cpa summary notes statement of cash flow objective of ias...
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CPA Summary Notes
Statement of Cash Flow
Objective of IAS 7
The objective of IAS 7 is to require the presentation of information about the historical changes in cash and
cash equivalents of an entity by means of a statement of cash flows, which classifies cash flows during the
period according to operating, investing, and financing activities
.
Fundamental principle in IAS 7
All entities that prepare financial statements in conformity with IFRSs are required to present a statement of
cash flows. [IAS 7.1]
The statement of cash flows analyses changes in cash and cash equivalents during a period. Cash and cash
equivalents comprise cash on hand and demand deposits, together with shortterm, highly liquid
investments that are readily convertible to a known amount of cash, and that are subject to an insignificant
risk of changes in value. Guidance notes indicate that an investment normally meets the definition of a cash
equivalent when it has a maturity of three months or less from the date of acquisition. Equity investments
are normally excluded, unless they are in substance a cash equivalent (e.g. preferred shares acquired within
three months of their specified redemption date). Bank overdrafts which are repayable on demand and
which form an integral part of an entity's cash management are also included as a component of cash and
cash equivalents. [IAS 7.78]
Presentation of the Statement of Cash Flows
Cash flows must be analysed between operating, investing and financing activities. [IAS 7.10]
Key principles specified by IAS 7 for the preparation of a statement of cash flows are as follows:
◦ operating activities are the main revenueproducing activities of the entity that are not investing or
financing activities, so operating cash flows include cash received from customers and cash paid to
suppliers and employees [IAS 7.14]
◦ investing activities are the acquisition and disposal of longterm assets and other investments that are not
considered to be cash equivalents [IAS 7.6]
◦ financing activities are activities that alter the equity capital and borrowing structure of the entity [IAS
7.6]
◦ interest and dividends received and paid may be classified as operating, investing, or financing cash flows,
provided that they are classified consistently from period to period [IAS 7.31]
◦ cash flows arising from taxes on income are normally classified as operating, unless they can be
specifically identified with financing or investing activities [IAS 7.35]
◦ for operating cash flows, the direct method of presentation is encouraged, but the indirect method is
acceptable [IAS 7.18] The direct method shows each major class of gross cash receipts and gross cash
payments. The operating cash flows section of the statement of cash flows under the direct method would
appear something like this:
Cash receipts from customers xx,xxxCash paid to suppliers xx,xxxCash paid to employees xx,xxxCash paid for other operating expenses xx,xxxInterest paid xx,xxxIncome taxes paid xx,xxxNet cash from operating activities xx,xxx
◦ The indirect methodadjusts accrual basis net profit or loss for the effects of noncash transactions. The
operating cash flows section of the statement of cash flows under the indirect method would appear
something like this:
Profit before interest and income taxes xx,xxxAdd back depreciation xx,xxxAdd back amortisation of goodwill xx,xxxIncrease in receivables xx,xxxDecrease in inventories xx,xxxIncrease in trade payables xx,xxxInterest expense xx,xxxLess Interest accrued but not yet paid xx,xxxInterest paid xx,xxxIncome taxes paid xx,xxxNet cash from operating activities xx,xxx
◦ the exchange rate used for translation of transactions denominated in a foreign currency should be the rate
in effect at the date of the cash flows [IAS 7.25]
◦ cash flows of foreign subsidiaries should be translated at the exchange rates prevailing when the cash flows
took place [IAS 7.26]
◦ as regards the cash flows of associates and joint ventures, where the equity method is used, the statement of
cash flows should report only cash flows between the investor and the investee; where proportionate
consolidation is used, the cash flow statement should include the venturer's share of the cash flows of the
investee [IAS 7.3738]
◦ aggregate cash flows relating to acquisitions and disposals of subsidiaries and other business units should
be presented separately and classified as investing activities, with specified additional disclosures. [IAS
7.39] The aggregate cash paid or received as consideration should be reported net of cash and cash
equivalents acquired or disposed of [IAS 7.42]
◦ cash flows from investing and financing activities should be reported gross by major class of cash receipts
and major class of cash payments except for the following cases, which may be reported on a net basis:
[IAS 7.2224]
◦ cash receipts and payments on behalf of customers (for example, receipt and repayment of demand deposits
by banks, and receipts collected on behalf of and paid over to the owner of a property)
◦ cash receipts and payments for items in which the turnover is quick, the amounts are large, and the
maturities are short, generally less than three months (for example, charges and collections from credit card
customers, and purchase and sale of investments)
◦ cash receipts and payments relating to deposits by financial institutions
◦ cash advances and loans made to customers and repayments thereof
◦ investing and financing transactions which do not require the use of cash should be excluded from the
statement of cash flows, but they should be separately disclosed elsewhere in the financial statements [IAS
7.43]
◦ the components of cash and cash equivalents should be disclosed, and a reconciliation presented to amounts
reported in the statement of financial position [IAS 7.45]
the amount of cash and cash equivalents held by the entity that is not available for use by the group should
be disclosed, together with a commentary by management [IAS 7.48]
Provisions, Contingent Liabilities and Contingent Assets
Objective
The objective of IAS 37 is to ensure that appropriate recognition criteria and measurement bases are
applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed
in the notes to the financial statements to enable users to understand their nature, timing and amount. The
key principle established by the Standard is that a provision should be recognized only when there is a
liability i.e. a present obligation resulting from past events. The Standard thus aims to ensure that only
genuine obligations are dealt with in the financial statements – planned future expenditure, even where
authorised by the board of directors or equivalent governing body, is excluded from recognition.
