Advanced Financial Acct-I Chap 1-6 .pptx

Course Title: Advanced Financial
Acct.I

Chapter one
Accounting for Income Taxes
 In almost all countries entities are taxed on the basis
of their trading income. In some countries this may
be called corporation or corporate tax, but we will
follow the terminology of IAS 12 Income taxes and
call it income tax. There are two aspects of income
tax which must be accounted for:
 Current tax is the amount actually payable to the tax
authorities in relation to the trading activities of the
entity during the period.
 Deferred tax is an accounting measure, used to
match the tax effects of transactions with their
accounting impact and thereby produce less distorted
results.

FUNDAMENTALS OF ACCOUNTING FOR INCOME TAXE
Up to this point, you have learned the basic
guidelines that corporations use to report
information to investors and creditors.
 Corporations also must file income tax returns
following the guidelines developed by the Internal
Revenue Service (IRS).
Because GAAP and tax regulations differ in a
number of ways, so frequently do pretax financial
income and taxable income.
Consequently, the amount that a company reports
as tax expense will differ from the amount of taxes
payable to the IRS.

Fundamental Differences between Financial and Tax
Reporting

Cont…
 Pretax financial income is a financial reporting term. It
also is often referred to as income before taxes, income
for financial reporting purposes, or income for book purr-
poses.
 Companies determine pretax financial income according
to GAAP.
 They measure it with the objective of providing useful
information to investors and creditors.
 Taxable income (income for tax purposes) is a tax
accounting term. It indicates the amount used to
compute income taxes payable.
 Companies determine taxable income according to the
Internal Revenue Code (the tax code). Income taxes
provide money to support government operations.

Example
To illustrate how differences in GAAP and IRS
rules affect financial reporting and taxable
income, assume that Chelsea Inc. reported
revenues of $130,000 and expenses of $60,000
in each of its first three years of operations.
Financial Reporting Income

Cont…
 For tax purposes (following the tax code), Chelsea
reported the same expenses to the IRS in each of the
years.
 Chelsea reported taxable revenues of $100,000 in
2017, $150,000 in 2018, and $140,000 in 2019
Tax Reporting Income

Comparison of Income Tax Expense to Income Taxes
Payable
Income tax expense and income taxes payable
differed over the three years but were equal in
total, as shows below.
 The differences between income tax expense and
income taxes payable in this example arise for a
simple reason. For financial reporting, companies use
the full accrual method to report revenues.

Cont…
For tax purposes, they use a modified cash
basis.
As a result, Chelsea reports pretax
financial income of $70,000 and income
tax expense of $28,000 for each of the
three years. However, taxable income
fluctuates. For example, in 2017 taxable
income is only $40,000, so Chelsea owes
just $16,000 to the IRS that year.

Cont…
Chelsea classifies the income taxes payable as a
current liability on the balance sheet.
As the above last table indicates, for Chelsea the
$12,000 ($28,000 − $16,000) difference between
income tax expense and income taxes payable in
2017 reflects taxes that it will pay in future
periods.
This $12,000 difference is often referred to as a
deferred tax amount. In this case, it is a deferred
tax liability. In cases where taxes will be lower in
the future, Chelsea records a deferred tax asset.

Recognition of current tax liabilities and assets
AS 12 requires any unpaid tax in respect of the
current or prior periods to be recognised as a
liability. Conversely, any excess tax paid in respect
of current or prior periods over what is due should
be recognised as an asset.

Cont…
Illustration
In 20X8 ABC. Co had taxable profits of $120,000. In
the previous year (20X7) income tax on 20X7 profits
had been estimated as $30,000. The corporate
income tax rate is 30%.
Required Calculate tax payable and the charge for
20X8 if the tax due on 20X7 profits was
subsequently agreed with the tax authorities as:
(a) $35,000; or
(b) $25,000.
Any under or over payments are not settled until
the following year's tax payment is due.

Solution
(a)
Tax due on 20X8 profits ($120,000 x 30%)…… $36,000
Underpayment for 20X7………………………………….5,000
Tax charge and liability…………………………………… 41,000
(b)
Tax due on 20X8 profits………………… $36,000 Overpayment
for 20X7………………………………………. (5,000)
Tax charge and liability…………………………….31,000
Alternatively, the rebate due could be shown separately as
income in the statement of comprehensive income and as
an asset in the statement of financial position. An offset
approach like this is, however, most likely.

Future Taxable Amounts and Deferred Taxes
 The example summarized in above shows how income taxes
payable can differ from income tax expense. This can happen when
there are temporary differences between the amounts reported
for tax purposes and those reported for book purposes.
 A temporary difference is the difference between the tax basis of
an asset or liability and its reported (carrying or book) amount in
the financial statements, which will result in taxable amounts or
deductible amounts in future years.
 Taxable amounts increase taxable income in future years.
Deductible amounts decrease taxable income in future years.
 Deductible amounts occur in future tax returns. These future
deductible amounts cause taxable income to be less than pretax
financial income in the future as a result of an existing temporary
difference.

Cont…
Taxable temporary differences are temporary
differences that will result in taxable amounts in
future years when the related assets are recovered.
Deductible temporary differences are temporary
differences that will result in deductible amounts in
future years, when the related book liabilities are
settled. As discussed earlier, taxable temporary
differences give rise to recording deferred tax
liabilities. Deductible temporary differences give rise
to recording deferred tax assets.

Deferred Tax Liability
 Deferred tax liability is the deferred tax consequences
attributable to taxable temporary differences.
 In other words, a deferred tax liability represents the
increase in taxes payable in future years as a result of
taxable temporary differences existing at the end of the
current year.

A deferred tax asset is the deferred tax
consequence attributable to deductible
temporary differences. In other words, a deferred
tax asset represents the increase in taxes
refundable (or saved) in future years as a result of
deductible temporary differences existing at the
end of the current year
Deferred Tax Asset

Cont….
To illustrate, assume that Hunt Company has
revenues of $900,000 for both 2017 and 2018. It
also has operating expenses of $400,000 for each of
these years.
In addition, Hunt accrues a loss and related liability
of $50,000 for financial reporting purposes because
of pending litigation. Hunt cannot deduct this
amount for tax purposes until it pays the liability,
expected in 2018.
As a result, a deductible amount will occur in 2018
when Hunt settles the liability, causing taxable
income to be lower than pretax financial
information.

