Example accounting policies

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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Accounting for Business combinations cash flows

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

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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Cash flows from discontinued operations IFRS 5 – 2 Detailed Examples

 Cash flows from discontinued operations – Detailed Examples

IAS 7 requires an entity to include all of its cash flows in the statement of cash flows, including those generated from both continuing and discontinued activities.

IFRS 5 Non-current Assets Held for Sale and Discontinued Operations requires an entity to disclose its net cash flows derived from operating, investing and financing activities in respect of discontinued operations. There are two ways in which this can be achieved:

===1) Presentation in the statement of cash flows

Net cash flows from each type of activity (operating, investing and financing) derived from discontinued operations are presented separately in the statement of cash flows.

===2) Presentation in a note

Cash flows from discontinued operations are included together with cash flows from continuing operations in each line Cash flows from discontinued operationsitem in the statement of cash flows. The net cash flows relating to each type of activity (operating, investing and financing) derived from discontinued operations are then disclosed separately in a note to the financial statements.

When a disposal group that meets the definition of a discontinued operation is classified as held for sale in the current period, and has not been realised/disposed of at the entity’s reporting date, the closing balance of cash and cash equivalents presented in the statement of cash flows will not reconcile to the cash and cash equivalents balances that are included in the statement of financial position at the reporting date.

This is because the cash and cash equivalents related to the disposal group are subsumed into the assets and liabilities of the disposal group and presented within the single line item in the statement of financial position.

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Borrowing costs – Q&A IAS 23

Q&A Borrowing costs

Q&A Borrowing costs is a questions and answers lesson type of narrative following the captions of this rather simple IFRS Standard.

  1. General scope and definitions
  2. Borrowing costs eligible for capitalisation
  3. Foreign exchange differences
  4. Cessation of capitalisation
  5. Interaction IAS 23 and IFRS 15 Construction contracts with customers

General scope and definitions

1.1 A qualifying asset is an asset that ‘necessarily takes a substantial period of time to get ready for its intended use or sale’. Is there any bright line for determining the ‘substantial period of time’?

No. IAS 23 does not define ‘substantial period of time’. Management exercises judgement when determining which assets are qualifying assets, taking into account, among other factors, the nature of the asset. An asset that normally takes more than a year to be ready for use will usually be a qualifying asset. Once management chooses the criteria and type of assets, it applies this consistently to those types of asset.

Management discloses in the notes to the financial statements, when relevant, how the assessment was performed, which criteria were considered and which types of assets are subject to capitalisation of borrowing costs.

1.2 The IASB has amended the list of costs that can be included in borrowing costs, as part of its 2008 minor improvement project. Will this change anything in practice?

The amendment eliminates inconsistencies between interest expense as calculated under IAS 23 and IFRS 9. IAS 23 refers to the effective interest rate method as described in IFRS 9. The calculation includes fees, transaction costs and amortisation of discounts or premiums relating to borrowings. These components were already included in IAS 23. However, IAS 23 also referred to ‘ancillary costs’ and did not define this term.

This could have resulted in a different calculation of interest expense than under IFRS 9. No significant impact is expected from this change. Alignment of the definitions means that management only uses one method to calculate interest expense.

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Capitalisation of expenditure – 1 Complete answer

Capitalisation of expenditure

Capitalisation of expenditure is only possible when one of the following situations occur:

  • Capital expenditure (including equipment repairs and maintenance)
  • Recording lease contracts – Right-of-Use Assets
  • Capitalisation of borrowing costs
  • Capitalisation of cloud computing costs
  • Capitalisation of intangible assets
  • Capitalisation of internally capitalized intangible assets
  • Research & development costs
  • Prepaid expenses

Capital expenditure (including equipment repairs and maintenance)

The cost of an item of property, plant and equipment under IAS 16 Property, plant and equipment shall be recognised as an asset if, and only if:

  • it is probable that future economic benefits associated with the item will flow to the entity; and
  • the cost of the item can be measured reliably. (IAS 16.7)

Investment property

Certain properties which are used on rental are classified as an investment property in which case IAS 40 Investment property will apply. Only tangible items which have a useful life of more than one period are classified as property, plant and equipment as per IAS 16. But refer to the words “more than one period” as more than one accounting period of 12 months.

Also, an entity shall determine a threshold limit commensurate to its size for recognizing a tangible item as property, plant and equipment. For example, a tangible item of insignificant amount although satisfying the definition of property, plant and equipment may be expensed.

Initial recognition of indirect costs

Items of property, plant and equipment may be acquired for safety or environmental reasons. The acquisition of such property plant and equipment, although not directly increasing the future economic benefits of any particular existing item of property, plant and equipment, may be necessary for an entity to obtain the future economic benefits from its other assets.

Such items of property plant and equipment qualify for recognition as assets because they enable an entity to derive future economic benefits from related assets in excess of what could be derived had those items not been acquired.

Subsequent recognition of indirect costs

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Acquisitions and mergers as per IFRS 3

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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Fair value employee share options in IFRS 2

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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IFRS 10 Principal versus agent considerations – Best complete read

Principal versus agent considerations

– Certain decision-makers may be obligated to exercise their decision powers on behalf of other parties and do not exercise their decision powers for their own benefit. IFRS 10 regards such decision-makers as ‘agents’ that are engaged to act on behalf of another party (the ‘principal’).

A principal may delegate some of its power over the investee to the agent, but the agent does not control the investee when it exercises that power on behalf of the principal (IFRS 10.B58).

Power normally resides with the principal rather than the agent (IFRS 10.B59). There may be multiple principals, in which case each of the principals should assess whether it has power over the … Read more

EBITDA – 1 Best complete read

EBITDA – Earnings before interest taxes depreciation and amortisation

– is a measure of a company’s overall financial performance and is used as an alternative to simple earnings or net income in some circumstances. Earnings before interest, taxes, depreciation and amortisation, however, can be misleading because it strips out the cost of capital investments like property, plant, and equipment.

This metric also excludes expenses associated with debt by adding back interest expense and taxes to earnings. Nonetheless, it is a more precise measure of corporate performance since it is able to show earnings before the influence of accounting and financial deductions.EBITDA

Simply put, Earnings before interest, taxes, depreciation and amortisation is a measure of profitability. While there is no legal requirement for companies to disclose their EBITDA (here also written as EBIT-DA), according to the U.S. generally accepted accounting principles (US GAAP) or International Financial Reporting Standards (IFRS), it can be worked out and reported using information found in a company’s financial statements.

The earnings, tax, and interest figures are found on the income statement, while the depreciation and amortisation figures are normally found in the notes to operating profit or on the cash flow statement. The usual shortcut to calculate EBITDA is to start with operating profit, also called earnings before interest and tax (EBIT) and then add back depreciation and amortisation.

https://www.merriam-webster.com/dictionary/EBITDA

Origins of EBITDA

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