GAAP Handbook 2020 9780639003795, 9780639003801

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W Badenhorst L Kotze o Pretorius

LexisNexis'

2020 Volume 1&2

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GAAP Handbook

2020 Volume 1

GAAP Handbook 2020 Wessel Badenhorst MCom (Accounting Sciences), PhD (Financial Management), CA(SA) Senior lecturer, Department of Accounting University of Pretoria

Denice Pretorius MCom (Accounting Sciences), CA(SA) Senior lecturer, Department of Accounting University of Pretoria

Lizette Kotze MCom (Accounting Sciences), CA(SA) Senior lecturer, Department of Accounting University of Pretoria

Assisted by:

Rieka von Well MCom (Accounting Sciences), CA(SA) Senior lecturer, Department of Accounting University of Pretoria

.

' LexisNexis'

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Preface The purpose of this book is to set out the principles and conceptual issues of International Financial Reporting Standards (I FRS). In addition, the book summarises by topic the accounting and disclosure requirements of the accounting standards. The book is aimed at both the undergraduate and postgraduate student, practising accountants, financial analysts, credit providers and the wider business community. Each chapter includes practical examples, with journal entries where appropriate, that demonstrate the more important principles. Disclosure requirements are specifically illustrated where appropriate. The underlying concepts of the Conceptual Framework are incorporated into the topics and taxation issues are addressed to the extent that deferred taxation is applicable to certain accounting areas. The text should be useful to-

•

university students studying accounting courses in financial accounting;

•

members and students of professional bodies such as the South African Institute of Chartered Accountants (SAICA), the South African Institute of Professional Accountants (SAIPA), the Chartered Institute of Secretaries and Administrators (SAICSA) and the Institute of Bankers (lOB); and

•

preparers of financial statements.

GAAP Handbook 2020 covers accounting standards, interpretations and updates issued by the IASB up to 30 September 2019.

Volume 2 of GAAP Handbook 2020 deals with all IFRSs relating to consolidations. Extensive examples are included that address issues regarding business combinations, changes in interests in investments, investments in associates and joint arrangements, foreign operations and the consolidated statement of cash flows.

The Authors Pretoria

November 2019

Chapter contents Volume 1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32

The conceptual framework (2010) ....................................................................... 1 Presentation of financial statements .................................................................. 15 Inventories ......................................................................................................... 45 Statement of cash flows .................................................................................... 59 Accounting policies, changes in accounting estimates and errors .................... 81 Events after the reporting period ..................................................................... 105 Fair value measurement .................................................................................. 111 Taxation ........................................................................................................... 141 Property, plant and equipment .... ............ 175 Leases ............................................................................................................. 209 Revenue from contracts with customers ......................................................... 281 Employee benefits ........................................................................... .. ............ 345 Government grants and assistance ................................................................. 393 The effects of changes in foreign exchange rates .......................................... .407 Borrowing costs...................................................................... .. ... ............ 423 Related party disclosures ................................................................................ 433 Hyperinflationary economies ........................................................................... 449 Financial instruments ......................... ........................ ........................ .......... .465 Earnings per share .......................................................................................... 685 Interim financial reporting ................................................................................ 725 Impairment of assets .............................................................. .. .. .. .. ......... 737 Provisions, contingent assets and contingent liabilities ................................... 769 Intangible assets .............................................................................................. 785 Investment property ............................................................................. ........... 811 ~Moo~u~~3

First-time adoption of international financial reporting standards .................... 845 Share-based payments ........................................................................ ........... 855 Non-current assets held for sale and discontinued operations ....................... 901 Operating segments ........................................................................................ 931 Service concession arrangements .......................... .. ........................ ............ 943 Small and medium-sized entities ..................................................................... 955 The conceptual framework (2018) ................................................................... 959

Volume 2 1 2 3 4 5 6 7 8 9 10

Separate financial statements ............................................................................. 1 Business combinations ........................................................................................ 7 Consolidated financial statements .................................................... .. .............. 69 Associates and joint arrangements ................................................................. 107 Changes in interests in investments - Acquisitions ........................................ 167 .. ......... 189 Changes in interests in investments - Disposals .................. .. .. .. Changes in interests in investments - Other ................................................... 265 Foreign operations ........................................................................................... 311 Consolidated statement of cash flows ..................... .. ........................ ............ 339 Disclosure of interests in other entities ............................................................ 381

Quick reference to abbreviations used CGT

Capital Gains Tax

CGU

Cash generating unit

F/P

Statement of financial position

GAAP

Generally Accepted Accounting Practice

IASB

International Accounting Standards Board

IFRIC

International Financial Reporting Interpretations Committee

IFRS

International Financial Reporting Standards

OCI

Other comprehensive income

P/L

Profit or loss

PPE

Property, plant and equipment

SARs

Share appreciation rights

SoCE

Statement of Changes in Equity

Standard index Document

Topic

Volume Chapter Page

Circular 2/2015

Headline earnings

19

685

Circular 2/2017

Inventories

3

45

Circular 9/2006

Inventories

3

45

Conceptual

Conceptual Framework (2010)

32

959

8

141

transactions

27

855

FRG 3

Employee benefits: SA situation

12

345

lAS 1

Presentation of financial statements

2

15

lAS 2

Inventories

3

45

Framework for Financial Reporting (2010) Conceptual

Conceptual Framework (2018)

Framework for Financial Reporting (2018) FRG 1 FRG 2

Substantively enacted tax rates and tax laws Accounting for Black Economic Empowerment (BEE)

lAS 7

Statement of cash flows

lAS 7

Consolidated statement of cash flows

lAS 8

Accounting policies, changes in accounting estimates

2

4

59

9

339

and errors

5

81

Events after the reporting period

6

105

lAS 12

Income taxes

8

141

lAS 16

Property, plant and equipment

9

175

lAS 10

lAS 19

Employee benefits

12

345

lAS 20

Government grants and assistance

13

393

lAS 21

Foreign exchange

lAS 21

Foreign operations

2

14

407

8

311

lAS 23

Borrowing costs

15

423

lAS 24

Related party disclosures

16

433

107

lAS 27

Separate financial statements

2

lAS 28

Associates and joint arrangements

2

4

lAS 28

Changes in interests in investments - acquisitions

2

5

167

lAS 28

Changes in interests in investments - disposals

2

6

189

lAS 28

Changes in interests in investments - other

2

7

265

lAS 29

Hyperinflationary economies

17

449

lAS 32

Financial instruments: Presentation

18

465

Volume Chapter Page

Document

Topic

lAS 33

Earnings per share

19

685

lAS 34

Interim financial reporting

20

725

lAS 36

Impainnent of assets

21

737

lAS 37

Provisions and contingencies

22

769

lAS 38

Intangible assets

23

785

lAS 40

Investment property

24

811

lAS 41

Agriculture

25

833

IFRIC 1

Changes in existing decommissioning , restoration and 9

175

similar liabilities IFRIC 2 IFRIC 21 IFRIC 5

Members' shares in co-operative entities and similar

instruments

18

465

Levies

22

769

22

769

22

769

Rights to interests arising from decommissioning, restoration and environmental rehabilitation funds

IFRIC 6

liabilities arising from participating in a specific market waste electrical and electronic equipment

IFRIC 7

Applying the restatement approach under lAS 29 financing hyperinflationary economies

17

449

IFRIC 10

Interim financial reporting and impairment

20

725

IFRIC 12

Service concession arrangements

30

943

IFRIC 14

Limit on defined benefit asset, minimum funding requirements

12

345

IFRIC 16

Hedges of a net investment in a foreign operation

18

465

IFRIC 17

Distributions of non-cash assets to OINners

2

15

IFRIC 19

Extinguishing financial liabilities with equity instruments

18

465

IFRIC 22

Foreign currency transactions and advance consideration

14

407

8

141

26

845

27

855

2

7

IFRIC 23

Uncertainty over income tax treatments

IFRS 1

First-time adoption of International Financial Reporting Standards

IFRS 2

Share-based payments

IFRS 3

Business combinations

2

IFRS 3

Changes in interests in investments - acquisitions

2

5

167

IFRS 3

Changes in interests in investments - other

2

7

265

operations

28

901

IFRS 7

Financial instruments: Disclosure

18

465

IFRS 8

Operating segments

29

931

IFRS 9

Financial instruments

18

465

IFRS 5

Non-current assets held for sale and discontinuing

IFRS 10

Consolidated financial statements

2

3

69

IFRS 10

Changes in interests in investments - acquisitions

2

5

167

IFRS 10

Changes in interests in investments - disposals

2

6

189

Document

Topic

IFRS 10

Changes in interests in investments - other

2

7

265

IFRS 11

/lssociates and joint arrangements

2

4

107

IFRS 12

Disclosure of interests in other entities

2

10

381

IFRS 13

Fair value measurement

7

111

IFRS 15

Revenue from contracts with customers

11

281

IFRS 16

Leases

10

209

IFRS for SMEs

Small and medium-sized entities

31

955

SIC 7

Introduction of the Euro

14

407

SIC 10

Government assistance

13

393

SIC 25

Income taxes - Changes in the tax status of an enterprise 8

141

or its shareholders

Volume Chapter Page

SIC 29

Service concession arrangements

30

943

SIC 32

Web site costs

23

785

Detailed chapter contents Volume 1 1 1.1 1.2 1.2.1

1.2.2 1.2.2.1 1.2.2.2 1.2.2.2.1 1.2.2.2.2 1.2.2.2.3

1.3 1.3.1 1.3.11 1.3.1.2 1.3.1.2.1 1.3.1.2.2 1.3.1.2.3 1.3.1.3 1.3.2 1.3.2.1 1.3.2.2 1.3.2.3 1.3.2.4 1.3.2.5 1.3.3

1.4 1.5 151

1.5.2 1.5.3 1.5.4 155 1.6

1.6.1 1.6.2 1.7 1.71

THE CONCEPTUAL FRAMEWORK ............................................................. 1 Introduction ......................................................................................................... 1 The objective of general purpose financial reporting ....................................... 2 Objective, usefulness and limitations of general purpose financial reporting ................................................................................................................ 2 Infonnation about a reporting entity's economic resources, claims and changes in resources and claims ........................................................................... 3 Economic resources and claims (statement of financial position) ........................ 3 Changes in economic resources and claims .......................................................... 3 Financial perfonnance reflected by accrual accounting (statement of profit or loss and other comprehensive income) ............................................................. 3 Financial perfonnance reflected by past cash flows (statement of cash flows) .................................................................................................................... 4 Changes in economic resources and claims not resulting from financial perfonnance (statement of cash flows) ................................................................ .4 The qualitative characteristics of useful financial information ....................... 4 Fundamental qualitative characteristics ................................................................. 4 Relevance .............................................................................................................. 5 Faithful representation .......................................................................................... 5 Completeness ................................................. . ..................................................... 5 Neutrality .............................................................................................................. 6 Free from error ...................................................................................................... 6 Applying the fundamental qualitative characteristics .............................. . ........... 6 Enhancing qualitative characteristics .................................................................... 6 Comparability ....................................................................................................... 6 Verifiability .......................................................................................................... 7 Timeliness ............................................................................................................. 7 Understandability .................................................................................................. 7 Applying the enhancing qualitative characteristics ............................................... 7 The cost constraint on useful financial reporting .................................................. 7 Underlying assumption ....................................................................................... 8 The elements of financial statements ................................................................. 8 Assets .................................................................................................................... 8 Liabilities .............................................................................................................. 9 Equity ............................... . .............................. . .............................. . ................... 9 Income ................................................................................................................ 10 Expenses ............................................................................................................. 10 Recognition issues .............................................................................................. 10 Probability of future economic benefits .............................................................. 11 Reliability of measurement ................................................................................. 11 Measurement issues ........................................................................................... 11 Historical cost ..................................................................................................... 11

XIV

1.72 1.73 1.7.4 1.8 181 1.8.2

1.9 1.10

2 2.1

2.2 2.3 2.3.1 2.3.1.1 2.3.1.2 2.3.2 2.3.3 2.3.4 2.3.5 2.3.6 2.3.7 2.3.7.1 2.3.7.2 2.3.8 2.4 2.4.1 2.4.1.1 2.4.1.2 2.4.1.3 2.4.2 2.4.2.1 2.4.2.1.1

2.4.2.1.2

2.4.2.1.3 2.4.2.2 2.4.2.3 2.4.2.4 2.4.3 2.4.3.1

GAAP Handbook 2020: Volume 1

Current cost ........................................................................................................ II Realisable value .................................................................................................. II Present value ....................................................................................................... 12 Concepts of capital maintenance ...................................................................... 12 Financial capital .................................................................................................. 12 Physical capital ................................................................................................... 12 Conclusion .......................................................................................................... 13 Summary of the conceptual framework .......................................................... 14 PRESENTATION OF FINANCIAL STATEMENTS ................................... 15 Scope and objectives .......................................................................................... 15 Identification of financial statements ............................................................... 15 General features ................................................................................................ 16 Fair presentation and compliance with IFRS ...................................................... 16 Achieving fair presentation ................................................................................. 16 Allowed departure from IFRS requirements ....................................................... 16 Going concern .................................................................................................... 17 Accrual basis of accounting ................................................................................ 17 Materiality and aggregation ................................................................................ 17 Offsetting ............................................................................................................ 18 Frequency of reporting ........................................................................................ 18 Comparative infonnation .................................................................................... 18 Minimum comparative infonnation .................................................................... 18 Change in accounting policy, retrospective restatement or reclassification ....... 19 Consistency of presentation ................................................................................ 19 Financial statements .......................................................................................... 20 Statement of financial position ........................................................................... 20 Information to be presented in the statement of financial position ..................... 20 Current or non-current distinction ...................................................................... 21 Infonnation on the face of the statement of financial position or in the notes .................................................................................................................... 23 Statement of profit or loss and other comprehensive income ............................. 24 Infonnation to be presented in the separate statements (two-statement format) or separate sections (one-statement format) ........................................... 25 Infonnation to be presented in the profit or loss section (if one-statement format is used) or separate statement of profit or loss (if two-statement format is used) .................................................................................................... 25 Information to be presented in the other comprehensive income section (if one-statement fonnat is used) or separate statement of profit or loss and other comprehensive income (if two-statement fonnat is used) ......................... 26 Additional information affecting both sections or statements ............................ 26 Other comprehensive income: reclassification adjustments ............................... 29 Other comprehensive income: tax effects ........................................................... 31 Information on the face of the statement of profit or loss and other comprehensive income or in the notes ................................................................ 33 Statement of changes in equity ........................................................................... 35 Interaction between statement of changes in equity and statement of profit or loss and other comprehensive income ............................................................ 36

Detailed chapter contents

2.4.4 2.4.5

2.5 2.6 2.6.1 2.6.2 2.6.3 2.6.4

2.7 2.8 3 3.1 3.1.1 3.1.2

3.2 3.3 3.3.1 3.3.1.1 3.3.1.2 3.3.1.3 3.3.2 3.3.2.1 3.3.2.2 3.3.3 3.3.4 3.4 3.4.1 3.4.2 3.5 3.5.1 3.5.2 3.5.3 3.5.3.1 3.5.3.2 3.5.4

3.6 3.6.1 3.6.2

3.7 3.7.1 3.7.2 3.8

xv

Statement of cash flows ...................................................................................... 37 Notes ................................................................................................................... 37 Supplementary information ............................................................................. 38 Distributions of non-cash assets to owners ...................................................... 39 Accounting treatment of the liability to distribute non-cash assets ..................... 39 Accounting treatment of the non-cash assets ...................................................... 39 Settlement of the liability .................................................................................... 40 Presentation and disclosure regarding distribution of non-cash assets ............... 40 Disclosure examples .......................................................................................... 43 Summary ofIAS 1, Presentation of financial statements .............................. .44 INVENTORIES ................................................................................................. 45 Introduction ...................................................................................................... .45 Definition ............................................................................................................ 45 Exclusions ........................................................................................................... 45 Recognition and derecognition ......................................................................... 46 Initial measurement of inventory ..................................................................... 46 Purchase costs ..................................................................................................... 46 Rebates ............................................................................................................... 47 Settlement discounts ........................................................................................... 47 Deferred settlement terms ................................................................................... 47 Conversion costs .............................. . .............................. . ................................. 48 Joint products ...................................................................................................... 50 By-products ........................................................................................................ 50 Other costs .......................................................................................................... 50 Costs excluded .................................................................................................... 51 Subsequent measurement of inventory ............................................................ 51 Net realisable value ................................................ . ............ ... . ............ . ............ 51 Reversal of write-downs ..................................................................................... 54 Cost formulas ..................................................................................................... 54 Specific identification .............................. . .............................. . ......................... 54 First-in-first-out (FIFO) ...................................................................................... 54 Weighted average ............................................................................................... 54 Weighted average - periodic basis ..................................................................... 55 Weighted average - moving basis ...................................................................... 55 Consistency - different cost formulas ................................................................. 55 Techniques for the measurement of cost ......................................................... 55 Standard cost ....................................................................................................... 56 Retail method ...................................................................................................... 56 Financial statement presentation ..................................................................... 56 lAS 2 requirements .............................................................................................. 56 Disclosure example ............................................................................................. 57 Summary of lAS 2, Inventories ........................................................................ 58

XV!

4

4.1

4.2 4.2.1 4.2.2 4.2.3 4.2.4

4.3 4.3.1 4.3.1.1 4.3.1.2 4.3.1.3 4.3.1.4 4.3.2 4.3.2.1 4.3.3 4.3.4 4.3.5 4.4 4.4.1 4.4.2 4.4.3 4.4.4 4.4.4.1 4.4.5 4.4.6

4.5 4.5.1 4.5.2 4.5.3 4.5.4 4.5.5

4.6 5 5.1

5.2 5.2.1 5.2.2 5.2.3 5.2.4 5.2.5 5.2.5.1 5.2.5.2 5.2.5.3

GAAP Handbook 2020: Volume 1

STATEMENT OF CASH FLOWS .................................................................. 59 Introduction ....................................................................................................... 59 Elements of a statement of cash flows .............................................................. 59 Cash and cash equivalents ............................. . ................................................... 60 Operating activities ............................................................................................. 60 Investing activities .............................................................................................. 61 Financing activities ............................................................................................. 61 Calculating and presenting cash flows ............................................................. 62 Cash flows from operating activities ................................................................... 62 Indirect method ................................................................................................... 62 Direct method ..................................................................................................... 63 Changes in working capital ................................................................................. 64 Interest, dividends and tax .................................................................................. 66 Cash flows from investing activities ................................................................... 67 Non-cash investing and financing activities ....................................................... 68 Cash flows from financing activities .................................................................. 69 Net effect of all cash flows ................................................................................. 70 Balancing the statement of cash flows ................................................................ 70 Other issues ........................................................................................................ 70 lli~sm

Capitalised borrowing costs ................................................................................ 70 Consolidated financial statements ....................................................................... 71 Gross versus net cash flows ................................................................................ 71 Value-added taxation .......................................................................................... 71 Foreign currency cash flows ............................................................................... 72 Sale of property, plant and equipment held for rental ......................................... 74 Financial statement presentation ..................................................................... 74 lAS 7 requirements for cash flow items ............... . ....................... . ................... 74 lAS 7 requirements for non-cash flow items ...................................................... 75 IFRS 5 requirem ents ........................................................................................... 75 IFRS 16 requirem ents ......................................................................................... 75 lAS 7 requirements for liabilities from financing activities ................................ 77 Summary ofIAS 7, Statement of cash flows ................................................... 79 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS .......................................................................... 81 Introduction ....................................................................................................... 81 Accounting policies ............................................................................................ 81 Accounting policies - definition ......................................................................... 81 How to select an accounting policy .................................................................... 81 Is it compulsory to apply an accounting policy that is prescribed by a standard? ............................................................................................................. 81 Consistency of accounting policies ..................................................................... 82 Changes in accounting policies ........................................................................... 82 Change in accounting policy due to initial adoption of standard or interpretation ....................................................................................................... 83 Voluntary change in accounting policy .............................................................. 83 Retrospective application ................................................................................... 83

Detailed chapter contents

5.2.5.4 5.2.5.5 5.2.6 5.2.6.1 5.2.6.2 5.2.6.3

5.3 5.3.1 5.3.2 5.3.3

5.4 5.4.1 5.4.2 5.4.3 5.4.4 5.4.5

5.5 6 6.1

6.2 6.3 6.4 6.4.1 6.4.2

6.5 6.5.1 6.5.2 6.5.3 6.6 7 7.1

7.2 7.2.1 7.2.2 7.2.3 7.2.4 7.2.5

7.3 7.3.1

7.4 7.4.1 7.4.2 7.4.3 7.4.4 7.4.4.1 7.4.5 7.4.6

XVll

What if retrospective application is not practicable? .......................................... 86 Change in accounting policy from cost model to revaluation model .................. 92 Disclosure requirements for changes in accounting policies .............................. 92 Initial adoption of standard/interpretation .......................................................... 92 Voluntary change ................................................................................................ 93 New standard or interpretation not yet applied ................................................... 93 Changes in accounting estimates ...................................................................... 93 Change in accounting estimate - definition ......................................................... 93 Accounting treatment of a change in accounting estimate .................................. 94 Disclosure requirements of changes in accounting estimates ............................. 94 Errors ................................................................................................................. 96 Prior period errors ............................................................................................... 96 Material prior period errors ................................................................................. 96 Retrospective correction of errors ....................................................................... 96 If retrospective correction is not practicable ....................................................... 99 Disclosure requirements of correction of prior period errors ............................ 102 Summary of lAS 8, Accounting policies, estimates and errors .................... 103 EVENTS AFTER THE REPORTING PERIOD .......................................... 105 Introduction ..................................................................................................... 105 Adjusting events .............................................................................................. 105 Non-adjusting events ....................................................................................... 106 Specific issues ................................................................................................... 106 Dividends .......................................................................................................... 106 Going concern .................................................................................................. 107 Financial statement presentation ................................................................... 107 lAS 10 requirements ......................................................................................... 107 IFRI C 17 requirem ents ..................................................................................... 107 Disclosure example ........................................................................................... 107 Summary ofIAS 10, Events after the reporting period ............................... 109 FAIR VALUE MEASUREMENT ................................................................. 111 Introduction ..................................................................................................... 111 Definition of fair value .................................................................................... 111 An asset or a liability ........................................................................................ III A transaction ..................................................................................................... 112 Orderly .............................................................................................................. 112 Market participants ........................................................................................... 114 The price ........................................................................................................... 114 Fair value at initial recognition ...................................................................... 115 Factors at initial recognition .............................................................................. 115 Valuation techniques ....................................................................................... 116 Single and multiple techniques .......................................................................... 117 Using unobservable inputs ................................................................................ 117 Inputs into valuation techniques ....................................................................... 118 Market approach ............................................................................................... 119 Bid, ruling and asking (offer) prices ................................................................. 119 Cost approach ................................................................................................... 120 Income approach ............................................................................................... 120

XV111

7.4.6.1 7.4.6.2 7.4.6.2.1 7.4.6.2.2 7.4.7 7.4.71 7.4.72 7.4.73

7.5 7.5.1 7.5.1.1 7.5.2 7.5.2.1 7.5.2.2 7.5.2.3 7.5.2.4 7.5.2.5 7.5.3 7.5.3.1 7.5.3.2

7.6 7.6.1 7.6.2 7.6.3 7.6.4

7.7 8 8.1

8.2 8.3 8.3.1 8.3.1.1 8.3.1.2 8.3.1.3 8.3.1.4 8.3.2 8.3.2.1 8.3.2.2 8.3.3 8.3.3.1 8.3.3.2 8.3.3.3 8.3.4 8.3.4.1

GAAP Handbook 2020: Volume 1

Application of present value techniques ........................................................... 121 Examples of present value techniques in IFRS 13 ............................................ 121 The discount rate adjustment technique ............................................................ 121 Expected present value technique ..................................................................... 122 Fair value hierarchy .......................................................................................... 123 Levell inputs ................................................................................................... 124 Level 2 inputs ................................................................................................... 125 Level 3 inputs ................................................................................................... 126 Specific applications of IFRS 13 ..................................................................... 126 Non-financial assets .......................................................................................... 126 Non-financial assets used in a group of assets and liabilities ........................... 127 Liabilities and an entity's own equity instruments ........................................... 129 Liabilities and equity instruments held by other parties as assets ..................... 129 Liabilities and equity instruments not held by other parties as assets ............... 131 Non-performance risk ....................................................................................... 132 Restrictions on the transfer of the liability or own equity instrument ............... 132 Financial liabilities with a demand feature ....................................................... 133 Financial assets and financial liabilities with offsetting market risk or counterparty credit risk ..................................................................................... 133 Exposure to market risks .................................................................................. 134 Exposure to counterparty credit risk ................................................................. 134 Final statement presentation .......................................................................... 135 Assets and liabilities measured at fair value ...................................................... 135 Assets and liabilities disclosed at fair value ...................................................... 139 Policy disclosures ............................................................................................. 139 Other disclosures .............................................................................................. 139 Summary of IFRS 13, Fair value measurement ........................................... 140

TAXATION ..................................................................................................... 141 Introduction ..................................................................................................... 141 Current tax....................................................................................................... 141 Deferred tax ..................................................................................................... 142 The calculation of a temporary difference ........................................................ 143 Tax base of an asset .............................................. .. ........... .. ... ........................ 143 Tax base of a liability ........................................................................................ 143 Tax base of revenue received in advance .......................................................... 144 Determining whether temporary differences are taxable or deductible ............ 144 Consideration of the exemptions from the recognition of deferred tax for certain temporary differences ........................................................................... 146 Initial recognition of goodwill .......................................................................... 147 Initial recognition of an asset or liability .......................................................... 147 Consideration of the limitations on the recognition of a deferred tax asset for deductible temporary differences and unused tax losses or credits ............. 149 Assessment of deductible temporary differences .............................................. 149 Assessment for unused tax losses and unused tax credits ................................. 150 Arumal review of recognised and unrecognised deferred tax assets ................. 150 The appropriate tax rates (and tax laws) ........................................................... 151 Enacted or substantively enacted tax rates and tax laws ................................... 151

Detailed chapter contents

8.3.4.2 8.3.5 8.3.5.1 8.3.5.2 8.3.5.3 8.4 8.4.1 8.4.2 8.4.3 8.4.3.1 8.4.3.2 8.4.3.3 8.4.3.4 8.4.4 8.5 8.5.1 8.5.2 8.5.3 8.5.3.1 8.5.3.2 8.5.3.3 8.5.4 8.5.5

8.6 9 9.1 9.1.1 9.1.2

9.2 9.2.1 9.2.2 9.2.3 9.2.4

9.3 9.3.1 9.3.2 9.3.3 9.3.4 9.3.5 9.3.6 9.4 9.4.1 9.4.1.1 9.4.1.2 9.4.1.3

XIX

Expected manner of recovery ........................................................................... 152 Recognition of the deferred tax income or expense .......................................... 153 Transaction recognised outside profit or loss ................................................... 153 Business corn bination ....................................................................................... 154 Changes in deferred tax balances without changes in temporary differences ........................................................................................................ 154 Specific issues ................................................................................................... 155 Changes in the tax status of an enterprise or its shareholders ............................ 155 Changes in the carrying amount of investments in subsidiaries, branches, associates and joint ventures ............................................................................. 156 Uncertainty over income tax treatment ............................................................. 158 Grouping uncertain tax treatments .................................................................... 158 Accounting treatment of uncertain tax treatments ............................................ 158 Changes in facts and circumstances .................................................................. 161 Flow diagram illustrating the application ofIFRIC 23 ..................................... 162 Dividends tax (withholding tax on dividends) ............................. ... . ................ 162 Financial statement presentation ................................................................... 163 lAS 1 requirements ............................................................................................ 163 lAS 37 requirements ......................................................................................... 163 lAS 12 requirements ......................................................................................... 163 Offsetting .......................................................................................................... 163 Presentation and disclosure ............................................................................... 164 Preparing the tax reconciliation or the tax rate reconciliation .......................... 165 Disclosure example ........................................................................................... 169 Comprehensive illustrative disclosure example ............................... . ............... 170 Summary of lAS 12, Income taxes ................................................................. 174

PROPERTY, PLANT AND EQIDPMENT .................................................. 175 Introduction ..................................................................................................... 175 Objectives ......................................................................................................... 175 Exclusions ......................................................................................................... 175 Recognition issues ............................................................................................ 176 Recognition of property. plant and equipment .................................................. 176 Spare parts, stand-by equipment and servicing equipment ............................... 176 Separate components and major inspections .................................................... 176 Safety and environmental equipment ............................................................... 178 Cost determination .......................................................................................... 178 Elements of cost ............................................................................................... 178 Costs that are excluded ..................................................................................... 179 Incidental operations ......................................................................................... 180 Abnormal credit terms ...................................................................................... 180 Construction of property, plant and equipment ................................................ 180 Exchange of assets ............................................................................................ 181 Depreciation ..................................................................................................... 182 Economic benefits consumed ............................................................................ 182 Useful life ............................................................................. .. ......................... 182 Residual value ................................................................................................... 183 Components ...................................................................................................... 184

xx

9.4.1.4 9.4.2 9.4.2.1 9.4.2.2 9.4.2.3 9.4.2.4

GAAP Handbook 2020: Volume 1

9.9.1 9.9.2 9.9.3 9.10

Commencement or cessation of depreciation ................................................... 185 Depreciation methods ....................................................................................... 185 Straight-line ...................................................................................................... 185 Diminishing balance ......................................................................................... 185 Unit of production method ................................................................................ 186 Sum-of-the-digits .............................................................................................. 186 Revaluations ..................................................................................................... 187 Fair value of revalued assets ............................................................................. 187 Frequency of revaluations ................................................................................. 188 Revaluation surplus and treatment of asset at date of revaluation .................... 188 Timing of revaluation ....................................................................................... 190 Subsequent revaluations or devaluations .......................................................... 190 Realisation of revaluation reserve ..................................................................... 191 Deferred tax implications ofrevaluations ......................................................... 193 Manner of recovery ........................................................................................... 193 Sale ............................................................................... . .................................. 193 Use .................................................................................................................... 194 Com bination of use and sale ............................................................................. 194 Recognition and presentation of deferred tax ................................................... 195 Subsequent classification as held for sale ......................................................... 196 Change in tax rate ............................................................................................. 196 Impairment losses ............................................................................................ 199 Compensation for impairment ........................................................................... 200 Derecognition ................................................................................................... 200 IFRIC 1, Changes in existing decommissioning, restoration and similar liabilities .............................................................................................. 201 Cost model ........................................................................................................ 202 Revaluation model ............................................................................................ 203 Financial statement presentation ................................................................... 204 lAS 16 requirements .......................................................................................... 204 IFRIC 1 requirements ....................................................................................... 205 Disclosure example: Revaluation of property, plant and equipment ............... 205 Summary ofIAS 16, Property, plant and equipment ................................... 208

10 10.1 10.1.1 10.1.2 10.1.3 10.1.3.1 10.1.3.2 10.1.3.2.1 10.1.3.2.2 10.1.3.2.3 10.1.3.2.4 10.1.3.2.5 10.1.3.3 10.1.3.4

LEASES ............................................................................................................ 209 Introduction ..................................................................................................... 209 Objective ........................................................................................................... 209 Exclusions ......................................................................................................... 209 Fundamental concepts ...................................................................................... 21 0 Inception of a lease versus commencement of the lease ................ . ................. 210 Lease term ......................................................................................................... 210 Non-cancellable period of a lease ..................................................................... 210 Extension and termination options held by the lessee ....................................... 210 Guaranteed return ............................................................................................. 211 Reassessment of extension and termination options held by the lessee ............ 212 Reassessment of the lease tenn ......................................................................... 212 Guaranteed versus unguaranteed residual values .............................................. 212 Lease payments ................................................................................................. 213

9.5 9.5.1 9.5.2 9.5.3 9.5.4 9.5.5 9.5.6 9.5.7 9.5.7.1 9.5.7.1.1 9.5.7.1.2 9.5.7.1.3 9.5.7.2 9.5.7.3 9.5.7.4

9.6 9.6.1

9.7 9.8 9.8.1 9.8.2

9.9

Detailed chapter contents

1013.5 10.13.7 10.2 10.2.1 10.22 10.22.1 10.2.2.2 10.23 1O.2A 10.2.4.1 10.2.4.2 1O.2A.3 10.2.5 10.2.6 10.3 10.3.1 10.3.1.1 10.3.1.2 10.3.13 10.3.2 10.3.2.1 10.3.2.2 10.3.2.3 1O.3.2A 10.4 10.4.1 10.4.1.1 10.4.1.2 10.4.13 10.4.13.1 10.4.13.2 10.4.13.3 1O.4.1A 10.4.1.5 10.4.1.5.1 10.4.1.5.2 10.4.1.5.3 10.4. 1.5 A 10.4.1.6 10.4.1.6.1 10.4.1.6.2 10.4.2 IOA.3 10.5 10.6 10.6.1

XXI

Economic life versus useful life ............................... . ....................................... 213 Interest rates ...................................................................................................... 213 Identifying a lease ............................................................................................ 214 The period of use ............................................................................................... 214 Identified asset .................................................................................................. 214 Substantive substitution rights .......................................................................... 215 Portions of assets .............................................................................................. 216 Right to obtain substantially all of the economic benefits ................................ 217 Right to direct the use of the identified asset .................................................... 218 Right to direct how and for what purpose the asset is used .............................. 218 Decisions during and before the period of use .................................................. 219 Protective rights ................................................................................................ 219 Reassessment of a contract .............................. . .............................. . ............... 219 Identification flow diagram ............................................................................... 220 Lease components ............................................................................................ 220 Identifying components within a contract ......................................................... 220 All of the components contain a lease .............................................................. 221 Some of the components contain a lease and others do not .............................. 221 Some of the components do not transfer any goods or services to the custom er ........................................................................................................... 221 Accounting for components within a contract .................................................. 221 Portfolio accounting (lessee and lessor) ........................................ . .................. 222 Com bination of contracts (lessee and lessor) .................................................... 222 Accounting for lease components: the lessee .................................................... 222 Accounting for lease components: the lessor .................................................... 223 Recognition and measurement: the lessee ..................................................... 223 The general lease accounting requirements ....................................................... 224 Initial measurement of the right-of-use asset ........................................ . .......... 224 Initial measurement of the lease liability .......................................................... 225 Subsequent measurement of the right-of-use asset ........................................... 228 Cost model ........................................................................................................ 228 Revaluation model ............................................................................................ 228 Fair value model ............................................................................................... 229 Subsequent measurement of the lease liability .............. . ................................. 229 Reassessment of the lease liability .................................................................... 233 General principle ............................................................................................... 233 Changes in the lease term / purchase options ................................................... 233 Changes in the amount payable in terms of a residual value guarantee / variable lease payments .................................................................................... 235 Changes in the interest rate ............................................................................... 236 Lease modifications .......................................................................................... 237 Lease modifications accounted for as separate leases ....................................... 237 Lease modifications which are not accounted for as separate leases ................ 237 Short-term leases .............................................................................................. 239 Leases of low value assets ................................................................................ 240 Tax consequences: the lessee .......................................................................... 242 Presentation: the lessee ................................................................................... 244 Statement of financial position ......................................................................... 244

XXI!

10.6.2 10.6.3

10.7 10.71 10.72 10.73 10.73.1 10.73.2 10.73.3 10.73.4 10.73.5

10.8 10.8.1 10.8.2 10.8.3 10.8.4 10.8.4.1 10.8.4.2 10.8.4.3 10.8.5 10.8.5.1 10.8.5.2 10.8.5.3 10.8.5.4 10.8.5.5 10.8.5.5.1 10.8.5.5.2 10.8.5.5.3 10.8.5.6 10.8.5.7

10.9 10.10 10.11 10.11.1 10.11.2 10.11.3

10.12 10.12.1 10.122

10.13

GAAP Handbook 2020: Volume 1

Statement of profit or loss and other comprehensive income ........................... 245 Statement of cash flows .................................................................................... 245 Disclosure: the lessee ....................................................................................... 245 Basic IFRS 16 disclosures ................................................................................ 245 Interaction with other standards ........................................................................ 247 Additional qualitative and quantitative IFRS 16 disclosures ............................ 247 Variable lease payments ................................................................................... 248 Extension and tennination options .................................................................... 248 Residual value guarantees ................................................................................. 248 Lease commitments ............................................................. .. "' ........................ 249 Sale-and-leaseback transactions ....................................................................... 249 Recognition and measurement: the lessor ..................................................... 249 Finance lease versus operating lease ................................................................. 249 Finance lease versus operating lease: land and buildings ................................. 251 Finance lease versus operating lease: subleases ............................................... 252 Operating leases ................................................................................................ 252 General accounting requirements for operating leases ..................................... 252 Lease incentives and operating leases ............................................................... 255 Modification of operating leases ....................................................................... 255 Finance leases ................................................................................................... 256 Gross investment versus net investment ........................................................... 256 Initial measurement of finance leases .............................. . ............................... 256 Subsequent measurement of finance leases ...................................................... 258 Initial direct costs (lessor) ................................................................................. 262 Reassessments of net investments in finance leases ......................................... 263 Reduction in the unguaranteed residual value .................................................. 263 Changes in variable interest rates of finance leases .......................................... 266 Other reassessments of finance leases .............................................................. 267 Manufacturer or dealer lessors .......................................................................... 267 Modification of finance leases .......................................................................... 269 Tax consequences: the lessor .......................................................................... 270 Presentation: the lessor ................................................................................... 273 Disclosure: the lessor ....................................................................................... 273 General disclosure requirements for the lessor ...................................... . ......... 274 Specific disclosures for finance leases .............................................................. 274 Specific disclosures for operating leases .......................................................... 274 Sale-and-leaseback transactions ..................................................................... 276 Transfer of the asset is a sale ............................................................................ 276 Transfer of the asset is not a sale ...................................................................... 278 Summary ofIFRS 16, Leases ......................................................................... 279

Detailed chapter contents

11

11.1 11.2 112.1 11.22 11.23

112.4 11.3 113.1 113.1.1 113.1.1.1 113.1.1.2 113.1.1.3 113.1.1.4 113.1.1.5 113.12 113.13 113.1.4 113.2 113.2.1 113.2.1.1 113.2.12 113.2.2 113.2.3 11.33

113.3.1 113.3.1.1 113.3.12 113.3.13 113.3.1.4 113.3.1.5 113.3.2 113.3.2.1 113.3.2.2 113.3.2.3 113.3.3 113.3.4 113.4 113.4.1 113.4.2 113.4.3 113.4.4 113.5

XXlll

REVENUE FROM CONTRACTS WITH CUSTOMERS .......................... 281 Introduction ..................................................................................................... 281 Scope ................................................................................................................. 281 Contracts with customers ................................................................................. 281 Non-monetary exchanges to facilitate sales to customers ................................. 282 Contracts with customers in the scope of other standards ................................ 282 Costs of obtaining contracts with customers ..................................................... 282 Revenue recognition approach ....................................................................... 283 Step 1: Identify the contract with a customer .................................................... 283 General principles ............................................................................................. 283 The parties to the contract have approved the contract ..................................... 283 The entity can identify each party's rights in relation to the goods or services to be transferred .................................................................................. 284 The entity can identify the payment terms ........................................................ 284 The contract has commercial substance ............................................................ 284 It is probable that the entity will collect the consideration ............................... 284 Accounting for consideration received when the general principles have not been met ..................................................................................................... 284 Com bination of contracts .................................................................................. 285 Assessment and reassessment of a contract ...................................................... 285 Step 2: Identify the performance obligations in the contract ............................ 286 A good or service that is distinct ...................................................................... 286 The good or service is capable of being distinct ............................................... 286 The good or service is distinct in the context of the contract ........................... 287 A series of distinct goods or services ................................................................ 288 Explicit and implicit promises .......................................................................... 288 Step 3: Determine the transaction price ............................................................ 289 Variable consideration ...................................................................................... 289 Limiting estimates of variable consideration .................................................... 291 Reassessment of variable consideration ........................................................... 292 Sales-based or usage-based royalties ................................................................ 292 Refund liabilities ............................................................................................... 292 Warranties ......................................................................................................... 294 Significant financing component ...................................................................... 295 Detennining whether a significant financing component exists ....................... 295 Measurement and recognition of the financing component .............................. 296 Presenting finance income or expense .............................................................. 297 Non-cash consideration .................................................................................... 297 Consideration payable to the customer ............................................................. 298 Step 4: Allocate the transaction price to the performance obligations in the contract ....................................................................................................... 300 Allocating the transaction price based on stand-alone selling prices ................ 301 Allocating a discount ........................................................................................ 303 Allocating variable consideration ..................................................................... 305 Changes in the transaction price ....................................................................... 307 Step 5: Recognise revenue when (or as) the entity satisfies a perfonnance obligation .......................................................................................................... 307

XXIV

11.3.5.1 11.3.5.1.1 11.3.5.1.2 11.3.5.1.3 11.3.5.2 11.3.5.3 11.3.5.3.1 11.3.5.3.2 11.3.5.3.3 11.3.5.4 11.3.5.4.1 11.3.5.4.2 11.3.5.4.3 11.3.5.4.4 11.3.5.4.5 11.3.5.5 11.3.5.5.1 11.3.5.5.2 11.3.5.5.3 11.3.5.5.4 11.3.5.5.5 11.4 11.4.1 11.4.1.1 11.4.1.2 11.4.1.3 11.4.2 11.4.3 11.4.4 11.4.4.1 11.4.4.2 11.4.4.3 11.4.5 11.4.6 11.5 115.1 115.2 115.3 11.6 11.6.1 11.6.2 11.6.3 11.6.4 11.7

GAAP Handbook 2020: Volume 1

Control of an asset ............................................................................................ 308 Repurchase agreements ..................................................................................... 308 Repurchase agreements where the customer does not obtain control of the asset .................................................................................................................. 308 Repurchase agreements where the customer obtains control of the asset ......... 309 Timing of satisfying a performance obligation ................................................. 310 Satisfying a performance obligation over time ................................................. 310 The customer simultaneously receives and consumes the benefits ................... 310 The customer controls the asset as it is being created or enhanced .................. 311 No alternative use to the entity with a right to payment ................................... 311 Satisfying a performance obligation at a point in time ..................................... 313 The entity has a present right to payment ......................................................... 314 The customer has legal title to the asset ........................................................... 314 The entity has transferred physical possession of the asset .............................. 314 The customer has the significant risks and rewards of ownership of the a~ct .................................................................................................................. 314 The customer has accepted the asset ................................................................. 314 Measuring progress and recognising revenue ................................................... 315 Methods for measuring progress ....................................................................... 315 Output methods for measuring progress ........................................................... 315 Input methods for measuring progress .............................................................. 316 Update measurements of progress .................................................................... 318 Reasonable measures of progress ..................................................................... 318 Revenue recognition for specific situations ................................................... 318 Acting as a principal or agent.. .......................................................................... 318 The entity is acting as a principal ..................................................................... 319 The entity is acting as an agent ......................................................................... 319 Transferring obligations and rights to another party ............. . .......................... 321 Consignment arrangements ............................................................................... 321 Bill-and-hold arrangements .............................................................................. 322 Granting licences .............................................................................................. 322 The promise to grant a licence is not distinct ................................................... 323 The promise to grant a licence is distinct ......................................................... 323 Sales-based or usage-based royalties ................................................................ 324 Granting options to purchase additional goods or services ............................... 325 Non-refundable upfront fees ............................................................................. 331 Contract modifications .................................................................................... 332 Contract modification accounted for as a separate contract ............................. 332 Contract modification accounted for as a change in an existing contract ......... 333 Contract modifications and changes in transaction price .................................. 334 Contract costs .................................................................................................. 336 Contract costs incurred before obtaining a contract ......................................... 336 Contract costs incurred to fulfil a contract ............................... . ....................... 336 Amortisation of contract cost assets ................................................................. 337 Impainnent of contract cost assets .................................................................... 337 Presentation ..................................................................................................... 337

Detailed chapter contents

xxv

11.8 118.1 118.1.1 118.1.2 118.1.3 118.1.4 118.2 118.3 11.9

Disclosure ......................................................................................................... 339 Information about the entity's contracts with customers .................................. 340 Disaggregation of revenue ................................................................................ 340 Contract balances .............................................................................................. 341 Performance obligations ................................................................................... 341 Transaction price allocated to the remaining performance obligations ............ 342 Information about significant judgements ........................................................ 343 Information about contract assets ..................................................................... 343 Summary of revenue from contracts with customers ................................... 344