GAAP and Tax Reporting, Hunt Company

Cont…
 In this case, Hunt records a deferred tax asset of
$20,000 at the end of 2017 because it represents
taxes that will be saved in future periods as a result
of a deductible temporary difference existing at the
end of 2017.
 Computation of Deferred Tax Asset, End of 2017

Cont…
Assuming that 2017 is Hunt’s first year of
operations and income taxes payable is
$200,000, Hunt computes its income tax
expense as follows.
Computation of Income Tax Expense, 2017

Cont…
• Hunt can also compute the deferred tax asset
by preparing a schedule that indicates the
future deductible amounts due to deductible
temporary differences.
• Schedule of Future Deductible Amounts

Cont…
 The deferred tax benefit results from the increase in the deferred tax asset from
the beginning to the end of the accounting period. The deferred tax benefit is a
negative component of income tax expense. The total income tax expense of
$180,000 on the income statement for 2017 thus consists of two elements—
current tax expense of $200,000 and a deferred tax benefit of $20,000. Hunt
makes the following journal entry at the end of 2017 to record income tax
expense, deferred income taxes, and income taxes payable.
 Income Tax Expense 180,000
Deferred Tax Asset 20,000
Income Taxes Payable 200,000

Financial Statement Effects
Balance Sheet Presentation, Deferred Tax Asset
 Income taxes payable is reported as a current
liability, and the deferred tax asset is reported as a
noncurrent asset.

Income Statement Presentation, Deferred Tax Asset

CHAPTER TWO
Share-based payment

IFRS 2 Share-based payment
Share-based payment transactions should be
recognized in the financial statements. You need
to understand and be able to advise on:
 Recognition
 Measurement
 Disclosure
of both equity settled and cash settled transactions.

CONT…
Transactions whereby entities purchase goods or
services from other parties, such as suppliers and
employees, by issuing shares or share options to
those other parties are increasingly common.
Share schemes are a common feature of director and
executive remuneration and in some countries the
authorities may offer tax incentives to encourage
more companies to offer shares to employees.
 Companies whose shares or share options are
regarded as a valuable 'currency' commonly use
share-based payment to obtain employee and
professional services.

Arguments against recognition of share-based
payment in the financial statements
 There are a number of arguments against recognition.
The IASB has considered and rejected the following
arguments.
(a) No cost therefore no charge
 There is no cost to the entity because the granting of
shares or options does not require the entity to
sacrifice cash or other assets. Therefore, a charge
should not be recognised.
 This argument is unsound because it ignores the fact
that a transaction has occurred.
 The employees have provided valuable services to the
entity in return for valuable shares or options.

b) Earnings per share is hit twice
It is argued that the charge to profit or loss for the
employee services consumed reduces the entity's
earnings, while at the same time there is an increase in
the number of shares issued.
However, the dual impact on earnings per share simply
reflects the two economic events that have occurred.
(i) The entity has issued shares or options, thus
increasing the denominator of the earnings per share
calculation.
(ii) It has also consumed the resources it received for
those shares or options, thus reducing the numerator.

(c) Adverse economic consequences
It could be argued that entities might be discouraged
from introducing or continuing employee share plans
if they were required to recognize them on the
financial statements.
However, if this happened, it might be because the
requirement for entities to account properly for
employee share plans had revealed the economic
consequences of such plans.
A situation where entities are able to obtain and
consume resources by issuing valuable shares or
options without having to account for such
transactions could be perceived as a distortion.

Objective and scope
IFRS 2 requires an entity to reflect the effects of share-based
payment transactions in its profit or loss and financial position.
 IFRS 2 applies to all share-based payment transactions.
There are three types.
(a) Equity-settled share-based payment transactions, in which the entity
receives goods or services in exchange for equity instruments of the
entity (including shares or share options)
(b) Cash-settled share-based payment transactions, in which the entity
receives goods or services in exchange for amounts of cash that are
based on the price (or value) of the entity's shares or other equity
instruments of the entity
(c) Transactions in which the entity receives or acquires goods or
services and either the entity or the supplier has a choice as to
whether the entity settles the transaction in cash (or other assets) or
by issuing equity instruments

Objective and scope
IFRS 2 was amended in 2009 to address situations
in those parts of the world where, for public
policy or other reasons, companies give their
shares or rights to shares to individuals,
organizations or groups that have not provided
goods or services to the company.
An example is the issue of shares to a charitable
organization for less than fair value, where the
benefits are more intangible than usual goods or
services.

Share-based payment among group
entities
Payment for goods or services received by an
entity within a group may be made in the form
of granting equity instruments of the parent
company, or equity instruments of another
group company.
IFRS 2 states that this type of transaction
qualifies as a share-based payment transaction
within the scope of IFRS 2.

Share-based payment among group
entities
 In 2009, the standard was amended to clarify that it
applies to the following arrangements:
(a) Where the entity's suppliers (including employees) will
receive cash payments that are linked to the price of the
equity instruments of the entity
(b) Where the entity's suppliers (including employees) will
receive cash payments that are linked to the price of the
equity instruments of the entity's parent
 Under either arrangement, the entity's parent had an
obligation to make the required cash payments to the
entity's suppliers. The entity itself did not have any
obligation to make such payments. IFRS 2 applies to
arrangements such as those described above even if the
entity that receives goods or services from its suppliers
has no obligation to make the required share-based cash
payments.

Transactions outside the scope of IFRS 2
Certain transactions are outside the scope of the IFRS:
(a) Transactions with employees and others in their
capacity as a holder of equity instruments of the entity
(for example, where an employee receives additional
shares in a rights issue to all shareholders)
(b) The issue of equity instruments in exchange for control
of another entity in a business combination

Key term
Share-based payment transaction. A transaction in which the
entity receives goods or services as consideration for equity
instruments of the entity (including shares or share options), or
acquires goods or services by incurring liabilities to the supplier
of those goods or services for amounts that are based on the
price of the entity's shares or other equity instruments of the
entity.
Share-based payment arrangement. An agreement between the
entity and another party (including an employee) to enter into a
share-based payment transaction, which thereby entitles the
other party to receive cash or other assets of the entity for
amounts that are based on the price of the entity's shares or
other equity instruments of the entity, or to receive equity
instruments of the entity, provided the specified vesting
conditions, if any, are met.

Key term
Equity instrument. A contract that evidences a
residual interest in the assets of an entity after
deducting all of its liabilities.
Equity instrument granted. The right (conditional or
unconditional) to an equity instrument of the entity
conferred by the entity on another party, under a
share-based payment arrangement.
Share option. A contract that gives the holder the
right, but not the obligation, to subscribe to the
entity's shares at a fixed or determinable price for a
specified period of time.

Key term
Fair value. The amount for which an asset could be exchanged,
a liability settled, or an equity instrument granted could be
exchanged, between knowledgeable, willing parties in an arm's
length transaction. (Note that this definition is different from
that in IFRS 13 Fair value measurement, but the IFRS 2
definition applies.)
Grant date. The date at which the entity and another party
(including an employee) agree to a share-based payment
arrangement, being when the entity and the other party have a
shared understanding of the terms and conditions of the
arrangement.
 At grant date the entity confers on the other party (the
counterparty) the right to cash, other assets, or equity
instruments of the entity, provided the specified vesting
conditions, if any, are met.
 If that agreement is subject to an approval process (for
example, by shareholders), grant date is the date when that
approval is obtained.

