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Study Text for exams up to June 2015
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FOR EXAMS IN DECEMBER 2 14 AND JUNE 2 15
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Contents iii
Contents Page
Introduction Helping you to pass – the ONLY P2 Study Text reviewed by the examiner! v
Studying P2 vii
The exam paper xxxiii
Part A Regulatory and ethical framework 1 Financial reporting framework 3
2 Professional and ethical duty of the accountant 27
3 Environmental and social reporting 57
Part B Accounting standards 4 Non-current assets 87
5 Employee benefits 133
6 Income taxes 155
7 Financial instruments 181
8 Share-based payment 231
9 Provisions, contingencies and events after the reporting period 245
10 Related parties 261
11 Leases 269
Part C Group financial statements 12 Revision of basic groups 291
13 Complex groups and joint arrangements 337
14 Changes in group structures 363
15 Continuing and discontinued interests 393
16 Foreign currency transactions and entities 401
17 Group statements of cash flows 423
Part D Performance reporting 18 Performance reporting 449
19 Current developments 507
21 Reporting for small and medium-sized entities 549
Practice question and answer bank 561
Mathematical tables 647
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The PER alert
Before you can qualify as an ACCA member, you not only have to pass all your exams but also fulfil a three
year practical experience requirement (PER). To help you to recognise areas of the syllabus that you
might be able to apply in the workplace to achieve different performance objectives, we have introduced
the ‘PER alert’ feature. You will find this feature throughout the Study Text to remind you that what you
are learning to pass your ACCA exams is equally useful to the fulfilment of the PER requirement .
Your achievement of the PER should now be recorded in your on-line My Experience record.
Tackling studying
Studying can be a daunting prospect, particularly when you have lots of other commitments. The
different features of the text, the purposes of which are explained fully on the Chapter features page, will
help you whilst studying and improve your chances of exam success.
Developing exam awareness
Our Texts are completely focused on helping you pass your exam.
Our advice on Studying P2 outlines the content of the paper, the necessary skills you are expected to be
able to demonstrate and any brought forward knowledge you are expected to have.
Exam focus points are included within the chapters to highlight when and how specific topics were
examined, or how they might be examined in the future.
Using the Syllabus and Study Guide
You can find the syllabus and Study Guide on pages ix – xxxii of this Study Text
Testing what you can do
Testing yourself helps you develop the skills you need to pass the exam and also confirms that you can
recall what you have learnt.
We include Questions – lots of them – both within chapters and in the Exam Question Bank, as well as
Quick Quizzes at the end of each chapter to test your knowledge of the chapter content.
vi Introduction
Chapter features
Each chapter contains a number of helpful features to guide you through each topic.
Topic list
Topic list Syllabus reference What you will be studying in this chapter and the relevant
section numbers, together with ACCA syllabus references.
Introduction Puts the chapter content in the context of the syllabus as
a whole.
Study Guide Links the chapter content with ACCA guidance.
Exam Guide Highlights how examinable the chapter content is likely to
be and the ways in which it could be examined.
Knowledge brought forward from earlier studies What you are assumed to know from previous
studies/exams.
allowing you to preview and review each section easily.
Examples Demonstrate how to apply key knowledge and
techniques.
Key terms Definitions of important concepts that can often earn you
easy marks in exams.
Exam focus points When and how specific topics were examined, or how
they may be examined in the future.
Formula to learn Formulae that are not given in the exam but which have to
be learnt.
closely relate to performance objectives in your Practical
Experience Requirement (PER).
Question Gives you essential practice of techniques covered in the
chapter.
Case Study Real world examples of theories and techniques.
Chapter Roundup A full list of the Fast Forwards included in the chapter,
providing an easy source of review.
Quick Quiz A quick test of your knowledge of the main topics in the
chapter.
Exam Question Bank Found at the back of the Study Text with more
comprehensive chapter questions. Cross referenced for
easy navigation.
FAST FORWARD
Introduction vii
Studying P2
Paper P2 Corporate Reporting is a tough paper, reflecting the demands that will be made upon the
professional accountant in his or her working life. At the Fundamentals level, you will have studied the
essentials of financial statement preparation and analysis, including those of group accounts. At the
Professional level, these essentials will be assumed knowledge. You will be required to apply them,
assuming the role of a professional adviser and analyst to the management as well as the shareholders
and other stakeholders.
A The professional and ethical duty of the accountant
B The financial reporting framework
C Reporting the financial performance of entities
D Financial statements of groups of entities
E Specialised entities
F Implications of changes in accounting regulation on financial reporting
G The appraisal of financial performance and position of entities
H Current developments
There is, of course, some overlap between these areas. For example, if you are discussing current
developments (H), you might be talking about the proposed changes to accounting for business
combinations (D) and considering the implications of changes in accounting regulation (F) and perhaps
even the ethical duty of the accountant to report those changes fairly and accurately (A).
Skills you have to demonstrate
At the Fundamentals level, the questions would be more easily categorised into syllabus areas. However,
at this level you may need to demonstrate knowledge, skills and thinking from outside the syllabus area
that the question seems to be about on the surface. The examiner has stated:
Students should be capable of relating professional issues to relevant concepts and practical
situations. The evaluation of alternative accounting practices and the identification and
prioritisation of issues will be a key element of the paper. Professional and ethical judgement will
need to be exercised, together with the integration of technical knowledge when addressing
corporate reporting issues in a business context.
So the paper is not predictable. That said, clear guidance has been given. The compulsory Section A
question, worth 50 marks, will always be on group accounts. It will also deal with issues in financial
reporting and will be case study based. In Section B, questions could be on any area of the syllabus, but
we have been told that two questions will be scenario based and one question will be an essay. You have a
choice of two from three.
Increasingly, questions are discursive rather than numerical, so it is vital that you get practice at
answering this type of question.
Important note for UK students
If you are sitting the UK P2 paper you will be studying under International standards and up to 20 marks
will be for comparisons between International and UK GAAP. The ACCA UK Syllabus and Study Guide
gives the following advice:
International Financial Reporting Standards (IFRS) are the main accounting standards examined in the
preparation of financial information. The key differences between UK GAAP and International Financial
Reporting Standards are looked at on a subject by subject basis. The comparison between IFRS and
UK GAAP will be based on the new UK GAAP as set out in FRSs 100-102, so the standard by standard
viii Introduction
comparisons that appeared in previous editions of this study guide are now combined in outcome C11
(d): Discuss the key differences between the IFRS for SMEs and UK GAAP.
This Study Text covers all the topics you need to know under International Financial Reporting Standards.
An online supplement will be available at www.bpp.com/learning-media, covering the additional UK issues.
Exam technique for P2
Do not be needlessly intimidated
There is no shortcut to passing this exam. It looks very difficult indeed, and many students wonder if they
will ever pass. But many do. How do they do this?
Easy marks
All the questions are demanding, but there are many easy marks to be gained. Suppose, for example, you
had a consolidated statement of cash flows with a disposal, some foreign exchange complications and an
impairment calculation. There will be easy marks available simply for the basic cash flow aspects, setting
out the proforma, setting up your workings, presenting your work neatly. If you recognise, as you should,
that the disposal needs to be taken into account, of course you will get marks for that, even if you make a
mistake in the arithmetic. If you get the foreign exchange right, so much the better, but you could pass the
question comfortably omitting this altogether. If you’re short of time, this is what you should do.
Be ruthless in ignoring the complications
Look at the question. Within reason, if there are complications – often only worth a few marks – that you
know you will not have time or knowledge to do, cross them out. It will make you feel better. Than tackle
the bits you can do. This is how people pass a seemingly impossible paper.
Answer all questions and all parts of questions
The examiner frequently comments that students don't do this, so they miss easy opportunities to gain
marks.
Be ruthless in allocating your time
At BPP, we have seen how very intelligent students do one almost perfect question, one averagely good
and one sketchy. For a fifty mark question, the first twenty marks are the easiest to get. Then you have to
push it up to what you think is thirty to get yourself a clear pass. For a twenty-five mark question, the first
eight to ten marks are the easiest to get, and then you must try to push it up to fifteen.
Do your best question either first or second, and the compulsory question either first or second. The
compulsory question, being on groups, will always have some easy marks available for consolidation
The P2 syllabus and study guide can be found below.
International
The paper will comprise two sections. Number of marks
Section A: 1 compulsory case study 50 Section B: Choice of 2 from 3 questions (25 marks each) 50
100
Section A will be a scenario-based question which will include:
The preparation of consolidated financial statements (including consolidated statements of cash
flows) with adjustments on other syllabus areas
A written part normally covering a particular accounting treatment and ethical and social issues in
financial reporting.
Section B will normally include:
Two scenario or case study-based questions (covering a range of standards and syllabus topics,
one usually in the context of a particular industry)
A essay-style discussion question, often encompassing current developments in corporate
reporting, which may also include some short calculations.
Analysis of past papers – by sitting
December 2013
Section A
1 Consolidated statement of cash flows with acquisition of subsidiary and adjustments for deferred tax, a
government grant and a pension plan; classification of cash flows; ethics
Section B
2 Revenue recognition; impairment loss; sale and leaseback
3 Specialised industry question set in a bank, covering debt versus equity, hedging and the application
of IFRS 10 in determining which party is the acquirer
4 IAS 8: use of judgement in selecting accounting policies; prior period errors (three scenarios)
June 2013
Section A
1 Consolidated statement of financial position with a ‘D’-shaped group; comparison of methods for
valuing non-controlling interest; ethics
2 Segment reporting, revenue recognition, provisions and property-related matters
3 In-depth analysis of whether a lease was a finance lease, a discontinued operation and fair value of an
investment property
4 Importance of and barriers to disclosures in annual reports and application to a scenario
Section B
2 Government grant; foreign exchange and cash flows; IFRS 10 and control; taxation and prior period
adjustment
3 Investment property; leasing (substance of transaction); provision; impairment
4 IFRS 13 Fair value measurement: principles, three-level hierarchy; IFRS 13 fair valuing of asset and
liability with computations
operation; de-recognition of financial asset; ethics
Section B
2 Sale and leaseback, defined benefit pension plan, cash-settled share-based payment and contingent
liability in the context of a business combination
3 Measuring fair value, impairment of goodwill, deferred tax liabilities and the fair value option for an
accounting mismatch; shares as financial liability or equity
4 Changing rules on provisions (discussion and calculation)
December 2011
Section A
reporting; ethics
Section B
4 Revenue recognition: principles and application
June 2011
Section A
1 Groups with a foreign subsidiary, other adjustments and the remainder on ethical issues
Section B
2 Specialised industry question with IFRS 1, IFRS 3 intangible assets and restructuring plans and
provisions
recognition, related party disclosures and classification of a employee benefit plan
4 Change to IFRS 9 rules for financial assets; change to expected loss model for impairment of
financial assets
1 Consolidated statement of cash flows; ethics of changing method
Section B
4 Small and medium-sized entities
June 2010
Section A
1 Groups with complex group and two disposals and the remainder on ethical issues
Section B
2 A range of topics including deferred tax, impairments, a deemed disposal/discontinuation and
retirement benefits
3 Specialised industry with derivatives, hedge accounting, brands and the purchase of retail outlets
through companies
4 Flaws in lease accounting; application of Framework, sale and leaseback
December 2009
Section A
1 Consolidated statement of financial position with changes in group structure
Section B
3 Revenue recognition; recognition of assets; joint control
4 Complexity in financial instruments
June 2009
Section A
Section B
on employee loan
December 2008
Section A
1 Group statement of cash flows with adjustments and interpretation; ethics
Section B
3 Tangibles, intangibles and revenue recognition
4 Accounting standards and disclosure
xxxvi Introduction
June 2008
Section A
1 Groups with a foreign subsidiary, other adjustments and the remainder on ethical issues
Section B
2 Segment reporting and revenue recognition in a specialised industry
3 Retirement benefits and financial instruments
4 Transition to IFRS
attitudes
4 Conceptual Framework
1 Statement of cash flows; criteria for consolidation; ethical behaviour
Section B
3 Deferred tax with pension scheme and financial instruments
4 Adoption of IFRS; proposals on business combinations
Analysis of past papers – by syllabus topic
The table below provides details of when each element of the syllabus has been examined and the
question number and section in which each element appeared. Further details can be found in the Exam
Focus Points in the relevant chapters.
Covered
3
unethical behaviour
3 Social responsibility Q4
financial statements in meeting
1
practices
– Substance over form issues Q1(a)
REPORTING THE FINANCIAL
PERFORMANCE OF ENTITIES
18 Performance reporting
– Intangible assets Q1(a),
– Investment properties Q1(a) Q3 Q3
– Government grants
Q3
Q3
Q3
18 Segment reporting Q1(b) Q2
5 Employee benefits Q1(a) Q3(d) Q1(a) Q2
6 Income taxes Q1(a) Q3 Q3
Provisions, contingencies and
Q2(d) Q2 Q3, Q4
10 Related parties Q3 Q3(c)
8 Share-based payment Q2, Q3 Q2
11 Leases Q4
12, 13,
13 Continuing and discontinued
Changes in group structure
– Group reorganisations Q2
– Foreign subsidiaries
SPECIALISED ENTITIES
standards on accounting systems
standards
Q2(a),
(b)
policies
Q4
18
19 Convergence between national and
international reporting standards
requirements
2 Corporate governance C1
3 Conceptual framework B2
Financial reporting
framework
Introduction Welcome to the Corporate Reporting paper using International Financial Reporting Standards (IFRS). This paper is about thinking and applying your knowledge of the IFRS. Most of the standards and topics have been covered in your earlier studies. However, at the Professional level, you need to think critically about them and show an understanding of topical issues. In the exam, you will need to put yourself in the role of an adviser to a business entity, using your knowledge to give practical advice.
In the exam, you will often be required to consider the impact of proposed changes to IFRS. Any such proposals are dealt with in this Study Text within the topic to which they relate.