12 12.1 12.2 12.3 12.3.1 12.3.2 12.3.3 12.3.4 12.4 12.5 12.6 12.6.1 12.6.2 12.6.3 12.6.3.1 12.6.3.2 12.6.3.2.1 12.6.3.2.2 12.6.3.3 12.6.3.4 12.6.3.5

EMPLOYEE BENEFITS ............................................................................... 345 Introduction ..................................................................................................... 345 General principle of the standard .................................................................. 345 Short-term employee benefits ......................................................................... 345 Salaries and wages ............................................................................................. 346 Short-tenu paid absences ............................................................. ... . ................ 347 Profit-sharing and bonus plans (settled within 12 months) ............................... 351 Non-monetary benefits ..................................................................................... 352 Post-employment employee benefits .............................................................. 352 Post-employment employee benefits: defined contribution plans ............... 353 Post-employment employee benefits: defined benefit plans ......................... 354 The actuarial valuation method ......................................................................... 355 Accounting for the defined benefit plan ........................................................... 356 The defined benefit obligation .......................................................................... 356 Current service cost .......................................................................................... 356 Past service cost and gains or losses on settlement ........................................... 357 Past service cost ................................................................................................ 357 Gains or losses on settlement ............................................................................ 358 Interest cost on the defined benefit obligation .................................................. 359 Benefits paid ..................................................................................................... 359 The actuarial valuation of the obligation and detennination of actuarial gains and losses ................................................................................................. 359 Plan assets ......................................................................................................... 361 Contributions to the plan ............................. ... . ........................... ... . ................ 361 Interest income .................................................................................................. 365 Benefits paid ..................................................................................................... 365 Settlement gains and losses ............................................................................... 365 Valuation of plan assets and calculation ofrelurn on plan assets ..................... 366 Reimbursement rights ....................................................................................... 367 Fair value of insurance policies ........................................................................ 368 Determining the amount of the net liability/asset in the statement of financial position .............................................................................................. 368 Components of defined benefit cost ................................................................. 368 Amounts recognised in profit or loss ................................................................ 368 Remeasurements of the net defined benefit liability (asset) ............................. 369 Defined benefit assets and the asset ceiling ...................................................... 371 The application of paragraph 64 ....................................................................... 371

12.6.4 12.6.4.1 12.6.4.2 12.6.4.3 12.6.4.4 12.6.4.5 12.6.4.6 12.6.4.7 12.6.5 12.6.6 12.6.6.1 12.6.6.2 12.6.7 12.6.7.1

XXVI

12.6.7.2

GAAP Handbook 2020: Volume 1

12.10

IFRIC 14, The limit on a defined benefit asset, minimum funding requirements and their interaction .................................................................... 372 Availability of economic benefits: general ....................................................... 372 Availability of economic benefits: refunds ....................................................... 372 Availability of economic benefits: contribution reduction ............................... 373 Availability of economic benefits: the South African situation ........................ 373 Minimum funding requirements: general ......................................................... 374 Minimum funding requirements: refunds ......................................................... 374 Minimum funding requirements: contribution reduction .................................. 375 Minimum funding requirements: "hidden liability" .......................................... 375 Other considerations ......................................................................................... 379 Multi-employer plans ........................................................................................ 379 Defined benefit plans that share risks between various entities under common control (e.g. a parent and its subsidiaries) .......................................... 380 Group administration plans ............................................................................... 380 State plans ......................................................................................................... 381 Insured benefits ................................................................................................. 381 Other long-term employee benefits ................................................................ 381 Termination benefits ....................................................................................... 383 Financial statement presentation ................................................................... 385 lAS 19 requirements .......................................................................................... 385 Short-tenu employee benefits ........................................................................... 385 Defined contribution plans ................................................................................ 385 Defined benefit plans ........................................................................................ 385 Other long-tenu employee benefits .................................................................. 386 Tenuination benefits ......................................................................................... 387 Disclosure example ........................................................................................... 387 Summary ofIAS 19, Employee benefits ........................................................ 391

13 13.1 131.1 131.2 13.2 132.1 132.2 132.3 132A 132.5 132.5.1 132.5.2 13.3 13.4 13.4.1 13.4.2 13.5 135.1 135.2

GOVERNMENT GRANTS AND ASSISTANCE ........................................ 393 Introduction ..................................................................................................... 393 Objectives ......................................................................................................... 393 Exclusions ......................................................................................................... 393 Government grants .......................................................................................... 393 General accounting aspects ............................................................................... 393 Grants related to assets (asset-based grants) ..................................................... 394 Grants related to income (income-based grants) ............................................... 395 Repayment of grants ......................................................................................... 396 Specific fonus of government grants ................................................................ 397 Low interest rate loans .......................................... . .......................................... 397 Forgivable loans ................................................................................................ 399 Other forms of government assistance .......................................................... 399 Financial statement presentation ................................................................... 400 lAS 20 requirements .......................................................................................... 400 Disclosure example ........................................................................................... 400 Deferred tax ..................................................................................................... 402 Taxable grant related to income ................................................................ ....... A03 Non-taxable grant related to income ................................................................ A03

12.6.7.2.1 12.6.7.2.2 12.6.7.2.3 12.6.7.2A 12.6.7.2.5 12.6.7.2.6 12.6.7.2.7 12.6.7.2.8 12.6.8 12.6.8.1 12.6.8.2 12.6.8.3 12.6.8A 12.6.8.5

12.7 12.8 12.9 12.9.1 12.9.1.1 12.9.1.2 12.9.1.3 12.9.1A 12.9.1.5 12.9.2

Detailed chapter contents

XXVll

13.5.3 13.54 13.6

Taxable grant related to an asset .............................................................. . ...... 403 Non-taxable grant related to an asset ............................................................... 404 Summary ofIAS 20, Accounting for government grants and disclosure of government assistance .............................................................. 406

14 14.1 14.1.1 14.1.2 14.1.3 14.2 14.2.1 14.2.2 14.3 14.3.1 14.3.2 14.3.3 14.4 14.4.1 14.4.2 14.5 14.6 14.7 14.7.1 14.7.2 14.8

THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES .... .407 Introduction .................................................................................................... .407 Foreign currency accounting ............................................................................. 407 Scope exclusions ............................................................................................... 408 Approach required by lAS 21 ........................................................................... 408 Identifying the functional currency .............................................................. .409 Primary and secondary indicators ...................................................................... 409 Change in the functional currency ................................................................... 410 Foreign currency transactions ........................................................................ 410 Initial recognition and measurement ................................................................. 410 Subsequent measurement .................................................................................. 411 Other issues regarding foreign transactions ...................................................... 416 Translation of financial statements ................................................................ 416 The closing rate method ................................................................................... 41 7 The hyperinflation method ............................................................................... 419 Books and records not kept in functional currency...................................... 420 Introduction of the Euro ................................................................................. 420 Financial statement presentation ................................................................... 420 lAS 21 requirements .......................................................................................... 420 Disclosure example ........................................................................................... 421 Summary ofIAS 21, The effects of changes in foreign exchange rates ...... .422

15 15.1 15.1.1 15.1.2 15.2 15.3 15.3.1 15.3.2 15.3.3 15.4 15.4.1 15.4.2 154.3 15.5 15.6 15.7 15.7.1 15.7.2 15.8

BORROWING COSTS ................................................................................... 423 Introduction .................................................................................................... .423 Borrowing costs and qualifying assets .............................................................. 423 Exclusions ......................................................................................................... 423 Recognition ..................................................................................................... .424 Borrowing costs eligible for capitalisation ................................................... .424 General principle ............................................................................................... 424 Specific borrowings .......................................................................................... 424 General borrowings .......................................................................................... 425 Capitalisation period ....................................................................................... 428 Commencement of capitalisation ...................................................................... 428 Cessation of capitalisation ................................................................................ 428 Suspension of capitalisation ............................................................................. 429 Capitalisation in group situations ................................................................. .429 Limit to capitalisation ..................................................................................... 430 Financial statement presentation ................................................................... 430 lAS 23 requirements .......................................................................................... 430 Disclosure example ........................................................................................... 430 Summary of lAS 23, Borrowing costs ........................................................... .432

XXV111

16 16.1 16.2 16.2.1

GAAP Handbook 2020: Volume 1

16.2.11 16.3 16.4 16.4.1 16.4.1.1 16.4.1.2 16.4.1.3 16.4.1A 16.4.2 16A.3 16AA 16.5

RELATED PARTY DISCLOSURES ............................................................ 433 Introduction .................................................................................................... .433 The related party definition ............................................................................ 434 A person that has control, joint control or significant influence over the entity ................................................................................................................. 434 Close family members of a person in 16.2.1 .................................................... A34 A person that is a member of the key management personnel ......................... .435 Close family members of a person in 16.2.2 .................................................... .435 Members of the same group .............................................................................. 436 Investor and associate or venturer and joint venture ......................................... 436 Joint ventures of the same third party ............................................................... 437 One entity is a joint venture and the other entity is an associate of the same third party ................................................................................................ 437 Post-employment benefit plan .......................................................................... 437 Entities controlled or jointly controlled by persons in 16.2.1 and 16.2.2 ........ .438 Entity in which a person having control or joint control over the reporting entity, has significant influence ............................................................... ........ A38 Entity (or group) that provides key management personnel services to the reporting entity or to its parent ........................................................................ A40 Parties deemed not to be related parties ............................................................ 440 State-controlled entities ................................................................................... 441 Financial statement presentation ................................................................... 442 lAS 24 requirements .......................................................................................... 442 Disclosure of related party relationships ........................................................... 442 Disclosure of key management personnel compensation ................................. 442 Disclosure of related party transactions ............................................................ 442 Government-related entities .............................................................................. 443 JSE listings requirements .................................................................................. 444 The King Code of Corporate Practices and Conduct ....................................... A45 Disclosure example ........................................................................................... 446 Summary ofIAS 24, Related party disclosures ............................................ 448

17 17.1 17.2 17.3 17.3.1 17.3.2 17.3.3 17.3A 17.3.5 17.3.6 17.3.7 17.4 17.4.1 17.4.2 17A.3 17AA

HYPERINFLATIONARY ECONOMIES .................................................... 449 Introduction .................................................................................................... .449 Identifying a hyperinflationary economy ...................................................... 449 Restatement of financial statements .............................................................. 450 Select a general price index .............................................................................. 450 Segregating monetary and non-monetary items ................................................ 450 Restate monetary items ..................................................................................... 450 Restate non-monetary items .............................................................................. 451 Restate the items of income and expense recognised in profit or loss .............. 453 Restate equity ................................................................................................... 453 Calculate the gain or loss on the net monetary position ................................ ... A53 Specific issues .................................................................................................. .456 Comparative amounts ........................................................................................ 456 General price index not available for property, plant and equipment .............. .457 Detailed acquisition dates not available ............................................................ 458 IFRIC 7: Economies becoming hyperinflationary ........................................... .458

16.2.1.1 16.2.2 16.2.2.1 16.2.3 16.2A 16.2.5 16.2.6 16.2.7 16.2.8 16.2.9 16.2.10

Detailed chapter contents

XXIX

174.5 174.6 174.7 174.8 17.5 17.5.1 17.5.2 17.6

IFRIC 7: Deferred tax .............................................................. . ...................... .458 Economies ceasing to be hyperinflationary ..................................................... .460 Consolidated financial statements ..................................................................... 460 Statement of cash flows .................................................................................... 461 Financial statement presentation ................................................................... 461 lAS 29 requirements .......................................................................................... 461 Disclosure example ........................................................................................... 462 Summary ofIAS 29, Financial reporting in hyperinflationary economies ......................................................................................................... 463

18 18.1 18.2 18.3 18.4 184.1 18.5 18.6 18.6.1 18.6.2 18.6.2 18.7 18.7.1 18.7.1.1 18.7.1.2 18.7.1.3 18.7.1.3.1 18.7.1.3.2 18.7.1.3.3 18.7.1.3,4 18.7.1,4 18.7.14.1 18.7.14.2 18.7.1,4.3 18.7.1,4,4 18.7.14.5 18.7.14.6 18.7.14.7 18.7.14.8

FINANCIAL INSTRUMENTS ...................................................................... 465 Introduction ..................................................................................................... 465 Identifying financial instruments ................................................................... 465 Scope exclusions ............................................................................................... 467 Initial recognition ............................................................................................ 468 Regular way contracts ....................................................................................... 469 Fair value ......................................................................................................... 470 Initial measurement of all financial instruments ......................................... .471 Fees on financial assets or liabilities ................................................................ .472 Day one gains and losses ................................................................................. .473 Transaction price includes "something other" .................................................. 474 Subsequent measurement of financial assets ................................................ 475 Aspects which drive the classification of financial assets ................................ .476 Held for trading ................................................................................................ .476 Investments in debt instruments or equity instruments .................................... .479 The objective of the business model for managing the financial asset ............ .480 Determining the objective of the business model ............................................ .480 The objective is to hold financial assets to collect contractual cash flows ...... .482 The objective is to collect contractual cash flows and sell financial assets ..... .483 Other objectives ................................................................................................ 484 The nature of the contractual cash flows of the financial asset ........................ .485 What are contractual cash flows? .................................................................... ,485 The nature of cash flows and the classification of financial assets .................. .485 On specified dates ............................................................................................. 485 Solely principal and interest (general) .............................................................. 486 Solely principal and interest (exchange rate risk) ............................................ .486 Solely principal and interest (leverage) ............................................................ 487 Solely principal and interest (modified time value of money) ......................... .488 Solely principal and interest (contractual terms which change the timing or amount of contractual cash flows) ................................................................ 490 Solely principal and interest (cash flows relating to a specific asset) .............. .491 Solely principal and interest (de minimis effect) ............................................. .492 Solely principal and interest (characteristics which are not genuine) .............. .492 Solely principal and interest (illustrative scenarios) ........................................ .493 Investments when tranches are present ............................................................ .494 The categories of financial assets .................................................................... ,496 Financial assets at amortised cost .................................................................... ,496 Financial assets which are not currently credit-impaired ................................. ,497

18.7.14.9 18.7.14.10 18.7.14.11 18.7.14.12 18.7.14.13 18.7.2 18.7.2.1 18.7.2.1.1

xxx

18.7.2.1.2 18.7.2.1.3 18.7.2.1.4 18.7.2.2 18.7.2.2.1 18.7.2.2.2 18.7.2.3 18.7.2.4 18.7.2.4.1 18.7.2.4.2 18.7.2.5 18.7.3 18.7.4 18.7.4.1 18.7.4.2 18.7.4.3 18.7.4.4 18.7.4.5 18.7.4.5.1 18.7.4.5.2 18.7.4.5.3 18.7.4.5.4 18.7.4.5.5 18.7.4.6 18.7.4.6.1 18.7.4.6.2 18.7.4.6.3 18.7.4.6.4 18.7.4.7 18.7.4.8 18.7.4.8.1 18.7.4.8.2 18.7.4.8.3 18.7.4.8.4

GAAP Handbook 2020: Volume 1

Financial assets which became credit-impaired after they were purchased or originated ...................................................................................................... 502 Financial assets which were credit-impaired when they were purchased or originated .......................................................................................................... 506 Irnpainnent of financial assets measured at amortised cost .............................. 507 Investments in debt instruments at fair value through other comprehensive mcome .............................................................................................................. 507 Impainnent of investment in debt instruments at fair value through other comprehensive income ..................................................................................... 509 Investment in foreign debt instruments at fair value through other comprehensive income ..................................................................................... 510 Investments in equity instruments at fair value through other comprehensive income ..................................................................................... 512 Financial assets at fair value through profit or loss ........................................... 514 Designated at fair value through profit or loss .................................................. 514 Mandatorily at fair value through profit or loss / financial assets which do not belong to any other category ....................................................................... 515 Fair value of investments in equity instruments ............................................... 516 Summary: classification of financial assets ...................................................... 518 Impainnent of financial assets .......................................................................... 518 What are credit losses? ..................................................................................... 519 Expected credit losses .................................................................... , ................. 519 Default .............................................................................................................. 520 Incurred credit losses and credit-impaired financial assets ............................... 520 Lifetime and 12-month expected credit losses .................................................. 521 Deciding between lifetime and 12-month expected credit losses ..................... 521 Impainnent of financial assets which were credit-impaired when they were purchased or originated ............................................................................ 522 Impainnent of trade receivables or contract assets in the scope ofIFRS 15 which do not contain a significant financing component ................................. 522 Accounting policy choice to apply lifetime expected credit losses ................... 522 Significant increases in credit risk since initial recognition .............................. 522 Detennining whether credit risk has increased significantly since initial recognition ........................................................................................................ 523 Individual and collective assessment ................................................................ 523 Methods to assess changes in credit risk ........................................................... 525 Indicators that credit risk has increased significantly since initial recognition ........................................................................................................ 526 The low credit risk exception ............................................................................ 526 Recognition of expected credit losses ............................................................... 527 Measuring expected credit losses ...................................................................... 527 Lifetime expected credit losses for financial assets which were never credit-impaired ................................................................................................. 528 Impainnent of financial assets which became credit-impaired after they were purchased or originated ............................................................................ 531 Impainnent of financial assets which were credit-impaired when they were purchased or originated ............................................................................ 533 12-month expected credit losses ....................................................................... 534

Detailed chapter contents

18.7.4.8.5 18.7.4.8.6 18.7.4.8.7 18.7.4.8.8 18.7.4.8.9 18.7.5 18.76 18.8 18.8.1 18.8.1.1 18.8.1.2 18.8.1.2.1 18.8.1.2.2 18.8.1.2.3 18.8.1.2.4 18.8.2 18.8.3 18.8.4 18.8.5 18.8.6 18.9 18.9.1 18.9.2 18.9.3 18.9.3.1 18.9.3.2 18.9.3.3 18.9.3.4 18.9.3.5 18.9.3.6 18.10 18.10.1 18.10.1.1 18.10.1.2 18.10.1.3 18.10.1.4 18.10.1.5 18.10.1.6 18.102 18.102.1 18.10.2.2 18.1023 18.10.2.4

XXXI

Practical expedients in the measurement of expected credit losses .................. 535 Impainnent of debt instruments at fair value through other comprehensive mcome .............................................................................................................. 535 Impainnent of lease receivables ....................................................................... 536 The impact of collateral on the measurement of expected credit losses ........... 537 Impainnent of loan commitments and financial guarantee contracts ................ 537 Write-off ........................................................................................................... 538 Modification of financial assets at amortised cost ............................................ 539 Subsequent measurement of financial liabilities ........................................... 543 Financial liabilities at fair value through profit or loss ...................................... 543 Mandatorily at fair value fhrough profit or loss ................................................ 543 Designated at fair value fhrough profit or loss .................................................. 543 Credit risk ......................................................................................................... 544 Separation of credit risk component prohibited ................................................ 544 Separation of credit risk component required ................................................... 545 Credit risk change reserve ............................................. . ...................... . .......... 547 Financial liabilities arising from derecognition ................................................ 547 Financial guarantee contracts ............................................................................ 547 Loan commitments ........................................................................................... 549 Contingent consideration in a business combination ........................................ 550 Financial liabilities at amortised cost ............................................................... 550 Reclassifications ............................................................................................... 550 Reclassification requirements ........................................................................... 550 Summary of reclassification requirements ........................................................ 552 Accounting for reclassifications ....................................................................... 552 Reclassification from amortised costto fair value fhrough profit or loss ......... 553 Reclassification from amortised cost to investments in debt instruments at fair value through other comprehensive income ............................................... 554 Reclassification from fair value fhrough profit or loss to amortised cost ......... 556 Reclassification from fair value through profit or loss to investments in debt instruments at fair value fhrough other comprehensive income ................ 558 Reclassification from investments in debt instruments at fair value through other comprehensive income to fair value through profit or loss ........ 560 Reclassification from investments in debt instruments at fair value through other comprehensive income to amortised cost ................................... 562 Derecognition of financial assets .................................................................... 564 The derecognition flowchart .............................................................................. 564 Step 1: Consolidate all subsidiaries .................................................................. 564 Step 2: Applied to all or part of a financial asset .............................................. 565 .................................. 565 Step 3: Have the rights to the cash flows expired? Step 4: Transfers of financial assets .................................................................. 567 Step 5: Risks and rewards model ...................................................................... 567 Step 6: The control model ................................................................................. 568 The accounting treatment of derecognition ...................................................... 569 Transfers that qualify for derecognition ........................................................... 569 Accounting treatment of transfers that do not qualify for derecognition .......... 572 Accounting treatment of transfers with continuing involvement ...................... 573 Accounting for non-cash collateral ................................................................... 574

XXXII

18.11 18.11.1 18.11.2 18.12 18.12.1 18.12.2 18.12.3 18.12.4 18.12.5 18.12.6 18.12.7 18.12.8 18.12.9 18.13 18.14 18.15 18.15.1 18.15.2 18.15.3 18.15.4 18.16 18.16.1 18.16.2 18.16.3 18.16.4 18.16.5 18.17 18.17.1 18.17.2 18.17.2.1 18.17.2.1.1 18.17.2.1.2 18.17.2.1.3 18.17.2.1.4 18.17.2.1.5 18.17.2.2 18.17.2.2.1 18.17.2.2.2 18.17.2.2.3 18.17.2.2.4 18.17.2.2.5 18.17.2.2.6 18.17.2.3 18.17.2.4 18.17.2.4.1 18.17.2.4.2 18.17.2.4.3

GMP Handbook 2020: Volume 1

Derecognition of financial liabilities .............................................................. 575 Restructuring of debt commitments .................................................................. 575 Extinguishing financial liabilities with equity instruments ............................... 577 The distinction between equity and liabilities ............................................... 578 Settlement in an entity's own equity instruments .............................................. 578 The existence of a contractual obligation ......................................................... 583 Contingent settlement provisions ...................................................................... 584 Perpetual debt instruments ................................................................................ 584 Compound financial instruments ...................................................................... 585 The classification of preference shares ............................................................. 587 Puttable instruments .......................................................................................... 588 Instruments that create obligations on liquidation ............................................ 590 Reclassification of puttable instruments and instruments that create an obligation on liquidation ................................................................................... 591 Share buy-backs and treasury shares ............................................................ 591 Interest, dividends, losses and gains ............................................................... 592 Offsetting .......................................................................................................... 592 Legally enforceable righL ................................................................................ 593 Intention of net / simultaneous settlement ........................................................ 593 Master netting arrangements ............................................................................. 594 Offsetting inappropriate .................................................................................... 594 Embedded derivatives ..................................................................................... 595 Transferability of the derivative ........................................................................ 595 Nature of the host contract ................................................................................ 596 Reassessment of embedded derivatives ............................................................ 597 Interest rate embedded derivative ..................................................................... 598 Foreign currency embedded derivatives ........................................................... 598 Hedge accounting ............................................................................................ 599 Background to hedge accounting ...................................................................... 599 Qualifying criteria ............................................................................................. 599 Qualifying hedged items ................................................................................... 600 Reliably measurable .......................................................................................... 600 Party external to the reporting entity ................................................................ 600 Aggregated exposures ....................................................................................... 601 Guidance on specific items ............................................................................... 602 Designating a component as the hedged item ................................................... 602 Qualifying hedging instruments ........................................................................ 605 Derivatives which qualify as hedging instruments ........................................... 605 Non-derivatives which qualify as hedging instruments .................................... 605 Party external to the reporting entity ........................................... .. .................. 605 Hedging instruments and components .............................................................. 606 Single and combined hedging instruments ....................................................... 606 Own equity instruments .................................................................................... 606 Formal designation and documentation ............................................................ 606 Hedge effectiveness .......................................................................................... 606 Hedge effectiveness: economic relationship ..................................................... 607 Hedge effectiveness: the effect of credit risk .................................................... 607 Hedge effectiveness: the hedge ratio ................................................................ 608

Detailed chapter contents

XXX111

18.17.2.4.4 18.17.2.4.5 18.17.3 18.17.3.1 18.17.3.1.1 18.17.3.1.2 18.17.3.1.3

Frequency of assessing hedge effectiveness ..................................................... 608 Methods for assessing hedge effectiveness ....................................................... 608 Accounting for qualifying hedging relationships .............................................. 609 Fair value hedge accounting ............................................................................. 610 Fair value hedge accounting of foreign currency risk ....................................... 611 Fair value hedge accounting of interest rate risk .............................................. 614 Fair value hedge accounting of investments in equity instruments at fair

18.17.3.1.4 18.17.3.2 18.17.3.2.1 18.17.3.2.2 18.17.3.2.3 18.17.3.2.4 18.17.3.3 18.17.3.4 18.17.3.4.1

Fair value hedge accounting for finn commitments ......................................... 617 Cash flow hedge accounting ............................................................................. 619 Cash flow hedge accounting of foreign currency risk ...................................... 620 Cash flow hedge accounting of interest rate risk .............................................. 622 Hedge accounting of investments in equity instruments ................................... 624 Cash flow hedge accounting for finn commitments ......................................... 624 Summary: types of hedging relationships ......................................................... 624 Components of hedging instruments ................................................................ 625 Components of hedging instruments when an entity decides not to apply the requirements of par 6.5.15 .......................................................................... 625 Components of hedging instruments when an entity decides to apply the requirements of par 6.5.15 ................................................................................ 627 Measuring hedge ineffectiveness ...................................................................... 631 Hedges of a net investment in a foreign operation ........................................... 632 Nature of the hedged risk and the amount of the hedged item .......................... 633 Where the hedging instrument can be held in a group ...................................... 633 Reclassification of amount accumulated in equity ............................................ 639 Rebalancing ...................................................................................................... 641 Hedging against credit risk ............................................................................... 642 A hedge of a group of items .............................................................................. 643 Meeting the requirements for a hedge of a group of items ............................... 643 Determining hedge effectiveness for a hedge of a group of items .................... 644 Net nil positions ................................................................................................ 644 Designation of a component of a nominal amount ........................................... 644 Accounting and presentation of a hedge of a group of items ............................ 645 Derivatives ........................................................................................................ 645 Futures contracts ............................................................................................... 645 Option contracts ................................................................................................ 646 Swap contracts .................................................................................................. 648 Forward rate agreements ................................................................................... 648 Financial statement presentation ................................................................... 649 Requirements of standards other than IFRS 7 ............... . ............ ... . ................ 649 Fair value measurement (IFRS 13) ................................................................... 649 Presentation of financial statements (IAS 1) ..................................................... 649 RequirementsofIFRS7 ................................................................................... 650 Financial risks as definedinIFRS 7 ................................................................. 650 Classes of financial instruments in IFRS 7 ....................................................... 650 Statement of financial position ......................................................................... 651 Categories of financial assets and financial liabilities ...................................... 651

value through other comprehensive income ..................................................... 617

18.17.3.4.2 18.17.3.5 18.17.3.6 18.17.3.6.1 18.17.3.6.2 18.17.3.6.3 18.17.3.7 18.17.3.8 18.17.3.9 18.17.3.9.1 18.17.3.9.2 18.17.3.9.3 18.17.3.9.4 18.17.3.9.5 18.18 18.18.1 18.18.2 18.18.3 18.18.4 18.19 18.19.1 18.19.1.1 18.19.1.2 18.19.2 18.19.2.1 18.19.2.2 18.19.3 18.19.3.1

XXXIV

18.19.3.2

GMP Handbook 2020: Volume 1

18.19.8.1.3 18.19.8.1.4 18.19.8.2 18.19.8.3 18.19.8.3.1 18.19.8.3.2 18.19.9 18.19.9.1 18.19.9.2 18.19.9.3 18.20 18.21

Financial assets or financial liabilities designated as at fair value through profit or loss ...................................................................................................... 652 Financial assets ................................................................................................. 652 Financial liabilities ............................................................................................ 653 Investments in equity instruments at fair value through other comprehensive income ..................................................................................... 656 Reclassification ................................................................................................. 657 Offsetting .......................................................................................................... 661 Collateral .......................................................................................................... 662 Compound financial instruments with multiple embedded derivatives ............ 663 Defaults and breaches ....................................................................................... 663 Statement of profit or loss and other comprehensive income ........................... 663 Items of income, expense, gains or losses ........................................................ 663 Other disclosures .............................................................................................. 665 Accounting policies .......................................................................................... 665 Hedge accounting ............................................................................................. 666 Risk management strategy ................................................................................ 666 Amount, timing and uncertainty of future cash flows ....................................... 666 The effects of hedge accounting on financial position and performance .......... 667 Hedges of credit risk ......................................................................................... 670 Fair value disclosures (IFRS 7) ......................................................................... 670 Nature and extent ofrisks arising from financial instruments .......................... 671 Qualitative disclosures ...................................................................................... 671 Quantitative disclosures .................................................................................... 671 Credit risk ......................................................................................................... 672 Credit risk management practices ..................................................................... 672 Quantitative and qualitative information about expected credit risk amounts ............................................................................................................. 673 Credit risk exposure .......................................................................................... 679 Collateral and other credit enhancements obtained .......................................... 679 Liquidity risk .................................................................................................... 680 Marketrisk ........................................................................................................ 680 Sensitivity analysis ........................................................................................... 680 Other market risk disclosures ........................................................................... 680 Derecognition ................................................................................................... 681 Transfers of financial assets .............................................................................. 681 Transferred financial assets not derecognised in their entirety ......................... 681 Transferred financial assets derecognised in their entirety ............................... 682 Summary ofIAS 32, Financial instruments: presentation ........................... 683 Summary ofIFRS 9, Financial instruments .................................................. 684

19 19.1 19.2 19.3 19.3.1 19.3.2 19.3.3

EARNINGS PER SHARE .............................................................................. 685 Introduction ..................................................................................................... 685 Basic earnings per share ................................................................................. 685 Basic EPS: earnings ......................................................................................... 687 Preference dividends ......................................................................................... 687 Increasing rate preference shares ...................................................................... 688 Buy-back of preference shares .......................................................................... 689

18.19.3.2.1 18.19.3.2.2 18.19.3.3 18.19.3.4 18.19.3.5 18.19.3.6 18.19.3.7 18.19.3.8 18.19.4 18.19.4.1 18.19.5 18.19.5.1 18.19.5.2 18.19.5.2.1 18.19.5.2.2 18.19.5.2.3 18.19.5.2.4 18.19.5.3 18.19.6 18.19.7 18.19.8 18.19.8.1 18.19.8.1.1 18.19.8.1.2

Detailed chapter contents

xxxv

19.3.4 19.3.5 19.4 19.4.1 19.4.1.1 19.4.1.2 19.4.1.3 19.4.2 19.4.2.1 19.4.2.2 19.4.2.3 19.4.2.4 19.5 19.5.1 19.5.2 19.5.3 19.5.4 19.5.5 19.5.6 19.5.7 19.5.8 19.5.9 19.5.10 19.5.11 19.6 19.7 19.7.1 19.7.2 19.7.3 19.7.4 19.7.5 19.7.5.1 19.7.5.2 19.8 19.9 19.9.1 19.9.2 19.9.3 19.9.4 19.10

Incentive for early conversion of preference shares ......................................... 689 Participating preference shares ......................................................................... 689 Basic EPS: shares ............................................................................................ 690 New share issues (with a change in resources) ................................................. 690 General principle ............................................................................................... 690 Mandatorily convertible instruments ................................................................ 691 Contingently issuable shares ............................................................................. 692 New share issues (without a change in resources) ............................................ 692 Capitalisation or bonus issues ........................................................................... 693 Share split ......................................................................................................... 693 Consolidation of shares ..................................................................................... 693 Rights issues ..................................................................................................... 694 Diluted earnings per share .............................................................................. 695 Earnings - diluted .............................................................................................. 695 Shares - diluted ................................................................................................ 696 Convertible instruments ........................................ . ...................... . .................. 696 Options, warrants and their equivalents ............................................................ 697 Contingently issuable shares ............................................................................. 698 Contracts that may be settled in ordinary shares or in cash .............................. 699 Purchased options ............................................................................................. 700 Written put options ........................................................................................... 701 Sequence of dilution ......................................................................................... 701 Subsidiaries, joint ventures and associates ....................................................... 703 Share-based payments ....................................................................................... 705 Restatement ...................................................................................................... 707 Headline earnings ............................................................................................ 707 The definition of headline earnings ................................................................... 707 What are separately identifiable remeasurements? ............................... . .......... 708 Included remeasurements ................................................................................. 709 Summary per IFRS standard ............................................................................. 709 Sector-specific rules for headline earnings ....................................................... 717 Remeasurements relating to private equity activities ........................................ 717 Remeasurements of investment property by listed life insurers ....................... 717 Dividend per share .......................................................................................... 717 Financial statement presentation ................................................................... 719 lAS 33 requirements .......................................................................................... 719 JSE listings requirements .................................................................................. 720 Circular 2/2015 ................................................................................................. 720 Disclosure example ........................................................................................... 722 Summary of lAS 33, Earnings per share and Circular 212013, Headline earnings ............................................................................................ 724

20 20.1 20.2 20.2.1 20.2.2 20.23

INTERIM FINANCIAL REPORTING ........................................................ 725 Scope and objectives ........................................................................................ 725 Contents and format ofthe interim report... ................................................. 725 Condensed statement of financial position ........................................................ 726 Condensed statement of profit or loss and other comprehensive income ......... 727 Condensed statement of changes in equity ....................................................... 727

XXXVI

GAAP Handbook 2020: Volume 1

20.2.4 20.2.5 20.3 20.3.1 20.3.2 20.33 20.3.4 20.3.5 20.3.6 20.4 20.5 20.6 20.7

Condensed statement of cash flows .................................................................. 727 Note disclosures ................................................................................................ 728 Recognition and measurement principles ..................................................... 730 Seasonal, cyclical and occasional revenues ....................................................... 730 Costs incurred unevenly .................................................................................... 730 Interim income tax expense .............................................................................. 731 Use of estimates ................................................................................................ 731 Materiality ........................................................................................................ 731 Restatement of previously reported data ........................................................... 732 Disclosure in annual financial statements ..................................................... 732 URIC 10, Interim financial reporting and impairment .............................. 732 Disclosure example .......................................................................................... 732 Summary of lAS 34, Interim financial reporting ......................................... 736

21

IMPAIRMENT OF ASSETS .......................................................................... 737 Introduction ..................................................................................................... 737 Identifying impairment ................................................................................... 737 Measurement of recoverable amount ............................................................ 738 Measuring the recoverable amount of an intangible asset with an indefinite useful life .......................................................................................... 739 Fair value less costs of disposal ........................................................................ 740 Value in use ...................................................................................................... 740 Future cash flows .............................................................................................. 741 Discount rate ..................................................................................................... 743 Recognition and measurement of an impairment loss for an individual asset ................................................................................................ 744 Reversal of an im pairment loss for an individual asset ................................ 745 Cash-generating units ..................................................................................... 747 Identification of a cash-generating unit to which an asset belongs ................... 747 Recoverable amount and carrying amount of a CGU ....................................... 748 Goodwill ........................................................................................................... 749 Allocating goodwill to cash-generating units ................................................... 749 Testing cash-generating units with goodwill for impairment ........................... 750 Non-controlling interest .................................................................................... 750 Non-controlling interest measured at proportionate share in the recognised amounts of identifiable net assets ..................................................................... 750 Non-controlling interest measured at fair value ................................................ 753 Subsidiary part of a larger cash-generating unit ............................................... 754 Portion of goodwill allocated to other cash-generating units ............................ 755 Timing of impairment tests relating to goodwill .............................................. 757 Impairment loss for a cash-generating unit ....................................................... 758 Reversal of an impainnent loss ......................................................................... 759 Reversal of an impairment loss for a CGU .............................. . ....................... 759 Reversal of an impairment loss for goodwill .................................................... 760 Corporate assets .............................................................................................. 760 Indication that a corporate asset is impaired ...................................................... 760 Indication that a CGU to which a corporate asset relates is impaired ............... 760

21.1

21.2 21.3 21.3.1 21.3.2 21.3.3 21.3.3.1 21.3.3.2 21.4 21.5 21.6 21.6.1 21.6.2 21.6.3 21.6.3.1 21.6.3.2 21.6.3.3 21.6.3.3.1 21.6.3.3.2 21.6.3.3.3 21.6.3.3.4 21.6.3.4 21.6.4 21.6.5 21.6.5.1 21.6.5.2 21.7 21.7.1 21.7.2

Detailed chapter contents

21.8 21.8.1 21.8.1.1 21.8.2 21.9 21.10

22 22.1 22.2 22.2.1 22.2.2 22.2.3 22.2.4 22.3 22.3.1 22.3.2 22.3.3 22.3.4 22.3.5 22.4 22.4.1 22.4.2 22.4.3 22.4.4 22.4.5 22.4.6 22.5 22.5.1 22.5.2 22.6

22.7 22.8 22.8.1 22.8.2 22.8.3 22.9 22.10 23 23.1 23.1.1 23.1.2 23.1.3

XXXVll

Financial statement presentation ................................................................... 761 lAS 36 requirements .......................................................................................... 761 Additional disclosures in terms ofIAS 36 for goodwill and intangible assets with indefinite useful lives ..................................................................... 763 Disclosure example ........................................................................................... 765 Taxation ............................................................................................................ 766 Summary ofIAS 36, 1m pairment of assets .................................................... 767

PROVISIONS, CONTINGENT ASSETS AND CONTINGENT LIABILITIES .................................................................................................. 769 Introduction ..................................................................................................... 769 Recognition ...................................................................................................... 769 Provisions ......................................................................................................... 769 Contingent liabilities ......................................................................................... 771 Contingent assets .............................................................................................. 772 Decision tree .................................................................................. , ................. 773 Measurement ................................................................................................... 773 Best estimate ..................................................................................................... 773 Risks and uncertainties ..................................................................................... 774 Present value ..................................................................................................... 774 Future events ..................................................................................................... 775 Expected disposals of assets ................. . .......................................................... 775 Specific issues ................................................................................................... 775 Reimbursement rights ........................................................................................ 775 Changes in provisions ....................................................................................... 776 Use of provisions .............................................................................................. 776 Future operating losses ..................................................................................... 776 Onerous contracts ............................................................................................. 776 Restructuring .................................................................................................... 776 IFRIC 5, Rights to interests arising from decommissioning, restoration and environmental rehabilitation funds .................................... 778 Contributor's interest in the fund ....................................................................... 778 Obligations to make additional payments ......................................................... 779 IFRIC 6, Liabilities arising from participating in a specific marketwaste electrical and electronic equipment ..................................................... 779 IFRIC 21, Levies .............................................................................................. 780 Financial statement presentation ................................................................... 780 lAS 37 requirements .......................................................................................... 780 IFRIC 5 requirements ....................................................................................... 782 Disclosure example ........................................................................................... 782 Taxation ............................................................................................................ 783 Summary of lAS 37, Provisions, contingent assets and contingent liabilities ........................................................................................................... 784 INT ANGIBLE ASSETS .................................................................................. 785 Introduction ..................................................................................................... 785 Objectives ......................................................................................................... 786 Exclusions ......................................................................................................... 786 Inclusions .......................................................................................................... 786

XXXV111

23.2 23.2.1 23.2.2 23.2.3 23.2.3.1 23.2.3.2 23.3 23.4 23.4.1 23.4.2 23.4.2.1 23.4.2.2 23.4.3 23.4.4 23.4.5 23.4.6 23.4.7 23.4.7.1 23.4.7.2 23.4.7.3 23.4.8 23.4.9 23.5 23.5.1 23.5.2 23.6 23.7 23.7.1 23.7.2 23.7.3 23.7.4 23.8 23.9 23.10 23.11 2311.1 23.11.2 23.12 24 24.1 24.2 24.3 24.3.1 24.3.2

GAAP Handbook 2020: Volume 1

Definition of an intangible asset ..................................................................... 786 Identifiability ..................................................................................................... 787 Non-monetary ................................................................................................... 787 Asset ................................................................................................................. 788 Control .............................................................................................................. 788 Future economic benefits .................................................................................. 789 Recognition ...................................................................................................... 789 Initial measurement ........................................................................................ 789 Separate acquisition .......................................................................................... 789 Acquisition as part of a business combination .................................................. 790 Acquired in-process research and development project ................................... 792 Further examples of intangible assets acquired in a business corn bination ...... 792 Acquisition by way of government grant ......................................................... 793 Exchange of assets ............................................................................................ 793 Internally generated goodwill ........................................................................... 794 Internally generated brands, mastheads, publishing titles, customer lists and similar items ............................................................................................... 794 Other internally generated intangible assets ..................................................... 794 Research phase .................................................................................................. 795 Development phase ........................................................................................... 795 SIC 32, Web site costs ...................................................................................... 796 Costs that are required to be expensed .............................................................. 798 Prepaym ents ...................................................................................................... 799 Subsequent measurement ............................................................................... 799 Cost model. ........................................................................................................ 799 Revaluation model ............................................................................................ 799 Intangible assets with an indefinite useful life .............................................. 801 Intangible assets with a finite useful life ........................................................ 802 Useful life .......................................................................................................... 802 Residual value ................................................................................................... 803 Amortisation method ........................................................................................ 804 Timing of amortisation ..................................................................................... 804 Impairment.. .................................................................................................... 805 Retirements and disposals .............................................................................. 805 Taxation ............................................................................................................ 806 Financial statement presentation ................................................................... 806 lAS 38 requirements .......................................................................................... 806 Disclosure example ........................................................................................... 807 Summary of lAS 38, Intangible assets ........................................................... 810 INVESTMENT PROPERTY ......................................................................... 811 Introduction ..................................................................................................... 811 Distinction between investment property and owner-occupied property ............................................................................................................ 811 Recognition and initial measurement ............................................................ 813 Recognition of owned investment property ....................................................... 813 Initial measurement of owned investment property .......................................... 813

Detailed chapter contents

XXXIX

24.4 24.4.1 24.4.1.1 24.4.1.2 24.4.2 24.4.3 24.5 24.5.1 24.5.2 24.5.3 24.5.4 24.6 24.7 24.8 24.8.1 24.8.1.1 24.8.1.2 24.8.1.3 24.8.2 24.8.3 24.8.4 24.8.4.1 24.8.4.2 24.9 24.9.1 24.9.2 24.9.2.1 24.9.2.1.1 24.9.2.1.2 24.10

Recognition and initial measurement of investment property held as a right-of-use asset .............................................................................................. 814 Subsequent measurement ............................................................................... 814 Fair value model .............................. . .............................. . ............................... 815 Determination of fair value ............................................................................... 815 Inability to measure fair value .......................................................................... 816 Property interest held as a right-of-use asset .................................................... 817 Cost model ........................................................................................................ 818 Transfers .......................................................................................................... 818 Transfer to inventories ...................................................................................... 819 Transfer from inventories ................................................................................. 819 Transfer to owner-occupied property ................................................................ 819 Transfer from owner-occupied property ........................................................... 820 Disposals ........................................................................................................... 821 Intra-group investment property ................................................................... 822 Financial statement presentation ................................................................... 823 lAS 40 requirements .......................................................................................... 823 General disclosures ........................................................................................... 823 Fair value model .............................................................. . ............................... 823 Cost model ........................................................................................................ 824 Disclosures required by IFRS 13 ...................................................................... 825 Disclosures required by IFRS 16 ...................................................................... 825 Disclosure example: Investment property ......................................................... 825 Fair value model ............................................................................................... 825 Cost model ........................................................................................................ 826 Deferred tax ..................................................................................................... 828 Cost model ........................................................................................................ 828 Fair value model .............................. . .............................. . .................. 828 Manner of recovery ........................................................................................... 828 S~ ................................................................................................................... 8E Use .................................................................................................................... 830 Summary of lAS 40, Investment properties .................................................. 832

25 25.1 25.2 25.3 25.3.1 25.3.2 25.4 25.5 25.5.1 25.5.2 25.6

AGRICULTURE ............................................................................................. 833 Introduction ..................................................................................................... 833 Definitions ........................................................................................................ 833 Recognition and measurement ....................................................................... 834 Biological assets and agricultural produce ........................................................ 834 Government grants ............................................................................................ 836 Recording ......................................................................................................... 837 Financial statement presentation ................................................................... 839 lAS 41 requirements .......................................................................................... 839 Disclosure example ........................................................................................... 841 Summary ofIAS 41, Agriculture ................................................................... 844

26

FIRST -TIME ADOPTION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS ......................................................................... 845 Introduction ..................................................................................................... 845 Opening IFRS statement of financial position .............................................. 845

24.3.3

26.1 26.2

xl 26.3 26.3.1 26.3.2 26.3.3 26.3.4 26.3.5 26.3.6 26.3.7 26.3.8 26.3.9 26.3.10 26.3.11 26.3.12 26.3.13 26.3.14 26.3.15 26.3.16 26.3.17 26.4 26.4.1 26.4.2 26.4.3 26.4.4 26.4.5 26.4.6 26.5 26.5.1 26.5.2 26.5.3 26.5.4 26.6

