Control

Example accounting policies

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Example accounting policies

Get the requirements for properly disclosing the accounting policies to provide the users of your financial statements with useful financial data, in the common language prescribed in the world’s most widely used standards for financial reporting, the IFRS Standards. First there is a section providing guidance on what the requirements are, followed by a comprehensive example, easy to tailor to the specific needs of your company.Example accounting policies

Example accounting policies guidance

Whether to disclose an accounting policy

1. In deciding whether a particular accounting policy should be disclosed, management considers whether disclosure would assist users in understanding how transactions, other events and conditions are reflected in the reported financial performance and financial position. Disclosure of particular accounting policies is especially useful to users where those policies are selected from alternatives allowed in IFRS. [IAS 1.119]

2. Some IFRSs specifically require disclosure of particular accounting policies, including choices made by management between different policies they allow. For example, IAS 16 Property, Plant and Equipment requires disclosure of the measurement bases used for classes of property, plant and equipment and IFRS 3 Business Combinations requires disclosure of the measurement basis used for non-controlling interest acquired during the period.

3. In this guidance, policies are disclosed that are specific to the entity and relevant for an understanding of individual line items in the financial statements, together with the notes for those line items. Other, more general policies are disclosed in the note 25 in the example below. Where permitted by local requirements, entities could consider moving these non-entity-specific policies into an Appendix.

Change in accounting policy – new and revised accounting standards

4. Where an entity has changed any of its accounting policies, either as a result of a new or revised accounting standard or voluntarily, it must explain the change in its notes. Additional disclosures are required where a policy is changed retrospectively, see note 26 for further information. [IAS 8.28]

5. New or revised accounting standards and interpretations only need to be disclosed if they resulted in a change in accounting policy which had an impact in the current year or could impact on future periods. There is no need to disclose pronouncements that did not have any impact on the entity’s accounting policies and amounts recognised in the financial statements. [IAS 8.28]

6. For the purpose of this edition, it is assumed that RePort Co. PLC did not have to make any changes to its accounting policies, as it is not affected by the interest rate benchmark reforms, and the other amendments summarised in Appendix D are only clarifications that did not require any changes. However, this assumption will not necessarily apply to all entities. Where there has been a change in policy, this will need to be explained, see note 26 for further information.

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Startup valuation

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Startup valuation

If every business starts with an idea, young companies can range the spectrum. Some are unformed, at least in a commercial sense, where the owner of the business has an idea that he or she thinks can fill an unfilled need among consumers.

Others have inched a little further up the scale and have converted the idea into a commercial product, albeit with little to show in terms of revenues or earnings. Still others have moved even further down the road to commercial success, and have a market for their product or service, with revenues and the potential, at least, for some profits.

Startup valuationSince young companies tend to be small, they represent only a small part of the overall economy. However, they tend to have a disproportionately large impact on the economy for several reasons.

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Accounting for Business combinations cash flows

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Accounting for Business combinations cash flows

1. Presentation and disclosure of cash paid/acquired in a business combination

When an entity acquires a business and part or all of the consideration is in cash or cash equivalents, part of the net assets acquired may include the acquiree’s existing cash balance. This results in different amounts being presented in the statement of cash flows and the notes to the financial statements.

IAS 7.39 and 42 require the net cash flows arising from gaining or losing control of a business, to be classified as arising from investing activities. Consequently, the statement of cash flows will not include the gross cash flows arisingBusiness combinations cash flows from the acquisition, and will instead show a single net amount. IAS 7.40 then requires the gross amounts to be disclosed in the notes.

The disclosures required by IFRS 3 Business Combinations include:

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The Statement of Cash Flows

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Statement of Cash Flows

IAS 7.10 requires an entity to analyse its cash inflows and outflows into three categories:

  • Operating;
  • Investing; and
  • Financing.

IAS 7.6 defines these as follows:

‘Operating activities are the principal revenue producing activities of the entity and other activities that are not investing or financing activities.’

‘Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.’

‘Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.’

1. Operating activities

It is often assumed that this category includes only those cash flows that arise from an entity’s principal revenue producing activities.

However, because cash flows arising from operating activities represents a residual category, which includes any cashStatement of cash flows flows that do not qualify to be recorded within either investing or financing activities, these can include cash flows that may initially not appear to be ‘operating’ in nature.

