ACCA_F7_Course_Notes.pdf-130-253.pdf

Syllabus B8abc)
a) Account for current taxation in accordance with relevant accounting standards.
b) Explain the effect of taxable temporary differences on accounting and taxable profits.
c) Compute and record deferred tax amounts in the financial statements.
Income Tax

Current tax

The amount of income taxes payable or receivable in a period.
Any tax loss that can be carried back to recover current tax of a previous period is shown as an
asset.
If the gain or loss went to the OCI, then the related tax goes there too.
Deferred Tax
This is basically the matching concept.
Let´s say we have credit sales of 100 (but not paid until next year).
There are no costs.
The tax man taxes us on the cash basis (i.e. next year).
The Income statement would look like this:
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This is how it should look.
The tax is brought in this year even though it´s not payable until next year, it´s just a temporary
timing difference.
Illustration
• Tax Base 
Let’s presume in one country’s tax law, royalties receivable are only taxed when
they are received
• IFRS 
IFRS, on the other hand, recognises them when they are receivable
Now let’s say in year 1, there are 1,000 royalties receivable but not received until year 2.
The Income statement would show:
Royalties Receivable 1000
Tax (0) (They are taxed when received in yr 2)
This does not give a faithful representation as we have shown the income but not the related tax
expense.
Therefore, IFRS actually states that matching should occur so the tax needs to be brought into
year 1.
Dr Tax (I/S)
Cr Deferred Tax (SFP provision)
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Deferred tax on a revaluation
Deferred tax is caused by a temporary difference between accounts rules and tax rules.
One of those is a revaluation:
Accounting rules bring it in now.
Tax rules ignore the gain until it is sold.
So the accounting rules will be showing more assets and more gain so we need to match with the
temporarily missing tax.
Illustration
A company revalues its assets upwards making a 100 gain as follows:
This is how it should look.
The tax is brought in this year even though it´s not payable until sold, it´s just a temporary timing
difference.
Notice the tax matches where the gain has gone to.
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Syllabus B9. Reporting financial performance
Syllabus B9a) Discuss the importance of identifying and reporting the results of discontinued
operations.
Discontinued Operation

An analysis between continuing and discontinuing operations improves the
usefulness of financial statements.

When forecasting ONLY the results of continuing operations should be used.
Because discontinued operations profits or losses will not be repeated.
What is a discontinued operation?
1 A separate major line of business or geographical area 
or..
2 is part of a single co-ordinated plan to dispose of a separate major line of
business or geographical area 
or..
3 is a subsidiary acquired exclusively with a view to resale
How is it shown on the Income Statement?
The PAT and any gain/loss on disposal
• A single line in I/S
How is it shown on the SFP?
If not already disposed of yet?
• Held for sale disposal group 
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How is it shown on the cash-flow statement?
• Separately presented
• in all 3 areas - operating; investing and financing
No Retroactive Classification
IFRS 5 prohibits the retroactive classification as a discontinued operation, when the discontinued
criteria are met after the end of the reporting period 
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Syllabus B9b)
Define and account for non-current assets held for sale and discontinued operations.
Assets Held for Sale

How do we deal with items in our accounts which we are no longer going to
use, instead we are going to sell them

So, think about this for a moment.. Why does this matter to users?
Well, the accounts show the business performance and position, and you expect to see assets in
there that they actually are looking to continue using.
Therefore their values do not have to be shown at their market value necessarily (as your intention
is not to sell them)
Here, though, everything changes… we are going to sell them.
So maybe market value is a better value to use, but they haven’t been sold yet, so showing them
at MV might still not be appropriate as this value has not yet been achieved
So these are the issues that IFRS 5 tried, in part, to deal with and came up with the following
solution..
Accounting Treatment
1 Step 1 - Calculate the Carrying Amount... 
 
Bring everything up to date when we decide to sell 
This means: 
- charge the depreciation as we would normally up to that date or 
- revalue it at that date (if following the revaluation policy) 
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2 Step 2 - Calculate FV - CTS
 
Now we can get on with putting the new value on the asset to be sold.. 
Measure it at Fair Value less costs to sell (FV-cts).  
This is because, if you think about it, this is the what the company will receive. 
HOWEVER, the company hasn’t actually made this sale yet and so to revalue it now
to this amount would be showing a profit that has not yet happened
3 Step 3 - Value the Assets held for sale  
IFRS 5 says the new value should actually be… 
...The lower of carrying amount (step 1) and FV-CTS (step 2)
4 Step 4 - Check for an Impairment  
Revaluing to this amount might mean an impairment (revaluation downwards) is
needed.  
This must be recognised in profit or loss, even for assets previously carried at
revalued amounts.
Also, any assets under the revaluation policy will have been revalued to FV under step 1
Then in step 2, it will be revalued downwards to FV-cts.
Therefore, revalued assets will need to deduct costs to sell from their fair value and this will result
in an immediate charge to profit or loss.
Subsequent increase in Fair Value?
• This basically happens at the year-end if the asset still has not been sold 
A gain is recognised in the p&l up to the amount of all previous impairment losses.
Non-depreciation
Non-current assets or disposal groups that are classified as held for sale shall not be depreciated.
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When is an asset recognised as held for sale?
• Management is committed to a plan to sell
• The asset is available for immediate sale
• An active programme to locate a buyer is initiated
• The sale is highly probable, within 12 months of classification as held for sale
• The asset is being actively marketed for sale at a sales price reasonable in
relation to its fair value
Abandoned Assets
The assets need to be disposed of through sale. Therefore, operations that are expected to be
wound down or abandoned would not meet the definition. Therefore assets to be abandoned would
still be depreciated.
Balance sheet presentation
Presented separately on the face of the balance sheet in current assets
• Subsidiaries Held for Disposal 
IFRS 5 applies to accounting for an investment in a subsidiary held only with a view
to its subsequent disposal in the near future.
• Subsidiaries already consolidated now held for sale 
The parent must continue to consolidate such a subsidiary until it is actually
disposed of. It is not excluded from consolidation and is reported as an asset held
for sale under IFRS 5. 
So subsidiaries held for sale are accounted for initially and subsequently at FV-CTS
of all the net assets not just the amount to be disposed of.
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Syllabus B9c)
Indicate the circumstances where separate disclosure of material items of income and expense is
required.
Separate disclosure of material items

Exceptional items get disclosed separately

This is where disclosure is necessary in order to explain the performance of the entity better
The NORMAL accounting treatment is to:
• Show in the standard line in the I/S
• Disclose the nature and amount in notes
EXCEPTIONS such as these can have their own I/S line:
• Write down of inventories to net realisable value (NRV)
• Write down of property, plant and equipment to recoverable amount
• Restructuring costs
• Gains/losses on disposal of non-current assets
• Discontinued operations profits / losses
• Litigation settlements
• Reversals of provisions  
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Syllabus A1g/B9d
g) Discuss the principle of comparability in accounting for changes in accounting policies.
d) Account for changes in accounting estimates, changes in accounting policy and correction of prior
period errors.
IAS 8 Changes in accounting policies and accounting
estimates

Comparatives are changed for accounting POLICY changes only

Changes in accounting estimates have no effect on the comparative
Changes in accounting policy means we must change the comparative too to ensure we keep the
accounts comparable for trend analysis
Accounting Policy

Definition
“the specific principles, bases, conventions, rules and practices applied by an entity in preparing
and presenting the financial statements”
An entity should follow accounting standards when deciding its accounting policies
If there is no guidance in the standards, management should use the most relevant and reliable
policy 
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Changes to Accounting Policy
These are only made if:
- It is required by a Standard or Interpretation; or
- It would give more relevant and reliable information
1 Adjust the comparative amounts for the affected item 
(as if the policy had always been applied)
2 Adjust Opening retained earnings 
(Show this in statement of changes in Equity too)
Accounting Estimates

Definition
“an adjustment of the carrying amount of an asset or liability, or related expense, resulting from
reassessing the expected future benefits and obligations associated with that asset or liability”
Examples
Allowances for doubtful debts;
Inventory obsolescence;
A change in the estimate of the useful economic life of property, plant and equipment
Changes in Accounting Estimate
1 Simply change the current year
2 No change to comparatives
Prior Period Errors

These are accounted for in the same way as changes in accounting policy
Accounting treatment
1 Adjust the comparative amounts for the affected item
2 Adjust Opening retained earnings 
(Show this in statement of changes in Equity too) 
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Syllabus B9e)
Earnings per share (eps)
i) calculate the eps in accordance with relevant accounting standards (dealing with bonus issues, full
market value issues and rights issues)
ii) explain the relevance of the diluted eps and calculate the diluted eps involving convertible debt and
share options (warrants)
IAS 33 EPS Introduction

EPS is a much used PERFORMANCE appraisal measure

It is calculated as:
PAT - Preference dividends / Number of shares
It is not only an important measure in its own right but also as a component in the price earnings
(P/E) ratio (see below)
Diluted EPS
This is saying that the basic EPS might get worse due to things that are ALREADY in issue such
as:
• Convertible Loan 
This will mean more shares when converted
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• Share options 
This will mean more shares when exercised
Who has to report an EPS?
• PLCs
• Group accounts where the parent has shares similarly traded/being issued
EPS to be presented in the income statement. 
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Syllabus B9e)
IAS 33 EPS - earnings figure

