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IAS 16 PROPERTY, PLANT & EQUIPMENT

IAS 16 defines PPE as tangible items that:a) Are held for use in the production or supply of goods or services, for rental to

others or for administrative purposes andb) Are expected to be used during more than one period.

Initial recognition: measured at its cost.As with all assets, recognition depends on two criteria. It is probable that future economic benefits associated with the item will flow to theentity

The cost of the item can be measured reliablyCost includes all costs which are directly attributable to bringing the asset into workingcondition for intended use. These costs should be capitalized until the asset is physicallyready for use.

They include:- Purchase price, less trade discounts- commissioning costs, site preparation- installation and testing cost- Initial estimate of the costs of dismantling and removing the item and

restoring the siteon which it is located.(IAS 37)

-

Finance cost must be capitalised if they are directly attributable to theacquisition of the qualifying asset

The following costs are specifically excluded:

* Administration and general overheads.* Abnormal costs (repairs, wastage, idle time)* Costs incurred after the asset is physically ready for use.

* Any further costs incurred before a machine is used at its full capacity

Subsequent Measurement

A company can either use cost model or revaluation model to subsequently measure

PPE.

Cost model

Asset is carried at cost less accumulated depreciation and impairment loss (if any)

Depreciation

* All assets with a finite useful life must be depreciated.

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Review of useful lives and depreciation method

* The useful life of an asset and its residual value should be reviewed at leastannually.

* Any adjustments made will be reflected in the current and future profit or loss for

the periods as a change in accounting estimate. It is not a change in accountingpolicy and so it cannot be treated as a prior period adjustment.

Depreciation of separate components

Separate components of non-current assets should be recognized separately, anddepreciated over their own lives.

Revaluation model* Enterprises may revalue assets to their current fair value.* Asset revalued must be adjusted to the new value and should be subsequently

depreciated base on new value over its remaining useful life

* Any revaluation increaseor gain should be recognized in other comprehensiveincome and should be reflected in equity under revaluation surplus.

* If the increase or gain is reversing an initial decrease on the same asset which wasrecognised in profit or loss for the period, the increase should be recognised profitor loss for the period to the extent of the decrease and the excess if any should berecognised in other comprehensive income

* A revaluation decrease should be recognised in profit or loss for the period exceptthere is an existing reserve on the same asset

* If an enterprise chooses to revalue an asset, then it must revalue all assets of thesame class to avoid selective revaluation.

* Revaluation must be made with sufficient regularity to ensure that carrying amount

does not materially differ from the fair value at each reporting date

Derecognition

PPE should be derecognised if the initial recognition criteria are not compliedwith

When an asset is disposed, profit or loss on disposal must be recognised in profitor loss for the period

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IAS 40 INVESTMENT PROPERTIES

Investment property is land or a building held to earn rentals or for capital appreciation orboth rather than for use in the entity or for sale in the ordinary course of business.Examples of investment properties include:

(1)Land held for long-term capital appreciation(2)Buildding owed by the reporting entity and leased out under an operating lease.Note the following are not Investment Property

(1) Property intended for sale in the ordinary course of business(2) Property being constructed or developed on behalf of third parties IAS Convention.(3) Owner-occupied property IAS 16 PPE..

RECOGNITION

IP should be recognised as asset when two conditions are met.

(1) It is probable that the future economic benefits that are associated with theinvestment property will flow to the entity.

(2) The cost of the investment property can be measured reliably.

INITIAL MEASUREMENT

An IP should be measured initially at its cost.

SUBSEQUENT MEASUREMENTS

IAS 40 requires an entity to choose between 2 models:

- The Fair Value Model- The Cost Model.

Whatever policy it chooses should be applied to all of its investment property.

Cost Model: Cost less accumulated depreciation.

Under Fair Value Model:

- the asset is revalued to fair value at the end of each year- the gain or loss is shown directly in profit or loss for the period- No depreciation is charged on the asset.

FV is normally established by reference to current prices on an activee market forproperties in the same location and condition.

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IAS 23 BORROWING COSTRevised January 2008

Borrowing cost are interest and other cost incurred by an entity in connection with theborrowing of funds.

IAS 23 states that borrowing cost should be capitalised as part of the cost of an asset if itis incurred on qualifying asset.

A qualifying asset is an asset that necessarily takes a substantial period of time to getready for its intended use or sale.

RATE OF INTEREST TO BE TAKEN

Borrowing costs which may be capitalized are those actually incurred, less any

investment income on the temporary investment of the borrowings.

COMMENCEMENT OF CAPITALIZATION

Capitalization of borrowing cost should commence when all of the following conditionsare met:

(1) Expenditure for the asset is being incurred(2) Borrowing costs are being incurred(3) Activities that are necessary to prepare the asset for its intended use or sale are in

progress.

