CIMA F2 CHAPTER 1 to 19 others

IAS 11 Accounting treatment

We incur costs on a contract: Dr Contract costs Cr Bank/payables We raise an invoice: Dr Receivables Cr Progress payments We receive payment from the customer: Dr Bank Cr Receivables We record a sales value (based on stage of completion): Dr Progress payments Cr Revenue We match related costs (based on stage of completion): Dr Cost of sales Cr Contract costs The profit shown in the statement of profit or loss is calculated by looking at the sales account less cost of sales account. The statement of financial position is calculated by netting off the contract costs and the progress payments accounts.

A financial instrument

A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.

Equity instruments

A financial instrument is only an equity instrument if there is no such contractual obligation.

Dividend cover

Dividend cover indicates the number of times profits will cover the dividend; the higher the ratio the better as shareholders may expect a sustainable dividend payment.

Dividend cover

Dividend cover measures the ability of the entity to maintain the existing level of dividend and is used in conjunction with the dividend yield: Earnings per share / Dividends per share

Dividend yield

Dividend yield will indicate the return on capital investment, relative to market price: (Dividend per share / Market price per share)*100

IAS 12 Current tax entries

Dr Income tax expense (SPL) Cr Income tax liability (SFP - current liability)

IFRS 13 Fair Value Measurement as

'the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date'.

Summary of accounting entries

(1) At the inception of the lease: Dr Non-current assets Cr Finance lease liability with the present value of the minimum lease payments/fair value of the leased asset. (2) At the end of each period of the lease: Dr Depreciation expense (statement of profit or loss) Cr Non-current assets with the depreciation charge for the period. (3) As each rental is paid: Dr Finance lease liability Cr Cash with the rental paid Dr Finance cost (statement of profit or loss) Cr Finance lease liability with the finance charge.

the cost of debt - kd Features

(1) Debt is tax deductible and hence interest payments are made net of tax. (2) Debt is always quoted in $100 nominal units or blocks. (3) Interest paid on the debt is stated as a percentage of nominal value. This is known as the coupon rate. It is not the same as the cost of debt. The amount of interest payable on the debt is fixed. The interest is calculated as the coupon rate multiplied by the nominal value of the debt. (4) Debt is normally redeemable at par (nominal value) or at a premium or discount. (5) Interest can be either fixed or floating (variable) on borrowings, but bonds normally pay fixed rate interest.

Covenants include

(1) Dividend restrictions - Limitations on the level of dividends a company is permitted to pay. This is designed to prevent excessive dividend payments which may seriously weaken the company's future cash flows and thereby place the lender at greater risk. (2) Financial ratios - Specified levels below which certain ratios may not fall, e.g. debt to net assets ratio, current ratio. (3) Financial reports - Regular accounts and financial reports to be provided to the lender to monitor progress. (4) Issue of further debt - The amount and type of debt that can be issued may be restricted. Subordinated debt (i.e. debt ranking below the existing unsecured debt) can usually still be issued

keeping financing off the statement of financial position include the following:

(1) Effect on the gearing (leverage) ratio. (2) Borrowing capacity. (3) Borrowing costs. (4) Management incentives.

IAS 12 Accounting for deferred tax

(1) Establish the temporary difference at the year end = carrying value of net assets less the tax base (2) Deferred tax balance (for SFP) = temporary difference × tax rate Note that this could be a liability or asset, depending on whether the future tax consequence would increase or decrease the tax payable. - It will be a deferred tax liability if the carrying value of net assets is greater than the tax base. This is the situation where there are taxable temporary differences. - It would be a deferred tax asset if the carrying value of net assets was lower than the tax base. In this situation there would be deductable temporary differences. (3) Deferred tax expense/credit (for SPL&OCI) = increase/decrease in deferred tax balance in year

Security - charges

(1) Fixed charge - The debt is secured against a specific asset, normally land or buildings. This form of security is preferred because, in the event of liquidation, it puts the lender at the 'front of the queue' of creditors. (2) Floating charge - The debt is secured against the general assets of the business. This form of security is not as strong; again it confers a measure of security on liquidation as a 'preferred creditor', meaning the lender is higher in the list of creditors than otherwise.

Step acquisitions - There are two possible scenarios

(1) Non-control to control E.g. the parent acquires 40% of the equity shares of an entity and then purchases a further 20% to bring the total shareholding up to 60%. The investment becomes a subsidiary when the additional 20% of the shares are acquired, as this is when control is achieved. (2) Control to control E.g. the parent acquires 60% of the equity shares of an entity and then purchases a further 15% to bring the total shareholding up to 75%.

Sources of long term finance

(1) The capital markets, (2) Bank borrowings, (3) Government and similar sources

Rights issue Determining the weighted average capital, therefore, involves two steps as follows:

(1) adjust for the bonus element in the rights issue, by multiplying capital in issue before the rights issue by the following fraction: Actual cum rights price (CRP) / Theoretical ex rights price (TERP) - The cum rights price will be given to you in the exam question. It is the share price on the last trading day before the rights issue, i.e. the price of a share 'including' the rights. - The theoretical ex-rights price is the theoretical share price after the rights issue has occurred. This must be calculated. (2) calculate the weighted average capital in the issue on a time apportioned basis.

Implications of a rights issue

(a) From the viewpoint of the shareholders: - they have the option of buying shares at preferential price - they have the option of withdrawing cash by selling their rights - they are able to maintain their existing relative voting position (by exercising the rights). (b) From the viewpoint of the company: - it is simple and cheap to implement - it is usually successful ('fully subscribed') - it often provides favourable publicity.

IAS 32 requires compound financial instruments be split into their component parts:

- a financial liability (the debt) - measured as the present value of the future cashflows, including redemption, using a discount rate that equates to the interest rate on similar instruments without conversion rights - an equity instrument (the option to convert into shares) - calculated as the balancing figure.

Capital markets

1. Bonds 2. Commercial paper

A construction contract - Recognise results on completion

1. Complies with prudence since it will not be certain that the contract is profitable until completion. 2. Reliable since revenue, costs and profits will be known with certainty on completion. 3. Not relevant since reported results will not reflect activities of the entity in the period. 4. Is likely to cause reported results to be distorted and so incomparable

A construction contract - Recognise results as contract progresses

1. Complies with the matching concept as results will match work performed during the accounting period. 2. Less reliable since calculations will involve estimates regarding the future. 3. Achieves relevance since reported results will reflect the activities of the entity. 4. Will enable financial statements to be more comparable with other entities.

IAS 28 Associates Adjustments required

1. Intercompany transactions & balances 2. Provisions for unrealised profit (PUP)

A construction contract - There are two alternative views recognized in accounting

1. Recognise results on completion 2. Recognise results as contract progresses

Analysing efficiency/activity

1. the inventory holding period 2. The receivables collection period 3. The payables payment period 4. Asset turnover 5. Non-current asset turnover

Initial measurement of financial instruments

A financial asset or liability should be initially recognised at its fair value. Except in the case of assets or liabilities at fair value through profit or loss (see next section), directly attributable transaction costs are added to an asset and deducted from a liability.

Bonds

A bond is a debt security, in which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal at a later date. i.e. a bond is a formal contract to repay borrowed money with interest at fixed intervals.

A construction contract

A construction contract is defined as a contract specifically negotiated for the construction of an asset or a combination of assets that are related. A construction contract is a contract to a construct a substantial asset, such as a bridge, a building, a ship or a tunnel.

IAS 37 A contingent asset

A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.

IAS 12 Deferred tax on losses

A deferred tax asset is recognised on unutilised losses carried forward (as there will be a future tax benefit when the losses are offset against future profits). However, the asset can only be recognised to the extent that it is probable that future taxable profits will be available against which the losses can be utilised.

Characteristics of a derivative

A derivative has all of the following characteristics: • Its value changes in response to changes in the underlying item. • It requires little or no initial investment. • It is settled at a future date.

Definition of derivatives

A derivative is a financial instrument that derives its value from the value of an underlying asset, price, rate or index. • Underlying items include equities, bonds, commodities, interest rates, exchange rates and stock market and other indices. • Derivative financial instruments include futures, options, forward contracts, interest rate and currency swaps.

financial asset

A financial asset is any asset that is: • cash • an equity instrument of another entity • a contractual right to receive cash or another financial asset from another entity • a contractual right to exchange financial instruments with another entity under conditions that are potentially favourable Examples of financial assets are: • Investments in ordinary shares of another entity • Investments in debentures/loan stock/loan notes/bonds i.e. lending money to another entity

A financial liability

A financial liability is any liability that is a contractual obligation: • to deliver cash or another financial asset to another entity • to exchange financial instruments with another entity under conditions that are potentially unfavourable Examples of financial liabilities are: • Issue of debentures/ loan stock/ loan notes/ bonds i.e. borrowing money from another entity

Covenants

A further means of limiting the risk to the lender is to restrict the actions of the directors through the means of covenants. These are specific requirements or limitations laid down as a condition of taking on debt financing

A joint arrangemen

A joint arrangement is an arrangement of which two or more parties have joint control.

Joint operations

A joint operation is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement.

A joint venture

A joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.

A liability

A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

Mixed groups

A mixed group exists where the parent has a direct holding in the sub-subsidiary as well as the indirect holding via the subsidiary Accounting for a mixed group is very similar to that of a vertical group. The only slight difference is that, in the calculation of goodwill, there will be two elements to the parent's investment: one direct and one indirect, and only the indirect investment should be adusted for the IHA.

IFRS 10 Exemption from group accounts

A parent need not present consolidated financial statements if it meets all of the following conditions: • it is a wholly owned subsidiary or a partially-owned subsidiary and its owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements • its debt or equity instruments are not traded in a public market • it did not file its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market • its ultimate parent produces consolidated financial statements available for public use that comply with IFRS.

IAS 24 Related parties - the detail vol 1

A person or close member of that person's family is related to a reporting entity if that person: • has control or joint control over the reporting entity • has significant influence over the reporting entity • is a member of the key management personnel of the reporting entity or of a parent of the reporting entity.

Private limited company (Ltd in UK terminology)

A private company limited by shares, usually called a private limited company, has shareholders with limited liability and its shares may not be offered to the general public, unlike those of a public limited company

A provision

A provision is a liability of uncertain timing or amount.

Recognition of a provision IAS 37

A provision should be recognised when: • an entity has a present obligation (legal or constructive) as a result of a past event • it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and • a reliable estimate can be made of the amount of the obligation. If any one of these conditions is not met, no provision may be recognised.

Public limited company (plc in UK terminology)

A public limited company is a limited liability company that may sell shares to the public. It can be either an unlisted company, or a listed company on the stock exchange.

IAS 24 A related party is

A related party is a person or entity that is related to the entity that is preparing its financial statements (the reporting entity). A relationship typically exists if control, joint control, common control or significant influence exists between the party and the reporting entity.

IAS 24 A related party transaction is

A related party transaction is a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged. Where there have been transactions between the entity and a related party, the entity is required to disclose: • The nature of the related party relationship • The nature of the transaction • The amount of the transaction • Any outstanding balance relating to the transaction • Any provisions for doubtful debts remaining to the amount of any outstanding balance.

IAS 37 Restructuring

A restructuring is a programme planned and controlled by management that materially changes the scope of business undertaken or the manner in which that business is conducted.

Receivables days

A retail or cash-based entity may have zero or very low receivables days. Note that, where an entity sells for both cash and on credit, it will be necessary to split revenue into the two types.

Rights issues

A rights issue is where new shares are offered for sale to existing shareholders, in proportion to the size of their shareholding.

Sale and operating leaseback

A sale and operating leaseback transfers the risks and rewards incidental to ownership of the asset to the buyer/lessor. Therefore it is treated as a disposal and the asset is no longer recognised in the financial statements of the lessee.

Step acquisitions

A step acquisition occurs when the parent acquires a controlling interest in another entity in stages. The parent will only start to consolidate the investment from the date it achieves control. It is at this point in time that goodwill and the non-controlling interest in the subsidiary are initially recognised.

Vertical groups

A vertical group exists when a subsidiary is indirectly controlled by the parent. The subsidiary indirectly controlled is often known as a sub-subsidiary. The parent has: • direct control of the subsidiary, and • indirect control of the sub-subsidiary, via the subsidiary

Debt with warrants attached

A warrant is an option to buy shares at a specified point in the future for a specified (exercise) price. Warrants are often issued with a bond as a sweetener to encourage investors to purchase the bonds. The warrant offers a potential capital gain where the share price may rise above the exercise price. The holder has the option to buy the share on the exercise date but can also choose to sell the warrant before that date.

Issue of shares at full market price

An issue at full market price brings additional resources to the entity, but the impact on earnings is only from the date of issue. Therefore the number of shares are time apportioned.