This is basically Profit after Tax

less preference dividends
*Be careful of the type of preference share though…
Redeemable preference shares
These are actually liabilities and their finance charge isn’t a dividend in the accounts but interest.
• Do not adjust for these dividends.
Irredeemable preference shares
These are equity and the finance charge is dividends
• Do adjust for these dividends
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Syllabus B9e)
IAS 33 EPS - Number of shares

Calculating the weighted average number of ordinary shares

The number of shares given in the SFP at the year-end - may not be the number of shares in issue
ALL year.
So we need to know how many we had in issue on AVERAGE instead of at the end.
Well if there were no additional shares in the year then obviously the weighted average is the same
as the year end - so no problem!
However, if additional shares have been issued we’ve got some work to do as follows (depending
on how those shares were issued):
Full Market Price issue of shares
No problem here as the new shares came with the right amount of new resources so the company
should be able to use those new resources to maintain the EPS
• No adjustment needed (apart from time)
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Bonus & Rights Issue of shares
More problematic, as the share were issued for cheaper (rights) than usual or for free (bonus).
In both cases the company has not been given enough new resource to expect the EPS to be
maintained.
This causes comparison to last year problems.
• Adjust for these (Bonus fraction)
• Pretend they were in issue ALL year
• Change comparative (Pretend they were in last year too)
So, how to calculate it is best explained by example:
1st January 100 shares in issue
1st May Full market price issue of 400 shares
1st July 1 for 5 bonus issue
Solution
Draw up a table like this:
Now fill in the first 2 columns:
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Notice how this shows the TOTAL shares. Now fill in the timing of how long these TOTALS lasted
for in the year.
Finally look for any bonus issues and pretend that they happened at the start of the year. We do
this by applying the bonus fraction to all entries BEFORE the actual bonus or rights issue.
In this case the bonus fraction would be 6/5 - so apply this to everything before the actual bonus
issue:
Finally, multiply through and calculate the weighted average:
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Syllabus B9e)
IAS 33 Bonus issue

Additional shares are issued to the ordinary equity holders in proportion to their current
shareholding, for example 1 new share for every 2 shares already owned.
No cash is received for these shares.
Double Entry
• Dr Reserves or Share premium
• Cr Share Capital 
IAS 33 pretends that the bonus issue has been in place all year - regardless of when it was
actually made.
We do this by multiplying the totals before the issue by a “bonus fraction”.
Bonus Fraction Calculation - Bonus issue
1 for 2 bonus issue - means we’ve now got 3 where we used to have 2 = 3/2
2 for 5 - now got 7 used to have 5 = 7/5
3 for 4 - now got 7 used to have 4 = 7/4 
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Example
1st Jan 100 shares in issue
1st July 1 for 2 bonus issue (i.e. 50 more shares)
• Weighted Average number of shares  
100 x 6/12 (we had a total of 100 for 6 months) = 50 x 3/2 (bonus fraction) = 75 
150 x 6/12 (we had a total of 150 for 6 months) = 75 
Total = 150
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Syllabus B9e)
IAS 33 Rights Issue

Rights issue

A rights issue is:
• An issue of shares for cash to the existing ordinary equity holders in proportion to
their current shareholdings.
• At a discount to the current market price. It is, in fact, a mixture of a full price and
bonus issue. 
So again we do the same as in the bonus issue - we pretend it happened all year
and to do this we multiply the previous totals by the bonus fraction. 
The problem is - calculating the bonus fraction for a rights issue is slightly different:
Example
2 for 5 offered at £4 when the market value is £10
So we are being offered 2 @ £4 = £8
For every 5 which cost us £10 each = £50
So we now have 7 at a cost of £58 = 8.29
This is what we call the TERP (theoretical ex-rights price).
The bonus fraction is the current MV / TERP = 10 / 8.29 
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Syllabus B9e)
IAS 33 Basic EPS putting it all together

IAS 33 Basic EPS putting it all together

1 Step 1: Calculate the EARNINGS (PAT - irredeemable pref. shares)
2 Step 2: Calculate Weighted average NUMBER OF SHARES
3 Divide one by the other! 
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Syllabus B9e)
IAS 33 Diluted EPS

This is the basic EPS adjusted for the potential eﬀects of a convertible loan
(currently in the SFP) being converted and options (currently in issue) being
exercised.

This is because these things will possibly increase the number of shares in the future and thus
dilute EPS.
This is how these items affect the Basic Earnings and Shares.
Earnings
The convertible loan will (once converted) increase earnings as interest will no longer have to be
paid.
So increase the basic earnings with a tax adjusted interest savings.
Shares
• Simply add the shares which will result from the convertible loan
• Also add the “free” shares from a share option 
Convertible loan
• Add the interest saved (after tax) to the EARNINGS from basic EPS
• Add the extra shares convertible to the SHARES from basic EPS 
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Options

Step 1 : Calculate the money the options will bring in
Step 2 : Calculate how many shares this would normally buy
Step 3 : Look at the number of shares given away in the option, compare it to those in step 2 and
these are the “free shares”
We add the free shares to the SHARES figure from basic EPS.
Illustration

5% 800 convertible loan - each 100 can be converted into 20 shares (tax 30%)
100 share options @ $2 (MV $5)
How to calculate Interest Saved
5% x 800 = 40 x 70% (tax adjusted) = 28
How to calculate the extra convertible shares
800/100 x 20 = 160
How to calculate the free shares in share options
Cash in from option $200, this would normally mean the company issuing (200/5) 40 shares
instead of the 100, so there has effectively been 60 shares issued for ‘free’. We use this figure in
the diluted eps calculation.
An alternative calculation is: 
100 x (5-2) / 5 = 60
Solution
Basic EPS Convertible Loan Share options
E 100 + 28
S 50 + 160 + 60
Diluted EPS = 128 / 270 = 0.47 
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Syllabus B9e)
EPS as a performance measure

EPS is better than PAT as an earnings performance indicator

Profit after tax gives an absolute figure
An increase in PAT does not show the whole picture about a company's profitability
Some profit growth may come from acquiring other companies
If the acquisition was funded by new shares then profit will grow but not necessarily EPS
So EPS trends show a better picture of profitability than PAT
Simply looking at PAT growth ignores any increases in the resources used to earn them
The diluted EPS is useful as it alerts existing shareholders to the fact that future EPS may be
reduced as a result of share capital changes
Where the finance cost per potential new share is less than the basic EPS, there will be a dilution 
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Syllabus B10. Revenue
Syllabus B10a) Explain and apply the principles of recognition of revenue:
(i) Identification of contracts
(ii) Identification of performance obligations
(iii) Determination of transaction price
(iv) Allocation of the price to performance obligations
(v) Recognition of revenue when/as performance obligations are satisfied.
Revenue Recognition - IFRS 15 - introduction

Revenue Recognition - IFRS 15

When & how much to Recognise Revenue?
Here you need to go through the 5 step process…
1 Identify the contract(s) with a customer
2 Identify the performance obligations in the contract
3 Determine the transaction price
4 Allocate the transaction price to the performance obligations in the contract
5 Recognise revenue when (or as) the entity satisfies a performance obligation
Before we do that though, let’s get some key definitions out of the way..
Key definitions
• Contract 
An agreement between two or more parties that creates enforceable rights and
obligations. 
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• Income 
Increases in economic benefits during the accounting period in the form of
increasing assets or decreasing liabilities
• Performance obligation 
A promise in a contract to transfer to the customer either: 
- a good or service that is distinct; or  
- a series of distinct goods or services that are substantially the same and that have
the same pattern of transfer to the customer.
• Revenue 
Income arising in the course of an entity’s ordinary activities.
• Transaction price 
The amount of consideration to which an entity expects to be entitled in exchange
for transferring promised goods or services to a customer. 
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Syllabus B10abcd)
a) Explain and apply the principles of recognition of revenue:
(i) Identification of contracts
(ii) Identification of performance obligations
(iii) Determination of transaction price
(iv) Allocation of the price to performance obligations
(v) Recognition of revenue when/as performance obligations are satisfied.
b) Explain and apply the criteria for recognising revenue generated from contracts where performance
obligations are satisfied over time or at a point in time.
c) Describe the acceptable methods for measuring progress towards complete satisfaction of a
performance obligation.
d) Explain and apply the criteria for the recognition of contract costs.
Revenue Recognition - IFRS 15 - 5 steps