For example, the acquisition of land would typically be viewed as an investing activity, as land is a long-term asset. However, this classification is dependent on the nature of the entity’s operations and business practices. For example, an entity that acquires land regularly to develop residential housing to be sold would classify land acquisitions as an operating activity, as such cash flows relate to its principal revenue producing activities and therefore meet the definition of an operating cash flow.

2. Investing activities

An entity’s investing activities typically include the purchase and disposal of its intangible assets, property, plant and equipment, and interests in other entities that are not held for trading purposes. However, in an entity’s consolidated financial statements, cash flows from investing activities do not include those arising from changes in ownership interest of subsidiaries that do not result in a change in control, which are classified as arising from financing activities.

It should be noted that cash flows related to the sale of leased assets (when the entity is the lessor) may be classified as operating or investing activities depending on the specific facts and circumstances.

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The real meaning of Integrated reporting

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The real meaning of integrated reporting

Integrated reporting is more than only aimed at informing interested stakeholders about performance achieved against targets, the vision and strategy adopted to serve the stakeholders’ interests, and other factors that can influence business performance in future.

Clearly regulations require companies to exercise transparency. However, a more fundamental reason for reporting lies in accountability: a company needs to account for the impact it has on the stakeholders it relates to. Not exercising such transparency would impose serious risks, including high financing costs to compensate for a lack of transparency or governance or, ultimately, losing the license to operate. By contrast, a transparent approach would not only improve reputation, but also would bind stakeholders such as employees to the company’s objectives.

The reason for including environmental and social factors in reporting

In today’s world companies play a significant role in shaping the future of society. Awareness of this has risen significantly over the last decades, resulting in changed attitudes towards the role business is expected to play.

It also resulted in changes in the views of business leaders about the role they want to play.

Business these days is seen more than ever as the agent of a wide group of stakeholders. Unlike the old paradigm that ‘the business of business is business’, companies accept wider accountability in current times towards the stakeholders whose interests they impact – no longer can companies focus only on the interests of those with a financial interest.

This wider accountability implies that companies have to fulfil the (information) needs of those who provide them with integrated reportingother economic resources such as labour, space, air or natural resources and those who enter into transactions with the organization such as customers. Therefore a company’s current performance and future ability to continue operations and achieve business growth needs to be evaluated on the basis of a comprehensive set of factors that influence these.

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Acquisitions and mergers as per IFRS 3

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Acquisitions and mergers

Acquisitions and mergers are becoming more and more common as entities aim to achieve their growth objectives. IFRS 3 ‘Business Combinations’ contains the requirements for these transactions, which are challenging in practice.

This narrative sets out how an entity should determine if the transaction is a business combination, and whether it is within the scope of IFRS 3.

Identifying a business combination

IFRS 3 refers to a ‘business combination’ rather than more commonly used phrases such as takeover, acquisition or Acquisitions and mergersmerger because the objective is to encompass all the transactions in which an acquirer obtains control over an acquiree no matter how the transaction is structured. A business combination is defined as a transaction or other event in which an acquirer (an investor entity) obtains control of one or more businesses.

An entity’s purchase of a controlling interest in another unrelated operating entity will usually be a business combination (see case below).

Case – Straightforward business combination

Entity T is a clothing manufacturer and has traded for a number of years. Entity T is deemed to be a business.

On 1 January 2020, Entity A pays CU 2,000 to acquire 100% of the ordinary voting shares of Entity T. No other type of shares has been issued by Entity T. On the same day, the three main executive directors of Entity A take on the same roles in Entity T.

Consider this…..

Entity A obtains control on 1 January 2020 by acquiring 100% of the voting rights. As Entity T is a business, this is a business combination in accordance with IFRS 3.

However, a business combination may be structured, and an entity may obtain control of that structure, in a variety of ways.