Scope
IAS 37 excludes obligations and contingencies arising from: [IAS 37.16]
◦ financial instruments that are in the scope of IAS 39 Financial Instruments: Recognition and Measurement
(or IFRS 9 Financial Instruments)
◦ nononerous executory contracts
◦ insurance contracts (see IFRS 4 Insurance Contracts), but IAS 37 does apply to other provisions, contingent
liabilities and contingent assets of an insurer
◦ items covered by another IFRS. For example, IAS 11 Construction Contracts applies to obligations arising
under such contracts; IAS 12 Income Taxes applies to obligations for current or deferred income taxes; IAS
17 Leases applies to lease obligations; and IAS 19 Employee Benefits applies to pension and other employee
benefit obligations; and .
Key definitions [IAS 37.10]
Provision: a liability of uncertain timing or amount.
Liability:
◦ present obligation as a result of past events
◦ settlement is expected to result in an outflow of resources (payment)
Contingent liability:
◦ a possible obligation depending on whether some uncertain future event occurs, or
◦ a present obligation but payment is not probable or the amount cannot be measured reliably
Contingent asset:
◦ a possible asset that arises from past events, and
◦ whose existence will be confirmed only by the occurrence or nonoccurrence of one or more uncertain
future events not wholly within the control of the entity.
Recognition of a provision
An entity must recognize a provision if, and only if: [IAS 37.14]
◦ a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event),
◦ payment is probable ('more likely than not'), and
◦ the amount can be estimated reliably.
An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an
entity having no realistic alternative but to settle the obligation. [IAS 37.10]
A constructive obligation arises if past practice creates a valid expectation on the part of a third party, for
example, a retail store that has a longstanding policy of allowing customers to return merchandise within,
say, a 30day period. [IAS 37.10]
A possible obligation (a contingent liability) is disclosed but not accrued. However, disclosure is not
required if payment is remote. [IAS 37.86]
In rare cases, for example in a lawsuit, it may not be clear whether an entity has a present obligation. In
those cases, a past event is deemed to give rise to a present obligation if, taking account of all available
evidence, it is more likely than not that a present obligation exists at the balance sheet date. A provision
should be recognized for that present obligation if the other recognition criteria described above are met. If
it is more likely than not that no present obligation exists, the entity should disclose a contingent liability,
unless the possibility of an outflow of resources is remote. [IAS 37.15]
Measurement of provisions
The amount recognized as a provision should be the best estimate of the expenditure required to settle the
present obligation at the balance sheet date, that is, the amount that an entity would rationally pay to settle
the obligation at the balance sheet date or to transfer it to a third party. [IAS 37.36] This means:
◦ Provisions for oneoff events (restructuring, environmental cleanup, settlement of a lawsuit) are measured
at the most likely amount. [IAS 37.40]
◦ Provisions for large populations of events (warranties, customer refunds) are measured at a probability
weighted expected value. [IAS 37.39]
◦ Both measurements are at discounted present value using a pretax discount rate that reflects the current
market assessments of the time value of money and the risks specific to the liability. [IAS 37.45 and 37.47]
In reaching its best estimate, the entity should take into account the risks and uncertainties that surround the
underlying events. [IAS 37.42]
If some or all of the expenditure required to settle a provision is expected to be reimbursed by another party,
the reimbursement should be recognized as a separate asset, and not as a reduction of the required
provision, when, and only when, it is virtually certain that reimbursement will be received if the entity
settles the obligation. The amount recognized should not exceed the amount of the provision. [IAS 37.53]
In measuring a provision consider future events as follows:
◦ forecast reasonable changes in applying existing technology [IAS 37.49]
◦ ignore possible gains on sale of assets [IAS 37.51]
◦ consider changes in legislation only if virtually certain to be enacted [IAS 37.50]
Remeasurement of provisions [IAS 37.59]
◦ Review and adjust provisions at each balance sheet date
◦ If an outflow no longer probable, provision is reversed.