Revenue Recognition - IFRS 15 - 5 steps

Ok let’s now get into a bit more detail…
Step 1: Identify the contract(s) with a customer
• The contract must be approved by all involved
• Everyone’s rights can be identified
• It must have commercial substance
• The consideration will probably be paid
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Step 2: Identify the separate performance obligations in the contract
This will be goods or services promised to the customer
These goods / services need to be distinct and create a separately identifiable obligation
• Distinct means: 
The customer can benefit from the goods/service on its own AND 
The promise to give the goods/services is separately identifiable (from other
promises)
• Separately identifiable means: 
No significant integrating of the goods/service with others promised in the contract  
The goods/service doesn’t significantly modify another good or service promised in
the contract.  
The goods/service is not highly related/dependent on other goods or services
promised in the contract.
Step 3: Determine the transaction price
How much the entity expects, considering past customary business practices
• Variable Consideration 
If the price may vary (eg. possible refunds, rebates, discounts, bonuses, contingent
consideration etc) - then estimate the amount expected
• However variable consideration is only included if it’s highly probable there won’t
need to be a significant revenue reversal in the future (when the uncertainty has
been subsequently resolved)
• However, for royalties from licensing intellectual property - recognise only when the
usage occurs
Step 4: Allocate the transaction price to the separate performance obligations
If there’s multiple performance obligations, split the transaction price by using their standalone
selling prices. (Estimate if not readily available)
• How to estimate a selling Price 
- Adjusted market assessment approach  
- Expected cost plus a margin approach  
- Residual approach (only permissible in limited circumstances). 
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• If paid in advance, discount down if it’s significant (>12m)
Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation
Revenue is recognised as control is passed, over time or at a point in time.
• What is Control 
It’s the ability to direct the use of and get almost all of the benefits from the asset.  
This includes the ability to prevent others from directing the use of and obtaining the
benefits from the asset.
• Benefits could be: 
- Direct or indirect cash flows that may be obtained directly or indirectly 
- Using the asset to enhance the value of other assets;  
- Pledging the asset to secure a loan 
- Holding the asset.
• So remember we recognise revenue as asset control is passed (obligations
satisfied) to the customer 
This could be over time or at a specific point in time.
Examples (of factors to consider) of a specific point in time:
1 The entity now has a present right to receive payment for the asset;
2 The customer has legal title to the asset;
3 The entity has transferred physical possession of the asset;
4 The customer has the significant risks and rewards related to the ownership of the
asset; and
5 The customer has accepted the asset.
Contract costs - that the entity can get back from the customer
These must be recognised as an asset (unless the subsequent amortisation would be less 12m),
but must be directly related to the contract (e.g. ‘success fees’ paid to agents).
Examples would be direct labour, materials, and the allocation of overheads - this asset is then
amortised
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Syllabus B10e)
Apply the principles of recognition of revenue, and specifically account for the following types of
transaction:
(i) principal versus agent
(ii) repurchase agreements
(iii) bill and hold arrangements
(iv) consignments
Exam Standard Illustrations

Illustration 1 - Agent or not?

An entity negotiates with major airlines to purchase tickets at reduced rates
It agrees to buy a specific number of tickets and must pay even if unable to resell them.
The entity then sets the price for these ticket for its own customers and receives cash immediately
on purchase
The entity also assists the customers in resolving complaints with the service provided by airlines.
However, each airline is responsible for fulfilling obligations associated with the ticket, including
remedies to a customer for dissatisfaction with the service.
How would this be dealt with under IFRS 15?
1 Step 1: Identify the contract(s) with a customer  
This is clear here when the ticket is purchased
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2 Step 2: Identify the performance obligations in the contract  
This is tricky - is it to arrange for another party provide a flight ticket - or is it - to
provide the flight ticket themselves?
Well - look at the risks involved. If the flight is cancelled the airline pays to
reimburse
 
If the ticket doesn't get sold - the entity loses out
 
Look at the rewards - the entity can set its own price and thus rewards
 
On balance therefore the entity takes most of the risks and rewards here and thus
controls the ticket - thus they have the obligation to provide the right to fly ticket
3 Step 3: Determine the transaction price  
This is set by the entity
4 Step 4: Allocate the transaction price to the performance obligations in the
contract 
The price here is the GROSS amount of the ticket price (they sell it for)
5 Step 5: Recognise revenue when (or as) the entity satisfies a performance
obligation 
Recognise the revenue once the flight has occurred
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Illustration 2 - Loyalty discounts

An entity has a customer loyalty programme that rewards a customer with one customer loyalty
point for every $10 of purchases.
Each point is redeemable for a $1 discount on any future purchases
Customers purchase products for $100,000 and earn 10,000 points
The entity expects 9,500 points to be redeemed, so they have a stand-alone selling price $9,500
How would this be dealt with under IFRS 15?
1 Step 1: Identify the contract(s) with a customer  
This is when goods are purchased
2 Step 2: Identify the performance obligations in the contract  
The promise to provide points to the customer is a performance obligation along
with, of course, the obligation to provide the goods initially purchased
3 Step 3: Determine the transaction price  
$100,000
4 Step 4: Allocate the transaction price to the performance obligations in the
contract 
The entity allocates the $100,000 to the product and the points on a relative stand-
alone selling price basis as follows: 
So the standalone selling price total is 100,000 + 9,500 = 109,500 
Now we split this according to their own standalone prices pro-rata
Product $91,324 [100,000 x (100,000 / 109,500]  
Points $8,676 [100,000 x 9,500 /109,500]
5 Step 5: Recognise revenue when (or as) the entity satisfies a performance
obligation 
Of course the products get recognised immediately on purchase but now lets look at
the points.. 
Let’s say at the end of the first reporting period, 4,500 points (out of the 9,500) have
been redeemed  
The entity recognises revenue of $4,110 [(4,500 points ÷ 9,500 points) × $8,676]
and recognises a contract liability of $4,566 (8,676 – 4,110) for the unredeemed
points 
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Syllabus B10f)
Prepare financial statement extracts for contracts where performance obligations are satisfied over
time.
Revenues - Presentation in financial statements

Presentation in financial statements

Show in the SFP as a contract liability, asset, or a receivable, depending on when paid and
performed
i.e.. Paid upfront but not yet performed would be a contract liability
Performed but not paid would be a contract receivable or asset
1 A contract asset if the payment is conditional (on something other than time)
2 A receivable if the payment is unconditional
Contract assets and receivables shall be accounted for in accordance with IFRS 9.
Disclosures
All qualitative and quantitative information about:
• its contracts with customers;
• the significant judgments in applying the guidance to those contracts; and
• any assets recognised from the costs to fulfil a contract with a customer.  
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Syllabus B10b)
Explain and apply the criteria for recognising revenue generated from contracts where performance
obligations are satisfied over time or at a point in time.
Accrued and deferred Income

An entity will accrue income when it has earned the income during the period but it has not yet
been invoiced or received. This will increase income in the statement of profit or loss and be shown
as a receivable in the statement of financial position at year end.
Accounting Treatment: Accrued Income

Dr Accrued income (SOFP)
Cr Income Account (I/S)
When an entity has received income in advance of it being earned, it should be deferred to the
following period. This will reduce income in the statement of profit or loss and be shown as a
payable in the statement of financial position at the year end.
Accounting Treatment: Deferred Income

Dr Income Account (I/S)
Cr Deferred Income (SOFP)
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Syllabus B11a)
Apply the provisions of relevant accounting standards in relation to accounting for government
grants.
Government Grants Part 1

Government grants are a form of government assistance.

When can you recognise a government grant?
When there is reasonable assurance that:
• The entity will comply with any conditions attached to the grant and
• the grant will be received
However, IAS 20 does not apply to the following situations:
1 Tax breaks from the government
2 Government acting as part-owner of the entity
3 Free technical or marketing advice
Accounting treatment of government grants
Dr Cash
The debit is always cash so we only have to know where we put the credit..
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There are 2 approaches - depending on what the grant is given for:
• Capital Grant approach: 
(Given for Assets - For NCA such as machines and buildings) 
Recognise the grant outside profit or loss initially: 
Dr Cash 
Cr Cost of asset or 
Cr Deferred Income
• Income Grant approach:
(Given for expenses - For I/S items such as wages etc) 
Recognise the grant in profit or loss 
Dr Cash  
Cr Other income (or expense)
Capital Grant approach - accounting for as "Cr Cost of asset”
• Dr Cash Cr Cost of asset 
This will have the effect of reducing depreciation on the income statement and the
asset on the SFP
• An Example 
Asset $100 with 10yrs estimated useful life 
Received grant of $50 
Accounting for a grant received: 
DR Cash $50 
CR Asset $50 
At the Y/E 
Depreciation charge: 
DR Depreciation expense (I/S) (100-50)/10yrs = $5 
CR Accumulate depreciation $5
Capital Grant approach - accounting for as "Cr Deferred Income”
• Dr Cash  
Cr Deferred Income 
This will have the effect of keeping full depreciation on the income statement and
the full asset and liability on the SFP 
Then... 
Dr Deferred Income  
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Cr Income statement (over life of asset) 
This will have the effect of reducing the liability and the expense on the income
statement
• An Example 
Asset $100 with 10yrs estimated useful life 
Received grant of $50 
Accounting for a grant received: 
DR Cash $50 
CR Deferred income $50 
At the Y/E 
Depreciation charge: 
DR Depreciation expense (I/S) 100/10yrs = $10 
CR Accumulate depreciation $10 
Release of deferred income: 
DR Deferred income 50/10yrs =$5 
CR I/S $5
That's all I'll say here as it is best seen visually and practically in the video :) 
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Syllabus B11. Government grants
Syllabus B11a) Apply the provisions of relevant accounting standards in relation to accounting for
government grants.
Government Grants Part 2