Provision for unrealised profit (PUP) in NCA

Adjustment required - CSFP: • Profit on disposal - reduce Net assets at reporting date if S sells the asset or reduce Consolidated reserves if P sells the asset. • Extra depreciation - increase Consolidated reserves if S sells the asset or increase Net assets at reporting date if P sells the asset. • Decrease the non-current asset in the CSFP with the net amount. Adjustment required - CSCI: • Deduct profit on disposal • Add back excess depreciation charged (therefore reduce related expense category) • In NCI share of profit working: - If P is seller, add back excess depreciation charged by S - If S is seller, deduct profit on disposal made by S

Recognition and measurement

All derivatives are categorised as fair value through the profit or loss (FVPL). On initial recognition they are recorded at fair value which is usually nil as the derivative gains value as the underlying item's price moves. At each reporting date, the derivative is restated to fair value and recorded as a financial asset or financial liability on the statement of financial position. Any gains/losses are taken to the statement of profit or loss.

IAS 12 Under and over provisions

Amount settled > amount previously recognised => under-provision (additional expense) Amount settled < amount previously recognised => over-provision (credit)

associate

An associate is an entity over which the investor has significant influence and which is neither a subsidiary nor a joint venture of the investor.

IAS 24 Related parties - the detail vol 2

An entity is related to a reporting entity if any of the following conditions applies: • The entity and the reporting entity are members of the same group • One entity is an associate or joint venture of the other entity • Both entities are joint ventures of the same third party • One entity is a joint venture of a third entity and the other entity is an associate of the third entity • The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity • The entity is controlled or jointly controlled by a person identified as a related party to the reporting entity • A person identified as a related party of the reporting entity has significant influence over the entity or is a member of the key management personnel of the entity

Derecognition of financial assets

An entity should derecognise a financial asset when: • the contractual rights to the cash flows from the financial asset expire; or • it transfers substantially all the risks and rewards of ownership of the financial asset. Upon derecognition, any difference between proceeds and carrying value is recognised through profit or loss. If the asset was classified as available for sale, any gains or losses accumulated within other components of equity are reclassified and included in profit or loss at the date of disposal.

Initial recognition of financial instruments

An entity should recognise a financial asset or a financial liability in its statement of financial position when, and only when, it becomes a party to the contractual provisions of the instrument.

Borrowing costs.

An entity with an already high level of borrowings will pay a risk premium for further borrowing in the form of a higher interest rate.

An equity instrument

An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. An example of an equity instrument is: • Issue of ordinary shares

The yield on debt

An investor who purchases a traded debt instrument (e.g. a bond) receives a return, known as a 'yield', in the form of the annual interest (or 'coupon') payments and, if the debt is redeemable, the final redemption payment. This return is also known as the 'yield to maturity' (YTM), or 'redemption yield' on the bond, and it is defined as: YTM = effective average annual percentage return to the investor, relative to the current market value of the bond. If the bond is irredeemable, the calculation is very simple. However, it becomes more complex if the bond is redeemable.

IAS 37 Onerous contracts

An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. A provision is required for the 'least net cost' of exiting the contract, which is the lower of: • cost of fulfilling the contract • any compensation/penalties payable for failing to fulfil it

Options and warrants to subscribe for shares

An option or warrant gives the holder the right to buy shares at some time in the future at a predetermined price.The cash received by the entity when the option is exercised will be less than the market price of the shares, as the option will only be exercised if the exercise price is lower than the market price. The increase in resources does not match the increase there would be in resources if the issue of shares were at market value. The options will therefore have a dilutive effect on EPS.

IAS 12 Deferred tax impact in OCI

Any deferred tax charge/credit that relates to an item that has been recognised in other comprehensive income should also be recognised in other comprehensive income. The most common example of this relates to the revaluation of non-current assets: • When an asset is revalued upwards, it increases the carrying value of the asset but it does not affect the tax base. • The cumulative temporary difference therefore increases and this gives rise to an additional deferred tax liability. • The revaluation surplus is recognised in other comprehensive income. • Therefore, the movement in the deferred tax liability that relates to the revaluation surplus should also be recognised in other comprehensive income.

Accounting treatment of the commercial substance of a lease

As the commercial substance of a finance lease is that the lessee is the effective owner of the asset the required accounting treatment is to: • record the asset as a non-current asset in the lessee's statement of financial position • record a liability for the lease payments payable to the lessor.

Transfer between owners

As we've just seen in the previous chapter, if the parent either acquires more shares in a subsidiary or sells shares but retains control there is an adjustment to both the NCI and the parent's reserves. This therefore needs to be reflected in the statement of changes in equity.

Asset turnover

Asset turnover measures how much revenue is being generated from the overall capital invested. It is a measure of the efficiency/activity of the capital.

Recognition and derecognition of assets and liabilities

Assets and liabilities should be recognised in the statement of financial position where: • it is probable that any future economic benefit associated with the item will flow to or from the entity and • the item has a cost or value that can be measured with reliability. When either of these criteria are not met the item should be derecognised.

Assets

Assets are defined in the Framework as resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

IAS 24 Disclosure requirements

At a minimum, disclosures shall include: • the amount of the transactions • the amount of outstanding balances: their terms and conditions, including whether they are secured, and the nature of the consideration to be provided in settlement and details of any guarantees given or received • provisions for doubtful debts related to the amount of outstanding balances • the expense recognised during the period in respect of bad or doubtful debts due from related parties.

Recording a finance lease - Initial recording

At the start of the lease: • the fair value or, if lower, the present value of the minimum lease payments (MLPs) should be included as a non-current asset, subject to depreciation • the same amount (being the obligation to pay rentals) should be included as a loan, i.e. a liability. In practice, the fair value of the asset or its cash price will often be a sufficiently close approximation to the present value of the MLPs and therefore can be used instead.

Average rate of borrowings

Average rate of borrowings indicates the typical interest rate that the entity pays on its debt finance. A high rate would suggest that lenders consider the entity to be a relatively high risk.

Management incentives.

Bonuses and performance-related pay may be based upon reported earnings for a period. If an entity is able to benefit from off-balance-sheet financing arrangements, costs may be lower, thus improving earnings.

Business angels

Business angels are similar to venture capitalists. Venture capitalists are rarely interested in investing in very small businesses, on the grounds that monitoring progress is uneconomic. Business angels are wealthy investors who provide equity finance to small businesses.

Cash flows from investing activities

Cash flows to appear under this heading include: • cash paid for property, plant and equipment and other non-current assets • cash received on the sale of property, plant and equipment and other non-current assets • cash paid for investments in or loans to other entities (excluding movements on loans from financial institutions, which are shown under financing) • cash received for the sale of investments or the repayment of loans to other entities (again excluding loans from financial institutions).

Intra-group balances - Cash in transit

Cash has been sent by one group entity, but has not been received and so is not recorded in the books of the other group entity. The following adjustment will be required: Cr Receivables (with the higher amount) Dr Bank (with the amount in transit i.e. the difference) Dr Payables (with the lower amount)

Monetary items

Currency held and assets or liabilities to be received or paid in currency. E.g. cash, receivables, payables, loans Treatment: Retranslate using the closing rate (year end exchange rate Any exchange difference arising on the retranslation of monetary items must be taken to the statement of profit or loss in the period in which it arises.

Capital markets

Capital markets (or stock markets) must fulfil both primary and secondary functions.

Cash

Cash consists of cash in hand and deposits repayable upon demand, less overdrafts. This includes cash held in a foreign currency.

Cash equivalents

Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and are subject to an insignificant risk of changes in value.

Cash flows

Cash flows are inflows and outflows of cash and cash equivalents

Changes in group structure

Changes in group structure are reflected in the consolidated statement of changes in equity.

IAS 24 Close family members

Close members of the family of a person are those family members who may be expected to influence, or be influenced by, that person in their dealings with the entity. They would include: • children • spouse or domestic partner • children, and other dependents, of spouse or domestic partner

Determining the substance of a transaction

Common features of transactions whose substance is not readily apparent are: • the legal title to an asset may be separated from the principal benefits and risks associated with the asset • a transaction may be linked with other transactions which means that the commercial effect of the individual transaction cannot be understood without an understanding of all of the transactions • options may be included in a transaction where the terms of the option make it highly likely that the option will be exercised.

IFRS 3 Impairment of goodwill - Fair value method

Consequently, any impairment loss is charged to both the parent and NCI shareholders in the equity section of the CSFP in accordance with their percentage holdings. To record the impairment loss: • Reduce Goodwill by the full amount of the impairment loss (Cr). • Reduce NCI equity by the NCI% of the impairment loss (Dr). • Reduce Consolidated retained earnings by the P% of the impairment loss (Dr).

IFRS 10 Preparation of consolidate financial statements

Consolidated financial statements should be prepared when the parent has control over one or more subsidiaries (for examination purposes control is usually established based on ownership of more than 50% of the voting rights). The method of consolidation applied is known as acquisition accounting.

Contingent consideration

Contingent consideration is measured at its fair value at the date of acquisition, to be consistent with how other forms of consideration are measured. This will typically be based on a probability weighted present value. Adjustments to the value of contingent consideration arising from events after the acquisition date, e.g. a profit target not being met, are normally charged/credited to profits.

Contract costs

Contract costs consist of costs that directly relate to the contract, i.e. site labour costs, materials, costs of depreciation for equipment used in the contract, costs of hiring/moving equipment for the contract, etc.

Contract revenue

Contract revenue is the amount of revenue the contract has been agreed for, i.e. contract price.

IAS 11 The cost basis is calculated as follows:

Costs incurred to date / Total cost for the contract = % of completion

Price earnings ratio

Current market price per share / Earnings per share Earnings per share is basically the earnings available for distribution divided by the number of ordinary shares in issue. The calculation of earnings per share is governed by IAS 33 Earnings per share and the rules of this accounting standard are covered in an earlier chapter of this text. The P/E ratio calculation produces a number which can be useful for assessing the relative risk of an investment.

Payables days

Current payables comprise a form of finance which is free, or almost free. However, there may be costs in terms of loss of prompt payment discount, and loss of supplier goodwill where excessive time is taken to pay. Efficiency is measured relative to industry norms, receivables days and supplier terms. To calculate the working capital cycle, if figures are not available for credit sales and credit purchases (as may well be the case if the data source is a set of published accounts), an approximation may be obtained by using total revenue and cost of sales respectively, but the results of such ratio calculations must be treated with caution.

IAS 12 Current tax

Current tax is the estimated amount of tax payable on the taxable profits of the enterprise for the period.

Subsequent measurement of financial instruments

Equity instruments are not re-measured after initial recognition. Subsequent measurement of other financial instruments depends on how that particular financial instrument is classified. IAS 39 deals separately with four types of financial asset and two types of financial liability.

The internal rate of return (IRR)

Definition The IRR is the discount rate which gives a zero NPV. Calculation It can be estimated by working out the NPV at two different rates (L, the lower rate, and H, the higher rate) and then using the following (linear interpolation) formula.

Directly attributable costs of acquisition

Directly attributable costs of acquisition are expensed to the parent's statement of profit or loss. This is because they are not part of what the parent gives in return for the shareholding in the subsidiary and so do not represent part of the value of that shareholding.

EBITDA

EBITDA is an acronym for earnings before interest, tax, depreciation and amortisation. In recent years many large entities have adopted EBITDA as a key measure of financial performance. Sceptics suggest that they do this in order to publicise a higher measure of earnings than profit from operations (this type of measurement is sometimes cynically referred to as EBB - earnings before the bad bits). However, it does make some sense to measure EBITDA, provided that the user fully understands what is included and what is left out. Depreciation and amortisation are accounting adjustments, not representing cash flows, that are determined by management. It can therefore be argued that excluding these items in assessing earnings eliminates a major area where management bias can operate. Unfortunately, EBITDA is consequently often misunderstood as being a measurement of cash flow, which of course it is not. Even though two categories of non-cash adjustment are eliminated, financial statements are prepared on an accruals basis. EBITDA makes no adjustments in respect of accruals or working capital movements, and so is emphatically not a cash flow measurement.

Bonus issue in the calculation of EPS formula

EPS = Earnings / No. of shares before bonus × bonus fraction Bonus fraction = No. of shares after bonus issue / No. of shares before bonus issue

The basic EPS calculation is:

EPS = Earnings / Number of shares This is expressed as dollars or cents per share (cents if the amount is less that $1). • Earnings: Net profit attributable to ordinary equity shareholders of the parent entity, i.e. group profit after tax less profit attributable to non-controlling interests and irredeemable preference share dividends. • Number of shares: Weighted average number of ordinary shares on a time weighted basis.

Earnings per share IAS 33

Earnings per share (EPS) is widely regarded as the most important indicator of a company's performance. It is also used in the calculation of the price-earnings ratio, a ratio closely monitored by analysts for listed companies. The price earnings ratio is equal to market price per share divided by earnings per share and gives an indicator of the level of confidence in the company by the market. Consequently, EPS is the topic of its own accounting standard, IAS 33, which details rules on its calculation and presentation to ensure consistent treatment and comparability between companies.

Effective tax rate

Effective tax rate assesses the extent of the impact that tax has on the entity's profit.