Circumstance Recognize a provision?
Restructuring by
sale of an
operation
Only when the entity is committed to a sale, i.e. there is a binding sale agreement [IAS 37.78]
Restructuring by
closure or
reorganization
Only when a detailed form plan is in place and the entity has started to implement the plan, or
announced its main features to those affected. A Board decision is insufficient [IAS 37.72, Appendix C,
Examples 5A & 5B]
WarrantyWhen an obligating event occurs (sale of product with a warranty and probable warranty claims will be
made) [Appendix C, Example 1]
Land
contamination
A provision is recognized as contamination occurs for any legal obligations of clean up, or for
constructive obligations if the company's published policy is to clean up even if there is no legal
requirement to do so (past event is the contamination and public expectation created by the company's
policy) [Appendix C, Examples 2B]
Customer
refunds
Recognize a provision if the entity's established policy is to give refunds (past event is the sale of the
product together with the customer's expectation, at time of purchase, that a refund would be available)
[Appendix C, Example 4]Offshore oil rig
must be removed
and sea bed
restored
Recognized a provision for removal costs arising from the construction of the the oil rig as it is
constructed, and add to the cost of the asset. Obligations arising from the production of oil are
recognized as the production occurs [Appendix C, Example 3]
Abandoned
leasehold, four
years to run, no
reletting
possible
A provision is recognized for the unavoidable lease payments [Appendix C, Example 8]
CPA firm must
staff training for
recent changes in
tax law
No provision is recognized (there is no obligation to provide the training, recognize a liability if and
when the retraining occurs) [Appendix C, Example 7]
Major overhaul
or repairsNo provision is recognized (no obligation) [Appendix C, Example 11]
Onerous (loss
making) contractRecognize a provision [IAS 37.66]
Future operating
lossesNo provision is recognized (no liability) [IAS 37.63]
Restructurings
A restructuring is: [IAS 37.70]
◦ sale or termination of a line of business
◦ closure of business locations
◦ changes in management structure
◦ fundamental reorganisations.
Restructuring provisions should be recognized as follows: [IAS 37.72]
◦ Sale of operation: recognize a provision only after a binding sale agreement [IAS 37.78]
◦ Closure or reorganisation: recognize a provision only after a detailed formal plan is adopted and has
started being implemented, or announced to those affected. A board decision of itself is insufficient.
◦ Future operating losses: provisions are not recognized for future operating losses, even in a restructuring
◦ Restructuring provision on acquisition: recognize a provision only if there is an obligation at acquisition
date [IFRS 3.11]
Restructuring provisions should include only direct expenditures necessarily entailed by the restructuring,
not costs that associated with the ongoing activities of the entity. [IAS 37.80]
What is the debit entry?
When a provision (liability) is recognized, the debit entry for a provision is not always an expense.