27 27.1 27.2 27.3 27.4 27.4.1 27.4.2 27.4.3 27.4.4 27.4.4.1 27.4.4.2 27.5 27.5.1

GAAP Handbook 2020: Volume 1

Exemptions from other IFRSs ........................................................................ 846 Business corn binations ...................................................................................... 846 Deemed cost ..................................................................................................... 846 Joint arrangements ............................................................................................ 847 Cumulative translation differences ................................................................... 847 Compound financial instruments ...................................................................... 847 Investments in subsidiaries, joint ventures and associates ................................ 847 Assets and liabilities of subsidiaries, associates and joint ventures .................. 847 Designation of previously recognised financial instruments ............................ 848 Share-based payment transactions .................................................................... 848 Insurance contracts ........................................................................................... 848 Decommissioning liabilities included in the cost of property, plant and equipment ......................................................................................................... 848 Leases ............................................................................................................... 849 Fair value measurement of financial assets and financial liabilities ................. 849 Service concession arrangements ..................................................................... 849 Borrowing costs ................................................................................................ 849 Transfers of assets from customers ................................................................... 849 Extinguishing financial liabilities with equity instruments ............................... 849 Exceptions to retrospective application ......................................................... 850 Derecognition of financial assets and financial liabilities ................................. 850 Hedge accounting ......................................................................... . .................. 850 Non-controlling interest .................................................................................... 850 Classification and measurement of financial assets .......................................... 851 Impairment of financial assets .......................................................................... 851 Embedded derivatives ....................................................................................... 851 Presentation and disclosure ............................................................................ 851 Comparative information ............................. ... . ................................................ 851 Explanation of transition to IFRSs .................................................................... 851 Interim financial reports .................................................................................... 852 Other disclosures .............................................................................................. 852 Summary ofIFRS 1, First-time adoption ofIFRS ....................................... 854 SHARE-BASED PAYMENTS ....................................................................... 855 Introduction ..................................................................................................... 855 Definitions ........................................................................................................ 855 Date when transaction is recognised .............................................................. 857 Equity-settled share-based payment transactions - detail rules ................. 858 Fair value - does it relate to the goods/services or equity instruments? ............ 858 Vesting .............................................................................................................. 859 Fair value .......................................................................................................... 865 Modification to terms and conditions of equity instruments granted ................ 868 Beneficial modifications ................................................................................... 868 Modifications that are not beneficial ................................................................ 869 Cash-settled share-based payment transactions ........................................... 873 Modification of a share-based payment transaction that changes its classification from cash-settled to equity-settled .............................................. 877

Detailed chapter contents

27.6 27.6.1 27.6.2 27.6.3 27.7 27.7.1 27.7.1.1 27.7.2 27.7.2.1 27.7.2.1.1 27.7.2.1.2 27.7.2.2 27.7.2.3 27.7.2.4 27.7.3 27.8 27.8.1 27.8.2 27.8.3 27.9 28 28.1 28.2 28.3 28.4 28.4.1 28.4.2 28.4.3 28.5 28.6 28.6.1 28.6.2 28.6.3 28.6.4 28.7 28.7.1

xli

Share-based payment transactions with cash alternatives ........................... 879 Share-based payment transactions in which the counterparty has the choice of settlement .......................................................................................... 879 Share-based payment transactions where the entity has the choice of settlement .......................................................................................................... 883 Share-based payment transactions with a net settlement feature for withholding tax obligations .............................................................................. 884 Scope of IFRS 2 ................................................................................................ 885 Non-identifiable goods or services ................................................................... 885 FRG 2 - Accounting for Black Economic Empowerment (BEE) transactions ....................................................................................................... 885 Group share-based payment transactions .......................................................... 887 Share-based payment arrangements involving equity instruments of the parent ................................................................................................................ 888 Parent entity grants its equity instruments to subsidiary's employees .............. 888 Subsidiary grants to its employees equity instruments of its parent ................. 889 Group share-based payment arrangements involving cash-settled payment to employees ..................................................................................................... 890 Share-based payment arrangements involving an entity's own equity instruments ........................................................................................................ 893 Transfer of employees between group entities ................................................. 894 Scope exclusions .......................................................................... .. .................. 895 Financial statement presentation ................................................................... 895 IFRS 2 disclosures ............................................................................................. 895 JSE listings requirements .................................................................................. 897 Disclosure example ........................................................................................... 897 Summary of IFRS 2, Share-based payment.. ................................................ 899

NON-CURRENT ASSETS HEW FOR SALE AND DISCONTINUED OPERATIONS ................................................................. 901 Introduction ..................................................................................................... 901 Current / non-current distinction .................................................................. 901 Scope ................................................................................................................. 902 Classification of a non-current asset (or disposal group) as held for sale .................................................................................................................... 903 Criteria met after reporting date ........................................................................ 904 Loss of control of subsidiary ............................................................................ 904 Non-current assets held for distribution to owners ........................................... 904 General measurement principles ................................................................... 905 Measurement of individual non-current asset within measurement scope ................................................................................................................. 905 Measurement on date of classification (asset within measurement scope) ........ 905 Recognition of impainnent losses (asset within measurement scope) .............. 906 Subsequent measurement (asset within measurement scope) ........................... 906 Reversal of an impainnent loss (asset within measurement scope) .................. 906 Measurement of individual non-current asset outside measurement scope ................................................................................................................. 907 Measurement on date of classification (asset outside measurement scope) ...... 907

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28.7.2 28.8 28.8.1

GAAP Handbook 2020: Volume 1

28.9.2 28.10 28.10.1 28.102 28.11 28.12 28.13 28.14 28.15 28.16 28.16.1 28.16.2 28.17 28.17.1 28.17.2 28.17.3 28.17.4 28.18

Subsequent measurement (asset outside measurement scope) .......................... 907 Measurement of a disposal group within measurement scope .................... 908 Measurement on date of classification (disposal group within measurement scope) .......................................................................................... 908 Impairment loss for a disposal group (disposal group within measurement scope) ................................................................................................................ 908 Subsequent measurement (disposal group within measurement scope) ............ 909 Reversal of an impairment loss for a disposal group (disposal group within measurement scope) .............................................................................. 909 Measurement ofa disposal group outside measurement scope ................... 911 Measurement on date of classification (disposal group outside measurement scope) .......................................................................................... 911 Subsequent measurement (disposal group outside measurement scope) .......... 911 Newly acquired assets ..................................................................................... 912 Classification of a newly acquired asset as held for sale ................................... 912 Measurement of a newly acquired asset classified as held for sale ................... 912 Non-current assets that are to be abandoned ................................................ 913 Costs to sell and time value of money ............................................................ 913 Gain or loss on disposaL ................................................................................ 913 Changes to a plan of sale ................................................................................. 914 Deferred tax effect of classification as held for sale ...................................... 915 Discontinued operations .................................................................................. 917 Presentation of discontinued operations ............................................................ 920 Subsidiary acquired exclusively with a view to resale ...................................... 924 Financial statement presentation ................................................................... 924 Discontinued operations .................................................................................... 924 Non-current assets and disposal groups classified as held for sale ................... 924 Disclosure example - non-current assets held for sale ..................................... 925 Disclosure example - discontinued operations ................................................. 926 Summary ofIFRS 5, Non-current assets held for sale ................................. 929

29 29.1 29.2 29.2.1 29.2.2 29.3 29.3.1 29.3.2 29.4 29.5 29.5.1 29.5.1.1 29.5.1.2 29.5.1.3 29.6

OPERATING SEGMENTS ............................................................................ 931 Introduction ..................................................................................................... 931 Conceptual issues ............................................................................................. 932 The objective of financial statements ................................................................ 932 Definitions ........................................................................................................ 932 Reportable segments ....................................................................................... 932 Aggregation criteria ........................................................................................... 933 Quantitative criteria .......................................................................................... 933 Measurement.. ................................................................................................. 935 Financial statement presentation ................................................................... 936 IFRS 8 requirements .......................................................................................... 936 Segment information ........................................................................................ 936 Measurement .................................................................................................... 939 Entity-wide disclosures ..................................................................................... 939 Summary ofIFRS 8, Operating segments ..................................................... 941

28.8.2 28.8.3 28.8.4 28.9 28.9.1

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30 30.1 30.2 30.3 30.3.1 30.3.2 30.33 30.3.4 30.4 30.5 30.6 30.6.1 30.6.1.1 30.6.1.2 30.6.2 30.6.3 30.7 30.7.1 30.7.2 30.8 30.9

SERVICE CONCESSION ARRANGEMENTS ........................................... 943 Introduction ..................................................................................................... 943 Definition of puhlic-to-private service concession arrangements ................ 943 Scope of URIC 12 ........................................................................................... 933 Control or regulation of services and pricing .................................................... 944 Control over the residual interest in the infrastructure ...................................... 944 Partly wrregulated infrastructure and ancillary services ................................... 945 Other scope issues ............................................................................................. 945 Infrastructure: is it property, plant and equipment ofthe operator? ........ 945 Arrangement consideration ............................................................................ 945 The construction or upgrade phase ............................................................... 946 The distinction between a financial asset and an intangible asset ..................... 946 Subsequent treatment of the financial asset ...................................................... 947 Subsequent treatment of the intangible asset .................................................... 947 Borrowing costs ................................................................................................ 948 Keep or deal items ........................................ . .................................................. 948 The operating phase ........................................................................................ 948 Revenue from operation services ...................................................................... 948 Maintenance obligations ................................................................................... 948 Illustrative examples ....................................................................................... 948 Financial statement presentation ................................................................... 953

31 31.1 31.2 31.2.1 31.2.2 31.2.3 31.2.4

SMALL AND MEDIUM-SIZED ENTITIES ................................................ 955 Introduction ..................................................................................................... 955 The South African process .............................................................................. 955 The adoption ofIASB documents in South Africa ............................................ 955 Types of companies .......................................................................................... 956 Scope of the IFRS for SMEs ............................................................................. 957 Which entities in South Africa can apply IFRS for SMEs and the Statement of GAAP: IFRS for SMEs? .............................................................. 957 Main features ofthe IFRS for SMEs ............................................................. 958

31.3

32 32.1 32.1.1 32.2 32.2.1 32.2.2 32.2.2.1 32.2.2.2 32.2.2.2.1 32.2.2.2.2 32.2.2.2.3 32.2.3 32.3

THE CONCEPTUAL FRAMEWORK (2018) .............................................. 959 Introduction ..................................................................................................... 959 Status and purpose of the conceptual framework (2018) .................................. 959 The objective of general purpose financial reporting ................................... 960 Objective, usefulness and limitations of general purpose financial reporting ............................................................................................................ 960 Infonnation about a reporting entity's economic resources, claims and changes in resources and claims ....................................................................... 960 Economic resources and claims ........................................................................ 961 Changes in economic resources and claims ...................................................... 961 Financial performance reflected by accrual accounting .................................... 961 Financial performance reflected by past cash flows ......................................... 962 Changes in economic resources and claims not resulting from financial performance ...................................................................................................... 962 Infonnation about the use of the entity's economic resources .......................... 962 The qualitative characteristics of useful financial infonnation ......................... 962

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32.3.1 32.3.1.1 32.3.1.2 32.3.1.2.1 32.3.1.2.2 32.3.1.2.3 32.3.1.3 32.3.2 32.3.2.1 32.3.2.2 32.3.2.3 32.3.2.4 32.3.2.5 32.3.3 32.4 32.4.1 32.4.1.1 32.4.1.2 32.4.2 32.5 32.5.1 32.5.1.1 32.5.1.2 32.5.1.3 32.5.2 32.5.2.1 32.5.2.2 32.5.2.3 32.5.3 32.5.3.1 32.5.3.2 32.5.3.3 32.5.4 32.5.5 32.6 32.6.1 32.6.2 32.6.2.1 32.6.2.2 32.6.3 32.7 32.7.1 32.7.2 32.7.2.1 32.7.2.2 32.7.2.3 32.7.3 32.7.3.1

GAAP Handbook 2020: Volume 1

Fundamental qualitative characteristics ............................................................ 962 Relevance .......................................................................................................... 963 Faithful representation ...................................................................................... 963 Completeness ......................................................................................... . ......... 963 Neutrality .......................................................................................................... 963 Free from error .................................................................................................. 964 Applying the fundamental qualitative characteristics ....................................... 964 Enhancing qualitative characteristics ................................................................ 964 Comparability ................................................................................................... 964 Verifiability ...................................................................................................... 965 Timeliness ......................................................................................................... 965 Understandability .............................................................................................. 965 Applying the enhancing qualitative characteristics ........................................... 965 The cost constraint on useful financial reporting .............................................. 966 Financial statements and the reporting entity .............................................. 966 Financial statements .......................................................................................... 966 Objective and scope of financial statements ..................................................... 966 The reporting period ......................................................................................... 966 The reporting entity .......................................................................................... 967 The elements of financial statements ............................................................. 967 Definition of an asset ........................................................................................ 967 Right ................................................................................................................. 967 Potential to produce economic benefits ............................................................ 968 Control .............................................................................................................. 968 Definition of a liability ..................................................................................... 969 Obligation ......................................................................................................... 969 Transfer of an economic resource ..................................................................... 969 Present obligation as a result of past events ...................................................... 969 Assets and liabilities ......................................................................................... 969 Unit of account ................................................................................................. 969 Executory contracts .......................................................................................... 970 Substance of contractual rights and contractual obligations ............................. 970 Definition of equity ........................................................................................... 970 Definitions of income and expenses ................................................................. 971 Recognition and derecognition ....................................................................... 971 The recognition process ..................................................................................... 971 Recognition criteria .......................................................................................... 971 Relevance .......................................................................................................... 972 Faithful representation ...................................................................................... 972 Derecognition ................................................................................................... 973 Measurement.. ................................................................................................. 973 Historical cost ................................................................................................... 973 Current value .................................................................................................... 974 Fair value .......................................................................................................... 975 Value in use and fulfilment value ..................................................................... 975 Current cost .................................................................................. . .................. 976 Factors to consider when selecting a measurement basis ................................. 976 Relevance .......................................................................................................... 976

Detailed chapter contents

32.7.3.2 32.7.3.3 32.7.3.4 32.7.4 32.7.5 32.8 32.8.1 32.8.2 32.8.2.1 32.8.2.2 32.8.23 32.8.3 32.9 32.9.1 32.9.2 32.10 32.11

xlv

Faithful representation ...................................................................................... 977 Enhancing qualitative characteristics and the cost constraint ........................... 977 Other factors ..................................................................................................... 978 Measurement of equity ......................................... . ...................... . .................. 978 Cash-flow-based measurement techniques ....................................................... 978 Presentation and disclosure ............................................................................ 979 Presentation and disclosure objectives and principles ...................................... 979 Classification .................................................................................................... 979 Classification of assets and liabilities ............................................................... 979 Classification of equity .......................................... . ......................................... 979 Classification of income and expenses ............................................................. 980 Aggregation ...................................................................................................... 980 Concepts of capital maintenance .................................................................... 980 Financial capital ................................................................................................ 980 Physical capital ................................................................................................. 981 Conclusion ........................................................................................................ 981 Summary ofthe conceptual framework (2018) ............................................. 982

1

The conceptual framework (2010) Conceptual Frameworkfor Financial Reporting (Published September 2010)

1.1 Introduction A framework could be viewed as a set of interrelated objectives and theoretical principles, which forms a reference for the llllderlying discipline. In the case of financial reporting, it concerns the provision of information that is useful in making economic decisions. Therefore, it should establish the basis for determining which events should be reported, how they should be measured and the format in which they should be communicated to users.

In 1989 the predecessor body to the International Accounting Standards Board (IASB), the International Accounting Standards Committee (lASe), issued the Framework for the Preparation and Presentation of Financial Statements (the framework (1989». A project was subsequently lallllched to update the Framework for the Preparation and Presentation of Financial Statements and to replace it with the Conceptual Framework for Financial Reporting (the conceptual framework). It should be noted at the outset of this discussion that the focus of the framework (1989) and the conceptual framework is different. The framework (1989) dealt exclusively with financial statements while the conceptual framework establishes an objective for financial reporting in general, although mostly involving the financial statements. The scope of the conceptual framework is therefore broader than that of the framework (1989). The conceptual framework was to be completed and published in phases (chapters) - as each chapter was completed and published, the relevant chapters in the framework (1989) were to be replaced. As part of the first phase of the replacement project, the IASB published chapter 1: The objective of general financial reporting and chapter 3: Qualitative characteristics of useful financial information, during 2010. The parts of the framework (1989) that have not been replaced as a result of the project remained effective at that stage. For purposes of this text book, this version ofthe conceptual framework will be referred to as the conceptual framework (2010). In March 2018, the IASB issued the entire revised conceptual framework. For purposes of this text book, this revised version ofthe conceptual framework will be referred to as the conceptual framework (2018). The content of the two chapters as issued in the conceptual framework (2010) (Chapter 1: The objective of general financial reporting and Chapter 3: Qualitative characteristics of usefulfinancial information) remain mainly unchanged in the revised conceptual framework (2018). However, in the revised conceptual framework (2018), the chapter on Qualitative characteristics of useful financial information has been published as Chapter 2. The remaining text of the framework (1989) was replaced by Chapters 3 to 7 of the revised conceptual framework (2018). The revised conceptual framework (2018) introduces the following main improvements: • the updating of the definitions of an asset and a liability; • the updating of the criteria for including an asset and liability in financial statements; • the introduction of concepts on measurement, including factors to be considered when selecting a measurement basis; • the introduction of concepts on presentation and disclosure, including guidance on the classification of income and expenses in other comprehensive income; • guidance on the derecognition of assets and liabilities; and • the clarification of the concepts of prudence, stewardship, measurement llllcertainty and substance over fonn.

GAAP Handbook 2020: Volume 1

2

The revised conceptual framework (2018) is effective immediately with regard to the development of new standards by the IASB and the IFRS Interpretations Committee. However, it will only be effective for annual periods begiIliling on or after 1 January 2020 for preparers who develop an accounting policy based on the conceptual framework. As some existing IFRSs still refer to the conceptual framework (2010), while others refer to the conceptual framework (2018), this text book will address both the 2010 and 2018 versions of the conceptual framework. This chapter will discuss the conceptual framework (2010), while chapter 32 will deal with the revised conceptual framework (2018).

The conceptual framework (2010) deals with• the objective of general purpose financial reporting; • the reporting entity (not part of the September 2010 phase); • the qualitative characteristics of useful financial information; • the underlying assumption in the preparation of general purpose financial statements (retained from 1989 framework); • the definition, recognition and measurement of the elements from which financial statements are constructed (retained from 1989 framework); and • the concepts of capital and capital maintenance (retained from 1989 framework). Each of these topics is dealt with in the remainder of this chapter.

1.2 The objective of general purpose financial reporting The objective of general purpose financial reporting forms the fOlllldation of the conceptual framework (2010) and the other parts of the conceptual framework (2010) stem logically from this foundation.

1.2.1 Objective, usefulness and limitations of general purpose financial reporting The conceptual framework (2010) (par. OB2) states that the objective of financial statements is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit. As many of the decisions made by the existing and potential investors, lenders and other creditors of an entity are based on their respective expected returns (e.g. dividends, principal and interest payments, market price increases, etc.) these users of financial statements need information to help them assess the prospects for future net cash inflows to an entity. The existing and potential investors, lenders and other creditors of the entity are explicitly identified as the primary users to whom general purpose financial reports are directed. Without identifying such a clearly defined group of primary users, a conceptual framework would risk becoming unduly vague or abstract which would diminish its utility. These stated primary users typically are not in a position to require entities to provide information directly to them and must rely on general purpose financial statements to assist their decision making. As individual primary users have differing information needs, and possibly even conflicting information needs, the conceptual framework (2010) seeks to provide information which meets with the needs of the maximum number of primary users. It is emphasised in the conceptual framework (2010) (par. OB8) that focussing on the common information needs does not prevent an entity from providing additional information that is useful to a specific subset of primary users. Although the management of the entity is also interested in financial information about the entity, they need not rely on general purpose financial reports to obtain their requisite information as they are able to obtain financial information internally. Other parties such as regulators and members of the public (other than investors, lenders and other creditors) may also find general purpose financial reports useful. However, those reports are not primarily directed towards those groups.

The conceptualframework (2010)

3

1.2.2 Information about a reporting entity's economic resources, claims and changes in resources and claims General purpose financial reports provide • information regarding the financial position of an entity in the form of information about the economic resources of the entity as well as claims against it; and • information regarding transactions and other events which change the economic resources and claims against the entity. Both sets of information assist users in making decisions about providing resources to the entity and it follows that no one type of information is the primary focus of financial reporting.

1.2.2.1

Economic resources and claims (statement of financial position)

The financial strengths and weaknesses of an entity are communicated to users through the provision of information about the nature and amOllllts of an entity's economic resources and claims. Providing this information will assist users in assessing the liquidity and solvency of the entity, its needs for additional financing and also its likely success in obtaining that additional financing. Information about the payment requirements of existing claims allows users to predict how future cash flows will be distributed amongst those with a claim against the entity. The conceptual framework (2010) (par. OBI4) acknowledges that different types of economic resources may affect the users' assessment of the future cash flows of the entity differently. For example, certain cash flows result directly from existing economic resources, such as trade receivables to be collected in cash, while other cash flows are a result of using several resources in combination to produce and maIket goods or services to customers of the entity. In the latter case, cash flows cannot be identified with the individual resources, but users still need to know the nature and amount of these resources available for use in the entity's operations.

1.2.2.2 Changes in economic resources and claims Changes in the economic resources and claims of an entity result from the following: • The financial performance of the entity (discussed in section 1.2.2.2.1 and 1.2.2.2.2 below); other events and transactions, e.g. the issuance of new debt or equity instruments (discussed in section 1.2.2.2.3 below). In order to adequately assess the prospective future cash flows of the entity, users must be able to distinguish between the above changes.

•

In general terms, information about the present and past financial performance assists users in understanding the return an entity has generated on its economic resources and also provides an indication of how management has discharged its responsibility to make efficient and effective use of the entity's resources. The conceptual framework (2010) (par. OBI6) stresses the importance of also providing information on the variability of the components of the return, especially for purposes of assessing the uncertainty of future cash flows. For example, where an entity has generated exceptional returns on its investment portfolios as a result of rare and isolated market events, disclosure of the nature and amount of such returns will assist users in evaluating expected future cash inflows to the entity, which are likely not to include such exceptional returns.

1.2.2.2.1

Financial performance reflected by accrual accounting (statement of profit or loss and other com prehensive income) The accrual basis of accounting reflects transactions and other events in the financial statements when they occur regardless of the period in which the related cash flows take place. Financial reporting prepared on this basis provides a better basis for evaluating the past and future performance of the entity than information based exclusively on cash payments and receipts would. Reporting information about the entity's financial performance due to changes in economic resources and claims other than by obtaining additional resources directly from investors and creditors is useful in assessing the past and future ability of the entity to generate net cash inflows. Such

4

GAAP Handbook 2020: Volume 1

information indicates the entity's capacity for generating cash flows through its operations as opposed to obtaining additional resources from investors and creditors. The provision of information about the financial performance of an entity may also provide an indication of the extent to which factors such as market prices and interest rates have impacted on the economic resources and claims of the entity which affects the entity's ability to generate net cash inflows.

1.2.2.2.2 Financial performance reflected by past cash flows (statement of cash flows) Cash flow information about an entity allows for the evaluation of the ability of the entity to generate future net cash inflows. Information about how the entity obtains and spends cash (including borrowings, repayments of debt, cash dividends, etc.) provides users with insights into the factors which may influence the liquidity and solvency of the entity. 1.2.2.2.3 Changes in economic resources and claims not resulting from financial performance (statement of cash flows) Factors other than financial performance may change the economic resources and claims of an entity. For instance, the issuance of additional share capital would result in increased economic resources (cash) and this would not have resulted from the entity's financial performance. Reporting on such changes allows users to fully llllderstand the reasons for changes in economic resources and claims of the entity and facilitates their evaluation of the implications of such changes on the future financial performance of the entity.

1.3 The qualitative characteristics of useful financial information The conceptual framework (2010) outlines the qualitative characteristics which, when embodied in the financial reports of an entity, are likely to be most useful to the primary users of those financial reports when making decisions concerning the reporting entity on the basis of information contained in its financial reports. The conceptual framework (2010) also discusses cost, which is a pervasive constraint on financial reporting. These qualitative characteristics apply to both financial information provided in the financial statements and financial information provided in other ways. However, the application of the qualitative characteristics may differ. For example, applying them to fOIWard-looking information may differ to their application to information about the current economic resources of the entity and claims against those resources. A distinction is drawn between fundamental and enhancing qualitative characteristics. The fundamental qualitative characteristics are critical to the representation of useful financial information, whilst the enhancing qualitative characteristics are less critical but still highly desirable. In order to be useful, financial information must be relevant and must faithfully represent what it purports to represent (flllldamental qualitative characteristics). The usefulness of financial information is enhanced when it is comparable, timely, understandable and verifiable (enhancing qualitative characteristics). The qualitative characteristics of useful financial information, as well as the cost constraint attached to the provision of information, are considered in the following sections.

1.3.1 Fundamental qualitative characteristics The conceptual framework (2010) (par. QC 5) identifies relevance andfaithful representation as the flllldamental qualitative characteristics. The flllldamental qualitative characteristics are crucial to reporting useful financial information. Information presented must be both relevant and faithfully represented in order to be useful. Neither a faithful representation of an irrelevant event nor an unfaithful representation of a relevant event helps users make good decisions. Representing information faithfully does not by itself result in information that is particularly useful. For example, where an entity receives an asset through a government grant, reporting that the asset was

The conceptualframework (2010)

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acquired at no cost would faithfully represent the cost of the asset but would not be very useful. Providing the fair value of the asset would most likely be more relevant and useful. Information that does not conform to the characteristics of relevance and faithful representation cannot be made useful by conforming to the enhancing qualitative characteristics described in section 1.3.2. Relevant and faithfully represented information can however still be useful even when it does not possess any of the enhancing qualitative characteristics.

1.3.1.1

Relevance

Information that is relevant is capable of making a difference in the decisions made by users, even if some users choose not to take advantage of it or are already aware of it from other sources. In order to be capable of making a difference in the decisions made by users, information should have either predictive value, confirmatory value or both. Information has predictive value if it lends itself to be used as an input to processes employed by users to predict future outcomes. Information has confirmatory value when it provides feedback on previous evaluations. Predictive and confirmatory value is interrelated, as information with predictive value frequently also has confirmatory value. For example, information regarding the investment income of the entity during the period may assist users in predicting future investment revenues, while comparison of the current period's investment income to that of the prior period provides valuable feedback in terms of the outcome of the evaluations and projections made during the prior period. The relevance of information is affected by its materiality. Information is material if omitting or misstating it could influence the decisions users make on the basis of financial information about a specific entity. Materiality is therefore an entity-specific aspect of relevance and is based on the nature or magnitude, or both, of the items to which the information relates in the context of an individual entity's financial report. As a result of the specific nature of materiality, no uniform quantitative threshold is provided in the conceptual framework (2010). Nevertheless, accOllllting standards make frequent reference to materiality - usually only material items require separate disclosure.

1.3.1.2 Faithful representation Financial reports represent economic events and circumstances in words and figures. In order to be useful, financial information must not only depict relevant events and circumstances, but should also faithfully represent the events and circumstances which it purports to present. For example, if an entity's statement of financial position (balance sheet) discloses finished goods, users would be justified in assuming that the financial statements were truthful and the inventories represented goods freely available for sale by the entity. It is implicit in faithful representation that the substance of an economic phenomenon is depicted rather than merely its legal form, as representing a legal form which differs from the economic substance of the underlying economic phenomenon could not result in faithful representation. The three characteristics of information that is perfectly faithfully represented, is identified in the conceptual framework (2010) (par. QC12) as financial information that is complete, neutral and free from error. The objective of the conceptual framework (2010) is to maximise these qualities in order to enhance the faithful representation of financial information.

1.3.1.2.1 Completeness Completeness of financial information relates to the inclusion of all information necessary for a user to understand the events and circumstances being depicted (including descriptions and explanations). For example, a complete representation of a portfolio of financial instruments would include, at a minimum, a description of the investments held within the portfolio, a numerical depiction of the investments as well as a description of what the numerical depiction represents (e.g. fair value or amortised cost). Certain items will require additional information such as an explanation of significant facts about the nature and quality of items, factors that might affect this nature and quality, as well as the process followed in arriving at the numerical depiction of those items.

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1.3.1.2.2 Neutrality

A neutral depiction is without bias in the selection and presentation of financial information. It is not slanted, weighted, emphasised, de-emphasised or otherwise manipulated to increase the probability that the information will be received favourably or unfavourably by users. However, neutrality does not imply information that has no purpose and which does not influence behaviour. Relevant financial information is, by definition, capable of making a difference in the decisions of users. 1.3.1.2.3 Free from error The conceptual framework (2010) (par. QC15) recognises thatinfonnation that is represented faithfully is not necessarily perfectly accurate in all respects. Free from error means that there are no errors or omissions in the description of events and circumstances, and the process employed to produce the reported information has been selected and applied without error. For example, when estimating the fair value of an item, it is unlikely that this estimate will be 100% accurate. However, faithful representation can still be achieved with regards to such an estimate, for example, when the amollllt is clearly and accurately described as an estimate and the nature and limitations of the estimation process are explained, and provided no errors have been made in selecting and applying an appropriate process for developing the estimate.

1.3.1.3 Applying the fundamental qualitative characteristics Generally, the most effective and efficient method of applying the fimdamental qualitative characteristics would be as follows (conceptual framework (2010) par. QC18): • identify an economic phenomenon which has the potential to be useful to users; • identify the type of information about the phenomenon which would be most relevant to users; and • determine whether that information is available and can be faithfully represented. When the above steps can be successfully followed, the process of satisfying the flllldamental qualitative characteristics ends at that point. If the above requirements are not met, the process should be repeated with the next most relevant type of information (i.e. return to the second step).

1.3.2 Enhancing qualitative characteristics The usefulness of information that is relevant and represented faithfully is enhanced by the qualitative characteristics of comparability, verifiability, timeliness and llllderstandability. These enhancing qualitative characteristics are also useful in deciding between alternative depictions of events when they are considered equally relevant and faithfully represented.

1.3.2.1 Comparability Users often need to make decisions involving a choice between alternatives. When making such decisions, information is more useful when it can be compared with similar information about other entities or similar information about the same entity for another period or date. Comparability allows for the identification and llllderstanding of similarities and differences among items. In contrast to the other qualitative characteristics, comparability does not relate to a single item but requires at least two items. To enhance comparability, it is important that financial statements show corresponding information for the preceding periods, i.e. comparative figures and information. The conceptual framework (2010) (par. QC22) clearly distinguishes comparability from consistency, as the latter concept relates to the use of the same methods for the same items, whether from period to period within a single entity, or within a single period between different entities. Comparability is described as the goal while consistency assists in reaching that goal. Permitting alternative accounting methods for the same economic phenomenon would clearly diminish comparability, even though all of these alternatives may result in faithful representation. The need for comparability should not be confused with uniformity and should not be allowed to become an impediment to the introduction of improved accollllting standards.

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1.3.2.2 Verifiability Verifiability relates to the principle that different knowledgeable and independent observers could reach consensus (not necessarily complete agreement) that a particular depiction is a faithful representation. Verification may be direct or indirect depending on the information depicted. For instance, cOllllting cash would be a direct method of verifying the amollllt disclosed as cash by a reporting entity, while veritying the carrying amount of an amortised cost investment may be done indirectly by checking inputs and recalculating the carrying amollllt using the same assumptions employed by the entity. Certain fOIWard-looking financial information may not be verifiable lllltil a future period, if at all. Disclosure of the llllderlying assumptions, methods of compiling the information and other facts and circumstances supporting the information would typically be necessrny in assisting users' decisions as to whether such information is useful.

1.3.2.3 Timeliness Timeliness relates to the availability of information to decision-makers in time to be capable of influencing their decisions. Although older information is typically less useful than current information, certain users will continue to find information useful long after the end ofthe relevant reporting period, as they may need it to evaluate and identify trends.

1.3.2.4 Understandability Information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence. It should be noted that accollllting standards are established for general purpose reporting and financial reporting should therefore provide information that can be used by all users who are willing to learn to use it properly. The clear and concise classification, presentation and characterisation of information ensure its understandability. However, certain events are inherently complex and cannot be made easy to understand. It is important that financial reporting should not exclude such information merely on the grollllds that it may be too difficult for certain users to understand, as those reports would be incomplete and potentially misleading.

1.3.2.5 Applying the enhancing qualitative characteristics The enhancing qualitative characteristics discussed in the previous sections should be maximised to the extent possible. The conceptual framework (2010) (par. QC 34) does not outline a prescribed order to follow in the application of the enhancing qualitative characteristics but recognises that in some instances it may be necessrny to diminish one enhancing qualitative characteristic in order to maximise another qualitative characteristic. For example, the retrospective application of a new accounting standard may temporarily reduce comparability. However, in the longer term, a worthwhile improvement is achieved in terms of relevance and faithful representation. In this example, appropriate disclosures would compensate for a lack of comparability.

1.3.3 The cost constraint on useful financial reporting Cost is a significant and pervasive constraint on the information which can be provided by financial reporting. The costs of reporting information should be justified by the benefits of doing so. Several types of costs and benefits should be considered in making this assessment. Although providers of financial information expend most of the effort involved in reporting financial information, it is the users that ultimately absorb those costs in the form of reduced returns. Additionally, if important information is not provided, users incur additional costs to obtain such information elsewhere in estimating it. Users are able to make decisions with more confidence when they are provided with relevant and faithfully represented information. This results in more efficient capital markets and a lower cost of capital for the economy as a whole. Individual users also benefit by making more informed decisions.

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GAAP Handbook 2020: Volume 1

However, general purpose financial statements, by definition, cannot provide information which every user finds relevant. Evaluating the benefits and costs ofinfonnation is a demanding and subjective task. It is therefore difficult to apply a costlbenefit test in any particular case. The conceptual framework (2010) (par. QC38) emphasises that, in most situations, assessments will be based on a combination of quantitative and qualitative information.

1.4 Underlying assumption Financial statements should be prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future. If this is not the case, then the financial statements may have to be prepared on a different basis and, if so, the basis used should be disclosed.

1.5 The elements of financial statements Financial statements portray the financial effects of transactions and other events by grouping them into broad classes according to their economic characteristics. These broad classes are termed the elements of financial statements. Five main classes of transactions are identified relating to the statement of financial position (balance sheet) and the statement of profit or loss and other comprehensive income (income statement). The elements identified are assets, liabilities, equity, income and expenses.

1.5.1 Assets Assets are defined as being resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. For example, an item of inventory on hand is a resource controlled by the entity as a result of a past event (the purchase thereof) and from which future economic benefits are expected (the intention is to sell the item of inventory at a profit). Assets are the economic resources used to cany out an entity's economic activities. The primary characteristic of all assets is the future economic benefit (or service potential) which eventually results in net cash inflows to the entity. In terms ofthe above definition, an economic resource must have three characteristics prior to being considered as an asset: • The resource should provide future economic benefits, which will usually be in the form of future receipts of cash, although economic benefits may also be only indirectly related to the generation of cash, for example the use of a factory to produce goods - the future cash flows relate to the sale of the goods but the factory is indirectly generating those cash flows. • The future economic benefit should be within the control of the entity. This includes the ability to restrict the access of others to the benefits. Control implies that the entity can generally deny or regulate the ability of others to utilise the resource. • The event giving rise to the company's right to the resource and control over the future benefits must already have occurred (i.e. past event). The recognition of an asset is restricted to the position where the transaction resulting in the right to the economic benefit has passed. The future economic benefits embodied in an asset may flow to the entity in a number of ways. For example, an asset may be used in the production of goods or services, exchanged for other assets, used to settle a liability, or distributed to owners. There is a close association between incuni.ng expenditure and generating assets, but the two do not necessarily coincide. For example, an entity may make a donation with the intention of obtaining future economic benefits, but the donation may not satisfY the definition of an asset. It should be noted that legal ownership of an item is not essential for its recognition as an asset; the right to future economic benefits is a requirement for asset recognition and, providing the entity controls these benefits, then a right to use an item is classified as an asset. An example of this occurs when companies capitalise leased assets.

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9

Similarly, physical form is not essential to the existence of an asset. Patents and copyrights, for example, are regarded as assets if future economic benefits are expected to flow from them and they are controlled by the entity.

1.5.2 Liabilities Liabilities are defined as present obligations of an entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. A liability, therefore, has three essential characteristics: • It embodies a present responsibility to one or more other parties that entails settlement by future transfer of economic benefits. These economic benefits could be transferred either through use of the entity's assets at a specified or determinable date, on occurrence of a specified event, or on demand. Settlement of a liability may occur by the payment of cash, the transfer of assets, the provision of services, the waiving of the creditor's rights, the replacement of that obligation with another obligation or the conversion of the obligation to equity. • The responsibility obligates the entity, leaving it with little or no discretion to avoid the future sacrifice of economic benefits. • The transaction or other event obligating the entity has already happened. It should be noted that although a liability is recognised only when the entity is obliged to give up

economic benefits, the obligation need not be a legally enforceable one. For example, to maintain good business relations with customers and promote the entity's image, products and service, a policy may be followed to rectify faults in products even after the warranty period has expired. Liabilities arise primarily from deferring payment for goods or services received and from borrowing monies. Liabilities also result from collecting economic resources in advance of providing goods or services to customers and from selling goods subject to warranties. Assets and liabilities could be considered mirror images of each other and are in many ways complimentrny. Assets and liabilities, however, are normally reported gross and should only be netted off llllder special circumstances. A distinction should be drawn between an obligation and a future commitment. A decision by the management of an entity to acquire assets in the future does not, by itself, give rise to a present obligation. An obligation normally arises only when the asset is delivered or the entity enters into an irrevocable agreement to acquire the asset. Some liabilities can be measured only by using a substantial degree of estimation. For example, a provision for future warranty expenditure is a liability requiring estimation based on past warranty claims and the deemed quality ofthe warranted products. Provided that the provision involves a present obligation (i.e. relates to sales already made) and satisfies the remainder of the definition of a liability, then it is a liability even if the amollllt has to be estimated.

1.5.3 Equity Equity is defined as the residual interest in the assets of an entity after deducting all of its liabilities. Equity is usually sub-classified in the statement of financial position (balance sheet), for example, companies often distinguish share capital, retained earnings, distributable reserves and capital maintenance reserves separately. These classifications are usually relevant to users of financial statements when they indicate legal or other restrictions on the ability of the entity to distribute or otherwise apply its equity. The amollllt at which equity is shown in the statement of financial position (balance sheet) is dependent on the measurement of assets and liabilities and not the value of the entity as a whole on the going concern basis, the market value of its shares or the amollllts that would be raised by disposing of assets on a piece-meal basis. Although the legal and regulatory framework pertaining to entities other than cOIporate entities (e.g. sole proprietorships, partnerships and trusts) is different, the definition of equity and the other aspects of the accounting framework dealing with equity are, mutatis mutandis, also applicable to such entities.

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1.5.4 Income Income is defined as increases in economic benefits during the accOllllting period in the fonn of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from the owners of the entity. As a result of the interrelationship between the components of financial statements, changes in the net assets of an entity depicted in the statement of financial position (balance sheet) are also reflected in its performance (the statement of profit or loss and other comprehensive income I income statement). Income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent. Chapter 11, Revenue from contracts with customers, deals further with the appropriate accOllllting treatment for revenue. Gains represent other items that meet the definition of income and may, or may not, arise in the course of the ordinrny activities of an entity. Gains include, for example, those arising on the disposal of non-current assets. The definition of income also includes umealised gains. For example, the surplus arising on the revaluation of listed investments and increases in the carrying amount oflong-term assets constitute gains.

1.5.5 Expenses Expenses are defined as decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or the incurrence ofliabilities which result in decreases in equity, other than those relating to distributions to owners of the entity. The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinrny activities ofthe entity, for example, cost of sales, wages and depreciation. Losses represent other items that meet the definition of expenses and may, or may not, arise in the course of the ordinrny activities of the entity. Losses include, for example, those resulting from disasters such as fire and flood as well as those arising on the disposal of non-current assets. The definition of expenses also includes umealised losses, for example those arising from the effects of changes in the rate of exchange for a foreign currency in respect of an entity's uncovered borrowings.

1.6 Recognition issues Recognition is the process of incorporating a transaction or event into one or more of the elements of the financial statements. It involves depiction of the transaction or event in words and in monetrny terms and the inclusion of that item and amount in the appropriate financial statement total. Generally, a transaction or event should be recognised in the financial statements if• it meets the definition of an element of the financial statements (considered in section 1.5); and • it is probable that a future economic benefit associated with the transaction or event will flow to or from the entity; and • it can be measured in monetrny terms with sufficient reliability. When assessing whether a transaction or event meets the above criteria, and therefore qualifies for recognition in the financial statements, regard needs to be given to the materiality considerations when examining the qualitative characteristics of useful financial information. The interrelationship between the elements means that an item that meets the definition and recognition criteria for a particular element, for example an asset, automatically requires the recognition of another element, for example income or a liability. When economic benefits are expected to arise over several accounting periods, related expenses which can only be broadly or indirectly determined (e.g. depreciation of the assets employed to generate such benefits) are recognised on a systematic and rational basis.

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1.6.1 Probability offuture economic benefits The environment in which an entity operates is inherently llllcertain and for many past events there is either a lack of certainty that there has been a change in the entity's assets or liabilities or llllcertainty as to the monetary amount of the change. It is this lack of certainty that gives rise to recognition problems. An assessment of the degree ofllllcertainty attached to the flow of future economic benefits is made on the basis ofthe evidence available when the financial statements are prepared. For example, if it is probable that a receivable owed to an entity will be collected, it is then justifiable, in the absence of any evidence to the contrary, to recognise the receivable as an asset. For a large population of receivables, however, some degree of non-payment is normally considered probable; hence an expense representing the expected reduction in economic benefits is recognised.

1.6.2 Reliability of measurement Before a transaction or event is recognised as an element in financial statements, it must possess a cost or value that can be measured with reliability. In many cases, the cost or value is estimated, as the use of reasonable estimates is an essential part of the preparation of financial statements. The use of estimates does not lllldermine the reliability of financial statements. However, when a reasonable estimate cannot be made, then a transaction or event is not recognised. The existence of the transaction or event, however, should be disclosed in the notes, explanatory material or supplementrny schedules to the financial statements. The use of estimates implies an element of llllcertainty about the llllderlying measurement of a transaction or event. Uncertainty is usually cOlllltered by evidence; the more evidence there is about a transaction or event and the better the quality of that evidence, the less llllcertainty there will be over its existence, nature and measurement.

1.7 Measurement issues Measurement is the process of determining the monetary amollllts at which the elements ofthe financial statements are to be recognised and reflected in the financial statements. There are a number of different measurement bases which are employed to different degrees and in varying combinations in financial statements. Traditionally, the historical cost basis has been used for the measurement of the various elements of financial statements. However, other bases are sometimes encolllltered, namely current cost, realisable value and present value.

1.7.1 Historical cost Under the historical cost basis of accollllting, assets are recorded at the amollllt of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amollllts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business.

1.7.2 Current cost Under the current cost basis of accollllting, assets are carried at the amollllt of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the lllldiscollllted amount of cash or cash equivalents that would be required to settle the obligation currently.

1.7.3 Realisable value Under the realisable (or settlement) value basis of accollllting, assets are carried at the amollllt of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is, the lllldiscollllted amollllt of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.

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1.7.4 Present value Under the present value basis of accOllllting, assets are carried at the present discOllllted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present diScOllllted value of the future net cash outflows that are expected to be required to settle the liability in the normal course of business.

1.8 Concepts of capital maintenance The selection of an appropriate concept of capital by an entity should be based on the needs of the users of its financial statements. Most entities adopt a financial concept of capital (see section 1.8.1), but where the main concern of users is with the operating capability of the entity then a physical concept of capital should be used (refer section 1.8.2). The concept chosen indicates the goal to be attained in determining profit even though there may be some measurement difficulties in making the concept operational.