Key term
Intrinsic value. The difference between the fair value of the
shares to which the counterparty has the (conditional or
unconditional) right to subscribe or which it has the right to
receive, and the price (if any) the other party is (or will be)
required to pay for those shares. For example, a share option
with an exercise price of $15 on a share with a fair value of $20,
has an intrinsic value of $5.
Measurement date. The date at which the fair value of the
equity instruments granted is measured. For transactions with
employees and others providing similar services, the
measurement date is the grant date. For transactions with
parties other than employees (and those providing similar
services), the measurement date is the date the entity obtains
the goods or the counterparty renders service.

Key term
Vest. To become an entitlement. Under a share-based payment
arrangement, a counterparty's right to receive cash, other assets,
or equity instruments of the entity vests upon satisfaction of any
specified vesting conditions.
Vesting conditions. The conditions that must be satisfied for the
counterparty to become entitled to receive cash, other assets or
equity instruments of the entity, under a share-based payment
arrangement.
Vesting conditions include service conditions, which require the
other party to complete a specified period of service, and
performance conditions, which require specified performance
targets to be met (such as a specified increase in the entity's
profit over a specified period of time).
Vesting period. The period during which all the specified vesting
conditions of a share-based payment arrangement are to be
satisfied.

Vesting conditions
 IFRS 2 recognizes two types of vesting conditions: Non-
market based vesting conditions
 These are conditions other than those relating to the
market value of the entity's shares.
Examples include vesting dependent on:
 The employee completing a minimum period of service
(also referred to as a service condition)
 Achievement of minimum sales or earnings target
 Achievement of a specific increase in profit or earnings
per share
 Successful completion of a flotation
 Completion of a particular project

Market based vesting conditions
 Market-based performance or vesting conditions are
conditions linked to the market price of the shares in
some way.
Examples include vesting dependent on achieving:
 A minimum increase in the share price of the entity
 A minimum increase in shareholder return
 A specified target share price relative to an index of
market prices
The definition of vesting conditions is:
 Restricted to service conditions and performance
conditions, and
 Excludes other features such as a requirement for
employees to make regular contributions into a savings
scheme.

Recognition: the basic principle
 An entity should recognize goods or services received or
acquired in a share-based payment transaction when it
obtains the goods or as the services are received.
 Goods or services received or acquired in a share-based
payment transaction should be recognized as expenses
unless they qualify for recognition as assets. For
example, services are normally recognized as expenses
(because they are normally rendered immediately), while
goods are recognized as assets.
 If the goods or services were received or acquired in an
equity-settled share-based payment transaction the
entity should recognize a corresponding increase in equity
(reserves).
 If the goods or services were received or acquired in a cash-
settled share-based payment transaction the entity should
recognize a liability.

Equity-settled share-based payment transactions
Measurement
 The issue here is how to measure the 'cost' of the goods
and services received and the equity instruments (eg
the share options) granted in return.
 The general principle in IFRS 2 is that when an entity
recognizes the goods or services received and the
corresponding increase in equity, it should measure
these at the fair value of the goods or services received.
 Where the transaction is with parties other than
employees, there is a rebuttable presumption that the
fair value of the goods or services received can be
estimated reliably.

Cont…
 If the fair value of the goods or services received cannot be
measured reliably, the entity should measure their value by
reference to the fair value of the equity instruments granted.
 Where the transaction is with a party other than an employee
fair value should be measured at the date the entity obtains
the goods or the counterparty renders service.
 Where shares, share options or other equity instruments are
granted to employees as part of their remuneration
package, it is not normally possible to measure directly the
services received. For this reason, the entity should measure
the fair value of the employee services received by reference
to the fair value of the equity instruments granted. The fair
value of those equity instruments should be measured at the
grant date.

Determining the fair value of equity instruments
granted
Where a transaction is measured by reference to
the fair value of the equity instruments granted,
fair value is based on market prices if available,
taking into account the terms and conditions
upon which those equity instruments were
granted.
If market prices are not available, the entity
should estimate the fair value of the equity
instruments granted using a valuation technique.

Transactions in which services are received
 The issue here is when to recognize the transaction.
 When equity instruments are granted they may vest immediately,
but often the counterparty has to meet specified conditions first.
For example, an employee may have to complete a specified period of
service. This means that the effect of the transaction normally has to
be allocated over more than one accounting period.
 If the equity instruments granted vest immediately, (ie the
counterparty is not required to complete a specified period of
service before becoming unconditionally entitled to the equity
instruments) it is presumed that the services have already been
received (in the absence of evidence to the contrary).
 The entity should recognise the services received in full, with a
corresponding increase in equity, on the grant date.

Cont…
If the equity instruments granted do not vest until
the counterparty completes a specified period of
service, the entity should account for those
services as they are rendered by the counterparty
during the vesting period.
For example if an employee is granted share
options on condition that he or she completes
three years' service, then the services to be
rendered by the employee as consideration for
the share options will be received in the future,
over that three-year vesting period.

Cont…
 The entity should recognise an amount for the goods
or services received during the vesting period based on
the best available estimate of the number of equity
instruments expected to vest.
 It should revise that estimate if subsequent
information indicates that the number of equity
instruments expected to vest differs from previous
estimates.
 On vesting date, the entity should revise the estimate
to equal the number of equity instruments that
actually vest.
 Once the goods and services received and the
corresponding increase in equity have been
recognised, the entity should make no subsequent
adjustment to total equity after vesting date.

Example: Equity-settled share-based payment
transaction
On 1 January 20X1 an entity grants 100 share
options to each of its 400 employees. Each grant
is conditional upon the employee working for the
entity until 31 December 20X3. The fair value of
each share option is $20.
During 20X1 20 employees leave and the entity
estimates that 20% of the employees will leave
during the three-year period.
During 20X2 a further 25 employees leave and
the entity now estimates that 25% of its
employees will leave during the three-year
period.
During 20X3 a further 10 employees leave.

transaction
Required
 Calculate the remuneration expense that will be
recognized in respect of the share-based payment
transaction for each of the three years ended 31
December 20X3.
Solution
 IFRS 2 requires the entity to recognize the remuneration
expense, based on the fair value of the share options
granted, as the services are received during the three-
year vesting period.
 In 20X1 and 20X2 the entity estimates the number of
options expected to vest (by estimating the number of
employees likely to leave) and bases the amount that it
recognizes for the year on this estimate.

transaction
Solution
 In 20X3 it recognizes an amount based on the number
of options that actually vest. A total of 55 employees
left during the three-year period and therefore 34,500
options ((400 – 55) x 100) vested. The amount
recognized as an expense for each of the three years is
calculated as follows:

Cash-settled share-based payment
transactions
Examples of this type of transaction include:
(a) Share appreciation rights granted to employees: the
employees become entitled to a future cash payment
(rather than an equity instrument), based on the
increase in the entity's share price from a specified level
over a specified period of time, or
(b) An entity might grant to its employees a right to
receive a future cash payment by granting to them a
right to shares that are redeemable.
 The basic principle is that the entity measures the
goods or services acquired and the liability incurred
at the fair value of the liability.