Government grants Part 2

Conditions
These may help the company decide the periods over which the grant will be earned.
It may be that the grant needs to be split up and taken to the income statement on different bases.
Compensation
The grant may be for compensation on expenses already spent.
Or it might be just for financial support with no actual related future costs.
Whatever the situation, the grant should be recognised in profit or loss when it becomes
receivable.
NB
If a condition might not be met then a contingent liability should be disclosed in the notes. Similarly
if it has already not been met then a provision is required.
Non-monetary government grants
Think here, for example, of the government giving you some land (ie not cash).
To put a value on it - we use the Fair Value. Alternatively, both may be valued at a nominal
amount. 
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Repayment of government grants
This means when we are not allowed the grant anymore and so have to repay it back.
This would be a change in accounting estimate (IAS 8) and so you do not change past periods just
the current one.
• Accounting treatment (capital grant repayment):  
• Dr Any deferred Income Balance or Dr Cost of asset 
• Dr Income statement with any balance 
and CR cash with the amount repaid 
The extra depreciation to date that would have been recognised had the grant not
been netted off against cost should be recognised immediately as an expense.
• Accounting treatment - Income Grant Repayment 
Dr Income statement 
Cr Cash
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Syllabus B12. Foreign currency transactions
Syllabus B12a) Explain the difference between functional and presentation currency and explain why
adjustments for foreign currency transactions are necessary.
Foreign currency - extras

Foreign Currency - Examinable Narrative & Miscellaneous points

Functional Currency
Every entity has its own functional currency and measures its results in that currency
Functional currency is the one that
influences sales price
the one used in the country where most competitors are and where regulations are made and
the one that influences labour and material costs
If functional currency changes then all items are translated at the exchange rate at the date of
change
Presentation Currency
An entity can present in any currency it chooses.
The foreign sub (with a foreign functional currency) will present normally in the parents
presentation currency and hence the need for foreign sub translation rules!
Foreign currency dealings between H and S
There is often a loan between H and a foreign sub. If the loan is in a foreign currency don’t forget
that this will need retranslating in H’s or S’s (depending on who has the ‘foreign’ loan) own
accounts with the difference going to its income statement.
If H sells foreign S, any exchange differences (from translating that sub) in equity are taken to the
income statement (and out of the OCI). 
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Deferred tax
There are deferred tax consequences of foreign exchange gains (see tax chapter). This is because
the gains and losses are recognised by H now but will not be dealt with by the taxman until S is
eventually sold. 
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Syllabus B12b)
Account for the translation of foreign currency transactions and monetary/non-monetary foreign
currency items at the reporting date.
Foreign Exchange Single company

Foreign Exchange Single company

Transactions in a single company
This is where a company simples deals with companies abroad (who have a different currency).
The key thing to remember is that…
ALL EXCHANGE DIFFERENCES TO INCOME STATEMENT
So - a company will buy on credit (or sell) and then pay or receive later. The problem is that the
exchange rate will have moved and caused an exchange difference.
Step 1: Translate at spot rate
Step 2: If there is a creditor/debtor @ y/e - retranslate it (exch gain/loss to I/S)
Step 3: Pay off creditor - exchange gain/loss to I/S
Illustration 1
On 1 July an entity purchased goods from a foreign country for Y$10,000.
On 1 September the goods were paid in full.
The exchange rates were:
1 July $1 = Y$10
1 September $1 = Y$9
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Calculate the exchange difference to be included in profit or loss according to IAS 21 The
Effects of Changes in Foreign Exchange Rates.
Solution
 
Account for Payables on 1 July: Y$10,000/10 = 1,000 
Payment performed on 1 September: Y$10,000 / 9 = 1,111 
The Exchange difference: 1,000 - 1,111 = 111 loss
Illustration 2
Maltese Co. buys £100 goods on 1st June (£1:€1.2)
Year End (31/12) payable still outstanding (£1:€1.1)
5th January £100 paid (£1:€1.05)
Solution
Initial Transaction
Dr Purchases 120
Cr Payables 120
Year End
Dr Payables 10
Cr I/S Ex gain 10
On payment
Dr Payables 110
Cr I/S Ex gain 5
Cr Cash 105
Also items revalued to Fair Value will be retranslated at the date of revaluation and the exchange
gain/loss to Income statement.
All foreign monetary balances are also translated at the year end and the differences taken to the
income statement.
This would include receivables, payables, loans etc. 
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Syllabus C: ANALYSING AND INTERPRETING
THE FINANCIAL STATEMENTS
Syllabus C1. Limitations of financial statements
Syllabus C1a) Indicate the problems of using historic information to predict future performance and
trends.
Problems Using Historic Information To Predict Future

Historic info gets out of date

especially in times of rising prices
Effect on Predicting Future
1 Cost of replacing asset (in the future) MUCH higher than NBV of asset currently
2 This means higher future depreciation (and interest if a loan is needed)
3 Cost of Sales are understated (if using FIFO) - yet sales revenue keeps up to date -
thus overstating profit trends
Also, the low depreciation and interest etc could have led to too many profits being distributed thus
meaning more loans needed in the future potentially
So profits are overstated and assets understated - making ROCE seem higher compared to those
in the future
The ‘overstated’ profit means more tax payable and maybe even employees want more wages
The understatement of assets can depress a company’s share price and may make it vulnerable to
a takeover bid.
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These problems can be overcome by introducing current values by following a policy of
revaluations. Also IFRS's are now using Fair (current) Values more eg. Investment Properties and
FVTPL items
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Syllabus C1b)
Discuss how financial statements may be manipulated to produce a desired effect (creative
accounting, window dressing).
Manipulating Financial Statements

Creative Accounting

Example 1 - Using Provisions
• Create an unnecessary provision in good times (this reduces profits)
• Release this provision in bad times (this increases profits)
The effect of this is a smoother profitability rather than big up and down swings (which investors
don't like)
Window Dressing
Cash Postpone paying suppliers, so Y/E cashbooks good
Receivables Record an unusually low bad debt provision
Revenue Offer early shipment discounts to get revenues in current year
Expenses Withhold supplier payments, so that they are recorded in a later period.
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Syllabus C1c)
Explain why figures in a statement of financial position may not be representative of average values
throughout the period for example, due to:
i) seasonal trading
ii) major asset acquisitions near the end of the accounting period.
When The Financial Position May Not Be Representative

Seasonal Trading

This is best explained by an example:
Imagine a company who has highly seasonal trading.
Their year end may be immediately after this high trading period
Therefore, they will probably have higher than normal levels of cash and receivables and lower
than normal levels of payables
Major Asset Acquisitions Near The Year-End
This has the effect of:
Higher Assets (and maybe loans) but...
No related Income (as it was just before the year end)
This makes ROCE look worse 
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Syllabus C1d)
Explain how the use of consolidated financial statements might limit interpretation techniques.
Consolidated Financial Statements Might Limit
Interpretation

The main problem comes from mid year acquisitions / disposals

Problems include:
1 Income statement includes only half the returns (if mid-year acq) 
But the SFP includes all the assets (capital employed) 
Thus distorting ROCE
2 Synergies can take a while to come in and so return is artificially low
3 Subs are acquired at FV 
This generally increases asset values 
Meaning a deterioration in ROCE and Asset Turnover
4 Goodwill is now recognised whereas before it wasn't
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Syllabus C1)
Ratio limitations
Ratio limitations

Ratios aren't always comparable

Factors affecting comparability
1 Different accounting policies 
Eg One company may revalue its property; this will increase its capital employed
and (probably) lower its ROCE 
Others may carry their property at historical cost
2 Different accounting dates 
Eg One company has a year ended 30 June, whereas another has 30 September 
If the sector is exposed to seasonal trading, this could have a significant impact on
many ratios.
3 Different ratio definitions 
Eg This may be a particular problem with ratios like ROCE as there is no universally
accepted definition
4 Comparing to averages 
Sector averages are just that: averages 
Many of the companies included in the sector may not be a good match to the type
of business being compared 
Some companies go for high mark-ups, but usually lower inventory turnover,
whereas others go for selling more with lower margins
5 Possible deliberate manipulation (creative accounting)
6 Different managerial policies
 
e.g. different companies offer customers different payment terms
Compare ratios with
1 Industry averages
2 Other businesses in the same business
3 With prior year information 
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Syllabus C2. Interpretation of accounting ratios
Syllabus C2abcd)
a) Define and compute relevant financial ratios
b) Explain what aspects of performance specific ratios are intended to assess.
c) Analyse and interpret ratios to give an assessment of an entity’s/group’s performance and financial
position in comparison with:
i) previous period’s financial statements
ii) another similar entity/group for the same reporting period
iii) industry average ratios.
d) Interpret financial statements to give advice from the perspectives of different stakeholders.
Profitability

Return on Capital Employed

ROCE
This is a measure of management’s overall efficiency in using the finance/assets
• is affected by the carrying amount of PPE
• So old plant will give a higher than usual ROCE
• Revaluations upwards will give a lower than usual ROCE 
ROCE can be broken down (explained by) 2 more ratios:
Operating Margin
Asset Turnover
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So if operating margin goes up and ROCE goes down - you know that ROCE is going down due to
a poor Net asset turnover.
The assets aren't producing the amount of sales they used to
Operating Margin
= Operating profit (PBIT) / Sales
Asset Turnover
= Sales / Capital Employed
Gross Margin
This is affected by..
An increase in gross profit doesn't necessarily mean an increase in the margin
This is because Gross profit is also affected by the volume of sales (not just the margin made on
each one)
• Opening and closing inventory measured at different costs
• Inventory write downs due to damage/obsolescence
• A change in the sales mix 
eg. from higher to lower margin sales
• New (different margin) products
• New suppliers with different costs
• Selling prices change 
eg. discounts offered
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• More or less Import duties
• Exchange rate fluctuations
• Change in cost classification:  
eg. Some costs included as operating expenses now in cost of sales 
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Syllabus C2abcd)
Gearing