CESSATION OF CAPITALISATION

Capitalisation of borrowing cost should cease when either:

(1)Substantially all the activities necessary to prepare the qualifying asset for itsintended use or sale are complete, or

(2)Construction is suspended e.g. due to industrial disputes.

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IAS 38 - INTANGIBLE ASSET

Intangible asset is an identifiable non-monetary asset without physical substance.

Example of intangible asset are computer software, patents, copyrights, franchise.

RECOGNITION OF IA

Before an item can be recognised as IA, it must:

(1) meet the definition of Intangible Asset framework(2) meet the IASB recognition criterion for an asset. That is:

(a) It must be probable that future economic benefit attributable to the asset will flowto the entity.

(b) The cost of the asset can be measured reliably.

Identifiable means that IA must be separable i.e. if it could be rented out or soldseparately.

INTERNALLY GENERATED INTANGIBLES

IAS 38 states that internally generated items may not be recognised as an asset. This isbecause it is impossible to separate the cost of internally generated intangibles from thenormal cost of running and developing a business, so these intangible cannot be measured

reliably. Examples of internally generated items are (1) goodwill (2) brands (3)publishing titles (4) customer lists.

IAS 38 only allows the recognition of purchased intangibles.

MEASUREMENT OF INTANGIBLE ASSET

IA should be initially recognised at cost.

Subsequent measurement can either be at cost model or revaluation model.

COST MODEL

The IA should be carried at cost less amortization and any imparment loss. This model iscommonly used in practice.

REVALUATION MODEL

The IA may be revalued to a carrying value of fair value less subsequent amortizationand imparment losses.

- Revaluation should be made with sufficient regularity such that the carrying amountdoes not differ materially from fair value at the reporting date.

- If an intangible item is revalued, all other assets in its class should also be revalued,unless there is no active market for those asset.

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AMORTISATION

An intangible asset with a finite useful life must be amortised over its expected usefullife.

An intangible asset with indefinite useful life should not be amortised but should betested for impairment annually and more often if there is an indication of possibleimpairment.

An asset will be deemed to have an indefinite life if there is no forseeable limit to theperiod over which the entity will gain economic benefit from the asset in the form of netcash inflows:

GOODWILL

Goodwill is the difference between the value of a business as a whole and the aggregateof the fair value of its separable net asset.

Separable net assets are those assets (and liabilities) which can be identified and sold offseparately without necessarily disposing of the business as a whole.

Goodwill may exist because of the following factors:(1) reputation for quality or services(2) technical expertise(3) possession of favourable contract(4) good management staff.

PURCHASED AND NON-PURCHASED GOODWILL

Purchased goodwill: This arises when a business acquires another as a going concern anddit includes goodwill on consolidation of a subsidiary or associated company.

Purchased goodwill will be capitalised in financial statement as intangible asset. This isbecause it has been paid for. IFRS 3 states that purchased goodwill should not beamortised but must be tested for impairment annually in accordance with IAS 36.

NOW PURCHASED GOODWILL

Is also known as Inherent Goodwill and it has no identifiable value. Therefore it is notrecognised in the financial statement.

RESEARCH AND DEVELOPMENT EXPENDITURE

Research is original and planned investigation undertaken with the prospect of gainingnew scientific knowledge and understanding.Development is the application of research findings or other knowledge to a plan ordesign for the production of new or substantially improved materials, devices, products,processes, systems or servgices before the start of commercial production or use.

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ACCOUNTING FOR RESEARCH AND DEVELOPMENT

Research expenditure should be written off as an expense as they are incurred because itis still uncertain that future economic benefits will probably flow to the entity from the

project.

DEVELOPMENT EXPENDITURE maybe recognised as an intangible asset if an entitycan demonstrate:

(1) the technical feasibility of completing the intangible asset so that it will be availablefor use or sale

(2) its itention to complete the intangible asset and use or sell it

(3) its ability to use or sell the intangible asset

(4) how the intangible asset will generate probable future economic benefit

(5) its ability to measure the expenditure attributable to the intangible asset during itsdevelopment.

NOTE

It is only expenditure incurred after the recognition criteria have been met that should berecognised as an asset. Development expenditure recognised as an expense in profit orloss cannot subsequently be restated as an asset.

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IFRS 5 NON-CURRENT ASSETS HELD FOR SALE AND

DISCONTINUED OPERATIONS

A non-current asset should be classified as held for sale if its carrying amount will berecovered principally through a sale transaction rather than through continuing use.

For this to be the case, the following conditions must apply:

(a) The asset must be available for immediate sale in present condition

(b) The sale must be highly probable, meaning that:- Management are committed to a plan to sell the asset- There is an active programme to locate a buyer- The asset is being actively marketed.