4 1: Financial reporting framework Part A Regulatory and ethical framework
Study guide Intellectual level
A1 Professional behaviour and compliance with accounting standards
(a) Appraise the ethical and professional issues in advising on corporate reporting
3
(b) Assess the relevance and importance of ethical and professional issues in complying with accounting standards
3
A2 Ethical requirements of corporate reporting and the consequences of
unethical behaviour
(a) Appraise the potential ethical implications of professional and managerial decisions in the preparation of corporate reports
3
B1 The applications, strengths and weaknesses of an accounting framework
(a) Evaluate the valuation models adopted by standard setters
C1 Performance reporting
(a) Prepare reports relating to corporate performance for external stakeholders 3
B2 The applications, strength and weaknesses of an accounting framework
(a) Evaluate the valuation models adopted by standard setters 3
(b) Discuss the use of an accounting framework in underpinning the production of accounting standards
3
(c) Assess the success of such a framework in introducing rigorous and consistent accounting standards
3
Exam guide
This chapter is partly background knowledge to set the scene about the reporting framework before you look at ethical issues. It also discusses the Management Commentary and the Conceptual Framework .
The examiner has stated that revenue recognition is important.
1 International Financial Reporting Standards (IFRSs)
One of the competences you need to fulfil Objective 10 of the Practical Experience Requirement (PER) is to recognise and apply the external legal and professional framework and regulations to financial reporting. You can apply the knowledge you obtain from this section of the Text to demonstrate this competence.
To date the IASB has the following standards in issue.
1.1 Current accounting standards and documents examinable at P2
The documents listed as being examinable are the latest that were issued before 1 September 2013, and will be examinable in December 2014 and June 2015. This Study Text is for exams in December 2014
and June 2015.
The study guide offers more detail guidance on the depth and level at which the examinable documents will be examined. The study guide should be read in conjunction with the examinable documents list.

