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and
    3. the hybrid contract is not measured at fair value with changes in fair value recognised in profit or loss (i.e. a derivative that is embedded in a financial liability at fair value through profit or loss is not separated).

    When these conditions are met, the embedded derivative is separated from the host contract and accounted for like any other derivative. The host contract is accounted for in accordance with the relevant accounting standard, separately from the derivative.

    Derecognition of Financial instruments

    Derecognition of a financial liability

    A financial liability (or a part of a financial liability) is derecognised when, and only when, it is extinguished. This is when the obligation specified in the contract is discharged or cancelled or expires.

    Derecognition of a financial asset

    A financial asset is derecognised if one of three combinations of circumstances occur:

    • The contractual rights to the cash flows from the financial asset expire; or
    • The financial asset is transferred and substantially all of the risks and rewards of ownership pass to the transferee; or
    • The financial asset is transferred, substantially all of the risks and rewards of ownership are neither transferred nor retained but control of the asset has been lost.

    Most transactions being considered involve the receipt of cash.

    • Transactions where the asset is derecognised may lead to the recognition of a profit or loss on disposal.
    • Transactions where the asset is not derecognised lead to the recognition of a liability for the cash received.

    Reclassification of financial assets

    Financial liabilities cannot be reclassified.

    Generally, financial assets should not be reclassified. However, it might be necessary to reclassify a financial asset when an entity changes its business model.

    Reclassification applies prospectively from the reclassification date. Previously recognised gains, losses etc. are not restated as a result of the reclassification.

    Hedge accounting

    Hedging is the process of entering into a transaction in order to reduce risk. Companies may use derivatives to establish ‘positions’, so that gains or losses from holding the position in derivatives will offset losses or gains on the related item that is being hedged.

    The logic of accounting for hedging should be that if a position is hedged, gains (or losses) on the hedged position that are reported in profit and loss should be offset by matching losses (or gains) on the hedging position in derivatives also reported in profit or loss.

    IFRS 9 only allows hedge accounting when certain conditions are satisfied.

    Hedged item

    A hedged item can be a recognised asset or liability, an unrecognised firm commitment, a forecast transaction or a net investment in a foreign operation.

    • The hedged item can be a single item or a group of items (subject to certain conditions).
    • A hedged item can also be a component of such an item or group of items.

    Only the following types of components (including combinations) may be designated as hedged items:

    • changes in the cash flows or fair value of an item attributable to a specific risk or risks (risk component) as long as the risk component is separately identifiable and reliably measurable;
    • one or more selected contractual cash flows; or
    • components of a nominal amount, i.e. a specified part of the amount of an item.

    Hedged item limitations

    Hedge accounting can be applied to transactions between entities in the same group only in the individual or separate financial statements of those entities but not in the consolidated financial statements of the group.

    Hedging instrument

    The following instruments may be designated as a hedging instrument:

    • A derivative measured at fair value through profit or loss (except for some written options);
    • A non-derivative financial asset measured at fair value through profit or loss;
    • A non-derivative financial liability measured at fair value through profit or loss
    • the foreign currency risk component of a non-derivative financial instrument

    Qualifying criteria for hedge accounting

    Hedge accounting can only be used where all of the following criteria are met:

    • the hedging relationship consists only of eligible hedging instruments and eligible hedged items.
    • at the inception of the hedging relationship there is formal designation and documentation of the hedging relationship and the entity’s risk management objective and strategy for undertaking the hedge.
    • there is an economic relationship between the hedged item and the hedging instrument;
    • the effect of credit risk does not dominate the value changes that result from that economic relationship; and

    Hedge accounting is allowed but not required. Where the conditions for using hedge accounting are met, the method of hedge accounting to be used depends on the type of hedge. IFRS 9 identifies three types of hedging relationship:

    1. fair value hedge
    2. cash flow hedge
    3. hedge of a net investment in a foreign entity (accounted for as a cash flow hedge).

    Fair value hedge

    A fair value hedge is a hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised firm commitment, or a component of any such item, that is attributable to a particular risk and could affect profit or loss

    Accounting treatment of fair value hedges

    Accounting for a fair value hedge is as follows:

    • The gain or loss on the hedging instrument (the derivative) is taken to profit or loss, as normal.
    • The carrying amount of the hedged item is adjusted by the loss or gain on the hedged item attributable to the hedged risk with the other side of the entry recognised in profit or loss.

    Financial asset measured at fair value through other comprehensive income

    A financial asset measured at fair value through other comprehensive income would (of course) normally result in the recognition of the full fair value change in OCI. If such an asset is a hedged item in a relationship that qualifies for fair value hedge accounting, that part of the value change due to the hedged risk is recognised in profit or loss.

    Exception

    IFRS 9 allows an entity to may make an irrevocable election at initial recognition for an investment in equity instruments that would otherwise be measured at fair value through profit or loss to be measured at fair value through other comprehensive income.

    If such an asset is a hedged item the fair value hedge accounting rules are different and are as follows:

    • The gain or loss on the hedging instrument (the derivative) is taken to OCI.
    • The fair value difference on the hedged item (which would include that part attributable to the hedged risk) is recognised in OCI in the usual way.

    Hedge of a firm commitment

    Firm commitments are not recognised but may be hedged. For fair value hedges of firm commitments, the gain or loss attributable to the hedged risk is recognised as an asset or liability in its own right.

    A hedged item may be a firm commitment to acquire an asset (or to assume a liability). In such a case carrying amount of an asset (or liability) that results from the firm commitment being met is adjusted to include the cumulative change in the fair value of the hedged item recognised in the statement of financial position.

    Cash flow hedge

    A cash flow hedge is a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with a recognised asset or liability or a highly probable forecast transaction, and could affect profit or loss.

    Hedges relating to future cash flows from interest payments or foreign exchange receipts are common cash flow hedges.

    Accounting treatment of cash flow hedges

    Accounting for a cash flow hedge is as follows:

    • The change in the fair value of the hedging instrument is analysed into ‘effective’ and ‘ineffective’ elements.
    • The ‘effective’ portion is recognised in other comprehensive income (and accumulated as a reserve in equity).
    • The ‘ineffective’ portion is recognised in profit or loss.
    • The amount recognised in other comprehensive income is subsequently released to the profit or loss as a reclassification adjustment in the same period as the hedged forecast cash flows affect profit or loss.