IAS 24 Examples of related parties

Examples of related party transactions would be: • Purchases/sales of goods (even if no price is charged) • Purchases/sales of property or other assets • Rendering/receipt of services • Leasing arrangements • Management contracts • Finance arrangements, e.g. loan guarantee.

Exceptional items

Exceptional items such as a profit on disposal of a non-current asset should be removed from the analysis to enable comparisons to be made.

Exchange gains or losses on translation

Exchange differences arise upon translation of the subsidiary and can be separated into two main components: • Exchange difference on net assets • Exchange difference on goodwill

Cash flows from financing activities

Financing cash flows mainly comprise receipts or repayments of principal from or to external providers of finance.

Equity-settled share-based payments

For equity-settled transactions the fair value is typically the option price at the grant date (rather than the fair value of the goods or services received). If the options vest immediately i.e. employees are entitled to the shares immediately, it is presumed that the entity has received the benefit of the services and the full amount is recognised on the grant date. If the options do not vest immediately, as is usually the case, the company should spread the cost of the options over the vesting period, the period during which the specific vesting conditions are satisfied e.g. length of service with the company. To record the cost on an annual basis: Dr P/L Cr Equity (other reserves) The amount is: total number of options issued and expected to vest multiplied by the fair value of an option at grant date, spread over the vesting period.

Yield on irredeemable debt

For irredeemable debt: YTM = (annual interest received/current market value of debt) × 100%

forward rate agreements

Forward rate agreements can be used to fix the interest charge on a floating rate loan.

Futures contracts

Futures contracts oblige the holder to buy or sell a standard quantity of a specific underlying item at a specified future date. Futures contracts are very similar to forward contracts. The difference is that futures contracts have standard terms and are traded on a financial exchange, whereas forward contracts are tailor made and are not traded on a financial exchange.

Gearing

Gearing is an important measure of risk and a guide to the long term solvency of the entity. It is calculated by taking long term debt as a percentage of total capital employed, i.e. long term debt plus shareholders' funds. Alternatively it can be calculated by taking debt as a percentage of equity, or shareholders' funds. Make your calculation clear in the exam. It is important to assess the gearing ratio against the industry average and to ensure that the debt finance is put to good use to generate revenue and profits.

Intra-group balances - Goods in transit

Goods have been sent by one entity, but have not been received and so are not recorded in the books of the other group entity. The following adjustment will be required: Cr Receivables (with the higher amount) Dr Inventory (with the amount in transit i.e. the difference) Dr Payables (with the lower amount)

IFRS 3 Business Combinations - Goodwill

Goodwill is a residual amount calculated by comparing, at acquisition, the value of the subsidiary as a whole and the fair value of its identifiable net assets at this time. A residual amount may exist as a result of the subsidiary's: • Positive reputation • Loyal customer base • Staff expertise etc Goodwill is capitalised as an intangible asset on the consolidated statement of financial position (CSFP). It is subject to an annual impairment review to ensure its value is not overstated on the CSFP.

Government assistance

Governments will often have a number of schemes, aimed at providing assistance to: • small- and medium-sized profit-making entities • entities wanting to expand or relocate in particular regions • promote innovation and technology • projects that will create new jobs or protect existing ones

Gross profit margin

Gross profit margin is the percentage of revenue retained after costs of sale are deducted. Entities will aim to sell many products with a low margin or potentially fewer products with a high margin. A change in gross profit margin may be due to a change in product mix, for example selling more of a product with a higher margin or conversely bringing a new product to market with a low margin to gain market share.

Dividend related ratios

Growth potential and the ability to generate future wealth in the entity may depend on the amount of profits retained. This relationship may be measured using the profit retention ratio: (Profit after dividends / Profit before dividends)*100 The higher the proportion of earnings retained, the higher the growth potential. Cash is retained in the entity for growth as opposed to being paid to shareholders.

IAS 11 Loss making contracts

IAS 11 requires that an expected loss on a construction contract should be recognised immediately. Revenue will be calculated as before, but the whole loss will then be recorded on the gross profit line and cost of sales will be calculated as a balancing figure.

IAS 11 Accounting treatment of construction contracts

IAS 11 states that when the outcome of a construction contract can be estimated reliably, contract revenue and contract costs should be recognised in the statement of profit or loss by reference to the stage of completion of the contract activity at the reporting date.

IAS 17 Leases

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

IAS 18 Revenue

IAS 18 defines revenue as the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity.

IAS 27 Separate financial statements

IAS 27 (revised) applies when an entity has interests in subsidiaries, joint ventures or associates and either elects to, or is required to, prepare separate non-consolidated financial statements.

IAS 28 Significant influence

IAS 28 explains that an investor probably has significant influence if: • It is represented on the board of directors. • It participates in policy-making processes, including decisions about dividends or other distributions. • There are material transactions between the investor and investee. • There is interchange of managerial personnel. • There is provision of essential technical information.

IAS 28 Provisions for unrealised profit (PUP)

IAS 28 requires unrealised profits on transactions between the group and the associate to be eliminated. Only the investor's share of the profit is removed since the group financial statements only reflect the investor's share of the associate profits in the first place. The PUP adjustment is calculated as: PUP = P% × unrealised profit in inventory Parent sells to associate In the CSFP: • Reduce Consolidated retained earnings • Reduce Investment in associate In the CSCI: • Increase Cost of sales Associate sells to parent In the CSFP: • Reduce Consolidated retained earnings • Reduce Inventory In the CSCI: • Reduce Share of profit of associate

Offsetting a financial asset and a financial liability

IAS 32 states that a financial asset and a financial liability may only be offset in very limited circumstances. The net amount may only be reported when the entity: • has a legally enforceable right to set off the amounts • intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.

Importance of DEPS

IAS 33 therefore requires an entity to disclose the DEPS, as well as the basic EPS, calculated using current earnings but assuming that the worst possible future dilution has already happened. Existing shareholders can look at the DEPS to see the effect on current profitability of commitments already entered into to issue ordinary shares in the future.

IAS 37 Provisions, Contingent Liabilities and Contingent Assets,

IAS 37 introduced a set of criteria that must be satisfied before a provision can be recognised. The standard also requires comprehensive disclosure of any provisions that have been made so that users can understand the impact that they have had on the financial performance of the reporting entity.

Interest and dividends

IAS 7 allows interest and dividends, whether received or paid, to be classified under any of the three headings, provided the classification is consistent from period to period. • interest received as a cash flow from investing activities • interest paid as a cash flow from operating activities • dividends received as a cash flow from investing activities • dividends paid as a cash flow from financing activities.

IFRS 10 - Consolidated financial statements

IFRS 10 Consolidated Financial Statements sets out the definition of control and gives guidance on how to identify whether control exists.

IFRS 3 Business Combinations

IFRS 3 Business Combinations allows two methods to be used to value the NCI at the date of acquisition: • Fair value • Proportion of net assets IFRS 3 permits groups to choose how to value NCI on an acquisition by acquisition basis. In other words, it is possible for a group to apply the fair value method for some subsidiaries and the proportion of net assets method for other subsidiaries.

IFRS 3 Impairment of goodwill

IFRS 3 requires that goodwill is tested at each reporting date for impairment. This means that goodwill is reviewed to ensure that its value is not overstated in the consolidated statement of financial position. If an impairment loss exists, goodwill is written down and the loss is charged against profits in the statement of profit or loss.

Inappropriate classification of leases

If an entity inappropriately recognises a finance lease as an operating lease, it will have the following effect on the financial statements: • Assets will be understated Therefore ratios such as return on assets and asset turnover will be overstated • Liabilities will be understated Therefore gearing will be understated This practice is often referred to as 'off balance sheet financing' and is considered to be unethical. Entities should classify leases in accordance with their substance, rather than selecting the classification that enhances their reported performance and position the most.

Effect on the gearing (leverage) ratio.

If an entity is able to exclude liabilities from its statement of financial position it can manipulate the gearing ratio to the lowest possible level. High gearing levels tend to have adverse effects on share prices because the share is perceived by the market as riskier.

Translating the financial statements of a foreign operation

If the currency of a subsidiary is different to that of the parent entity, it will be necessary to translate the subsidiary's financial statements into the parent's presentation currency prior to consolidation. This is done using the 'closing rate' or 'net investment' method and the following exchange rates should be used in the translation: Statement of comprehensive income • Income and expenses - average rate for the year Statement of financial position • Assets and liabilities - closing rate i.e. the rate at the reporting date • Goodwill of subsidiary - closing rate

Control to control disposal

If there is a sale of shares but the parent still retains control then, from the group perspective, there is simply a transaction between owners with the parent's share decreasing and the NCI's share increasing. Where there is such an increase in the non-controlling interest: • No gain or loss on disposal is calculated • No adjustment is made to the carrying value of goodwill • The difference between the proceeds received and change in the non-controlling interest is accounted for in other components of equity

Effect of incorrect classification

If we consider a lessee who has a finance lease but is incorrectly treating it as an operating lease, in the statement of financial position there will be no non-current asset recorded which means that the assets that are earning income for the company are effectively understated. Also, no liability will be recognised and therefore the gearing of the entity will be understated. The correct treatment under a finance lease would be a depreciation charge based on the fair value of the finance lease asset and the finance cost element of the lease payment. However if the lease is treated as an operating lease then the entire lease payment will be charged to the statement of profit or loss. This will probably mean that the total charge to profit or loss will be similar under both treatments.

Impairment of financial assets

Impairments apply only to assets categorised as held to maturity or loans and receivables i.e. those that are measured at amortised cost. Other financial assets are already recorded at fair value and any impairment would have been taken into account when measuring the fair value.

Factoring of receivables

In a factoring arrangement, an entity transfers some or all of its receivables (a category of financial assets) to another entity (the factor) in return for a cash advance. The factor then assumes responsibility for collecting the amounts outstanding from the customers. The legal title to the receivables has transferred to the factor. The factor pays a cash advance to the entity in return for legal title, e.g. 80% of the carrying value of the receivable.

Sale and leaseback transactions

In a sale and leaseback transaction an entity sells one of its assets and immediately leases the asset back. • This is a common way of raising finance whilst retaining the use of the related assets. The buyer/lessor is normally a bank. • There are two key questions to ask when assessing the substance of these transactions: - Is the new lease a finance lease or an operating lease? - If the new lease is an operating lease, was the sale at fair value or not? • The leaseback is classified in accordance with the usual criteria set out in IAS 17.

Sale and finance leaseback IAS 17

In accordance with IAS 17, a sale and leaseback arrangement is, in essence, a financing arrangement. The substance of the transaction is that the asset has been used as security for a loan. The accounting treatment required by IAS 17 is as follows: • The lessee initially defers any gain or loss on disposal of the asset and recognises it over the subsequent lease term. • The lessee then recognises both a finance lease asset and liability in accordance with normal IAS 17 rules

Accounting treatment In accordance with IAS 39

In accordance with IAS 39, the entity should only derecognise the receivables if it has transferred substantially all the risks and rewards of ownership. Factors to consider are: • Does the factor have right of recourse (i.e. can the factor recover the cash advanced in the event of the customer not settling the amount outstanding)? • Can the factor only recover a fixed amount (and if so, does this reflect the majority of the receivables value or not)? • Who bears the risk of slow payment?

IFRS 10, an investor controls an investee

In accordance with IFRS 10, an investor controls an investee if and only if the investor has all of the following elements: • power over the investee (see definition of power above) • exposure, or rights, to variable returns from its involvement with the investee, and • the ability to use its power over the investee to affect the amount of the investor's returns.

Finance leases - The meaning of substance over form

In many types of transactions there is a difference between the commercial substance and the legal form: • Commercial substance reflects the financial reality of the transaction. • Legal form is the legal reality of the transaction. Financial statements are generally required to reflect commercial substance rather than legal form.

IAS 24 Related parties - exclusions from definition

In the context of this standard, the following are not necessarily related parties: (a) two entities simply because they have a director or other member of key management personnel in common, notwithstanding the above definition of 'related party' (b) two venturers simply because they share joint control over a joint venture (c) providers of finance (d) trade unions (e) public utilities (f) government departments and agencies, simply by virtue of their normal dealings with an entity (even though they may affect the freedom of action of an entity or participate in its decision-making process) (g) a customer, supplier, franchisor, distributor or general agent with whom an entity transacts a significant volume of business, merely by virtue of the resulting economic dependence.

The current ratio

The current ratio compares current assets to current liabilities. A ratio greater than 1 indicates there are more current assets than current liabilities. The current ratio guides us to the extent the entity is able to meet its current liabilities as they fall due.

Institutional investors

Institutional investors have little direct involvement other than as investors, agreeing to buy a certain number of shares. They may also be used by the entity and its advisors to provide an indication of the likely take up and acceptable offer price for the shares. Once the shares are in issue institutional investors have a major influence on the evaluation and the market for the shares.

Interest cover

Interest cover indicates the number of times profits will cover the interest charge; the higher the ratio, the better. When looking at interest cover, the stability of profits is important as the interest must be paid consistently out of available profits otherwise the entity may default on its debt and may have to repay it at short notice.