(c) The sale is expected to be completed within 12 months of its classification as heldfor sale.

(d) It is unlikely that the plan will be significantly changed or will be withdrawn.

NOTE: That in order to qualify as held for sale, asset must be expected to be disposed ofthrough sale. Operations that are to be abandoned or wound down gradually cannot beclassified as held for sale. This is because its carrying amount will be recoveredprincipally through continous use. However, a disposal group to be abandoned may meetthe definition of a discontinued operation and therefore separate disclosure may be

required.

MEASUREMENT OF NON-CURRENT ASSET HELD FOR SALE

Non-current asset that qualify as held for sale should be measured at the tower of:- Their carrying amount- Fair value less cost to sell.

Any impairment loss recognised, to write down an asset to its fair value less cost to sell,should normally be charged to income statement.

Once an asset has been classified as held for sale, it should cease to be depreciated (oramortised) because depriciation is a measure of consumption, which is no longer relevantas the asset will be sold rather than consumed.

Held for sale non-current asset should be presented separately on the face of thestatement of financial position e.g.

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NON-CURRENT ASSET $ $

Property, Plant and equipment XX

Goodwill XX XX

CURRENT ASSET

Inventory XX

Receivables XX

Non-current asset classified as held for sale XX XX

XX

Example:

On 1 January 2001, A Co. bought a machine for $20,000. It has an expected useful lifeof 10 years and a nil residual value. On 31 December 2002, A Co decides to sell themachine and starts action to locate a buyer. A Co is confident that the machine will be

sold fairly quickly. Its current market value is $15,000 and it will cost $500 to dismantlethe machine and make it available to the purchaser.

At what value should be machine be stated in Michelle Co.s statement of financialposition at 31 December 2002.

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DISCOUNTINUED OPERATIONS

A discontinued operation is a component of an entity that either has been disposed of, oris classified as held for sale and:

- represent a separate major line of business or geographical area of operation

- is part of a single co-ordinated to dispose of a separate major line of business orgeographical area of operation or

- is a subsidiary acquired exclusively with a view to resale.

Discontinued operations are required to be shown separately in order to help users topredict future performance i.e. based upon continuing operations.

PRESENTATION IN THE STATEMENT OF COMPREHENSIVE INCOME

An entity must disclose a single amount on the face of comprehensive income comprisingthe total of:

- the post-tax profit or loss of discontinued operation and- the post-tax gain or loss recognised on the measurement to fair value less cost to sell, or

on the disposal, of the asset constituting the discontinued operation.

An entity should also disclose an analysis of this single amount into:

(a) Revenue, expenses and pre-tax profit or loss of discontinued operation(b) The related income tax expense(c) The gain or loss recognised on the measurement to fair value less cost to sell or on

the disposal of the asset of the discontinued operation(d) The related income tax expense.

ABC GROUPINCOME STATEMENT PRESENTATION

Continuing Operations

Revenue XXCost of sales (XX)Gross profit XXOther Income XXDistribution cost (XX)Administrative expenses (XX)Other expenses (XX)Finance costs (XX)Profit before tax XXIncome tax Expense (XX)Profit for the year from continuing operation XX

Discontinued Operations

Profit for the period from discontinued operation XXTotal Profit for the period XX

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IAS 10

EVENTS AFTER REPORTING PERIOD

Events after reporting period are those events both favourable and unfavourable, thatoccur between the end of the reporting period and the date on which the financialstatements are authorised for issue.

Two types of events can be identified:

1. ADJUSTING EVENTS

These are events after the reporting period, which provide additional evidence ofcondition existing at reporting period.

Examples of adjusting events

(1) Sale of inventory after the reporting period for less than its carrying value at theyear end.

(2) Irrecoverable debt arising after the reporting period, which may help to quantifythe allowance for receivable at the reporting period.

(3) Discovery of fraud and error(4) Amount received or paid in respect of legal or insurance claim which were in

negotiation at the year end(5) Evidence of a permanent diminution in the value of a long-term investment prior

to the year end.

2. NON-ADJUSTING EVENT

These are events after the reporting period which concern condition that arose afterthe reporting period.

Examples of non-adjusting events

(1) Acquisition or disposal of a subsidiary after the year end(2) Announcement of a plan to discontinue an operation(3) Major purchases and disposals of asset(4) Destruction of production plant by fire after the reporting period(5) Share transaction after reporting period.

ACCOUNTING FOR ADJUSTING AND NON-ADJUSTING EVENTS

IAS 10 require adjusting events to be recognised in the financial statement.Non adjusting events should be disclosed by note if they are of such importance that non-disclosure would affect the ability of the users of the financial statement to make properevaluation and decision.