    Cash flow hedge – Basis adjustment

    A cash flow hedged transaction might be the future purchase of a non-financial asset.

    IFRS 9 says that if a hedged forecast transaction subsequently results in the recognition of a non-financial asset or non-financial liability (or a hedged forecast transaction for a non-financial asset or a non-financial liability becomes a firm commitment for which fair value hedge accounting is applied), the amount held in the cash flow hedge reserve is included directly in the initial cost of the asset or the liability. This is known as a basis adjustment.

    A basis adjustment is required for hedges of non-financial assets and liabilities but is not allowed for hedges of financial assets and liabilities.

    Hedges of a net investment in a foreign operation

    The net assets of the foreign subsidiary are translated at the end of each financial year, and any foreign exchange differences are recognised in other comprehensive income (until the foreign subsidiary is disposed of, when the cumulative profit or loss is then reclassified from ‘equity’ to profit or loss).

    IFRS 9 allows hedge accounting for an investment in a foreign subsidiary. An entity may designate an eligible hedging instrument for a net investment in a foreign subsidiary, provided that the hedging instrument is equal to or less than the value of the net assets in the foreign subsidiary.

  • IFRS 8 Operating segments

    IFRS 8 Operating segments

    Overview

    IFRS 8 Operating segments – IFRS 8 requires quoted companies to disclose information about their different operating segments. Without segment information, good performance in some segments may ‘hide’ very poor performance in another segment. These IFRS 8 summary notes are prepared by mindmaplab team and covering, IFRS 8 revised amendment, the key definitions, full standard with illustrative examples, segment reporting, segment information, codm IFRS 8 and management approach with disclosure requirements. This is the IFRS 8 full text guide; we have also prepared IFRS 8 pdf version download.

    IAS Standards

    IAS 2 Inventories       

    IAS 7 Statements of cash flows

    IAS 7 Statement of cash flows  – Revisited

    IAS 8 Accounting policies, changes in accounting estimates, and errors

    IAS 10 Events after the reporting period       

    IAS 12 Income taxes 

    IAS 16 Property, plant and equipment          

    IAS 17 Leases

    IAS 19 Employee benefits     

    IAS 20 Accounting for government grants and disclosure of government assistance          

    IAS 21 The effects of changes in foreign exchange rates     

    IAS 23 Borrowing costs        

    IAS 24 Related party disclosures

    IAS 27 Consolidated and separate financial statements        

    IAS 28 Investments in associates and joint ventures 

    IAS 32 Financial instruments: presentation  

    IAS 33 Earnings per share

    IAS 33 Earnings per share – Revisited          

    IAS 36 Impairment of assets 

    IAS 37 Provisions, contingent liabilities and contingent assets        

    IAS 38 Intangible assets

    IAS 40 Investment property

    IFRS Standards

    IFRS 3 Business combinations    

    IFRS 5 Non-current assets held for sale and discontinued operations    

    IFRS 7 Financial instruments: disclosures          

    IFRS 8 Operating segments         

    IFRS 9 Financial instruments      

    IFRS 10 Consolidated financial statements        

    IFRS 11 Joint arrangements         

    IFRS 12 Disclosure of interests in other entities 

    IFRS 13 Fair value measurement 

    IFRS 15 Revenues from contracts with customers          

    IFRS 16 Leases

    IAS 17 VS IFRS 16 Lease – Differences

    Ratio Analysis

    Scope and objective of IFRS 8 Operating segments

    IFRS 8 requires quoted companies to disclose information about their different operating segments.

    Many companies operate in several different industries (or ‘product markets’) or diversify their operations across several geographical locations. A consequence of diversification is that companies are exposed to different rates of profitability, different growth prospects and different amounts of risk for each separate ‘segment’ of their operations.

    Without segment information, good performance in some segments may ‘hide’ very poor performance in another segment. If an entity includes some segment information in the annual report that doesn’t comply with IFRS 8, it cannot call it ‘segmental information.’

    Reportable segments (Accounting for Operating segments)

    An entity MUST report separately information about each operating segment that:

    1. has been identified in accordance with the definition of an operating segment.
    2. or is aggregated with another segment.
    3. or exceeds the quantitative thresholds.

    If the total external revenue reported by operating segments constitutes less than 75% of the entity’s total revenue, then additional operating segments must be identified as reporting segments, even if they do not meet the criteria, until 75% of revenue is included in reportable segments.

    Operating segments (Definition)

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

    1. that engages in business activities from which it earns revenues and incurs expenses
    2. whose operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and
    3. for which discrete financial information is available.

    Aggregation of segments

    Two or more operating segments may be aggregated into a single operating segment if they have similar economic characteristics, and the segments are similar in each of the following respects:

    1. the nature of the products and services
    2. the nature of the production process
    3. the type or class of customer for their products and services
    4. the methods used to distribute their products or provide their services, and
    5. if applicable, the nature of the regulatory environment, for example, banking insurance or public utilities.

    Quantitative thresholds

    An entity must report separately information about an operating segment that meets ANY of the following quantitative thresholds:

    1. its reported revenue, including external sales and intersegment sales is 10% or more of the combined internal and external revenue of all operating segments.
    2. its reported profit is 10% or more of the greater of the combined profit of all segments that did not report a loss and the combined reporting loss of all segments that reported a loss.
    3. its assets are 10% or more of the combined assets of all operating segments.

    Non-Reportable Segments

    • Operating segments that do not meet any of the quantitative thresholds may be reported separately if management believes that information about the segment would be useful to users of the financial statements.
    • Non-reportable segments are required by IFRS 8 to be combined and disclosed in an ‘all other segments’ category separate from other reconciling items in the reconciliations required by IFRS 8.
    • Entities must disclose the sources of revenue in the ‘all other segments’ category.

    IFRS 8 Operating segments Disclosure

    The information that is to be disclosed is:

    • a measure of profit or loss and total assets liabilities for each reportable segment.
    • information about:
      • revenues from external customers
      • revenues from transactions with other operating segments of the same entity
      • interest revenue and interest expense
      • income tax expense or income
    • reconciliation of the totals of segment revenues to the entity’s revenue
    • reconciliation of the total of reported segment profits or losses to the entity’s profit before tax and discontinued operations
    • reconciliation of the total of the assets of the reportable segments to the entity’s assets
    • reconciliation of the total of the liabilities of the reportable segments to the entity’s liabilities
  • IFRS 7 Financial Instruments Disclosure

    IFRS 7 Financial Instruments Disclosure

    Overview

    IFRS 7 Financial Instruments Disclosure requires that an entity should disclose information that enables users of the financial statements to ‘evaluate the significance of financial instruments’ for the entity’s financial position and financial performance. These IFRS 7 summary notes are prepared by mindmaplab team and covering, IFRS 7 revised amendment, the key definitions, full standard with illustrative examples, IFRS 7 liquidity risk, difference between IFRS 7 and IFRS 9, IFRS 7 maturity analysis, credit risk with disclosure requirements and a checklist. This is the IFRS 7 full text guide; we have also prepared IFRS 7 pdf version download.