IAS 18 Interest, royalties and dividends

Interest, royalties and dividends should be recognised when: • it is probable that economic benefits will flow to the entity • the revenue can be measured reliably. Interest and royalties should be recognised on an accruals basis, i.e. when earned rather than received. Dividends should be recognised when the right to receive them is established.

Intra-group balances

Intra-group balances and transactions must be eliminated in full, as the group is treated as a single entity and therefore cannot trade with or owe money to itself. • Intra-group balances are eliminated from the consolidated statement of financial position • Intra-group transactions are eliminated from the consolidated statement of comprehensive income • Any profit still held within the group's assets from intra-group trading should also be eliminated (the provision for unrealised profit (PUP) adjustment)

The role of advisors in a share issue

Investment banks usually take the lead role in share issues and will advise on: • the appointment of other specialists (e.g. lawyers) • stock exchange requirements • forms of any new capital to be made available • the number of shares to be issued and the issue price • arrangements for underwriting • publishing the offer.

kd for irredeemable, or undated, bonds

It is highly unusual for bonds to be irredeemable but, if it were, the cost of debt could be calculated as follows: kd =i(1 - T)/ P0 where i = interest paid each year T = marginal rate of tax P0 = ex interest market price of the bonds, normally quoted per 100 unit nominal Note that this formula can also be applied to redeemable bonds trading at par (where the current price is the same as the nominal value), or as an approximation for long-dated debt. Note, for bonds trading at par, P0 is the nominal value and so this formula can be simplified to kd = r(1-T), where r is the interest rate, expressed in percentage terms

Joint contro

Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control.

IAS 24 Key management personnel

Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of that entity.

Identifying assets and liabilities

Key to determining the substance of a transaction is to identify whether assets and liabilities arise subsequent to that transaction by considering: • who enjoys the benefits of any asset • who is exposed to the principal risks of any asset.

Commercial paper

Large profit-making entities may issue unsecured short-term loan notes in the capital market, referred to as commercial paper. These loan notes will generally mature within 9 months, typically between a week and 3 months. The notes can be traded at any time before their maturity date.

Liabilities

Liabilities are defined in the Framework as present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits from the entity.

Preference shares

Preference shares are shares that pays a fixed dividend, which is paid in preference to (before) ordinary share dividends, hence the name.

Options and warrants to subscribe for shares, these 'free' shares are equal to:

No. of options * ((FV - EP))/FV) FV = fair value of the share price EP = exercise price of the shares

Non-current asset policies

Non-current asset policies can have a substantial effect on ratios and comparison between entities. For example, there may be differences in whether an entity owns or leases assets and whether assets are measured at historical cost or are revalued. Depreciation charges will be higher for revalued assets. Depreciation may be categorised as a cost of sale or operating expense.

Non-current asset turnover

Non-current asset turnover is a similar calculation but measuring the efficiency/activity of non-current assets only. There are many variations of this ratio that can provide useful information, such as total asset turnover and working capital turnover.

IFRS 3 Negative goodwill

Occasionally, the consideration paid for the subsidiary may be less than the fair value of the identifiable net assets at acquisition. This may arise when the previous shareholders have been forced to sell the subsidiary and so are selling their holding at a bargain price. This situation gives rise to 'negative goodwill' at acquisition and represents a credit balance. It is viewed as a gain on a 'bargain purchase' (essentially a discount received) and is credited directly to profits and so the group's retained earnings.

'Ex rights'

On the first day of dealings in the newly issued shares, the rights no longer exist and the old shares are now traded 'ex rights' (without rights attached).

Off balance sheet financing

One method of off balance sheet financing is to recognise a finance lease as an operating lease, is however not the only method for removing debt from the statement of financial position. Often the motivation behind transactions that require adjustment for substance over form is the avoidance of liabilities on the statement of financial position.

Capital markets functions

Primary function: The primary function of a stock market is to enable companies to raise new finance (either equity or debt). Through the stock market, a company can communicate with a large pool of potential investors, so it is much easier for a company to raise finance in this way, rather than contacting investors individually. Note that in the UK, a company must be a plc before it is allowed to raise finance from the public on the stock market. Secondary function: The secondary function of a stock market is to enable investors to sell their investments to other investors. A listed company's shares are therefore more marketable than an unlisted company's, which means that they tend to be more attractive to investors

Operating profit margin

Operating profit is the profit from the trading activities of the business; it comprises profits after operating costs, but before finance costs, tax, investment income and any share of profits from an associate. Note that IAS 1 revised does not encourage the reporting of operating profit as a separate line item, although there is nothing to prevent entities

Ordinary shares

Ordinary shares pay dividends at the discretion of the entity's directors. The ordinary shareholders of a company are the owners of the company and they have the right to attend meetings and vote on any important matters.

Non-monetary items

Other items in the statement of financial position. E.g. non-current assets, inventory, investments Treatment: Do not translate i.e. leave at historic rate

Provision for unrealised profit (PUP) in inventory

PUP adjustment = profit on inventory still held in group at year end In the consolidated statement of financial position, deduct from: • Net assets at reporting date column (in net assets working) if S sells the goods or Consolidated reserves if P sells the goods - thereby removing the profit from the appropriate entity's retained earnings figure. • Inventory on the face of the CSFP. In the consolidated statement of comprehensive income: • Add to cost of sales (to reflect reduction in closing inventory and profit) • If S is the seller, adjust the NCI to reflect their share of the PUP adjustment

Revenue

Problems can arise in making a valid interpretation of movements in revenue. For example: • Accounting policies on revenue recognition may vary between entities. There may be inconsistencies between accounting periods, especially where the entity derives some or all of its revenue from long-term contracts. • Inflation may account for some of the increase in price. • A detailed breakdown of revenue for the entity may not be available. To some extent IFRS 8 Operating Segments (see later in the chapter for more details) requires revenue details for different segments of the entity. However there are problems in using segmental data, for example, segments may not be consistently defined. Understanding the reasons for movements in revenue may help to explain movements in costs such as cost of sales, advertising, selling and distribution costs and telephone charges. If revenue increases, then a similar increase in these revenue-related costs could be expected. Conversely, an increase in, say, marketing and advertising expenditure might help to explain an increase in revenue.

Profit before tax margin

Profit before tax margin expresses the relationship between profit before tax and sales. Profit for this purpose would be after deduction of finance costs. An alternative is to calculate profit after tax margin.

IFRS 3 Measuring fair value

Property, plant and equipment Market value. If there is no evidence of market value, depreciated replacement cost should be used Intangible assets Market value. If none exists, an amount that reflects what the acquirer would have paid otherwise. Inventories (i) Finished goods should be valued at selling prices less the sum of disposal costs and a reasonable profit allowance. (ii) Work in progress should be valued at ultimate selling prices less the sum of completion costs, disposal costs and a reasonable profit allowance. (iii) Raw materials should be valued at current replacement costs. Receivables, payables and loans Present value of future cash flows expected to be received or paid. Discounting is unlikely to be necessary for short-term receivables or payables.

IAS 37 Future operating losses

Provisions cannot be made for future operating losses - as they do not meet the definition of a liability (they are an expectation rather than an obligation).

Provisions for future losses in subsidiary acquired

Provisions for future losses or expenses are not part of the value of the parent's holding in the subsidiary. However, they may be provided for in the parent's individual financial statements in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets if the recognition criteria are met.

A rights issue may be defined as:

Raising of new capital by giving existing shareholders the right to subscribe to new shares in proportion to their current holdings. These shares are usually issued at a discount to market price.

Return on capital employed

Return on capital employed (ROCE) is a measurement that is frequently used in the analysis of financial statements. This shows the overall performance of the entity, expressed as a percentage return on the total investment. It measures management's efficiency in generating profits from the resources available. Consistency of numerator and denominator is important in this ratio. Therefore, in calculating ROCE, the numerator should include profit before any deductions for finance costs. If capital employed includes a bank overdraft, the profit figure used in the calculation should exclude interest paid and payable on the overdraft. The basic capital employed figure (the denominator) is equity (including share capital, reserves and NCI) and interest bearing borrowings. An adjustment should then be made to remove the carrying value of any non-current asset that does not contribute to operating profit (the numerator) in order to provide consistency. A classic example of this is an investment in associate. The share of associate profit is presented in the statement of profit or loss below operating profit, therefore the value of the investment in associate should be deducted from the capital employed figure.

Return on capital employed (ROCE)

Return on capital employed (ROCE) is a very useful measure when analysing performance. It assesses the efficiency with which the entity uses its assets to produce profit. You should consider any changes in capital employed and, for example, whether an increase occurred towards the end of an accounting period and hence there has not yet been an opportunity for the entity to use the capital to generate increased profit.

IAS 11 A construction contract formulas

Revenue = Total contract revenue × % complete Cost of sales = Total expected contract costs × % complete Gross profit = Total expected profit × % complete

IAS 18 Rendering of services

Revenue from services should be recognised when all of the following criteria have been met: • the revenue can be measured reliably • it is probable that economic benefits will flow to the entity (i.e. the buyer will pay for the services) • the stage of completion of the transaction can be measured reliably • the costs to the seller can be measured reliably. The revenue would then be recognised by reference to the stage of completion of the transaction at the reporting date.

IAS 18 Sale of goods

Revenue from the sale of goods should be recognised when all of the following criteria have been met: • the significant risks and rewards of ownership have transferred to the buyer • the seller does not retain continuing managerial involvement or control over the goods • the revenue can be measured reliably • it is probable that economic benefits will flow to the entity (i.e. that the buyer will pay for the goods) • the costs to the seller can be measured reliably.

IAS 18 Measurement of revenue

Revenue should be measured at the fair value of the consideration received or receivable. • In most cases this will be the amount of cash received or receivable. • If the effect of the time value for money is material, the revenue should be the discounted present value.

Sale and repurchase transactions

Sale and repurchase agreements are situations where an asset is sold by one party to another. The terms of the sale provide for the seller to repurchase the asset in certain circumstances at some point in the future. Sale and repurchase agreements are common in property developments and in maturing inventories such as whisky. The asset has been 'legally' sold, but there is either a commitment or an option to repurchase the asset at a later date.

Associates - Significant influence

Significant influence is defined as the power to participate in the financial and operating policy decisions of the investee but not control or joint control of those policies. A holding of 20% or more of the voting power is presumed to give significant influence unless it can be clearly demonstrated that this is not the case. At the same time a holding of less than 20% is assumed not to give significant influence unless such influence can be clearly demonstrated.

Presentation of liabilities and equity

The issuer of a financial instrument must classify it as a financial liability or equity instrument on initial recognition according to its substance.

Procedure for calculating the WACC

Step 1 Calculate weights for each source of capital. Step 2 Estimate the cost of each source of capital. Step 3 Multiply the proportion of the total of each source of capital by the cost of that source of capital. Step 4 Sum the results of step 3 to give the weighted average cost of capital.

Stockbrokers provide

Stockbrokers provide advice on the various methods of obtaining a listing. They may work with investment banks on identifying institutional investors, but usually they are involved with smaller issues and placings.

IAS 12 Taxable profits

Taxable profits are the profits on which tax is payable, calculated in accordance with the rules of local tax authorities.

IAS 12 Temporary differences

Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base (i.e. the amount attributed to it for tax purposes). Examples of temporary differences include: • certain types of income and expenditure that are taxed on a cash, rather than an accruals basis, e.g. certain provisions • the difference between the depreciation charged on a non-current asset and the actual tax allowances given (see the expandable text below for an example of this scenario)

The dividend valuation model (DVM) term

The DVM is a method of calculating cost of equity. This model makes the assumption that the market price of a share is related to the future dividend income stream from that share, in such a way that the market price is assumed to be the present value of that future dividend income stream. This is known as the fundamental theory of share valuation.

The dividend valuation model (DVM)

The DVM states that the current share price is determined by the future dividends, discounted at the investors' required rate of return. P0 = d/ke where ke = cost of equity d = is the constant dividend P0 = the ex div market price of the share This is a variant of the formula for a perpetuity.

When can WACC be used as a discount rate?

The WACC is often used as a discount rate when using net present value or internal rate of return calculations. However, this is only appropriate if the following conditions are met: (1) The capital structure is constant. If the capital structure changes, the weightings in the WACC will also change. (2) The new investment does not carry a different business risk profile to the existing entity's operations. (3) The new investment is marginal to the entity. If we are only looking at a small investment then we would not expect any of ke, kd or the WACC to change materially. If the investment is substantial it will usually cause these values to change.

actuarial method

The actuarial method uses the interest rate implicit in the lease (the effective rate) and applies this to the outstanding balance on the liability each period. The liability is effectively being amortised and this treatment is consistent with other financial liabilities

Analysing liquidity

The analysis of the liquidity of an entity should start with a review of the actual bank balance in absolute terms. Has the bank balance increased or decreased significantly? It could be that the overdraft is near to its permitted limit or that high cash resources indicate a good takeover prospect. 1. The current ratio 2. The quick ratio

Mid-year acquisitions

The consolidated statement of financial position (CSFP) reflects the position at the reporting date and therefore figures on the face of the CSFP should never be time apportioned. However, you may be required to time apportion results in order to calculate the reserves at acquisition (for the net assets working). Depending on the information provided, you will be required to either: • Subtract the profits for the post acquisition portion of the year from the closing reserves balance, or • Add the profits for the pre-acquisition portion of the year to the opening reserves balance.

kd for bank borrowings

The cost of debt for bank borrowings is simply kd = r (1 - T) where: r = annual interest rate in percentage terms T = corporate tax rate

the cost of debt - kd

The cost of debt is the rate of return that debt providers require on the funds that they provide. The value of debt is assumed to be the present value of its future cash flows.