Part A Regulatory and ethical framework 1: Financial reporting framework 5
Title Date issued
Financial Reporting Standards (IFRSs)
IAS 1 Presentation of financial statements Dec 03, rev. Sept 07 and June 11
IAS 2 Inventories Dec 03
IAS 7 Statement of cash flows Dec 92
IAS 8 Accounting policies, changes in accounting estimates and errors
Dec 03
IAS 12 Income taxes Nov 00
IAS 16 Property, plant and equipment Dec 03
IAS 17 Leases Dec 03
IAS 18 Revenue Dec 93
IAS 19 Employee benefits Nov 00, revised 2011
IAS 20 Accounting for government grants and disclosure of government assistance
Jan 95
IAS 21 The effects of changes in foreign exchange rates Dec 03
IAS 23 Borrowing costs Dec 93
IAS 24 Related party disclosures Dec 03
IAS 27 Separate financial statements Dec 03, revised 2011
IAS 28 Investments in associates and joint ventures Dec 03, revised 2011
IAS 32 Financial Instruments: presentation Dec 03
IAS 33 Earnings per share Dec 03
IAS 34 Interim financial reporting Feb 98
IAS 36 Impairment of assets June 98
IAS 37 Provisions, contingent liabilities and contingent assets Sept 98
IAS 38 Intangible assets Sept 98
IAS 39 Financial Instruments: recognition and measurement Dec 03
IAS 40 Investment property Dec 03
IAS 41 Agriculture Feb 01
IFRS 1 First-time adoption of International Financial Reporting Standards
June 03
IFRS 3 Business combinations Mar 04, revised Jan 08
IFRS 5 Non-current assets held for sale and discontinued operations Mar 04
IFRS 7 Financial instruments: disclosures Aug 05
IFRS 8 Operating segments Nov 06
IFRS 9 Financial instruments Nov 09

Title Date issued
IFRS 11 Joint arrangements May 11
IFRS 12 Disclosure of interests in other entities May 11
IFRS 13 Fair value measurement May 11
IFRS For Small and Medium-sized Entities July 09
Other Statements
Practice Statement: Management Commentary
EDs, Discussion Papers and Other Documents
ED Financial instruments: Expected credit losses
ED Revenue from contracts with customers
ED Leases
ED Sale or contribution of assets between an investor and its associate or joint venture
Draft IFRS IFRS 9 Chapter 6 Hedge accounting
ED Equity method: share of other net asset changes
ED Improvements to IFRSs
ED Acquisition of an interest in a joint operation
Discussion Paper A review of the Conceptual Framework for Financial Reporting
Note. The accounting of financial assets and financial liabilities is accounted for in accordance with
IFRS 9 to the extent that this standard was in issue as at 1 September 2013. For any elements
of the study guide deemed as examinable and not covered by IFRS 9, these elements should be dealt with by studying IAS 39.
2 Corporate governance
Corporate governance has been important in recent years and in the current syllabus it is important in the context of ethical behaviour.
One of the major business debates recently is about corporate governance, particularly in the UK and the USA.
Corporate governance is the system by which companies are directed and controlled. (Cadbury Report)
The trigger for this debate was the collapse of major international companies during the 1980s, including Maxwell, BCCI and Polly Peck. These collapses were often unexpected, and dubious (or even fraudulent) activities were sometimes attributed to their owners and managers. These events represented a nasty shock for countries, such as the UK and the USA, that felt they had well-regulated markets and strong company legislation. It became obvious, however, that part of the problem was the way in which regulation was spread between different national authorities for these global conglomerates, so that no
one national authority had the whole picture of the affairs of such companies, nor full powers over the whole of the business.
Individual countries began to develop better guidelines for corporate governance, and efforts have been
made to produce an international standard on corporate governance.
Key term
FAST FORWARD

Corporate governance is covered in other papers, so is not examinable in P2. This is for background information only.
3 Conceptual framework 12/07
The 1989 Framework for the Preparation and Presentation of Financial Statements was replaced in 2010 by the Conceptual Framework for Financial Reporting . This is the result of a joint project with the FASB.
3.1 The search for a conceptual framework
A conceptual framework, in the field we are concerned with, is a statement of generally accepted
theoretical principles which form the frame of reference for financial reporting. These theoretical principles provide the basis for the development of new accounting standards and the evaluation of those already in existence.
The financial reporting process is concerned with providing information that is useful in the business and economic decision-making process. Therefore a conceptual framework will form the theoretical basis for determining which events should be accounted for, how they should be measured and how they should be communicated to the user.
Although it is theoretical in nature, a conceptual framework for financial reporting has highly practical final aims.
The danger of not having a conceptual framework is demonstrated in the way some countries' standards
have developed over recent years; standards tend to be produced in a haphazard and fire-fighting
approach. Where an agreed framework exists, the standard-setting body acts as an architect or designer, rather than a fire-fighter, building accounting rules on the foundation of sound, agreed basic principles.
The lack of a conceptual framework also means that fundamental principles are tackled more than once in different standards, thereby producing contradictions and inconsistencies in basic concepts, such as those of prudence and matching. This leads to ambiguity and it affects the true and fair concept of financial reporting.
Another problem with the lack of a conceptual framework has become apparent in the USA. The large number of highly detailed standards produced by the Financial Accounting Standards Board (FASB) has created a financial reporting environment governed by specific rules rather than general principles. This would be avoided if a cohesive set of principles were in place.
A conceptual framework can also bolster standard setters against political pressure from various 'lobby groups' and interested parties. Such pressure would only prevail if it was acceptable under the conceptual framework.
3.2 Advantages of a conceptual framework
The advantages arising from using a conceptual framework may be summarised as follows.
(a) The situation is avoided whereby standards are being developed on a piecemeal basis, where a
particular accounting problem is recognised as having emerged, and resources were then channelled into standardising accounting practice in that area, without regard to whether that particular issue was necessarily the most important issue remaining at that time without standardisation.
(b) As stated above, the development of certain standards (particularly national standards) have been subject to considerable political interference from interested parties. Where there is a conflict of interest between user groups on which policies to choose, policies deriving from a conceptual framework will be less open to criticism that the standard-setter buckled to external pressure.
Exam focus point