Cash-settled share-based payment
transactions
The entity should remeasure the fair value of the
liability at each reporting date until the liability is
settled and at the date of settlement.
Any changes in fair value are recognised in profit
or loss for the period.
The entity should recognise the services received,
and a liability to pay for those services, as the
employees render service.
For example, if share appreciation rights do not
vest until the employees have completed a
specified period of service, the entity should
recognise the services received and the related
liability, over that period.

Example: Cash-settled share-based payment
transaction
On 1 January 20X1 an entity grants 100 cash share
appreciation rights (SARS) to each of its 500
employees, on condition that the employees
continue to work for the entity until 31 December
20X3.
During 20X1 35 employees leave. The entity
estimates that a further 60 will leave during 20X2
and 20X3.
During 20X2 40 employees leave and the entity
estimates that a further 25 will leave during 20X3.
During 20X3 22 employees leave.

transaction
 At 31 December 20X3 150 employees exercise their
SARs. Another 140 employees exercise their SARs at 31
December 20X4 and the remaining 113 employees
exercise their SARs at the end of 20X5.
 The fair values of the SARs for each year in which a
liability exists are shown below, together with the
intrinsic values at the dates of exercise.

transaction
Required
Calculate the amount to be recognised in the profit or
loss for each of the five years ended 31 December 20X5
and the liability to be recognised in the statement of
financial position at 31 December for each of the five
years.
Solution
 For the three years to the vesting date of 31 December
20X3 the expense is based on the entity's estimate of
the number of SARs that will actually vest (as for an
equity-settled transaction).
However, the fair value of the liability is re-measured at
each year-end.
The intrinsic value of the SARs at the date of exercise is

CHAPTER THREE
Accounting for
Agriculture

IAS 41 Agriculture
IAS 41 applies the requirements of IFRS to the
treatment of biological assets.
IAS 41 has contributed to the international
harmonisation of accounting standards,
because agriculture in particular was
characterised by a great diversity in
accounting treatments. Cows, for instance,
were accounted for as 'inventories' in Ireland
but as 'non-current assets' in the UK.

Definitions
The following definitions are used in IAS 41 (you
should be familiar with the definitions of fair value
and carrying amount by now).
Agricultural activity is the management by an
enterprise of the biological transformation of
biological assets for sale, into agricultural produce
or into additional biological assets.
Agricultural produce is the harvested product of
an enterprise's biological assets.
 A biological asset is a living animal or plant.

Cont…
 Biological transformation comprises the processes of growth,
degeneration, production and procreation that cause
qualitative and quantitative changes in a biological asset.
 A group of biological assets is an aggregation of similar living
animals or plants.
 Harvest is the detachment of produce from a biological asset
or the cessation of a biological asset's life processes
 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.
 Carrying amount is the amount at which an asset is
recognised in the statement of financial position.

Scope
 The standard applies to the three elements that
form part of, or result from, agricultural activity.
 Biological assets
 Agricultural produce at the point of harvest
 Government grants
 The standard does not apply to agricultural land
(IASs 16 and 40) or intangible assets related to
agricultural activity (IAS 38). After harvest, IAS 2
is applied.

Biological assets
 Biological assets are the core income-producing assets of
agricultural activities, held for their transformative
capabilities.
 Biological transformation leads to various different
outcomes.
Asset changes:
– Growth: increase in quantity and or quality
– Degeneration: decrease in quantity and/or quality
Creation of new assets:
– Production: producing separable non-living products
– Procreation: producing separable living animals

Biological assets cont…
 We can distinguish between the importance of these by
saying that asset changes are critical to the flow of future
economic benefits both in and beyond the current
period, but the relative importance of new asset creation
will depend on the purpose of the agricultural activity.
 The IAS distinguishes therefore between two broad
categories of agricultural production system.
(a) Consumable: animals/plants themselves are harvested
(b) Bearer: animals/plants bear produce for harvest

Biological assets cont…
A few further points are made.
(a) Biological assets are usually managed in
groups of animal or plant classes, with
characteristics (eg male/female ratio) which
allow sustainability in perpetuity.
(b) Land often forms an integral part of the
activity itself in pastoral and other land-based
agricultural activities.
The Standard then goes on to look at the principal
issues in accounting for biological assets.

Recognition of biological assets
 The recognition criteria are very similar to those for other assets, in
that animals or plants should be recognised as assets in the
following circumstances.
(a) The entity controls the asset as a result of past events
(b) It is probable that the future economic benefits associated with
the asset will flow to the entity
(c) The fair value or cost of the asset to the entity can be measured
reliably
 The significant physical attributes of biological assets can be
measured using various methods (which are used by markets to
measure value) and generally indicate the source of future
economic benefits.
 The certainty of the flow of rewards can be determined by formal
ownership records, eg land title, branding. The availability of both
cost and value for biological assets indicates the reliability aspect of
the measurement criteria is fulfilled.

Measurement of biological assets

Determining fair value
 The standard states that the primary indicator of fair value should be net
market value. This is reasonable as efficient markets exist for most
biological assets in most locations and net market value is usually
considered as providing the best evidence of fair value where an active
market exists.
 Markets will generally differentiate between differing qualities and
quantities.
 Market value is not generally predicated on management's intended use,
however, but recognizes alternative uses.
 IFRS 13 requires the fair value of a biological asset to be determined by
reference to the principal market for the asset. This may or may not be the
most favourable market.
 An active and efficient market may not be available for a class of
biological assets in a specific location, or there may be imperfections in
the market.
 The standard goes into some detail about how fair value should be
measured in such circumstances, but in summary the valuation techniques
should be consistent with the objectives of measuring fair value and
should attain an appropriate balance between relevance and reliability.

Chapter Four
LEGAL PRINCIPLES OF INSURANCE CONTRACTS
 A contract is an agreement embodying a set of
promises that are enforceable at law, or for breach of
which the law provides a remedy.
 In general, there are four conditions, or requirements,
these are:
1) The agreement must be for a legal purpose
2) The parties must have legal capacity to contract
3) There must be evidence of agreement of the parties
to the promises
4) The promises must be supported by some
consideration, which may take the form of money, or
by some action by the parties that would not have
been required had it not been for the agreement.

Cont…
The promises must be supported by
some consideration, which may take the
form of money, or by some action by the
parties that would not have been
required had it not been for the
agreement.

Principle of Insurable Interest
A fundamental legal principle underlying all
insurance contracts is insurable interest.
Insurable interest is always a legal requirement
because to hold otherwise would mean that an
insured could collect without personal loss.
When we say that a businessman has an “interest
in several companies,” we usually imply that he
has more than mere mental attraction towards
them. This is also the sense in which the term is
used in insurable interest.