1.8.1 Financial capital Under this concept of capital maintenance, a profit is earned only if the financial (or money) amollllt of the net assets at the end of the period exceeds the financial (or money) amollllt of net assets at the beginning of the period (excluding any distributions to and contributions from owners during the period). For example, if an entity that buys and sells widgets started trading on 1 January 20Xl with capital of R 1 000 in the bank, assuming no payment of dividends or injections of fresh capital, the company will not have earned a profit unless it has net assets (or equity) in excess of Rl 000 at the end of 20Xl. Assuming that the trading of widgets for one year results in the company having R800 on deposit with the bank and having inventory on the statement of financial position amollllting to R700, the company has increased its financial capital by R500. Notice that this increase in financial capital is measured in terms of nominal monetary units, i.e. without taking inflation into aCCOllllt. The profit can also be measured in units of constant purchasing power. In this case, general inflation for the year 20Xl would have to be taken into aCCOllllt. Assuming inflation of lO%, this would require that the Rl 000 injected at the beginning of the year in constant purchasing power terms is equivalent to R 1 lOO at the end of the year. In order to maintain financial capital using constant purchasing power units, therefore, profit of only R400 should be recognised, i.e. the capital of Rl 500 at the end of the period is in essence R400 of profit and R 1 100 of capital. The R 1 lOO of capital equates to the original injection ofRl 000 at the beginning of the year.

1.8.2 Physical capital Under the physical capital maintenance concept, a profit is earned only if the physical productive capacity (or operating capability) of the entity at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to and contributions from owners during the period. The physical capital maintenance concept requires the adoption of the current cost basis of measurement. Price changes affecting the assets and liabilities of an entity are viewed as changes in the measurement of physical productive capacity. Such price changes are therefore treated as capital maintenance adjustments (part of equity) and not as profit. Under this concept of capital maintenance, therefore, capital is looked at from a physical point of view, that is, the ability to maintain the physical productive capacity of the entity in all respects, measured on the current cost basis. This should be distinguished from the financial capital maintenance concept, where capital is looked at from a monetary point of view. Itis argued that a major disadvantage of the historic cost concept is that it follows the financial capital maintenance concept (in nominal monetary units only) and as such overstates profit in a period of rising prices, which could lead to an erosion of capital.

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13

1.9 Conclusion The conceptual framework (2010) seeks to provide a basis for the reporting of useful financial information. To achieve this goal, the objective and qualitative characteristics of useful financial information are established. Thereafter, the conceptual framework (2010) identifies the elements of financial statements and the related measurement issues. In this way, the basis for determining which events should be reported, how they should be measured and the format in which they should be communicated to the primary users is established. The conceptual framework (2010) should not be viewed as the last word on the basis for financial reporting. Financial accOllllting and reporting is an evolving discipline that needs to be responsive to ever-increasing user demands. This evolution may require a future paradigm shift away from the traditional accounting model. The conceptual framework (2010) provides a useful foundation for the continuing evolution of financial reporting practice.

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OBJECTIVE & CONCEPTS UNDERL YING THE REPORTING OF GENERAL PURPOSE FINANCIAL INFORMA TlON

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Provide useful financial information to • pri mary users of financial information in order to assist decisions about providing resources to the entity. Decisions involve buying/selling equity or debt instruments and the provision of credit. Primary users are: exiting/potential investors; • lenders; and • other creditors.

•

Elements of financial statements

Definition, recognition & measurement of: • Assets • Liabilities • Equity • Income • Expenses. If definition is met, recognise if • probable that future economic benefits will flow, and • can be measured reliably.

Qualitative characteristics of useful financial information

Attributes that make information provided useful to users: Fundamental • Relevance Relevant to decision-making needs Materiality Faithful representation • Information is complete, neutral and free from error. Enhancing • Comparability • Verifiability • Timeliness • Understandability Fundamental characteristics are of paramount importance. Enhancing characteristics cannot make irrelevant information or information not faithfully represented useful. Cost constraints • Benefits should justify costs • Benefits include more efficient capital markets Users ultimately absorb cost. • Underlying assumption: Going concern

Capital maintenance (contributions by and distributions to owners excluded)

Physical • Profit recognised = physical productive capacity at end of period> at beginning of period • Current cost measurement required.

Financial • Profit recognised = financial amount of net assets at end of period> at beginning of period • Measurement nominal monetary units, or units of constant purchasing power.

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Presentation of financial statements lAS 1 (Effective date 1 January 2009) lFRIC 17 (Effective date 1 July 2009)

2.1 Scope and objectives The objective of general purpose financial statements is to provide information in a structured fashion aboutthefinancial position,performance and cashjlows ofan entity. This information should be useful to a wide range of users in making economic decisions.

The objective of lAS 1 is to prescribe the basis for presentation of general purpose financial statements. General purpose financial statements are those statements intended to meet the needs of those users who are not in a position to require an entity to prepare reports tailored to their particular information needs. Adherence to the requirements ofthe standard should ensure comparability both with the entity's own financial statements of previous periods and with the financial statements of other entities, including foreign and international entities complying with International Financial Reporting Standards (IFRS). lAS 1 applies to all types of entities (i.e. not only to companies but also to other forms of entities such as public sector enterprises, banks, close corporations, partnerships, sole proprietors, non-profit organisations and trusts). All general purpose financial statements prepared and presented in accordance with IFRS should comply with the requirements of the standard. "Where not suitable, entities withnot-forprofit activities may amend the descriptions used in the standard for particular line items and for the financial statements themselves. Similarly, entities that do not have equity as defined in lAS 32 (e.g. some mutual funds) and entities whose share capital is not equity (e.g. some co-operative entities) may need to adapt the financial statement presentation of members' or unit holders' interests.

2.2 Identification of financial statements Some entities present, outside the financial statements, additional information such as a financial review by management, environmental reports and value added statements. Reports and statements presented outside financial statements are outside the scope ofIFRS. For users to be able to identify information prepared on the basis of IFRS, the financial statements should be clearly identified and distinguished from other information in the same published document. Moreover, an entity should clearly identifY each financial statement and the notes - the following information should be prominently displayed (and repeated where and when necessrny): • The name of the reporting entity (or other means of identification), and any change in that information. • Whether the financial statements are those of the individual entity or a group of entities. • The date ofthe end of the reporting period or the period covered by the set of financial statements or notes, whichever is applicable to the related financial statement. • The presentation currency. • The level of rOllllding used (e.g. R '000) in presenting amounts in the financial statements. An entity meets the abovementioned requirements by presenting appropriate headings for pages, statements, notes, colunms and the like. Judgement is required in determining the best way of presenting such information. For example, when an entity presents the financial statements in an electronic format, 15

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separate pages are not always used. In such a case an entity presents the above items to ensure that the information included in the financial statements can be understood.

2.3 General features 2.3.1 Fair presentation and compliance with IFRS 2.3.1.1

Achieving fair presentation

Financial statements should present fairly the financial position at the reporting date and the financial performance and cash flows for the accOllllting period ended on the reporting date. Fair presentation requires the faithful presentation ofthe effects oftransactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses as set out in The Conceptual Framework. The application ofIFRS, with additional disclosure when necessrny, is presumed to result in financial statements that achieve a fair presentation. A fair presentation also requires an entity • to select and apply accOllllting policies in accordance with lAS 8; • to present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information; and • to provide additional disclosures when compliance with the specific requirements of IFRS is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity's financial position and financial performance. Financial statements complying with IFRS should contain an explicit and unreserved statement of such compliance in the notes. Such annotation may not be made unless all the requirements of each applicable standard and each applicable interpretation have been complied with. Inappropriate accounting and reporting cannot be rectified by disclosure of the (unacceptable) accounting policies used or by presenting explanations.

2.3.1.2 Allowed departure from IFRS requirements lAS 1 admits that there could be instances (although extremely rare) in which compliance with a requirement of an accounting standard or interpretation might give rise to misleading presentation and therefore departure from the requirement would be necessrny to achieve fair presentation. If management concludes that such action is warranted and if the relevant regulatory framework requires or does not prohibit departure from IFRS, the entity should in its financial statements• disclose that management has concluded that the financial statements present fairly the entity's financial position, financial performance and cash flows; • confirm that it has complied with applicable IFRSs and interpretations, except that it has departed from a particular requirement of a standard or interpretation in order to achieve fair presentation; • indicate the title of the standard or interpretation from which the entity has departed, the nature of the departure including the treatment that the standard or interpretation would require, the reason why such treatment would be so misleading in the circumstances that it would conflict with the objective of financial statements, and the treatment adopted (note that this disclosure is also required if departure in a prior period affects amounts in the current period); • disclose the financial effect of the departure on each item in the financial statements that would have been reported in complying with the requirement, for each period presented (note that this disclosure is also required if departure in a prior period affects amounts in the current period). The above provisions are both sensible and important. International harmonisation of accounting standards needs to overcome the general problem of diverse conditions and circumstances prevailing in different countries. These provisions offer a meaningful mechanism to ensure relevant and fair presentation in financial statements in cases where requirements are clearly inappropriate. In assessing whether compliance with a specific requirement of a standard or interpretation would be misleading,

Presentation offinancial statements

17

consideration is given to why the objective of financial statements is not achieved in the particular circumstances and to the way in which the entity's circumstances differ from those of other entities that do comply with the requirement. There is a rebuttable presumption that if other entities in similar circumstances comply with the requirement, the entity's compliance with the requirement would not be so misleading that fair presentation would not be achieved. Ifthe relevant regulatory framework prohibits departure from IFRS, then the accOllllting standard or interpretation, which is believed to be misleading, will have to be complied with in the financial statements. The perceived misleading aspects of compliance should then be reduced by disclosing the following: • The title of the relevant standard or interpretation containing the requirement that is believed to be misleading. • The nature of the requirement which is believed to be misleading. • The reason why management has concluded that complying with the requirement would be misleading. • For each period presented, the adjustments to each item in the financial statements that management has concluded would be necessrny to achieve fair presentation.

2.3.2 Going concern Financial statements should be prepared on a going concern basis unless management intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. Accordingly, management should, at the time of the preparation of the financial statements, make an assessment of the entity's ability to continue as a going concern. The period assessed should cover at least twelve months from the reporting date. When an entity has a history of profitable operations and ready access to financial resources, the entity may reach a conclusion that the going concern basis is appropriate without detailed analysis. In other cases, a more detailed analysis may be required, including factors such as profitability, debt repayment schedules and potential sources of financing. Any uncertainties regarding the ability to continue as a going concern should be disclosed. If the financial statements have not been prepared on a going concern basis, the following should be disclosed • the fact that the financial statements have not been prepared on a going concern basis, • the basis on which the financial statements have been prepared, and • the reason(s) why the entity is not considered to be a going concern.

2.3.3 Accrual basis of accounting Financial statements, with the exception of cash flow information, should be prepared using the accrual basis of accounting, i.e. transactions and events should be recognised when they occur and not as cash or its equivalent is received or paid. This leads to assets, liabilities, equity, income and expenses being recognised when they satisfy the definitions and recognition criteria as per The Conceptual Framework.

2.3.4 Materiality and aggregation Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primrny users of general purpose financial statements make on the basis of those financial statements. To obscure information is to include it in the financial statements in such a way that it has a similar effect as omitting or misstating the information. This is achieved by, for example, using vague or unclear language, by scattering the information throughout the financial statements, by inappropriately aggregating or disaggregating information, or by disclosing immaterial information to hide material information. Materiality depends on the nature and/or magnitude of an item and, for a specific disclosure, is assessed in the context of the financial statements taken as a whole. If an item is not material enough to warrant separate presentation on the face of the financial statements, it may still be material enough for

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separate disclosure in the notes. If a specific disclosure is, however, unlikely to reasonably influence the capital allocation decisions of primary users, it is not material. Applying the concept of materiality means that the specific disclosure requirements of an accOllllting standard or interpretation need not be met if the resulting information is not material. Each material class of similar items should be presented separately in the financial statements. Items of dissimilar nature or fllllction should also be presented separately lllliess they are immaterial. Immaterial amOllllts can be aggregated with items of a dissimilar nature, and need not be presented separately.

2.3.5 Offsetting As a basic rule items should not be set off against each other. Offsetting detracts from the ability of users of financial statements to llllderstand the financial position and transactions undertaken and to assess the future cash flows of the entity. Hence, offsetting is only permitted ifit is required or permitted by another IFRS. It is important to note that the reporting of assets net of allowances, for example an allowance for credit losses or for obsolete inventories, is not offsetting.

In the course of its ordinary activities an entity may lllldertake transactions that do not generate revenue, but are incidental to the main revenue-generating activities. The results of such transactions are presented by netting any income with related expenses, provided that this presentation reflects the substance of the transaction. This will include, for example, reporting a gain on the disposal of plant by deducting the carrying amount of the plant and the related selling expenses from the amollllt of consideration on disposal. Furthermore gains and losses arising from a group of similar transactions are reported on a net basis, for example foreign exchange gains and losses and fair value adjustments on financial assets held for trading. Such gains and losses are however disclosed separately if they are material.

2.3.6 Frequency of reporting An entity is required to present a complete set of financial statements (including comparative information) at least annually. When an entity changes the end of its reporting period and presents financial statements for a period longer or shorter than one year, an entity should disclose (in addition to the period covered by the financial statements) • the reason for using a longer or shorter period; and • the fact that the amollllts presented in the financial statements are not entirely comparable.

2.3.7 Comparative information 2.3.7.1

Minimum comparative information

The following comparative information in respect of the preceding accollllting period should be included in the current period's financial statements, unless an IFRS or interpretation permits or requires otherwise: • All numerical information for all amollllts reported in the current period's financial statements. • The narrative and descriptive information relating to the comparative period if it is relevant to llllderstanding the current period's financial statements. An entity should present, as a minimum, two statements of financial position, two statements of profit or loss and other comprehensive income, two separate statements of profit or loss (if presented), two statements of cash flows, two statements of changes in equity and related notes. lAS 1 recognises that in some cases, the narrative information disclosed with respect to the preceding period continues to be relevant in the current period. An example of this would be a large insurance claim which an entity has instituted but which is being disputed by the insurer and which has not yet been resolved. Users may benefit from the disclosure of information that the llllcertainty existed at the end of

Presentation offinancial statements

19

the preceding period and from the disclosure of information about the steps that have been taken during the period to resolve the llllcertainty. Entities are permitted to disclose comparative information in addition to that required by IFRSs as long as that information is prepared in terms ofIFRSs. This may include presenting additional components of the financial statements, for example, a third statement of cash flows. When this is the case, an entity should present the related note information which accompanies the additional item(s) presented. The additional information disclosed need not form a complete set of financial statements. For instance, where the entity presents an additional statement of cash flows (thus three years of cash flow information) the entity is not required to also present a third statement of profit or loss and other comprehensive income, a third statement of financial position and a third statement of changes in equity also. However, the entity should disclose notes to the additional statement of cash flows presented.

2.3.7.2 Change in accounting policy, retrospective restatement or reclassification In the following circumstances an entity is required to present a third statement of financial position (at the end of the current period, at the end of the preceding period and at the beginning of the preceding period) in addition to the minimum comparative financial statements required to be presented by lAS 1: • when an entity applies an accollllting policy retrospectively, makes a retrospective restatement of items in its financial statements or reclassifies items in its financial statements; and . • the retrospective application, retrospective restatement or the reclassification has a material effect on the information in the statement of financial position at the beginning of the preceding period. The date ofthe third statement offinancial position should be as at the begiIliling of the preceding period regardless of whether the entity's financial statements present comparative information for earlierperiods as described in 2.3.7.1. When an entity is required to present a third statement of financial position, it need not disclose notes to the statement of financial position at the beginning of the preceding period. In other words, the entity will then disclose only two sets of notes (for the current period and the end of the preceding period). If a third statement of financial position is required because of reclassifications, lAS 1 has specific disclosure requirements. Reclassifications take place when an entity changes the presentation or classification of items in the financial statements from one period to the next. This would be the case, for instance, where an entity previously presented its entire post-employment benefit obligation as a noncurrent liability as allowed by lAS 19 and during the current financial year it decided to split the obligation into its current and non-current components for presentation purposes. When a reclassification takes place during the current period, comparative amollllts should also be reclassified, unless it is impracticable (i.e. not possible after making every reasonable effort to do so). When comparative amollllts are reclassified, the following disclosures are required: • The nature of the reclassification. • The amollllt of each item or class of items that is reclassified. • The reason for the reclassification. When it is impracticable to reclassify comparative amollllts, the following disclosures are required: • The reason for not reclassifying the amounts. • The nature of the adjustments that would have been made if the amollllts had been reclassified. If a third statement of financial position is required because the entity applied an accollllting policy or corrected a prior period error retrospectively, the entity must comply with the disclosure requirements of lAS 8 (refer to chapter 5) in addition to the requirements of lAS 1.

2.3.8 Consistency of presentation The classification and presentation of items in the financial statements of an entity should be retained from one accollllting period to the next. Financial statements should only be presented differently when• it is required by IFRS; or

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GAAP Handbook 2020: Volume 1

• a review of the financial statement presentation demonstrates that the change will result in a more appropriate presentation, having regard to the criteria for the selection and application of accOllllting policies in lAS 8; or • a significant change in the nature of the entity's operations requires a different structure. When a change in classification and presentation of items in the financial statements from one accOllllting period to the next is made, the disclosure requirements discussed in 2.3.7 are applicable.

2.4 Financial statements Under lAS 1 a complete set of financial statements comprises• a statement of financial position at the end of the period; • a statement of profit or loss and other comprehensive income for the period; • a statement of changes in equity for the period; • a statement of cash flows for the period; • notes, comprising a summrny of significant accOllllting policies and other explanatory information; • comparative information in respect of the preceding period • a statement of financial position at the beginning of the preceding period when an entityapplies an accounting policy retrospectively; makes a retrospective restatement of items in its financial statements; or reclassifies items in its financial statements. An entity is allowed to use titles for the various financial statements other than those used in lAS 1. For example, an entity may use the title 'statement of comprehensive income' instead of 'statement of profit orloss and other comprehensive income' or 'balance sheet' instead of 'statement of financial position'. All the financial statements in a complete set of financial statements should be presented with equal prommence. When presenting profit or loss and other comprehensive income, an entity may use a one-statement or two-statement format. With a one-statement format, profit or loss and other comprehensive income are presented in a single statement, in which the profit or loss section precedes the other comprehensive income section. This statement is referred to as the 'statement of profit or loss and other comprehensive income'. Alternatively an entity may follow a two-statement format, where a separate 'statement of profit or loss' is displayed immediately before a statement representing total comprehensive income. This statement representing total comprehensive income is also referred to as a 'statement of profit or loss and other comprehensive income', but contains only one line item relating to profit or loss, namely the total profit or loss. When a separate statement of profit or loss is presented, it forms part of a complete set of financial statements. Refer to section 2.4.2 for a more detailed explanation.

2.4.1 Statement of financial position Usually a statement of financial position comprises two main sections, namely assets and (below assets) equity and liabilities. In tum, assets are classified as either current or non-current (with the latter appearing first), and equity and liabilities are reflected by means of the subsections total equity, noncurrent liabilities and current liabilities. Equity represents the residual between assets and liabilities.

2.4.1.1

Information to be presented in the statement of financial position

At a minimum, the following line items should be presented on the face of the statement of financial position: • Property, plant and equipment. • Investment property. • Intangible assets.

Presentation offinancial statements

21

• Financial assets (other than those disclosed separately, namely equity accOllllted investments, trade and other receivables, cash and cash equivalents). • Investments accounted for using the equity method. • Biological assets. • Inventories. • Trade and other receivables. • Cash and cash equivalents. • Non-current assets classified as held for sale (and assets included in disposal groups classified as held for sale) in terms ofIFRS 5. • Trade and other payables. • Provisions. • Financial liabilities (excluding trade and other payables and provisions). • Current tax liabilities and assets. • Deferred tax liabilities and assets (may not be classified as "current"). • Liabilities included in disposal groups classified as held for sale in terms of IFRS 5. • Issued capital and reserves attributable to owners of the parent. • Non-controlling interest (within equity). Additional line items, headings and subtotals should be presented on the face of the statement of financial position when such presentation is relevant to an understanding of the entity's financial position. If an entity presents additional subtotals, those subtotals shall: • comprise of amounts from line items recognised and measured according to IFRS; • be labelled and presented in a clear and understandable manner; • be consistent from period to period; and • be presented with the same or lesser prominence than the subtotals and totals required by IFRS. An entity makes the judgement about whether to present additional items separately on the basis of assessment of: • the nature and liquidity of assets; • the function of assets within the entity; and • the amounts, nature and timing of liabilities. The descriptions provided above are broad in nature and may be amended to better suit and reflect the nature of an entity, its transactions and its financial position. For example, a financial institution may amend the above descriptions to provide information that is relevant to the operations of a financial institution. Separate line items should be presented in respect of the same category of assets or liabilities if different measurement bases are used, for example, certain classes of property may be canied at cost and others at revalued amounts.

2.4.1.2 Current or non-current distinction An entity should present current and non-current assets and current and non-current liabilities as separate classifications on the face of its statement of financial position, except when a liquidity approach (where assets and liabilities are presented broadly in order of liquidity) provides more relevant and reliable information. The former approach will usually be followed by entities with a clearly identifiable operating cycle and the latter by entities without such an operating cycle, for example financial institutions. Entities with diverse operations may even choose to follow a mixed approach. Whichever method is adopted, if a line item combines items to be recovered or settled in less than twelve months and items to be recovered or settled in more than twelve months, the amount expected to be recovered or settled after more than twelve months should be disclosed.

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GAAP Handbook 2020: Volume 1

A current asset is an asset that • is expected to be realised in, or is held for sale or consumption in the normal course of the entity's operating cycle (e.g. inventory); • is held primarily for trading purposes (e.g. some financial assets held for trading); • is expected to be realised within twelve months of the reporting date (e.g. nOll-current assets classified as held for sale); or • is cash or a cash equivalent that is not restricted from being exchanged or used to settle a liability for at least twelve months from the reporting date (e.g. a call aCcOllllt).

All other assets are classified as non-current.

The operating cycle of an entity is the time between the acquisition of raw materials and their realisation in cash or cash equivalents. Depending on the length of an operating cycle, current assets could therefore include assets that are not expected to be realised within twelve months. If an entity's operating cycle is not clearly identifiable, its length should be assumed to be twelve months. A current liability is a liability that• is expected to be settled in the normal course of the entity's operating cycle (e.g. trade payables); • is held primarily for trading pmposes (e.g. some financial liabilities held for trading); • is due to be settled within twelve months from the reporting date (e.g. dividends payable, income tax payable); or • the entity does not have an llllconditional right to defer settlement of the liability for at least twelve months after the reporting period (e.g. a bank overdraft or liability payable on demand). [Note that if the terms of the liability provide for share settlement at the option of the cOllllterparty, the share settlement option should not affect the classification of the liability as current or non-current - the classification of this instrument (i.e. an instrument convertible at the option of the cOllllterparty) as current or non-current should therefore be based on the expected transfer of cash or other assets rather than on share settlement.] All other liabilities are classified as non-current, for example a long-term loan. Some current liabilities, such as trade payables, are part of the working capital used in the normal operating cycle of an entity. Such items are classified as current even if they are due to be settled after more than twelve months. A long-term financial liability, with an original term of more than twelve months, which is due within twelve months from the reporting date, should be classified as a current liability. This classification is also appropriate if an agreement to refinance on a long-term basis is completed only after the reporting period (i.e. non-adjusting event after the reporting period). If, however, the entity has the discretion to refinance the obligation for at least twelve months after the reporting period and the entity expects to refinance, then the obligation should be classified as non-current, irrespective of when the actual refinancing occurs. If, before year-end, an entity breaches an undertaking llllder a long-term loan with the effect that the liability becomes payable on demand, the liability should be classified as current. The liability will still be classified as current if the lender agreed only after the reporting period not to demand payment (i.e. non-adjusting event after the reporting period). Only if the lender agreed before reporting date not to demand payment, will the liability be classified as non-current. Similarly, if the lender agreed before year-end to provide a period of grace ending at least twelve months after the reporting period, within which the entity can rectify the breach, the liability should be classified as non-current. In respect ofloans classified as current liabilities, ifthe following non-adjusting events occur after the reporting period, the entity should provide the disclosure required by lAS 10: • Refinancing on a long-term basis. • Rectification of a breach of a long-term loan arrangement. • The granting by the lender of a period of grace to rectifY a breach of a long-term loan arrangement ending at least twelve months after the reporting period.

Presentation offinancial statements

23

2.4.1.3 Information on the face of the statement of financial position or in the notes Further sub-classifications of the line items presented should be disclosed either on the face of the statement of financial position or in the notes thereto. The detail provided in sub-classifications depends on the requirements of all the accounting standards and interpretations, as well as on the size, nature and fllllction of the amollllts involved. The following are examples of sub-classifications:

• Property, plant and equipment:

Land and buildings Plant and machinery Furniture and fittings Office equipment Motor vehicles Development costs • Intangible assets: Trademarks Raw materials • Inventories: Consumables Work-in-progress Finished goods Trade customers • Receivables: Related parties Prepayments Employee benefits • Provisions: Other provisions Paid-up capital • Equity capital and reserves Reserves Fairly detailed disclosure is required in respect of share capital, reserves and dividends, either on the face of the statement of financial position or the statement of changes in equity or in the notes: • For each class of share capital: - The number of shares authorised. -

The number of shares issued and fully paid.

-

The number of shares issued and not fully paid.

-

The par value per share, or that the shares have no par value.

-

A reconciliation of the number of shares at the beginning and at the end of the financial year.

-

The rights, preferences and restrictions attached to the shares (including restrictions on the distribution of dividends and the repayment of capital). Shares in the entity held by the entity itself and/or by subsidiaries and/or associates ofthe entity. Shares reserved for issue llllder options and/or sale contracts, and the related terms and amollllts.

(Note that the JSE listings requirements section 8.63 G) also requires disclosure of issues of securities for cash during the period, distinguishing between general and specific issues, indicating at least the number of securities issued, the price at which and, in the event of a specific issue to non-public shareholders, to whom they were issued.) • A description of the nature and purpose of each reserve within equity. (Note that this may imply that an entity may not create a general reserve, as it is difficult to provide the nature and purpose of such a reserve.) Entities without share capital (e.g. close corporations, partnerships and trusts) should disclose, to the extent applicable, information equivalent to the above. In particular, movements during the accounting period in each category of equity interest and the rights, preferences and restrictions attached to each category of equity interest should be duly disclosed. Entities which reclassified puttable financial instruments classified as equity instruments between financial liabilities and equity should disclose the amollllt reclassified into and out of each category (financial liabilities or equity), the timing and reason for that reclassification. The same applies if the

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entity reclassified instruments classified as equity instruments which would result in the entity delivering to another party a pro rata share of the net assets of the entity only on liquidation. The principal requirements of lAS 1 with regard to a statement of financial position are illustrated in example 2.1.

Example 2.1: Statement of financial position conforming to lAS 1 Xenon Ltd Statement of financial position as at 31 December 20X2

20X2

20X1

R'OOO

R'OOO

000 000 000 000 000 000

000 000 000 000 000 000

Inventories Trade receivables Other current assets Cash and cash equivalents

000 000 000 000 000

000 000 000 000 000

Total assets

000

000

Share capital Retained earnings Other components of equity

000 000 000 000 000

000 000 000 000 000

Non-controlling interest

000

000

Total liabilities

000

000

Non-current liabilities

000

000

Long-term borrowings Deferred tax Long-term provisions Cutrent liabilities

000 000 000 000

000 000 000 000

Trade and other payables Short-term borrowings Current portion of long-term borrowings Current tax payable Short-term provisions

000 000 000 000 000

000 000 000 000 000

Total equity and liabilities

000

000

Notes

Assets Non-current assets Property, plant and equipment Goodwill Other intangible assets I nvestments in associates Financial assets Current assets

Equity and liabilities Total equity Equity attributable to owners of the parent

2.4.2 Statement of profit or loss and other comprehensive income lAS 1 defines the following concepts: • Profit or loss is the total of income less expenses, excluding the items of other comprehensive income.

Presentation offinancial statements •

25

Other comprehensive income comprises items of income and expense (including reclassification adjustments) that are not recognised in profit or loss, as required or permitted by other IFRSs. Examples include:

-

Changes in a revaluation smplus relating to property, plant and equipment. Remeasurements of defined benefit plans.

-

Gains or losses arising from translating the financial statements of a foreign operation. Gains or losses on remeasuring investments in equity instruments designated at fair value through other comprehensive income (IFRS 9.5.7.5). Gains or losses on remeasuring investments in debt instruments at fair value through other comprehensive income (IFRS 9.4.1.2A).

-

The effective portion of gains or losses on hedging instruments in a cash flow hedge. Changes in fair value attributable to credit risk for particular liabilities designated as at fair value through profit or loss.

Changes in time value of money values of options when the hedging instrument was designated as the changes in the intrinsic value of the options. - Changes in the value ofthe forward elements of a forward contract, when only the changes in the spot element of the forward contract were designated as the hedging instrument. • Reclassification adjustments are amOllllts reclassified to profit or loss in the current period that were recognised in other comprehensive income in the current or previous periods. -

•

Total comprehensive income is the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners.

• Owners are holders of instruments classified as equity. An entity has a choice for the presentation of items of income and expense recognised in the period. Items of income and expense can either be recognised-

• in a single statement of profit or loss and other comprehensive income; or • in two statements: - a statement displaying components of profit or loss (separate statement of profit or loss); and - a second statement beginning with profit or loss and displaying items of other comprehensive income (statement of profit or loss and other comprehensive income).

2.4.2.1

Information to be presented in the separate statements (twostatement format) or separate sections (one-statement format)

2.4.2.1.1

Information to be presented in the profit or loss section (if one-statement format is used) or separate statement of profit or loss (if two-statement format is used) In addition to items required by other IFRSs, the profit or loss section or separate statement of profit or loss should reflect line items that present the following (to the extent applicable to the entity): • Revenue, interest revenue calculated by using the effective interest method should be presented separately • Gains or losses on derecognition of financial assets measured at amortised cost in terms of IFRS 9 • Finance costs • Impairment losses and gains on financial instruments (IFRS 9.5.5) • Share of the after-tax profitsllosses of associates and joint ventures accounted for using the equity method • Gains or losses arising from financial assets reclassified to be measured at fair value from amortised cost category (difference between previous amortised cost and its fair value on date of reclassification) in terms of IFRS 9

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GAAP Handbook 2020: Volume 1

• Cumulative gains or losses previously recognised in other comprehensive income from financial assets reclassified to be measured at fair value through profit or loss from the fair value through other comprehensive income category in terms of IFRS 9

• Tax expense • A single amollllt for the total of discontinued operations.

2.4.2.1.2 Information to be presented in the other comprehensive income section (if onestatement format is used) or separate statement of profit or loss and other comprehensive income (iftwo-statementformat is used) The other comprehensive income section should present line items for amOllllts of other comprehensive income in the period, classified by nature, including the entity's share of the other comprehensive income of associates and joint ventures aCcOllllted for using the equity method. Other comprehensive income line items should be grouped into those that, in accordance with other IFRSs: • will not be subsequently reclassified to profit or loss; and • will be subsequently reclassified to profit or loss when specified conditions are met (refer to section 2.4.2.2 for an explanation of reclassification adjustments).

2.4.2.1.3 Additional information affecting both sections or statements Additional line items, headings and subtotals should be presented in the statement(s) of profit or loss and other comprehensive income when such presentation is relevant to an llllderstanding of the entity's financial performance. Descriptions and the sequence of items may be amended to better explain the elements of performance. If an entity presents additional subtotals, those subtotals shall: • comprise of amollllts from line items recognised and measured according to IFRS; • be labelled and presented in a clear and llllderstandable manner; • be consistent from period to period; and • be presented with the same or lesser prominence than the subtotals and totals required by IFRS. The line items in the statement(s) of profit or loss and other comprehensive income that reconcile any additional subtotals to the subtotals and totals as required by IFRS, should be presented. In addition to the profit or loss and other comprehensive income sections presented, the statement(s) of profit or loss and other comprehensive income should also display: • Profit or loss; • total other comprehensive income; and • comprehensive income for the period, being the total of profit or loss and other comprehensive income (referred to in this work as total comprehensive income). Furthermore, entities should present the following allocations of profit or loss and other comprehensive income for the period: • Profit for the period attributable to: - non-controlling interests; and -

owners of the parent (where a separate statement of profit or loss is presented, an entity should disclose this attribution of profit or loss for the period in that statement). • Total comprehensive income (profit or loss plus other comprehensive income) attributable to: - non-controlling interests; and - owners of the parent. Example 2.2 illustrates the one-statement format of the statement of profit or loss and other comprehensive income, while Example 2.3 illustrates the two-statement format.

27

Presentation offinancial statements

Example 2.2:

One-statement format for the statement of profit or loss and other comprehensive income

Xenon Ltd Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2

20X2

20X1

R'OOO

R'OOO

Revenue Cost of sales

000 (000)

000 (000)

G ross profit Other income Distribution costs Administrative expenses Other expenses Finance costs Share of profit of associates

000 000 (000) (000) (000) (000) 000

000 000 (000) (000) (000) (000) 000

Profit before tax Income tax expense

000 (000)

000 (000)

Profit for the year Other comprehensive income: Items that will not be reclassified to profit or loss

000

000

000

000

Gains on property revaluation Remeasurements on defined benefit plans Gains/Closses) on investments in equity instruments at fair value through other comprehensive income Credit risk component of designated financial liabilities Share of gain on property revaluation of associates Gains arising on cash flow hedges I nco me tax relating to items that will not be reclassified

000 000

000 000

(000) 000 000 000 (000)

000 000 000 000 (000)

000

000

Exchange differences on translating foreign operations Gains arising on cash flow hedges Share of cash flow hedges of associates Income tax relating to items that may be reclassified

000 000 000 (000)

000 000 000 (000)

Other comprehensive income for the year, net of tax

000

000

Total comprehensive income for the year

000

000

Profit attributable to: OVVners of the parent Non-controlling interests

000 000

000 000

000

000

000 000

000 000

000

000

Items that may be reclassified to profit or loss

Total comprehensive income attributable to: OVVners of the parent Non-controlling interests

In this example the items of other comprehensive income are presented before related tax effects and the tax effects are shown in aggregate relating to those items. Tax effects are presented separately for those items of other comprehensive income that will not be reclassified to profit or loss and those that may be reclassified to profit or loss. An entity is also allowed to present the items of other comprehensive income net of related tax effects, in which case the aggregate tax effects will no longer be shown as a separate line item.

28

GMP Handbaak 2020: Va/ume 1

Example 2.3:

Two-statement format for the statement of profit or loss and other

comprehensive income Xenon Ltd Statement of profit or loss for the year ended 31 December 20X2

20X2

20X1

R'OOO

R'OOO

Revenue Cost of sales

000 (000)

000 (000)

G ross profit Other income Distribution costs Administrative expenses Other expenses Finance costs Share of profit of associates

000 000 (000) (000) (000) (000) 000

000 000 (000) (000) (000) (000) 000

Profit before tax

000 (000)

000 (000)

000

000

000 000

000 000

000

000

I ncome tax expense

Profit for the year Profit attributable to: OVVners of the parent Non-controlling interests

Xenon Ltd Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2 20X2 20X1

R'OOO

R'OOO

Profit for the year

000

000

Other comprehensive income: Items that will not be reclassified to profit or loss

000

000

000 000

000 000

(000) 000 000 000 (000)

000 000 000 000 (000)

000 000 000 000 (000)

000 000 000 000 (000)

Other comprehensive income for the year, net of tax

000

000

Total comprehensive income for the year

000

000

000 000

000 000

000

000

Gains on property revaluation Remeasurements on defined benefit plans Gains/Closses) on financial assets at fair value through other comprehensive income Credit risk component of designated financial liabilities Share of gain on property revaluation of associates Gains on cash flow hedges I nco me tax relating to items that will not be reclassified

Items that may be reclassified to profit or loss Exchange differences on translating foreign operations Gains on cash flow hedges Share of cash flow hedges of associates Income tax relating to items that may be reclassified

Total comprehensive income attributable to: OVVners of the parent Non-controlling interests

Presentation offinancial statements

29

In this example the items of other comprehensive income are presented before related tax effects and the tax effects are shown in aggregate relating to those items. Tax effects are presented separately for those items of other comprehensive income that will not be reclassified to profit or loss and those that may be reclassified to profit or loss. An entity is also allowed to present the items of other comprehensive income net of related tax effects, in which case the aggregate tax effects will no longer be shown as a separate line item.

2.4.2.2 Other comprehensive income: reclassification adjustments Reclassification adjustments relating to items of other comprehensive income should be disclosed separately (either on the face of the statement of profit or loss and other comprehensive income or in the notes). For example, when an entity disposes of a foreign operation (whether partially or entirely), a gain or loss will be recognised in profit or loss of the current period. A portion of this gain or loss may have been recognised in other comprehensive income as umealised translation gains or losses in the current or previous periods. Those unrealised gains or losses must be eliminated from other comprehensive income in the period in which the realised gains or losses are reclassified to profit or loss to avoid including them in total comprehensive income twice. Entities presenting reclassification adjustments in the notes, present the items of other comprehensive income on the face of the statement of profit or loss and other comprehensive income after any related reclassification adjustments. Examples of items of other comprehensive income that IFRS currently allows to be reclassified to profit or loss include: • The effective portion for cash flow hedges llllder specific circumstances (see chapter 18); • The mark-to-market reserve on debt instruments (see chapter 18); • The expected credit losses reserve on debt instruments (see chapter 18); and • The foreign currency translation reserve for foreign operations (see chapter 8 of volume 2). By contrast, other items recognised in other comprehensive income may never be reclassified to profit or loss. These include, for example, the following items: • Remeasurement differences on defined benefit plans (see chapter 10); • Changes in fair value attributable to credit risk of certain designated financial liabilities (see chapter 18); and • Revaluation smpluses on property, plant and equipment (see chapter 9). If these reserves relates to these items are transferred to retained earnings directly on the statement of changes in equity, these transfer are not reclassification adjustments, as they do not represent amollllts recognised in profit or loss. Example 2.4 illustrates the disclosure of reclassification adjustments on the face of the statement of profit or loss and other comprehensive income, while Example 2.5 illustrates the disclosure of reclassification adjustments in the notes.

30

GMP Handbaak 2020: Va/ume 1

Example 2.4: Xenon Ltd

Reclassification adjustments disclosed on the face

Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2

20X2

20X1

R'OOO

R'OOO

000

000

000

000

000 000

000 (000)

(000)

000

000 000 (000)

000 000 (000)

Items that may be reclassified to profit or loss

000

000

Exchange differences on translating foreign operations

000

000

Profit for the year Other comprehensive income: Items that will not be reclassified to profit or loss Gains on property revaluation Remeasurements on defined benefit plans Gains/Closses) on investment in equity investments at fair value through other comprehensive income Credit risk component of designated financial liabilities Gains on cash flow hedges I nco me tax relating to items that will not be reclassified

[J;J [J;J [J;J [J;J

Gains arising during the year Less: Reclassification adjustments for gains included in profit or loss Cash flow hedges Gains arising during the year Less: Reclassification adjustments for gains included in profit or loss

(000)

(000)

000

000

(000)

(000)

Income tax relating to items that may be reclassified

(000)

(000)

Other comprehensive income for the year, net of tax

000

000

Total comprehensive income for the year

000

000

Example 2.5: Xenon Ltd

Reclassification adjustments disclosed in the notes

Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2 20X2 20X1 Notes

R'OOO

R'OOO

000

000

000 000 000

000 000 (000)

(000)

000

000 000 (000)

000 000 (000)

000 000 000 (000)

000 000 000 (000)

Other comprehensive income for the year, net of tax

000

000

Total comprehensive income for the year

000

000

Profit for the year Other comprehensive income: Items that will not be reclassified to profit or loss Gains on property revaluation Remeasurements on defined benefit plans Gains/Closses) on investments in equity instruments at fair value through other comprehensive income Credit risk component of designated financial liabilities Gains on cash flow hedges I nco me tax relating to items that will not be reclassified Items that may be reclassified to profit or loss Gains on cash flow hedges Exchange differences on translating foreign operations Income tax relating to items that may be reclassified

7 7

31

Presentation offinancial statements

Xenon Ltd Notes for the year ended 31 December 20X2 20X2

20X1

R'OOO

R'OOO

000

000

7. Other comprehensive income - reclassification adjustments Exchange differences on translating foreign operations

[J;J [J;J [J;J [J;J

Gains arising during the year Less: Reclassification adjustments for gains included in profit or loss Gains on cash flow hedges Gains arising during the year Less: Reclassification adjustments for gains included in profit or loss Income tax relating to items that may be reclassified Items that may be reclassified to profit or loss

(000)

(000)

000

000

(000)

(000)

(000)

(000)

000

000

2.4.2.3 Other comprehensive income: tax effects An entity is required to disclose the amollllt of income tax relating to each item of other comprehensive income (including reclassification adjustments), either in the statement of profit or loss and other comprehensive income orin the notes. Items of other comprehensive income may be presented either• net of related tax effects, in which case the income tax relating to each item will be disclosed in the notes; or • before related tax effects, in which case the income tax relating to each item may be disclosed in the notes or on the face of the statement of profit or loss and other comprehensive income. If note disclosure is used, the income tax on the face of the statement of profit or loss and other comprehensive income will be shown in aggregate separately for those items that may be subsequently reclassified to profit or loss and those that will not - therefore two tax figures will be presented (as illustrated in Example 2.2 - Example 2.5). Example 2.6 illustrates the disclosure in the notes of the tax effects relating to each item of other comprehensive income, while Example 2.7 illustrates the disclosure of these tax effects on the face of the statement of profit or loss and other comprehensive income.

Example 2.6: Xenon Ltd

Tax effects of other comprehensive income disclosed in notes

Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2 20X2 20X1 Notes

R'OOO

R'OOO

Profit for the year Other comprehensive income: Items that will not be reclassified to profit or loss

000

000

000

000

Gains on property revaluation Gains/Closses) on investments in equity instruments at fair value through other comprehensive income Remeasurements on defined benefit plans Credit risk component of designated financial liabilities Share of gain on property revaluation of associates Gains on cash flow hedges I nco me tax relating to items that will not be reclassified

000

000

(000) 000 000 000 000 (000)

000 000 000 000 000 (000)

8

32

GAAP Handbook 2020: Volume 1

20X2

20X1

R'OOO

R'OOO

000 000 000 000 (000)

000 (000) 000 000 (000)

Other comprehensive income for the year, net of tax

000

000

Total comprehensive income for the year

000

000

Notes Items that may be reclassified to profit or loss Exchange differences on translating foreign operations Gains on cash flow hedges Share of cash flow hedges of associates Income tax relating to items that may be reclassified

8

Xenon Ltd

Notes for the year ended 31 December 20X2 8. Income tax relating to other comprehensive income

Relating to items that will not be reclassified Gains on property revaluation Gains/Closses) on investments in equity instruments atfair value through other comprehensive income Remeasurements on defined benefit plans Credit risk component of designated financial liabilities Share of gain on property revaluation of associates Gains on cash flow hedges

20X2 R'OOO

R'OOO

R'OOO

Before-tax amount

Tax (expense) Ibenelit

Net-ol-tax

000 (000) 000 000 000 000

Relating to items that may be reclassified Exchange differences on translating foreign operations Gains on cash flow hedges Share of cash flow hedges of associates

000 000 000

Other comprehensive income for the year

000

(Comparative information will be required for 20X1)

(000) (000) 000 (000) (000) -

(000) (000) (000) (000) 000

amount

000 (000) 000 000 000 000

000 000 000 000

33

Presentation offinancial statements

Example 2.7: Xenon Ltd

Tax effects of other comprehensive income disclosed on face

Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2 20X2 20X1

R'OOO

R'OOO

Profit for the year Other comprehensive income:

000

000

Items that will not be reclassified to profit or loss

000

000

Gains on property revaluation Gains arising during the year Less: Tax expense

000

000

~ ~ (000)

(000)

(000)

000

GainS/Closses) arising during the year Less: Tax Cexpense)/benefit

I (000) I 000

[J;J

Remeasurements on defined benefit plans Gains arising during the year Less: Tax expense

000

000

Gains/Closses) on investments in equity instruments at fair value through other comprehensive income

Credit risk component of designated financial liabilities Gains arising during the year Less: Tax expense Cash flow hedges Gains arising during the year Less: Tax expense

(000)

~ ~ ~ (000) 000

(000) 000

000 (000)

(000)

0000

000

(:;)1

II

000 (000)

Share of gain on property revaluation of associates

000

000

Items that may be reclassified to profit or loss

000

000

Exchange differences in translating foreign operations

000

000

000

000

Less: Reclassification adjustments for gains included in profit or loss

(000)

(000)

Less: Tax expense

(000)

(000)

000

000

000 (000) (000)

000 (000) (000)

Share of cash flow hedges of associates

000

000

Total comprehensive income for the year

000

000

Gains arising during the year

Cash flow hedges Gains arising during the year Less: Reclassification adjustments for gains included in profit or loss Less: Tax expense

I

2.4.2.4 Information on the face of the statement of profit or loss and other comprehensive income or in the notes When items of income and expense are material (i.e. of such size, nature or incidence that disclosure is relevant to explain the performance of the entity), then the nature and amolllltthereofshould be disclosed separately, either on the face ofthe statement of profit or loss and other comprehensive income or in the notes. The following items may give rise to separate disclosure: • The write-down of inventories to net realisable value and the reversal of the write-down. • The write-down of property, plant and equipment to recoverable amollllt and the reversal of the writedown.