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PROPOSED DIVIDEND

A major change in IAS 10 is that equity dividend proposed before but declared after thereporting period may no longer be included as liabilities at the reporting period. The

liability arises at the declaration date so they are non-adjusting events after the reportingperiod and must be disclosed by note.

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IAS 18

REVENUE

Revenue is the gross inflow of economic benefit during the period arising in the course ofthe ordinary activities of an entity.

Revenue is measured by the fair value of the consideration received or receivable.

Fair value is the amount for which an asset could be exchanged, or a liability settled,between knowledgeable, willing parties in an arms length transaction.

REVENUE FROM THE SALE OF GOODS

According to IAS 18 Revenue, the following conditions must be satisfied before therevenue from the sale of goods should be recognised:

- The seller has transferred the significant risk and rewards of ownership to the buyer.

- The seller does not retain continuing managerial involvement to the degree usuallyassociated with ownership and does not have effective control over the goods sold.

- The amount of the revenue can be measured reliably.

- It is probable that the economic benefit associated with the transaction will flow to theseller.

- The cost incured or to be incured in respect of the transaction can be measured reliably.

REVENUE FROM SERVICES

Revenue from services should be recognised, according to the stage of completion at thereporting date when all the following conditions are met:

(a) The amount of revenue can be measured reliably

(b) It is probable that the economic benefit associated with the transaction will flow tothe entity.

(c) The stage of completion of transaction at the reporting date can be measured reliably.

(d) The cost incured for the transaction and the cost to complete the transaction can bemeasured reliably.

If these conditions are not met, revenue should be recognised only to the extent of the

expenses recognised that are recoverable.

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IAS 2

INVENTORY

Inventories are asset held for sale in the ordinary course of business or asset in theprocess of production for such sale.

Inventory are valued at the lower of cost and net realisable value.

Cost include all cost incurred in bringing the item of inventory to its present location andcondition, i.e. cost of purchase and cost of conversion.

Cost of purchase comprises:

(1) Purchase price including import duties, transport and handling cost.

(2) Any other directly attributable cost less trade discount, rebates and subsidies.

Cost of conversion include:

- cost specifically attributable to the units of production e.g. direct labour, directexpenses and subcontracted work.

- production overheads, which must be based on the normal level of activity.

- other overhead, if any, attributable in the particular circumstances of the business tobringing the product or service to its present location.

The following costs should be excluded and charged as expenses of the period in whichthey are incurred:

- abnormal waste- storage cost- administrative overhead which do not contribute to bringing inventory to their present

location and condition.- selling cost.

NET REALISABLE VALUE is the estimated selling price in the ordinary course of

business less the estimated costs of completion and the estimated cost necessary to makethe sale.

VALUATION METHODS

(1) Actual unit cost(2) First in First Out (FIFO)(3) Weighted Average Cost (AVCO).

Question

Equipment constructed for a customer for an agreed price of $18000. This has recentlybeen completed at cost of $16,800. It has now been discovered that in order to meet

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certain regulations, conversion with an extra cost of $4200 will be required. Thecustomer has accepted partial responsibility and agreed to meet half the extra cost.

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IAS 11CONSTRUCTION CONTRACTS

A Construction Contract is a contract specifically negotiated for the construction of anasset or a combination of assets that are closely interrelated or interdependent in terms oftheir design technology and function or their ultimate purpose.

Contract Revenue comprises:

- the initial amount of revenue agreed in the contract- variations in the contract work and claims, to the extent that:

(a) it is probable that they will result in revenue(b) they are capable of being reliably measured.

Claims are amount that the contractor seeks to reclaim from the customer asreimbursement for cost not included in the contract price. They may arise due to errors indesign or customer caused delay.

Incentive payments (additional payments made to the contractor if performance standardare met or exceeded) when:

(a) the contract is sufficiently advanced that it is probable that the specified performancestandard will be met or exceeded

(b) the amount of incentive can be measured reliably.

Contract revenue is reduced by the amount of any penalties arising from delays caused bythe contractor in the completion of the contract.

CONTRACT COST: This comprise:

(a) costs that relate directly to specific contract(b) costs that are attributable to contract activity in general and can be allocated to the

contract(c) such other costs as are specifically chargeable to the customer under the terms of the

contract.

RECOGNITION OF CONTRACT REVENUE AND EXPENSES

Recognition depends upon whether the outcome of a contract can be measured reliably.

WHERE THE OUTCOME OF A CONTRACT CAN BE ESTIMATED RELIABLY

- If the expected outcome is a profit:Revenue and costs should be recognised according to the stage of completion of thecontract.