    IAS Standards

    IAS 2 Inventories       

    IAS 7 Statements of cash flows

    IAS 7 Statement of cash flows  – Revisited

    IAS 8 Accounting policies, changes in accounting estimates, and errors

    IAS 10 Events after the reporting period       

    IAS 12 Income taxes 

    IAS 16 Property, plant and equipment          

    IAS 17 Leases

    IAS 19 Employee benefits     

    IAS 20 Accounting for government grants and disclosure of government assistance          

    IAS 21 The effects of changes in foreign exchange rates     

    IAS 23 Borrowing costs        

    IAS 24 Related party disclosures

    IAS 27 Consolidated and separate financial statements        

    IAS 28 Investments in associates and joint ventures 

    IAS 32 Financial instruments: presentation  

    IAS 33 Earnings per share

    IAS 33 Earnings per share – Revisited          

    IAS 36 Impairment of assets 

    IAS 37 Provisions, contingent liabilities and contingent assets        

    IAS 38 Intangible assets

    IAS 40 Investment property

    IFRS Standards

    IFRS 3 Business combinations    

    IFRS 5 Non-current assets held for sale and discontinued operations    

    IFRS 7 Financial instruments: disclosures          

    IFRS 8 Operating segments         

    IFRS 9 Financial instruments      

    IFRS 10 Consolidated financial statements        

    IFRS 11 Joint arrangements         

    IFRS 12 Disclosure of interests in other entities 

    IFRS 13 Fair value measurement 

    IFRS 15 Revenues from contracts with customers          

    IFRS 16 Leases

    IAS 17 VS IFRS 16 Lease – Differences

    Ratio Analysis

    Objectives of IFRS 7

    All companies are exposed to various types of financial risk. Some risks are obvious from looking at the statement of financial position.

    IFRS 7 requires that an entity should disclose information that enables users of the financial statements to ‘evaluate the significance of financial instruments’ for the entity’s financial position and financial performance.

    There are two main parts to IFRS 7:

    1. A section on the disclosure of ‘the significance of financial instruments’ for the entity’s financial position and financial performance.
    2. A section on disclosures of the nature and extent of risks arising from financial instruments.

    Statement of financial position disclosures

    The carrying amounts of financial instruments must be shown, either in the statement of financial position or in a note to the financial statements, for each class of financial instrument:

    • Financial assets at fair value through profit or loss
    • Financial assets at amortised cost
    • Financial liabilities at fair value through profit or loss
    • Financial liabilities measured at amortised cost.

    Other disclosures relating to the statement of financial position are also required. These include the following:

    • Collateral – A note should disclose the carrying amount of financial assets that the entity has pledged as collateral for liabilities or contingent liabilities, the terms and conditions relating to its pledge.
    • Allowance account for credit losses
    • Defaults and breaches

    Statement of profit or loss disclosures

    An entity must disclose the following items either in the statement of profit or loss or in notes to the financial statements:

    • Net gains or losses on financial assets or financial liabilities at fair value through profit or loss.
    • Net gains or losses on available-for-sale financial assets.
    • Total interest income and total interest expense, calculated using the effective interest method, for financial assets or liabilities that are not at fair value through profit or loss.
    • Fee income and expenses arising from financial assets or liabilities that are not at fair value through profit or loss.

    Other disclosures

    IFRS 7 also requires other disclosures. These include the following:

    • Information relating to hedge accounting, for cash flow hedges, fair value hedges and hedges of net investments in foreign operations. The disclosures should include:
      • a description of each type of hedge
      • a description of the financial instruments designated as hedging instruments
      • their fair values at the reporting date, and the nature of the risks being hedged.
    • With some exceptions, for each class of financial asset and financial liability, an entity must disclose the fair value of the assets or liabilities in a way that permits the fair value to be compared with the carrying amount for that class.

    Risk disclosures

    IFRS 7 also requires that an entity should disclose information that enables users of its financial statements to evaluate the nature and extent of the risks arising from its financial instruments.

    These risks typically include, but are not restricted to:

    • Credit risk
    • Liquidity risk
    • Market risk

    For each category of risk, the entity should provide both quantitative and qualitative information about the risks.

    Qualitative disclosures – For each type of risk, there should be disclosures of the exposures to risk and how they arise; and the objectives policies and processes for managing the risk and the methods used to measure the risk.

    Quantitative disclosures – For each type of risk, the entity should also disclose summary quantitative data about its exposures at the end of the reporting period. This disclosure should be based on information presented to the entity’s senior management, such as the board of directors or chief executive officer.

  • IFRS 3 Business Combinations

    IFRS 3 Business Combinations

    Overview

    IFRS 3 Business Combinations – is largely about how the initial accounting for a new investment, setting out the rules on the calculation of goodwill. These IFRS 3 summary notes are prepared by mindmaplab team and covering, IFRS 3 revised amendment, the key definitions, full standard with illustrative examples, IFRS 3 goodwill, negative goodwill IFRS, contingent consideration, purchase price allocation (ppa), step acquisition, IAS 3 consolidated financial statements, IFRS 3 intangible assets, difference between IFRS 3 and IFRS 10, goodwill impairment with IFRS 3 disclosure requirements. This is the IFRS 3 full text guide; we have also prepared IFRS 3 pdf version download.