34

GMP Handbaak 2020: Va/ume 1

• A restructuring of the activities of an entity and the reversal of any provisions for the costs of restructuring. • Disposals of items of property, plant and equipment. • Disposals of investments. • Discontinued operations. • Litigation settlements. • Other reversals of provisions. Separate disclosure of items such as these should be encouraged as it enables users to assess the sustainable earnings of an entity and to adjust reported earnings per share, which is based on profit or loss for the period, accordingly. However, items may llllder no circumstances be presented as extraordinary items, whether as part of profit or loss, other comprehensive income, or in the notes. lAS 1 requires an analysis of expenses recognised in profit or loss to be presented • either on the face of the statement of profit or loss and other comprehensive income or in the separate statement of profit or loss, if presented (the preferable format) • or in the notes to the statement of profit or loss and other comprehensive income, using a classification based on • either the nature of expenses (for example depreciation, purchases, wages, transport costs, etc.) • or their function within the entity (for example cost of sales, distribution costs, administrative expenses, etc.) Entities classifying expenses by fllllction need to provide additional information on the nature of expenses, including depreciation, amortisation and employee benefits expense, to enable users of the financial statements to predict future cash flows. "When classifying expenses by fimction, expenses should be analysed, as a minimum, between cost of sales and other expenses.

Example 2.8: Nature of expense method Xenon Ltd Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2

20X2

20X1

R'OOO

R'OOO

Revenue Other income Changes in inventories of finished goods and work in progress Work performed by the entity and capitalised Raw material and consumables used Employee benefits expense Depreciation expense Amortisation expense Impairment of property, plant and equipment Other expenses Finance costs Share of profit of associates

000 000 (000) 000 (000) (000) (000) (000) (000) (000) (000) 000

000 000 000 000 (000) (000) (000) (000) (000) (000) (000) 000

Profit before tax Income tax expense

000 (000)

000 (000)

Profit and total comprehensive income for the year

000

000

Attributable to: ONners of the parent Non-controlling interests

000 000

000 000

000

000

The simplicity of the nature of expense method makes it a useful format to small entities.

35

Presentation offinancial statements

Example 2.9: Function of expense method Xenon Ltd Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2 20X2 20X1 R'OOO R'OOO Revenue 000 000 (000) (000) Cost of sales G ross profit Other income Distribution costs Administrative expenses Other expenses Finance costs Share of profit of associates

000 000 (000) (000) (000) (000) 000

000 000 (000) (000) (000) (000) 000

Profit before tax I ncome tax expense

000 (000)

000 (000)

Profit and total comprehensive income for the year

000

000

Attributable to: OVVners of the parent Non-controlling interests

000 000

000 000

000

000

A statement of profit or loss and other comprehensive income and accompanying notes prepared on the fllllction of expense method provides more useful and relevant information to users than the nature of expense method; however, cost allocations will often have to be arbitrary and involve considerable judgement.

2.4.3 Statement of changes in equity Changes in owners' equity during an accollllting period represent the increase or decrease in the entity's net assets, measured llllder the particular accollllting principles and policies adopted by the entity. Changes in equity are especially important to the owners of an entity since it determines their wealth in the entity or group. It can also be regarded as an overall measure of performance by the entity or group. In addition to income, expenses, gains and losses, changes in equity are also brought about by capital transactions with and distributions to equity owners. The importance of changes in equity and proper, separate disclosure thereof is recognised by lAS 1, which requires that a separate statement of changes in equity be compiled to form part of a company's financial statements. This requirement is equally applicable to group financial statements. A statement of changes in equity should include the following information • total comprehensive income for the period (showing separately the total amollllts attributable to owners of the parent and to non-controlling interests); • for each component of equity, the effects of retrospective application or retrospective restatement recognised in accordance with lAS 8; • for each component of equity, a reconciliation between the carrying amollllt at the beginning and the end of the period, separately disclosing changes resulting from: - profit or loss; -

other comprehensive income; and

-

the amollllts of transactions with owners in their capacity as owners, showing separately contributions by and distributions to owners and ownership interest changes in subsidiaries that did not result in a loss of control.

36

GAAP Handbook 2020: Volume 1

An entity is required to present for each component of equity an analysis of other comprehensive income by item, as well as the amollllt of dividends recognised as distributions to owners and the related amount of dividends per share, either in the statement of changes in equity or in the notes. It is not allowed to present dividend per share on the face of the statement of profit or loss and other comprehensive income or in the separate statement of profit or loss (if presented).

Example 2.10: Statement of changes in equity Xenon Ltd Statement of changes in equity for the year ended 31 Decem ber 20X2' Attributable to owners of the parent Share Other Translation Retained Total capital reserves b reserve earnings

Noncontrolling interests

Total equity

R'OOO

R'OOO

R'OOO

R'OOO

R'OOO

R'OOO

R'OOO

Balance at 31 December 20X 1 Changes in accounting policy

000

000

(000)

000 (000)

000 (000)

000 (000)

000 (000)

Restated balance Total comprehensive income for the year:

000

000

(000)

000

000

000

000

(000)

000

000

000

000

Profit for the year other comprehensive income for the year Dividends Issue of share capital Interest changes in subsidiary that did not result in loss of control Equity share options issued Balance at 31 December 20X2

b

DB 000

I (000) I

LJ ~ ~ ~ (000)

000 000 000 000

000

000

000

000

(000) 000 000

(000)

(000) 000 000

000

000 (000)

000

000

000 000

000

In order to provide comparative figures, similar information as that contained in the 20X2 statement will have to be disclosed in respect of 20X 1. A practical approach would be to structure a single statement covering both years, i.e. start off with the balance at 31 December 20XO, work to a sUb-total at 31 December 20X 1, and then to a total at 31 December 20X2, reconciling the data from year to year. other reserves are analysed into their components, if material. A description of the nature and purpose of each reserve should also be provided. If this component of equity (other reserves) combines more than one item of other comprehensive income, an analysis of other comprehensive income by item should be provided, either inthe statement of changes in equity or in the notes.

2.4.3.1

Interaction between statement of changes in equity and statement of profit or loss and other comprehensive income

From the discussion in the previous sections it should be clear that changes in equity (i.e. changes in net assets) are recognised either directly in the statement of changes in equity, or alternatively in the statement of profit or loss and other comprehensive income from where it is then transferred to the statement of changes in equity. The following diagram illustrates the difference between the nature of the items recognised in the statement of changes in equity and the statement of profit or loss and other comprehensive income.

37

Presentation offinancial statements

Changes in equity (i.e. changes in net assets)

.

• Owner changes

Non-owner changes

Transactions with owners in their capacity as owners, e.g. issue of shares, payment of dividends, change in interest of subsidiary without relinquishing control

Changes other than owner changes

.!

~

Statement of profit or loss and other comprehensive income

Statement of changes in equity

...:----

~

Profit or loss

Other comprehensive income

•

Income and expenses that may not be recognised directly in equity

•

Gains and losses recognised directly in equity

•

•

E.g. sales, cost of sales, other

E.g. revaluation surplus, cash flow hedge, remeasurements on

income, other expenses

defined benefit plans

.

2.4.4 Statement of cash flows A statement of cash flows is another important component of a set of financial statements. Historic cash flow information is useful as a basis for assessing the ability of an entity to generate cash and cash equivalents, and to assess the needs of such entity to utilise those cash flows. Statements of cash flows are dealt with in chapter 4.

2.4.5 Notes The final section of a set of financial statements comprises the notes, which should • affirm compliance with all applicable IFRSs; • describe the measurement basis/bases used in preparing the financial statements, e.g. historical cost, current cost, net realisable value, fair value or recoverable amollllt; • describe each accounting policy that is necessrny for a proper llllderstanding of the financial statements, e.g. the accollllting policies adopted and applied with regard to revenue recognition, depreciation/amortisation of assets, leases, j oint arrangements and research and development costs; • disclose the information required by applicable IFRSs and Interpretations that does not appear elsewhere in the financial statements; • provide additional (supporting) information that is necessrny for a fair presentation, e.g. narrative descriptions or more detailed analyses of amollllts shown as line items elsewhere, commitments, and other financial as well as non-financial disclosures; • be presented in a systematic manner; and • be cross-referenced to the related items on the face of the financial statements.

GAAP Handbook 2020: Volume 1

38

Although the order of notes are not prescribed, the notes are normally presented in the following sequence: • Statement of compliance with IFRS and Interpretations. • AccOllllting policies, including measurement bases. • Supporting information for items presented on the face of the financial statements. • Other disclosures, e.g. contingencies and non-financial disclosures. The notes to the financial statements should indicate the total amollllt of dividends proposed or declared after year-end but before the financial statements were authorised for issue (including the amollllt per share), as well as the amount of any cumulative preference dividends not recognised.

An entity should also disclose the judgements made by management in applying the accOllllting policies that have the most significant effect on the amounts of items recognised in the financial statements. This disclosure may be done in the summary of significant accOllllting policies, or alternatively elsewhere in the notes, and includes issues such as the judgements an entity has made in determining whether it controls another entity, whether certain investments qualify as investments carned at amortised cost, etc. Furthermore the notes should contain information regarding key assumptions about the future, and other sources of estimation uncertainty, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year. The nature and carrying amounts of those assets and liabilities should also be disclosed. Key assumptions would include, for example, future interest rates, future salary increases, inputs into fair value measurement, useful lives, etc. Note that these disclosures are not required for asset and liabilities measured at fair value based on a quoted price in an active market for an identical asset or liability. Disclosure is also required of information that will enable users to evaluate the entity's objectives, policies and processes for managing capital. The level of an entity's capital and how this capital is managed are important factors to consider when assessing the entity's risk profile. Accordingly the following should be disclosed: • Qualitative information regarding the entity's objectives, policies and processes for managing capital, including: a description of what is being managed as capital (i.e. which components of equity are included/excluded from "capital"); the nature of externally imposed capital requirements (if any) and how those requirements are incorporated into the management of capital; how the entity meets it obj ectives regarding capital management. • Quantitative data about what is being managed as capital. • Any changes in the above from the previous period. • Whether externally imposed capital requirements were complied with during the period, and if not, the consequences of such non-compliance. An entity should disclose, to the extent that it is not disclosed elsewhere, the following information for puttable financial instruments classified as equity instruments: • Smnmary quantitative data relating to the amount classified as equity. • The entity's objectives, policies and processes (including any changes from the previous period) for managing the entity's obligation to repurchase or redeem these instruments. • The expected cash outflow on the redemption or repurchase of the instruments. • Information as to how the expected cash outflow on redemption or repurchase was determined.

2.5 Supplementary information The following should be published in or with the financial statements: • Legal form of the entity.

Presentation offinancial statements

• • • •

39

Domicile. COlllltry of incorporation. Address of the registered office. Nature of operations and principal activities.

• Name of parent and ultimate parent of the group, if applicable to the entity. • With regards to a limited life entity, information regarding the length of the entity's life.

2.6 Distributions of non-cash assets to owners lAS 1 requires disclosure of the amount of dividends recognised as a distribution to owners and the related amount per share, either in the statement of changes in equity or in the notes. Dividends are normally paid in cash, but an entity may also distribute assets other than cash to its owners as dividends. These non-cash assets may include, for example, items of property, plant and equipment or share investments. IFRIC 17,Distributions ofnon-cash assets to owners, clarifies the accounting treatment of such non-cash distributions to owners acting in their capacity as owners, provided all owners of the same class of equity instruments are treated equally. However, it should be noted that if the non-cash assets distributed to the owners of the entity are ultimately controlled by the same parties both before and after the distribution, IFRIC 17 will not apply. For example, if a parent distributes some of the shares in its subsidiary but retains control of the subsidiary, IFRIC 17 will not apply (such a distribution will be accounted for in terms oflFRS 10 - refer to volume 2 chapter 6). Similarly, if an entity is controlled by a single shareholder (or a group of shareholders bound by a contractual agreement), and the entity distributes non-cash assets to its shareholders, the non-cash assets distributed to the controlling shareholder\s) will be controlled by the sarne shareholder\s) both before and after the distribution and IFRIC 17 will not apply to this distribution. On the other hand, if the entity is owned by public shareholders and no single shareholder (or group of shareholders bound by a contractual agreement) controls the entity, IFRIC 17 will be applicable to the distribution. It should be noted that a decision to distribute non-cash assets as a dividend leads not only to the recognition of a liability for the dividend, but may also impact on the measurement ofthe related assets, as can be seen from the next sections.

2.6.1 Accounting treatment of the liability to distribute non-cash assets A liability to pay a dividend is recognised when the dividend is appropriately authorised and no longer at the discretion of the entity. If the declaration of a dividend needs no further approval, the dividend liability will be recognised when the dividend is declared. However, if the declaration of a dividend needs to be approved by the shareholders, the liability will be recognised only upon approval by the shareholders. The liability to distribute non-cash assets as a dividend to owners should initially be recognised at the fair value of the assets to be distributed. This liability should then be remeasured at the end of each reporting period and at settlement date and any changes in the carrying amount thereof should be recognised in the statement of changes in equity as an adjustment to the amount of the distribution (i.e. as a dividend adjustment). If the entity gives the shareholders a choice between cash and non-cash assets, the fair value of the liability should be determined with reference to the fair value of each alternative and the probability of shareholders selecting each alternative.

2.6.2 Accounting treatment of the non-cash assets The treatment of non-current assets to be distributed as a dividend is governed by IFRS 5, Non-current assets held for sale and discontinued operations. Non-current assets (or a disposal group) to be distributed as a dividend should be classified as held for distribution if the following classification requirements are met:

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• The entity should be committed to distribute the asset (or disposal group) to the owners. For this to be the case, the assets must be available for immediate distribution in their present condition and the distribution must be highly probable. • For the distribution to be highly probable, actions to complete the distribution must have been initiated and should be expected to be completed within one year from the date of classification. Actions required to complete the distribution should indicate that it is unlikely that significant changes to the distribution will be made or that the distribution will be withdrawn. The probability of shareholders' approval (if required in the jurisdiction) should be considered as part of the assessment ofwhetherthe distribution is highly probable. A nOll-current asset (or disposal group) classified as held for distribution to owners should be measured at the lower of its carrying amount and fair value less costs to distribute, provided the asset (or disposal group) falls within the measurement scope ofIFRS 5. If the asset (or disposal group) does not fall within the measurement scope ofIFRS 5, it should be measured in terms of its applicable standard, for example financial assets will be measured in terms of IFRS 9 and investment property measured at fair value will be dealt with in terms of lAS 40. Refer to chapter 28 for a detailed discussion of IFRS 5.

2.6.3 Settlement of the liability When the entity settles the dividend payable, the difference between the carrying amollllt of the liability (discussed in 2.6.1) and the carrying amollllt of the assets distributed (discussed in 2.6.2) should be recognised in profit or loss.

2.6.4 Presentation and disclosure regarding distribution of noncash assets The difference between the carrying amollllt of the liability and the carrying amollllt of the assets distributed should be presented as a separate line item in profit or loss. Furthermore the dividend liability should be reconciled from its opening to its closing balance. The presentation and disclosure requirements of IFRS 5 will apply to non-current assets classified as held for distribution. If, after the reporting period but before the financial statements are authorised for issue, an entity declares a dividend to distribute a non-cash asset, the entity should disclose the following: • the nature of the asset; • the carrying amollllt of the asset at the end of the reporting period; • the fair value of the asset at the end of the reporting period; and • the method used to measure fair value.

Example 2.11: Distribution of non-cash assets to owners - property, plant and equipment (PPE) On 30 September 20X1 the directors of A Ltd declared a dividend payable to all of the company's shareholders. This dividend will take the form of non-cash items (PPE) that will be distributed to the shareholders. Shareholder approval is required for all dividends declared by the directors and this approval was given by the shareholders on 31 October 20X1. The distribution of the PPE to the shareholders took place on 28 February 20X2. Assume that the PPE met the requirements to be classified as held for distribution on 31 October 20X 1, on which date the carrying amount thereof was R 150 000. A Ltd has a 31 December year-end. The fair value of the PPE and the costs to distribute the PPE as a dividend were as follows at various dates: Costs to Fair value distribute Date R R 30 September 20X1 161 000 9000 31 October 20X1 160000 9000 31 December 20X 1 145000 11000 28 February 20X2 148000 10800

41

Presentation offinancial statements

The liability forthe dividend distribution should be recognised on 31 October 20X1 when the shareholders approved the dividend declaration and should be measured at the fair value of the PPE (R160 000). On this date the PPE should be classified as non-current assets held for distribution and should be measured at the lower of the carrying amount (R150 000) and fair value less costs to distribute (160 000 - 9000 = R151 000) i e R150000 The following journal entries will be processed on this date'

Dividends paid (SoC E) Dividend liability Recognition of dividend liability) Non-current assets held for distribution PPE Reclassification of assets)

Dr R 160000

Cr R 160000

150000 150000

At year-end, the liability should be remeasured to the fair value of the non-cash assets (R145 000), resulting in an adjustment of R15 000 (160 000 -145 000). This adjustment should be recognised in the statement of changes in equity (as an adjustment to dividends paid). The assets should be measured at the lower of their carrying amount of R150 000 and their fair value less costs to distribute of R134 000 (145000 -11 000), i.e. R134 000. This will result in an impairment loss of R16 000 (150 000 -134000) being recognised in profit or loss. The journal entries on 31 December 20X1 will be as follows:

Dividend liability Dividends paid (SoCE) Remeasurement of dividend liability) Impairment loss (P/L) Non-current assets held for distribution Remeasurement of assets)

Dr R 15000

Cr R 15000

16000 16000

At settlement date (28 February 20X2) the liability should again be remeasured to the falrvalue of the noncash assets, resulting in an adjustment of R3000 (148000 - 145000). This adjustment should be recognised in the statement of changes in equity

Dividends paid (SoC E) Dividend liability Remeasurement of dividend liability)

Dr R 3000

Cr R 3000

Furthermore, at settlement date, the difference betvveen the carrying amount of the liability and the carrying amount of the assets should be recognised in profit or loss. The costs to distribute should be recognised in profit or loss when incurred

Dividend liability Non-current assets held for distribution Gain on distribution of non-current assets (P/L) Settlement of dividend liabilitv) Distribution costs (P/L) Bank Payment of distribution costs)

Dr R 148000

Cr R 134000 14000

10800 10800

The net effect on profit or loss at settlement date IS a gain of R3 200 (14 000 - 10 800), representing the increase in the fair value less costs to distribute of the non-cash assets from 31 December 20X1 to 28 February 20X2 [(148 000 - 10 800) - (145 000 - 11 000)[.

Example 2.12: Distribution of non-cash assets to owners - investment in an equity instrument at fair value through other comprehensive income On 30 September 20X1 the directors of A Ltd declared a dividend payable to all of the company's shareholders. This dividend will take the form of non-cash items (a share investment classified as at fair value through other comprehensive income) that will be distributed to the shareholders. Shareholder approval is required for all dividends declared by the directors and this approval was given by the shareholders on 31 October 20X 1. The distribution of the share investment to the shareholders took place

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on 28 February 20X2. Assume that the share investment met the requirements to be classified as held for distribution on 31 October 20X 1, on which date the carrying amount thereof was R 150 000 (original cost of R120 000). A Ltd has a 31 December year-end. The fair value of the share investment and the costs to distribute the investment as a dividend were as follows at various dates:

Costs to

30 31 31 28

Date September 20X1 October 20X1 December 20X1 February 20X2

Fair value

distribute

R 161 000 160000 145000 148000

R 9000 9000 11000 10800

The liability forthe dividend distribution should be recognised on 31 October 20X 1 when the shareholders

approved the dividend declaration and should be measured at the fair value of the share investment (R160 000). On this date the investment should be classified as non-current assets held for distribution. I mmediately before classification as held for distribution, the share investment should be measured atfair value in terms of IFRS 9. (As investment in equity instruments at fair value through other comprehensive income are excluded from the measurement scope of IFRS 5, this measurement in terms of IFRS 9 will continue until distribution date.) Upon classification as held for distribution, all amounts recognised in other comprehensive income relating to this share investment should be reclassified to a separate componentof equity. The following journal entries will therefore be processed on 31 October 20X1·

Dividends paid (SoC E)

Dr R 160000

Dividend liability Recognition of dividend liability) Investment in equity instrument atfairvalue through other comprehensive 10 000 income Mark-to-market reserve on equity instruments (OCI) Remeasurement of investment to fair value) (160000 FV -150000 CA) Non-current assets held for distribution 160000 Investment in equity instrument at fair value through other comprehensive income Reclassification of assets) Mark-to-market reserve on equity instruments (SoC E) 40000 Equity associated w ith non-current assets held for distribution (SoCE)

Cr R 160000

10 000

160000

40000

Reclassification of equity) (160 000 CA - 120 000 cost) At year-end, the liability should be remeasured to the fair value of the non-cash assets (R145 000),

resulting in an adjustment of R15 000 (160 000 -145 000). This adjustment should be recognised in the statement of changes in equity (as an adjustmentto dividends paid). The asset should also be measured at

its fair value of R145 000. This will result in a fair value loss of R15 000 (160000 - 145000) being recognised in other comprehensive income The journal entries on 31 December 20X1 will be as follows:

Dividend liability Dividends paid (SoC E)

Dr R 15000

Cr R 15000

Remeasurement of dividend liability) Equity associated with non-current assets held for distribution (OCI) Non-current assets held for distribution Remeasurement of assets)

15000 15000

At settlement date (28 February 20X2) the liability should again be remeasured to the falrvalue of the non-

cash assets, resulting in an adjustment of R3 000 (148000 - 145000). This adjustment should be recognised in the statement of changes in equity. The asset should at this date also be remeasured to fair value, with the fair value movement being recognised in other comprehensive income.

Presentation offinancial statements

43 Dr R 3000

Cr R

Dividends paid (SoC E) Dividend liability 3000 Remeasurement of dividend liability) Non-current assets held for distribution 3000 Equity associated with non-current assets held for distribution (OCI) 3000 Remeasurement of assets) At settlement date, the difference between the carrying amount of the liability and the carrying amount of the assets should be recognised in profit or loss. However, as the carrying amount of the liability is equal to the carrying amount of the assets, there is no gain or loss to be recognised in profit or loss. At settlement date the cumulative fair value adjustments recognised in other comprehensive income relating to the share investment remain in equity and may be transferred to another component within equity (reclassification of the gains to profit or loss is not permitted by IFRS 9), while the costs to distribute the investment should be recognised in profit or loss. Dr Cr R R Dividend liability 148000 Non-current assets held for distribution 148000 Settlement of dividend liabilitv) Equity associated with non-current assets held for distribution (SoC E) 28000 Retained earnings (SoC E) 28000 Transfer of fair value gains within equity) (148 000 CA - 120 000 cost) Distribution costs (P/L) 10800 Bank 10800 Payment of distribution costs)

2.7 Disclosure examples Refer to the following examples for recommended disclosure and format: Statement of financial position:

Example 2.1

Statement of profit or loss and other comprehensive income:

Examples 2.2 10 2.9

Statement of changes in equity:

Example 2.10

Statement of cash flows:

Chapler4

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GMP Handbaak 2020: Va/ume 1

2.8 Summary of lAS 1, Presentation of financial statements

I

Complete set of financial statements

General features of financial statements

I

Statement offinancial position

•

Assets and liabilities should be distinguished between current and noncurrent, unless presentation is done based on order of liquidity.

•

Certain information may only be presented on the face of statement of financial position, e.g. line items for property, plant and equipment, investment property, provisions, etc. Certain information may be presented on the face of the statement of financial position or in the notes, e.g. further sub-classifications of line items presented, information on share capital. Third statement of financial position presented (as at the beginning of the preceding period) when an accounting policy is applied retrospectively, an error is corrected or items are reclassified and it is material.

Statement of profit or loss and other comorehensive income Entity has choice between: single statement of profit or loss and other comprehensive income; two-statement format (separate statement of profit or loss and reduced statement of profit or loss and other comprehensive income).

•

• • •

• •

•

Items of expense should be presented either by function or by nature. Items of other comprehensive income must be distinguished between those items that may be reclassified to profit or loss in subsequent periods and those that will not be reclassified.

•

Entities may present items of other comprehensive income: net of related tax effects; or before the related tax effects, with one amount showing the aggregate tax effect for items that will not be reclassified to profit or loss in subsequent periods and one amount showing the aggregated tax effect for items that may be reclassified to profit or loss in subsequent periods.

• •

Certain information may only be presented on the face of the statement of profit or loss and other comprehensive income, e.g. line items for revenue, finance costs, tax expense, etc. Certain information may be presented on the face of the statement of profit or loss and other comprehensive income or in the notes, e.g. material item s. Items of income or expense may not be presented as extraordinary items. Reclassification adjustments should be disclosed separately, either on the face of the statement of profit or loss and other comprehensive income or in the notes. The tax effect relating to each item of other comprehensive income should be disclosed separately, either on the face or in the notes.

Statement of chanaes in eauitv Includes owner changes in equity, e.g. contributions and distributions. For each component, a reconciliation between the opening and closing balance is required.

Statement of cash flows - refer chapter 4 Notes Includes summary of significant accounting policies, supporting information for items presented in the financial statements, the judgements management has made in the process of applying the r~ccounting policies, sources of estimation uncertainty and certain capital disclosure.

Fair presentation and compliance with IFRS. Financial statements are prepared on the going concern assumption. Accrual basis of accounting (items are recognised when they satisfy the definitions and recognition criteria in The Conceptual Framework). Materiality and aggregation (each material class of similar items should be presented separately). Offsetting (only allowed if required or permitted by another IFRS). Frequency of reporting (at least annually). Comparative information (for amounts and certain narrative information). Consistency of presentation (classification only changed in limited cases).

3

Inventories lAS 2 (Effective date 1 January 2005) Circular 912006 (Effective date 1 May 2006) Circular 212017 (Effective date 1 June 2017)

3.1. Introduction 3.1.1 Definition Inventories are defined by lAS 2.6 as assets-

• held for sale in the ordinary course of business (i.e. finished goods and merchandise), • in the process of production for such sale (i.e. work-in-progress), or • in the fonn of materials or supplies to be consumed in the production process or in the rendering of services (i.e. raw materials and consumables). It should be noted that it is not necessary for an item to be intended for sale for it to be included in the definition of inventories. Consumables, for example, are not held for sale, but are still treated as part of inventories, as these consumables will be used to manufacture goods intended for resale. Similarly, stationery held by an accOllllting finn is not held for sale, but will be consumed in the rendering of accOllllting services, resulting in classification of the stationery as inventories. Not all assets held for resale will qualify as inventories. In order to qualify as inventories, the sale has to be in the ordinary course of business. If an entity normally trades in machinery and suddenly acquires land with the intention of reselling the land, the land does not qualify as inventory, as the land will not be sold in the ordinary course of business. On the other hand, if the land is acquired by a property developer, it will qualify as inventory. Spare parts expected to be used for one accounting period or less, are regarded as inventories, while major spare parts expected to be used for more than one period, are regarded as property, plant and equipment. If these spare parts are used to provide maintenance services to others, the period of usage by the other party is irrelevant, as the spare parts are consumed in the rendering of services, resulting in classification as inventories. There is no requirement that inventories should be tangible assets. As a result, intangible assets such as computer software developed for resale, as well as unbilled work of a service provider, will form part of inventories. The main focus ofIAS 2 is on the calculation of the cost of inventories, the recognition ofthis cost as an expense, as well as the recognition of other expenses associated with inventories, such as writedowns to net realisable value. Inventories for purposes of lAS 2 encompass both products and servIces.

3.1.2 Exclusions lAS 2 contains two sets of exclusions from its scope, the first being items that are excluded in full and the second being items that are excluded from only the measurement requirements of the standard. The items excluded in full are financial instruments and agricultural produce at the point of harvest and biological assets related to agricultural activity. Financial instruments are covered by lAS 32 and 45

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GAAP Handbook 2020: Volume 1

IFRS 9 (see chapter 18), and biological assets (living animals and plants) are covered by lAS 41 (see chapter 25). Agricultural produce (the harvested product of an entity's biological assets) is valued at the point of harvest in terms ofIAS 41 (see chapter 25). Immediately after harvesting, lAS 2 becomes applicable to the produce and the value determined at the point of harvest, in accordance with lAS 41, then becomes the cost of the haIVested produce for pmposes of lAS 2.

The items excluded from only the measurement requirements of lAS 2 relate to the mining, forestry and agricultural industry, provided that a well-established practice exists in those industries to measure goods at net realisable value at certain stages of production. This will normally happen only when the sale of the goods is assured by means of a forward contract or government guarantee, or if there is an active market for the goods and sale is virtually certain. Any changes in net realisable value should then immediately be recognised in profit or loss. Also excluded from the measurement requirements of lAS 2 are the inventories of commodity broker-traders who measure their inventory at fair value less costs to sell, with changes recognised in profit or loss. Broker-traders usually buy and sell commodities on behalf of others and their established practice is to follow a mark-to-market approach for these commodities. [It should be noted that although the items referred to in this paragraph are excluded from the measurement requirements of lAS 2, the disclosure and recognition requirements of the standard are still applicable.]

3.2 Recognition and derecognition Inventory on hand is recognised as an asset where • it is controlled by the entity, • as a result of a past event (acquisition or production thereof), • from which probable future benefits will flow, and • it has a cost which can be measured reliably. An entity should recognise inventories as an asset from the date when the risks and rewards of ownership of the inventories have been transferred to the entity. This will normally be the date on which the inventories are delivered. However, there are exceptions, for example when inventories are shipped free on board (FOB), in which case the risks and rewards are transferred to the buyer when the goods are loaded onto the ship, resulting in the buyer recognising the inventory on the FOB date. When inventories are derecognised, the carrying amount of the inventories are recognised as an expense (part of cost of sales). The derecognition of the inventories coincides with the recognition of the related revenue, which means that reference should be made to IFRS 15 for guidance on exactly when inventories should be derecognised. For example, the revenue from consignment sales is recognised only when the goods are sold to a third party - the consignment inventories should then also be derecognised only when they are sold to a third party.

3.3 Initial measurement of inventories The primary issue in accOllllting for inventories is the amount of cost to be recognised as an asset and carried forward until related revenues are recognised. Calculating the cost of inventories is often an extremely complicated exercise. As a general rule, inventories are initially recognised at cost, which is the aggregate cost of purchase, cost of conversion, and other costs incurred in bringing the inventory to its present location and condition. Subsequent measurement is at the lower of cost and net realisable value.

3.3.1 Purchase costs Purchase costs comprise the purchase price, including import duties and other non-recoverable purchase taxes, transport and handling costs, and any other costs directly attributable to the acquisition of raw materials, merchandise and consumables. Any trade discounts or cash discounts received should be deducted from the cost of inventories.

47

Inventories

Example 3.1: Cost of purchase X Ltd buys inventories for R171 000 (VAT inclusive) and pays cash in order to make use of a 5% cash discount offered by the supplier. The inventories are transferred to X Ltd's premises by train, and the total railage amounts to R500 (VAT exclusive). Costs incurred to insure the inventories while in transit, amounts to R900 (VAT exclusive). The cost of the inventories is calculated as follows: R

Purchase price VAT (171 000 x 14/114) Cash discount (171000 x 5% x 100/114) Railage Insurance

171 000 (21 000) (7500) 500 900 143900

3.3.1.1

Rebates

Rebates to be received from the supplier, which represent a reflllld of part of the purchase price, should be estimated at the date of purchase of the inventories and should be deducted from the cost of the inventories. If, however, the rebates represent a refimd of selling expenses incurred by the buyer of the inventories, the rebates should not affect the cost of the inventories.

Example 3.2: Rebates X Ltd sells shoes and these shoes are bought from B Ltd at R300 per pair B Ltd has agreed to grant X Ltd a rebate of 2% on all purchases if X Ltd buys at least 200 pairs during a period of twelve months. The rebate will be settled in cash at the end of the twelve month period. If, based on past experience, it is very likely that X Ltd will meet this target, each pair of shoes should be recognised at a cost of R294 (300 x 98%), with a receivable of R6 being recognised for the anticipated rebate. On the other hand, if it is not probable that the target will be reached, each pair of shoes should be recognised at a cost of R300. Should the receipt of the rebate then become probable at a subsequent date, the effect thereof should be recognised subsequently. Any portion of the rebate that relates to shoes already sold should then be recognised in cost of sales, while the remainder should be deducted from inventories.

3.3.1.2 Settlement discounts Any settlement diSCOllllt to be received for prompt settlement of the purchase price due should be estimated at the date of purchase of the inventories and should be deducted from the cost of the inventories.

Example 3.3: Settlement discounts X Ltd buys inventories with a cost of R100 000 from supplier A, who offers a 10% discount if the amount due is settled within 15 days. If X Ltd intends to settle the amount within 15 days, the cost of the inventories would amount to R90000 (debit inventories and credit supplier with R90000). However, if X Ltd intends not to settle within 15 days, the cost of the inventories would amount to R100 000 (debit inventories and credit supplier with R100 000).

3.3.1.3 Deferred settlement terms If an entity purchases inventories on deferred settlement terms, the entity should assess whether, at inception, the transaction contains a financing element. If a financing element is included in the transaction, an assessment should be done to determine whether the financing element is material to the transaction. If the financing element is material to the transaction, it should be accollllted for as a separate element. The following non-exhaustive list of factors should be considered in assessing whether the transaction includes a financing element, or if the deferral exists for other reasons: • Differential pricing between the cash payment price and the price paid on deferred settlement terms;

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GAAP Handbook 2020: Volume 1

Settlement terms deferred beyond industry norms and practice;

• The date from which an entity is entitled to levy interest on overdue payments; • The existence of a transaction initiation process and credit assessment process;

• Any collateral required for the transaction or payment; • A substantial amollllt of the transaction price is variable, the variability is outside the control of both parties, and the parties have decided to delay payment lllltil a substantial amollllt of the variability is removed; • The business pmpose for the different timing between delivery of the goods and the payment; or • Volume of credit purchases in relation to cash purchases

If, after applying judgement when considering the above and other factors, it is determined that a financing element exists, an assessment should be performed to determine if this is material to the transaction. This is done by discOllllting the future cash flows back to a present value. Any difference between the present value and the amount actually paid is the financing element. Should the amount of the financing element be material to the transaction, it is accounted for as interest over the period of financing. It should be noted that this treatment is to be followed even if the selling price has not been inflated to compensate the seller for the effect of the extended payment period.

Example 3.4: Deferred settlementterms X Ltd buys inventories, with a cost of R250 000, from B Ltd. Due to cash flow problems experienced by X Ltd, it is agreed that the amount due will be settled after nine months, even though the normal credit period granted by B Ltd is only three months. A fair discount rate is 12% per annum, compounded monthly. The fact that the settlement is deferred beyond the normal credit period, indicates that the transaction includes a financing element. The financing element will probably be material to the transaction as the period is extended for nine months. The cost of the inventories should be the present value of R250 000, discounted over a period of nine months, at a rate of 1% per month. This will amount to R228 585 (FV = 250000; i = 12/12; n = 9). A separate financing element of R21 415 (R250 000 - R228 585) should be recognised over the nine month deferred settlement period. An alternative view is that the discounting should be done for a period of six months only, as the normal credit period is extended by six months. The authors are of the opinion that this is not in line with IFRS 9, which requires payables to be discounted whenever the effect of discounting is material. Circular 2/2017 also requires the financing element to be recognised separately only when it is material to the transaction. In the above example, if the credit period is three months, discounting is not required as the effect would probably be immaterial. No separate financing element would therefore be recognised. However, as soon as the period is extended to nine months, the effect of discounting becomes material, with the result that the payable has to be recognised at fair value and the resulting financing element recognised separately. The fair value of the payable is calculated by discounting future cash flows back to transaction date (i.e. for nine months). If the payable is discounted for a nine month period, the inventories have to be recognised at the same amount.

3.3.2 Conversion costs Conversion costs are the manufacturing or processing costs (including normal spillages) that relate to the conversion of raw materials into finished goods. The cost of conversion includes direct costs (costs directly related to the units of production), for example direct labour - note that these labour costs will include pension costs and other fringe benefits relating to factory workers. Conversion costs also include an allocation of indirect costs, being indirect fixed production overheads and indirect variable production overheads. It should be noted that lAS 2 makes the inclusion of fixed production overheads in the cost of inventories mandatory. It is sometimes argued that the omission of fixed production overheads from the cost of inventories is prudent. The counter argument is that prudence should be applied through the net realisable value test and not through the somewhat arbitrary omission of relevant costs.

Indirect variable production overheads are the indirect costs of production that vary directly, or nearly directly, with the volume of production, for example indirect materials, water consumption

49

Inventories

during production, and electricity used by the production machines. The allocation of indirect variable production overheads is relatively straightforward; variable overheads are allocated to each unit of production on the basis of the actual use of the production resources. Indirect fixed production overheads are the indirect costs of production such as factory rental, salaries of factory supervisors, insurance of plant, depreciation of factory buildings and equipment, and depreciation on right-of-use assets used in the production process. These costs remain relatively constant within the relevant range, regardless of the volume of production. The allocation of indirect fixed production overheads to the cost of inventories is usually based on the normal capacity of the production facility, which is the average production expected to be achieved over a number of periods under normal circumstances, taking into account capacity losses due to planned maintenance. The actual production level may be used only if it approximates normal capacity. If there is a substantial difference between normal capacity and actual capacity which continues for an extended period, the entity should consider revising its normal capacity. The allocation of conversion costs can be illustrated as follows: Conversion costs

Direct converSIOn costs

Direct labour

Allocated based on actual use

Indirect converSIOn costs

Fixed production overheads

Variable production overheads

Allocated based

Allocated based

on normal capacity

on actual use

When normal capacity is used for the allocation of fixed production overheads, the fixed costs allocated per unit should not be increased in periods of low production - any llllallocated fixed costs should merely be charged directly to cost of sales. In periods of abnormally high production, the amollllt of fixed costs per unit should, however, be decreased to ensure that inventories are not valued above cost. The amollllt allocated to the inventory is thus limited to the actual expenditure incurred.

Example 3.5: Allocation offixed production overheads Assume that fixed production overheads amount to R 100 000 and normal capacity equals 10 000 units. The actual production during the year amounted to only 7 000 units. The allocation of the overheads should be based on the normal capacity of 10 000 units, resulting in a cost of R10 per unit As the actual production was less than expected, only R70 000 (7 000 x 10) of the overheads will thus be allocated to the cost of the inventories. The remaining R30 000 should be recognised in profit or loss as part of cost of sales. If actual production is however 15000 units (abnormally high), the fixed cost per unit must be reduced to R6,67 (100 000 I 15 000) to ensure that only R100 000 is allocated to the cost of inventories.

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GMP Handbaak 2020: Va/ume 1

Joint products

A single production process may result in more than one product being manufactured simultaneously. The products manufactured are then referred to as joint products. When joint products are manufactured and the costs of conversion of each product cannot be separately identified, conversion costs should be allocated to each product on a rational and consistent basis. The allocation is often based on relative sales value, either at the point of separation or at completion.

Example 3.6: Joint products X Ltd manufactures diet supplements, including Omega 3 and Omega 6 capsules. The basic ingredient for both of these capsules is marine oil, which costs R36 per litre. A machine is used to extract the Omega 3 and Omega 6 from the marine oil. The depreciation on the machine amounts to R1 000 per day, while the machine operator is paid R200 per day. The machine can process 10 litres of marine oil in one day. One litre of marine oil is used to produce ten Omega 3 capsules and eight Omega 6 capsules. The selling price per capsule amounts to R8 for Omega 3 and R12 for Omega 6. One litre of marine oil produces ten Omega 3 capsules and eight Omega 6 capsules. The relative sales value of these Omega 3 capsules is RSO (10 x RS), and that of the Omega 6 capsules, R96 (S x R 12). The total costs of converting one litre of marine oil amount to R 156 (R36 + R 1 000 I 10 litres + R200 110 litres). For every one litre of marine oil used, R71 [156 x SO 1 (SO + 96)[ will be allocated to the Omega 3 capsules (R7,09 per capsule), and RS5 [156 x 961 (SO + 96)[ to the Omega 6 capsules (R 10,63 per capsule).

3.3.2.2 By-products A production process may also result in by-products being generated. By-products are products that emerge incidentally from the production process and have minor sales value. By-products are generally immaterial, and as a result, they are often measured at net realisable value. This value is then deducted from the cost of the main product and, due to the fact that this value is immaterial, the carrying amollllt of the main product will still be close to its cost.

Example 3.7: By-products X Ltd is a supplier of canned meats. Ten kilograms of raw meat is required to produce 20 cans of processed meat. The raw meat costs R20 per kilogram, while the conversion costs amount to R10 per kilogram. During the canning process all visible fat is removed from the raw meat, after which it is sold to a dog food manufacturer, at a price of R5 per kilogram. Ten kilograms of raw meat usually have only 0,5 kilograms of fat The processed meat will be valued at R 14,88 per can. This is calculated as follows: R 200,00 Cost of 10 kg of meat (R20 x 10kg) Costs to process 10 kg of meat (R 10 x 10kg) 100,00 Net realisable value of fat (0,50kg x R5) (2,50) 297,50 Cost per can (297,50/20) Any unsold fat will be valued at R5 per kilogram.

R14,SS

3.3.3 Other costs Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. This may include the following: • the costs to design a product for a specific customer; • the amortisation of development costs relating to a specific product; • restoration/rehabilitation costs incurred as a result of the manufacturing of inventories during a specific period; • packaging costs incurred to prepare inventory for sale; and • borrowing costs incurred on inventory that is a qualifying asset.

Inventories

51

3.3.4 Costs excluded The following costs should be excluded from the cost of inventories: • abnormal amOllllts of waste incurred in the production process (for example spillages of raw materials, labour costs during strikes and abnormal machine breakdowns); • impairment losses on machinery and equipment used in the manufacturing process; • costs to distribute and transport goods to customers; and • selling expenses, advertisement costs, general administrative overheads and storage costs. [However, should storage costs relate directly to the production process (e.g. storage costs incurred while wine is maturing), they would form part of the cost of the inventories.]

Example 3.8: Costs excluded X Ltd employs 10 factory workers at a rate of R15 per hour. These employees were on strike for one entire month, during which production ceased completely. After negotiations with the trade union, X Ltd agreed to pay these workers a total amount of R15 000 for the month during which they were on strike. The total wage bill in respect of these employees amounted to R280 000 for the year. Labour costs incurred during the month of the strike action may not be capitalised to the cost of inventory. Consequently the R15 000 paid to the workers for the month during which they were on strike should be expensed in profit or loss (as part of cost of sales). The remaining R265 000 should be capitalised to the cost of inventories.

3.4 Subsequent measurement of inventory 3.4.1 Net realisable value Inventories should be measured at the lower of cost and net realisable value. The recognition of an asset is dependent on future economic benefits being probable. It follows that those future economic benefits should amount to at least the recorded value of the asset, otherwise the asset is not capable of recovery through future revenue. If the future net revenue expected to be generated by the sale of inventories on hand is less than the cost of those inventories then the inventories should be written down. The measurement of expected future revenue should take into account the costs of selling the inventory, for example marketing costs, distribution costs, packaging costs and sales commission. The cost of inventories may not be recoverable if the inventories are damaged, obsolete, if selling prices have declined, if the estimated costs to be incurred in making the sale have increased or if the estimated costs of completion of manufactured goods have increased. In these circumstances, inventory is written down to "net realisable value". Net realisable value is defined as the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

In principle, no item in inventories should be carried at an amount in excess of the net amount that it is expected to realise and no future period should be burdened with a loss on realisation of an oveIValued item currently held. All costs to realise the sale of such item should therefore be estimated and deducted from the estimated selling price in order to arrive at the net realisable value of the item. This can be illustrated as follows:

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GAAP Handbook 2020: Volume 1

•

T-----

-w---

o

95 N

110 S

100 C

WhereS C T N

W

Estimated selling price (RIIO) Cost (RIOO) Total estimated costs to realise item (e.g. selling expenses R7 + packing R3 + delivery RS Net realisable value (S - T ~ RllO - RIS ~ R9S) Write-down amount (C - N ~ RIOO - R9S ~ RS)

~

RIS)

Ideally inventories should be written down to net realisable value on an item by item basis, but, in limited cases, it may be appropriate to group similar items together. Grouping of items may be required where these items relate to the same product line, have similar purposes, are produced and marketed in the same geographical area, and cannot be practicably evaluated separately from other items in that product line. It is not acceptable, however, to write inventories down on the basis of an entire classification, for example, finished goods.