Principle of Insurable Interest
The essentials of insurable interest are as follows:
Presence of subject matter to be insured.
Existence of monetary relationship between the
subject matter and there would be policyholder.
The relationship existing between the policyholder
and the subject matter need to be legal.
The policyholder must be economically benefited by
the survival or suffer an economic-loss from the
damage or destruction of the subject matter.
An insurable interest may be applied on life,
property, or potential liability.

Life
Self insurance. An individual has an insurable
interest in his own life, and there is no limit to the
sum for which a man may insure his own life. In
practice, the sum insured is restricted by the
insured’s ability to pay premium.
Husband and Wife. A wife may insure the life of
her husband because his continued existence is
valuable to her and she would suffer a financial
loss upon his death. Likewise, a husband may
insure the life of his wife because her continued
existence is valuable to him and he could suffer a
financial loss upon her death.

Life
Creditors and Debtors. A creditor stands to loss if
his debtor dies without paying the debt. Thus, he
has the right to insure the debtor up to the amount
of the loan.
Partners. The death of a partner could well cause
financial loss to the survivor(s), who therefore,
have a right to insure him. This could arise with a
professional firm or perhaps with theatrical
performers. The amount of insurable interest
would be difficult to ascertain, but legally it is
limited to the financial involvement in the person
insured.

Property
Insurable interest in property may arise as follows:
Ownership. This is the most obvious form and in
addition to full ownership, part or joint ownership gives
the right to insure. With part ownership, the insurable
interest is strictly limited to the financial involvement,
but a part owner may insure the property for the full
value, as he will be deemed to be acting as an agent for
the other co-owners. Any amount he receives from the
insurance, over and above his own interest, is to be
held in trust for the co-owners.
Husband and Wife. A husband has an insurable interest
in his wife’s property as he is legally entitled to share
her enjoyment of it, and a wife similarly has an
insurable interest in her husband’s property as their
relationship is reciprocal.

CHAPTER 5
Employee benefits
84

IAS 19: Employee benefits
Contents
1 IAS 19: Employee benefits
2 Post-employment benefits
3 IFRIC 14: IAS19 –The limit on a defined
benefit
asset, minimum funding requirements and
their
interaction

Objective
The objective of this unit is to prescribe the accounting
and disclosure for employee benefits, i.e.:
1. When the cost of employee benefits should be
recognized as a liability or an expense.
2. The amount of the liability or expense that should be
recognized
 Employee benefits - are all forms of consideration
given by an entity in exchange for service rendered by
employees or for the termination of employment.
86

CONT…
• Definition
Employee benefits are all forms of
consideration given by an entity in
exchange for service rendered by
employees or for the termination of
employment.

Categories of Employee Benefits
There are four categories of employee benefits that
need a different accounting treatment for each.
1. Short-term employee benefits – are defined expected to
be settled wholly before twelve months after the end of
the annual reporting period.
 Example: Wages and salaries, Social security
contributions, Paid annual leave, Paid sick leave, Paid
maternity/paternity leave, Profit shares and bonuses,
Non-monetary benefits, e.g. medical care, housing,
cars, free or subsidized goods, etc.
88

2. Termination benefits – they are provided in exchange
for the termination of an employee’s employment as a
result of either:
a)an entity's decision to terminate an employee's
employment before the normal retirement date, or
b)an employee's decision to accept an offer of benefits
in exchange for the termination of employment.
 Example: early retirement payments & redundancy
payments.
89

3. Post-employment benefits - are employee benefits
(other than termination benefits & short-term
employee benefits) that are payable after the
completion of employment.
 Example: Pensions & Post-employment medical care
& insurance.
4. Other long-term employee benefits - are all
employee benefits other than short-term, post-
employment & termination benefits.
 Example: Sabbatical leave, Long-service & long-term
disability benefits, etc.
90

 Such benefits include items such as the following, if
not expected to be settled wholly before 12 months:
a) Long-term paid absences such as long-service or
sabbatical leave;
b) Jubilee/anniversary or other long-service benefits;
c) long-term disability benefits;
d) profit-sharing & bonuses; and
e) deferred remuneration.
91

Recognition & Measurement
1. Short-term employee benefit costs.
 simply recognized as an expense in the
employer's F/S of the current period.
 Unpaid short-term employee benefits at
the end of an accounting period should be
recognized as an accrued expense.
 Any short-term benefits paid in advance
should be recognized as a prepayment
(i.e. reduction in future payments or a
cash refund).
92

• Short-term compensated absences:
– Recognize a cost and liability = the undiscounted
amount of benefits expected to be paid
– Some benefits accumulate
 Accrue as employee provides services (e.g., paid
vacation leave)
– Some do not accrue
 (e.g., Sick Leave, Maternal/paternal leave)
 Recognize cost and liability when event occurs that
obligates the entity to provide the benefit
93

• Profit-sharing & bonus plans:
– Recognize cost & liability only when
• a legal or constructive obligation exists, &
• amount can be reasonably estimated
To reasonably estimate, must have one of the
following:
• plan has formal terms including a formula
• amount is known before F/S are authorized for
release
• past practice provides clear evidence of amount
94

• An entity has 5 employees and each is entitled to 20 days
paid vacation per year, at a rate of Br.50 per day. Unused
vacation is carried forward to the ff year.
• All 5 employees work for the entity throughout the year
and are therefore entitled to their 20 days of vacation.
An expense should be recognized in P/L for:
5 employees x 20 days x CU50 = CU5,000
• 4 of the employees use their complete entitlement for
the year & the other, having used 16 days, is permitted
to carry forward the remaining 4 days to the following
period.
 A liability will be recognised at EOY for:
1 employee x 4 days x CU50 = CU200
95

Activity
• Ex : Profit sharing or bonus plans. ABC Co pays 3% of
year’s profit (before profit sharing) to employees who serve
throughout the current year & who will continue to serve
throughout the following year. ABC Co expects to save 10%
through staff turnover. The bonus will be paid on
31/12/20X2. Profit for 20X1 before profit sharing =
$1,000,000.
 Liability at 31/12/20X1 & Expense = $27,000 (i. e 3% ×
$1,000,000 × 90%)
96

2. Deferred employee benefits costs.
 Much more difficult because of the large
amounts involved, as well as the long time
scale, complicated estimates and
uncertainties.
97

Termination Benefits:
 Recognize liability and expense at the earlier of:
a) The date the entity can no longer withdraw the
benefit or offer
b) The date the entity recognizes restructuring costs
under IAS 37.
If termination benefits settled wholly before 12 months
from reporting date, apply requirements for short-term
employee benefits.
If termination benefits are not settled wholly before 12
months from reporting date, apply requirements for
other long term employee benefits.
98

Other Long Term Employee Benefits:
• Statement of financial position
a) Carrying amount of liability = PV of obligation (-) Fair Value of
any plan assets;
b) Actuarial gains & losses & past service costs are recognized
immediately in OCI and SP/L respectively in the Statement of
Comprehensive Income.
• Statement of comprehensive income
 Recognize the net total of : Current service cost (+) Net interest
on net defined benefit liability/(asset) (+) re-measurement of
the net defined benefit liability/(asset).
99