    IAS Standards

    IAS 2 Inventories       

    IAS 7 Statements of cash flows

    IAS 7 Statement of cash flows  – Revisited

    IAS 8 Accounting policies, changes in accounting estimates, and errors

    IAS 10 Events after the reporting period       

    IAS 12 Income taxes 

    IAS 16 Property, plant and equipment          

    IAS 17 Leases

    IAS 19 Employee benefits     

    IAS 20 Accounting for government grants and disclosure of government assistance          

    IAS 21 The effects of changes in foreign exchange rates     

    IAS 23 Borrowing costs        

    IAS 24 Related party disclosures

    IAS 27 Consolidated and separate financial statements        

    IAS 28 Investments in associates and joint ventures 

    IAS 32 Financial instruments: presentation  

    IAS 33 Earnings per share

    IAS 33 Earnings per share – Revisited          

    IAS 36 Impairment of assets 

    IAS 37 Provisions, contingent liabilities and contingent assets        

    IAS 38 Intangible assets

    IAS 40 Investment property

    IFRS Standards

    IFRS 3 Business combinations    

    IFRS 5 Non-current assets held for sale and discontinued operations    

    IFRS 7 Financial instruments: disclosures          

    IFRS 8 Operating segments         

    IFRS 9 Financial instruments      

    IFRS 10 Consolidated financial statements        

    IFRS 11 Joint arrangements         

    IFRS 12 Disclosure of interests in other entities 

    IFRS 13 Fair value measurement 

    IFRS 15 Revenues from contracts with customers          

    IFRS 16 Leases

    IAS 17 VS IFRS 16 Lease – Differences

    Ratio Analysis

    International accounting standards and group accounts

    The following standards relate to accounting for investments:

    • IFRS 3 Business combinations
    • IFRS 10 Consolidated financial statements
    • IFRS 11 Joint Arrangements
    • IAS 27 Separate financial statements
    • IAS 28 Investments in associates and joint ventures

    Guidance on the process of consolidation is set out in two standards, IFRS 3 Business Combinations and IFRS 10 Consolidated Financial Statements.

    Introduction to IFRS 3

    It establishes principles and requirements for:

    1. the recognition and measurement of identifiable assets acquired, liabilities assumed and non-controlling interest in the acquiree;
    2. IFRS 3 is largely about how the initial accounting for a new investment, setting out the rules on the calculation of goodwill.
    3. IFRS 3 explains how to account for further investments in a subsidiary after control has been achieved. These are called step acquisitions.
    4. disclosures that enable users to evaluate the nature and financial effects of a business combination.

    IFRS 3 Definitions

    Business combination – A transaction or other event in which an acquirer obtains control of one or more businesses.

    Acquisition date – is the date on which the acquirer effectively obtains control of the acquiree.

    Goodwill – An asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised.

    Goodwill

    IFRS 3 GOODWILL

    IFRS 3 gives guidance on:

    1. cost of a business combination;
    2. recognition and measurement of identifiable assets and liabilities assumed; and
    3. accounting for goodwill.

    Cost (consideration transferred)

    IFRS 3 states that the purchase consideration for an acquisition (business combination) is the sum of:

    1. the fair values, at the acquisition date, of the assets transferred by the acquirer, such as cash
    2. the liabilities incurred by the acquirer to the former owners of the acquire
    3. equity instruments issued by the acquirer in exchange for control of the acquiree.

    * The purchase consideration may include some deferred consideration.

    Consideration includes any asset or liability resulting from a contingent consideration arrangement:

    • recognised at acquisition-date fair value; and
    • classified as a liability or equity on the basis of guidance in IAS 32 or other applicable IFRSs.

    Acquisition-related (transaction) costs are costs the acquirer incurs to effect a business combination. For example, the cost of the advisory, legal. These costs must be treated as an expense as incurred and written off to profit or loss.

    Contingent consideration

    Sometimes the final cost of the combination is contingent on (depends on) a future event. In a situation such as this, the contingent payment should be included in the cost of the combination (discounted to present value if the payment will occur more than 12 months in the future).

    * Under the rules of IFRS 3, contingent consideration must be recognised at fair value at acquisition, even if it is not probable that the consideration will actually have to be paid.

    If the contingent consideration is still there at the end of an accounting period, it might be necessary to re-measure it. If the contingent consideration will be payable in cash or take the form of debt it should be re-measured to fair value at the end of the reporting period. Any gain or loss on re-measurement should be taken to profit or loss.

    If the contingent consideration will take the form of equity, it is not re-measured at the end of the reporting period.

    * IFRS 3 states that the award of share options to the previous owners as an incentive to stay on and work for the subsidiary after it has been acquired is not a part of the purchase consideration.

    Acquisition date amounts of assets acquired and liabilities assumed

    An acquirer of a business must recognise assets acquired and liabilities assumed at their acquisition date fair values. To support this IFRS 3 sets out:

    1. a recognition principle;
    2. classification guidance; with
    3. a measurement principle.

    Recognition principle

    An acquirer must recognise (separately from goodwill), identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree as of the acquisition date.

    This might result in recognition of assets and liabilities not previously recognised by the acquiree.

    The contingent liabilities should be measured at fair value at the acquisition date (even if it is not probable). Contingent assets are not recognised.

    An acquirer should not recognise a liability for the cost of restructuring a subsidiary or for any other costs expected to be incurred as a result of the acquisition (including future losses).

    Measurement principle

    Identifiable assets acquired and the liabilities assumed are measured at their acquisition date fair values.

    Deferred income tax assets and liabilities are recognised and measured in accordance with IAS 12 Income Taxes, rather than at their acquisition-date fair values.

    Classification guidance

    Identifiable assets acquired and liabilities assumed must be classified (designated) as necessary at the acquisition date so as to allow subsequent application of appropriate IFRS.

    • classification of a lease contract in accordance with IFRS 16 Leases; and
    • classification of a contract as an insurance contract in accordance with IFRS 4 Insurance Contracts.

    Accounting for Goodwill

    After initial recognition goodwill is measured at cost less any accumulated impairment losses. It is not amortised.

    Gain from a bargain purchase (“Negative goodwill”)

    A bargain purchase is a business combination in which the calculation of goodwill leads to a negative figure. Such amount is recognised as a gain in consolidated profit or loss on the acquisition date.

    Impairment testing of goodwill

    Purchased goodwill is not amortised, but must be tested for impairment on an annual basis. It cannot be tested for impairment directly. It is allocated to one or more cash generating unit (IAS 36).

    Partial goodwill method (NCI at acquisition measured as a proportionate share of subsidiary’s net assets)

    The carrying amount of the CGU is made up of:

    • the total net assets of the unit (parent’s interest and NCI’s); and
    • the parent’s interest in goodwill.