Financial Gearing

This could also be calculated as:
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Interest Cover
Points to notice about LOW interest cover
Low interest cover is a direct consequence of high gearing and . For example,
• It makes profits vulnerable to relatively small changes in operating activity
• So small reductions in sales / margins or small increases in expenses may mean
interest can't be paid
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Syllabus C2abcd)
Liquidity

Current ratio

Quick Ratio

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Bank Account / Overdraft
Don't forget the obvious and look at the movement on this
• Look for why it has increased or decreased
• If money is spent on assets thats normally a good thing
• If money is spent on high dividends (with little cash) thats a bad thing
• If a loan is paid off - that's normally a bad idea (as the company should be
able to make a better return)
Working Capital Cycle

This is made up of
The difference between being paid needs to be funded (often by an overdraft)
1 Inventory Days + (ideally these are low)
2 Receivable days - (ideally these are low)
3 Payable days (ideally these are high)
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Indicators of deteriorating liquidity
• Cash balances falling
• New share / loan issues with no respective increase in assets
• Sale and leaseback of assets
• Payables days getting longer 
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Syllabus C2e)
Discuss how the interpretation of current value based financial statements would differ from those
using historical cost based accounts.
Interpretation Of Current V Historic Value Based Financial
Statements

ROCE is aﬀected because

• HC Capital Employed is understated compared to using CV
• HC profits are overstated in comparison to CV
• Both of the above have the effect of overstating ROCE 
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Syllabus C3. Limitations of interpretation techniques
Syllabus C3abcdef)
a) Discuss the limitations in the use of ratio analysis for assessing corporate performance.
b) Discuss the effect that changes in accounting policies or the use of different accounting polices
between entities can have on the ability to interpret performance.
c) Indicate other information, including non- financial information, that may be of relevance to the
assessment of an entity’s performance.
d) Compare the usefulness of cash flow information with that of a statement of profit or loss or a
statement of profit or loss and other comprehensive income.
e) Interpret a statement of cash flows (together with other financial information) to assess the
performance and financial position of an entity.
f) i) explain why the trend of eps may be a more accurate indicator of performance than a company’s
profit trend and the importance of eps as a stock market indicator
ii) discuss the limitations of using eps as a performance measure.
Other relevant information

When buying a company

• Audited financial statements
• Forward looking information  
Eg. Profit and financial position forecasts 
Capital expenditure budgets and  
Cash budgets and  
Order levels
• Current (fair) values of assets being acquired
• Level of business risk 
Highly profitable companies may also be highly risky, whereas a less profitable
company may have more stable ‘quality’ earnings
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• Expected price to acquire a company 
It may be that a poorer performing business may be a more 
attractive purchase because it has higher potential for growth 
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Syllabus C3c)
Indicate other information, including non- financial information, that may be of relevance to the
assessment of an entity’s performance.
Other Helpful Information

Other helpful Information includes..

1 Order Books
2 Loan Repayment Dates
3 Age of Company
4 Asset Replacement Dates
5 Management Skills
6 Potential Synergies
7 FV of Assets  
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Syllabus C4. Specialised, not-for-profit and public sector
entities
Syllabus C4a) Explain how the interpretation of the financial statement of a specialised, not-for-profit or
public sector organisations might differ from that of a profit making entity by reference to the different
aims, objectives and reporting requirements.
Not for Profit sector

Getting a Loan

Similar criteria as would be used for profit-orientated entities
• How secure is the loan? 
Here use the capital gearing ratio: 
Long-term loans to net assets 
Clearly if this ratio is high, further borrowing would be at an increased risk
• Ability to repay the interest & capital 
Interest cover should be calculated 
PBIT / Interest 
The higher this ratio the less risk of interest default 
Look for trends indicating a deterioration in this ratio
• Nature and trend of income 
Are the sources of income increasing or decreasing 
Does the reported income contain ‘one-off’ donations (which may not be recurring)
etc?
• Other matters 
Market value of, and prior charges against, any assets used as loan security 
Any (perhaps the trustees) personal guarantees for the loan 
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Syllabus D: PREPARATION OF FINANCIAL
STATEMENTS
Syllabus D1. CF - Approach to the Question
Syllabus D1c) Prepare a statement of cash flows for a single entity (not a group) in accordance with
relevant accounting standards using the indirect method.
Cashflow statements - Step 1

Cash flow statements - Step 1

Indirect method
The idea here is simply to get to the profit from operating activities as a starting point - nothing
more!
So IAS tells us that although we need to get to the operating profit figure we must start with Profit
before tax (PBT) and reconcile this to the operating profit figure.
Operating Profit
Before we do this let’s remind ourselves what “Operating profit” is.
Operating Profit is:
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Illustration
tart with the profit before tax figure and then reconcile to the operating profit figure.
Operating profit would be:
o, let’s start reconciling…
Then fill in the reconciling figures between them (income is a negative and expense a positive
here). This is because we are going upwards on the income statement, rather than the normal
downwards. 
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So this is the final answer to step 1:
You place this in the “Cashflow from Operating Activities” part of the cash-flow statement. 
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Syllabus D1c)
Prepare a statement of cash flows for a single entity (not a group) in accordance with relevant
accounting standards using the indirect method.


Now we have the operating profit figure we need to get to the cash.
We do this by taking the profit figure (calculated and reconciled to in step 1) and adding back all
the non-cash items (we get to the cash therefore indirectly).
Key point to remember here
The non-cash items we add back are ONLY those in operating profit (Sales, COS, admin and distr.
costs).
For example:
Depreciation, amortisation, impairments, profit on sale, receivables, payables and inventory
There could be more - it depends on the question - but dealing with these will ensure you pass.
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So the operating activities part of the cash flow will now look like this:
Ensure you get the signs the right way around!
For example an increase in stock means less cash so (x).
Notice we added back receivables / payables & Inventory.
This is because credit sales, stock and credit payables are not cash and are in the operating profit
figure.
You just need to be careful that you get the signs the right way around as with these we just
account for the movement in them.
Think of it like this:
• Increase in Inventory - means less cash - so show as a negative
• Increase in receivables - means less cash now - so show as a negative
• Increase in payables - means don’t have to pay people just yet so an increase in
cash - so show as a positive
We have now dealt with the first part of the income statement - Sales, COS, administration
expenses and distribution costs. We have indirectly got the cash from these figures by adding back
all the non-cash items that may have been in there (as above).
All of this happens in the “Cashflow from Operating Activities” part of the cash-flow
statement. 
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Syllabus D1c)


So far we have got the cash (indirectly) from operating profit. This means we have the cash from
Sales, COS, admin and distribution costs. What we now do is look at what’s left in the income
statement and try to find the cash.
(In our example in step 1, we would have to deal with IP income, finance costs and tax).
So we are looking at the other parts of the income statement (after operating profit) and finding the
cash and putting this directly into the cash-flow statement.
Direct method
We do this by using a different method to the one in step 2 as we are now looking to put the cash
in directly to the cash-flow statement (rather than taking a profit figure and adding back the non-
cash items to indirectly arrive at cash).
So how do we do this?
Let’s say you owed somebody 100, then bought 20 more in the year - you should therefore owe
them 120 right?
However you look at your books at the year end and you see you only owe them 70
Therefore, you must have paid cash to them of 50 - this is the figure we then put in our cash-flow
statement.
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To show this differently (and how the examiner often shows it):
We use this format for the rest of the cashflow question - though it may need adjusting slightly
(PPE is calculated differently).
We will now go on to look at the different items that you may find in the income statement and how
we deal with them in the cash-flow statement using this method.
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Syllabus D1c)
Cashflow statement - finance costs

Finance Costs - Illustration of Step 3

Solution
Finance costs of 120 paid go to the operating activities section of the cashflow statement. 
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Syllabus D1c)
Cashflow statement - taxation

Taxation - Illustration of Step 3

Solution
Taxation costs of 150 paid go to the operating activities section of the cashflow statement. 
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Syllabus D1c)
Cashflow statement - Investment property

Investment Property Income - Illustration of Step 3

There were no purchases of IP in the year.
Solution
Investment property income of 20 (rent received probably) goes to the investing activities
section of the cashflow statement. 
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Syllabus D1c)


So in the first 3 steps, we have turned the Income statement into cash and placed it into the cash-
flow statement. We now need to do the same with the S - remember much of it we have already
dealt with (e.g. receivables, inventory, payables, investment
Property, interest and tax payable
So let’s begin with…
PPE
We deal with this slightly differently to the income statement items in step 3:
Process to follow
Here’s the process to follow:
Write down the PPE figures per the accounts
Work out the cash element of each item (if any)
Illustration
Notes:
Depreciation in year = 50
Revaluation = 100
Disposal = Asset sold for 100 making 20 profit 
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Solution
The key here is to try and find the balancing figure (per the accounts) which will be additions in the
year.
Note: we are dealing with NBVs.
Write down the PPE figures per the accounts.
The balancing figure is 90 and this is additions.
Work out the cash element of each item (if any):

All PPE items go the investing activities section of the cashflow statement. 
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Syllabus D1c)
Cashflow statements - Step 5 - Loans

Cashflow statements - Step 5 - Loans

Let’s now look at another one of the items that would still be left on the SFP, that we need to find
the cash and take to the cash-flow statement - Loans
Illustration
Follow same techniques as before..
Solution
Loan repayments of 40 go to the financing activities section of the cashflow statement. 
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Syllabus D1c)
Cashflow statements - Step 5 - Shares

Cashflow statements - Step 5 - Shares

So in steps 1-3 we looked at how we got the cash from the income statement and into the
statement of cash flows.
In step 4 we looked at getting the cash flows from PPE.
So now in our final step we look at getting cash from what’s left in the SFP… starting with shares.
Share issues
Again let’s look at this by illustration and we are using virtually the same technique as step 3 as
you will see..
Solution
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Share Proceeds goes to the financing activities section of the cashflow statement.
Effect of Bonus Issue
If there’s been a bonus issue, you need to be careful.
You need to look at where the debit went - share premium or retained earnings:
If share premium - ignore the bonus issue and the answer calculated above is still correct
If Retained earnings - reduce the cash by the amount of the bonus issue
See the quizzes for examples of this. 
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Syllabus D2. Preparing group SFP
Syllabus D2a) Prepare a consolidated statement of financial position for a simple group (parent and
one subsidiary and associate) dealing with pre and post acquisition profits, non-controlling interests
and consolidated goodwill.
Business Combinations - Basics

The purpose of consolidated accounts is to show the group as a single
economic entity.