(c) Some standards may concentrate on the statement of profit or loss and other comprehensive income (formerly statement of comprehensive income, see Chapter 18 for the details of the change of name) whereas some may concentrate on the valuation of net assets (statement of financial position).
3.3 Counter-argument
A counter-argument might be as follows:
(a) Financial statements are intended for a variety of users, and it is not certain that a single conceptual framework can be devised which will suit all users.
(b) Given the diversity of user requirements, there may be a need for a variety of accounting standards, each produced for a different purpose (and with different concepts as a basis).
(c) It is not clear that a conceptual framework makes the task of preparing and then implementing standards any easier than without a framework.
Before we look at the IASB's attempt to produce a conceptual framework, we need to consider another term of importance to this debate: generally accepted accounting practice; or GAAP.
3.4 Generally Accepted Accounting Practice (GAAP)
This term has sprung up in recent years and its signifies all the rules, from whatever source, which govern accounting. In individual countries this is seen primarily as a combination of:
National corporate law
National accounting standards
Local stock exchange requirements
Although those sources are the basis for the GAAP of individual countries, the concept also includes the effects of non-mandatory sources such as:
International financial reporting standards
Statutory requirements in other countries
In many countries, like the UK, GAAP does not have any statutory or regulatory authority or definition, unlike other countries, such as the USA. The term is mentioned rarely in legislation, and only then in fairly limited terms.
3.5 GAAP and a conceptual framework
A conceptual framework for financial reporting can be defined as an attempt to codify existing GAAP in order to reappraise current accounting standards and to produce new standards.
3.6 The IASB Conceptual Framework
The IASB Framework for the Preparation and Presentation of Financial Statements was produced in 1989
and is gradually being replaced by the new Conceptual Framework for Financial Reporting . This is the result of an IASB/FASB joint project and is being carried out in phases. The first phase, comprising Chapters 1 and 3, was published in September 2010. Chapter 2 entitled ‘The reporting entity’ has not yet been published. The current version of the Conceptual Framework includes the remaining chapters of the 1989 Framework as Chapter 4.
The Conceptual Framework for Financial Reporting is currently as follows:
Chapter 1: The objective of general purpose financial reporting
Chapter 2: The reporting entity (to be issued)
Chapter 3: Qualitative characteristics of useful financial information
Chapter 4: Remaining text of the 1989 Framework :

Underlying assumption
Recognition of the elements of financial statements
Measurement of the elements of financial statements
Concepts of capital and capital maintenance
You have studied the 1989 Framework in your earlier studies. We will now look at some of these sections in more detail.
3.7 Introduction to the Conceptual Framework
The Introduction provides a list of the purposes of the Conceptual Framework :
(a) To assist the Board in the development of future IFRSs and in its review of existing IFRSs.
(b) To assist the Board in promoting harmonisation of regulations, accounting standards and procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative accounting treatments permitted by IFRSs.
(c) To assist national standard-setting bodies in developing national standards.
(d) To assist preparers of financial statements in applying IFRSs and in dealing with topics that have
yet to form the subject of an IFRS.
(e) To assist auditors in forming an opinion as to whether financial statements comply with IFRSs.
(f) To assist users of financial statements in interpreting the information contained in financial statements prepared in compliance with IFRSs.
(g) To provide those who are interested in the work of the IASB with information about its approach to
the formulation of IFRSs.
The Conceptual Framework is not an IFRS and so does not overrule any individual IFRS. In the (rare) case
of conflict between an IFRS and the Conceptual Framework , the IFRS will prevail.
3.8 Chapter 1: The Objective of General Purpose Financial Reporting
The Conceptual Framework states that:
‘The objective of general purpose financial reporting is to provide information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.’
These users need information about:
The economic resources of the entity;
The claims against the entity; and
Changes in the entity’s economic resources and claims
Information about the entity’s economic resources and the claims against it helps users to assess the
entity’s liquidity and solvency and its likely needs for additional financing.
Information about a reporting entity’s financial performance (the changes in its economic resources and
claims) helps users to understand the return that the entity has produced on its economic resources.
This is an indicator of how efficiently and effectively management has used the resources of the entity and is helpful in predicting future returns.
The Conceptual Framework makes it clear that this information should be prepared on an accruals basis.
Information about a reporting entity’s cash flows during a period also helps users assess the entity’s ability to generate future net cash inflows and gives users a better understanding of its operations.

3.9 Chapter 3: Qualitative characteristics of useful financial information
Qualitative characteristics are attributes that make financial information useful to users.
Chapter 3 distinguishes between fundamental and enhancing qualitative characteristics, for analysis
purposes. Fundamental qualitative characteristics distinguish useful financial reporting information from information that is not useful or misleading. Enhancing qualitative characteristics distinguish more useful information from less useful information.
The two fundamental qualitative characteristics are:
(a) Relevance: Relevant information has predictive value or confirmatory value, or both. It is capable
of making a difference in the decisions made by users.
The relevance of information is affected by its nature and its materiality.
(b) Faithful representation: Information must be complete, neutral and free from error (replacing 'reliability').
Financial reports represent economic phenomena in words and numbers. To be useful, financial
information must not only represent relevant phenomena but must faithfully represent the phenomena that it purports to represent.
A complete depiction includes all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations.
A neutral depiction is without bias in the selection or presentation of financial information. This means
that information must not be manipulated in any way in order to influence the decisions of users.
Free from error means there are no errors or omissions in the description of the phenomenon and no
errors made in the process by which the financial information was produced. It does not mean that no inaccuracies can arise, particularly where estimates have to be made.
Substance over form
This is not a separate qualitative characteristic under the Conceptual Framework . The IASB says that to
do so would be redundant because it is implied in faithful representation. Faithful representation of a
transaction is only possible if it is accounted for according to its substance and economic reality.
3.9.1 Enhancing qualitative characteristics
Comparability is the qualitative characteristic that enables users to identify and understand similarities in,
and differences among, items. Information about a reporting entity is more useful if it can be compared
with similar information about other entities and with similar information about the same entity for another
period or another date.
Consistency, although related to comparability, is not the same. It refers to the use of the same methods
for the same items (ie consistency of treatment) either from period to period within a reporting entity or in
a single period across entities.
The disclosure of accounting policies is particularly important here. Users must be able to distinguish
between different accounting policies in order to be able to make a valid comparison of similar items in the
accounts of different entities.
Comparability is not the same as uniformity. Entities should change accounting policies if those policies
become inappropriate.
Corresponding information for preceding periods should be shown to enable comparison over time.