    The goodwill included in the CGU, as stated above, represents the parent’s share only, but the cash flow contributed by goodwill does not pertain to parent share of goodwill only. It also includes contribution made by NCI share of goodwill. Therefore, IAS 36 requires a working that grosses up the carrying amount of the CGU’s assets by the NCI share of goodwill.

    *Note that NCI share of goodwill is only for a working purpose, it is not part of the double entry.

    This notionally adjusted carrying amount is then compared with the recoverable amount of the unit to determine whether the cash-generating unit is impaired.

    *Only that part of any impairment loss attributable to the parent is recognised by the entity as a goodwill impairment loss.

    IFRS 3 Partial goodwill method

    Full goodwill method (NCI at acquisition measured at fair value)

    When non-controlling interests are valued by the fair value method, any impairment in the total goodwill after acquisition should be shared between the parent company shareholders and the NCI.

    If there is an NCI in a cash-generating unit to which goodwill has been allocated, the carrying amount of that unit is made up of:

    • both the parent’s interest and the NCI in the net assets of the unit; and
    • both the parent’s interest in goodwill and the NCI’s interest in goodwill.

    Acquisitions achieved in stages

    Control might be achieved through a series of transactions. (These are known as step acquisitions, successive share purchases or piecemeal acquisitions).

    Consolidation is from the acquisition date which is the date that control is achieved.

    IFRS 3 requires that, for a business combination achieved in stages, the parent must remeasure any previously held equity interest in the new subsidiary to its fair value at the date that control is achieved. This is added to the cost of the investment that resulted in control.

    The gain or loss on the remeasurement of the previously held equity interest is recognised in profit or loss or other comprehensive income.

    IFRS 3 Acquisitions achieved in stages

    Purchase of additional equity interest after control is achieved

    A company may make a further purchase of shares after control has been achieved.

    This is a transaction between the owners of the subsidiary (the controlling interest and the non-controlling interest) which will cause the non-controlling interest to change.

    Any difference between the purchase consideration and the change in the non-controlling interest is recognised directly in equity.

    IFRS 3 EQUITY ADJUSTMENT

    *The reduction in non-controlling interest at the date of the purchase is the share of net assets given up by the non-controlling interest at that date.

    Non-controlling interest (NCI)

    IFRS 3 Non-controlling interest (NCI)

    Consolidated retained earnings

    IFRS 3 Consolidated retained earnings

    Accounting Summary: Pattern of ownership in the consolidated statement of profit or loss

    IFRS 3 Pattern of ownership in the consolidated statement of profit or loss

    Situation 4: Purchase turning significant influence into control

    In this case the parent had significant influence in the first part of the years and then made an acquisition which achieved control. The results for the year must be split into two parts. The results for the period in which the parent had significant influence must be equity accounted. The results for the period in which the parent had control must be consolidated.

    Consolidated statement of profit or loss

    The basic rules

    A consolidated statement of profit or loss brings together the sales revenue, income and expenses of the parent and the sales revenue, income and expenses of its subsidiaries.

    Inter-company items

    It is usually necessary to make adjustments to eliminate the results of inter-company trading. This includes adjustments to cancel out inter-company trading balances and unrealised profit.

    Inter-company trading

    Inter-company trading will be included in revenue of one group company and purchases of another. These are cancelled on consolidation.

    Unrealised profits on trading

    If any items sold by one group company to another are included in inventory (i.e. have not been sold on outside the group by the year end), their value must be adjusted to lower of cost and net realisable value from the group viewpoint (as for the consolidated statement of financial position).

    The adjustment in the statement of comprehensive income reduces gross profit and hence profit for the year. The NCI share in this reduced figure and the balance is added to retained earnings. Thus, the adjustment is shared between both ownership interests.

    Inter-company management fees and interest

    All other inter-company amounts must also be cancelled.

    Inter-company dividends

    The parent may have accounted for dividend income from a subsidiary. This is cancelled on consolidation.

    Dividends received from a subsidiary are ignored in the consolidation of the statement of comprehensive income because the profit out of which they are paid has already been consolidated.

    Accounting for Impairment of goodwill

    If goodwill is impaired:

    • It is written down in value in the consolidated statement of financial position, and
    • The amount of the write-down is charged as an expense in the consolidated income statement (normally in administrative expenses).

    Consolidated statement of other comprehensive income

    The basic rules

    A consolidated statement of other comprehensive income brings together the gains and losses of the parent and the gains and losses of its subsidiaries.

    Items in the statement of comprehensive income are unlikely to be affected by inter-company trading or similar issues.

    Consolidated financial statements must disclose total comprehensive income for the period attributable to the:

    • owners of the parent company; and
    • non-controlling interests.

    consolidated statement of other comprehensive income

    Consolidation of sub-subsidiaries (two stage method)

    Vertical groups

    A group structure in which a parent has a subsidiary which in turn is itself a parent of another subsidiary is known as a vertical group. It follows that a parent will also control its subsidiary’s subsidiary.

    Date of acquisition of the sub-subsidiary

    A subsidiary must be consolidated from the date of acquisition. The acquisition date for a sub-subsidiary in a vertical group depends on whether:

    • the holding company H acquired its shares in subsidiary S before S acquired its shares in the sub-subsidiary T; or
    • the holding company H acquired its shares in subsidiary S after S acquired its shares in the sub-subsidiary T

    IFRS 3 Vertical groups

    IFRS 3 Vertical groups 2

    *There are two methods (direct and indirect) which can be used for dealing with sub-subsidiaries. The different methods may result in different balances for certain items.

    Indirect method (2 stages)

    The consolidation takes place in two stages. Firstly, the S group accounts are prepared by consolidating T into S. Then, the S group accounts are consolidated into H.

    The indirect method is the way that most groups would perform consolidation in practice.

    Direct method (1 stage)

    This approach involves identifying holding company H’s effective holding in the sub-subsidiary and then using this to consolidate the sub-subsidiary directly along with the main subsidiary.

    IFRS 3 effective holding

    The main subsidiary is consolidated by the parent in the usual way.

    The sub-subsidiary is also consolidated by the parent in the usual way using the effective holding with one further adjustment. The cost of investment in T is split. H’s share is used in the goodwill working and the balance is charged to the non-controlling interest.

    Rationale for splitting the cost of investment when using the direct method

    Goodwill

    The effective interest is the parent’s share of the main subsidiaries share of the sub-subsidiary.

    • Goodwill calculated for the main subsidiary is cost less share of net assets.
    • Goodwill calculated for the sub-subsidiary must be the share of cost less share of share of net assets.