The cost of equity - ke

The cost of equity is the rate of return that ordinary shareholders expect to receive on their investment. The main method of computing ke is the dividend valuation model (DVM).

Non-control to control

The date at which control is achieved is the date of acquisition of the subsidiary. • consolidate income, expenses, assets and liabilities on a line by line basis • recognise goodwill • recognise non-controlling interests. At the date when control is achieved: (1) Remeasure the previously held interest to fair value (2) Recognise any resulting gain or loss within the statement of profit or loss (and so retained earnings).

IAS 37 Provisions for dismantling/decommissioning costs

The decommissioning costs form part of the cost of the asset and are therefore capitalised and expensed over the life of the asset (as part of the depreciation charge). To record the provision: Dr Asset (oil well/mine) Cr Provision The provision should be based on the present value of the expected decommissioning cost and therefore, in addition, a finance cost will arise each year as the discount is unwound. To unwind the discount: Dr Finance cost (P/L) Cr Provision

IAS 28 Investments in Associates

The equity method should not be used if: • the investment is classified as held for sale in accordance with IFRS 5, or • the parent is exempted from having to prepare consolidated accounts on the grounds that it is itself a wholly, or partially, owned subsidiary of another company (IFRS 10).

Cum div and ex div share prices

The ex dividend ('ex div') value of a share is the value just after a dividend has been paid. Occasionally in questions, you may be given a share price just before the payment of a dividend (a 'cum div' price). In this case, the value of the upcoming dividend should be deducted from the cum div price to give the ex div price. For example, if a dividend of 20 cents is due to be paid on a share which has a cum div value of $3.45, the ex div share price to be entered into the DVM formula is $3.45 - $0.20 = $3.25.

IFRS 10 Fair value method

The fair value of the non-controlling interest may be calculated using the market value of the subsidiary's shares at the date of acquisition or other valuation techniques if the subsidiary's shares are not traded in an active market. In the assessment, you will be told the fair value of the NCI or will be given the subsidiary's share price in order to be able to calculate it.

Purchasers

The final players in the bond market are those who buy the bonds. Buyers basically include every group mentioned as well as any other type of investor, including the individual.

Fair value of parent's consideration - Exclusions from consideration

The following should never be recognised as part of consideration paid: • Legal and professional fees (and other directly attributable costs of acquisition) • Provisions for future losses in subsidiary acquired

The functional currency

The functional currency is the currency of the primary economic environment in which the entity operates. In most cases this will be the local currency.

Issuers

The issuers sell bonds in the capital markets to fund the operations of their organisations. This area of the market is mostly made up of governments, banks and corporations.

Forward contracts

The holder of a forward contract is obliged to buy or sell a defined amount of a specific underlying asset, at a specified price at a specified future date. For example, a forward contract for foreign currency might require £100,000 to be exchanged for $150,000 in three months' time. Both parties to the contract have both a financial asset and a financial liability. For example, one party has the right to receive $150,000 and the obligation to pay £100,000. Forward currency contracts may be used to minimise the risk on amounts receivable or payable in foreign currencies.

IAS 12 Income taxes

The income tax expense in the statement of profit or loss typically consists of three elements: • current tax expense for the year • under or over provisions in relation to the tax expense of the previous period • deferred tax.

Financial liabilities

The instrument will be classified as a liability if the issuer has a contractual obligation: • to deliver cash (or another financial asset) to the holder • to exchange financial instruments on potentially unfavourable terms.

the inventory holding period

The inventory holding period indicates how much working capital is tied up in goods in the warehouse by giving an average number of days that inventory is held before being sold. An entity must balance the need to supply goods on time to customers with the risk of obsolescence.

kd for redeemable bonds

The kd for redeemable bonds is given by the IRR of the relevant cash flows. The relevant cash flows would be (assuming that there is no one year delay in the tax saving): Year Cash flow 0 Market value of the bond (or nominal value if being issued or is trading at par) (P0) 1 to n Annual interest payments net of tax i(1 - T) n Redemption value of the bond RV There are four steps to ensuring an accurate computation: (1) Identify the cash flows. Note that the interest payments should be included net of tax when calculating the cost of debt for bonds from the viewpoint of the issuer, whereas tax is not deducted when calculating the return to the investor. (2) Estimate the IRR. (3) Calculate two NPVs (preferably one -ve and one +ve). (4) Calculate the IRR.

Recording a finance lease - the lease term.

The lease term is essentially the period over which the lessee has the use of the asset. It includes: • the primary (non-cancellable) period • any secondary periods during which the lessee has the option to continue to lease the asset, provided that it is reasonably certain at the outset that this option will be exercised.

The working capital cycle

The length of the working capital cycle can assist in determining the immediate effects of the financial position on the bank balance. The working capital cycle comprises cash, receivables, inventory and payables. The entity uses cash to buy inventory. Additional inventory may be purchased on credit. Inventories are sold and become receivables. Receivables pay and then the entity has cash available to repay payables or buy further inventory. The total length of the working capital cycle is the inventory holding period plus the receivables days less the payables days, which approximates to the total time it takes to purchase the inventory, sell the inventory and receive cash.

Borrowing capacity.

The lower the level of liabilities recorded on the statement of financial position, the greater the capacity for further borrowings.

IAS 18 issue with revenue is to determin

The main issue with revenue is determining when it should be recognised in the financial statements. The basic principles applied are that revenue should only be recognised when both of the following are satisfied: • it is probable that future economic benefits will flow to the entity • these benefits can be measured reliably.

Money market borrowings

The money market consists of financial institutions and dealers in money or credit who wish to either borrow or lend. The money market is used by participants as a means for borrowing and lending in the short term, from several days to just under a year. This contrasts with the capital market for longer-term funding, for example bonds and equity. The core of the money market consists of interbank lending - banks borrowing from, and lending to, each other. However, large profit-making entities will also borrow and lend on the money market.

Recording a finance lease - Depreciation

The non-current asset should be depreciated over the shorter of: • the useful life of the asset (as in IAS 16) • the lease term.

IAS 37 Obligations

The obligation can be: • legal, i.e. arising from - a contract - legislation - other operation of law • constructive, i.e the entity has created a valid expectation via - established pattern of past practice - published policy or statement

The simplest way to prepare a working for amortised cost is to use the following table.

The opening balance in year 1 is the net proceeds (i.e. after deduction of any discounts and issue costs): • Dr Cash • Cr Liability Effective interest is calculated on the opening balance each period and is charged to the statement of profit or loss (P/L): • Dr Finance costs (P/L) • Cr Liability The coupon paid is the coupon percentage multiplied by the face/nominal value of the debt: • Dr Liability • Cr Cash The closing balance is the figure for the statement of financial position (SFP) at the reporting date

Amortised cost Financial assets

The opening balance in year 1 is the total investment (cash invested plus transaction costs): • Dr Asset • Cr Cash Effective interest is calculated on the opening balance and is credited to the statement of profit or loss (P/L) as finance income: • Dr Asset • Cr Finance income (P/L) The coupon received is the coupon percentage multiplied by the face value of the instrument: • Dr Cash • Cr Asset The closing balance is the figure for the statement of financial position (SFP) at the reporting date.

The operating profit margin

The operating profit margin is the trading or operating profit in relation to revenue, expressed as a percentage. The difference between gross profit margin and operating profit margin is the operating costs of the entity such as administration costs, telephone costs and advertising costs. You need to use any background information provided to assess how these expenses may differ to the prior year or to another entity.

IAS 37 Probable outflow

The outflow of resources must be considered to be more likely than not. Where there are a number of similar obligations, probability is assessed across the entire class of obligations rather than individually.

Fair value of parent's consideration

The types of consideration that may be included are: • Cash (FV = amount paid) • Shares issued by the parent (FV = market price of shares issued) • Deferred consideration (FV = present value) • Contingent consideration (FV = probability weighted present value)

Disposal scenarios - Control to control

The parent disposes of part of its shareholding, leaving a controlling interest after the sale. This situation is the reverse of the control to control acquisitions that we considered earlier in the chapter. There is no change in the status of the investment, it should continue to be recognised as a subsidiary. However the balance of ownership has changed, with the parent selling part of its share to the non-controlling interest. This is reflected within group equity.

Disposal scenarios - Control to non-control

The parent may have sold: - its entire shareholding in subsidiary - part of its shareholding, leaving a residual holding between 20% and 50%, i.e. an associate - part of its shareholding, leaving a residual holding of less than 20%, i.e. a financial asset. In all three of these situations the parent no longer has a controlling interest in the entity and therefore must recognise a disposal of a subsidiary.

The payables payment period

The payables payment period is the length of time it takes to pay suppliers for goods bought on credit. This is effectively a free source of finance but the business should make sure suppliers are paid on a timely basis to avoid the risk of stock-outs.

The presentation currency

The presentation currency is the currency in which the entity presents its financial statements. This can be different from the functional currency, particularly if the entity in question is a foreign owned subsidiary. It may have to present its financial statements in the currency of its parent, even though that is different to its own functional currency.

Convertible debt

The principles of convertible bonds and convertible preference shares are similar and will be dealt with together. If the convertible bonds/preference shares had been converted: • the interest/dividend would be saved therefore earnings would be higher • the number of shares would increase. Note: Interest on bonds is tax deductible however preference dividends do not attract tax relief. Therefore, the interest adjustment should only be reflected net of tax in the case of bonds. Note: If there is an option to convert the debt into a variable number of ordinary shares depending on when conversion takes place, the maximum possible number of additional shares is used in the calculation.

The quick ratio

The quick ratio compares current assets, excluding inventory, to current liabilities. The quick ratio gives a better indicator of liquidity if the inventory of an entity is difficult to realise into cash, for example, a whisky distillery that requires a number of months to mature before being sold.

Short term liquidity

The quick ratio recognises that the time taken to convert inventory into cash in many entities is significantly longer than other current assets and so gives a more conservative view of liquidity. However, it is important to select ratios suitable for the circumstances of the entity. If inventory is an insignificant amount (as it would be, for example, in most service entities), there is little point in calculating the quick ratio. There is no standard number that should be expected in these calculations; it should depend on the industry and should be linked to other areas of the analysis. The higher the ratio, the more liquid the entity, but high liquidity can itself be a problem. It may mean that the entity is unable to utilise cash effectively by investing it profitably.

Inventory holding period

The ratio gives the number of days that inventory, on average, has remained in the warehouse. If only a closing figure is available for inventory, then that can be used. However, the result must be treated with some caution, as the closing figure may be unrepresentative, particularly if the nature of the entity's business is seasonal.

The receivables collection period

The receivables collection period tells us the number of days it takes on average to receive payment from credit customers. It should be based on the credit agreement with customers. Cash should be collected efficiently whilst bearing in mind customers in a strong negotiating position.

Underwriters

The underwriting segment of the bond market is traditionally made up of investment banks and other financial institutions that help the issuer to sell the bonds in the market.

IAS 37 Reliable estimate

The standard states that situations in which a reliable estimate cannot be made should be rare. The estimate should be: • the best estimate of likely outflow • a prudent estimate • discounted when time value of money is material

Consolidated statement of changes in equity - the basics

The statement of changes in equity explains the movement in the equity section of the statement of financial position from the previous reporting date to the current reporting date. From a group perspective, the equity of the group belongs partly to the parent shareholders and partly to the NCI shareholders. A consolidated statement of changes in equity (CSOCIE) will therefore be made up of two columns reflecting: • The changes in equity attributable to parent shareholders, made up of share capital, share premium, retained earnings and any other reserves • The changes in equity attributable to NCI shareholders

sum of digits method.

The sum of digits method provides a reasonable approximation to the actuarial method and therefore can be used as an alternative.

Unsettled transactions at the reporting date

The treatment of any 'foreign' items remaining in the statement of financial position at the year end will depend on whether they are classified as monetary or non-monetary.

Weighted Average Cost of Capital (WACC)

The weighted average cost of capital (WACC) is the average cost of the entity's finance (equity, bonds, bank loans, and preference shares) weighted according to the proportion each element bears to the total pool of funds.

Theoretical prices/values

Theoretical 'ex rights' price is the theoretical price that the class of shares will trade at on the first trading day after issue. It is calculated as follows: (N × cum rights price) + Issue price ————————————————— N+1

Allocation of interest

There are two main methods of allocating the finance cost over the lease period: • actuarial method • sum of digits method.