- If the expected outcome is a loss:The whole loss to completion should be recognisedd immediately.

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WHERE OUTCOME OF A CONTRACT CANNOT BE ESTIMATED RELIABLY

- Revenue should be recognised only to the extent of contract costs incurred that it isprobable will be recoverable.

- Contract cost should be recognised as expense in the period in which they are incurred.

An expected loss on such a construction contract should be recognised as an expenseimmediately.

Example:The following information relates to a construction contract:

Estimated Contract Revenue $800,000, Cost to date $320,000, Estimated Cost tocomplete $280,000, Estimated stage of completion 60%.

(a) What amount of revenue, cost and profit should be recognised in the incomestatement?

(b) Take the same contract but now assume that the business is not able to reliablyestimate the outcome of the contract although it is believed that all cost incurredwill be recoverable from the customer. What amount should be recognised for cost,revenue and profit in comprehenssive income?

DETERMINING THE STAGE OF COMPLETION OF A CONTRACT

(1) The proportion that contract cost incurred for work performed to date bear to theestimated total contract cost Cost to date x 100% = % completion.

Total Cost

(2) Surveys of work performedWork certified x 100%Contract Price

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PRESENTATION IN FINANCIAL STATEMENT

STATEMENT OF COMPREHENSIVE INCOME

The following will appear in comprehensive income for construction contract:(1) Revenue (2) Cost (3) Profit or loss.

STATEMENT OF FINANCIAL POSITION

The following figures may appear in statement of financial position:(a) Gross amount due from customer - asset(b) Gross amount due to customer - liability.

The calculation (which may result in asset or liability) is:

$Cost incured XAdd recognised profit XLess recognised losses (X)Less progress billings (X)Gross amount due to/from customer X

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IAS 36 IMPAIRMENT OF ASSETS

An asset is impaired if the carrying value is higher than the recoverable value.

Recoverable amount is the higher of:(a) Fair Value less Cost to Sell(b) Value in use.

- Asset fair value less cost to sell is the amount net of selling cost that could be obtainedfrom the sale of the asset.

- Value in Use of an asset is measured as the present value of estimated future cashflows generated by the asset, including its estimated net disposal value (if any) at theend of its expected useful life.

INDICATIONS OF IMPAIRMENT

IAS 36 requires that at each reporting date, an entity must assess whether there areindication of impairment.

Indication of impairment may be from internal sources or external sources.

EXTERNAL SOURCES OF INFORMATION

(1) The assets market value has declined more than expected.

(2) Changes in the technological, market, economic or legal environment of the businessin which the asset are employed.

(3) Interest rate have changed, thus increasing the discount rate used in calculating theassets value in use.

INTERNAL SOURCES OF INFORMATION

(1) There is evidence of obsolescence or damage to the asset(2) Changes in the way the asset is used have occured.(3) Evidence is available from internal reporting indicating that the economic

performance of an asset is, or will be worse than expected.

Where there is no indication of impairment, then no further action need be taken.

An exception to this rule is:

(1) Goodwill acquired in big combination(2) An intangible asset with an indefinite useful life(3) An intangible asset not yet available for use.IAS 36 requires annual impairment review for these asset irrespective of whether there is

an indication of impairment.

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RECOGNITION AND MEASUREMENT OF AN IMPAIRMENT

Where there is an indication of impairment, an impairment review should be carried out:

- The recoverable amount should be calculated- The asset should be written down to recoverable amount and depreciation charge

should be based on its new carrying amount.- The impairment loss should be recognised immediately in income statement.

The only exception to this is if the impairment reverses a previous gain taken to therevaluation surplus. In this case, the impairment will be taken first to the revaluationreserve until the revaluation surplus is reversed and then to the income statement.

Example:

An entity owns a property which was purchased for $300,000. The property has beenrevalued to $500,000 with the revaluation of $200,000 being recognised as revaluationsurplus. The property has a current carrying value of $460,000 but the recoverableamount of the property has just been estimated at only $200,000. What is the amount ofimpairment and how should this be treated in financial statement.

REVERSAL OF IMPAIRMENT LOSS

An entity should consider whether the indication for impairment listed above hasimproved in deciding whether an impairment loss has reversed.

A justifiable reversal of an impairment loss should be recognised immediately as incomein income statement (or as a revaluation increase to the extent that the originalimpairment had been charged against the revaluation surplus).

No reversal is permitted of an impairment loss previously recognised in respect ofgoodwill. The rationale being that any increase in goodwill must relate to non-purchasedgoodwill which cannot be capitalized.

CASH GENERATING UNIT (CGU)

A CGU is defined as the smallest identifiable group of assets which generates cash

inflows independent of those of other asset.