Sometimes the provision may form part of the cost of the asset. Examples: included in the cost of
inventories, or an obligation for environmental cleanup when a new mine is opened or an offshore oil rig is
installed. [IAS 37.8]
Use of provisions
Provisions should only be used for the purpose for which they were originally recognized. They should be
reviewed at each balance sheet date and adjusted to reflect the current best estimate. If it is no longer
probable that an outflow of resources will be required to settle the obligation, the provision should be
reversed. [IAS 37.61]
Contingent liabilities
Since there is common ground as regards liabilities that are uncertain, IAS 37 also deals with
contingencies. It requires that entities should not recognize contingent liabilities – but should disclose them,
unless the possibility of an outflow of economic resources is remote. [IAS 37.86]
Contingent assets
Contingent assets should not be recognized – but should be disclosed where an inflow of economic benefits
is probable. When the realisation of income is virtually certain, then the related asset is not a contingent
asset and its recognition is appropriate. [IAS 37.3135]
Disclosures
Reconciliation for each class of provision: [IAS 37.84]
◦ opening balance
◦ additions
◦ used (amounts charged against the provision)
◦ unused amounts reversed
◦ unwinding of the discount, or changes in discount rate
◦ closing balance
A prior year reconciliation is not required. [IAS 37.84]
For each class of provision, a brief description of: [IAS 37.85]
◦ nature
◦ timing
◦ uncertainties
◦ assumptions
reimbursement, if any
IAS 18: REVENUE RECOGNITION
Objective of IAS 18
The objective of IAS 18 is to prescribe the accounting treatment for revenue arising from certain types of
transactions and events.
Key definition
Revenue: the gross inflow of economic benefits (cash, receivables, other assets) arising from the ordinary
operating activities of an entity (such as sales of goods, sales of services, interest, royalties, and dividends).
[IAS 18.7]
Measurement of revenue
Revenue should be measured at the fair value of the consideration received or receivable. [IAS 18.9] An
exchange for goods or services of a similar nature and value is not regarded as a transaction that generates
revenue. However, exchanges for dissimilar items are regarded as generating revenue. [IAS 18.12]
If the inflow of cash or cash equivalents is deferred, the fair value of the consideration receivable is less
than the nominal amount of cash and cash equivalents to be received, and discounting is appropriate. This
would occur, for instance, if the seller is providing interestfree credit to the buyer or is charging a below
market rate of interest. Interest must be imputed based on market rates. [IAS 18.11]
Recognition of revenue
Recognition, as defined in the IASB Framework, means incorporating an item that meets the definition of
revenue (above) in the income statement when it meets the following criteria:
◦ it is probable that any future economic benefit associated with the item of revenue will flow to the entity,
and
◦ the amount of revenue can be measured with reliability
IAS 18 provides guidance for recognising the following specific categories of revenue:
Sale of goods
Revenue arising from the sale of goods should be recognised when all of the following criteria have been
satisfied: [IAS 18.14]
◦ the seller has transferred to the buyer the significant risks and rewards of ownership
◦ the seller retains neither continuing managerial involvement to the degree usually associated with
ownership nor effective control over the goods sold
◦ the amount of revenue can be measured reliably
◦ it is probable that the economic benefits associated with the transaction will flow to the seller, and
◦ the costs incurred or to be incurred in respect of the transaction can be measured reliably
Rendering of services
For revenue arising from the rendering of services, provided that all of the following criteria are met,
revenue should be recognised by reference to the stage of completion of the transaction at the balance sheet
date (the percentageofcompletion method): [IAS 18.20]
◦ the amount of revenue can be measured reliably;
◦ it is probable that the economic benefits will flow to the seller;
◦ the stage of completion at the balance sheet date can be measured reliably; and
◦ the costs incurred, or to be incurred, in respect of the transaction can be measured reliably.
When the above criteria are not met, revenue arising from the rendering of services should be recognised
only to the extent of the expenses recognised that are recoverable (a "costrecovery approach". [IAS 18.26]
Interest, royalties, and dividends
For interest, royalties and dividends, provided that it is probable that the economic benefits will flow to the
enterprise and the amount of revenue can be measured reliably, revenue should be recognised as follows:
[IAS 18.2930]
◦ interest: using the effective interest method as set out in IAS 39
◦ royalties: on an accruals basis in accordance with the substance of the relevant agreement
◦ dividends: when the shareholder's right to receive payment is established
Disclosure [IAS 18.35]
◦ accounting policy for recognising revenue
◦ amount of each of the following types of revenue:
1 sale of goods
2 rendering of services
3 interest
4 royalties
5 dividends
within each of the above categories, the amount of revenue from exchanges of goods or services
IAS 2: INVENTORIES
Objective of IAS 2
The objective of IAS 2 is to prescribe the accounting treatment for inventories. It provides guidance for
determining the cost of inventories and for subsequently recognizing an expense, including any writedown
to net realizable value. It also provides guidance on the cost formulas that are used to assign costs to
inventories.