Verifiability
to represent. It means that different knowledgeable and independent observers could reach consensus
that a particular depiction is a faithful representation.
Timeliness
Information may become less useful if there is a delay in reporting it. There is a balance between
timeliness and the provision of reliable information.
If information is reported on a timely basis when not all aspects of the transaction are known, it may not be complete or free from error.
Conversely, if every detail of a transaction is known, it may be too late to publish the information because it has become irrelevant. The overriding consideration is how best to satisfy the economic decision-making needs of the users.
Understandability
Financial reports are prepared for users who have a reasonable knowledge of business and economic
activities and who review and analyse the information diligently. Some phenomena are inherently complex
and cannot be made easy to understand. Excluding information on those phenomena might make the
information easier to understand, but without it those reports would be incomplete and therefore
misleading. Therefore matters should not be left out of financial statements simply due to their difficulty as
even well-informed and diligent users may sometimes need the aid of an adviser to understand
information about complex economic phenomena.
The cost constraint on useful financial reporting
This is a pervasive constraint, not a qualitative characteristic. When information is provided, its benefits
must exceed the costs of obtaining and presenting it. This is a subjective area and there are other
difficulties: others, not the intended users, may gain a benefit; also the cost may be paid by someone other
than the users. It is therefore difficult to apply a cost-benefit analysis, but preparers and users should be
aware of the constraint.
The 1989 Framework identified two underlying assumptions – accruals and going concern. The Conceptual Framework makes it clear that financial information should be prepared on an accruals
basis but only identifies one underlying assumption – going concern.
3.10 Exposure Draft: Chapter 2: The Reporting Entity
This ED was issued in March 2010. It presents the IASB's consideration of issues in the development of a reporting entity concept for inclusion in the Conceptual Framework for Financial Reporting. There are four sections.
3 10 1 The reporting entity concept
This deals with general issues relating to the reporting entity concept. For example, it considers whether a precise definition of a reporting entity is necessary and whether a reporting entity must be a legal entity.
The Board's conclusion at this stage is that the conceptual framework should broadly describe rather than
precisely define a reporting entity as a circumscribed area of business activity of interest to present and
potential equity investors, lenders and other creditors who cannot directly obtain the information they
need in making decisions about providing resources to the entity and in assessing whether management and the governing board of the entity have made efficient and effective use of the resources provided.
Examples of reporting entities include a sole trader, corporation, trust, partnership, association and group.

3.10.2 When does an entity control another entity?
Consolidated financial statements are presented when control exists. Control exists where an entity has the power to direct the activities of another entity to generate benefits or limit losses to itself.
If control is shared, no consolidated financial statements need be presented.
3.10.3 Portion of an entity
A portion of an entity could qualify as a reporting entity if the economic activities of that portion can be distinguished objectively from the rest of the entity and financial information about that portion of the entity has the potential to be useful in making decisions about providing resources to that portion of the entity.
3.10.4 Financial statements other than consolidated financial statements
This section considers two issues:
(a) Parent-only financial statements
(b) Combined financial statements. These would include information about two or more commonly controlled entities
The IASB's preliminary conclusion is that (a) parent-only financial statements may be presented
provided they are included in the same financial report as consolidated financial statements and
(b) combined financial statements might provide useful information about commonly controlled entities as a group.
3.11 Potential problems
The UK's Accounting Standards Board (ASB) has highlighted a number of potential objections that may be made to the proposals.
(a) Users. The ASB is concerned about the proposal that the objective of financial reporting should focus only on decision-usefulness, with stewardship being subsumed within this rather than being referred to as a specific part of the objective, or a separate objective. The ASB believes that stewardship should be a separate objective. The ASB is also concerned that the shareholder user perspective is being downplayed.
(b) Qualitative characteristics: what happens to reliability? The DP proposes replacing the qualitative characteristic of 'reliability' in the current Framework with 'faithful representation'. The ASB believes that faithful representation is a softer notion which, when combined with a lack of specific identification of substance over form as a principle, could lead to a number of problems.
(c) Financial reporting or financial statements. The ASB believes the boundary between financial
statements and financial reporting has not been properly considered.
(d) Limited in scope. The Discussion Paper is limited to private enterprises, rather than, as the ASB
believes it should be, encompassing the not-for profit sector.
(e) Too theoretical. This may alienate preparers and auditors of accounts.
(f) Too piecemeal. This is likely to lead to internal inconsistency.
(g) The entity perspective is adopted without an in-depth comparisonwith other possible
perspectives (such as the proprietary perspective, the parent shareholder perspective and other hybrid models).
(h) The differentiation between fundamental and enhancing qualitative characteristics is artificial.
(i) The qualitative characteristic of 'verifiability' is problematic.

(j) In the proposed 'Reporting Entity' chapter, the entity perspective and the definitions of control
have been insufficiently thought through. In addition, the 'risks and rewards' model is not
adopted, thereby losing a useful concept.
3.12 Discussion Paper: Review of the Conceptual Framework
As the first step towards a revised Conceptual Framework, the IASB issued a Discussion Paper Review of
the Conceptual Framework in July 2013. The Paper deals with the following issues.
(a) Definitions of assets and liabilities. The current definitions of assets and liabilities require a
probable expectation of future economic benefits or resource outflow. The IASB argues that the definitions of assets and liabilities should not require an expected or probable inflow or outflow as it should be sufficient that a resource or obligation can produce or result in a transfer of economic benefits. While the IASB believes that the current definitions have worked well in the past, it wishes to refine them in order to place more emphasis on the fact that an asset is a resource and a liability is an obligation. In addition, the notion of probability will be removed from the definitions. The proposed definitions are:
(i) An asset is a present economic resource controlled by the entity because of past events.
(ii) A liability is a present obligation of the entity to transfer an economic resource because of past events.
Under the Discussion Paper, constructive obligations would qualify as liabilities and certain avoidable obligations, for example directors’ bonuses, could qualify.
(b) Recognition and derecognition of assets and liabilities.Generally all assets and liabilities are to
be recognised unless recognising an asset or a liability is considered irrelevant or not sufficiently relevant to justify the costs for doing so or no measurement of the item would lead to a sufficiently faithful representation. For the first time, the Conceptual Framework will give guidance on derecognition. Generally entities should derecognise an asset or liability, or part of an asset or liability, when it no longer meets the recognition criteria.
(c) Measurement. This section considers the objectives of different categories of measurement,
noting that the use of only one measurement basis for all assets and liabilities would not be appropriate. The measurement basis selected must provide the most relevant information in the statement of financial position and statement of profit or loss and other comprehensive income.
(d) Equity. This is still defined as a residual interest (in the assets of the entity after deducting all its liabilities). However, there is a new departure: entities will be required to provide further information about the claims of different classes of equity in order to show dilution effects. Finally the section addresses the question whether the most subordinated class of instruments should be treated as equity if an entity has issued no equity instruments. See Paragraph 3.12.1 below for more detail on the distinction between equity and liabilities.
(e) Profit or loss and other comprehensive income. This part of the Discussion Paper tackles the distinction between profit or loss and other comprehensive income. Both profit or loss and other comprehensive income would be retained and marked by subtotals or totals. By default, all income and expense will be shown in profit or loss unless relating to the remeasurement of assets and liabilities - these would normally be shown in other comprehensive income with recycling generally permitted. There is no detailed definition of profit or loss. See Paragraph 3.12.2 below for more detail.
(f) Presentation and disclosure. This section is new, with no equivalent in the current Conceptual
Framework. The aim is to provide a framework for disclosure to ensure that the information disclosed is relevant to investors. In the short term, this will result in amendments to IAS 1 and a new focus on materiality and on disclosure requirements in current projects. In the longer term it is likely that a replacement will be proposed for IAS 1, IAS 7 and IAS 8. Examples of types of disclosure include risks, methods, assumptions and judgements, unrecognised assets or liabilities