Other Long term EB Expenses
=
Current Service Cost + Int. Cost – Expected
Return on ANY plan Asset + Actuarial
Gains or losses + All Past Service Costs
Other Long term EB Liab.
=
PV of DBO – Fair Value of Any Plan
Assets 100

Post-employment benefits
Two types of post-employment benefit plan:
A. Defined contribution plans – are post-employment
benefit plans that an entity pays:
1. fixed contributions into a separate entity (a fund) &
2. no further liability to pay and
3. no exposure to risks if the fund does not hold
sufficient assets to pay all employee benefits relating to
employee service in the current and prior periods.
 They are simple to account for as the benefits.
102

Recognition & Measurement - Defined contribution plan
Example: Defined contribution plan would be
where the employee and employer agreed to
contribute an amount of 7 % and 11 % of basic
salary respectively into a post-employment plan.
1.The obligation is measured by the amounts to be
contributed for that period.
2.There are no actuarial assumptions to make.
3.If the obligation is settled in the current or next
period, there is no requirement for discounting.
103

Recognition & Measurement - Defined contribution
plan
 IAS 19 requires the following accounting
treatment Defined contribution plans.
1. Contributions to a defined contribution plan
should be recognized as an expense in the period
they are payable.
2. Any liability for unpaid contributions that are due
as at the end of the period should be recognized
as a liability (accrued expense).
3. Any excess contributions paid should be
recognized as an asset (prepaid expense).
104

Post-employment benefits
B.Defined benefit plans are post-employment benefit
plans other than defined contribution plans that an
entity pays:
1. fixed contributions into a separate entity ( fund).
2. further liability to pay and
3. exposure to risks if the fund/plan assets are
insufficient to meet the plan liabilities to pay
pensions in future, the entity will have to make up
any deficit.
 They are difficult to deal with.
105

Recognition & Measurement - Defined benefit plans
Accounting for defined benefit plans is much more
complex because of:
1. The future benefits (arising from employee service
in the current or prior years) cannot be measured
exactly but the liability should be recognized now.
 To measure these future obligations, it is necessary
to use actuarial assumptions.
106

2. The obligations payable in future years should be
valued, by discounting, on a present value basis. This is
because the obligations may be settled in many years'
time.
3. If actuarial assumptions change, the amount of
required contributions to the fund will change, and
there may be actuarial gains or losses.
 A contribution into a fund in any period will not equal
the expense for that period, due to actuarial gains or
losses. 107

Actuarial gains/losses:
 recognize all actuarial gains/losses in
OCI when they occur, and then directly
to RE – not through P&L
108

Accounting building blocks:
– PV of a defined benefit obligation – the discounted PV
of the expected future payments required to settle an
entity’s obligation resulting from employee service
accumulated to date.
– Plant assets – assets held by the long-term employee
benefit fund that exists solely to pay employee benefits
as they fall due.
109

Recognition & Measurement - Defined benefit
plans
Changes in the PV of the defined benefit obligation (DBO):
based on projected salaries:
PV of the obligation ( beg. of period)
+ Current period’s service cost
+ Interest cost on the outstanding obligation for
+/- Past service costs from plan amendments in the period
- Benefits paid under the plan in the period
+/- Actuarial gains (-) & losses (+) in the period
= Present value of the obligation ( End of Year)
110

Disclosure
• IAS 19 requires extensive disclosures in
respect of defined benefit plans including
narrative descriptions of:
 the regulatory framework;
 funding arrangements;
 potential (non-) financial risks;
 and/or asset ceiling tests.
 etc
111

Activity
1. Differentiate among the four
categories of employee benefits given
by IAS 19?
2. Distinguish between the two kinds of
post-employment benefits.
3. Recognize the model of the necessary
journal entries related to employment
benefits in Ethiopia.
4. Which kind of post-employment
benefit is applicable in Ethiopia? 112

Activity : Ethiopian Payroll Accounting based on IAS 19
Assume that a newly established district of an
organization has five employees. Both employees and
employer contribute to Pension Fund as per the new
legislation of the country. The organization also pays 1 %
of Basic Salary as bonus to all employees per month.
The employees promised to contribute one month
salary for Renaissance Dam to be deducted equally over
one year. They also save 10% of their Basic Salary in
saving and Credit Association. The organization expects
employees to work 8 hrs/day, 5 days/wk, 4 wks/month
& entirely 160hrs/ month. All employees worked what is
expected of them during the month. The data for the
month of Hamle, 2008 E.C are presented below.
113

Activity : Ethiopian Payroll Accounting based on IAS 19
114

Required : Prepare the “Payroll Register” in the order of the
following headings & pass the necessary journal entries.
Employee Id
Employee Name
 basic Salary
Allowance Taxable
Allowance Non
Taxable
Bonus
OT
Gross Earnings
Income Tax
Pension Contribution
of Employees
Abay deduction
Credit Association
Other deductions
Total deductions
 Net Pay
 Signature
115

Employment Income Tax Schedule
• The newly issued Proclamation 979/2016 gives the
following rates
TB Income Rate Ded EIT Calculation
1 0 – 600 0% 0.00 No Tax Payment
2 601 – 1,650 10% 60.00 EIT = TEI @ 10% – 60
3 1,651– 3,200 15% 142.50 EIT = TEI @ 15% – 142.50
4 3,201 – 5,250 20% 302.50 EIT = TEI @ 20% – 302.50
5 5,250 – 7,800 25% 565.00 EIT = TEI @ 25% – 565.00
6 7,800 – 10,900 30% 955.00 EIT = TEI @ 30% – 955.00
7 Over 10,900 35% 1,500.00 EIT= TEI@ 35% - 1,500.00
116

CHAPTER 6
Asset Valuation for Financial
Reporting

118
IFRS 13
Fair Value Measurement

1.Objective
• The objectives of IFRS 13 are to:
1) Define fair value;
2) Provide a single set of
requirements for measuring fair
value;
3) Specify the disclosure
requirements for fair value
measurement.
119

2. Scope
• IFRS 13 FV Measurement applies
when another IFRS requires or
permits either:
1) Fair value measurements and/or
2) Disclosures about FV measurements.
120

3. Main Definitions
1)Fair Value : 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.
 This definition of fair value is sometimes
referred to as an ‘exit price’.
121

3. Main Definitions
2)Market Participants : are buyers and sellers in
the principal (or most advantageous) market for
the asset or liability that have all of the following
characteristics:
a)They are independent of each other, i.e. they
are not related parties as defined in IAS 24 :
Related Party Disclosures, although the price in a
related party transaction may be used as an
input to a fair value measurement if the entity
has evidence that the transaction was entered
into at market terms;
122

3. Main Definitions
b)They are knowledgeable, having a reasonable
understanding about the asset or liability and the
transaction using all available information,
including information that might be obtained
through due diligence efforts that are usual and
customary;
c)They are able to enter into a transaction for the
asset or liability;
d)They are willing to enter into a transaction for the
asset or liability (i.e. they are motivated, but not
forced or otherwise compelled, to do so).
123

