MODULE 1 The Role And Importance Of Financial Reporting

Conceptual Framework

The conceptual framework ''sets out the concepts that underlie the preparation and presentation of financial statements. It is a practical tool that assists the IASB when developing and revising IFRSs'' (Conceptual Framework, para. 1). When standards do not provide guidance or sufficient guidance on a particular transaction, the conceptual framework is referred to provide guidance.

Fundamental qualitative characteristics

There are two fundamental qualitative characteristics of useful financial information according to the conceptual framework:
1) Relevance (Materiality is only part of relevance, it is not a fundamental nor an enhancing qualitative characteristic)
2) Faithful representation

Enchancing qualitative characteristics

The four enhancing qualitative characteristics of useful financial information according to the conceptual framework:
1) Comparability
2) Verifiability
3) Timeliness
4) Understandability

Calculations In This Module

Amortised Cost
Definition: 'the amount at which the financial asset or financial liability is measured at initial recognition minus the principal repayments, plus or minus the cumulative amortization 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' (IFRS 9, Appendix A).
In the study guide, example 1.1 to 1.3 is used to showcase this particular cost-based measure.

Example
A ltd issues a note payable with the following terms:
• maturity value of $150000;
• repayable at the end of Year 4; and
• coupon interest at the rate of 12 per cent per period (year), which is payable at the end of each year.
• market expects a rate of return 14 per cent

a) Calculate the amount for the initial recognition of the note payable?
b) What is the journal entry at recognition?
c) What is the journal entry at end of the second year?
There are many ways to calculate the answer. Below is how the examiner will expect the calculations to be shown:
PV of 150000 due in 4 years: 150000/(1+0.14)^4 = 88812.04
PV of 18000 cash flows for 4 years: 18000*2.914 = 52452
So the answer is 88812.04+52452= 141264.04

The financial calculator can also be used to calculate this. If the financial calculator was to be used you should state:
1) the calculator model
2) the steps I pressed in my calculator.
So the workings should be shown as follow:
Using the Texas BA2 plus financial calculator, I typed:
1) N = 4
2) I/Y = 14
3) PMT = -18000
4) FV = -150000
5) Lastly, CPT PV will give an answer of 141258.86

As long as you show FULLY your calculations, you will get the full marks.

Leases IFRS 16 (Lessee perspective)

It is not considered a lease if the lease is for
1) the short term (no more than 12 months)
OR
2) low value underlying assets (US$5000 or less). Assets are considered low value when:

the lessee can benefit from use of the underlying asset on its own or together with other resources that are readily available to the lessee (tablets, telephones and computers are generally of low value and can be used independently of each other); AND
the underlying asset is not highly dependent on, or highly interrelated with, other assets (let's say a bus is being leased and the finance team wants to recognise the seats as separate and not part of the lease agreement, essentially using the lease exemption of low value assets. This is not permitted as the lease would not materialise if the seats don't come together with the bus. The seats and bus are dependent on each other to make the bus function).

The lessee shall recognise the underlying asset essentially as an asset (initial costs, depreciation and treat as disposal with no gain or loss at end of lease term). The lessee recognises the lessor as liability (like a banker).

Leases IFRS 16 (Lessor perspective)

The lessor must firstly recognise the lease as either finance or operating lease.

If the lease is classified as a finance lease, the underlying asset is treated as though it is disposed of without gain or loss on disposal of asset in the beginning of the lease.

If the lease is classified as an operating lease, the underlying asset remains in the balance sheet of the lessor. The asset will still be depreciated normally.