and amounts recognised in the financial statements. Other disclosures will relate to the reporting entity, for example group structure, business model and going concern.
(g) Other matters. This section includes a review of issues raised in the 2010 ED The Reporting Entity.
It also includes a summary of concerns raised in the feedback on the existing document with regard to stewardship, reliability and prudence.
3 12 1 Equity versus liabilities
The distinction between equity and liabilities is clarified through focus on the definition of a liability. The
paper identifies two types of approach: narrow equity and strict obligation.
(a) Narrow equity approach. Equity is treated as being only the residual class issued, with changes in the measurement of other equity claims recognised in profit or loss.
(b) Strict obligation approach. All equity claims are classified as equity with obligations to deliver cash or assets being classified as liabilities. Any changes in the measurement of equity claims would be shown in the statement of changes in equity.
Under the strict obligation approach, certain transactions now classified as liabilities would now be classified as equity because they do not involve an obligation to transfer cash or assets. An example of this is an issue of shares for a fixed monetary amount.
3 12 2 Profit or loss versus other comprehensive income
Currently, the Conceptual Framework does not contain principles to determine:
(a) What items are recognised in profit or loss
(b) What items are recognised in other comprehensive income
(c) Whether, and when, items can be recycled from other comprehensive income to profit or loss
In response, the Discussion Paper proposes that the Conceptual Framework should:
(a) Require a profit or loss total or subtotal that also results, or could result, in some items of income
or expense being recycled.
(b) Limit the use of OCI (only to income and expenses resulting from remeasurements of assets and
liabilities).
The Discussion Paper proposes a narrow and broad approach to what should be included in other
comprehensive income, but the IASB has not yet decided which approach it will use.
(a) Narrow approach. Other comprehensive income would include bridging items and mismatched
remeasurements.
Bridging items are items of income or expense which represent the difference between measurement used in determining profit or loss and remeasurement used in the statement of financial position. An example would be investments in equity instruments with changes in fair value recorded in other comprehensive income. Such items would have to be recycled as a
consequence of the measurement basis presented in profit or loss.
Mismatched remeasurements represent the effects of part of a linked set of assets, liabilities or past or planned transactions. It represents their effect so incompletely that, in the opinion of the IASB, the item provides little relevant information about the return that the entity has made on its economic resources in the period. An example would be a cash flow hedge, where fair value gains and losses are accumulated in other comprehensive income until the hedged transaction affects
profit or loss. These amounts should be recycled when the item can be presented with the
matched item.
(b) Broad approach. In addition to the narrow approach, this would also include transitory
remeasurements. Transitory remeasurements are remeasurements of long-term assets and
liabilities that are likely to reverse or significantly change over time. These items would be shown in

OCI - for example, the remeasurement of a net defined pension benefit liability or asset. The IASB
would decide in each IFRS whether a transitory remeasurement should be subsequently
recycled.
3.13 Recent developments
So far the other parts of the Conceptual Framework are still at the discussion stage. Below is a summary
of progress at the time of writing (May 2014):
(a) Objectives and qualitative characteristics – see above.
(b) Elements and recognition. The Board has tentatively agreed that the focus of the definition of an asset should be on a present economic resource rather than on future economic benefits and an assessment of likelihood should be removed from the definition of an asset. The definition should focus on the present rather than on past transactions or events. No definition of a liability has been agreed.
(c) Measurement. Various measurement bases have been discussed. They are divided into past
present and future. Past bases are:
(i) Past entry price (ii) Modified past entry amount (iii) Past exit price
Present bases are:
(i) Current entry price (ii) Current exit price (iii) Current equilibrium price (iv) Value in use
Future bases are:
(d) Reporting entity – see above
(e) Purpose and status – discussions pending
(f) Application to not for profit entities – discussions pending
(g) Remaining issues – discussions pending
The examining team have flagged this topic as important. Keep an eye on future developments by reading Student Accountant and www.iasplus.com/agenda/framework.htm
4 Revenue recognition 6/08, 12/08, 6/11, 12/11, 6/13, 12/13
Revenue recognition is straightforward in most business transactions, but some situations are more
complicated.
4.1 Introduction
Accruals accounting is based on the matching of costs with the revenue they generate. It is crucially important under this convention that we can establish the point at which revenue may be recognised so that the correct treatment can be applied to the related costs. For example, the costs of producing an item of finished goods should be carried as an asset in the statement of financial position until such time as it is sold; they should then be written off as a charge to the trading account. Which of these two treatments should be applied cannot be decided until it is clear at what moment the sale of the item takes place.
FAST FORWARD
The decision has a direct impact on profit since under the prudence concept it would be unacceptable to recognise the profit on sale until a sale had taken place in accordance with the criteria of revenue recognition.
Revenue is generally recognised as earned at the point of sale, because at that point four criteria will
generally have been met.
The product or service has been provided to the buyer.
The buyer has recognised his liability to pay for the goods or services provided. The converse of this is that the seller has recognised that ownership of goods has passed from himself to the buyer.
The buyer has indicated his willingness to hand over cash or other assets in settlement of his
liability.
The monetary value of the goods or services has been established.
At earlier points in the business cycle there will not, in general, be firm evidence that the above criteria will be met. Until work on a product is complete, there is a risk that some flaw in the manufacturing process will necessitate its writing off; even when the product is complete there is no guarantee that it will find a buyer.
At later points in the business cycle, for example when cash is received for the sale, the recognition of revenue may occur in a period later than that in which the related costs were charged. Revenue recognition would then depend on fortuitous circumstances, such as the cash flow of a company's customers, and might fluctuate misleadingly from one period to another.
However, there are times when revenue is recognised at other times than at the completion of a sale.
For example, in the recognition of profit on long-term construction contracts. Under IAS 11 Construction
contracts contract revenue and contract costs associated with the construction contract should be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the year end.
(a) Owing to the length of time taken to complete such contracts, to defer taking profit into account until completion may result in the statement of profit or loss and other comprehensive income reflecting, not so much a fair view of the activity of the company during the year, but rather the results relating to contracts which have been completed by the year end.
(b) Revenue in this case is recognised when production on, say, a section of the total contract is complete, even though no sale can be made until the whole is complete.
4.2 IAS 18 Revenue
IAS 18 Revenue is concerned with the recognition of revenues arising from fairly common transactions.
– The sale of goods – The rendering of services – The use by others of enterprise assets yielding interest, royalties and dividends
Generally revenue is recognised when the entity has transferred to the buyer the significant risks and
rewards of ownership and when the revenue can be measured reliably.
IAS 18 governs the recognition of revenue in specific (common) types of transaction. Generally, recognition should be when it is probable that future economic benefits will flow to the enterprise and
when these benefits can be measured reliably.
Income, as defined by the IASB's Framework document (see above), includes both revenues and gains. Revenue is income arising in the ordinary course of an enterprise's activities and it may be called different names, such as sales, fees, interest, dividends or royalties.
FAST FORWARD