Example 3.9: Net realisable value X Ltd sells appliances and furniture. The following information relates to appliances on hand at yearend: Net realisable Cost value R R Fridge 5500 5000 Stove 4000 4800 Microwave 1200 800

10700

10600

Taking into account the above information, the first impression might be that the inventories (appliances) of X Ltd should be written down from Rl0 700 to Rl0 600. However, the items on hand should rather be assessed individually, which means that only the fridge and microwave should be written down to net realisable value. The carrying amount of the appliances inventories at year-end will thus amount to R9 800 (5 000 + 4 000 + 800).

The estimates of net realisable value are based on the most reliable evidence available and take into accOllllt fluctuations in price after year-end, provided that such events confirm conditions that existed at year-end (i.e. adjusting events after the reporting period). For example, if a competitor introduces a product after year-end which results in a reduction in the selling price of the reporting entity's inventories, the net realisable value of the inventories as at year-end is not affected, as the competitor's product was introduced only after year-end. Estimates of net realisable value should take into account the purpose for which inventories are held. For example, if an entity sells spare parts and also uses spare parts to service the vehicles of customers, the net realisable value of similar spare parts may differ depending on their expected use. The net realisable value of inventories held to satisfY firm sales or service contracts is based on the contract price. If the inventories on hand exceed the quantities required in terms of the contract, then the net realisable value of the excess should be based on general selling prices.

Inventories

53

Example 3.10: Firm sales contract Inventories with a cost of R200 per unit will be sold at a price of R180 per unit in terms of an existing contract. Similar products are selling at R210 per unit in the open market. The contract requires delivery of 10 000 units. At year-end, the company had 10 100 units on hand. The 10000 units to which the contract relates, have a net realisable value of R180 per unit, and should thus be written down from R2 000 000 (200 x 10000) to R1 800000 (180 x 10000). In respect of the remaining 100 units, the cost of R200 per unit is less than the net realisable value of R210 per unit, and therefore these units should remain at their total cost of R20 000 (100 x 200). If the company has only 9 000 units on hand (instead of 10 100), then these units should be written down from R1 800000 (200 x 9000) to R1 620000 (180 x 9 000). If the remaining 1 000 units to be delivered in terms of the contract will be acquired at a price exceeding R180 per unit, an onerous contract arises, as the costs of meeting the obligation in terms of the contract exceed the economic benefits, thus necessitating the creation of a provision (refer to chapter 22). For example, if these units can be bought from a supplier at R190 per unit, the provision will amount to R10 000 [(190 - 180) x 1 000[.

Net realisable value is defined as the estimated selling price less the costs of completion and the costs necessary to make the sale. This implies that the net realisable value of incomplete goods (such as raw materials and work in progress) should be determined by subtracting the costs to sell as well as any outstanding conversion costs from the expected selling price of the completed product. The net realisable value of raw materials is thus calculated by subtracting their expected conversion costs from the net realisable value of the finished goods into which the raw materials will be converted. As a result, raw materials to be converted into finished goods are written down only where it is estimated that the cost of the finished product will exceed its net realisable value.

Example 3.11: Net realisable value of raw materials Raw materials with a cost of R1 000 will be converted into a finished product with a net realisable value of R 1 800. The conversion costs that will be incurred to convert the raw materials into finished goods amount to R500 and the cost of the finished product will thus amount to R1 500 (R 1 000 raw materials + R500 conversion cost). As it is expected that the net realisable value of the finished product (R 1 800) will exceed its cost (R1 500), there is no need to write the raw materials down. This can be confirmed by calculating the net realisable value of the raw materials, i.e. R 1 800 - R500 = R 1 300, which exceeds the cost of R 1 000. However, if the net realisable value of the finished product is expected to be only R1 400, the net realisable value of the raw materials will amount to R900 (R1 400 - R500), thereby necessitating a write-down of R 100 (R 1 000 - R900) on the raw materials.

If an entity has excess raw materials on hand that it will not be able to use in production, the net realisable value of these raw materials should be based on their selling price instead of the selling price of the finished goods less conversion costs. The selling price of finished goods on hand may be sensitive to the cost of the related raw materials. As a result, a decrease in raw material prices may lead to a decrease in the selling price of existing finished goods. For example, if there is a reduction in the gold price (raw materials), the price of all jewellery (finished products) may also decrease instantaneously, even though this jewellery was manufactured before the reduction in the gold price. A significant decrease in the price of raw materials could thus indicate that the net realisable value of existing finished goods is lower than their cost (as the cost of these finished goods still includes the higher raw material cost). The new selling price of the finished goods should then be used to calculate their net realisable value and should also seIVe as basis for calculating the net realisable value of any raw materials on hand. This may result in the write-down of the finished goods on hand, as well as raw materials on hand. Ifit is not possible to determine the net realisable value of the raw materials due to difficulties in establishing the selling price of the finished goods, then the net realisable value of the raw materials should be based on their replacement cost.

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3.4.2 Reversal of write-downs A new assessment of net realisable value is made in each accOllllting period. In terms of lAS 2, writedowns to net realisable value may be reversed if there is a change in economic conditions, or if the circumstances, which previously caused the inventory to be written down below cost, no longer exist. The new carrying amollllt should be the lower of the cost and the revised net realisable value (the reversal is thus limited to the amount of the original write-down). Such a reversal is aCcOllllted for as a reduction in cost of sales.

Example 3.12: Reversal of write-down An inventory item with a cost of R500 was written down to its net realisable value of R450 at the end of 20X 1. This item is still on hand at the end of 20X2, at which stage the net realisable value increased to R510. At the end of 20X2, the item will be carried at the cost of R500, as this is lower than the net realisable value of R510. The reversal of the write-down will amount to R50 (500 - 450).

3.5 Cost formulas 3.5.1 Specific identification The specific identification formula attributes specific costs to identified items of inventory and is the most accurate method of costing, since the cost of each item is based on the actual costs that have been incurred in its purchase or production. lAS 2.23 states that the specific identification formula is an appropriate treatment for goods that are not ordinarily interchangeable and goods produced and segregated for a specific project, for example custom-built furnishings and works of art. It is only in these circumstances that the specific identification formula is practicable as, where there is a high volume of production, it may be impossible to determine the individual costs to be attributed to each unit of production. Furthermore, if the items are interchangeable, it may be impossible to differentiate between two or more items, thereby creating the opportunity to manipulate profits by selecting whether the items on hand at year-end are the ones with the higher or lower cost.

3.5.2 First-in-first-out (FIFO) First-in-first-out is one of two formulas that are used for the purpose of assigning costs to items of inventory that are ordinarily interchangeable. The llllderlying assumption of FIFO is that the goods that are produced or purchased first are sold first. Under this method, items remaining in inventory at the end of the period are those items that have been produced or purchased at the most recent level(s) of cost. Under FIFO, the statement of financial position reflects inventories at fairly recent costs, while the statement of profit or loss and other comprehensive income provides a close approximation to the actual costs incurred in the production or purchase of each llllit of sales. In periods of high inflation there may, however, be a mismatch in the statement of profit or loss and other comprehensive income between recent revenue figures and less recent cost of sales figures, resulting in abnormally high profits.

Example 3.13: FIFO On 1 January 20X1 A Ltd buys 1 000 units of product X at R10 per unit At 1 September 20X1 the company buys another 500 units of product X at R 12 per unit At 31 December (year-end) 600 units of product X were on hand. Under the FIFO method the units on hand will be valued at R7 000 [(500 x 12) + (100 x 10)[, as it is assumed that the items on hand were purchased last.

3.5.3 Weighted average This is the second formula used for assigning costs to items that are ordinarily interchangeable. Under the weighted average cost formula, the cost of each item is determined from the weighted

55

Inventories

average of the cost of similar items at the start of the period and the cost of similar items purchased or produced during the period. The total costs of purchase over a period are, therefore, divided equally between all the goods purchased during that period. The average is calculated either on a periodic basis (e.g. annually or monthly) or as each additional shipment of inventories is received, depending upon the circumstances of the entity and the sophistication of its accOllllting system. The weighted average formula is unlikely to reflect the actual costs incurred in the production or purchase of each actual unit of sales. However, in times of moderate inflation, the difference is not material and this method is fairly widely used.

Example 3.14: Weighted average On 1 January 20X1 A Ltd buys 1 000 units of product X at R10 per unit At 1 September 20X1 the company buys another 500 units of product X at R 12 per unit At 31 December (year-end) 600 units of product X were on hand. The average cost per unit is R10,67 {[(1 000 x 10) + (500 x 12)1/1 500). Therefore the units on hand will be valued at R6 400 (10,67 x 600).

3.5.3.1

Weighted average - periodic basis

This weighted average formula assumes that the closing inventories are valued at the average cost of all purchases during the period. For example, if total units purchased during the year amount to 30000 at a cost ofR246 000, the average cost is R8,20 (R246 000 130 000).

3.5.3.2 Weighted average - moving basis Under this method the average cost is calculated each time a new shipment of the particular item is received. Because of the large number of ongoing computations involved, the moving weighted average method would normally only be found in computerised systems.

3.5.4 Consistency - different cost formulas lAS 2 allows the FIFO or weighted average cost formula for inventories that are ordinarily interchangeable or that are not produced and segregated for specific projects. The same cost formula should be used for all inventories having a similar nature and use to the entity. For inventories with a different nature or use, different cost formulas may be justified. A difference in geographical location of inventories (and the respective tax rules), by itself, is not sufficient to justify the use of different cost formulas.

Example 3.15:

Consistency of costformulas

A Ltd has two divisions. The first division sells motor vehicle spare parts, while the second division leases motor vehicles to customers. The latter division has to keep spare parts in stock to perform repair and maintenance work on its vehicles. Both divisions have spare parts in stock, but the use of these spare parts differ, as one division regards it as consumables, while the other regards it as merchandise. Consequently, the first division may use, for example, FIFO to value its inventories, while the other division may use the weighted average method.

3.6 Techniques for the measurement of cost lAS 2 discusses two techniques that may be used to value inventories, provided that the results of these techniques approximate cost. These techniques are the standard cost method and the retail method. It should be noted that when these techniques are used, inventories are still valued by using either specific identification, the FIFO method or the weighted average method. For example, the standard cost method will be used to calculate the cost per unit, which will then be used in the FIFO or weighted average calculation.

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3.6.1 Standard cost The standard cost method involves valuing inventories by some fonn of cost standard which is normally set prior to production, by reference to product specifications, expected costs, operating volumes and efficiencies. Under the standard cost method, inventories are valued based on the standard cost established by management's estimates of the expected costs, level of operations and operational efficiency. Standards are often altered as experience of actual production grows. The alteration of a standard does not necessarily imply that the original standard was incorrect; rather it may reflect the improved experience and expertise of the production staff that led to reductions in cost. On the other hand, rising costs will necessitate the regular upward adjustment of standard costs in order for the latter to constantly reflect a credible correlation to actual costs. Differences between the standard cost of an item and its actual cost are known as variances and give rise to useful management control techniques. The use of standard costing for valuing inventories is acceptable if the standards approximate consistently the results that would be obtained if inventories were valued at historical cost. Care should be taken therefore to review standard costs frequently to ensure that they bear a reasonable relationship to actual costs.

3.6.2 Retail method lAS 2 allows the use of the retail method for valuing merchandise. Under this method, the average profit margin is deducted from the selling price of inventories to arrive at a reasonable estimate of cost. This method may be used if it approximates actual historical cost. The method is often employed by organisations with fixed margins (usually retailers, hence the name retail method) where it may be the only practical method to adopt. Care should be taken when calculating the cost of inventories which have been marked down to below their original selling price. If the average profit margin is deducted from this reduced selling price, the calculated amollllt will be below both the historical cost and the net realisable value. The profit margin should rather be deducted from the original selling price, or alternatively the profit margin should be reduced to make provision for items that have been marked down.

Example 3.16: Retail method X Ltd uses the retail method to value its merchandise. The total selling price of all inventories at yearend amounts to R120 000. X Ltd uses an average profit margin of 20% on cost. The inventories should be valued at R 100 000 at year-end (120 000 x 100 1120).

3.7 Financial statement presentation 3.7.1 lAS 2 requirements The disclosure requirements of lAS 2 for the statement of financial position, statement of profit or loss and other comprehensive income and notes are listed below. Statement of financial position

• Total carrying amollllt of inventories. Statement of profit or loss and other comprehensive income

• Amollllt of inventories recognised as an expense during the period, i.e. cost of sales (this will include the cost of inventory sold, llllallocated production overheads, abnormal wastage, writedowns of inventories, as well as reversals of write-downs). Notes

• Accollllting policies adopted in measuring inventories, including the cost formula used. • The carrying amount in classifications appropriate to the entity. • The carrying amollllt of inventories carned at fair value less costs to sell (in respect of commodity broker-traders).

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Inventories

• The carrying amount of inventories pledged as security for liabilities. • The amollllt of any reversal of a previous write-down recognised as a reduction in the amount of cost of sales. • The circumstances or events that led to the reversal of a previous write-down of inventories. • The amollllt of any write-down of inventories recognised as an expense.

3.7.2 Disclosure example Statement of financial position Current assets Inventories

Note

R'OOO

7

2649

Statement of profit or loss and other comprehensive income

R'OOO

XXX

Revenue Cost of sales

(14257)

G ross profit

XXX

Notes 1. Accounting policies 1.3

Inventories Inventories are stated at the lower of cost and net realisable value. Cost of manufactured goods comprises direct materials, direct costs of conversion and a proportion of manufacturing overheads, based on normal operating capacity. Cost is determined on a firstin-first-out basis. Any write-down to net realisable value is recognised in profit or loss. R'OOO

2. Profit before tax Included in profit before tax is the following: Write-down of consumable stores to net realisable value Reversal of write-down of raw materials to net realisable value (the reversal occurred as a result of an increase in the selling price of the related finished goods)

(7) 3 R'OOO

7. Inventories Raw materials Work-in-progress Finished goods Merchandise Consumable stores

715 860 1 000

50 24 2649

Inventories with a carrying amount of R300 000 have been pledged as security for the short-term borrowings.

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3.8 Summary of lAS 2, Inventories Definition

Assets heJ for sale (Finished goods, merchandise)

L

Assets in production process for sale (WIP)

Malerials or supplies be consumed (Raw materials, consumables)

I

I

In production process

I In

rend~ring

sel"\llces

of

Reco!=mition

• •

Probable that future economic benefits will flow to the entity Cost can be measured reliably

Measurement

• • •

Lower of cost and net realisable value (N RV) Write-down required if cost> NRV

•

Cost of purchase - Include purchase price, import duties, transport costs, etc

•

Selling price less (costs to complete + costs to sell)

-

• • •

Entity specific

Reversal of write-down if NRV increases: Limited to amount of original write-down

NRV

Cost

•

-

•

Indirect variable overheads (e.g. water, electricity - allocate based on actual use) Indirect fixed overheads (e.g. rental, insurance - allocate based on • normal capacity)

•

Other costs

-

• •

Deduct all discounts and rebates that will be received

Cost of conversion - Direct conversion costs (e.g. labour- allocate based on actual use)

Only if incurred to bring to present location and condition E.g. costs to design product for specific customer

Exclude abnormal spillages, selling expenses, admin overheads, etc More than one product being manufactured

-

Allocate between joint products based on relative sales value Measure by-products at NRV and deduct from cost of main product Cost techniques

• •

Standard cost Retail method

Cost formulas

• • •

Specific identification FIFO Weighted average Derecognition

• •

Derecognise when sold (coincides with recognition of revenue) Recognise cost of inventories in cost of sales together with

-

Unallocated production overheads Abnormal spillages Write-downs and reversals of write-downs

Evaluate item by item Consider events after the reporting period (adjusting events) Consider purpose for which held, e.g. firm sales contract NRV of raw materials linked to NRV of finished goods

4

Statement of cash flows lAS 7 (Effective date 1 July 1996)

4.1

Introduction

The main objective of financial reporting is to provide information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. Users of an entity's financial statements are, inter alia, interested in the ability of the entity to generate cash and cash equivalents and are also interested in the needs of the entity to utilise those cash flows. Accordingly, a statement of cash flows should be presented as an integral part of an entity's financial statements. Cash flow information, when used in conjllllction with the rest of the financial statements, provides information that enables users to evaluate the changes in net assets of an entity, its financial structure and its ability to respond to changing circumstances and opportunities. A statement of cash flows is useful in assessing the ability of an entity to generate cash and enables users to develop models for assessment and comparison of the forecast future cash flows of different entities. In addition, comparability of operating performance by different entities is enhanced because cash flow information eliminates the effects of using different accOllllting treatments for the same transactions and events. For example, two similar companies may use different accounting methods to depreciate property, plant and equipment. These companies would report different earnings figures but their choice of depreciation methods has no effect on their cash flows. Although a statement of cash flows prepared in accordance with lAS 7 presents historical cash flows, such information is useful as an indicator of the amount, timing and certainty of future cash flows. It is also useful in checking the accuracy of past assessments of future cash flows and in examining the relationship between profitability and net cash flow as well as the impact of changing prices. Moreover, a statement of cash flows highlights the liquidity and working capital management of an entity. This enables users to be better informed about management performance during the accounting period. Cash flows should be presented for the accounting period under review as well as for the preceding accounting period.

4.2

Elements of a statement of cash flows

A statement of cash flows should report cash flows classified by operating, investing and financing activities. The basic lAS 7 format is as follows: Cash flows from operating activities

+1Cash flows from investing activities

+1Cash flows from financing activities Net movement in cash and cash equivalents

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These elements will now be addressed in more detail.

4.2.1

Cash and cash equivalents

The statement of cash flows reports movements in cash and cash equivalents. Cash comprises cash on hand and demand deposits. Note that demand deposits have the same level of liquidity as cash, as these deposits may be withdrawn at any time. Examples of cash include petty cash, current aCcOllllts and call aCcOllllts. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amOllllts of cash and which are subject to an insignificant risk of changes in value. These investments are primarily held for the purpose of meeting short-term cash commitments and should therefore have a short maturity (three months or less). Cash equivalents will include, for example, a 32-day notice deposit, as this investment can, at any given point, be converted into cash within 32 days. Note that investments with a maturity period of more than three months, for example a six-month fixed deposit do not qualify as a cash equivalent, even when their remaining maturity period falls below three months. An investment in ordinary shares, although easily convertible into cash, will not qualify as a cash equivalent, as the risk of a change in value is too high. However, an investment in redeemable preference shares which is acquired three months from the redemption date qualifies as a cash equivalent, as the amollllt receivable is fixed and will be received within a relatively short period.

Bank overdrafts that are repayable on demand are included as a component of cash and cash equivalents. A characteristic of such an overdraft facility is that it normally fluctuates between a positive and negative balance on an ongoing basis. However, where an overdraft facility constantly reflects an overdrawn balance, it is managed as an ongoing element of the entity's overall borrowings and would generally be classified as a financing activity. Note that, although a bank overdraft may be netted against cash and cash equivalents for purposes of the statement of cash flows, this may not be done in the statement of financial position, unless the offsetting criteria are met. Cash flows are inflows and outflows of cash and movement between two components of cash and cash purposes of a statement of cash flows. For example, accollllt and deposits it in a 32-day notice deposit, statement of cash flows.

4.2.2

cash equivalents. It should be noted that a equivalents does not constitute cash flow for if an entity withdraws cash from its current this movement will not be reflected in the

Operating activities

Operating activities are the principal revenue-producing activities of the entity and other activities that are not investing or financing activities. This means that, if a cash flow does not meet the definition of investing or financing activities, the default classification would be operating activities.

Cash flows from operating activities are disclosed separately to indicate the extent to which the entity's operations generate sufficient cash flows to pay dividends, to repay loans, to maintain the operating capability of the entity and to make new investments. Examples of cash flows from operating activities include the following: • Cash receipts from the sale of goods and the rendering of services. • Cash receipts from royalties, fees, commissions and other revenue. • Cash payments to suppliers for goods and services. • Cash payments to and on behalf of employees. • Cash flows from the acquisition and disposal of financial assets that are held for trading. (It should be noted that cash flows relating to these financial assets are dealt with in the statement of cash flows in a manner similar to cash flows from the purchase and sale of normal inventories.) • Cash payments or refunds of income taxes, unless these cash flows can be specifically identified with financing and investing activities (refer section 4.3.1.4). • Interest and dividends received, if not regarded as part of investing activities (refer section 4.3.1.4).

Statement of cashjlows

61

• Interest and dividends paid, if not regarded as part of financing activities (refer section 4.3.1.4).

4.2.3

Investing activities

Investing activities comprise the acquisition and disposal of long-term assets, as well as the acquisition and disposal of those investments that do not form part of cash equivalents. (Note that financial assets held for trading form part of operating activities, as discussed in 4.2.2.) Only transactions that resulted in the recognition of an asset in the statement of financial position may be classified as investing activities.

Cash flows from investing activities are separately disclosed because it is important to show the extent to which cash expenditures have been made for resources intended to generate future income and cash flows. Examples of investing activity cash flows include the following: • Cash payments to acquire property, plant and equipment, intangible assets and other non-current assets. • Cash receipts from the disposal of property, plant and equipment, intangible assets and other noncurrent assets. • Capitalised development costs. • Cash payments of tax if specifically identified with investing activities (refer section 4.3.1.4). • Cash payments to acquire equity or debt instruments of other entities, including interests in joint ventures, associates and subsidiaries (unless regarded as cash equivalents or classified as held for trading). • Cash receipts from the disposal of equity or debt instruments of other entities, including interests in joint ventures, associates and subsidiaries (unless regarded as cash equivalents or classified as held for trading). • Cash advances and loans made to other parties. • Cash receipts from the repayment of advances and loans made to other parties. • Interest and dividends received, if not regarded as part of operating activities (refer section 4.3.1.4). Note: If the disposal of any of the above items gives rise to a gain or loss, the gain or loss will not form part of operating activities, as the total disposal proceeds will be reported as an investing activity.

4.2.4

Financing activities

Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity. The separate disclosure of cash flows arising from financing activities is important because of its usefulness in predicting claims on future cash flows by providers of capital. Cash flows arising from financing activities include the following:

• Cash proceeds from issuing shares or other equity instruments. • Cash payments to redeem shares. • Cash proceeds from issuing debentures, loans, notes or bonds and incuning mortgages and other borrowings. • Cash repayments of amounts borrowed, including the capital portion of lease instalments. • Cash flows from bank overdraft facilities not repayable on demand. • Cash payments of tax if specifically identified with financing activities (refer section 4.3.1.4). • Interest and dividends paid, if not regarded as part of operating activities (refer section 4.3.1.4).

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4.3 4.3.1

GMP Handbaak 2020: Va/ume 1

Calculating and presenting cash flows Cash flows from operating activities

An entity may report cash flows from operating activities on either• the direct method (favoured by lAS 7); or • the indirect method.

4.3.1.1

Indirect method

In terms of the indirect method, the profit or loss before taxation is adjusted for the effects of• non-cash items (e.g. depreciation, impairment losses, fair value adjustments, provisions, unrealised foreign exchange gains/losses and lllldistributed profits of associates), • deferrals or accruals of past or future operating cash receipts or payments (e.g. increase or decrease in trade debtors, trade creditors, inventories, amounts received in advance, amOllllts receivable, prepayments and accruals), • items of income and expense associated with investing and financing cash flows (being separate categories) (e.g. a profit on the sale ofland, which forms part of the disposal proceeds disclosed llllder investing activities, or a realised exchange loss on the repayment of a loan, which forms part of financing activities), and • items disclosed separately (e.g. interest received or paid and dividends received) that are included in the profit before tax figure to establish cash generated from operations, after which the following separately disclosed items will appear in order to ani.ve at net cash inflow from operating activities: • Interest received, • interest paid, • dividends received, • dividends paid, and • tax paid. The cash flows from operating activities, reported on the indirect method, is illustrated in the following example:

Example 4.1:

Operating activities - indirect method

The trial balance of X Ltd at 31 December 20X1 is as follows:

Sales Other income** Mark-to-market reserve Share capital Long-term loans# Short-term loans Trade creditors Retained earnings Cost of sales Other expenses* Taxation paid (including capital gains tax of R10 000) Dividends paid Trade debtors Allowance account for expected credit losses Inventories Property, plant and equipment - net carrying amount Financial assets at fair value through other comprehensive income

20X1 R'OOO Dr/(Cr) (31 000) (433) (350) (20250) (4890) (98) (2679) (11 860) 20744 9000 492 384 4687 (450) 1 891 33185 1 527

20XO R'OOO Dr/(Cr) XXX XXX (300) (20000) (5000) (2500) XXX XXX XXX XXX XXX 4000 (200) 1 500 33300 1 000

63

Statement of cashjlows 20X1 R'OOO 100

Bank *other expenses include the following: Depreciation Credit losses written off (without using an allowance account) Increase in allowance for expected credit losses I nterest paid

556 450 250 500

**other income includes the following: Credit losses recovered (bad debts recovered) I nterest received Dividends received Profit on sale of land - the proceeds amounted to R 170 000

48 120 225 40

20XO R'OOO 60

#Repayments on long-term loans amounted to R310 000 during 20X 1. The cash flows from operating activities, reported on the indirect method, will be presented as follows: R'OOO Profit before taxation (31 000 + 433 - 20 744 - 9 000) 1689 Adjustments for: Depreciation [non-cash] 556 Credit losses written off (without using an allowance account) [non-cash] 450 Increase in allowance for expected credit losses [non-cash] 250 Profit on disposal of land [investing activity] (40) Dividends received [disclosed separately] (225) (120) Interest received [disclosed separately] Interest paid [disclosed separately[ 500 Operating profit before working capital changes Working capital changes: Increase in inventories (1891 - 1 500) Increase in debtors (4 687 - 4 000 + 450') Increase in creditors (2 679 - 2500) Cash generated by operations Interest received Interest paid Dividends received Dividends paid Normal tax paid (492 - 10 CGT#) Net cash inflow from operating activities

3060 (1 349) (391) (1 137) 179 1 711 120 (500) 225 (384) (482) 690

Note that the movement in debtors should exclude the effect of the credit losses written off, as this does not represent cash flow. # If the capital gains tax can be specifically identified with investing activities, it should be reclassified to investing activities (refer to section 4.3.1.4).

4.3.1.2

Direct method

The (preferred) direct method discloses major classes of gross cash receipts and payments. These cash flows may be obtained either from the accounting records or from the statement of profit or loss and other comprehensive income and the statement of financial position by • adjusting sales in order to determine cash receipts from customers with the following: changes during the period in trade debtors (taking into accOllllt non-cash movements in trade debtors, e.g. credit losses written off without using an allowance account), other cash flows relating to sales and trade debtors (e.g. credit losses recovered) and non-cash items relating to sales (e.g. deferred revenue of the prior year recognised in the current year); and

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GAAP Handbook 2020: Volume 1

• adjusting cost of sales and the other expenses in profit or loss in order to arrive at cash paid to suppliers and employees with the following: changes during the period in inventory, changes in trade creditors, changes in prepayments, changes in accruals, non-cash items and items disclosed separately in the statement of cash flows. The cash flow from operating activities reported on the direct method is illustrated in the following example:

Example 4.2:

Operating activities - direct method

Use the information in example 4.1. The cash flows from operating activities, reported on the direct method, will be calculated and presented as follows: Cash receipts from customers: R'OOO Sales 31000 Changes in debtors - increase (4 687 - 4 000 + 450') (1 137) (use balances before allowance account for expected credit losses) Credit losses recovered 48 29911 Note that the movement in debtors should exclude the effect of the credit losses written off, as this does not represent cash flow. Cash paid to suppliers and employees: Cost of sales Changes in inventory - increase (1891 - 1 500) Changes in creditors - increase (2 679 - 2 500) other expenses in profit or loss: Total Eliminate non-cash items: Depreciation Credit losses written off (without using an allowance account) Increase in allowance for expected credit losses Eliminate item to be disclosed separately: Interest paid

R'OOO 20744 391 (179) 9000 (556) (450) (250) (500) 28200

The format of the operating activities section of the statement of cash flows (based on the direct method) is as follows:

R'OOO Cash flows from operating activities Cash receipts from customers Cash paid to suppliers and employees Cash generated by operations I nterest received I nterest paid Dividends received Dividends paid Normal tax paid (492 - 10 CGT) Net cash inflow from operating activities

4.3.1.3

29911 (28200) 1 711 120 (500) 225 (384) (482) 690

Changes in working capital

When calculating the changes in the working capital elements (inventories, debtors or receivables and creditors or payables), it is important to separately identify amOllllts that relate to investing or financing activities. For example, if an amount receivable in respect of the disposal of land is included with debtors, it should be excluded from the working capital calculation and should be taken into account when calculating investing activities.

65

Statement of cashjlows

Example 4.3:

Receivable relating to the sale of property, plant and equipment

The receivables of Z Ltd amounted to R50000 on 31 December 20XO and to R180000 on 31 December 20X1. Included in the balance at 31 December 20X1 is R100 000 relating to the sale of plant. This plant was sold for R150 000, but only a portion of the proceeds was received before yearend. The revenue of Z Ltd for the year ended 31 December 20X1 amounted to R500 000. Receipts from customers (an operating activity) will amount to R470 000 [500000 + 50000 (180000 - 100000)[, while the cash proceeds on the sale of plant (an investing activity) will be reflected at only R50 000 (150 000 - 100 000).

If an entity manufactures its own inventories, the cost of this inventory may include capitalised noncash expenditure, for example capitalised depreciation. This non-cash expenditure should be taken into account when calculating changes in working capital, as is illustrated in the following example:

Example 4.4:

Depreciation capitalised to inventories

The following information relates to Y Ltd for the year ended 31 December 20X1: 20X1

R Inventories Trade payables Cost of sales

90000 30000 450000

20XO

R 36000 25000 425000

Depreciation to the amount of R20 000 was capitalised to the cost of inventories during the 20X1 financial year. Thirty percent of this inventories was still on hand at 31 December 20X1. The calculation of cash paid to suppliers and employees for 20X1 will be done as follows: R

Cost of sales Increase in inventories (90 000 - 36 000) I ncrease in payables (30 000 - 25 000) Elimination of non-cash depreciation

450000 54000 (5000) (20000) 479000

Note that the full depreciation amount should be eliminated, even though only 70% of the inventories was sold. The reason for this is as follows: the above calculation adds the increase in inventories to the cost of sales - effectively the opening inventory is deducted from cost of sales while the closing inventory is added to cost of sales. Therefore, after this increase in inventories has been added to cost of sales, the adjusted amount will include the total depreciation amount of R20 000 - 70% of the depreciation will be included in cost of sales and the other 30% will be included in closing inventory. The total R20 000 should thus be eliminated. Alternatively the calculation could be done as follows, by eliminating only the depreciation included in cost of sales (i.e. only 70%): R

Cost of sales Increase in inventories, excluding depreciation [(90000 - (20000 x 30%)) - 36 OOO[ I ncrease in payables (30 000 - 25 000) Elimination of non-cash depreciation included in cost of sales (20000 x 70%)

450000 48000 (5000) (14000) 479000

If the opening inventories included a depreciation component of R4 000, the first calculation will not be affected, but the second (alternative) calculation will change as follows: R

Cost of sales Increase in inventories, excluding depreciation [(90000 - (20000 x 30%)) - (36000 - 4 000)[ I ncrease in payables (30 000 - 25 000) Elimination of non-cash depreciation included in cost of sales [(20000 x 70%) + 4 OOO[

450000 52000 (5000) (18000) 479000

66

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GAAP Handbook 2020: Volume 1

Interest, dividends and tax

Interest received, dividends received, interest paid, dividends paid and tax paid should each be disclosed separately in the statement of cash flows. Interest received and dividends received may be classified as either investing activities or operating activities. The classification should be consistent from year to year. The cash amollllt actually received during the accOllllting period is disclosed, i.e. after adjusting for the effect of amOllllts receivable or received in advance. Similarly, interest paid and dividends paid may be classified as either financing activities or operating activities, provided that the classification is consistent from one period to the next. The cash amOllllts actually paid during the accOllllting period are disclosed, i.e. after adjusting for the effect of prepayments and accruals. Cash flows arising from taxes should be classified as operating activity, unless it can be specifically identified with financing and investing activities. However, a split of the tax cash flows is often not practical resulting in the total amount of the tax paid being disclosed as part of operating activities. For example, if the total tax expense for the year amOllllts to Rl 000 of which R200 relates to a recoupment on property, plant and equipment (investing activity), and taxes amounting to only R600 were paid during the year by means of provisional tax payments, it is impossible to determine how much of the R600 paid relates to investing activities. As a result, the total amount of R600 may be classified as operating activities. Note that if a portion of the tax cash flows is allocated to investing or financing activities, the total (combined) amount of taxes paid should be disclosed in the notes to the statement of cash flows. As the payment of capital gains tax usually relates to investing activities, it should be included in the investing activities section of the statement of cash flows, provided the amount of capital gains tax paid is practicably determinable. Interest paid, dividends paid and tax paid effectively show the extent to which the cash generated by operations has been used to pay taxation, interest and dividends during the accounting period.

Example 4.5:

Interest paid, dividends paid and tax paid

The following information relates to Y Ltd for the year ended 31 December 20X1: 20X1

R Finance costs included in profit or loss Accrued interest I ncome tax expense Tax due to SARS Deferred tax liability* Dividends declared during the year Shareholders for dividends

20XO

R

20000 6000 50000 2000 8000 10000 4200

15000 5000 48000 5000 4600 7500 3500

Interest

Dividends

* Plant was revalued with R 10 000 during 20X 1 - assume a tax rate of 28%.

Interest paid and dividends paid will be calculated as follows: R

Due at beginning of the year Finance costs or dividends declared Due at end of year

5000 20000 (6000)

R 3500 10 000 (4200)

Amounts paid

19000

9300

67

Statement of cashjlows 20X1 R

20XO R

The calculation of tax paid will be as follows:

Tax

Deferred tax liability at beginning of year Deferred tax on revaluation (10 000 x 28%) Deferred tax liability at end of year

R 4600 2800 (8000)

Deferred tax in profit or loss I ncome tax expense

(600) 50000

Current tax for the year Due to SARS at beginning of year Due to SARS at end of year

49400 5000 (2000)

Amount paid

52400

4.3.2

Cash flows from investing activities

Cash flows involving investing activities can sometimes be segregated into cash flows that relate to the maintenance of operating capacity and cash flows that are associated with the expansion of operating capacity. For example, the acquisition of a replacement machine involves the maintenance of a company's operating capacity, whereas a cash flow associated with the acquisition of an additional machine involves an expansion of its operating capacity. The separate disclosure of these cash flows, wherever possible, is useful for the user of financial statements to determine whether or not the entity is investing adequately in the maintenance of its operating capacity. Cash flows related to investing activities can normally be established from the statement of financial position and notes thereto by comparing the balances of the relevant items in the statement of financial position to the corresponding figures at the preceding year-end. However, since such differentials represent net changes (inflows and outflows could have been offset against each other, e.g. property sold and bought posted to the same accOllllt), it would usually be necessary to consult the ledger accounts concerned in order to ascertain gross inflows and outflows. When determining cash flows relating to investing activities, it is thus often necessary to reconstruct the general ledger accounts to identify cash flows. When performing this reconstruction, it is necessary to include all movements in the accounts, including those that do not represent cash flows, for example revaluations, impairment losses, depreciation, fair value adjustments, etc. This is illustrated in the following example (note that gross receipts and gross payments should be reported separately).

Example 4.6: Investing activities Use the information in example 4.1. The format of the investing activities section of the statement of cash flows is as follows: R'OOO

Cash flows from investing activities Purchase of property, plant and equipment [Calculation 1[ Proceeds from sale of land Capital gains tax paid# Acquisition of investments at fair value through other comprehensive income [Calculation 2[ Net cash outflow from investing activities #

(571) 170 (10) (477) (888)

If the capital gains tax can be specifically identified with investing activities, it should be presented as part of investing activities.

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GAAP Handbook 2020: Volume 1 R'OOO

Calculation 1 - Additions to property, plant and equipment: Carrying amount at beginning of year Depreciation Carrying amount of land disposed of (170 - 40) Carrying amount at end of year

33300 (556) (130) (33 185) (571)

Calculation 2 - Additions to investments at fair value through other comprehensive income: Carrying amount at beginning of year I ncrease in mark-to-market reserve (350 000 - 300 000) (deferred tax ignored in this example) Carrying amount end of year

1 000 50

(1 527) (477)

4.3.2.1

Non-cash investing and financing activities

lAS 7 requires a pure cash flow approach, i.e. only amOllllts that were actually received and paid should be included in the statement of cash flows. However, a teclmical application of such an approach creates a practical problem (which is not addressed by lAS 7) and may produce misleading data where assets were purchased on credit, or any amollllt owing to the supplier was paid directly by a financier. The point in question is illustrated by example 4.7.

Example 4.7:

Indirect cash flows

A Ltd purchases a machine from B Ltd for R 100 000. A pays B a deposit of R20 000. The balance of R80 000 is financed by C Bank, which makes a direct payment to B. Strict application of the pure cash flow rule will result in only R20 000 appearing in the statement of cash flows as an investing activity, nothing under financing activities and the transaction being revealed in a note to the statement of cash flows. This may frustrate certain of the objectives of the statement of cash flows in that the statement does not provide the user thereof with a comprehensive picture of the entity's investing and financing activities during the year. It will have to be gleaned from notes and from reworking figures in the statement of financial position. On the other hand, had the financier paid over the R80 000 to A, who then settled the debt, the transaction would have been disclosed properly and in total in the statement of cash flows, i.e. an investing activity of R100 000 and a financing activity to the amount of R80 000. Accordingly, in the authors' opinion such cash flows should be presented gross in order to provide a meaningful analysis of an entity's cash flows.

Information about a non-cash investing or financing transaction is to be disclosed in a note to the statement of cash flows. For example, the acquisition of an asset in exchange for shares would not be shown in the statement of cash flows, but note disclosure would reflect information about the transaction. A note disclosing this information may read as follows: "During the period additional share capital of RIO 000 was issued in exchange for machinery." The initial acquisition of a right-of-use asset in terms of a lease agreement is also not reflected on the face of the statement of cash flows, but is merely disclosed in the note on non-cash investing and financing activities. In general, cash flows relating to a lease agreement reflect lease payments after the initial recognition of the lease. IFRS 16 has very specific requirements on the presentation of lease cash flows by the lessee, namely that the lessee should classify the cash flow from leases as follows: • Cash payments for the principal portion of the lease liability should be classified as cash flows from financing activities; • Cash payments for the interest portion of the lease liability should be classified as interest payments for the purposes of lAS 7 and presented in accordance with the general requirements of this standard in respect of cash flows related to interest payments (refer to section 4.3.1.4);

Statement of cashjlows

69

• Cash lease payments related to leases accOllllted for using the simplified accounting method (this method may be applied to short-term leases or leases oflow value assets under certain conditions) should be classified as cash flows from operating activities; and • Cash lease payments for variable lease payments not included in the measurement of the lease liability should be classified as cash flows from operating activities. For detail discussions oflease classification and accounting, refer to the chapter on leases. Some of the cash flow presentation implications for lease agreements are illustrated in the following example.

Example 4.8:

Lease agreement

The following information relates to P Ltd for the year ended 31 December 20X1: 20X1

20XO

R

R

Long-term borrowings 255 000 100 000 Right-of-use assets - total cost 480000 400000 Right-of-use assets R80 000 was acquired by means of a lease. Instalments amounting to R20000 were paid in respect of these related lease liabilities, of which R5000 represented finance costs. These were the only repayments relating to long-term borrowings. 20XO R

The cash additions to the right-of-use assets will be calculated as follows: Cost at beginning of year Lease - no initial cash outflow Cost at end of year

400000 80000 (480000)

Cash additions to right-of-use assets The cash proceeds on loans raised will be calculated as follows: Balance at beginning of year Lease liability - no initial cash inflow Capital repayments on lease (20 000 - 5 000) Balance end of year

Loans raised

90000

The above information will result in the following disclosures in the statement of cash flows Interest paid (part of operating activities) Proceeds from long-term loans (part of financing activities)* Repayment of long-term loans (part of financing activities)* * Note that gross receipts and gross payments should be reported separately.

4.3.3

100000 80000 (15000) (255000)

(5000) 90000 (15000)

Cash flows from financing activities

These cash flows comprise the capital element of inflows and outflows of cash from and to the providers of capital, i.e. owners and outside financiers. The separate disclosure of the cash effects of financing activities enables users to predict claims on future cash flows by providers of capital to the entity. Gross receipts and gross payments should be reported separately.

Example 4.9:

Financing activities

Use the information in example 4.1. The format of the financing activities section of the statement of cash flows is as follows: R'OOO Cash flows from financing activities Proceeds from rights issue (20 250 - 20 000) 250 Proceeds from long-term borrowings· (5000 - 310 - 4890) 200 Proceeds from short-term borrowings 98 (310) Repayment of long-term borrowings* Net cash inflow from financing activities * Note that these amounts may not be off-set and reported as a single line item.

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70

4.3.4

Net effect of all cash flows

The statement of cash flows is concluded with the net effect of the cash flows from operating, investing and financing activities (+ 690 000 - 888 000 + 238 000 in the illustrative examples 4.1, 4.6 and 4.9 above) and the impact thereof on the entity's cash resources: R'OOO 40

Net increase in cash and cash equivalents (690 - 888 + 238) Cash and cash equivalents at beginning of period (example 4.1)

60

Cash and cash equivalents at end of period (example 4.1)

4.3.5

100

Balancing the statement of cash flows

In order to ensure that a statement of cash flows balances, two basic principles must be adhered to: all items and amOllllts in the statement of profit or loss and other comprehensive income and statement of financial position must be dealt with - directly or indirectly - and all non-cash flow items must be eliminated. Certain cash flows arise from the activities reflected in the statement of profit or loss and other comprehensive income (excluding non-cash items). The net effects of other cash flows can be ascertained by comparing items in the statement of financial position from year to year and adjusting for non-cash entries in the accOllllts.

4.4 4.4.1

Other issues Hedges

Derivative instruments, such as options, futures and swaps, may be used as hedging instruments. The cash flows resulting from these hedging instruments should be classified in the same manner as the cash flows from the hedged item. For example, if an entity hedges a foreign trade creditor by means of a forward exchange contract (FE C), the cash flows from the FEC should form part of operating activities, as the settlement of the trade creditor forms part of operating activities. If the entity hedges the repayment of a foreign long-term loan, the cash flows from the FEC should form part of financing activities, as the settlement of the long-term loan forms part of financing activities.

4.4.2

Capitalised borrowing costs

lAS 7 requires the total amount of interest paid during the year to be disclosed in the statement of cash flows as part of interest paid, irrespective of whether this interest was capitalised or expensed. Therefore, unlike capitalised development costs, capitalised borrowing costs do not form part of investing activities.

Example 4.10: Borrowing costs The following information relates to T Ltd for the year ended 31 December 20X1: 20X1 Property, plant and equipment - net carrying amount Depreciation Finance costs in profit or loss Borrowing costs amounting to R20 000 were capitalised to property, plant and equipment during 20X1.

20XO

R

R

800000 45000 80000

500000

The borrowing costs reported in the statement of cash flows will be calculated as follows: Amount included in profit or loss Amount capitalised Amount paid

R 80000 20000

100000

71

Statement of cashjlows 20X1 R

The additions to property, plant and equipment will be calculated as follows: Balance at beginning of year Borrowing costs capitalised Depreciation Balance at end of year

500000 20000 (45000) (800000)

Cash additions

4.4.3

20XO R

325000

Consolidated financial statements

Where consolidated financial statements are prepared, a consolidated statement of cash flow information is presented. The preparation of a consolidated statement of cash flows is dealt with in detail in chapter 9 of volume 2.

4.4.4

Gross versus net cash flows

lAS 7 requires an entity to report gross receipts and gross payments (i.e. cash receipts and payments may not be offset). An exception to this rule is where receipts and payments are made on behalf of customers and the cash flows reflect the activities of the customer rather than of the reporting entity. An example of this situation is where an entity collects rents on behalf of owners of properties and then pays the amOllllts collected over to these lessors. As the entity merely acts as middle man between the lessee and lessor, it would be acceptable to report cash flows on a net basis. Therefore, if rentals amounting to R80 000 were collected from lessees of which only R 70 000 were paid over to lessors, it would be acceptable to report a net inflow of RIO 000. (It should be noted that reporting cash flows on a net basis is not compulsory - it is an option.)