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Bill-and-hold arrangements in IFRS 15

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Bill-and-hold arrangements

Bill-and-hold arrangements occur when an entity bills a customer for a product that it transfers at a point in time, but retains physical possession of the product until it is transferred to the customer at a future point in time. This might occur to accommodate a customer’s lack of available space for the product or delays in production schedules. [IFRS 15.B79]

To determine when to recognize revenue, an entity needs to determine when the customer obtains control of the product. Generally, this occurs at shipment or delivery to the customer, depending on the contract terms (for discussion of the indicators for transfer of control at a point in time, see Performance obligations satisfied at a point in time from Step 5 IFRS 15 in the link). The new standard provides criteria that have to be met for a customer to obtain control of a product in a bill-and-hold arrangement. These are illustrated below. [IFRS 15.B80–B81]

Bill-and-hold arrangements

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5 steps in IFRS 15 – best quick read

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5 steps in IFRS 15

Under IFRS 15 Revenue from contracts with customers, entities apply the 5 steps in IFRS 15 to determine when to recognize revenue, and at what amount. The model specifies that revenue is recognized when or as an entity transfers control of goods or services to a customer at the amount to which the entity expects to be entitled. Depending on whether certain criteria are met, revenue is recognized:

  • over time, in a manner that best reflects the entity’s performance; or
  • at a point in time, when control of the goods or services is transferred to the customer.

IFRS 15 provides application guidance on numerous related topics, including warranties and licenses. It also provides guidance on when to capitalize the costs of obtaining a contract and some costs of fulfilling a contract (specifically those that are not addressed in other relevant authoritative guidance – e.g. for inventory).

5 steps in IFRS 15 – What is IFRS 15?

Step 1: Identify the contract with a customer

A contract with a customer is in the scope of IFRS 15 when the contract is legally enforceable and certain criteria are met. If the criteria are not met, then the contract does not exist for purposes of applying the general model of IFRS 15, and any consideration received from the customer is generally recognized as a deposit (liability). Contracts entered into at or near the same time with the same customer (or a related party of the customer) are combined and treated as a single contract when certain criteria are met.

A contract with a customer is in the scope of IFRS 15 when it is legally enforceable and meets all of the following criteria. [IFRS 15.9]

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Accounting for mergers – Best 2 Read

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Accounting for mergers

Mergers and acquisitions (business combinations) can have a fundamental impact on the acquirer’s operations, resources and strategies. For most entities such transactions are infrequent, and each is unique. IFRS 3 ‘Business Combinations’ contains the requirements for accounting for mergers, which are challenging in practice.

This narrative provides a high-level overview of IFRS 3 and explains the key steps in accounting for business combinations in accordance with this Standard. It also highlights some practical application issues dealing with:

  • how to avoid unintended accounting consequences when bringing two businesses together, and
  • deal terms and what effect they can have on accounting for business combinations.

The acquisition method in accounting for mergers

IFRS 3 establishes the accounting and reporting requirements (known as ‘the acquisition method’) for the acquirer in a business combination. The key steps in applying the acquisition method are summarised below:

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Fair value employee share options in IFRS 2

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Fair value employee share options

Share options give the holder the right to buy the underlying shares at a set price, called the ‘exercise price’, over or at the end of an agreed period. If the share price exceeds the option’s exercise price when the option is exercised, then the holder of the option profits by the amount of the excess of the share price over the exercise price. Benefit is derived from the right under the option to buy a share for less than its value.

The holder’s cost is the exercise price, whereas the value is the share price. It is not necessary for the holder to sell the share for this profit to exist. Sale only results in realisation of the profit. Because an option holder’s profit increases as the underlying share price increases, share options are used to incentivise employees to contribute to an increase in the price of the underlying shares.

Employee options are typically call options, which give holders the right but not the obligation to buy shares. However, other types of options are also traded in markets. For example, put options give holders the right to sell the underlying shares at an agreed price for a set period.

Given that holders of put options profit when share prices fall below the exercise price, such options are not viewed as aligning the interests of employees and shareholders. All references in this section to ‘share options’ are to employee call options.

Share options granted by entities often cannot be valued with reference to market prices. Many entities, even those whose shares are quoted publicly, do not have options traded on their shares. Options that trade on recognised exchanges such as the Chicago Board Options Exchange are created by market participants and are not issued by entities directly.

Even when there are exchange-traded options on an entity’s shares for which prices are available, the terms and conditions of these options are generally different from the terms and conditions of options issued by entities in share-based payments and, as a result, the prices of such traded options cannot be used directly to value share options issued in a share-based payment.

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