So first of all - what is a business combination?
• Well my little calf, it’s an event where the acquirer obtains control of another
business.
• Let me explain, let’s say we are the Parent acquiring the subsidiary.  
We must prepare our own accounts AND those of us and the sub put together
(called “consolidated accounts”) 
This is to show our shareholders what we CONTROL.
Basic principles
The accounts show all that is controlled by the parent, this means:
1 All assets and liabilities of a subsidiary are included
2 All income and expenses of the subsidiary are included
Non controlling Interest (NCI)
However the parent does not always own all of the above.
So the % that is not owned by the parent is called the “non-controlling interest”.
• A line is included in equity called non-controlling interests. This accounts for their
share of the assets and liabilities on the SFP. 
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• A line is also included on the income statement which accounts for the NCI’s share
of the income and expenses.
One Thing you must understand before we go on
Forgive me if this is basic, but hey, sometimes it’s good to be sure.
Notice if you add the assets together and take away the liabilities for H - it comes to 400
(500+200+100-100-300)
There are 2 things to understand about this figure:
1 It is NOT the true/fair value of the company
2 It is equal to the equity section of the SFP
Equity
• This shows you how the net assets figure has come about. The share capital is the
capital introduced from the owners (as is share premium). 
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• The reserves are all the accumulated profits/losses/gains less dividends since the
business started. Here the figure is 400 for H. 
Notice it is equal to the net assets
Acquisition costs
• Where there’s an acquisition there’s probably some of the costs eg legal fees etc 
Costs directly attributable to the acquisition are expensed to the income statement.
• Be careful though, any costs which are just for the parent (acquirer) issuing its own
debt or shares are deducted from the debt or equity itself (often share premium). 
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Syllabus D2a)
Prepare a consolidated statement of financial position for a simple group (parent and one subsidiary
and associate) dealing with pre and post acquisition profits, non-controlling interests and
consolidated goodwill.
Simple Goodwill

Simple Goodwill

Goodwill
• When a company buys another - it is not often that it does so at the fair value of the
net assets only. 
This is because most businesses are more than just the sum total of their ‘net
assets’ on the SFP.  
Customer base, reputation, workforce etc. are all part of the value of the company
that is not reflected in the accounts.  
This is called “goodwill”
• Goodwill only occurs on a business combination. Individual companies cannot show
their individual goodwill on their SFPs. 
This is because they cannot get a reliable measure, This is because nobody has
purchased the company to value the goodwill appropriately. 
On a business combination the acquirer (Parent) purchases the subsidiary -
normally at an amount higher than the FV of the net assets on the SFP, they buy it
at a figure that effectively includes goodwill.  
Therefore the goodwill can now be measured and so does show in the group
accounts.
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How is goodwill calculated?
On a basic level - I hope you can see - that it is the amount paid by the parent less the FV of the
subs assets on their SFP.

Let me explain..
In this example S’s Net assets are 900 (same as their equity remember).
This is just the ‘book value’ of the net assets.
The Fair Value of the net assets may be, say, 1,000.
However a company may buy the company for 1.200. So, Goodwill would be 200.
The goodwill represents the reputation etc. of a company and can only be reliably measured when
the company is bought out.
Here it was bought for 1,200. Therefore, as the FV of the net assets of S was only 1,000 - the extra
200 is deemed to be for goodwill.
The increase from book value 900 to FV 1,000 is what we call a Fair Value adjustment. 
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Bargain Purchase
This is where the parent and NCI paid less at acquisition than the FV of S’s net assets. This is
obviously very rare and means a bargain was acquired
So rare in fact that the standard suggests you look closely again at your calculation of S’s net
assets value because it is strange that you got such a bargain and perhaps your original
calculations of their FV were wrong
However, if the calculations are all correct and you have indeed got a bargain then this is
NOT shown on the SFP rather it is shown as:
• Income on the income statement in the year of acquisition 
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Syllabus D2a)
NCI in the Goodwill calculation

NCI in the Goodwill calculation

So far we have presumed that the company has been 100% purchased when calculating goodwill.

Our calculation has been this:
Non-controlling Interests
Let’s now take into account what happens when we do not buy all of S. (eg. 80%)
This means we now have some non-controlling interests (NCI) at 20%
The formula changes to this:
213 aCOWtancy.com

This NCI can be calculated in 2 ways:

1 Proportion of FV of S’s Net Assets
2 FV of NCI itself
Proportion of FV of S’s Net Assets method
This is very straight forward. All we do is give the NCI their share of FV of S’s Net Assets..Consider
this:
P buys 80% S for 1,000. The FV of S’s Net assets were 1,100.
How much is goodwill?
The NCI is calculated as 20% of FV of S’s NA of 1,100 = 220
“Fair Value Method” of Calculating NCI in Goodwill
• So in the previous example NCI was just given their share of S’s Net assets.  
They were not given any of their reputation etc.  
In other words, NCI were not given any goodwill.
• I repeat, under the proportionate method, NCI is NOT given any goodwill. 
Under the FV method, they are given some goodwill.
• This is because NCI is not just given their share of S’s NA but actually the FV of
their 20% as a whole (ie NA + Goodwill). 
This FV figure is either given in the exam or can be calculated by looking at the
share price.
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P buys 80% S for 1,000. The FV of S’s Net assets were 1,100. The FV of NCI at this date was
250.

How much is goodwill?
Notice how goodwill is now 30 more than in the proportionate example. This is the goodwill
attributable to NCI.
NCI goodwill = FV of NCI - their share of FV of S’s NA
Remember
Under the proportionate method NCI does not get any of S’s Goodwill (only their share of S’s NA).
Under the FV method, NCI gets given their share of S’s NA AND their share of S’s goodwill. 
215 aCOWtancy.com

Syllabus D2a)
Equity Table

Equity Table

S’s Equity Table
As you will see when we get on to doing bigger questions, this is always our first working.
This is because it helps all the other workings.
Remember that Equity = Net assets
Equity is made up of:
1 Share Capital
2 Share Premium
3 Retained Earnings
4 Revaluation Reserve
5 Any other ‘reserve’!
If any of the above is mentioned in the question for S, then they must go into this equity table
working.
216 aCOWtancy.com

What does the table look like?
Remember that any other reserve would also go in here.
So how do we fill in this table?
1 Enter the "Year end" figures straight from the SFP
2 Enter the "At acquisition" figures from looking at the information given normally in
note 1 of the question.  
Please note you can presume the share capital and share premium is the same as
the year-end figures, so you're only looking for the at acquisition reserves figures
3 Enter "Post Acquisition" figures simply by taking away the "At acquisition" figures
away from the "Year end" figures  
(ie. Y/E - Acquisition = Post acquisition)
So let's try a simple example.. (although this is given in a different format to the actual exam let's
do it this way to start with).

A company has share capital of 200, share premium of 100 and total reserves at acquisition of 100
at acquisition and have made profits since of 400. There have been no issues of shares since
acquisition and no dividends paid out.

Show the Equity table to calculate the net assets now at the year end, at acquisition and
post-acquisition
 
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Solution
Fair Value Adjustments
Ok the next step is to also place into the Equity table any Fair Value adjustments
When a subsidiary is purchased - it is purchased at FAIR VALUE at acquisition.
Using the figures above, if I were to tell you that the FV of the sub at acquisition was 480.
Hopefully you can see we would need to make an adjustment of 80 (let’s say that this was because
Land had a FV 80 higher than in the books):
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Now as land doesn’t depreciate - it would still now be at 80 - so the table changes to this:
If instead the FV adjustment was due to PPE with a 10 year useful economic life left - and lets say
acquisition was 2 years ago, the table would look like this:
The -16 in the post acquisition column is the depreciation on the FV adjustment. (80 / 10 years x 2
years).