Retained earnings/existing cash balances

There is a common misconception that an entity with a large amount of retained earnings in its statement of financial position can fund its new investment projects using these retained earnings. This is not the case. An entity can only use internal sources of finance to fund new projects if it has enough cash in hand. The level of retained earnings reflects the amount of profit accumulated over the entity's life. It is not the same as cash.

IAS 12 & IFRS 2 Deferred tax on share option schemes

There is therefore a temporary difference between the impact of the scheme on profit and the impact in tax and this gives rise to a deferred tax asset (it is a deductible temporary difference giving rise to a future benefit). The deferred tax asset should be calculated using the intrinsic value of the options - as this is the amount on which the tax deduction will be based.

Grants

These are often related to technology, job creation or regional policy. They are of particular importance to small and medium-sized businesses (i.e. unlisted). Their key advantage is that they do not need to be paid back. Grants can be provided by local governments, national governments, and other larger bodies such as the European Union.

Options

These give the holder the right, but not the obligation, to buy or sell a specific underlying asset on or before a specified future date.

Asset turnover/utilisation

This calculation shows how much revenue is produced per unit of capital invested. This ratio shows the productivity of assets in generating sales. It should be noted that this ratio is not always useful or informative. Where an entity is using assets that are nearing the end of their useful lives, having been subject to annual depreciation charges over a relatively long period, the ratio is likely to be rather high. Similarly, where an entity uses the historical cost convention, unmodified by revaluation, asset values are also likely to be relatively low, an effect which is more intrusive as the assets age. Also, in labour-intensive entities, where the non-current asset base is low, the ratio tends to lack significance. Note that, where possible, the average asset figure over the year should be used in the denominator of the fraction. This is likely to give a more consistent and representative result. External users of annual reports do not have access to monthly information with which to calculate an average, but opening and closing figures often give a reasonable approximation. The denominator should exclude any assets that do not contribute to revenue as these would distort the ratio.

Deferred consideration

This is consideration, normally cash, which will be paid in the future. It is measured at its present value at acquisition for inclusion within the goodwill calculation, i.e. the future cash flow is discounted. It is recorded in the parent's individual financial statements by: Dr Investments Cr Deferred consideration liability Every year after acquisition, the liability will need to be increased to reflect unwinding the discount. The increase in the liability is charged as a finance cost. Therefore, the entry recorded in the parent's individual financial statements is: Dr Finance cost (and so reduces the parent's retained earnings) Cr Deferred consideration liability

Venture capital

This is finance provided to young, unquoted profit-making entities to help them to expand. It is usually provided in the form of equity finance, but may be a mix of equity and debt. Venture capitalists generally accept low levels of dividends and expect to make most of their returns as capital gains on exit. A typical exit route is an IPO or flotation, which enables the venture capitalist to sell his stake in the entity on the stock market.

Convertible debt

This is similar in effect to attaching a warrant to a debt instrument except that the warrant cannot be detached and traded separately. With convertible debt, the debt itself can be converted into shares at a predetermined price at a date or range of dates in the future. This has the effect of giving the debt holder a potential capital gain over and above the return from the debt interest. If the value of the shares is greater than that of the debt on the exercise date, then conversion will be made by the investor. If, however, the share value is lower than the debt value, the investor may retain the debt to maturity.

Debt finance

This is the loan of funds to a business without conferring ownership rights. The key features of debt financing arising from this 'arm's length relationship' are: • Interest is paid out of pre-tax profits as an expense of the business. • It carries a risk of default if interest and principal payments are not met.

Sale and leaseback

This means selling good quality fixed assets such as high street buildings and leasing them back over many years (25+). Funds are released without any loss of use of assets. Any potential capital gain on assets is forgone. Sale and leaseback is a popular means of funding for retail organisations with substantial high street property e.g. Tesco, Marks and Spencer.

Gross profit margin vol 2

This ratio is expected to be more or less constant from one year to the next within an entity. Even if there is an increase in direct costs, an efficient entity could be expected to pass on the increases in the form of increased sales prices. However, this may not be the case in reality. The gross profit margin requires a detailed breakdown in order to gain an understanding of movements. Ideally, the analyst requires information relating to opening and closing inventories, purchases, direct wages and overheads. Further information as to the following items would be required in order to evaluate gross profit margin fully: • breakdown by product, geographical area or other segment • inventory valuation policies • overhead allocation methods • purchasing details such as bulk discounts, purchasing errors, wastage or theft • selling prices of different products over the period. Obviously, much of this information is not available from an entity's annual report. Some entities do not even report gross profits.

Gross amounts due from customers

This represents the total cost incurred plus any recognised profits (in the statement of profit or loss) less amounts invoiced to customers. This amount is shown as an asset because it represents money that has been spent on the project but customers have not yet been invoiced because it relates to a future activity (no work done yet).

Gross amounts due to customers

This represents the total costs incurred plus any recognised profits (in the statement of profit or loss) less amounts invoiced to customers. This amount is shown as a liability because the amounts invoiced to customers exceeds the amount spent on the project so far, therefore strictly this money is owed to customers (although wouldn't actually be repaid).

Acquisition or disposal of subsidiary

This will affect the NCI column. Upon acquisition of a subsidiary, the NCI is credited initially with either: • Fair value of the NCI at acquisition • The NCI proportion of the fair value of the net assets at acquisition and this credit would be reflected as an increase in the equity attributable to the NCI. When a subsidiary is disposed of, the NCI at the date of disposal is derecognised and would therefore be reflected as a decrease in the equity attributable to the NCI. The consolidated profit or loss on disposal of the subsidiary would be reflected in the comprehensive income attributable to the equity shareholders of the parent.

Effective tax rate vol 2

This will help to understand the impact that tax has on the overall profit for the year. Tax is a consequence of being profitable and, to a certain extent, the impact of tax on profits is outside the control of the entity, however it should be considered when making investment decisions.

Diluted earnings per share (DEPS) basic principles of calculation

To deal with potential ordinary shares, adjust basic earnings and number of shares assuming convertibles, options, etc. had converted to equity shares on the first day of the accounting period, or on the date of issue, if later. DEPS is calculated as follows: Earnings + notional extra earnings / Number of shares + notional extra shares

Impact on post-acquisition depreciation

To record depreciation adjustments in the CSFP: • Adjust net assets working in reporting date column to reflect the cumulative impact on depreciation of the fair value adjustment. • Also reflect adjustment on the face of CSFP. To record depreciation adjustments in the CSCI: • An adjustment should be made to reflect the impact of the fair value adjustment on the current year's depreciation charge. • As this depreciation charge relates to the subsidiary's assets, the adjustment should be reflected in the calculation of profit attributable to the NCI.

Swaps

Two parties agree to exchange periodic payments at specified intervals over a specified time period. For example, in an interest rate swap, the parties may agree to exchange fixed and floating rate interest payments calculated by reference to a notional principal amount. This enables companies to keep a balance between their fixed and floating rate interest payments without having to change the underlying loans.

Revolving credit facilities (RCFs)

Under a RCF the borrower may use or withdraw funds up to a pre-approved credit limit. The amount of available credit decreases and increases as funds are borrowed and then repaid.

Finance leases

Under a finance lease the risk and rewards of ownership lie with the lessee. Therefore, by applying substance over form the lessee should recognise the item being leased as an asset in its statement of financial position.

Operating leases

Under an operating lease the risks and rewards of ownership lie with the lessor, not the lessee. Therefore it can be concluded that the lessee should not record the item being leased as an asset.

IAS 7 cash flow

Under the indirect method adjustments are needed for a number of items, the most frequently occurring of which are: • depreciation, amortisation and impairment • profit or loss on disposal of non current assets • change in inventory • change in receivables • change in payables

IFRS 10 Proportion of net assets method

Under this method, the NCI is measured by calculating the share of the fair value of the subsidiary's net assets at acquisition.

'Cum rights'

When a rights issue is announced, all existing shareholders have the right to subscribe for new shares, and so there are rights ('cum rights') attached to the shares, and the shares are traded 'cum rights'

Substance over form with a finance lease

When an asset is leased under a finance lease there is a difference between the legal form of that transaction and its commercial substance: Legal form: the asset remains legally owned by the party leasing it out (the lessor). Commercial substance: the party making the lease payments (the lessee) has the use of the asset for most or all of its useful life. The lessee has effectively purchased the asset by taking out a loan (the finance lease commitments).

Over-trading

When an entity grows rapidly there is a risk of over-trading, i.e. expanding the entity without adequate long term finance. Inventory, receivables and payables increase but there is a decline in cash and the entity may be unable to pay its suppliers as debts fall due. Entities in this position should look to raise long-term finance. This will enable the entity to improve its inventory and credit control and, by reducing its inventory and receivable days, improve its cash-flow. Other options include factoring of receivables or invoice discounting facilities.

A stock exchange listing

When an entity obtains a listing (or quotation) for its shares on a stock exchange this is referred to as a flotation or an Initial Public Offering (IPO).

The basic principles IFRS 2 share based payment

When an entity receives employee services or goods as a result of a share-based payment transaction, it recognises either an expense or an asset. • If the goods or services are received in exchange for equity (e.g. for share options), the entity recognises an increase in equity. - The double entry is: - Dr Expense/Asset - Cr Equity (normally a special reserve). • If the goods or services are received or acquired in a cash-settled share-based payment transaction, the entity recognises a liability. - The double entry is: - Dr Expense/Asset - Cr Liability. All share-based payment transactions are measured at fair value.

Analysing investor ratios and data

When appraising an entity as a potential investment, all the ratios discussed above may be used. This information may be supplemented by further ratios specifically for investors. The market price of an ordinary share is often used in this analysis.

Subsequent measurement - settled transactions

When cash settlement occurs, for example payment received from a foreign customer, the settled amount should be translated using the spot exchange rate on the settlement date. If this amount differs from that recorded when the transaction occurred, there will be an exchange difference which is taken to the statement of profit or loss in the period in which it arises.

Intra-group balances - in transit items

When eliminating intra-group receivables and payables, the account balances may disagree. This is most likely to be due to cash in transit or goods in transit.

IAS 11 overall outcome

When the overall outcome (profit or loss) cannot be estimated reliably IAS 11 requires revenue to be recognised equal to costs incurred in period (assuming the revenue will probably be recovered). Therefore, nil profit will be recognised.

Translation of foreign currency transactions

Where an entity enters into a transaction denominated in a currency other than its functional currency, that transaction must be translated into the functional currency before it is recorded.

Profit before/after tax margin

Where comparing profit year on year, it is important to allow for any exceptional charges or credits. Also, it would be sensible when calculating profit after tax margin to take into account any large adjustments in respect of under- or over-provided tax provisions.

Control to control

Where the parent already owns a controlling shareholding and subsequently purchases additional shares, they are simply purchasing the shares from the NCI shareholders. This means that the transaction is between the owners of the group, with the parent's share increasing and the NCI's share decreasing.

IAS 39 Treatment of investment as available for sale

the investment will have been remeasured to fair value since the date of acquisition, with any gains or losses arising being taken to other components of equity. Upon consolidation, these gains or losses should be reversed back out so that the investment is restated to its fair value at the date of acquisition (for inclusion in the goodwill calculation).

IAS 11 The work certified basis is calculated as follows:

Work certified to date / Total revenue for the contract = % of completion

IAS 11 Profitable contracts

Workings • Calculate overall expected profit on the contract. • Calculate percentage completion of contract as at the reporting date. Statement of profit or loss • Revenue for period = (% × total revenue) - revenues previously recognised in prior periods • Cost of sales = (% × total costs) - costs previously recognised in prior periods • Gross profit = Revenue - Cost of Sales Statement of financial position • IAS 11 requires the 'gross amount due from/to customers' to be disclosed in the statement of financial position as either an asset or a liability. • Amounts due from customers = asset (positive figure) • Amounts due to customers = liability (negative figure)

Yield on redeemable debt

YTM = the internal rate of return (IRR) of the bond price, the annual interest received and the final redemption amount. This ensures that the yield calculation incorporates a return in the form of the final redemption amount as well as the annual interest amounts.

Diluted earnings per share (DEPS)

a diluted EPS figure attempts to alert shareholders to the potential impact of these changes on the EPS figure.

Share

a fixed identifiable unit of capital in an entity which normally has a fixed nominal value, which may be quite different from its market value. Shareholders receive returns from their investment in shares in the form of dividends, and also capital growth in the share price.

Exchange difference on net assets

arising as opening net assets are initially translated at the opening rate, the comprehensive income for the year (i.e. movement on net assets) will have been translated at average rate and the closing net assets on the statement of financial position are then translated at the closing rate

Cash-settled share-based payments

cash-settled share-based payment transaction is the payment of a bonus to an employee based on the entity's share price.

IFRS 11 Joint Arrangements

defines two types of arrangement in which there is joint control - a joint venture and a joint operation - and sets out the accounting treatment of each.

IAS 11 The stage of completion can be calculated in various ways,

e.g. cost basis (internal method), work certified basis (external method).