4.4.4.1

Value-added taxation

Value-added tax (VAT) is collected on behalf of the taxation authorities. The question arises as to whether VAT receipts and payments may be reported on a net basis. This issue was referred to the IFRIC, who responded by stating that no exception is given in lAS 7 to permit VAT receipts and VAT payments to be reported on a net basis. Only amounts collected on behalf of customers may be reported on a net basis. Therefore VAT receipts should be reported separately from VAT payments. As a result, these amounts may either be included in the receipts from customers and payments to suppliers, or may alternatively be reported as separate line items. This is illustrated in the following example.

Example 4.11: VAT The following information relates to X Ltd for the year ended 31 December 20X1:

Sales for the year Purchases for the year Debtors - opening balance Debtors - closing balance Creditors - opening balance Creditors - closing balance VAT due to SARS - opening balance VAT due to SARS - closing balance

VAT exclusive R'OOO 1000 800 200 500 600 200

VAT inclusive R'OOO 1 140 912 228 570 684 228 80 75

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GAAP Handbook 2020: Volume 1

If the amounts presented in the statement of cash flows are reported inclusive of VAT, the operating section of the statement of cash flows will be presented as follows: Cash receipts from customers (228 + 1 140 - 570) Cash payments to suppliers and employees (684 + 912 - 228) VAT paid to SARS (80 + 140 output VAT - 112 input VAT - 75) Cash utilised by operations

R'OOO 798 (1 368) (33) (603)

If the amounts presented in the statement of cash flows are reported exclusive of VAT, the operating section of the statement of cash flows will be presented as follows: R'OOO 700 Cash receipts from customers (200 + 1 000 - 500) Output VAT received from customers (228 - 200) + (1 140 - 1 000) - (570 - 500) 98 Cash payments to suppliers and employees (600 + 800 - 200) (1 200) I nput VAT paid to suppliers (684 - 600) + (912 - 800) - (228 - 200) (168) VAT paid to SARS (80 + 140 output VAT - 112 input VAT - 75) (33) Cash utilised by operations

4.4.5

(603)

Foreign currency cash flows

Cash flows arising from transactions in a foreign currency should be translated at the exchange rates ruling at the dates of the respective cash flows. An average rate that approximates the actual rates may be used. The treatment of foreign currency transactions is not as complex as it might appear; if the transaction has been settled during the period then the amollllt of cash that has changed hands must appear in the statement of cash flows. For example, if an entity buys inventories, the inventories are recorded at the exchange rate at transaction date. At reporting date, depending on whether the inventory was sold, this amount will fonn part of either inventories or cost of sales and will be included in the calculation of cash payments to suppliers. Any exchange difference that arises on settlement will be included in other expenses and will also fonn part of the calculation of cash payments to suppliers. The total amollllt paid (cost of inventories + exchange difference) is therefore automatically reflected in operating activities and no adjustments are required. If the amollllt due has not been settled during the period, accollllts payable and other expenses will both include an unrealised exchange difference, which will have to be adjusted for, as this difference does not represent cash flow.

Example 4.12:

Exchange differences on trade payables

B Ltd acquired inventories with a cost of $10 000 when the exchange rate was $1 = R7. The amount due was settled tvvo months later (before year-end), when the exchange rate was $1 = R7,50. Assume that the inventories were sold before year-end. The inventories will be reflected at a cost of R70 000 (10 000 x 7), while a realised exchange loss of R5 000 [(7,50 - 7) x 10 OOO[ will be included in other expenses. When the inventories are sold, the cost of R70 000 will be transferred to cost of sales. When calculating amounts paid to suppliers, the point of departure is the total expenses included in profit or loss. The total expenses amount to R75000 (70000 cost of sales + 5000 exchange loss), which is equal to the amount paid to the supplier. No adjustments are thus required. If the creditor is still unpaid at year-end and the exchange rate at year-end is $1 = R8, an unrealised exchange loss of R10 000 [(8 - 7) x 10 OOO[ should be accounted for. The creditor will then have a balance of R80 000 at year-end. When calculating amounts paid to suppliers, the point of departure is the total expenses in profit or loss. If it is assumed that the inventories were sold, the total expenses will amount to R80 000 (70 000 cost of sales + 10 000 exchange loss). However, the R10 000 does not represent cash flow and should be eliminated as a non-cash transaction, resulting in a remaining balance of R70 000. The next step is to adjust this balance for the movement between the opening and closing balance of trade payables, in order to arrive at cash payments. Although the movement on trade payables amounts to R80000, this movement includes the effect of the unrealised exchange loss, which should be eliminated as it does not represent cash flow. The actual movement between the opening and closing balance is thus only R70000. If this amount is subtracted from the total

73

Statement of cashjlows

expenditure of R70 000, the result (i.e. cash flow) is zero, which is correct as no cash payments were made to the supplier in the current year.

In respect of a foreign currency transaction that does not form part of operating activities, for example the acquisition of property, plant and equipment or the raising of a loan, exchange differences will have to be eliminated from operating activities irrespective of whether these exchange differences are realised or umealised. Umealised exchange differences need to be eliminated as they do not represent cash flow, while realised exchange differences need to be reclassified from operating activities to investing or financing activities, as appropriate. This is illustrated in the following example.

Example 4.13:

Exchange differences relating to property, plant and equipment

A company imports an item of plant for $10 000 when the exchange rate is $1 = R10. When the creditor is settled two months later, the exchange rate amounts to $1 = R 11, resulting in a realised exchange loss of R 10 000 [(11 - 10) x 10 000[. Although the plant is recorded at a cost of R 100 000 (10000 x 10) the actual cash flow relating to the acquisition of the plant amounts to R110 000 (10 000 x 11), which is also the amount that should be reported in the statement of cash flows under investing activities. When calculating the cash additions to property, plant and equipment, the first step is to determine the increase in the property, plant and equipment balance. This will amount to only R100 000, as the cost of the plant is R100 000. The next step is to reclassify the realised exchange loss (that is included in other expenses in profit or loss) from operating activities to investing activities. The R10000 will thus be eliminated (added back to profit) when calculating the cash flow from operating activities and will then be added to the R100 000 increase in property, plant and equipment to arrive at investing activities of R 11 0 000. If the amount payable in respect of the property, plant and equipment is still unpaid at year-end and the exchange rate at year-end is $1 = R12, an unrealised exchange loss of R20 000 [(12 - 10) x 10000] will be included in profit or loss, while the related creditor will amount to R120 000. When calculating the cash flows from operating activities, the unrealised exchange loss should be eliminated (added back to profit), as it represents a non-cash item. Furthermore the increase in the property, plant and equipment balance of R100 000 does not represent cash flow and will not be reported in the statement of cash flows, as it coincides with an increase of R100 000 in a creditor's balance (the R100 000 increase in the creditor is calculated as the difference between the opening balance of zero, the unrealised exchange loss of R20 000 and the closing balance of R120 000).

Exchange differences may arise on cash and cash equivalents denominated in a foreign currency. In terms of lAS 7, these differences should appear as a reconciling item in the statement of cash flows, presented separately from operating, investing and financing activities. This is illustrated in the following example.

Example 4.14:

Exchange differences on cash and cash equivalents

R10 000 was invested in a foreign bank account at the end of the prior financial year, when the exchange rate was $1 = R7. The transaction was thus recorded at R10 000 at the end of the prior financial year. If the exchange rate amounts to $1 = R7,50 at the end of the current financial year, the investment will increase to R10714 (10 000 I 7 x 7,50), resulting in an exchange gain of R714 recognised in profit or loss. This gain should be eliminated from operating activities and should be reported in the statement of cash flows as a separate line item, immediately after financing activities, in order to reconcile the movement in cash and cash equivalents. Assuming that this was the only transaction during the year, the statement of cash flows will reflect the following: R

Cash flows from Cash flows from Cash flows from Exchange gains

operating activities (714 - 714) investing activities financing activities on cash and cash equivalents

714

Net increase in cash and cash equivalents Cash and cash equivalents at the beginning of the period

714 10 000

Cash and cash equivalents at the end of the period

10714

74

4.4.6

GAAP Handbook 2020: Volume 1

Sale of property, plant and equipment held for rental

If an entity, in the course of its ordinary activities, routinely sells items of property, plant and equipment that it has held for rental to others, these items of property, plant and equipment should be transferred to inventories at their carrying amollllt when they cease to be rented and are held for sale. When these assets are sold, the total proceeds should be recognised as revenue as it relates to the sale of inventories. Consequently the cash receipts from the disposal of these assets should be reported as operating activities and not as investing activities in the statement of cash flows. Similarly, the cash payments to manufacture or acquire these assets should also be reported as operating activities.

Example 4.15:

Sale of property, plant and equipment held for rental

T Ltd leases motor vehicles to other companies in terms of operating leases. When the vehicles are no longer leased out, the company sells these vehicles in the course of its ordinary activities. During 20X1 vehicles with a carrying amount of R120 000 and cost of R230 000 where transferred from property, plant and equipment to inventories as they were no longer suitable for leasing. These vehicles were replaced at a cost of R300 000. The following additional information relates to T Ltd for the year ended 31 December20X1: 20X1 20XO R R Property, plant and equipment - net carrying amount 710000 500000 Inventories 500000 600000 Trade creditors Cost of sales 800000 Other expenses (including depreciation of R50 000) 350000 Cash paid to suppliers and employees will be calculated as follows: Cost of sales Other expenses Depreciation Purchases of motor vehicles held for rental- regarded as operating activities Decrease in inventories (600 000 + 120 000 - 500 000)

800000 350000 (50000) 300000 (220000) 1 180000

Additions to properly, plant and equipment will be calculated as follows: Balance beginning of year Purchases of motor vehicles held for rental - reclassified to operating activities Depreciation Transfer of motor vehicles to inventories Balance end of year

500000 300000 (50000) (120000) (710000) 80000

4.5 4.5.1

Financial statement presentation lAS 7 requirements for cash now items

The following disclosure requirements are listed in lAS 7: • Cash flows during the period classified by operating, investing and financing activities. • The major classes of gross cash receipts and gross cash payments arising from investing and financing activities. • Separate disclosure of cash flows from interest and dividends received and paid. • Cash flows arising from taxes on income, separately disclosed and classified as cash flows from operating activities, unless they can be specifically identified with financing and/or investing

Statement of cashjlows

75

activities. If tax cash flows are allocated over more than one class of activity, the total amollllt of taxes paid should be disclosed. • The aggregate cash flows arising from obtaining and losing control of subsidiaries or other businesses, separately disclosed and classified as investing activities. • In aggregate, in respect of both obtaining and losing control of subsidiaries or other businesses during the period, each of the following: - the total consideration paid or received; - the portion of the consideration consisting of cash and cash equivalents; -

the amollllt of cash and cash equivalents in the subsidiary or other businesses over which control is obtained or lost; and - the amount of the assets and liabilities, other than cash or cash equivalents in the subsidiary or other businesses over which control is obtained or lost, smnmarised by each maj or category. • The accollllting policy for the composition of cash and cash equivalents. Any changes in the composition of cash and cash equivalents should be accollllted for as a change in accollllting policy. • The components of cash and cash equivalents and a reconciliation of the amounts in the statement of cash flows with the equivalent items reported in the statement of financial position. • The amollllt of significant cash and cash equivalent balances held by the entity that are not available for use by the group, together with a commentary by management (for example if exchange controls prevent the transfer of cash from a foreign subsidiary to the parent company). • In addition, the following disclosures are encouraged: - lllldrawn borrowing facilities, indicating any restrictions on the use thereof; -

the aggregate amollllt of cash flows that represent increases in operating capacity separately from those cash flows that are required to maintain operating capacity; and the amollllt of the cash flows arising from the operating, investing and financing activities of each reportable segment.

4.5.2

lAS 7 requirements for non-cash now items

In addition to disclosure requirements for items contained within the cash flow statement, lAS 7 also contains disclosure requirements for certain non-cash items. Specifically, the standard notes that investing and financing transactions that do not require the use of cash or cash equivalents are excluded from a statement of cash flows. Such transactions should be disclosed in the notes to the financial statements in a way that provides all the relevant information about these investing and financing activities.

4.5.3

IFRS 5 requirements

IFRS 5.33(c) requires the following in respect of discontinued operations: • Net cash flows attributable to the operating, investing and financing activities of discontinued operations. These disclosures may be presented in the notes or on the face of the statement of cash flows.

4.5.4

IFRS 16 requirements

IFRS 16.53(g) requires that a lessee must disclose the total cash outflow for leases. Therefore, if the cash flows from leases have been allocated to different activities on the face of the statement of cash flows (or combined with cash flows from other items by, for example, adding interest on lease liabilities to other cash interest payments), the entity will have to add these amollllts together and disclose the total cash outflow. This will normally form part of the single note on leases that IFRS 16 requires. Refer to the chapter on leases for further detail as well as a disclosure example for these requirements.

76

Example 4.16:

GMP Handbaak 2020: Va/ume 1

Disclosure requirements for the cash flow statement

This example uses information in other examples in this chapter to illustrate the presentation and disclosure requirements for cash flows. Although comparatives have not been illustrated, these would be required in accordance with lAS 1. A Ltd Statement of cash flows for the year ended 31 December 20X5 Note

Cash flows from operating activities Cash receipts from customers Cash paid to suppliers and employees Cash generated by operations [lAS 7.18] Interest received [lAS 7.31] Interest paid [lAS 7.31] Dividends received [lAS 7.31] Dividends paid [lAS 7.31] Normal tax paid [lAS 7.35] Net cash inflow from operating activities Cash flows from investing activities Purchase of property, plant and equipment Replacement of property, plant and equipment [lAS 7.50(c)] Additions to property, plant and equipment [lAS 7.50(c)] Proceeds from sale of land Capital gains tax paid [lAS 7.35] Acquisition of investments at fair value through other comprehensive income Net cash outflow from investing activities Cash flows from financing activities Proceeds from rights issue Proceeds from long-term borrowings Proceeds from short-term borrowings Repayment of long-term borrowings Net cash inflow from financing activities Net increase in cash and cash equivalents (690 - 888 + 238) Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period

2

R'OOO 29911 (28200) 1 711 120 (500) 225 (384) (482) 690 571 (232) 339

2

170 (10) (477) (888)

250 200 98 (310) 238 40 60 100

Notes for the year ended 31 December 20X5 20X5 R'OOO

1. Components of cash and cash equivalents [lAS 7.45[ Current account Call account

60 40

Cash and cash equivalents per statement of financial position

100

2. Tax cash flows Total amount of taxes paid [lAS 7.36] (482 + 10)

492

3. Non-cash investing and financing activities [lAS 7.43] Provide details of non-cash transactions which have not been disclosed in other notes.

77

Statement of cashjlows

4. Leases 4.1. Cash flows relating to leases

Cash outflows relating to leases have been classified as follows in the statement of cash flows: As part of financing activities Cash payments for the principal portion of lease liabilities (as part of the line item "repayment of long-term borrowings") [IFRS 16.50(a)]

XXX

As part of operating activities Cash payments for the interest portion of lease liabilities (as part of the line item "interest paid") [IFRS 16.50(b)]

XXX

Cash payments for short-term leases (as part of the line item "cash paid to suppliers and employees") [IFRS 16.50(c)]

XXX

Cash payments for leases of low value assets (as part of the line item "cash paid to suppliers and employees") [IFRS16.50(c)]

XXX

Cash payments for variable lease payments (as part of the line item "cash paid to suppliers and employees") [IFRS16.50(c)]

XXX

Total cash outflow relating to leases [IFRS16.53(g)]

XXX

Note: only the cash flow disclosure requirements of IFRS 16 has been illustrated in the above note. For illustrations of the other disclosures required for lease transactions, refer to the chapter on leases.

4.5.5

lAS 7 requirements for liabilities from financing activities

lAS 7 determines that an entity should provide disclosures which enable users of financial statements to evaluate the changes in liabilities which arise from financing activities, generally in the form of a reconciliation of the opening and closing balances. A liability arises from financing activities if its current, past or future cash flows are classified as cash flows from financing activities on the cash flow statement when they take place. The reconciliation of changes must include those due to cash flows as well as non-cash based changes and users of the financial statements must be able to link items in the reconciliation to line items in the statement of financial position and statement of cash flows. Specifically, the standard requires that the reconciliation should disclose the following changes in liabilities arising from financing activities: • Changes from financing cash flows; • Changes due to changes in control of subsidiaries or other businesses; • The effect of changes in foreign exchange rates; • Changes in fair values; and • Other changes. If the cash flows from these liabilities are hedged (refer to the chapter on financial instruments) the changes in any related financial assets (hedging assets) must be included in the reconciliation if the current, past or future cash flows of the financial assets will be classified as cash flows from financing activities. An entity may combine the above disclosures with other disclosures in the financial statements. However, in such a case, the entity should ensure that the changes in liabilities from financing activities are disclosed separately from changes in other assets and liabilities.

78

Example 4.17:

GMP Handbaak 2020: Va/ume 1

Disclosure requirements for liabilities from financing activities

This example illustrates the presentation and disclosure requirements for liabilities from financing activities (lAS 7.44A - 44E). Although comparatives have not been illustrated, these would be required

in accordance with lAS 1. B Ltd Group Notes for the year ended 31 December 20X5

2DX4 closing balance

Borrowings: -Long-term portion -Short-term portion Lease liabilities: -Long-term portion -Short-term portion Hedge assets Total liabilities from financing activities

Non-cash changes

Cash flows

R'DDD

R'DDD

Acquisitian of control R'DDD

XXX XXX

XXX (XXX)

XXX XXX

XXX XXX XXX XXX

(XXX) (XXX) XXX (XXX)

Non-cash

Change in

issues of

exchange

liabilities R'DDD

rates R'DDD

Change in fair values R'DDD

XXX

(XXX)

R'DDD

(XXX)

XXX XXX

XXX XXX

XXX XXX XXX XXX

(XXX) XXX XXX

XXX

2DX5 closing balance

79

Statement of cashjlows

4.6

Summary of lAS 7, Statement of cash flows Statement of cash flows deals with Cash

Cash equivalents

• Cash on hand

•

Short term « 3 months)

• Demand deposits

• •

Highly liquid Convertible to known amount of cash

•

Insiqnificant risk of chanqe

Presentation of statement of cash flows Operatinq activities +/- investinq activities +/- financinq activities = movement in cash and cash equivalents Operating activities

Investing activities

Financing activities

• Principle revenue producing activities, for example:

• Acquisition or disposal of longterm assets or investments that are not cash equivalents, for example:

•

-

Receipts from customers Payments to suppliers / employees

-

Purchase / sale of held for trading financial assets

-

Issue or redemption of shares

-

Proceeds or repayment of loans

-

Interest paid (including capitalised borrowing costs) and dividends paid

Income tax

-

Interest received / dividends received / interest paid (including capitalised borrowing costs) / dividends paid

Acquisition or sale of financial assets that are not held for trading

-

Loans granted and repayment thereof Format Capitalised development costs. Show gross receipts and Interest and dividends gross payments received

Format

-

• Direct method (preferred)

-

Acquisition or sale of PPE / intangibles / subsidiaries / JV / associates

Changes in size or composition of equity or borrowings, for example:

Receipts from customers less payments to suppliers and employees

• Indirect method - Profit before tax +/- non-cash item s in profit - investment income + finance costs +/- movements in debtors, creditors and inventories

Format

•

Show gross receipts and gross payments

Other issues • May report net cash flows if

-

Receipts or payments on behalf of customers (reflect activity of customer, e.g. rents collected on behalf of owners of property)

-

Receipts or payments for items in vvhich turnover is quick, amounts large, maturities short

• Foreign currency - Use rate on date of cash flows

-

Unrealised exchange gains or losses not cash flow Exchange gains or losses i.r.o. cash and cash equivalents reported separately in statement of cash flows

• Associate or JV on equity method

-

Report dividends / advances / acquisitions / disposals

• Acquisition/disposal of subsidiary (if control is obtained /Iost)

-

Present as investing activity, net of cash and cash equivalents acquired or disposed of Compulsory disclosure

• Non-cash investing and financing transactions • Accounting policy for composition of cash and equivalents • Components of cash and cash equivalents • Reconciliation of liabilities from financing activities • Cash and cash equivalents not available for use by group

5

Accounting policies, changes in accounting estimates and errors lAS 8 (Effective date 1 January 2005)

5.1 Introduction The purpose of lAS 8 is to prescribe criteria for the selection of an accounting policy, as well as to prescribe the accOllllting treatment and disclosure of changes in accOllllting policies, changes in accOllllting estimates and corrections of errors, to ensure consistent preparation and presentation of financial statements. The standard enhances the comparability of the entity's financial statements with previous periods, as well as with financial statements of other entities.

5.2 Accounting policies 5.2.1 Accounting policies - definition AccOllllting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements.

5.2.2 How to select an accounting policy When an accOllllting standard or interpretation specifically applies to a transaction, the accOllllting policy applied to that item should be determined in accordance with that standard or interpretation (and by considering any relevant implementation guidance in respect of that standard or interpretation). In the absence of an accounting standard or an interpretation that specifically applies to a transaction, judgement should be used in developing and applying an accounting policy that results in information that is both relevant and reliable. In making this judgement, management should refer to, and consider the applicability of, the following sources in descending order: • the requirements and guidance in standards and interpretations dealing with similar and related issues; and • the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in The Conceptual Frameworkfor Financial Accounting (2018). Management may also consider the most recent pronouncements of other standard-setting bodies (that use a similar conceptual framework to develop accounting standards), other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources above.

5.2.3 Is it compulsory to apply an accounting policy prescribed by a standard? Policies prescribed by standards need not be applied when the effect of applying them is immaterial. However, it is inappropriate to make, or leave uncorrected, immaterial departures from IFRS to achieve a particular presentation of an entity's financial position, financial performance or cash flows.

81

82

GMP Handbaak 2020: Va/ume 1

5.2.4 Consistency of accounting policies An entity should select and apply its accOllllting policies consistently for similar transactions, other events and conditions, unless an accOllllting standard or interpretation specifically requires or permits categorisation of items for which different policies may be appropriate. For example, lAS 2 allows different categories of inventory to be valued by using different cost formulas. It is therefore acceptable to value raw materials on the FIFO basis and finished goods on the weighted average basis. If a standard or an interpretation requires or permits such categorisation, an appropriate accOllllting policy should be selected and applied consistently to each category.

5.2.5 Changes in accounting policies Users of financial statements need to be able to compare the financial statements of an entity over time to identify trends in its financial position, financial performance and cash flows. This can only be achieved if the same accOllllting policies are applied within each period and from one period to the next. As a result, a change in accounting policy may only be made if • the change is required by an accounting standard or interpretation; or • the change results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity's financial position, financial performance or cash flows. The following decision tree summarises the process to be followed when an entity changes its accounting policy (a detailed discussion of this process follows immediately after the decision tree):

Change required by

No

new standard?

Will change result in

No

Change not allowed

Yes

Full retrospective

more reliable or relevant info?

Yes

Does standard have transitional

Yes

No

Are all period specific effects knOVvTl?

application

arrangements?

No Yes

Apply transitional

Is cumulative effect

arrangements

knOVvTl?

No

Prospective from earliest date practicable

Yes

Retrospective from earliest date practicable

Accounting policies, changes in accounting estimates and errors

5.2.5.1

83

Change in accounting policy due to initial adoption of standard or interpretation

If the change in accOllllting policy is required due to the initial application of an accounting standard or interpretation, the change should be accounted for in accordance with the transitional provisions of that standard or interpretation. If no transitional provisions are supplied, the change should be accounted for retrospectively (refer to 5.2.5.3).

5.2.5.2 Voluntary change in accounting policy If the change in accounting policy is made to reflect more relevant and reliable information (i.e. a voluntrny change in accounting policy), the change should be accounted for retrospectively (refer to 5.2.5.3 below).

5.2.5.3 Retrospective application Retrospective application means that an adjustment should be made against the opening balance of each affected component of equity for the earliest period presented, while comparative amounts should be restated. The result of this procedure is that the financial statements reflect the position and results of the entity as though the new policy had always been applied. Note that lAS 1 requires an entity to present a statement of financial position as at the beginning of the preceding period whenever a change in accounting policy is accounted for retrospectively, provided the application of the new policy has a material effect on the information in that statement of financial position. This means that, if financial statements are prepared for 20X5, the entity needs to present a statement of financial position as at the beginning of 20X4 in addition to the statements as at !be end of 20X5 and 20X4.

Example 5.1: Change in accounting policy (retrospectivelYI Bentleys Ltd, a manufacturer, values inventories at the lower of cost and net realisable value, with cost determined using the weighted average 0fVA) method. The value of closing inventories at 31 December 20X3, 20X4 and 20X5 was originally computed as follows: R

20X3 315000 20X4 175000 20X5 330000 During the year ended 31 December 20X5, management decided that the cost of inventories should rather be determined using the first-in-first-out (FIFO) basis to better reflect the physical flow of inventories. Closing inventories at 31 December 20X3, 20X4 and 20X5 were calculated on the FIFO basis as follows: R

430000 20X3 195000 20X4 450000 20X5 Profit before tax, before adjusting for the change in policy, for the years ended 31 December 20X3 to 31 December 20X5 was as follows: R

700000 (fully taxable) 20X3 850000 (fully taxable) 20X4 1 010000 (fully taxable) 20X5 Assume a tax rate of 30%. SARS indicated that the new inventory cost method will be taken into account only from the 20X5 year-end onwards (i.e. prior year assessments will not be reopened). Retained earnings at 1 January 20X4 amounted to R1 455000 and on 31 December 20X4 to R1 950 000. The issued share capital consists of 1 000000 ordinary shares that were issued at R1 each. Assume that a dividend of R100 000 is paid annually.

84

GAAP Handbook 2020: Volume 1

Required Disclose the above information in the statement of financial position, statement of changes in equity and statement of profit or loss and other comprehensive income of Bentleys Ltd for the year ended 31 December 20X5. Also provide the income tax expense note and the note on the change in accounting policy.

Example 5.1: Suggested answer Bentleys Ltd Statement of profit or loss and other comprehensive income for the year ended 31 December 20X5 Notes 20X5 20X4 R

R

1110000 (333000)

755000 (226500)

Profit I total comprehensive income for the year

777000

528500

Earnings per share (777 000 11 000 000) (528 500 11 000 000)

78 cents

Profit before tax [W2[ I ncome tax expense

53 cents

Bentleys Ltd Statement of changes in equity for the year ended 31 December 20X5 Share capital Notes R Balance on 31 December 20X3 1 000000 Change in accounting policy [W1 [ 2

Retained earnings R 1 455000 80500

2455000 80500

1 535500

2535500

Total R

Restated balance Total comprehensive income for the year: Profit for the year (restated) Dividends - 10 cents* per share

1 000000

Balance on 31 December 20X4 Total comprehensive income for the year: Profit for the year Dividends - 10 cents* per share

1 000000

.

1 000000

2641000

3641000

Assets

20X5

20X4

R

R

1/1/20X4 R

Current assets Inventories

450000

Balance on 31 December 20X5

528500 (100000) 1 964000 777000 (100000)

528500 (100000) 2964000 777000 (100000)

(100000/1000000)

Bentleys Ltd Statement offinancial position as at 31 December 20X5

Liabilities Non-current liabilities Deferred tax [W4 [ Cutrent liabilities Current tax payable [W3[

195000

430000

6000

34500

36000

[Note that due to the retrospective application of the change in accounting policy, lAS 1 requires a statement of financial position as at the beginning of 20X4.]

85

Accounting policies, changes in accounting estimates and errors Bentleys Ltd

Notes for the year ended 31 December 20X5

1.

Taxation SA normal taxation Current [W3[ Deferred [W4 [

20X5

20X4

R

R

339000 (6000)

255000 (28500)

333000

226500

2. Change in accounting policy The company changed its accounting policy for the determination of the cost of inventories from the weighted average method to the first-in-first-out method. This will result in fairer presentation as it better reflects the physical flow of inventories. The opening balance of equity at the beginning of 20X4 was adjusted while the comparative amounts were restated accordingly. The effect of the change in policy on the results of 20X4 and 20X5 was as follows: 20X5 20X4 1/1/20X4 R

Decrease/(1 ncrease) in cost of sales [W1] (Increase)/Decrease in income tax expense [W1] Increase/(Decrease) in profit for the year Increase in inventories Increase in deferred tax [W4] Increase in current tax payable [W3]

R

R

100000 (30000)

(95000) 28500

70000

(66500)

120000

20000 (6000)

115000 (34500)

14000

80500

(36000)

Increase in equity

84000

Adjustment against retained earnings at the beginning of 20X4 [W1[

80500

Increase/(Decrease) in earnings per share (66500/1 000000) (70000/1 000000)

(7 cents)

7 cents

WORKINGS W1. Change in policy

Original value (WA) Restated value (FIFO)

Difference Taxation thereon at 30%

20X5 (330000) 450000

Effect on 20X5 results (155000) 255000

120000 (36000) 84000

20X4 (175000) 195000

Effect on 20X4 results 140000 (235000)

20X3 (315000) 430000

100000 (30000)

20000 (6000)

(95000) 28500

115000 (34500)

70000

14000

(66500)

80500

W2. Profit before tax Given Change in policy [W1 [

W3. Current taxation On profit before taxation (before policy change) (1 010000 x 30%); (850000 x 30%) Increase in closing inventories (120 000 [W1] x 30%)

20X5 1010000 100000

20X4 850000 (95000)

1110000

755000

303000 36000

255000

339000

255000

GAAP Handbook 2020: Volume 1

86 Or

20X5 1110000

Profit before tax IW21 Temporary differences: Opening inventories - accounting Opening inventories - SARS Closing inventories - accounting Closing inventories - SARS

195000 (175000) (450000) 450000

Taxable income Current tax at 30%

W4. Deferred tax

01/01/20X4 31112/20X4 31/12/20X5

Carrying amount 430000 195000 450000

Tax base 315000 175000 450000

20X4 755000 430000 (315000) (195000) 175000

1 130000

850000

339000

255000

Temporary difference 115000 20000

Decrease in liability in 20X4 (34 500 - 6 000) Decrease in liability in 20X5 (6 000 - 0)

Deferred tax liability 34500 6000

28500 6000

Note that as the new inventory value will be taken into account for tax purposes only from the 20X5 year-end onwards, deferred tax will arise in periods before 20X5. As soon as the new inventory value is used for tax purposes (end of 20X5), the deferred tax balance will reverse (i.e. the deferred tax balance

returns to zero). From that point onwards the change in policy will impact on current tax, as the new inventory value will be taken into account by SARS in the calculation of taxable income.

5.2.5.4 What if retrospective application is not practicable? When retrospective application of a change in accOllllting policy is required, it may happen that it is impracticable to determine either the period-specific effects (i.e. the effect for a specific period) or the cumulative effect of the change. This may happen, for example, when the required data have not been collected in prior periods and it is impossible to recreate the relevant information. Should the impracticability relate to period-specific effects, the earliest period for which retrospective application is practicable, should be determined. The necessary adjustment should then be made against the opening balance of each affected component of equity for that specific period, after which restatement will commence from that period onwards. For example, should an entity that is presenting its financial statements for 20X4 (and that provides comparative amounts relating to both 20X3 and 20X2 (i.e. comparatives for two years», decide to change its accounting policy, the ideal retrospective treatment would be to adjust the opening balance of equity at the beginning of 20X2 and then to restate both 20X2 and 20X3. It may however happen that the effect on the results for 20X2 is not knoWIl, although the cumulative effect at the end of 20X2 can be calculated. Should this be the case, an adjustment should be made against the opening balance of equity as at the beginning of 20X3, while the 20X3 amounts are then restated. No adjustments are however made to the 20X2 results. Should it happen that the effect on 20X3 is also not knoWIl, although the cumulative effect at the end of 20X3 can be calculated, an adjustment should be made against the opening balance of20X4, without any restatement of either 20X2 or 20X3.

87

Accounting policies, changes in accounting estimates and errors

Example 5.2: Change in accounting policy (retrospective to the extent practicable) Use the same information as in example 5.1, except that it is not possible to calculate the value of inventories at 31 December 20X3 on the first-in-first-out basis. The inventory values are thus as follows at 31 December: WA FIFO 20X3 20X4 20X5

R

R

315000 175000 330000

195000 450000

?

Required Disclose the above information in the statement of financial position, statement of changes in equity and statement of profit or loss and other comprehensive income of Bentleys Ltd for the year ended 31 December 20X5. Also provide the income tax expense note and the note on the change in accounting policy.

Example 5.2: Suggested answer As the first-in-first-out value of the inventories as at 31 December 20X3 is not known, it is not possible to calculate the effect of the change in policy on the 20X4 results (value of opening inventories for 20X4 not available). However, the cumulative effect on 1 January 20X5 is available and therefore the change in policy will be accounted for retrospectively, but only from 1 January 20X5 onwards.

Bentleys Ltd Statement of profit or loss and other comprehensive income for the year ended 31 December 20X5 Notes 20X5 20X4 R

Profit before tax [W2] Tax expense

R

1110000 (333000)

850000 (255000)

Profit I total comprehensive income for the year

777000

595000

Earnings per share (777 000 11 000 000); (595 000 11 000 000)

78 cents

60 cents

Bentleys Ltd Statement of changes in equity for the year ended 31 December 20X5 Share capital Notes R Balance on 31 December 20X3 1 000000 Total comprehensive income for the year: Profit for the year Dividends - 10 cents* per share

Retained earnings

Total

R

R

1 455000

2455000

595000 (100000)

595000 (100000)

1 000000

1 950000 14000

2950000 14000

Restated balance Total comprehensive income for the year: Profit for the year Dividends - 10 cents* per share

1 000000

1 964000

2964000

Balance on 31 December 20X5

1 000000

Balance on 31 December 20X4 Change in accounting policy [W1]

•

(100000/1000000)

2

777000 (100000) 2641000

777000 (100000) 3641000

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GAAP Handbook 2020: Volume 1

Bentleys Ltd Statement offinancial position as at 31 December 20X5 Assets Current assets Inventories

Liabilities Cutrent liabilities Current tax payable [W3[

20X5

20X4

R

R

450000

175000

36000

Bentleys Ltd Notes for the year ended 31 December 20X5

1.

Taxation SA normal taxation Current [W3[ Deferred [W4 [

20X5 R

20X4 R

339000 (6000)

255000

333000

255000

2. Change in accounting policy The company changed its accounting policy for the determination of the cost of inventories from the weighted average method to the first-in-first-out method. This will result in fairer presentation as it better reflects the physical flow of inventories. It is not possible to fully account for this change retrospectively, as the value of inventories cannot be determined on the first-in-first-out method on 31 December 20X3, with the result that the effect of the change on the profit for 20X4 cannot be determined. Consequently the change has been accounted for retrospectively from the beginning of the 20X5 financial year, with an adjustment of R14 000 against the opening balance of retained earnings. The effect of the change in policy on the results of 20X5 was as follows: 20X5 R Decrease in cost of sales [W1] 100000 I ncrease in taxation expense [W1] (30000)

70000

I ncrease in profit for the year

120000 (36000)

Increase in inventories Increase in current tax payable [W3] I ncrease in equity

84000

Adjustment against retained earnings at the beginning of 20X5 [W1 [

14000

Increase in earnings per share (70 000 11 000 000)

7 cents

WORKINGS W1. Change in policy

Original value (WA) Restated value (FIFO) Difference Taxation thereon at 30%

20X5 End (330000) 450000

Effect on 20X5 results (155000) 255000

20X5 Star! (175000) 195000

120000 (36000)

100000 (30000)

84000

70000

Effect on 20X4 results 140000

20X3 (315000)

?

?

20000 (6000)

?

?

?

?

14000

?

?

89

Accounting policies, changes in accounting estimates and errors W2. Profit before tax

Given Change in policy [W1 [

20X5 1010000 100000

20X4 850000

1110000

850000

Note that the profit for 20X4 is not restated as the period-specific effect for 20X4 is not known. W3. Current taxation On profit before taxation (before change in policy) (1 010000 x 30%); (850000 x 30%) Increase in closing inventories (120 000 [W1] x 30%)

Or Profit before tax [W2[ Temporary differences: Opening inventories - accounting Opening inventories - SARS Closing inventories - accounting Closing inventories - SARS

Current tax at 30%

31/12/20X3 31112/20X4 01/01/20X5 (Retained earnings adjustment) 31/12/20X5

255000

339000

255000

1110000

850000

195000 (175000) (450000) 450000

Taxable income

W4. Deferred tax

303000 36000

Carrying amount 315000 175000 195000 450000

Tax base 315000 175000 175000 450000

Decrease in liability in 20X5 (6 000 - 0)

315000 (315000) (175000) 175000

1 130000

850000

339000

255000

Temporary difference

20000

Deferred tax liability

6000

6000

Ifit is impracticable to determine the cumulative effect of the change at the beginning of the current period, the new policy should be applied prospectively from the earliest date practicable. This means that the new policy is applied only to those transactions and events occuning after a specific point. The cumulative adjustment relating to transactions and events occuning before that date is then disregarded. For example, should an entity that is presenting its financial statements for 20X4 (and that provides comparative amounts relating to both 20X3 and 20X2 (i.e. comparatives for two years)), decide to change its accOllllting policy, the ideal retrospective treatment would be to adjust the opening balance of equity at the beginning of 20X2 and then to restate bofu 20X2 and 20X3. However, it may happen that the cumulative effect at the end of20X2 (and consequently at the end of 20X3) is not knOWIl, but information is available of the effect of the change on transactions occuning after 20X2. Should this be the case, no adjustment is made to the opening balance of the 20X3 equity, although the results presented for 20X3 will be restated to reflect the new policy.

Example 5.3: Change in accounting policy (prospectively) Use the same information as in example 5.1, except that it is not possible to calculate the value of inventories at 31 December 20X4 and 20X3 on the first-in-first-out basis. The inventory values are thus as follows at 31 December:

90

GAAP Handbook 2020: Volume 1 WA R 315000 175000 330000

20X3 20X4 20X5

FIFO R ? ?

450000

Required Disclose the above information in the statement of financial position, statement of changes in equity and statement of profit or loss and other comprehensive income of Bentleys Ltd for the year ended 31 December 20X5. Also provide the income tax expense note and the note on the change in accounting policy.

Example 5.3: Suggested answer As the first-in-first-out value of the inventories as at 31 December 20X4 is not known, it is not possible to determine the cumulative effect on 1 January 20X5. Accordingly it is not possible to account for the change in policy retrospectively, but it will be accounted for prospectively in the 20X5 financial year. This means that the closing inventories on 31 December 20X5 will be valued on the first-in-first-out basis, while the opening inventories on 1 January 20X5 will still be valued on the weighted average basis. No adjustment will be made against the opening balance of retained earnings on 1 January 20X5. Bentleys Ltd

Statement of profit or loss and other comprehensive income for the year ended 31 December 20X5 Notes 20X5 R Profit before tax [W2[ 1 130000 (339000) Tax expense Profit I total comprehensive income for the year

791 000

Earnings per share (791 000/1 000000); (595 000 11 000 000)

79 cents

20X4 R 850000 (255000) 595000

60 cents

Bentleys Ltd

Statement of changes in equity for the year ended 31 December 20X5 Share capital Notes R Balance on 31 December 20X3 1 000000 Total comprehensive income for the year: Profit for the year Dividends - 10 cents* per share Balance on 31 December 20X4 Total comprehensive income for the year: Profit for the year Dividends - 10 cents* per share

1 000000

Balance on 31 December 20X5

1 000000

•

(100000/1000000)

Retained earnings R 1 455000 595000 (100000) 1 950000 791 000 (100000) 2641000

Total R 2455000 595000 (100000) 2950000 791 000 (100000) 3641000

91

Accounting policies, changes in accounting estimates and errors Bentleys Ltd Statement offinancial position as at 31 December 20X5 Assets

Current assets Inventories Liabilities Cutrent liabilities Current tax payable [W3[

20X5 R

20X4 R

450000

175000

36000

Bentleys Ltd Notes for the year ended 31 December 20X5 20X5 R

1.

Taxation SA normal taxation Current [W3[

20X4 R

339000

255000

339000

255000

2. Change in accounting policy The company changed its accounting policy for the determination of the cost of inventories from the weighted average method to the first-in-first-out method. This will result in fairer presentation as it better reflects the physical flow of inventories. It is not possible to account for this change retrospectively, as the value of inventories cannot be determined on the first-in-first-out method on 31 December 20X4. Consequently the change has been accounted for prospectively from the end of the 20X5 financial year without any adjustment against the opening balance of retained earnings. The effect of the change in policy on the results of 20X5 was as follows: 20X5 R 120000 (36000)

Decrease in cost of sales [W1] Increase in taxation expense [W1] I ncrease in profit for the year

84000

Increase in inventories Increase in current tax payable [W3]

120000 (36000)

I ncrease in equity

84000

Increase in earnings per share (84 000 11 000 000)

8 cents

WORKINGS W1. Change in policy

Original value (WA) Restated value (FIFO) Difference Taxation thereon at 30%

20X5 (330000) 450000

Effect on 20X5 results (155000)

20X4 (175000)

Effect on 20X4 results 140000

20X3 (315000)

?

?

?

?

120000 (36000)

?

?

?

?

?

?

?

?

84000

?

?

?

?

GAAP Handbook 2020: Volume 1

92 W2. Profit before tax Given Change in policy [W1 [

W3. Current taxation On profit before taxation (before policy change) (1 010000 x 30%); (850000 x 30%) Increase in closing inventories (120 000 [W1] x 30%)

Or Profit before tax [W21 Temporary differences: Opening inventories - accounting Opening inventories - SARS Closing inventories - accounting Closing inventories - SARS Taxable income Current tax at 30%

20X5 1010000 120000

20X4 850000

1 130000

850000

303000 36000

255000

339000

255000

1 130000 175000 (175000) (450000) 450000

850000 315000 (315000) (175000) 175000

1 130000

850000

339000

255000

5.2.5.5 Change in accounting policy from cost model to revaluation model It is important to note that although the initial application of a policy to revalue property, plant and

equipment or intangible assets qualifies as a change in accOllllting policy, it should be aCcOllllted for as a normal revaluation and not as a change in accOllllting policy.

5.2.6 Disclosure requirements for changes in accounting policies Disclosures regarding changes in accOllllting policies need only be presented in the year of the change and not in subsequent periods, and consist of the following:

5.2.6.1

Initial adoption of standard/interpretation

When a change in accOllllting policy results from the initial application of an accounting standard or an interpretation, the following should be disclosed: • the title of the standard or interpretation; • when applicable, that the change in accounting policy is made in accordance with transitional provIsIOns; • the nature of the change in accounting policy; • when applicable, a description of the transitional provisions; • when applicable, the transitional provisions that might have an effect on future periods; • for the current period and each prior period presented, to the extent practicable, the amount of the adjustment: - for each financial statement line item affected; and - for basic and diluted earnings per share, if presented; • the amount of the adjustment relating to periods before those presented, to the extent practicable; and • if retrospective application is impracticable for a particular prior period, or for periods before those presented, the circumstances that led to the existence of that condition and a description of how and from when the change in accounting policy has been applied.

Accounting policies, changes in accounting estimates and errors

93

5.2.6.2 Voluntary change With a vohllltary change in accounting policy, the following should be disclosed: • the nature of the change in accounting policy; • the reasons why applying the new accounting policy provides reliable and more relevant information; • for the current period and each prior period presented, to the extent practicable, the amount of the adjustment: - for each financial statement line item affected; and - for basic and diluted earnings per share, if presented; • the amount of the adjustment relating to periods before those presented, to the extent practicable; and • if retrospective application is impracticable for a particular prior period, or for periods before those presented, the circumstances that led to the existence of that condition and a description of how and from when the change in accounting policy has been applied. Refer to examples 5.1 to 5.3 for an illustration of these disclosure requirements.

5.2.6.3 New standard or interpretation not yet applied When an entity has not applied a new standard or interpretation that has been issued but is not yet effective, the entity should disclose• this fact; and • known or reasonably estimable information relevant to assessing the possible impact that application of the new standard or interpretation will have on the entity's financial statements in the period of initial application.