4.3 Scope
IAS 18 covers the revenue from specific types of transaction or events.
Sale of goods (manufactured products and items purchased for resale)
Rendering of services
Use by others of enterprise assets yielding interest, royalties and dividends
Interest, royalties and dividends are included as income because they arise from the use of an entity's assets by other parties.
Interest is the charge for the use of cash or cash equivalents or amounts due to the entity.
Royalties are charges for the use of non-current assets of the entity, eg patents, computer software and
trademarks.
Dividends are distributions of profit to holders of equity investments, in proportion with their holdings, of
each relevant class of capital.
The standard specifically excludes various types of revenue arising from leases, insurance contracts, changes in value of financial instruments or other current assets, natural increases in agricultural assets and mineral ore extraction.
4.4 Definitions
The following definitions are given in the standard.
Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary
activities of an enterprise when those inflows result in increases in equity, other than increases relating to contributions from equity participants. (IAS 18)
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. (IFRS 13)
Revenue does not include sales taxes, value added taxes or goods and service taxes which are only collected for third parties, because these do not represent an economic benefit flowing to the entity. The same is true for revenues collected by an agent on behalf of a principal. Revenue for the agent is only the commission received for acting as agent.
4.5 Measurement of revenue
When a transaction takes place, the amount of revenue is usually decided by the agreement of the buyer
and seller. The revenue is actually measured, however, as the fair value of the consideration received,
which will take account of any trade discounts and volume rebates.
4.6 Identification of the transaction
Normally, each transaction can be looked at as a whole. Sometimes, however, transactions are more
complicated, and it is necessary to break a transaction down into its component parts. For example, a sale
may include the transfer of goods and the provision of future servicing, the revenue for which should be deferred over the period the service is performed.
At the other end of the scale, seemingly separate transactions must be considered together if apart they
lose their commercial meaning. An example would be to sell an asset with an agreement to buy it back at a later date. The second transaction cancels the first and so both must be considered together.
Key terms
Key terms

4.7 Sale of goods
Revenue from the sale of goods should only be recognised when all these conditions are satisfied.
(a) The entity has transferred the significant risks and rewards of ownership of the goods to the buyer
(b) The entity has no continuing managerial involvement to the degree usually associated with ownership, and no longer has effective control over the goods sold
(c) The amount of revenue can be measured reliably
(d) It is probable that the economic benefits associated with the transaction will flow to the enterprise
(e) The costs incurred in respect of the transaction can be measured reliably
The transfer of risks and rewards can only be decided by examining each transaction. Mainly, the transfer
occurs at the same time as either the transfer of legal title, or the passing of possession to the buyer – this is what happens when you buy something in a shop.
If significant risks and rewards remain with the seller, then the transaction is not a sale and revenue
cannot be recognised, for example if the receipt of the revenue from a particular sale depends on the buyer receiving revenue from his own sale of the goods.
It is possible for the seller to retain only an 'insignificant' risk of ownership and for the sale and revenue to be recognised. The main example here is where the seller retains title only to ensure collection of what is owed on the goods. This is a common commercial situation, and when it arises the revenue should be recognised on the date of sale.
The probability of the enterprise receiving the revenue arising from a transaction must be assessed. It may only become probable that the economic benefits will be received when an uncertainty is removed, for example government permission for funds to be received from another country. Only when the uncertainty is removed should the revenue be recognised. This is in contrast with the situation where revenue has
already been recognised but where the collectability of the cash is brought into doubt. Where recovery
has ceased to be probable, the amount should be recognised as an expense, not an adjustment of the revenue previously recognised. These points also refer to services and interest, royalties and dividends below.
Matching should take place, ie the revenue and expenses relating to the same transaction should be
recognised at the same time. It is usually easy to estimate expenses at the date of sale (eg warranty costs, shipment costs, etc). Where they cannot be estimated reliably, then revenue cannot be recognised; any consideration which has already been received is treated as a liability.
4.8 Rendering of services
When the outcome of a transaction involving the rendering of services can be estimated reliably, the
associated revenue should be recognised by reference to the stage of completion of the transaction at the
year end. The outcome of a transaction can be estimated reliably when all these conditions are satisfied.
(a) The amount of revenue can be measured reliably
(b) It is probable that the economic benefits associated with the transaction will flow to the enterprise
(c) The stage of completion of the transaction at the year end can be measured reliably
(d) The costs incurred for the transaction and the costs to complete the transaction can be measured reliably
The parties to the transaction will normally have to agree the following before an enterprise can make reliable estimates.
(a) Each party's enforceable rights regarding the service to be provided and received by the parties
(b) The consideration to be exchanged
(c) The manner and terms of settlement

There are various methods of determining the stage of completion of a transaction, but for practical purposes, when services are performed by an indeterminate number of acts over a period of time, revenue
should be recognised on a straight line basis over the period, unless there is evidence for the use of a more appropriate method. If one act is of more significance than the others, then the significant act should
be carried out before revenue is recognised.
In uncertain situations, when the outcome of the transaction involving the rendering of services cannot be estimated reliably, the standard recommends a no loss/no gain approach. Revenue is recognised only to
the extent of the expenses recognised that are recoverable.
This is particularly likely during the early stages of a transaction, but it is still probable that the enterprise
will recover the costs incurred. So the revenue recognised in such a period will be equal to the expenses incurred, with no profit.
Obviously, if the costs are not likely to be reimbursed, then they must be recognised as an expense immediately. When the uncertainties cease to exist, revenue should be recognised as laid out in the first
paragraph of this section.
When others use the enterprise's assets yielding interest, royalties and dividends, the revenue should be recognised on the bases set out below when:
(a) It is probable that the economic benefits associated with the transaction will flow to the enterprise; and
(b) The amount of the revenue can be measured reliably.
The revenue is recognised on the following bases.
(a) Interest is recognised on a time proportion basis that takes into account the effective yield on the asset.
(b) Royalties are recognised on an accruals basis in accordance with the substance of the relevant
agreement .
(c) Dividends are recognised when the shareholder's right to receive payment is established.
It is unlikely that you would be asked about anything as complex as this in the exam, but you should be
aware of the basic requirements of the standard. The effective yield on an asset mentioned above is the rate of interest required to discount the stream of future cash receipts expected over the life of the asset to equate to the initial carrying amount of the asset.
Royalties are usually recognised on the same basis that they accrue under the relevant agreement.
Sometimes the true substance of the agreement may require some other systematic and rational method of recognition.
Once again, the points made above about probability and collectability on sale of goods also apply here.
4.10 Disclosure
The following items should be disclosed.
(a) The accounting policies adopted for the recognition of revenue, including the methods used to determine the stage of completion of transactions involving the rendering of services.
(b) The amount of each significant category of revenue recognised during the period including
revenue arising from:
(i) The sale of goods (ii) The rendering of services (iii) Interest (iv) Royalties (v) Dividends