    Non-controlling interest

    Consolidation involves replacing cost of investment with a share of net assets. Using the effective interest to calculate the NCI in the sub-subsidiary gives the NCI in the main subsidiary a share of the net assets of the sub-subsidiary. However, the NCI in the main subsidiary has already been given a share of the net assets of the main subsidiary and this includes the cost of investment in T. Therefore, the NCI in the main subsidiary’s share of cost must be eliminated to avoid double counting.

    Mixed groups

    In a mixed group, the parent has both direct and indirect interests in the sub-subsidiary.

    IFRS 3 Mixed groups

    Date of acquisition of the sub-subsidiary in a mixed group

    The same rules apply to mixed groups as they do to vertical groups.

    If H’s direct and indirect interests in the sub-subsidiary arise on different dates the step acquisition rules apply.

    *Direct method consolidation of is used for mixed group

    Accounting for sub-associates

    There is no such choice in accounting for interests in sub-associates. They must be accounted for using a two-stage approach.

    • Step 1: The investment is equity accounted into the financial statements of the main subsidiary.
    • Step 2: The revised statements of the main subsidiary are then consolidated with those of the parent. The main subsidiary’s non-controlling interest will share in the equity accounted associate in the usual way.

    There is no concept of effective holding when accounting for investments in sub-associates.

    Consolidated statements of profit or loss when there are sub-subsidiaries

    Consolidation of statements of profit or loss involving sub-subsidiaries and sub-associates is carried out as normal. The effective rate may be used to consolidated sub-subsidiaries and sub-associates are equity accounted using a two-stage process.

    There is one possible complication when consolidating sub-subsidiaries.

    • If the sub-subsidiary has paid a dividend and the main subsidiary has accounted for its share through the profit and loss account this will be part of the subsidiary’s profit before tax.
    • It must be eliminated (as a consolidation adjustment) during the non-controlling interest calculation.
  • IAS 33 Earnings per share

    IAS 33 Earnings per share

    Overview

    IAS 33 Earnings per share – The rules for calculating EPS are set out in IAS 33 Earnings per share. It is simply the profit for the year (adjusted for a few things) divided by the weighted average number of ordinary shares in that year. These IAS 33 summary notes are prepared by mindmaplab team and covering the key definitions, full standard with examples. This is the IAS 33 full text; we have also prepared IAS 33 pdf version download.

    IAS Standards

    IAS 2 Inventories       

    IAS 7 Statements of cash flows

    IAS 7 Statement of cash flows  – Revisited

    IAS 8 Accounting policies, changes in accounting estimates, and errors

    IAS 10 Events after the reporting period       

    IAS 12 Income taxes 

    IAS 16 Property, plant and equipment          

    IAS 17 Leases

    IAS 19 Employee benefits     

    IAS 20 Accounting for government grants and disclosure of government assistance          

    IAS 21 The effects of changes in foreign exchange rates     

    IAS 23 Borrowing costs        

    IAS 24 Related party disclosures

    IAS 27 Consolidated and separate financial statements        

    IAS 28 Investments in associates and joint ventures 

    IAS 32 Financial instruments: presentation  

    IAS 33 Earnings per share

    IAS 33 Earnings per share – Revisited          

    IAS 36 Impairment of assets 

    IAS 37 Provisions, contingent liabilities and contingent assets        

    IAS 38 Intangible assets

    IAS 40 Investment property

    IFRS Standards

    IFRS 3 Business combinations    

    IFRS 5 Non-current assets held for sale and discontinued operations    

    IFRS 7 Financial instruments: disclosures          

    IFRS 8 Operating segments         

    IFRS 9 Financial instruments      

    IFRS 10 Consolidated financial statements        

    IFRS 11 Joint arrangements         

    IFRS 12 Disclosure of interests in other entities 

    IFRS 13 Fair value measurement 

    IFRS 15 Revenues from contracts with customers          

    IFRS 16 Leases

    IAS 17 VS IFRS 16 Lease – Differences

    Ratio Analysis

    IAS 33 Objectives and scope

    The rules for calculating EPS are set out in IAS 33 Earnings per share.

    It is simply the profit for the year (adjusted for a few things) divided by the weighted average number of ordinary shares in that year.

    IAS 33 specifies the profit figure that should be used and explains how to calculate the appropriate number of shares when there have been changes in share capital during the period under review.

    IAS 33 also describes the concept of dilution which is caused by the existence of potential ordinary shares.

    The higher a company’s EPS, the more profitable it is considered.

    A fall in EPS will affect the share price.

    The objective of IAS 33 is to set out principles for:

    1. the calculation of EPS; and
    2. the presentation of EPS in the financial statements.

    Most publicly-traded entities prepare consolidated financial statements as well as individual financial statements. When this is the case, IAS 33 requires disclosure only of EPS based on the figures in the consolidated financial statements.

    IAS 33 requires entities to calculate:

    • the basic earnings per share on its continuing operations
    • the diluted earnings per share on its continuing operations.

    Additional requirements apply to earnings relating to discontinued operations.

    IAS 33 Definitions

    Ordinary share – An ordinary share is an equity instrument that is subordinate to all other classes of equity instruments.

    Potential ordinary share – A potential ordinary share is a financial instrument or other contract that may entitle its holder to ordinary shares at some time in the future.

    • For examples:
      1. convertible debentures, convertible preference shares
      2. share options and warrants
    • shares that will be issued if certain contractual conditions are met, such as contractual conditions relating to the purchase of a business.

    Diluted EPS is a metric used in fundamental analysis to gauge its quality of earnings per share assuming all convertible securities are exercised.

    Convertible securities include all outstanding convertible preferred shares, convertible debt, options (mainly employee-based options) and warrants.

    BASIC EPS

    Basic earnings per share is calculated by dividing the profit or loss attributable to ordinary shareholders during a period on continuing operations by the weighted average number of ordinary shares in issue during the period.

    Formula: Basic EPS

    Total earnings

    weighted average number of shares in issue during the period

    Total earnings

    The total earnings figure is the profit or loss from continuing operations after deducting tax and preference dividends (and in the case of consolidated financial statements, after excluding the earnings attributable to non-controlling interests). Total earnings include any income from associates (i.e. any share of profits or losses of associates).

    Earnings from discontinued operations are dealt with separately. An EPS from any discontinued operations must also be disclosed.