Sale and operating leaseback - not on fair value

if the sale is not at fair value then this suggests that it is not a 'straight-forward' sale and the difference between sale proceeds and fair value needs to be considered carefully as follows: • If sale proceeds are greater than fair value, defer the excess and recognise over the lease term • If sale proceeds are lower than fair value, consider whether future lease payments are below market price: - If yes, defer the difference between proceeds and fair value (a loss) and amortise over lease term - If no, recognise total profit or loss on disposal immediately (no deferral)

Formula - given in the assessment WACC

k0=ke(Ve/(Ve+Vd))+kd(Vd(Ve+Vd))

The dividend valuation model with constant growth

ke =(d1/P0)+g or ke =(d0(1+g)/P0)+g where g = a constant rate of growth in dividends d1 = dividend to be paid in one year's time d0 = current dividend

The dividend valuation model with constant dividends

ke =d/P0

'Limited by shares'

means that the company has shareholders, and that the liability of the shareholders to creditors of the company is limited to the capital originally invested, i.e. the nominal value of the shares and any premium paid in return for the issue of the shares by the company. A shareholder's personal assets are thereby protected in the event of the company's insolvency, but money invested in the company will be lost.

IAS 32 Financial instruments

presentation provides the rules on classifying financial instruments as liabilities or equity. These are detailed below.

IAS 18 Revenue does not include:

• Proceeds from sale of non-current assets • Sales and other similar taxes • Other amounts collected on behalf of others - for example in an agency relationship, agent would only recognise commission

IAS 39 Financial instruments

recognition and measurement provides guidance on when financial instruments should be recognised in the financial statements and how they should be measured.

The consolidated statement of cash flows

required to deal with: • Dividends paid to non-controlling interests (financing cash outflow) • Dividends received from the associate (investing cash inflow) • Cash flows related to the acquisition or disposal of a subsidiary during the year (cash received/ paid net of the sub's cash balance) • If there has been an acquisition or disposal of a subsidiary during the year, the impact of it will need to be considered when using workings to calculate cash flows.

Establishing the group structure

the following should be carefully considered : • Control - which entities does the parent control either directly or indirectly? • Percentages - what are the effective ownership percentages for the consolidation? • Dates - when did the parent achieve control and so what is the date of acquisition?

the interest charged

the interest charged on debt finance should be compared to interest rates available to the entity from other sources. Also, debt is often secured on assets for security so there needs to be sufficient assets for this to be possible.

IAS 24 requires an entity to disclose key management personnel compensation

• short-term employee benefits • post-employment benefits • other long-term benefits • termination benefits • equity compensation benefits.

IFRS 3 Impairment of goodwill - Proportion of net assets method

valuing the NCI at the proportion of the subsidiary's net assets is equivalent to recognising only the goodwill attributable to the parent shareholders. Consequently, any impairment loss is only charged to the parent shareholders in the equity section of the CSFP. To record the impairment loss: • Reduce Goodwill by the amount of the impairment loss (Cr). • Reduce Consolidated retained earnings by the amount of the impairment loss

Exchange difference on goodwill

will have been previously translated at the current year's opening rate (the previous year's closing rate), any impairment in the year will be translated at average rate in the statement of profit or loss and the year end goodwill is then translated at closing rate in the statement of financial position

Presentation of compound instruments

• A compound instrument is a financial instrument that has characteristics of both equity and liabilities. • Convertible bonds are compound instruments (they are currently debt but can be converted into equity shares). • These must be shown separately in the financial statements. • Subsequently, the liability component is measured at amortised cost and the equity component remains unchanged. • Any transaction costs would be pro-rated between equity and liability component based on their values.

To record fair value adjustments in the CSFP

• Adjust the net assets working at acquisition and the reporting date as appropriate: - The fair value adjustment arises at acquisition so there should always be an adjustment to the net assets at the date of acquisition. - The net assets at the reporting date should also be adjusted unless you're told that the assets/liabilities to which the adjustment relates are no longer held by the group. • Reflect the reporting date adjustment on face of CSFP.

Market price after issue

• After the announcement of a rights issue there is a tendency for share prices to fall. • The temporary fall is due to uncertainty about: - consequences of the issue - future profits - future dividends. • After the actual issue the market price will normally fall again because: - there are more shares in issue (adverse affect on earnings per share), and - new shares were issued at market price discount.

Fair value of subsidiary's net assets

• An asset or liability may only be recognised if it meets the definition of an asset or liability as at the acquisition date. - For example, costs relating to restructuring the subsidiary that will arise after acquisition do not meet the definition of a liability at the date of acquisition. • An asset is identifiable if it either: - is capable of being separated (regardless of whether the subsidiary intends to sell it), or - arises from contractual or other legal rights. • Contingent liabilities of subsidiary are recognised in group accounts upon acquisition. - By definition, contingent liabilities are not recognised in the subsidiary's individual financial statements (they are disclosed by note in accordance with IAS 37). On consolidation, however, a contingent liability will be recognised as a liability if its fair value can be measured reliably, i.e. it is recognised even if it is not probable.

Impairment rules per IAS 39 are as follows:

• Assess at each reporting date whether there is any evidence of impairment, i.e. whether an event has occurred that has a negative impact on the estimated future cash flows of the financial asset. • If there is evidence, a detailed impairment review must be undertaken. • The impairment loss (if not given in the question) is the difference between the carrying amount and the present value of the cash flows estimated to arise from the asset, discounted at the asset's original effective interest rate. • Impairment losses are recognised through the statement of profit or loss.

Dividends received from associates

• Associates generate cash flows into the group to the extent that dividends are received out of the profits of the associate. • Such dividends received from associates should be disclosed separately in the statement of cash flows. • To calculate the amount received, reconcile the investment in associate in the statement of financial position from the opening to the closing balance. • The share of profit/loss of the associate is a non-cash item included within profit and therefore will be an adjustment in the operating activities section of the statement of cash flows. • If other comprehensive income includes any share of OCI of the associate then this should be taken into account when calculating the cash flow, but should not be adjusted for within operating activities as it is not part of profit.

Difficulties in drawing comparisons between different entities

• Comparisons affected by changes in the entity's business, for example selling an operation. • Different accounting policies between different entities, e.g. revaluations. • Different accounting practices between different entities, e.g. debt factoring, lease v buy decisions. • Different entities within the same industry may have different activities. • Non co-terminous accounting periods. • Different entities may not be comparable in terms of size. • Comparisons between entities operating in different countries will be influenced by different legal and regulatory systems, the relative strength and weakness of the national economy and exchange rate fluctuations.

With the case of assets there are two possible outcomes:

• Complete derecognition - when there is a transfer to another party of all the significant risks and benefits associated with the asset. • No derecognition - no significant change to benefits and risks.

Consolidated statement of financial position

• Consolidate as normal, with the increase in non-controlling interest reflected in the NCI reserve • Take the difference between proceeds and the transfer to the NCI to other components of equity as previously discussed.

Consolidated statement of comprehensive income

• Consolidate the subsidiary's results for the whole year. • Calculate the non-controlling interest relating to the periods before and after the disposal separately and then add together. For example, if the shares are sold on 1 November and year end is 31 December: (10 /12 × profit × 20%) + ( 2/12 × profit × 25%)

A stock exchange listing Disadvantages of a listing

• Costly for a small entity (flotation, underwriting costs, etc.) • Making enough shares available to allow a market, and hence loss of at least some control of the original owners. • Reporting requirements are more onerous. • Stock exchange rules for obtaining a quotation can be stringent

Inventory is legally owned by the manufacturer until:

• Dealer sells inventory onto a third party or • Dealer's right to return expires and the inventory is still held However, the inventory is actually held by the dealer.

IAS 37 Disclosures required for contingent liabilities and assets

• Description of nature of contingent liability/asset • An estimate of its financial effect • An indication of uncertainties relating to amount or timing of outflow/inflow • For contingent liabilities, the possibility of any reimbursement

A financial asset could be classified in one or more categories

• FVPL - if the loan was to be traded • HTM - if the loan was quoted and there was an ability and intention to hold to maturity • L&R - if the loan was unquoted.

an investment in another entity's ordinary shares could be classified as:

• FVPL - if the shares are held for trading • AFS - otherwise.

Financial assets

• Financial assets and liabilities are initially recognised at fair value (which is typically cash paid/received). • Except in the case of assets or liabilities at fair value through profit or loss, directly attributable transaction costs are added to an asset and deducted from a liability. • Subsequent measurement of financial instruments depends on how the instruments have been classified.

Types of derivative

• Forward - the obligation to buy or sell a defined amount of a specific underlying asset, at a specified price at a specified future date. • Forward rate agreements - a contract to fix the interest charge on a floating rate loan. • Futures contracts - the obligation to buy or sell a standard quantity of a specific underlying item at a specified future date. • Swaps - an agreement to exchange periodic payments at specified intervals over a specified time period. • Options - the right, but not the obligation, to buy or sell a specific underlying asset on or before a specified future date.

Sale and repurchase transactions - Factors to consider:

• Has the entity transferred the risks and benefits of the asset? E.g. can the entity still use the asset? Does the entity bear costs associated with the asset? • Was the asset "sold" at a price different to market value? • Is the entity obliged to repurchase the asset? • If the entity has the option to repurchase the asset are they likely to exercise this option?

There are four accounting standards that deal with financial instruments:

• IAS 32 Financial instruments: presentation • IAS 39 Financial instruments: recognition and measurement • IFRS 7 Financial instruments: disclosures • IFRS 9 Financial instruments IAS 32 deals with the classification of financial instruments and their presentation in financial statements. IAS 39 deals with how financial instruments are measured and when they should be recognised in financial statements. IFRS 7 deals with the disclosure of financial instruments in financial statements. This standard is not examinable in the F2 syllabus. IFRS 9 will eventually supersede IAS 39. It is currently a work in progress and no effective date for application has been set, therefore it is not examinable.

Objective of statements of cash flows

• IAS 7 Statement of cash flows provides guidance on the preparation of a statement of cash flows. • The objective of a statement of cash flows is to provide information on an entity's changes in cash and cash equivalents during the period. • The statement of financial position and statement of comprehensive income (SCI) are prepared on an accruals basis and do not show how the business has generated and used cash in the accounting period. • The SCI may show profits on an accruals basis even if the company is suffering severe cash flow problems. • Statements of cash flows enable users of the financial statements to assess the liquidity, solvency and financial adaptability of a business.

Acquisition and disposal of subsidiaries - Standard accounting practice

• If a subsidiary joins or leaves a group during a financial year, the cash flows of the group should include the cash flows of that subsidiary for the same period that the results of the subsidiary are included in the statement of comprehensive income. • Cash payments to acquire subsidiaries and receipts from disposals of subsidiaries must be reported separately in the statement of cash flows under investing activities.

Acquisition and disposal of subsidiaries - Acquisitions

• In the statement of cash flows we must record the actual cash flow for the purchase, not the net assets acquired. The cash outflow is net of any cash balances purchased with the subsidiary. • All assets and liabilities acquired must be included in any workings to calculate the cash movement for an item during the year. If they are not included in deriving the balancing figure, the incorrect cash flow figure will be calculated. This applies to all assets and liabilities acquired and also to the NCI reconciliation (to calculated dividends paid to NCI).

IAS 24 Typical related parties are:

• Key management personnel • Close family members of key management personnel • Entities that are members of the same group (including parent, subsidiaries, associates and joint ventures).

Accounting treatment for an operating lease

• Lease payments are charged to the statement of profit or loss on a straight line basis over the term of the lease, unless another systematic basis is more appropriate. • Any difference between amounts charged and amounts paid will be recognised as prepayments or accruals in the statement of financial position.

IAS 17 Indications of a finance lease

• Legal title is transferred to the lessee at the end of the lease. • The lessee has the option to purchase the asset for a price substantially below the fair value of the asset. • The lease term is for the majority of the asset's useful life. • The present value of the minimum lease payments amounts to substantially all of the fair value of the asset. • The leased assets are of such a specialised nature that only the lessee can use them without major modification. • The lessee bears losses arising from cancelling the lease. • Lessee has ability to continue the lease for a secondary period at a rate below market rent.

To deal with fair value adjustments in a foreign subsidiary, apply the following rules

• On the face of the consolidated statement of financial position, translate the fair value adjustment using the closing rate • In the statement of profit or loss, translate any fair value depreciation adjustment relating to the current year using the average rate

A stock exchange listing Advantages of a listing

• Once listed, the market will provide a more accurate valuation of the entity than had been previously possible. • Realisation of paper profits, and mechanism for buying and selling shares in the future at will. • Raise profile of entity, which may have an impact on revenues, credibility with suppliers and long-term providers of finance. • Raise capital for future investment. • Makes employee share schemes more accessible.

Amortised cost financial instruments

• One common form of financial instrument for many entities will be loans payable. These will normally be measured at amortised cost. The amortised cost of a liability equals: initial cost plus interest less repayments. • The interest will be charged on the outstanding balance at the effective rate. This is the internal rate of return of the instrument.