Scope
Inventories include assets held for sale in the ordinary course of business (finished goods), assets in the
production process for sale in the ordinary course of business (work in process), and materials and supplies
that are consumed in production (raw materials). [IAS 2.6]
However, IAS 2 excludes certain inventories from its scope: [IAS 2.2]
◦ work in process arising under construction contracts (see IAS 11 Construction Contracts)
◦ financial instruments (see IAS 39 Financial Instruments: Recognition and Measurement)
◦ biological assets related to agricultural activity and agricultural produce at the point of harvest (see IAS 41
Agriculture).
Also, while the following are within the scope of the standard, IAS 2 does not apply to the measurement of
inventories held by: [IAS 2.3]
◦ producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral
products, to the extent that they are measured at net realisable value (above or below cost) in accordance
with wellestablished practices in those industries. When such inventories are measured at net realisable
value, changes in that value are recognised in profit or loss in the period of the change.
◦ commodity brokers and dealers who measure their inventories at fair value less costs to sell. When such
inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognised
in profit or loss in the period of the change.
Fundamental principle of IAS 2
Inventories are required to be stated at the lower of cost and net realisable value (NRV). [IAS 2.9]
Measurement of inventories
Cost should include all: [IAS 2.10]
◦ costs of purchase (including taxes, transport, and handling) net of trade discounts received
◦ costs of conversion (including fixed and variable manufacturing overheads) and
◦ other costs incurred in bringing the inventories to their present location and condition
IAS 23 Borrowing Costs identifies some limited circumstances where borrowing costs (interest) can be
included in cost of inventories that meet the definition of a qualifying asset. [IAS 2.17 and IAS 23.4]
Inventory cost should not include: [IAS 2.16 and 2.18]
◦ abnormal waste
◦ storage costs
◦ administrative overheads unrelated to production
◦ selling costs
◦ foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign
currency
◦ interest cost when inventories are purchased with deferred settlement terms.
The standard cost and retail methods may be used for the measurement of cost, provided that the results
approximate actual cost. [IAS 2.2122]
For inventory items that are not interchangeable, specific costs are attributed to the specific individual items
of inventory. [IAS 2.23]
For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost formulas. [IAS 2.25]
The LIFO formula, which had been allowed prior to the 2003 revision of IAS 2, is no longer allowed.
The same cost formula should be used for all inventories with similar characteristics as to their nature and
use to the entity. For groups of inventories that have different characteristics, different cost formulas may be
justified. [IAS 2.25]
Writedown to net realizable value
NRV is the estimated selling price in the ordinary course of business, less the estimated cost of completion
and the estimated costs necessary to make the sale. [IAS 2.6] Any writedown to NRV should be
recognized as an expense in the period in which the writedown occurs. Any reversal should be recognized
in the income statement in the period in which the reversal occurs. [IAS 2.34]
Expense recognition
IAS 18 Revenue addresses revenue recognition for the sale of goods. When inventories are sold and revenue
is recognised, the carrying amount of those inventories is recognised as an expense (often called costof
goodssold). Any writedown to NRV and any inventory losses are also recognised as an expense when they
occur. [IAS 2.34]
Disclosure
Required disclosures: [IAS 2.36]
◦ accounting policy for inventories
◦ carrying amount, generally classified as merchandise, supplies, materials, work in progress, and finished
goods. The classifications depend on what is appropriate for the entity
◦ carrying amount of any inventories carried at fair value less costs to sell
◦ amount of any writedown of inventories recognized as an expense in the period
◦ amount of any reversal of a writedown to NRV and the circumstances that led to such reversal
◦ carrying amount of inventories pledged as security for liabilities
cost of inventories recognized as expense (cost of goods sold). IAS 2 acknowledges that some enterprises
classify income statement expenses by nature (materials, labour, and so on) rather than by function (cost of
goods sold, selling expense, and so on). Accordingly, as an alternative to disclosing cost of goods sold
expense, IAS 2 allows an entity to disclose operating costs recognized during the period by nature of the
cost (raw materials and consumables, labour costs, other operating costs) and the amount of the net change
in inventories for the period). [IAS 2.39] This is consistent with IAS 1 Presentation of Financial
Statements, which allows presentation of expenses by function or nature.
SS