(c) The amount of revenue arising from exchanges of goods or services included in each significant category of revenue.
Any contingent gains or losses, such as those relating to warranty costs, claims or penalties should be
treated according to IAS 37 Provisions, contingent liabilities and contingent assets (covered in your earlier studies).
4.11 Question practice
The examiner has recently emphasised that revenue recognition is an important topic, so have a go at the questions below.
Question Recognition
Given that prudence is the main consideration, discuss under what circumstances, if any, revenue might be recognised at the following stages of a sale.
(a) Goods are acquired by the business which it confidently expects to resell very quickly. (b) A customer places a firm order for goods. (c) Goods are delivered to the customer. (d) The customer is invoiced for goods. (e) The customer pays for the goods. (f) The customer's cheque in payment for the goods has been cleared by the bank.
Answer
(a) A sale must never be recognised before the goods have even been ordered by a customer. There is no certainty about the value of the sale, nor when it will take place, even if it is virtually certain that goods will be sold.
(b) A sale must never be recognised when the customer places an order. Even though the order will be for a specific quantity of goods at a specific price, it is not yet certain that the sale transaction will go through. The customer may cancel the order, the supplier might be unable to deliver the goods as ordered or it may be decided that the customer is not a good credit risk.
(c) A sale will be recognised when delivery of the goods is made only when:
(i) The sale is for cash, and so the cash is received at the same time; or (ii) The sale is on credit and the customer accepts delivery (eg by signing a delivery note).
(d) The critical event for a credit sale is usually the despatch of an invoice to the customer. There is then a legally enforceable debt, payable on specified terms, for a completed sale transaction.
(e) The critical event for a cash sale is when delivery takes place and when cash is received; both take place at the same time.
It would be too cautious or 'prudent' to await cash payment for a credit sale transaction before recognising the sale, unless the customer is a high credit risk and there is a serious doubt about his ability or intention to pay.

Question Revenue recognition
Caravans Deluxe is a retailer of caravans, dormer vans and mobile homes, with a year end of 30 June 20X8. It is having trouble selling one model – the $30,000 Mini-Lux, and so is offering incentives for customers who buy this model before 31 May 20X7:
(a) Customers buying this model before 31 May 20X7 will receive a period of interest free credit, provided they pay a non-refundable deposit of $3,000, an instalment of $15,000 on 1 August 20X7 and the balance of $12,000 on 1 August 20X9.
(b) A three-year service plan, normally worth $1,500, is included free in the price of the caravan.
On 1 May 20X7, a customer agrees to buy a Mini-Lux caravan, paying the deposit of $3,000. Delivery is arranged for 1 August 20X7.
As the sale has now been made, the director of Caravans Deluxe wishes to recognise the full sale price of the caravan, $30,000, in the accounts for the year ended 30 June 20X7.
Required
Advise the director of the correct accounting treatment for this transaction. Assume a 10% discount rate. Show the journal entries for this treatment.
Answer
The director wishes to recognise the sale as early as possible. However, following IAS 18 Revenue , he cannot recognise revenue from this sale because the risks and rewards of ownership of the caravan have not been transferred. This happens on the date of delivery, which is 1 August 20X7. Accordingly, no revenue can be recognised in the current period.
The receipt of cash in the form of the $3,000 deposit must be recognised. However, while the deposit is termed 'non-refundable', it does create an obligation to complete the contract. The other side of the entry is therefore to deferred income in the statement of financial position.
The journal entries would be as follows:
DEBIT Cash $3,000 CREDIT Deferred income $3,000
Being deposit received in advance of the sale being recognised.
On 1 August 20X7, when the sale is recognised, this deferred income account will be cleared. In addition:
The revenue from the sale of the caravan will be recognised. Of this, $12,000 is receivable in two years' time, which, with a 10% discount rate, is: $12,000/ 1.12 = $9,917. $15,000 is receivable on 1 August 20X7.
The service plan is not really 'free' – nothing is. It is merely a deduction from the cost of the caravan. The $1,500 must be recognised separately. It is deferred income and will be recognised over the three year period.
The sales revenue recognised in respect of the caravan will be a balancing figure.
The journal entries are as follows:
DEBIT Deferred income $3,000
DEBIT Cash (1st instalment) $15,000 DEBIT Receivable (balance discounted) $9,917
CREDIT Deferred income (service $1,500 plan monies received in advance)
CREDIT Sales (balancing figure) $26,417

BPP Note. This question is rather fiddly, so do not worry too much if you didn't get all of it right. Read through our solution carefully, going back to first principles where required.
4.12 Principal or agent?
Previously, IAS 18 covered the accounting treatment for amounts collected by an agent on behalf of a principal, which is: recognise only the commission as revenue (not the amounts collected on behalf of the principal). However, it did not give guidance on determining whether an entity is acting as agent or principal.
In April 2009, the IASB issued some improvements to IFRS, most of which are minor. The most significant change is the additional guidance in the appendix to IAS 18 Revenue on determining whether an entity is acting as an agent or principal. The guidance is as follows.
4.12.1 Acting as principal
An entity is acting as a principal when it is exposed to the significant risks and rewards associated with the sale of goods or rendering of services. Features that indicate that an entity is acting as a principal include (individually or in combination):
(a) Primary responsibility for providing goods or services to the customer or for fulfilling the order
(b) The entity having the inventory risk before or after the customer order, during shipping or on
return
(c) Discretion in establishing prices (directly or indirectly) eg providing additional goods or services
(d) The entity bearing the customer's credit risk for the amount receivable from the customer
4.12.2 Acting as agent
An entity is acting as an agent when it is not exposed to the significant risks and rewards associated with
the sale of goods or rendering of services. One feature that indicates that an entity is an agent is that the
amount the entity earns is predetermined eg fixed fee per transaction or percentage of amount billed to the customer.
4.13 Exposure Draft: Revenue recognition in contracts with customers
4.13.1 Reasons for the ED
The IASB and US Financial Accounting Standards Board (FASB) are undertaking a joint project to develop a new revenue recognition standard.
In US GAAP, there are more than 100 revenue recognition standards which produce results for different industries which are sometimes inconsistent with each other. In International GAAP, there are only two standards (IAS 11 and IAS 18), but they are inconsistent and vague.
The ED was issued in June 2010, following a 2008 Discussion Paper and re-exposed with some modifications in November 2011.
4.13.2 Proposed approach
Step 1 Identify the contract with the customer. Identifying a contract is usually straightforward, as
there will be a written agreement or an alternative according to normal business practice.
The entity would normally treat each contract separately, but there are cases where they
might combine them. The key point is price interdependence. Usually a company would
apply the proposals to a single contract. However, in some cases the company would
account for two or more contracts together if the prices of those contracts are
interdependent. Conversely, a company would segment a single contract and account for it

as two or more contracts if some goods or services are priced independently of other goods
and services.
Step 2 Identify the separate performance obligations. The key point is distinct goods or services.
A contract includes promises to provide goods or services to a customer. Those promises
are called performance obligations. A company would account for a performance obligation
separately only if the promised good or service is distinct. A good or service is distinct if it
is sold separately or if it could be sold separately because it has a distinct function and a
distinct profit margin.
Step 3 Determine the transaction price. The key proposal is a probability weighted expected
amount. The transaction price is the amount of consideration a company expects to be
entitled to from the customer in exchange for transferring goods or services. The
transaction price would reflect the company’s probability-weighted estimate of variable
consideration (including reasonable estimates of contingent amounts) in addition to the
effects of the customer’s credit risk and the time value of money (if material).
Step 4 Allocate the transaction price to the performance obligations. The key proposal is relative
selling price allocation. A company would allocate the transaction price to all separate
performance obligations in proportion to the stand-alone selling price of the good or service
underlying each performance obligation. If the good or service is not sold separately, the
company would estimate its stand-alone selling p