This makes the now column 64 (80 at acquisition - 16 depreciation post acquisition).
219 aCOWtancy.com

Syllabus D2a)
NCI on the SFP

Non-Controlling Interests

So far we have looked at goodwill and the effect of NCI on this.. Now let’s look at NCI in a bit more
detail (don’t worry we will pull all this together into a bigger question later).
If you remember there are 2 methods of measuring NCI at acquisition:
1 Proportionate method 
This is the NCI % of FV of S’s Net assets at acquisition.
2 FV Method 
This is the FV of the NCI shares at acquisition (given mostly in the question).
This choice is made at the beginning.
Obviously, S will make profits/losses after acquisition and the NCI deserve their share of these.
Therefore the formula to calculate NCI on the SFP is as follows:
* This figure depends on the option chosen at acquisition (Proportionate or FV method). 
220 aCOWtancy.com

Impairment
S may become impaired over time. If it does, it is S’s goodwill which will be reduced in value first. If
this happens it only affects NCI if you are using the FV method.
This is because the proportionate method only gives NCI their share of S’s Net assets and none of
the goodwill.
Whereas, when using the FV method, NCI at acquisition is given a share of S’s NA and a share of
the goodwill.
NCI on the SFP Formula revised
221 aCOWtancy.com

Syllabus D2a)
Basic groups - Simple Question 1


Have a look at this question and solution below and see if you can work out where all the figures in
the solution have come from.
Make sure to check out the videos too as these explain numbers questions such as these far better
than words can..
P acquired 80% S when S’s reserves were 80.
Prepare the Consolidated SFP, assuming P uses the proportionate method for measuring
NCI at acquisition. 
222 aCOWtancy.com

Goodwill
NCI
Reserves
223 aCOWtancy.com

Group SFP
Notice
1) Share Capital (and share premium) is always just the holding company
2) All P + S assets are just added together
3) “Investment in S”..becomes “Goodwill” in the consolidated SFP
4) NCI is an extra line in the equity section of consolidated SFP 
224 aCOWtancy.com

Syllabus D2a)


P acquired 80% S when S’s Reserves were 40.
At that date the FV of S’s NA was 150.
Difference is due to Land.
There have been no issues of shares since acquisition.
P uses the FV of NCI method at acquisition, and at acquisition the FV of NCI was 35. No
impairment of goodwill.
Prepare the consolidated set of accounts. 
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Step 1: Prepare S’s Equity Table
Now the extra 10 FV adjustment now must be added to the PPE when we come to do the SFP at
the end.
Step 2: Goodwill
Step 3: Do any adjustments in the question
: NONE
Step 4: NCI 
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Step 5: Reserves
Step 6: Prepare the final SFP (with all adjustments included)
227 aCOWtancy.com

Syllabus D2a)
Associates

An associate is an entity over which the group has significant influence, but not control.
Significant influence
Significant influence is normally said to occur when you own between 20-50% of the shares in a
company but is usually evidenced in one or more of the following ways:
• representation on the board of directors
• participation in the policy-making process
• material transactions between the investor and the investee
• interchange of managerial personnel; or
• provision of essential technical information
Accounting treatment
An associate is not a group company and so is not consolidated. Instead it is accounted for using
the equity method. Inter-company balances are not cancelled.
Statement of Financial Position
There is just one line only “investment in Associate” that goes into the consolidated SFP (under the
Non-current Assets section). 
228 aCOWtancy.com

It is calculated as follows:
Consolidated income statement
Again just one line in the consolidated income statement:
Include share of PAT less any impairment for that year in associate.
Do not include dividend received from A.
What’s important to notice is that you do NOT add across the associate’s Assets and Liabilities or
Income and expenses into the group totals of the consolidated accounts. Just simply place one line
in the SFP and one line in the Income Statement.
Unrealised profits for an associate
1 Only account for the parent’s share (eg 40%).  
This is because we only ever place in the consolidated accounts P’s share of A’s
profits so any adjustment also has to be only P’s share.
2 Adjust earnings of the seller
Adjustments required on Income Statement
• If A is the seller - reduce the line “share of A’s PAT”
• If P is the seller - increase P’s COS 
229 aCOWtancy.com

Adjustments required on SFP
• If A is the seller - reduce A’s Retained earnings and P’s Inventory
• If P is the seller - reduce P’s Retained Earnings and the “Investment in Associate”
line
Illustration
P sells goods to A (a 30% associate) for 1,000; making a 400 profit. 3/4 of the goods have been
sold to 3rd parties by A.
What entries are required in the group accounts?
Profit = 400; Unrealised (still in stock) 1/4 - so unrealised profit = 400 x 1/4 = 100. As this is an
associate we take the parents share of this (30%). So an adjustment of 100 x 30% = 30 is needed.
Adjustment required on the Income statement
P is the seller - so increase their COS by 30.
Adjustment required on the group SFP
P is the seller - so reduce their retained earnings and the line “Investment in Associate” by 30.
The retained earnings of S and A were £70,000 and £30,000 respectively when they were acquired
8 years ago.
There have been no issues of shares since then, and no FV adjustments required.
The group use the proportionate method for valuing NCI at acquisition.
Prepare the consolidated SFP 
230 aCOWtancy.com

Solution
Step 1: Equity Table

Step 2: Goodwill
H owns 18,000 of S’s share capital of 30,000 so 60%.
Step 3: NCI
231 aCOWtancy.com

Step 4: Retained Earnings
Step 5: Investment in Associate
Final answer - Goodwill
232 aCOWtancy.com

Syllabus D2b)
Prepare a consolidated statement of profit or loss and consolidated statement of profit or loss and
other comprehensive income for a simple group dealing with an acquisition in the period and non-
controlling interest.
Group Income Statement

Group Income Statement

Rule 1 - Add Across 100%
Like with the SFP, P and S are both added together. All the items from revenue down to Profit after
tax; except for:
1) Dividends from Subsidiaries
2) Dividends from Associates
Rule 2 - NCI
This is an extra line added into the consolidated income statement at the end. It is calculated as
NCI% x S’s PAT.
The reason for this is because we add across all of S (see rule 1) even if we only own 80% of S.
We therefore owe NCI 20% of this which we show at the bottom of the income statement.
Rule 3 - Associates
Simply show one line (so never add across an associate).
The line is called “Share in Associates’ Profit after tax”. 
233 aCOWtancy.com

Rule 4 - Depreciation from the Equity table working
Remember this working from when we looked at group SFP’s?
The -10 from the FV adjustment is a group adjustment. So needs to be altered on the group
income statement. It represents depreciation, so simply put it to admin expenses (or wherever the
examiner tells you), be careful though to only out in THE CURRENT YEAR depreciation charge.
Rule 5 - Time Apportioning
This isn’t difficult but can be awkward/tricky. Basically all you need to remember is the group only
shows POST -ACQUISITION profits. i.e. Profits made SINCE we bought the sub or associate.
If the sub or associate was bought many years ago this is not a problem in this year’s income
statement as it has been a sub or assoc. all year.
The problem arises when we acquire the sub or the associate mid year. Just remember to only add
across profits made after acquisition. The same applies to NCI (as after all this just a share of S’s
PAT).
For example if our year end is 31/12 and we buy the sub or assoc. on 31/3. We only add across
9/12 of the subs figures and NCI is % x S’s PAT x 9/12.
One final point to remember here is adjustments such as unrealised profits / depreciation on FV
adjustments are entirely post - acquisition and so are NEVER time apportioned.
234 aCOWtancy.com

Rule 6 - Unrealised Profit
You will remember this table I hope
Well the idea stays the same - it’s just how we alter the accounts that changes, because this is an
income statement after all and not an SFP. So the table you need to remember becomes:
Notice how we do not need to make an adjustment to reduce the value of inventory. This is
because we have increased cost of sales (to reduce profits), but we do this by actually reducing
the value of the closing stock. 
235 aCOWtancy.com

Syllabus D2cd)
c) Explain and account for other reserves (e.g. share premium and revaluation surplus).
d) Account for the effects in the financial statements of intra-group trading.
Unrealised Profit

Unrealised Profit

The key to understanding this - is the fact that when we make group accounts - we are pretending
P & S are the same entity.
Therefore you cannot make a profit by selling to yourself!
So any profits made between two group companies (and still in group inventory) need removing -
this is what we call ‘unrealised profit’.
Unrealised profit - more detail
Profit is only ‘unrealised’ if it remains within the group. If the stock leaves the group it has become
realised.
So ‘Unrealised profit” is profit made between group companies and REMAINS IN STOCK.
Example
P buys goods for 100 and sells them to S for 150. S has sold 2/5 of this stock.
The Unrealised Profit is: Profit between group companies 50 x 3/5 (what remains in stock) = 30.
How do we then deal with Unrealised Profit
If P buys goods for 100 and sells them to S for 150.
Thereby making a profit of 50 by selling to another group company.
S sells 4/5 of them to 3rd parties.
Unrealised profit is 50 x 1/5 = 10 
236 aCOWtancy.com

So why do we reduce inventory as well as profit?
Well let’s say that S buys goods for 100 and sells them to P for 150 and P still has them in stock.
How much did the stock actually cost the group?
The answer is 100, as they are still in the group.
However P will now have them in their stock at 150.
So we need to reduce stock/inventory also with any unrealised profit. 
237 aCOWtancy.com

Syllabus D2cd)
Intra-Group Balances & In-transit Items

Inter-group company balances

As with Unrealised Profit - this occurs because group companies are considered to be the same
entity in the group accounts.
Therefore you cannot owe or be owed by yourself.
So if P owes S - it means P has a payable with S, and S has a receivable from P in their
INDIVIDUAL accounts.
In the group accounts, you cannot owe/be owed by yourself - so simply cancel these out:
Dr Payable (in P) 
Cr Receivable (in S)
The only time this wouldn’t work is if the amounts didn’t balance, and the only way this could
happen is because something was still in transit at the year end. This could be stock or cash.
You always alter the receiving company. What I mean is - if the item is in transit, then the receiving
company has not received it yet - so simply make the RECEIVING company receive it as follows:
Stock in transit
In the RECEIVING company’s books:
Dr Inventory 
Cr Payable
238 aCOWtancy.com