As a basic rule, the recoverable amount of an asset should be calculated for the assetindividually. However, there will be occasion where it is not possible to estimate such avalue for an individual asset particularly in the calculation of value in use. This isbecause cash flows (inflows and outflows) cannot be attributed to the individual asset. Ifit is not possible to calculate the recoverable amount for individual asset, the recoverableamount of the asset cash-generating unit should be measured instead.

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CALCULATION OF IMPAIRMENT FOR CGU

(1) Assume the CGU is one asset

(2) Compare the carrying value of the CGU to the recoverable amount of CGU(3) If CGU is impaired asset must be written down in a strict order:

(a) Any obviously impaired asset(b)Goodwill allocated to CGU(c) Other assets (pro-rata according to carrying value).

NOTE: No individual asset should be written down below recoverable amount.

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PROVISION

A Provision is a liability of uncertain timing or amount. A liability is a present obligation

of an entity arising from past event the settlement of which is expected to result in anoutflow from the entity of resources embodying economic benefits.

RECOGNITION OF A PROVISION

A Provision should be recognised when:

- an entity has a present obligation (legal or constructive) as a result of past event- it is probable that an outflow of resources embodying economic benefit will be required

to settle the obligation and- a reliable estimate can be made of the amount of the obligation.

A Provision may be necessary as a result of a legal or a constructive obligation.

LEGAL OBLIGATION

This is an obligation that is derived from contract, legislation and other operation of law.

CONSTRUCTIVE OBLIGATION

This is an obligation that derives from an entitys action where:

- by an established pattern of past practice, published policies or a sufficiently specificcurrent statement, the entity has indicated to other parties that it will accept certainresponsibilities and

- as a result, the entity has created a valid expectation on the part of those other partiesthat it will discharge those responsibilities.

WARRANTY

This is often given in manufacturing and retailing businesses. It is either express (legal)or implied (constructive) obligation to make good or replace faulty product.

WARRANTY PROVISIONS

A provision is required at the time of the sale rather than the time of repair/replacementas the making of the sale is the past event which gives rise to an obligation. This requiresthe seller to analyse past experience so as to be able to estimate:

- how many claims will be made- how much each repair will cost.

GUARANTEE

A company may make a guarantee to another to pay off a loan, etc. if another company isunable to do so. The guarantee should be provided for if it is probable that the paymentwill have to be made.

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FUTURE OPERATING LOSSES

No provision may be made for future operating losses because they arise in the future and

therefore do not meet the criterion of a liability.

ONEROUS CONTRACTS

An onerous contract is a contract in which the unavoidable cost of meeting the obligationunder the contract exceed the economic benefit expected to be received under it. Thepresent obligation under this contract should be recognised and measured as provision.

ENVIRONMENTAL CONTAMINATION

If a company has an environmental policy such that other parties would expect the

company to clean up any contamination or if the company has broken currentenvironmental legislation then a provision for environmental damage must be made.

FUTURE REPAIRS AND REFURBISHMENT

Provision should not be recognised on future repairs and refurbishment unless they meetthe definition of a liability and the recognition criteria set out in the framework.

- There must be a present obligation as a result of past event- The transfer must be probable- It must be possible to make a reliable estimate of the amount.

PROVISION FOR REORGANISATION

Raeorganization do not meet the 3 criteria required to make a provision.

IAS 37 states that a constructive obligation to restructure arises only when an entity:

- has a detailed formal plan for restructuring- has raised a valid expectation in those affected that it will carry out the restructuring bystarting to implement that plan or announcing its main feature to those affected by it.

CONTIGENT LIABILITY is a possible obligation that arises from past events and whoseexistence will be confirmed only by the occurrence or non-occurence of one or moreuncertain future events not wholly within the control of the entity. It is a presentobligation that arises from past events but is not recognised because- it is not probable that an outflow of resources embodying economic benefit will be

required to settle the obligation;- the amount of the obligation cannot be measured with sufficient reliability.CONTINGENT ASSET

A Contingent asset is a possible asset that arises from past events and whose existence

will be confirmed only by the occurence or non occurence or one or more uncertainfuture events not wholly within the control of the entity.

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ACCOUNTING TREATMENT OF CONTINGENT LIABILITIES

Contingent liabilities:

- should not be recognised in the statement of financial position- should be disclosed in a note unless the possibility of transfer of economic benefit is

remote.

ACCOUNTING FOR CONTINGENT ASSETS

Contingent asset should not generally be recognised but if the possibility of inflows ofeconomic benefit is probable, they should be disclosed.

If a gain is virtually certain, it falls within the definition of an asset and should be

recognised as such and not as contigent asset.