    The total earnings figure must be adjusted for the interests of preference shareholders before in can be used in EPS calculations.

    Total earnings adjustments

    Preference shares

    Preference shares must be classified as equity or liability in accordance with the rules in IAS 32: Financial Instruments: Presentation.

    If a class of preference shares is classified as equity, any dividend relating to that share is recognised in equity. Any such dividend must be deducted from the profit or loss from continuing operations.

    If a class of preference shares is classified as liability (redeemable preference shares), any dividend relating to that share is recognised as a finance cost in the statement of profit or loss. It is already deducted from the profit or loss from continuing operations and no further adjustment need be made.

    Cumulative preference shares

    Some preference shares are cumulative preference shares. This means that if a company fails to declare a preference dividend in a period the holders are entitled to receive the missed dividend sometime in the future.

    If there are cumulative preference shares in issue the dividend must be deducted from profit or loss from continuing operations regardless of whether the dividend has been declared or not.

    if preference shares are non-cumulative then the dividend is deducted only in case of declaration by the company.

    Increasing rate preference shares

    These are preference shares that provide for a low initial dividend to compensate an entity for selling the preference shares at a discount, or an above-market dividend in later periods to compensate investors for purchasing preference shares at a premium.

    The discount or premium arising on the issue of increasing rate preference shares is amortised using the effective interest method and treated as a preference dividend for the purposes of calculating earnings per share.

    All these elements should be deducted in arriving at the earnings attributed to ordinary equity holders.

    Early conversion of preference shares

    An entity may achieve early conversion of convertible preference shares by improving the original conversion terms or paying additional consideration. Where this is the case, the excess amount transferred as a result of the improvement of conversion terms is treated as a return to the preference shareholders and must be deducted in arriving at earnings attributable to ordinary equity holders.

    Deduction = Fair value of ordinary shares issued (consideration paid) – Fair value of ordinary shares issuable under original terms

    Repurchase of preference shares

    Where the fair value of consideration paid to preference shareholders exceeds the carrying value of the preference shares repurchased, the excess is a return to the preference shareholders and must be deducted in calculating profits attributable to ordinary equity holders.

    Where the carrying value of preference shares repurchased exceeds the fair value of consideration paid, the excess is added in calculating profit attributable to ordinary equity holders.

    In respect of preference shares that are classified as liabilities, the above adjustments, where these are relevant, would have already been made in arriving at the profit or loss for the period.

    Participating securities and two-class ordinary shares

    The equity of some entities includes:

    • instruments that participate in dividends with ordinary shares.
    • a class of ordinary shares with a different dividend rate from that of another class of ordinary shares.

    To calculate basic earnings per share:

    Step 1 – Adjust profit or loss attributable to ordinary equity holders of the parent entity.

    Step 2 – Allocate the profit or loss to ordinary shares and participating equity instruments to the extent that each instrument shares in earnings as if all of the profit or loss for the period had been distributed. The total profit or loss allocated to each class of equity instrument is determined by adding together the amount allocated for dividends and the amount allocated for a participation feature.

    Step 3 – Divide the total amount of profit or loss allocated to each class of equity instrument by the number of outstanding instruments to which the earnings are allocated to determine the earnings per share for the instrument.

    Weighted average number of outstanding shares

    The number of shares outstanding in a company will often change due to a company issuing new shares, repurchasing, and retiring existing shares and other financial instruments, such as employee options being converted into shares.

    The weighted average number of shares is determined by taking the number of outstanding shares and multiplying it by the percentage of the reporting period (in terms of months) for which that number applies for each period.

    There are different ways in which the number of shares may change:

    1. Issues for full consideration (issue or redemption) of shares at a full market price).
    2. Issues for no consideration (issue or redemption) of shares with no change in net assets), for example:
      1. Bonus issues
      2. Share splits (where one share is split into several others)
      3. Reverse share splits (share consolidation)
      4. Bonus elements in other issues (see later discussion on rights issues)
    3. Rights issues (issue of shares for consideration but at less than the full market price of the share).

    IAS 33 gives guidance on how to incorporate changes in share capital during a period into the calculation of the weighted average of shares that must be used in the EPS calculation.

    Issue of shares at full market price

    The consideration received is available to boost earnings. Therefore, the shares are included from the date of issue.

    There is no adjustment to comparatives resulting from an issue at full price.

    Partly paid shares

    The number of ordinary shares is calculated based on the number of fully paid shares. In order to do this partly paid shares are included as an equivalent number of fully paid shares to the extent they are entitled to participate in dividends.

    Bonus issues of shares

    A bonus issue of shares (also called a scrip issue or a capitalisation issue) is an issue of new shares to existing shareholders, in proportion to their existing shareholding, for no consideration.

    No cash is raised from a bonus issue, therefore is no earnings boost from the issue. Bonus issued shares are treated as if they have always been in issue.

    The new number of shares (i.e. the number of shares after the bonus issue) can be found by multiplying the number of shares before the bonus issue by the bonus issue fraction.

    Formula: Bonus issue fraction

    Number of shares in holding after the bonus issue

    Number of shares in holding before the bonus issue

    * Remember that if a capital change is due to a bonus issue each preceding must be multiplied by the bonus fraction.

    Comparatives

    In order to ensure that the EPS in the year of the bonus issue is comparable with the previous year’s EPS, IAS 33 requires that the weighted average number of shares should be calculated as if the bonus shares had always been in issue.

    This means that:

    • the current period’s shares are adjusted as if the bonus shares were issued on the first day of the year; and
    • the comparative EPS for the previous year is restated on the same basis.

    The restatement of the comparatives is easily achieved by multiplying it by the inverse of the bonus fraction.

    Rights issues of shares

    A rights issue of shares is an issue of new shares for cash, where the new shares are offered initially to current shareholders in proportion to their existing shareholdings.

    The issue price of the new shares in a rights issue is always below the current market price for the shares already in issue. This means that they include a bonus element which must be taken into account in the calculation of the weighted average number of shares.

    Any comparatives must be restated by multiplying them by the inverse of the rights issue bonus fraction.

    Formula: Rights issue bonus issue fraction

    Actual cum rights price

    Theoretical ex rights price

    The actual cum-rights price is the market price of the shares before the rights issue.

    The theoretical ex-rights price is the price that the shares ought to be, in theory, after the rights issue. It is a weighted average price of the shares before the rights issue and the new shares in the rights issue.