Cash in transit
In the RECEIVING company’s books:
Dr Cash 
Cr Receivable
Having dealt with the amounts in transit - the inter group balances (receivables/payables) will
balance so again you simply:
Dr Payable 
Cr Receivable
Intra-group dividends
eliminate all dividends paid/payable to other entities within the group, and all intragroup dividends
received/receivable from other entities within the group. 
239 aCOWtancy.com

Syllabus D2cd)
Share for Share Exchanges

Share for share exchanges

These can form part, or all, of the cost of investment which is used in the goodwill
calculation.
Under normal circumstances, P acquires S’s shares by giving them cash, so the double entry is
Dr Cost of Investment 
Cr Cash
However this time, P does not give cash, but instead gives some of its own shares
If this exchange has yet to be accounted for, the double entry is always:
Dr Cost of Investment 
Cr Share capital (with the nominal value of P shares given out) 
Cr Share premium (with the premium)
Illustration
P acquired 80% of S shares via a 2 for 1 share exchange.
At the date of acquisition, the following balances were in the books of P and S: 
240 aCOWtancy.com

The share price of P was $2 at the date of acquisition. This has not been accounted for.
Show the accounting treatment required to account for the share exchange.
P acquired 80% of S’s shares.
The shares had a value of $400 but a nominal value of $0.50.
This means S has 800 shares in total. P acquired 80% x 800 = 640 shares
The share for share deal was 2 for 1.
So P gives 1,280 of its shares in return for 640 of S’s shares.
P’s shares have a MV of $2 at this date so the “cost of investment is 1,280 x 2 = 2,560
Double entry
Dr Cost of Investment 2,560 
Cr Share Capital (P) 1,280 
Cr Share Premium (P) 1,280
241 aCOWtancy.com

Syllabus D2efg)
e) Account for the effects of fair value adjustments (including their effect on consolidated goodwill) to:
i) depreciating and non-depreciating non-current assets
ii) inventory
iii) monetary liabilities
iv) assets and liabilities not included in the subsidiary’s own statement of financial position, including
contingent assets and liabilities
f) Account for goodwill impairment.
g) Describe and apply the required accounting treatment of consolidated goodwill.
Basic Goodwill Calculation

This is calculated on the date of acquisition of the sub

It represents the intangible reputation / customer base etc of the sub.
It is calculated as follows:
242 aCOWtancy.com

Syllabus D2efg)
ii) inventory
Make sure you use FV of Consideration

Consideration is simply what the Parent pays for the sub.

It is the first line in the goodwill working as follows:
Normal Consideration
This is straightforward. It is simply:
Dr Investment in S 
Cr Cash 
243 aCOWtancy.com

Future Consideration
This is a little more tricky but not much. Here, the payment is not made immediately but in the
future. So the credit is not to cash but is a liability.
Cr Liability
The only difficulty is with the amount.
As the payment is in the future we need to discount it down to the present value at the date of
acquisition.
Illustration
P agrees to pay S 1,000 in 3 years time (discount rate 10%).
Dr Investment in S 751
Cr Liability 751 (1,000 / 1.10^3)
As this is a discounted liability, we must unwind this discount over the 3 years to get it back to
1,000. We do this as follows:
Contingent Consideration
This is when P MAY OR MAY NOT have to pay an amount in the future (depending on, say, S’s
subsequent profits etc.). We deal with this as follows:
Cr Liability
All at fair value
You will notice that this is exactly the same double entry as the future consideration (not surprising
as this is a possible future payment!).
The only difference is with the amount.
Instead of only discounting, we also take into account the probability of the payment actually being
made. 
244 aCOWtancy.com

Doing this is easy in the exam - all you do is value it at the FV
(this will be given in the exam you’ll be pleased to know).
Illustration
1/1/x7 H acquired 100% S when it’s NA had a FV of £25m. H paid 4m of its own shares (mv at
acquisition £6) and cash of £6m on 1/1/x9 if profits hit a certain target.
At 1/1/x7 the probability of the target being hit was such that the FV of the consideration was now
only £2m. Discount rate of 8% was used.
At 31/12/x7 the probability was the same as at acquisition.
At 31/12/x8 it was clear that S would beat the target.
Show the double entry
Contingent consideration should always be brought in at FV. Any subsequent changes to this FV
post acquisition should go through the income statement.
Any discounting should always require an winding of the discount through interest on the income
statement
Double entry - Parent Company
1/1/x7
Dr Investment in S (4m x £6) + £2 = 26
Cr Share Capital 4
Cr Share premium 20
Cr Liability 2
31/12/x7
Dr interest 0.16
Cr Liability 0.16
31/12/x8
Dr Income statement 4 (6-2)
Dr Liability 2
Cr Cash 6
245 aCOWtancy.com

Syllabus D2efg)
ii) inventory
Use either proportionate or FV NCI

NCI can be valued using the PROPORTIONATE method or the FAIR VALUE
method

Proportionate method
Here NCI gets its % of S's NA
1 % of S's NA (at fair value)
2 No goodwill in S is given to NCI
Let's say the parent acquires 80% of a subsidiary with net assets of 100.
NCI would receive 20 at acquisition
The goodwill calculation would look like this…
246 aCOWtancy.com

Fair Value
Here NCI get their % of NA AND goodwill
1 % of S's NA (at fair value)
2 % of S's Goodwill
Let's say the parent acquires 80% of a subsidiary with net assets of 100.
NCI would receive the FV of its holding at acquisition
This would be given in the exam or calculated as NCI shares x share price
Let's say this is 28
The goodwill calculation would look like this…
247 aCOWtancy.com

Syllabus D2efg)
ii) inventory
Impairment of Goodwill

Goodwill is reviewed for impairment not amortised

An impairment occurs when the subs recoverable amount is less than the subs carrying value +
goodwill.
How this works in practice depends on how NCI is measured - Proportionate or Fair Value method.
Proportionate NCI
Here, NCI only receives % of S's net assets.
NCI DOES NOT have any share of the goodwill.
1 Compare the recoverable amount of S (100%) to..
2 NET ASSETS of S (100%) + 
Goodwill (100%)
3 The problem is that goodwill on the SFP is for the parent only - so this needs
grossing up first
4 Then find the difference - this is the impairment - but only show the parent % of the
impairment 
248 aCOWtancy.com

Example
H owns 80% of S. Proportionate NCI
Goodwill is 80 and NA are 200
Recoverable amount is 240
How much is the impairment?
Solution
RA = 240
NA = 200 + G/W (80 x 100/80) = 100 = 300
Impairment is therefore 60.
The impairment shown in the accounts though is 80% x 60 = 48.
This is because the goodwill in the proportionate method is parent goodwill only. Therefore only
parent impairment is shown.
Fair Value NCI
Here, NCI receives % of S's net assets AND goodwill.
NCI DOES now own some goodwill.
1 Compare the recoverable amount of S (100%) to..
2 NET ASSETS of S (100%) + 
Goodwill (100%)
3 As, here, goodwill on the SFP is 100% (parent & NCI) - so NO grossing up needed
4 Then find the difference - this is the impairment - this is split between the parent and
NCI share
Example
H owns 80% of S. Fair Value NCI
Goodwill is 80 and NA are 200
Recoverable amount is 240
How much is the impairment? 
249 aCOWtancy.com

Solution
RA = 240
NA = 200 + G/W 80 = 280
Impairment is therefore 40.
The impairment shown in P's RE as 80% x 40 = 32.
The impairment shown in NCI is 20% x 40 = 8.
Impairment adjustment on the Income Statement
1 Proportionate NCI 
Add it to P's expenses.
2 Fair Value NCI 
Add it to S's expenses 
(this reduces S's PAT so reduces NCI when it takes its share of S's PAT).
250 aCOWtancy.com

Syllabus D2efg)
ii) inventory
Make sure you use FV of Net Assets Acquired

A subsidiary is brought into group accounts at FAIR value at acquisition

Here's a subsidiary at Book Value  
251 aCOWtancy.com

The FAIR Values of the above net assets were the same as their book value with the exception of
PPE which had a FV $3000 in excess of the book value
Here's the subsidiary at FAIR Value
Once the FV of the NA has been calculated, the total goes into the goodwill calculation as follows:
252 aCOWtancy.com

Syllabus D2h)
h) Explain and illustrate the effect of the disposal of a parent’s investment in a subsidiary in the
parent’s individual financial statements and/or those of the group (restricted to disposals of the
parent’s entire investment in the subsidiary).
Full Disposal

Full Disposal

This is when we lose control, so we go from owning a % above 50 to one below 50 (eg 80% to
30%).
In this case we have effectively disposed of the subsidiary (and possibly created a new associate).
As the sub has been disposed of - then any gain or loss goes to the INCOME STATEMENT (and
hence retained earnings).
Also, the old Subs assets and liabilities no longer get added across, there will be no goodwill or
NCI for it either.
How do you calculate this gain or loss?
What’s the effect on the Income Statement?
Consolidated until sale; Then treat as Associate (if we have significant influence) otherwise a
FVTPL investment.
Show profit on disposal (see above).
253 aCOWtancy.com

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