SUMMARY OF ACCOUNTING TREATMENT

Degree of probability of anoutflow/inflow of resources Outflow Inflow

Virtually certain Liability Asset

Probable Liability Disclose by note

Possible Disclose by Note No disclosure

Remote No disclosure No disclosure.

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IAS 8

ACCOUNTING POLICIES, CHANGES IN ACCOUNTING

ESTIMATES AND ERROR

ACCOUNTING POLICIES: These are the principles, bases, conventions, rules andpractices applied by an entity which specify how the effects of transactions and otherevents are reflected in the financial statement.

IAS 8 states that where a standard or interpretation exist in respect of a transaction, theaccounting policy is determined by applying standard or interpretation.

Where there is no applicable standard or interpretation, management must use itsjudgement to develop and apply an accounting policy.

The accounting policy selected must result in information that is both:

(1) relevant to the decision-making needs of users and

(2) reliable in that they:(a) represent faithfully the result and financial position of the entity(b) reflect economic substance of events and transactions and not merly legal form(c) are neutral i.e. free from bias(d) complete in all material respect.

CHANGE IN ACCOUNTING POLICIES

Generally an entity must select and apply accounting policies consistently for similartransaction to ensure comparability of financial statement over time.

IAS 8 only allows change in accounting policy if the change:(1) is required by IFRS, or(2) will result in a reliable and more relevant presentation of events or transaction.

Change in accounting policy occurs if there has been a change in:

(a) Recognition e.g. an expense is now recognised rather than an asset(b) Presentation e.g. depreciaton is now included in cost of sales rather than

administrative expenses(c) Measurement basis e.g. stating asset at replacement cost rather than historical cost.

ACCOUNTING FOR A CHANGE IN ACCOUNTING POLICY

(a) The change should be applied retrospectively with an adjustment to opening balanceof retained earnings in the statement of changes in equity.

(b) Comparative information should be restated unless it is impracticable to do so.

(c) There will be a prior period adjustment to the balance of retained earnings brought

forward in the statement of changes in equity.

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(d) If the adjustment to opening retained earnings cannot be reasonably determined, thechange should be adjusted prospectively i.e. included in the current period incomestatement.

ACCOUNTING ESTIMATES

An accounting estimate is a method adopted by an entity to arrive at estimated amountfor the financial statements.

EXAMPLES OF CHANGES IN ACCOUNTING ESTIMATES

- Changes in the useful lives of non-current assets- Changes in the residual values of non-current asset- Changes in the method of depreciating non-current asset- Warranty provision, based upon more up to date information about claims frequency.

ACCOUNTING FOR CHANGE IN ACCOUNTING ESTIMATES

- The effect of a change in accounting estimate should be included in the incomestatement in the period of the change and if subsequent period are affected in thosesubsequent period.

- The effects of the change should be included in the same income statementclassification as was used for the original statement.

- If the effects of the change is material, its nature and amount must be disclosed.PRIOR PERIOD ERROR

Prior period errors are omissions from, and mi9sstatement in, the financial statement forone or more prior periods arising from a failure to use information that:

- was available when the financial statements for those periods were authorised forissue and

- could reasonably be expected to have been taken into account in preparing thosefinancial statement.

Such errors include mathematical mistakes, mistakes in applying accounting policies,oversight and fraud.

Current period that are discovered in that period should be corrected before the financialstatements are authorised for issue.

CORRECTION OF PRIOD PERIOD ERRORS

Prior period errors are dealt with by:

- restating the opening balance of assets, liabilities, and equity as if the error had neveroccurred and presenting necessary adjustment to the opening balance of retainedearnings in the statement of changes in equity.

- restating the comparative figures presented as if the error had never occurred.

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IAS 24

RELATED PARTY DISCLOSURE

A party (an individual or an entity) is related to another entity if it:

- controls, is controlled by or is under common control with the entity- has significant influence over the entity- has joint control over the entity- is a joint venture of the entity- is a member of the key management personnel of the entity- is a close family member of any of the above.

RELATED PARTY TRANSACTION

This is a transfer of resources, services or obligation between related parties, regardlessof whether or not a price is charged.

IAS 24 states that related party transaction MUST be disclosed.

NEED FOR DISCLOSURE

The reason why related party transactions must be disclosed is that users need to be madeaware of them. Otherwise they will assume that the entity has entered into all its

transaction on the same terms that it could have obtained from a third party (on an armslength basis) and that it has acted in its own interest throughout the period. They willthen assess the entitys results and position on this basis and may be misled as a result ofthis.

DISTORTION OF FINANCIAL STATEMENT

A related party relationship can affect the financial position and operating results of anentity in a number of ways:

- Transactions are entered into with a related party which may not have occurredwithout the relationship existing.