3. Main Definitions
3) Orderly transaction : ‘A transaction that assumes exposure
to the market for a period before the measurement date to
allow for marketing activities that are usual and customary
for transactions involving such assets or liabilities; it isn't a
forced transaction (e.g. a forced liquidation or distress sale).’
4) Principal market : ‘The market with the greatest volume and
level of activity for the asset or liability.’
5) ‘Most advantageous market’ : ‘The market that maximizes
the amount that would be received to sell the asset or
minimizes the amount that would be paid to transfer the
liability, after taking into account transaction costs and
transport costs’.
6) Unit of account : ‘the level at which an asset or a liability is
aggregated or disaggregated in an IFRS for recognition
purposes.’
124

 Activity: Principal vs. Most Advantageous Market
125
Ex : You have access to two active markets to sell an
asset:
– Market (M)1: price = $100; transaction costs = $10
– M2: price = $95; transaction costs = $3.
What is the fair value of the asset? Choose one of:
1) $100 if M1 is the principal market, otherwise $95;
2) $90 if M1 is the principal market, otherwise $92;
3) $95 because the most advantageous market (M2) must
be the principal market;
4) $92 because the most advantageous market (M2) must
be the principal market.

4. MEASUREMENT – KEY FACTORS AND CONSIDERATIONS
1. The asset or liability
• Fair value measurement - is specific to each asset
or liability. Consequently, FV measurement needs
to take into account the specific characteristics of
the asset or liability if market participants would
take those characteristics into account when
pricing the asset or liability at the measurement
date.
• For example : The condition, location and
restrictions (if any) on the sale or use of the asset.
126

2) Exit price vs. entry price
• When an asset is acquired or a liability is
assumed in an exchange transaction, the
transaction price is the amount:
a) Paid to acquire the asset or
b) Received to assume the liability.
• This amount is the entry price.
127

2) Exit price vs. entry price
In contrast, the FV of the asset or liability is the
amount that would be:
a) Received to sell the asset, or
b) Paid to transfer the liability
• This amount is the exit price.
128

3) The market concept
• One of the major principles of IFRS 13 is the
market concept (i.e. reference in IFRS 13 to
‘market participants’, ‘market conditions’,
‘market transactions’, ‘market information’,
‘principal market’, ‘most advantageous
market’).
• Also, IFRS 13 notes that: ‘Fair value is a market-
based measurement not an entity-specific
measurement…’.
129

4) Market participant
• The above discussion regarding the market in
which an entity may transact is sometimes
theoretical as many items are rarely bought or
sold on a standalone basis. Moreover, many
liabilities include restrictions that prevent their
transfer.
• Even then, fair value measurement is still made
from the perspective of market participant.
130

5)The Price
• Fair value is the price that would be received to
sell an asset or paid to transfer a liability in an
orderly transaction in the principal (or most
advantageous) market at the measurement date
under current market conditions (i.e. an exit
price) regardless of whether that price is directly
observable or estimated using another valuation
technique .
131

4. MEASUREMENT – KEY FACTORS & CONSIDERATIONS
6)Fair value at initial recognition
• Generally, the transaction price (entry price) will
equal the FV (exit price), although there is a
conceptual difference between the two.
• It is therefore important to understand that
transaction costs will not cause a difference
between entry price and exit price.
132

• IFRS 13 describes situations in which the transaction price
may not represent the FV of an asset or a liability at initial
recognition. These situations and others may include:
1)Transactions between related parties ;
2)Transactions that take place under pressure or under a
forced sale (e.g. the seller is experiencing financial difficulty
or the acquirer is obliged to purchase the asset or assume
the liability because of law or a court decision);
3)The unit of account represented by the transaction price is
different from the unit of account for the asset or liability
measured at FV;
4)The market in which the transaction takes place is different
from the principal market (or most advantageous market).
133

7)Non-financial assets
• IFRS 13 requires the FV of a non-financial asset to
be measured based on its highest and best use
(HBU) from a market participant’s perspective. This
requirement doesn’t apply to financial instruments
, liabilities or equity.
• FRS 13 states that HBU of a non-financial asset
takes into account the use of the asset that is
physically possible, legally permissible and
financially feasible, as follows:
134

a) A use that is physically possible takes into account the
physical characteristics of the asset that market
participants would take into account when pricing the
asset (e.g. the location or size of a property);
b) A use that is legally permissible takes into account any
legal restrictions on the use of the asset that market
participants would take into account when pricing the
asset (e.g. the zoning regulations applicable to a
property);
c) A use that is financially feasible takes into account
whether a use of the asset that is physically possible and
legally permissible generates adequate income or cash
flows to produce an investment return that market
participants would require from an investment in that
asset put to that use. 135

Activity : Non Financial Assets
136
Ex : Your Factory is built on Plot 900, in a recently developed
industrial development zone on the outskirts of Addis Ababa
where the land that is divided into one hundred two acre plots
that before their further development were essentially
homogenous. Factories, like yours, are the highest and best
use for the land rights.
• On December 31, 2000 two of the plots adjoining your plot
were sold (i.e. sale of the land rights and the buildings, if
any, constructed thereon):
– Plot 901, sold for $30 million: land rights with a similar factory of
the same age, same condition and same floor area as yours.
– Plot 899, sold for $10 million because it is undeveloped (yet to
be built on).

Activity : Non Financial Assets
137
On 31 December 2000, what is the fair value of your
land rights (i.e., excluding the factory building)?
• Choose 1 of:
1) $0; 2) $10 million; 3) $20 million; 4) $30 million; 5) $70
million; 6) $80 million; 7) $100; million; or 8) another
amount
On 31 December 2000, what is the fair value of your
factory building (i.e., excluding the land rights)?
• Choose 1 of:
1) $0; 2) $10 million; 3) $20 million; 4) $30 million; 5) $70
million; 6) $80 million; 7) $100; million; or 8) another
amount

Activity: Restriction on use : Non Financial Assets
Ex : You own land use rights to Plot A that is zoned ‘green belt’—which
prohibits the construction of buildings on that land.
Similar neighbouring plots’ with the same land use rights
and subject to the same restrictions sold recently:
 for Br950,000 on 30 October 2015 (Plot B); and
 for Br30,000,000 on 31 December 2015 (Plot C).
The difference in the selling price of Plots B and C is
attributable primarily to the press leaked confidential
government dossier (file) setting out the government’s
plans for proposing an amendment to the law to allow for
the construction of high-rise buildings on some (but
unspecified which) green belt land.
138

Activity: Restriction on use : Financial Assets
Entity A pledges 100,000 Awash International Bank shares that it
owns as collateral in a borrowing arrangement.
• Consequently, Entity A cannot sell its Awash International Bank
shares until it settles the borrowing.
• Awash International Bank shares are issued without such a
restriction and trade on Ethiopian Stock Exchange market.
Is the restriction relevant to measuring the fair value of the Awash
International Bank shares held by Entity A? Choose one of:
1) Yes
2) No
3) It depends (specify)
139