    DILUTED EPS

    ‘Dilution’ means ‘watering down’ or ‘reduction in strength’.

    An entity might have potential ordinary shares in issue. There is a possibility that these will become actual ordinary shares at some time in the future.

    If potential shares become actual ordinary shares, the earnings figure will be shared with a larger number of ordinary shares. This would dilute the EPS.

    Diluted EPS is calculated by adjusting the earnings and number of shares figures used in the basic EPS calculation.

    Earnings is adjusted to remove the effect of dividends or interest that have been recognised during the year for the potential ordinary shares, and for any other income or expense that would alter as a result of the conversion of the potential ordinary shares into actual ordinary shares.

    The dividend or interest reduces total earnings. However, if they had already been converted into ordinary shares (and the calculation of diluted EPS is based on this assumption) the dividends or interest would not have been payable. Total earnings would therefore have been higher. To calculate the diluted EPS, total earnings are adjusted to allow for this.

    Weighted average number of shares – Diluted EPS

    The weighted average number of shares must be adjusted. The method of making this adjustment is different for:

    • convertible bonds or convertible preference shares; and
    • share options or warrants.

    Convertible preference shares and convertible bonds

    Total earnings

    Total earnings are adjusted because the entity would not have to pay the dividend or interest on the convertible securities.

    • For convertible preference shares, add back the preference dividend paid in the year. Total earnings will be increased by the preference dividend saved.
    • For convertible bonds, add back the interest charge on the bonds in the year less the tax relief relating to that interest. Total earnings will increase by the interest saved less tax.

    Number of shares

    The weighted average number of shares is increased, by adding the maximum number of new shares that would be created if all the potential ordinary shares were converted into actual ordinary shares.

    New issue of convertibles in the year

    If new convertibles are issued during the course of the year, the additional number of shares and the earnings adjustment are included only from the time that the convertibles were issued.

    Options and warrants

    A different situation applies with share options and share warrants.

    Options (warrants) are contracts issued by a company which allow the holder of the option to buy shares of the company at some time in the future at a pre-agreed price.

    If the option holder exercises this right the number of shares would increase and the company would receive the cash paid for the shares and this would be available to invest in the business and in turn this would be expected to boost its earnings. However, it is impossible to predict how total earnings will be affected when the cash is eventually received.

    The amount that would be received on exercise of the options is treated as cash received from selling shares at full price with the remaining shares having been given away. The shares sold at full price are not considered to be dilutive as any cash would be invested to earn the same return as earned in the period. It is only the free shares that are dilutive.

    The following steps must be taken:

    Step 1 – Calculate the cash that would be received if the options are exercised.

    Step 2 – Calculate the number of shares that could be sold at (average) full market price to raise the same amount of cash. (Divide the figure from step 1 by the average share price in the period).

    Step 3 – Identify the number of shares that will be issued if all the options are exercised.

    Step 4 – Subtract the number of shares in step 2 from the number at step 3. These shares are treated as having been given away for free and is added to the existing number of shares in issue, to obtain the total shares for calculating the diluted EPS.

    Options are only included in the diluted EPS calculation if the average share price in the year is greater than the exercise price of the option. If this were not the case the option would not be exercised.

    • When the exercise price of the option is less than the share price they are said to be in the money.
    • When the exercise price of the option is more than the share price they are said to be out of the money.

    * In the money options are always dilutive. Out of the money options are always not dilutive.

    Employee share options

    Employee share options that have vested are treated in exactly the same way as any other option.

    Unvested options

    The company will recognise an expense in the future for those options which are unvested at the reporting date. This expense represents the service of the employee that will be consumed and used by the company in the future.

    IAS 33 requires that the future “service” received per share be added to the exercise price for the purpose of calculating the number of dilutive shares.

    The following steps must be taken:

    Step 1 – Calculate the cash that would be received if the options are exercised and the future expense that is expected to be charged to profit or loss.

    Step 2 – Calculate the number of shares that could be sold at full market price to raise an amount of cash equal to the future benefit identified at step 1. (Divide the figure from step 1 by the average share price in the period).

    Step 3 – Identify the number of shares that will be issued if all the options are exercised.

    Step 4 – Subtract the number of shares in step 2 from the number at step 3. These shares are treated as having been given away for free and is added to the existing number of shares in issue, to obtain the total shares for calculating the diluted EPS.

    Potential ordinary shares that are not dilutive

    Only dilutive potential ordinary shares are included in the dilutive EPS calculation.

    When there are several types of potential ordinary share in issue, they should be ranked in order of dilution, with the most dilutive potential ordinary shares ranked first. In order to carry out the ranking the earnings per incremental share is found for each potential ordinary share.

    In the money options always rank first as they increase the number of shares in the calculation without affecting the earnings.

    A diluted EPS should then be calculated in stages, taking in one potential ordinary share at a time, to establish whether any of them are not dilutive.

    Contingently issuable shares

    A company might enter into a contract where it will issue shares on the occurrence of some future event. They are taken into account in the diluted EPS only if the conditions leading to their issue have been satisfied. For this purpose, the reporting date is treated as the end of the contingency period.

    Actual conversion during the year

    If a conversion right is exercised during the year, interest paid to the holders of the convertible bond ceases on the date upon which they exercise their right to the shares and the new shares are included as part of the weighted average number of shares used in the basic EPS calculation.

    When this happens, the new shares issued and the resulting interest saving must be included in the diluted EPS calculation as an adjustment for the period before the right was exercised.

    The Price/Earnings (P/E) Ratio

    The price/earnings ratio (P/E ratio) is a key stock market ratio. It is a measure of the company’s current share price (market price) in relation to the EPS.

    Formula: Price earnings ratio

    Market value of share

    Earnings per share

    The P/E ratio can be used by investors to assess whether the shares of a company appear expensive or cheap. A high P/E ratio usually indicates that the stock market expects strong performance from the company in the future.

    IAS 33 Presentation and Disclosure requirements

    An entity should present in the statement of profit or loss:

    • the basic EPS and
    • the diluted EPS for the profit or loss from continuing operations.

    For consolidated accounts, this is the EPS and diluted EPS attributable to the owners of the parent company.

    If there is a discontinued operation, the basic EPS and diluted EPS from discontinued operation should be shown either on the face of the statement of profit or loss or in a note to the financial statements.

    The basic and the diluted EPS should be presented, even if it is a negative figure (even if it is a loss per share).