- Transactions may be entered into on terms different to those with an unrelated party

- Transaction with third parties may be affected by the existence of the related partyrelationship e.g. a parent company instruct a subsidiary to sell goods to a particularcustomer.

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IAS 17LEASE

LEASING AGREEMENT

This is an agreement whereby one party, the lessee pays lease rentals to another party, thelessor, in order to gain the use of an asset over a period of time.

IAS 17 defines a lease as an agreement whereby the lessor conveys to the lessee, in returnfor a payment or series of payments, the right to use an asset for an agreed period of time.

TYPES OF LEASE

There are two types of lease:

(1) Finance Lease(2) Operating Lease.

A finance lease is a lease that transfer substantially all the risks and rewards incidental toownership of an asset to the lessee.

An operating lease is any lease other than a finance lease.

Any lease that transfers risks and reward incidental to ownership of an asset to the lessee

is finance lease.

Risks include:

- lessee carries out repairs and maintenance- lessee insures the asset- leasee runs the risk of losses from idle capacity- lessee runs the risk of technological obsolescence.

REWARDS

Reward is transferred if the lesseehas right to use asset for most or all of its useful life.

IAS 17 also provides guidance as to the classification of lease and states that thefollowing should be classified as finance lease:

- The lessor transfer ownership of the asset to the lessee by the end of the lease tenure.- The lessee has the option to buy the asset at a price expected to be lower than fair

value at the time the option is exercised.- The lease term is for the major part of the economic life of the asset even if title is not

transferred.- At the beginning of the lease, the present value of the minimum lease payments is

approximately equal to the fair value of the asset.- The leased assets are of a specialised nature so that only the lessee can use them

without major modification.

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- If the lessor gives the lessee the right to cancel the lease, the lessors losses associatedwith the cancellation are borne by the lessee.

- Gain or losses from fluctuations in fair value are borne by the lessee.- The lessee has the ability to continue the lease for a secondary period at a rent below

the market rent.

LEASE AND SUBSTANCE OVER FORUM

Substance over form states that account should reflect commercial substance rather thanlegal form.

LEGAL FORM OF LEASE: Legally the asset remains legally owned by the partyleasing it out (lessor.

RECORDING A FINANCE LEASE ACCORDING TO ITS LEGAL FORM

The lessee would show no asset on statement of financial position. The lessee would show no liability in the statement of financial position Only effect would be to charge the lease payment as an expense in the income

statement.

The implication of this is that assets and liabilities of the business would be understated.Also return on capital employed would be misleading.

COMMERCIAL SUBSTANCE AND LEASE

The commercial substance of lease is that the party making the lease payment has the useof the asset for most or all of its useful life. The lessee has effectively purchased theasset by taking out a loan, therefore the lessee should recognise the asset as a non-currentasset and record a liability for the lease payment payable to the lessor.

ACCOUNTING FOR FINANCE LEASES

The assets should be recognised as non-current asset at fair value (or if lower, the presentvalue of minimum lease payments). The same amount (being the obligation to payrentals) should be included as a loan i.e. a liability.

DEPRECIATION

The non-current asset should be depreciated over the shorter of:

- the useful life of the asset- lease term.

A company has 2 options. It can buy an asset for cash at a cost of $5710 or it can lease itby way of a finance lease. The terms of the lease are as follows:

(1)Primary period is for 4 years from 1 January 2002 with a rental of $2000 p.a. payableon 31 December each year.

(2)The lessee has the right to continue to lease the asset after the end of the primaryperiod for an indefinite period subject only to norminal rent.

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(3)The lessee is required to pay all repairs, maintenance and insurance cost as they arise.(4)The interest rate implicit in the lease is 15%.The lessee estimates the useful economic life of the asset to be 8 years. Depreciation is

provided on a straight-line basis.

What figure should be shown in the financial statement in each of the years ended 31December 20X2 20X5 assuming the finance lease option is taken.

On 1 January 20X7 Jones Plc acquired the use of a major piece of heavy agriculturalplant under a finance lease. The machine has a useful life of 8 years with nil residualvalue. The cost of the plant would be $600,000 if it were bought for cash. The lease isan 8 year lease for the plant, with lease rental of $110,000 payable annually in advance.The interest rate implicit in the lease is 12.8%.

Show the amount to be included in the statement of financial position at 31 December20X7 and the amount to appear in the income statement for that year.

ACCOUNTING FOR OPERATING LEASE

- Under operating lease, no asset is recognised.- Instead, rentals under operating leases are charged to the income statement on a straight

line basis over the term of the lease.

Example

An entity enters into an operating lease for 3 years for an asset with a 10 year useful life.The annual lease rental are $8000 and the entity expects to use the asset evenly over the 3years period.

What is the annual charge to the income statement.