8)Liabilities and own credit risk (including equity
issued by the entity)
• The general principle for measuring the FV of
liabilities (and an entity’s own equity
instruments) in accordance with IFRS 13 is that
FV assumes that a financial or non-financial
liability or an entity’s own equity instrument (e.g.
equity interests issued as consideration in a
business combination) is transferred to a market
participant at the measurement date as
outstanding.
140

9) Bid and ask prices
• Bid and ask prices are common within markets for
securities, financial instruments and commodities.
• In these markets, dealers stand ready to buy at the
bid price and sell at the ask price.
• A bid price reflects the highest price a potential
buyer is willing to pay for an asset and an ask price
reflects the lowest price a potential seller will
accept. The difference is the bid-ask spread.
141

• IFRS 13 states that the entity should use the
price within the bid-ask spread that is most
representative of FV.
• The use of bid prices for asset positions and
ask prices for liability positions is permitted but
isn’t required.
• In practice, however, we would expect that for
stand-alone financial assets and financial
liabilities, bid and ask prices would be used for
valuation purposes.
142

10) Premium and discount
• When a quoted price in an active market exists for an item
(a Level 1 input), the quoted price is used without
adjustment.
• However, for certain financial and non-financial assets and
liabilities, quoted prices in an active market typically will
not exist (such as:
a) for shares in unlisted entities,
b) debt instruments not listed on a public market,
c) investment properties, and
d) items of property plant and equipment.
For those assets and liabilities, the FV measurement should
incorporate premiums or discounts if market participants
would consider them in determining FV for the purposes of
their acquisition or sale. 143

5. Fair Value Hierarchy : Levels 1, 2 and 3
144

• IFRS 13 : Fair Value Measurement establishes a
FV hierarchy.
• The IFRS 13 FV hierarchy categorizes elements
of the financial statements (that fall within the
scope of IFRS 13) into three levels, based on the
inputs used in the valuation techniques to
determine their FV.
• The FV hierarchy gives the highest priority to
Level 1 (observable) inputs, and the lowest
priority to Level 3 (unobservable) inputs .
145

1.Level 1 inputs
• Level 1 inputs - are quoted prices in active markets for
identical assets or liabilities that the entity can access
at the measurement date.
• A quoted market price in an active market provides
the most reliable evidence of FV and is used without
adjustment to measure FV whenever available, with
limited exceptions.
• Highest priority is given to quoted prices in active
markets for identical assets or liabilities
146

2.Level 2 inputs
 Level 2 inputs - are inputs other than quoted market prices
included within Level 1 that are observable for the asset or
liability, either directly or indirectly.
 Level 2 inputs include:
a) quoted prices for similar assets or liabilities in active
markets;
b) quoted prices for identical or similar assets or liabilities in
markets that are not active;
c) inputs other than quoted prices that are observable for the
asset or liability;
d) inputs that are derived principally from or corroborated by
observable market data by correlation or other means
('market-corroborated inputs').
147

3.Level 3 inputs
• Level 3 inputs are unobservable inputs for the asset or
liability.
• Unobservable inputs are used to measure FV to the
extent that relevant observable inputs are not available,
thereby allowing for situations in which there is little, if
any, market activity for the asset or liability at the
measurement date.
• An entity develops unobservable inputs using the best
information available in the circumstances, which might
include the entity's own data, taking into account all
information about market participant assumptions that is
reasonably available.
• Estimate using a valuation technique (a model) 148

6. Valuation Techniques
• Valuation techniques - used to measure fair value
should maximise the use of relevant observable inputs
and minimise the use of unobservable inputs
a)Observable inputs – developed using market data
such as publicly available information about actual
events or transactions
b)Unobservable inputs – market data not available
and developed using best information available
about assumptions that market participants would
use
149

• IFRS 13 includes definitions for three valuation
techniques that are commonly utilized in practice:
1. Market Approach : A valuation technique that uses
prices and other relevant information generated by
market transactions involving identical or comparable
(i.e. similar) assets, liabilities, or a group of assets and
liabilities. (e.g. a business)
 The following valuation techniques are described
under the market approach in the document:
a) Transaction price paid for an identical or a similar
instrument in an investee;
b) Comparable company valuation multiples.
150

2. Income approach : A valuation technique that converts
future amounts (e.g. cash flows or income and expenses) to
a single current (i.e. discounted/Present value) amount.
 The following valuation techniques are described in the
document:
a) Discounted cash flow method : Under this method, the
investor would discount expected cash flows to a present
value at a rate of return that represents the time value of
money and the relative risks of the investment.
b) Dividend discount model : This model assumes that the
price of an equity instrument equals the present value of all
its expected future dividends in perpetuity when the
investee consistently pays dividends.
151

B)Constant-growth dividend discount model : This
model determines the FV of the equity instrument
by referring to a forecast of growing dividend
streams. This model is sensitive to the
assumptions about the growth rate.
d) Capitalization model : This model applies a rate to
an amount that represents a measure of economic
income to arrive at an estimate of present value.
The model is useful as a cross-check when other
approaches have been used.
152

3. Cost approach / Adjusted net asset method
 A valuation technique that reflects the amount that
would be required currently to replace the service
capacity of an asset (often referred to as current
replacement cost).
 This cost approach definition assumes that FV is the
cost to acquire or construct a substitute asset of
comparable utility, adjusted for obsolescence
(including physical deterioration , functional
(technological) obsolescence and economic
(external) obsolescence)
153

7. Disclosures
• IFRS 13 FV Measurement - introduces a comprehensive
disclosure framework for FV measurement. This framework is
intended to help users of financial statements assess the
valuation techniques and inputs used to develop those
measurements.
• The disclosures required are affected by the FV hierarchy
discussed above, with increased disclosure requirements
applying to the lower levels of that hierarchy (in particular
Level 3).
• A distinction is also made between recurring FV
measurements (measurements made on a FV basis at each
reporting date) and non-recurring measurements
(measurements triggered by particular circumstances).
154

7. Disclosures
e of the effect of the FV measurement on
oss or other comprehensive income for the
required for recurring FV measurements that
gnificant unobservable (Level 3) inputs.
e requirements also apply to each class of
liability not measured at FV in the statement
al position but for which the fair value is
(e.g. financial instruments measured at
cost, and investment property accounted
cordance with the cost model). For these
disclosures requirements are less extensive.
155

Advanced Financial Acct-I Chap 1-6 .pptx

Recommended

Recommended

More Related Content

Similar to Advanced Financial Acct-I Chap 1-6 .pptx

Similar to Advanced Financial Acct-I Chap 1-6 .pptx (20)

Recently uploaded

Recently uploaded (20)

Advanced Financial Acct-I Chap 1-6 .pptx