Employee Benefits IAS 19

In essence, they are three types of employee benefits:
1) non-accumulating

the benefit is restricted to a particular year and employees cannot carry forward their entitlements to future periods.
These costs are recognized when it occurs eg wages and salaries

2) accumulating and non vesting

the employees can carry forward their entitlements to future periods (accumulating) but employee is not compensated for any unused entitlement if the employee resigns or is terminated (non vesting)
Provisions of these costs are recognized on the probability that the leave will be taken within 12 months after reporting year end eg sick leave
these costs are measured at the undiscounted amount the entity expects to pay within 12 months after reporting year end

3) accumulating and vesting

the employees can carry forward their entitlements to future periods (accumulating) and the employer has to make a payment to the employee for the benefit even if the employee resigns or is terminated (vesting).
Provisions of these costs are recognized as the employee render their services that increase their entitlement to future compensation eg long service leave and annual leave
the nominal or undiscounted amount must be used if the entity expects these costs to be settled within 12 months after reporting year end
these costs are measured at the present value of the amount the entity expects these costs to be settled over 12 months after reporting year end

Short-term compensated absences
Short-term compensated absences are to be settled before 12 months after the end of the annual reporting period in which the employees render the related service. This means a provision for these short-term compensated absences has to be recognized at the undiscounted amount expected to be paid on settlement within 12 months after reporting end. Short-term compensated absences include annual leave and sick leave (IAS 19, para. 9). Question 1.10 in the study guide showcases the calculation for sick leaves which is a short-term compensated absence and also an accumulating and non vesting compensated absence.

Long-term compensated absences
A provision should be recognized by the present value method if absence is to be settled over 12 months after year end reporting or at the undiscounted amount if absence is to be settled within 12 months. Example 1.4 showcases the calculation for sick leaves which is a long-term compensated absence and also an accumulating and vesting compensated absence.

Accounting For Share Based Payments IFRS 2

They are two types of share-based payment transactions, cash-settled and equity settled. Share-based payment transactions are measured as follows:
1) cash-settled

This is where the cash payment of goods and services depends on the fair value of the equity subject to other variables with respect to the equity (like cash bonus to employees according to the share price of 1000 shares times 10). As such no equity instrument is actually granted with regards to the payment of the goods and services.
initially recognized at the fair value of the goods or services.
the liability is remeasured at the end of each reporting period with changes in the equity instrument recognized in profit and loss if not yet settled

2) equity-settled

This is where the entity grants its own equity instruments in order to pay for goods or services
measure the goods or services based on their fair value if such goods and services can be reliably measured
measure the goods or services based on the fair value of equity instruments granted if such goods and services cannot be reliably measured

Example cash-settled share-based payments
At 31 May 20X7 a bonus expense was recognised in lieu of a companys' sales persons performance. The bonus payment is 10 times of the share price of 100000 ordinary shares.
At 31 May 20X7 a share price was $2 each.
At 30 June 20X7 (the year end reporting date) a share price was $1.50 each
At 31 July 20X7 the bonus payment was eventually settled when a share price was worth $2.50 each.
What are the journal entries at 31 May 20X7, 30 June 20X7 and 31 July 20X7?

Example equity-settled share-based payments
Adam bought machinery fair valued at $100000 from Sam by issuing 100000 shares valued at $2 each. What is the journal entry from Adams perspective assuming the shares are immediately vested on delivery of machinery?

Using the same facts as above but assume the machinery cannot be reliably measured. What is the journal entry from Adams perspective?

Investment Property IAS 40

IAS 40 Investment property (not to be confused with PPE accounted for under IAS 16) is defined IAS 40, para. 5, as:
property (land or a building—or part of a building—or both) held (by the owner or by the lessee as a right-of-use asset) to earn rentals or for capital appreciation or both, rather than for:
(a) use in the production or supply of goods or services or for administrative purposes; or
(b) sale in the ordinary course of business.

After the initial recognition of the investment property, an entity may choose to subsequently recognize the investment property either the:
A) cost model which is basically depreciation OR
B) revaluation model where all gains and losses arising from a change in the fair value of investment property is recognized in profit and loss (p&l).

Note that situations where companies can use more than one measurement method like investment properties where a companies can choose between the cost or revaluation model reduces the enhancing qualitative characteristic of comparability.

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