Limitations of financial reporting information

• Only provide historic data. • Only provide financial information. • Filed at least 3 months after reporting date reducing its relevance. • Limited information to be able to identify trends over time. • Lack of detailed information. • Historic cost accounting does not take into account inflation.

The key things to remember are:

• Profit or loss and other comprehensive income items are translated at average rate each year • Assets and liabilities are translated at closing rate each year • Exchange differences arising on the retranslation of the operation (on net assets and goodwill) are recognised within other comprehensive income. • The exchange difference on net assets is attributed between parent shareholders and NCI based on their percentage holdings • The exchange difference on goodwill be attributed as follows: - All to parent shareholders, if NCI is measured using proportion of net assets method - Between parent shareholders and NCI (based on their percentage holdings) if the NCI is measured using the fair value method - Note that this is consistent with the treatment of goodwill impairment. To calculate the exchange differences, the following proformas can be used.

Calculation and interpretation of ratios

• Profitability/performance ratios - Gross profit margin, operating profit margin, net profit margin - Return on capital employed • Liquidity ratios - Current and quick (acid test) ratios • Efficiency/activity ratios - Working capital ratios - Asset turnover ratios • Capital structure ratios - Gearing - Interest cover

Control to non-control

• Recognises: - the consideration received - any investment retained in the former subsidiary at fair value at the date of disposal • Derecognises: - the assets and liabilities of the subsidiary at the date of disposal - the goodwill in the subsidiary at the date of disposal - the non-controlling interest at the date of disposal • Any difference between these amounts is recognised as an exceptional gain or loss on disposal in the consolidated statement of profit or loss.

Interest, dividends, losses and gains

• The accounting treatment of interest, dividends, losses and gains relating to a financial instrument follows the treatment of the instrument itself. • For example, dividends paid in respect of preference shares classified as a liability will be charged as a finance expense through profit or loss. • Dividends paid on shares classified as equity will be reported in the statement of changes in equity.

The impact of the fair value adjustment would then need to be carefully considered when calculating the exchange difference for the year on the net assets:

• The comprehensive income for the year should be adjusted for the current year fair value depreciation • The opening and closing net assets should be adjusted for the fair value adjustment less accumulated depreciation at that point in time

An entity should consider the following when determining its functional currency:

• The currency that mainly influences sales prices for goods and services • The currency of the country whose competitive forces and regulations mainly determine the sales prices of goods and services • The currency that mainly influences labour, material and other costs of providing goods and services The following factors may also be considered: • The currency in which funding from issuing debt and equity is generated • The currency in which receipts from operating activities are usually retained The entity maintains its day-to-day financial records in its functional currency.

Cash flows from operating activitiesThere are two methods of calculating the cash from operations.

• The direct method shows operating cash receipts and payments. This includes cash receipts from customers, cash payments to suppliers and cash payments to and on behalf of employees. The Examiner has indicated that the direct method will not be examined and is not considered further within this text. • The indirect method starts with profit before tax and adjusts it for non-cash charges and credits, to reconcile it to the net cash flow from operating activities.

IFRS 10 Acquisition accounting

• The parent and subsidiaries' assets, liabilities, income and expenses are combined in full. • Goodwill is recognised in accordance with IFRS 3 (revised) Business Combinations. • The share capital of the group is the share capital of the parent only. • Intra-group balances and transactions are eliminated in full (including profits/losses on intra-group transactions still held in assets such as inventory and non-current assets - the PUP adjustment). • Uniform accounting policies must be used. • Non-controlling interests are presented within equity, separately from the equity of the owners of the parent. Profit and total comprehensive income are attributed to the owners of the parent and to the non-controlling interests.

Acquisition and disposal of subsidiaries - Disposals

• The statement of cash flows will show the cash received from the sale of the subsidiary, net of any cash balances that were transferred out with the sale. • When calculating the movement between the opening and closing balance of an item, the assets and liabilities that have been disposed of must be taken into account in order to calculate the correct cash figure. As with acquisitions, this applies to all asset and liability reconciliations and also to the NCI reconciliation (to calculated dividends paid to NCI).

Initial recognition

• The transaction will initially be recorded by applying the spot exchange rate, i.e. the exchange rate at the date of the transaction.

Control to control - parent holds 80% of the shares in a subsidiary and buys 5% more

• There is no change to the carrying value of goodwill • The income, expenses, assets and liabilities continue to be consolidated line by line • If the step acquisition happens mid-year, it will be necessary to time apportion profits when determining the NCI share of profits • No gain or loss arises as this is a transaction within equity i.e. a transaction between owners • A difference may arise that will be taken to other components of equity which can be determined using the following proforma.

Creative accounting

• Timing of transactions may be delayed/speeded up to improve results, e.g. not investing in non-current assets to ensure ROCE does not fall. • Profit smoothing using choices allowed, e.g. inventory valuation method. • Classification of items, e.g. expenses v non-current assets; ordinary v exceptional. • Off-balance sheet financing to improve gearing and ROCE. • Revenue recognition policies. • Managing market expectations.

Cash-settled share-based payments measure

• Until the liability is settled, the entity remeasures the fair value of the liability at each reporting date and then at the date of settlement. Notice that this is different from accounting for equity share-based payments, where the fair value is fixed at the grant date. • Changes in fair value are recognised in profit or loss for the period. • Where services are received, these are recognised over the period that the employees render the services. (This is the same principle as for equity-settled transactions). • The expense recognised in each accounting period has a double entry to a provision/liability account. - Dr P/L - Cr Liability • On the vesting date, the amount of the liability should equal the cash to be paid.

Dividends paid to non-controlling interests

• When a subsidiary has paid a dividend, only the share paid to the non-controlling interest is reflected in the consolidated financial statements (the share paid to the parent is eliminated as an intra-group transaction). • The dividends paid to the non-controlling interests should be disclosed separately from the dividends paid to the parent shareholders in the statement of cash flows. • To calculate the amount paid, reconcile the non-controlling interest in the statement of financial position from the opening to the closing balance.

Limitations of ratio analysis

• Where ratios have been provided, there may be discrepancies between how they have been calculated for each entity/period, e.g. gearing. • Distortions when using year-end figures, particularly in seasonal industries and when entities have different accounting dates. • Distortions due to not being able to use most appropriate figures, e.g. total sales revenue rather than credit sales when calculating receivables days. • It is difficult to identify reasons behind ratio movements without significant additional information.

to determine which entity should recognise the inventory

• Who bears the risks of the inventory? • Who has the benefits or rewards of the inventory? • Who has control over the inventory? Whoever bears the significant risks of the inventory should recognise it in the statement of financial position.

IAS 37 A contingent liability is:

• a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity, or • a present obligation that arises from past events but is not recognised because: - it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or - the amount of the obligation cannot be measured with sufficient reliability.

Classification of cash flows

• cash flows from operating activities, defined as the entity's principal revenue earning activities and other activities that do not fall under the next two headings • cash flows from investing activities, defined as the acquisition and disposal of long-term assets and other investments (excluding cash equivalents) • cash flows from financing activities, defined as activities that change the size and composition of the entity's equity and borrowings

Rights issue

• contribute additional resources; and • are normally priced below full market price. Therefore, they combine the characteristics of issues at full market price and bonus issues.

Different types of preference shares

• cumulative preference shares, for which dividends must be paid including skipped dividends i.e. if a dividend is skipped one year, the skipped dividend has to be paid the following year along with the 'normal' dividend. • non-cumulative preference shares, for which skipped dividends do not have to be paid later. • participating preference shares, which give the holder fixed dividends plus extra earnings based on certain conditions (in a similar way to ordinary shares). • convertible preference shares, which can be exchanged for a specified number of ordinary shares on some given future date.

Bonus issue

• does not provide additional resources to the issuer. • means that the shareholder owns the same proportion of the business before and after the issue.

IFRS 2 applies to all types of share-based payment transaction. There are two main types:

• in an equity-settled share-based payment transaction, the entity rewards staff (or other parties) with equity instruments (e.g. shares or share options) • in a cash-settled share-based payment transaction, the entity rewards staff (or other parties) with amounts of cash measured by reference to the entity's share price. The most common type of share-based payment transaction is where share options are granted to employees or directors as part of their remuneration.

Consignment inventory is inventory which:

• is legally owned by one party • is held by another party, on terms which give the holder the right to sell the inventory in the normal course of business or, at the holder's option, to return it to the legal owner. This type of arrangement is common in the motor trade. The manufacturer delivers inventory to the dealer which the dealer can then sell on to a customer.

IAS 37 Provision can then only be made for costs that are:

• necessarily entailed by the restructuring, and • not associated with the ongoing activities of the entity. Costs specifically not allowed include retraining/relocation of existing staff, marketing and investment in new systems.

IAS 37 Accounting for a contingent asset

• not recognised • disclosed in a note, if an inflow is considered probable.

IAS 37 Accounting for a contingent liability

• not recognised • disclosed in a note, unless the possibility of outflow is remote

IAS 12 Deferred tax - The differences between accounting profit and taxable profit can be caused by:

• permanent differences (e.g. expenses not allowed for tax purposes) • temporary differences (e.g. expenses allowed for tax purposes but in a later accounting period) Only temporary differences are taken into account when calculating deferred tax.

Financing cash inflows include:

• receipts from issuing shares or other equity instruments • receipts from issuing debentures, loan notes and bonds and from other long-term and short-term borrowings (other than overdrafts, which are normally included in cash and cash equivalents).

Financing cash outflows include:

• repayments of amounts borrowed (other than overdrafts) • the capital element of finance lease rental payments • payments to reacquire or redeem the entity's shares.

IFRS 12 Disclosure requirements include:

• significant judgements and assumptions made in determining whether an investor has control, joint control or significant influence over an investee • the nature, extent and financial effects of its interests in joint arrangements and associates • subsidiaries with non-controlling interests, joint arrangements and associates that are individually material • significant restrictions on the ability of the parent to access and use the assets or settle the liabilities of its subsidiaries • extended disclosures relating to 'structured entities' (previously known as special purpose entities) such as the terms on which an investor may be required to provide financial support to such an entity.

IFRS 12 Disclosure of interests in other entities

• subsidiaries • joint arrangements (joint operations or joint ventures) • associates • unconsolidated 'structured' entities. The objective of the standard is to enable users of financial statements to understand the risks associated with investments in other entities and to evaluate the effect that they have on the financial statements.

Bonus issue in the calculation of EPS:

• the bonus shares are deemed to have always been in issue and therefore are reflected for the full period. • the comparative figures are also restated to include the bonus shares.

Diluted earnings per share (DEPS) examples of dilutive factors are:

• the conversion terms for convertible bonds (or convertible preference shares) • the exercise price for options (or subscription price for warrants). When the potential ordinary shares are issued the total number of shares in issue will increase and this can have a dilutive effect on EPS i.e. it may fall. It will fall where the increase in shares outweighs any increase in profits, e.g. from a reduction in finance costs once debt has been converted.

IAS 21 deals with:

• the definition of functional and presentation currencies • accounting for individual transactions in a foreign currency • translating the financial statements of a foreign operation

IAS 37 A provision can only be made if:

• the entity has a detailed formal plan, and • has raised a valid expectation in those affected that it will carry out the restructuring by - starting to implement it, or - announcing it

IAS 12 Deferred tax

• the estimated future tax consequences of transactions and events recognised in the financial statements of the current and previous periods. Deferred tax does not represent the tax payable to the tax authorities. Deferred tax is a basis of allocating tax charges to particular accounting periods. It is an application of the accruals concept and aims to eliminate a mismatch between: • accounting profit, the profit before tax figure in the statement of profit or loss, and • taxable profit, the figure on which the tax authorities base their tax calculations.

IAS 27 Disclosures required when separate non-consolidated financial statements have been prepared by the parent entity include:

• the fact that exemption from consolidation has been used (usually as an intermediate holding entity) together with details of the ultimate parent who has prepared group financial statements • in cases other than being an intermediate holding entity, the reason why separate financial statements have been prepared • a list of names, interests in and principle place of business of each significant subsidiary, joint venture and associate, including details of how they have been accounted for in the separate financial statements.

two important capital markets in the UK:

• the full Stock Exchange - a market for larger companies. Entry costs are high and scrutiny is very high for companies listed on the 'full list', but the profile of a Stock Exchange listed company's shares is very high, so the shares are extremely marketable. • the Alternative Investment Market (AIM) - a market for smaller companies, with lower associated costs and less stringent entry criteria.

The total number of shares issued on the exercise of the option or warrant is split into two:

• the number of shares that would have been issued if the cash received had been used to buy shares at fair value (using the average price of the shares during the period); • the remainder, which are treated like a bonus issue (i.e. as having been issued for no consideration). The number of shares issued for no consideration is added to the weighted average number of shares when calculating the DEPS.

IAS 18 deals with the following:

• the sale of goods • the rendering of services • interest, royalties and dividends.

IAS 24 Note however that the following are normally considered not to be related parties

• two entities simply because they have a director/member of key management personnel in common • two joint venturers simply because they share joint control of a joint venture • providers of finance • key customers and suppliers.