5.3 Changes in accounting estimates 5.3.1

Change in accounting estimate - definition

As a result of the uncertainties inherent in business activities, many items in financial statements cannot be measured with precision and therefore need to be estimated. Estimation involves judgements based on the latest available, reliable information. For example, estimates may be required of • allowances for expected credit losses; • inventory obsolescence; • the fair value of financial assets or financial liabilities; • the useful lives of, or expected pattern of consumption of the future economic benefits embodied in depreciable assets (i.e. depreciation method); and • warranty obligations. An estimate may need revision if changes occur in the circumstances on which the estimate was based or as a result of new information or more experience. A change in accounting estimate is thus an adjustment of the carrying amount of an asset or a liability, or of the amount of the periodic consumption of an asset (i.e. depreciation or amortisation), that results from the assessment of the present status of, and expected future benefits and obligations associated with assets and liabilities. Changes in accounting estimates result from new information or new developments and, accordingly, are not corrections of errors. Occasionally it may happen that there is difficulty distinguishing between a change in accounting policy and a change in an accounting estimate. Should this happen, the change is treated as a change in an accounting estimate.

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GMP Handbaak 2020: Va/ume 1

5.3.2 Accounting treatment of a change in accounting estimate The effect of a change in an accOllllting estimate is recognised prospectively by including it in profit or loss in• the period of the change, if the change affects that period only; or • the period of the change and future periods, if the change affects both. Prospective recognition of the effect of a change in an accOllllting estimate means that the change is applied to transactions from the date of the change in estimate onwards. (Note that the date of the change in estimate refers to the beginning of the current financial year.) A change in an accOllllting estimate may affect only the current period's profit or loss, or the profit or loss of both the current period and future periods. For example, a change in the estimate of the amollllt of expected credit losses affects only the current period's profit or loss and therefore is recognised in the current period. However, a change in the estimated useful life or depreciation method of a depreciable asset affects depreciation expense for the current period and for each future period during the asset's remaining useful life. In both cases, the effect of the change relating to the current period is recognised as income or expense in the current period. The effect, if any, on future periods is recognised as income or expense in those future periods. Should a change in an accOllllting estimate give rise to changes in assets and liabilities without affecting equity (for example an increase in a dismantling provision which is adjusted for against the cost of the related asset), or relate to an item of equity (for example a revaluation reserve), the change should be accounted for by adjusting the carrying amount of the related asset, liability or equity item at the date of the change. It is suggested that these types of adjustments need not be accounted for from the beginning of the current year - instead they should be accounted for at the actual date of the change in estimate, which could be at any stage during the financial year.

5.3.3 Disclosure requirements of changes in accounting estimates The following should be disclosed in respect of changes in accounting estimates: • the nature of the change; • the amount of the change; • the effect on future periods if practicable to estimate - or else a statement that the future effect is impracticable to estimate.

Example 5.4: Change in accounting estimate Tyrol Ltd, a manufacturer of pharmaceutical products, was incorporated on 1 January 20X2. All the company's property, plant and equipment were purchased on this date and were available for use immediately. The following figures with regard to property, plant and equipment were extracted from the company's statement of financial position at 31 December 20X4: Accumulated Carrying amount depreciation Cost R'OOO R'OOO R'OOO Land 900 900 Buildings (used in a direct process of manufacture) 2400 144 2256 Plant and machinery 1 750 896 854 Motor vehicles 610 312 298 5660

1296

4364

The company has always depreciated its plant and machinery and motor vehicles at 20% per annum on the reducing balance basis. However, at the end of 20X5 the directors of the company decided to write these assets off on the straight-line basis over their remaining estimated useful lives, as from 1 January 20X5.

95

Accounting policies, changes in accounting estimates and errors On 31 December 20X5 the remaining useful lives of the assets were estimated at: Plant and machinery 2 years Motor vehicles 1 year Depreciation is recognised on buildings at 2% per annum on a straight-line basis.

Required Disclose the above information in the following notes of Tyrol Ltd for the year ended 31 December 20X5: Accounting policy Profit before tax.

Example 5.4: Suggested answer Tyrol Ltd Notes for the year ended 31 December 20X5

1. Accounting policies 1.1

Properly, plant and equipment and depreciation Property, plant and equipment are disclosed at cost less accumulated depreciation except for land which is not depreciated and is consequently carried at cost. Buildings are depreciated on a straight-line basis at 2% per annum. Plant, machinery and motor vehicles are depreciated on a straight-line basis over their estimated remaining useful lives, which were as follows on 1 January 20X5: Plant and equipment Vehicles

3 years 2 years

This represents a change in accounting estimate as these assets were previously written off at 20% per annum on the reducing balance basis. 2. Profit before tax 20X5 R'OOO

20X4 R'OOO

Profit before tax is shown after taking the following items into account: 503 350 Depreciation [W1 [ Included in depreciation for 20X5 is a change in estimate (increase in depreciation) of R214 000 (120000 + 94 000) [W1], arising from the decision to depreciate plant, machinery and vehicles on the straight-line basis in future instead of the reducing balance basis. This change will result in a decrease of depreciation in future periods, amounting to R214 000. WORKINGS

W1. Depreciation 20X5 Plant and machinery 20X4 (1 750 x 80% x 80% x 20%) or (896 x 20% 180%) 20X5 (8961 (2+1)) Old basis (896 x 20%) Change in estimate Motor vehicles 20X4 (610 x 80% x 80% x 20%) or (312 x 20% 180%) 20X5 (3121 (1+1)) Old basis (312 x 20%) Change in estimate Buildings 20X4 and 20X5 (2 400 x 2%)

20X4 224

299

em 120

78 156

[ill 94

48

48

503

350

96

GMP Handbaak 2020: Va/ume 1

5.4 Errors Errors can arise in respect of the recognition, measurement, presentation or disclosure of elements of financial statements. Financial statements do not comply with IFRS if they contain either• material errors; or • immaterial errors made intentionally to achieve a particular presentation of an entity's financial position, financial performance or cash flows. Errors discovered in the current period (and relating to the current period) are corrected before the financial statements are authorised for issue and therefore do not require special treatment or disclosure. Errors are however sometimes not discovered lllltil a subsequent period (called prior period errors - refer to 5.4.1) and may need special treatment depending on the materiality thereof.

5.4.1 Prior period errors Prior period errors are omissions from, and misstatements in, the entity's financial statements for one or more prior periods arising from a failure to use (or misuse of) reliable information that • was available when financial statements for those periods were authorised for issue; and • could reasonably be expected to have been obtained and taken into accOllllt in the preparation and presentation of those financial statements. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud. It is important to note that a change in an accounting estimate is not a correction of an error, as a change in estimate results from new information, whereas the correction of an error relates to information that was available in prior periods. For example, a gain or loss recognised on the outcome of a contingency is a change in estimate (new information) and not an error.

5.4.2 Material prior period errors Information omitted or misstated in prior periods is material if it could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements. Materiality depends on the nature and magnitude of the information omitted or misstated. An entity should correct material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery.

5.4.3 Retrospective correction of errors Retrospective correction of a material prior period error involves • restating the comparative amounts for the prior period(s) presented in which the error occurred; or • if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented. Note that lAS 1 requires an entity to present a statement of financial position as at the begiIliling of the preceding period whenever a prior period error is restated retrospectively, provided the restatement has a material effect on the information in that statement of financial position. This means that, if financial statements are prepared for 20X5, the entity needs to present a statement of financial position as at the beginning of 20X4 in addition to the statements as at the end of 20X5 and 20X4.

97

Accounting policies, changes in accounting estimates and errors

Example 5.5: Prior period error (retrospectively) The accountant of Burano Ltd prepared the following draft statement of profit or loss and other comprehensive income and statement of changes in equity for the year ended 30 June 20X6: Statement of profit or loss and other comprehensive income for the year ended 30 June 20X6 20X6 20X5 Profit from operations (fully taxable) I nterest paid

Profit before tax I ncome tax expense Profit I total comprehensive income for the year Earnings per share Dividend per share

R

R

5 406 500 (424050)

3 920 000 (57150)

4982450 (1 494735)

3862850 (1 158855)

3487715

2703995

349 cents 30 cents

270 cents 20 cents

Statement of changes in equity for the year ended 30 June 20X6

Share capital

Retained earnings

R

R

Balance on 30 June 20X4 Total comprehensive income for the year Dividends

1 000000

12710000 2703995 (200000)

Balance on 30 June 20X5 Total comprehensive income for the year Dividends

1 000000

15213995 3487715 (300000)

Balance on 30 June 20X6

1 000000

18401 710

Additional information 1. The company commenced with the construction of its new factory premises on 2 January 20X4. All construction activities are expected to be completed by 31 December 20X6 on which date the factory premises will be brought into use. 2. After the draft financial statements for the year ended 30 June 20X6 had been prepared, the financial director of the company discovered that the accountant incorrectly did not capitalise borrowing costs on the factory premises, as he mistakenly did not regard the factory premises as a qualifying asset. 3. Borrowing costs incurred and amounts that should have been capitalised are as follows: 20X6 20X5 20X4

R

R

R

Total borrowing costs incurred during the year 424050 57150 160200 Borrowing costs that should have been capitalised 263050 57150 144000 4. Depreciation on the factory premises will be written off at 2% per annum on the straight-line basis. 5. Assume a tax rate of 30%. SARS indicated that the tax assessments for 20X5 and 20X4 will be reopened, as the borrowing cost (pre-production interest) was incorrectly granted as a deduction when it was incurred. Assume for the purposes of this example that pre-production interest is granted as a tax deduction when the underlying asset is taken into use. 6. Assume that the share capital consists of 1 000000 shares.

Required Prepare the statement of profit or loss and other comprehensive income and statement of changes in equity (only the retained earnings column) of Burano Ltd, together with all the relevant notes thereto (excluding accounting policy notes), for the year ended 30 June 20X6.

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GAAP Handbook 2020: Volume 1

Example 5.5: Suggested answer Burano Ltd Statement of profit or loss and other comprehensive income for the year ended 30 June 20X6 20X6 20X5 Notes R R Profit from operations 5 406 500 3 920 000 Interest paid (424 050 - 263 050); (57 150 - 57150) 2 (161 000) Profit before tax Income tax expense [W1]

3

Profit I total comprehensive income for the year Earnings per share

5245500 (1 573650)

3920000 (1 176000)

3671 850

2744000

367 cents

274 cents

Burano Ltd Statement of changes in equity for the year ended 30 June 20X6 Notes Balance on 30 June 20X4 Correction of prior period error (144 000 x 70%)

4

Retained earnings R 12710000 100800

Restated balance Total comprehensive income for the year: Profit for the year (restated) Dividends - 20 cents per share

12810800

Balance on 30 June 20X5 Total comprehensive income for the year: Profit for the year Dividends - 30 cents per share

15354800

Balance on 30 June 20X6

18726650

2744000 (200000)

3671 850 (300000)

Note: If this example required a statement of financial position, this statement would be presented for three dates, namely 30 June 20X6, 30 June 20X5 and 1 July 20X4.

Burano Ltd Notes for the year ended 30 June 20X6

2. Finance costs

Total interest paid for the year Less: Capitalised

20X6 R

20X5 R

424050 (263050)

57150 (57 150)

161 000

3. Income tax expense

SA normal tax Current [W1 [

20X6 R

20X5 R

1 573650

1176000

Accounting policies, changes in accounting estimates and errors

99

4. Correction of prior period error The company did not capitalise borrowing costs on its factory premises, which is regarded as a qualifying asset. This error has been corrected retrospectively and comparative figures have been appropriately restated. The effect of the correction of the error on the results for 20X5 is as follows: 30/6/20X5 1/7/20X4 R R Decrease in finance cost 57150 Increase in income tax expense (17145) 40005

Increase in profit Increase in property, plant and equipment (144000 + 57150) Increase in current tax payable

201 150 (60345)

144000 (43200)

Increase in equity

140805

100800 100800

Adjustment against retained earnings at the beginning of 20X5 Increase in earnings per share (274 - 270)

4 cents

Note: With a prior period error, the effect on prior years should be disclosed, but not the effect on the current period. WORKINGS

W1. Current tax 20X6

20X5

R

R

Profit before taxation

5245500

3920000

Current taxation at 30%

1 573650

1176000

5.4.4 If retrospective correction is not practicable When retrospective correction of a material prior error is required, it may happen that it is impracticable to determine either the period-specific effects (i.e. the effect for a specific period) or the cumulative effect of the error. Should the impracticability relate to period-specific effects, the earliest period for which retrospective restatement is practicable, should be determined. The necessary adjustments should then be made against the opening balance of each affected component of equity for that specific period, after which restatement will commence from that period onwards.

Example 5.6: Prior period error (retrospective to the extent practicable) Use the same information as in example 5.5, except that the information in point 3 is as follows: 20X6 20X5 20X4

R

R

R

Total borrowing costs incurred during the year 424050 57150 160200 Borrowing costs that should have been capitalised 263050 ? ? Assume that the total borrowing costs to be capitalised during 20X4 and 20X5 amount to R201 150, but it is not possible (Le. it is impracticable) to allocate this amount between 20X4 and 20X5. [The cumulative effect of the prior period error is thus available, but not the effect in each period.]

Required Prepare the statement of profit or loss and other comprehensive income and statement of changes in equity (only the retained earnings column) for the year ended 30 June 20X6. Also show the note that deals with the correction of the error.

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GAAP Handbook 2020: Volume 1

Example 5.6: Suggested answer Burano Ltd Statement of profit or loss and other comprehensive income for the year ended 30 June 20X6 20X6 20X5 R R Profit from operations 5 406 500 3 920 000 Interest paid (424 050 - 263 050) (161000) (57150) Profit before tax Income tax expense

Profit I total comprehensive income for the year Earnings per share

5245500 (1 573650)

3862850 (1 158855)

3671 850

2703995

367 cents

270 cents

Burano Ltd Statement of changes in equity for the year ended 30 June 20X6 Notes Balance on 30 June 20X4 Total comprehensive income for the year: Profit for the year Dividends - 20 cents per share Balance on 30 June 20X5 Correction of prior period error (201 150 x 70%)

Retained earnings R 12710000

2703995 (200000) 4

15213995 140805

Balance on 30 June 20X5 (Restated balance) Total comprehensive income for the year: Profit for the year Dividends - 30 cents per share

15354800

Balance on 30 June 20X6

18726650

3671 850 (300000)

Burano Ltd Notes for the year ended 30 June 20X6

4. Correction of prior period error The company did not capitalise borrowing costs on its factory premises, which is regarded as a qualifying asset. It is not possible to fully account for the correction of this error retrospectively, as the annual effect on the results for 20X4 and 20X5 cannot be determined. Consequently the error has been corrected retrospectively from the beginning of the 20X6 financial year, with an adjustment of R140 805 against the opening balance of retained earnings. [Note: With a prior period error, only the effect on prior years should be disclosed. As comparatives were not restated, there is no disclosure apart from the adjustment against opening retained earnings.]

If it is impracticable to determine the cumulative effect of the error at the beginning of the current period, comparative information should be restated prospectively from the earliest date practicable. The cumulative restatement of assets, liabilities and equity arising before that specific date, is then disregarded. Note: The above treatment is identical to the treatment of a change in accounting policy where retrospective application of such a change is impracticable.

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Accounting policies, changes in accounting estimates and errors

Example 5.7: Prior period error (prospectively) Use the same information as in example 5.5, except that the information in point 3 is as follows: 20X6 20X5 20X4

R

R

R

Borrowing costs incurred during the year 424050 57150 160200 Borrowing costs that should have been capitalised 263050 57 150 ? Assume that it is not possible (i.e. it is impracticable) to calculate the borrowing costs that should have been capitalised during 20X4. The cumulative effect of the prior period error thus cannot be determined, but the effect per period is available from 20X5 onwards.

Required Prepare the statement of profit or loss and other comprehensive income and statement of changes in equity (only the retained earnings column) for the year ended 30 June 20X6. Also show the note dealing with the correction of the error.

Example 5.7: Suggested answer Burano Ltd Statement of profit or loss and other comprehensive income for the year ended 30 June 20X6 20X6 20X5 R R Profit from operations 5 406 500 3 920 000 Interest paid (424 050 - 263 050); (57 150 - 57150) (161 000) 5245500 (1 573650)

3920000 (1 176000)

Profit I total comprehensive income for the period

3671 850

2744000

Earnings per share

367 cents

274 cents

Profit before tax Income tax expense

Burano Ltd Statement of changes in equity for the year ended 30 June 20X6 Notes Balance on 30 June 20X4 Total comprehensive income for the year: Profit for the year (restated) Dividends - 20 cents per share

4

Retained earnings R 12710000

2744000 (200000)

Balance on 30 June 20X5 Total comprehensive income for the year: Profit for the year Dividends - 30 cents per share

15254000

Balance on 30 June 20X6

18625850

3671 850 (300000)

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Burano Ltd

Notes for the year ended 30 June 20X6

4. Correction of prior period error The company did not capitalise borrowing costs on its factory premises, which is regarded as a qualifying asset. It is not possible to account for the correction of this error retrospectively, as it is not possible to determine the cumulative effect of the change at the beginning of 20X6. Consequently the correction was done prospectively from the beginning of 20X5 without any adjustment against the opening balance of equity for 20X5. The effect of the correction on the 20X5 results is as follows: 20X5 R

Decrease in finance cost Increase in income tax expense Increase in profit Increase in property, plant and equipment Increase in current tax payable

57150 (17145) 40005 57150 (17145)

Increase in equity

40005

Increase in earnings per share (274 - 270)

4 cents

Note: Because the effect of the correction of the error in respect of 20X4 cannot be determined, it is not possible to calculate the cumulative effect of the change at the beginning of 20X6. (It differs from the previous example w here the cumulative effect w as given in the question.) As the cumulative effect is not known, the correction of the error must be applied prospectively.

5.4.5 Disclosure requirements of correction of prior period errors Disclosures regarding correction of prior period errors need only be presented in the year of the correction and not in subsequent periods, and consist of the following: • the nature of the prior period error; • for each prior period presented, to the extent practicable, the amollllt of the correction: -

for each financial statement line item affected; and

-

for basic and diluted earnings per share, if presented;

• the amollllt of the correction at the beginning of the earliest prior period presented; and • if retrospective restatement is impracticable for a particular prior period, the circumstances that led to the existence of that condition and a description of how and from when the error has been corrected. Refer to examples 5.5 to 5.7 for an illustration of these disclosure requirements.

103

Accounting policies, changes in accounting estimates and errors

5.5 Summary of lAS 8, Accounting policies, estimates and errors Selection of accounting policy Existing

.

standa~ I interpretation

t.

No existing standard I interpretation

t

.

Use PoliCY per standard I Interpretation

Develop policy with reference to •

Similar standards I interpretations

•

The Conceptual Framework (2018)

Change in accounting policy

,.

Voluntary change - more relevant or reliable info

Compulsory cha:e - new standard

t .

Apply change retrospectively, unless

~

+

standard contains No transitional arrangements transitional arrangements in standard

t

Period specific effects impracticable to determine

t

t

Apply these arrangements Apply change retrospectively

Apply retrospectively from earliest date practicable

Change in estimate

Change in ass! and liability or

•

I

Cumulative effect impracticable to determine Apply prosP!ivelY from earliest date practicable

.

Other changes in estimates

t

Change in equity item

t

Adjust carrying amount of asset, liability

Recognise change prospectively in current period only,

or equity item in period of change

or current and future periods, depending on periods affected

•

Prior oeriod error Correct retrospectively, unless

+ t

I

•t

Period specific effects impracticable to determine

Cumulative effect impracticable to determine

Correct retrospectively from earliest date practicable

Correct prospectively from earliest date practicable

6

Events after the reporting period lAS 10 (Effective date 1 January 2005)

6.1

Introduction

Events after the reporting period are those events, both favourable and llllfavourable, that occur between the reporting date and the date on which the financial statements are authorised for issue. As a rule the date on which financial statements are authorised for issue is the date on which the financial statements are approved by the board of directors Of, where management is required to submit the entity's financial statements to a supervisory board (comprising solely of non-executives), the date on which management authorises the statements for issue to such supervisory board. The date of issue does not imply the date of completion of the financial statements, the date that the statements are made available to shareholders, the date when profit and other financial information are annOllllced, the date of approval by shareholders, or the date the financial statements are filed with a regulatory body (e.g. the Registrar of Companies). lAS 10 is concerned with, firstly, those events that come to light which provide additional information about conditions that existed at the reporting date and, secondly, events that are indicative of conditions that arose subsequent to the reporting date but are relevant to users in assessing the future prospects of the entity, even though these events have no effect on the amounts recognised in the financial statements. From the previous paragraph it is clear that there are two different types of events after the reporting date. These events are commonly referred to as adjusting and non-adjusting events.

6.2

Adjusting events

Adjustments to amounts recognised in the financial statements, or recognition of amounts that were not previously recognised, are required for events occuning after the reporting date that provide further evidence of conditions that existed at the reporting date. An example of an adjusting event is where evidence that a trade debtor was insolvent at reporting date is received after the end of the reporting period. This would require that the amount owed by the debtor be written off, i.e. the financial statements would be adjusted to reflect the write-off of the debtor. This would however not be the case if the insolvency of the debtor was caused by, for instance, a crash in the stock market that occurred after the reporting date. In this case, the condition (insolvency) did not exist at the reporting date. Additional examples of possible adjusting events are as follows: • Assets: The determination after reporting date of the cost of assets purchased or the proceeds from assets sold before the reporting date. • Inventories: The proceeds from sales after the reporting date providing evidence regarding the net realisable value of inventories atthe reporting date. • Obligations: A court finding confirming an obligation at the reporting date (requiring an adjustment to a provision, or a provision to be created instead of merely disclosing a contingent liability), provided that the court case arises from events that occurred before reporting date. • Profit-sharing or bonus payments: Obligations existing at reporting date (as a result of events occuning before such date) but the amount of which is only determined after the reporting date. 105

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• Fraud or errors: The discovery of fraud or errors, which render the financial statements incorrect. • Investments: Evidence that an investment was impaired at reporting date. • Claims: AmOllllts received or receivable in respect of insurance claims that were in the course of negotiation at the reporting date. • Returns by customers: Returns after reporting date may indicate that products sold before reporting date were defective, requiring a provision to be raised for possible returns; the fact that defective products were sold before reporting date may also impact on the net realisable value of inventories should any of the products returned (or similar products) have been included in inventories at reporting date.

6.3

Non-adjusting events

Non-adjusting events are those events that are indicative of conditions that arose after the reporting date. Accordingly, amOllllts recognised in an entity's financial statements should not be adjusted for the effect of non-adjusting events since the related conditions did not exist at the reporting date. The following are examples of non-adjusting events that may occur between the reporting date and the date when the financial statements are authorised for issue: • A decline in the fair value of investments after reporting date. • Losses of assets as a result of fire or floods that occurred after reporting date. • Expropriation of assets after reporting date. • Acquisitions and disposals of subsidiaries after reporting date. • Issue of shares and debentures after reporting date. • Purchases and sales of assets after reporting date. • Classification of assets as held for sale after reporting date. • AIlilouncing a plan to discontinue an operation. • New trading activities or an expansion of existing trading activities after reporting date. • Changes in the rate of foreign exchange after reporting date. • Changes in the tax rate after reporting date. • AIlilouncing, or commencing the implementation of a maj or restructuring after reporting date. • Entering into significant commitments after reporting date, for example by issuing guarantees. • Strikes and other labour disputes after reporting date. • Commencing major litigation arising solely out of events that occurred after reporting date. Although amounts in the financial statements should not be adjusted for the effect of non-adjusting events, the materiality and importance of these events to users of the financial statements may warrant certain disclosures (refer to section 6.5.1).

6.4 6.4.1

Specific issues Dividends

Dividends declared after the reporting date to holders of equity instruments may not be recognised as a liability at the reporting date as there is no obligation at this date to pay the dividends (also refer to the chapter on Provisions, Contingent Assets and Contingent Liabilities). Such dividends are disclosed in the notes to the financial statements in accordance with lAS 1, which requires that both the total dividend and the amount per share should be disclosed. It is important to note that an entity's past practice of paying dividends does not give rise to a constructive obligation and therefore still does not warrant the recognition of a liability.

Events after the reporting period

6.4.2

107

Going concern

The importance of the going concern assumption necessitates a departure from the flllldamental rules in respect of adjusting and non-adjusting events if events or conditions emerge that may cast significant doubt upon the entity's ability to continue as a going concern, even if these events or conditions only came into being after the reporting date. lAS 10.14 rules that an entity should not prepare its financial statements on a going concern basis if management determines after the reporting date either that it intends to liquidate the entity or to cease trading, or that it has no realistic alternative but to do so. The going concern assumption is no longer appropriate in these circumstances and, as a result, a flllldamental change in the basis of accollllting is required. If financial statements are not prepared on a going concern basis or if there is doubt regarding an entity's ability to continue as a going concern, lAS 1 requires specific disclosures (refer to chapter 2).

6.5 6.5.1

Financial statement presentation lAS 10 requirements

The disclosure requirements of lAS 10 are as follows: General disclosures

• The date when the financial statements were authorised for issue; • Who gave that authorisation; and • That the entity's owners or others have the power to amend the financial statements after they have been issued, should this be the case. Adjusting events (new information about conditions existing at the reporting date)

• Update the relevant amollllts and other disclosures to reflect the new information. Non-adjusting events (information about conditions that arose after the reporting date)

If non-adjusting events after the reporting period are material, non-disclosure could influence the economic decisions that users make on the basis of the financial statements. As a result the following information should be provided in respect of each material category of non-adjusting event after the reporting period: • The nature of the event. • An estimate of the financial effect or a statement that such an estimate cannot be made.

6.5.2

IFRIC 17 requirements

In terms of IFRIC 17, if an entity declares a dividend after the end of the reporting period but before the financial statements are authorised for issue and the dividend takes the form of a distribution of a non-cash asset, the following should be disclosed: • Nature of the non-cash assetto be distributed; • Carrying amollllt of the non-cash asset to be distributed at the end of the reporting period; • Fair value of the non-cash asset at the end of the reporting period if it is different from the carrying amount at that date; and • Information about the methods used to measure the fair value of the asset.

6.5.3

Disclosure example

A Ltd had a debtor with an outstanding balance of R200000 at its financial year-end of 31 December 20X1. On 15 February 20X2 the debtor, who already experienced financial difficulties at 31 December 20X1, was declared insolvent. It is estimated that creditors will receive 25 cents in the rand. During January 20X2 a flood destroyed inventories to the value of R100 000. Assume that the

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normal taxation rate is 30%. The financial statements will be authorised for issue by the board of directors on 15 March 20X2. Assume that the above amounts are material. Relevant extracts from the company's adjusted financial statements are as follows: A Ltd Statement of profit or loss and other comprehensive income for the year ended 31 December 20Xl Other expenses (RXX + R 150 000) I ncome tax expense (RXX - R45 000)

R XX XX

Statement offinancial position as at 31 December 20X1 Assets Current assets Receivables (RXX - R 150 000)

XX

Equity and liabilities

Equity Retained earnings (RXX - Rl05 000)

XX

Current liabilities Taxation (RXX - R45 000)

XX

A Ltd Notes for the year ended 31 December 20X1

5. Events after the reporting period The financial statements were authorised for issue by the board of directors on 15 March 20X2 and are subject to the approval of the shareholders at the annual general meeting. The following nonadjusting event took place after the reporting period: • During January 20X2, a flood destroyed inventories to the value of R100 000. The effect is a reduction in profit before tax of R100 000 in the next financial year.

Events after the reporting period

6.6

109

Summary of lAS 10, Events after the reporting period Definition

Events after the reporting period are those events, both favourable and unfavourable, that occur between the reporting date and the date on which the financial statements are authorised for issue.

Provide more evidence of conditions that existed at the reporting date.

Indicative of conditions that arose after the reporting date.

ADJUSTING EVENT

NON-ADJUSTING EVENT

Update the relevant amounts and other disclosures to reflect the new information.

r-

For non-adjusting events that are material, disclose in the notes to the financial statements •

the nature of the event;

•

an estimate of the financial effect

S

P E

C I

F I

GoinQ concern An entity should not prepare its financial statements on a going concern basis if management determines after the reporting date that it intends to either-

• • •

liquidate the entity; or cease trading; or that it has no realistic alternative but to do so.

C

I

Dividends

S

Declared after the reporting date-

s

• • •

U

E

S '--

Are not a present obligation at reporting date therefore do not recognise at reporting date but disclose in a note to the financial statements (lAS 1).

7

Fair value measurement IFRS 13 (Effective date 1 January 2013)

7.1 Introduction Fair value, whether for measurement on initial recognition, subsequent measurement or disclosure purposes, is a concept cornmon to a large number of accOllllting standards. IFRS 13, Fair Value Measurement, defines fair value, provides guidance on determining it and sets out disclosure requirements specific to fair values. The standard is applied whenever another standard requires or permits fair value measurements or disclosures, with the following exceptions: • Both the measurement and disclosure requirements do not apply to: - share-based payment transactions that fall within the scope ofIFRS 2, Share-based Payments; - leasing transactions within the scope ofIFRS 16, Leases; and -

measurements that are closely related to fair value, but are not themselves fair value measurements. This would include measurements such as net realisable value in lAS 2, Inventories.

• Only the disclosure requirements do not apply to: - plan assets of defined benefit plans that are measured at fair value in accordance with lAS 19, Employee Benefits; and -

assets for which the recoverable amollllt is fair value less costs of disposal in accordance with lAS 36, Impairment ofAssets.

Note that IFRS 13 does apply to measurements derived from fair value (such as fair value less costs to sell or costs of disposal) and that the requirements of IFRS 13 are applied regardless of whether fair value is related to initial recognition or subsequent measurement.

7.2 Definition of fair value The standard defines fair value as • the price • that would be received to sell an asset or paid to transfer a liability • in an orderly transaction • between maIket participants • at the measurement date. The components of the definition are discussed in detail in the following sections.

7.2.1

An asset or a liability

Any fair value measurement is particular to an asset or liability and therefore an entity should take into accollllt all characteristics that market participants would take into account when pricing the asset or liability in question. The standard gives the following examples of characteristics that should be taken into accollllt when determining fair value:

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The condition and location of the asset. The simplest example where the condition and location of an asset may be important is that of property. A well-preserved property in a desirable part of town would clearly have a fair value that differs from that of an othe:rnrise identical property that is nmdown or located in a less desirable area.

• Restrictions on the sale or use afthe asset. Legallirnitations on the uses to which an asset may be put, could impact on the fair value that market participants would be willing to pay. Zoning restrictions on a property is a good example.

The asset or liability measured at fair value could be a stand-alone asset or liability, or part of a group of assets and/or liabilities, such as a cash-generating unit. It is important to note that fair values may sometimes be available for an asset or liability individually as well as part of a group. In such a case fair value is determined on an individual basis when other accOllllting standards require the asset or liability to be recognised separately. Similarly fair value is determined on a group basis when other accounting standards require the assets and/or liabilities to be aggregated.

7.2.2

A transaction

Fair value measurement requires that an entity assumes the disposal of an asset or the transfer of a liability under current market conditions at the measurement date, which is an assumed transaction that takes place on that date. An entity should determine the fair value measurement • with reference to the principal market for the assetlliability; or • if a principal market does not exist for the assetlliability in question, with reference to the most advantageous market for the asset/liability. The principal market for an asset or liability is the market with the greatest volume and level of activity. If there is a principal market for an asset or liability, fair value measurements should be based on prices in that market, regardless of whether it represents the most advantageous market to which an entity has access. For example, it may be possible to conclude off-market transactions for listed shares, but the principal market would remain the exchange on which the issuer maintains a listing. In such a case the fair value of the asset or liability would be determined with reference to the prices available from the exchange. Should no principal market exist for an asset (liability), an entity makes use of prices available in a market that maximises (minimises) the amount to be received (paid) for an asset (liability), after taking into account any transaction costs and transport costs, i.e. the most advantageous market to which the entity has access. However, an entity should have access to a particular market on the measurement date and accordingly the principal or most advantageous market may differ between entities for the same item. Note that, although the entity should have access to the market, it need not have the ability to sell the particular asset or transfer the particular liability on the measurement date. For example, should there be legal restrictions on the ability of an entity to sell the asset or transfer the liability on the measurement date, the entity can still use the prices of the applicable market as a basis for determining fair value (although adjustments may be necessary to reflect the restrictions). In determining the principal or most advantageous market, an entity takes into consideration all information that is reasonably available. However, there is a rebuttable presumption that the market in which the entity normally enters into transactions to sell specific assets or transfer specific liabilities is the principal or the most advantageous market, as the case may be. It is important to note that, although transaction costs are taken into account when determining the most advantageous market to which an entity has access, they are not deducted when fair value is determined for measurement purposes (also refer to section 7.2.5).

7.2.3

Orderly

The definition of fair value determines that the transaction used to determine fair value should be orderly. An orderly transaction is one that would be expected to take place under normal conditions. It would allow for the necessity of marketing activities that are usual and customary for the asset or liability in question and therefore does not reflect a forced transaction (such as a distress sale).

Fair value measurement

113

Before using a transaction price as evidence of fair value at a measurement date, an entity should thus consider whether the transaction was orderly. Circumstances that may indicate that a transaction is not orderly include the following: • the transaction took place within a time period that did not allow for the usual and customary marketing activities relating to the asset or liability; • there was a usual and customary marketing period, but the seller marketed the asset or liability to a single market participant; • the seller is nearly bankrupt (i.e. a distressed sale); • the seller was forced to sell due to regulatory or legal requirements; or • the transaction price is abnormal when compared with other recent transactions for the same or similar assets/liabilities. All relevant circumstances are evaluated by an entity to determine whether or not a transaction was orderly. An entity should take into consideration all information that is reasonably available and, should an entity be a party to a transaction, it is assumed to have sufficient information to conclude whether or not the transaction was orderly. Concluding that a transaction is not orderly could have a significant impact on the determination of the fair value of an asset or liability. In such a case an entity is allowed to place little or even no weight on the transaction price when determining fair value. In contrast, if an entity concludes that a transaction was orderly it must take the transaction price into accOllllt when determining fair value. However, the weight placed on the transaction would be influenced by factors such as the volume of the transaction, the similarity of the asset/liability involved to the assetlliability being measured and the proximity of the transaction date to the measurement date. Should an entity be unable to determine whether or not a transaction was orderly, it must take into account the transaction price when determining fair value. However, the transaction price is not the only factor in determining fair value and the entity would be required to consider other information. Furthermore, should there be a number of transactions of which only some have been determined to be orderly and there is insufficient information to make such a determination about the remainder, the entity should place greater weight on the information provided by the orderly transactions when determining fair value.

Example 7.1: Orderly transaction: distress sale Z Ltd holds an investment in unlisted shares of K Ltd. Close to the entity's measurement date an unrelated party sold its holding of K Ltd shares for R5 million. Z Ltd investigates and determines that the seller accepted the first offer that it received and that the seller's creditors shortly afterwards applied for its liquidation. Other transactions in the shares of K Ltd during the reporting period indicate that the shares of the seller would have sold for at least R 15 million in one of these transactions. Because the circumstances clearly indicate that the seller was in financial distress, Z Ltd would place little weight on the transaction and rather consider the other transactions that took place during the reporting period (as being orderly transactions) when determining the fair value of its investment.

Example 7.2: Orderly transaction: single participant A Ltd holds a seaside investment property that it carries under the fair value model in lAS 40. A recent transaction for a similar property suggests that the fair value of the property is R35 million, which is R10 million above its current carrying amount (determined three months before). Suppose A Ltd determines that the transaction represents a private sale where a property developer wished to purchase the property in order to obtain sufficient space for a planned development. Regardless of the marketing period, such a transaction would be based on the value to a single market participant (other buyers would not need the space for development) and accordingly the transaction would not be orderly. A Ltd would place little weight on the transaction in determining the fair value of its building.

The mere fact that volumes or the level of activity for an asset or liability has declined, does not necessarily provide evidence that transactions are no longer orderly. However, IFRS 13 allows that

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declining volumes or activity may impact on the fair value of an asset or liability and could be an indication that transactions are not orderly, therefore necessitating further analysis. An entity determines whether the volumes or activity levels for an asset or liability have declined with reference to the relevance and significance of factors such as the following: • recent transactions are few in number; • price quotations are not based on current information;

• indices that were previously highly correlated with the fair value of the asset or liability are demonstrably llllcorrelated with recent indications of fair values; • there is a significant increase in implied liquidity risk premiums, yields or performance indicators; • there is a significant increase in the bid-ask spread; • there is a significant decline in a market for new issues of the asset or liability; or • there is little publically available information. Although an entity may conclude that transactions are still orderly, a decline in the volume or activity for an assetlliability based on factors such as those listed above, may indicate that multiple valuation teclmiques may be appropriate. In such a case a range of possible fair values may be produced in which potential fair values would be weighted according to their relative probabilities. However, IFRS 13 requires an entity to consider whether the range is narrow enough to be reasonable or whether further analysis is required. A decline in the volume or activity of a maIket for an asset or liability may also indicate that the risk premium used in determining fair value should be increased. However, the objective should remain the same: to determine the price that would be received or paid in an orderly transaction between market participants under conditions existing at the measurement date.

7.2.4

Market participants

When determining fair value an entity should use the assumptions that market participants would use when pricing the asset or liability. The entity should assume that the market participants would act in their own economic best interest. This requirement does not imply that the entity should identify specific market participants. Rather, an entity determines the principal (or most advantageous) market for the specific asset or liability in question (also refer to section 7.2.2) and considers the assumptions that market participants would make that generally participate in that market. The market participants that an entity considers should• be independent of each other; -

a related party transaction may only be considered if the entity has evidence that the transaction in question was entered into at market terms

• be knowledgeable; -

market participants should be knowledgeable about the asset or liability as well as the transaction

-

the market participants should use all available information in pricing the asset or liability, including information that would be obtained through due diligence that is usual and customrny

• be able to enter into a transaction; and • be willing to enter into a transaction - market participants should be motivated, but not forced or compelled to enter into a transaction.

7.2.5

The price

An important consideration is that fair value is a market-based measure of an exit price that is receivable and is therefore not an entity-specific value. As such, an entity's intention with regard to the asset is not relevant when determining fair value.

Fair value measurement

115

Example 7.3: Entity's intention A Ltd holds an office building that is leased out to third parties under operating lease agreements and carried under the fair value model in lAS 40. At reporting date the fair values for similar properties have declined due to an economic downturn. A Ltd calculates that it would need to recognise a decrease in fair value of R2 million on its office building, based on the market price movements of similar properties. However, the company has the intention and financial ability to hold the building until it can realise a return on its initial investment of fifty percent. The intentions of A Ltd are ignored in determining the fair value of the office building for financial reporting purposes. Accordingly A Ltd would need to recognise the fair value loss of R2 million in its financial statements despite its intention to hold on to the building until it has recovered the loss.

The price used in determining fair value can be a price that is observed directly from market transactions or one that has been estimated using a valuation teclmique. It is not, however, adjusted for transaction costs. Transaction costs are those costs directly attributable to the disposal of the asset or the transfer of the liability and result directly from (and are essential to) a given transaction. Transaction costs are therefore costs that would not be incurred if a sale of an asset or a transfer of a liability does not take place. It is important to note that transaction costs are excluded from the measurement of fair value, as they do not relate to a characteristic of the asset or liability in question. In other words, transaction costs reflect the manner in which an asset or a liability is transferred and not the nature of the asset or liability itself. Accordingly transaction costs may differ depending on the entity and the markets to which it has access. Taking these costs into consideration would imply using an entity-specific, rather than a market-based, measure of fair value.

Transport costs, however, are not considered to be transaction costs. These are the costs that would be incurred to transport an asset from its current location to its principal (or most advantageous) market. The reason for taking these costs into accOllllt when determining fair value is that the location of an asset may be an important characteristic of the asset itself. With immovable investment properties, for example, it can easily be seen that the fair value of otherwise identical properties may vrny significantly depending on the location of each. Similarly, the proximity of a moveable asset to its maIket (as in the case of commodities) could impact significantly on the value that market participants place on it. In such a case transport costs would be deducted in determining the fair value of the asset.

7.3 Fair value at initial recognition In many cases the fair value at initial recognition will be represented by the transaction price, especially if the transaction was completed on an arms-length basis. However, as noted in the standard, the transaction price represents an entry price (i.e. the price at which the asset was acquired or the liability was assumed). By contrast, fair value is an exit price and represents the price an asset could be sold for or a liability transferred. As entities do not always sell assets (transfer liabilities) at the same price that they pay (receive) for them, there may upon initial recognition arise a difference between the fair value of an asset (liability) and the price paid (received) to acquire (assume) it. This difference is of significance if the IFRS applicable to the item requires the item to be initially recognised at fair value. As a general rule IFRS 13 determines that any difference arising between the transaction price and fair value upon initial recognition is recognised in profit or loss. However, the IFRS specific to the item in question may require otherwise.

7.3.1

Factors at initial recognition

The standard lists several factors in its appendix that an entity should take into consideration when determining whether the transaction price represents fair value at initial recognition. Factors that may, in terms of IFRS 13, indicate that a transaction price for an asset or liability does not represent its fair value at initial recognition include the following:

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•

The transaction is between related parties. A transaction between related parties is quite often not market-related due to special considerations of the parties concerned. However, if the entity has evidence that the transaction was entered into at market terms, the transaction price may still represent fair value.

•

The transaction takes place under compulsion. A forced sale is not an orderly transaction (refer section 7.2.3) and the selling price would therefore not represent fair value.

•

The unit of account for the transaction differs from the unit of account for recognition (i.e. the asset or liability being measured is only one of the elements of the transaction). One example of this would be a business combination transaction where a single price is paid for the business, but assets and liabilities are required to be recognised separately. Another example would be if the transaction price includes transaction costs.

•

The market dtffers from the principal (or most advantageous) market. As fair value should be determined on the basis of prices in the principal (or most advantageous market in certain cases), a transaction in another market may not represent fair value.

Example 7.4: Initial recognition at fair value: transaction costs G Ltd purchases 100 shares in F Ltd for R5 100, inclusive of brokerage fees and transfer taxes of R100. No designation of the shares has taken place. IFRS 9 requires financial assets to be recognised initially at fair value. In this case the transaction price does not represent the fair value of the financial asset. The fair value of the shares is in fact R5 000 (R5 100 - R 100). As no designation of the shares has taken place, they would be carried at fair value through profit or loss. The transaction costs of R100 are therefore not capitalised by G Ltd, but expensed upon initial recognition.

Example 7.5: Initial recognition atfair value: market T Ltd purchases 1 500 wheat futures contracts directly from an investment bank at R10,00 each. No transaction costs were payable. The most advantageous market that T Ltd has access to in respect of the futures is the national futures exchange. In this market, on the date of initial recognition, identical futures are trading at R10,05 each. The wheat futures represent a financial asset in terms of IFRS 9 and initial recognition must take place at fair value. In this case the futures would therefore initially be recognised at R15075 (1 500 x R10,05). The difference of R75 (1 500 x R10,00 - R15 075) would be recognised in profit or loss in terms of the requirements of IFRS 9.

7.4 Valuation techniques IFRS 13 requires an entity, when determining fair value, to use valuation techniques• that are appropriate in the circumstances; • for which sufficient data are available; • that maximise the use of relevant observable inputs; and • that minimise the use ofllllobservable inputs. Observable inputs are those that are developed using market data and reflect assumptions that market participants would use when pricing the asset or liability. In direct contrast, unobservable inputs are those for which market data is not available. However, all inputs should reflect the best information available about the assumptions that market participants would use when pricing the asset or liability. Note: If a market is not observable, this does not necessarily mean that a market does not exist. For a market to be observable, data must be publicly available. Accordingly a market where prices are kept confidential would still exist, but not be of use when determining a fair value measurement. Any valuation technique that is followed must be consistent with one or a combination of the following valuation approaches: • the market approach; • the cost approach; and

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• the income approach. Each of the valuation approaches listed above are discussed in further detail later in the chapter. Once an entity has selected a valuation technique, it must be applied consistently. This would imply that a valuation technique should be consistent over time with regard to a specific asset, while also being applied consistently for similar assets. It is not appropriate, for example, to use a discOllllted cash flow technique for some investment properties that generate rental income while valuing other similar properties using net replacement cost. However, the standard allows that a change in valuation technique is appropriate if the change results in a measurement that is equally or more representative of fair value. This change could be either a change in the valuation technique itself (for example from an income approach to a maIketbased approach) or a change in its application (for example a change in the weighting of a factor influencing the calculation). IFRS 13 provides the following examples of factors that indicate that a change to the valuation technique may be appropriate: • new maIkets develop; • new information becomes available; • information previously used is no longer available; • valuation techniques improve; or • market conditions change.

Example 7.6: Change in valuation technique: new markets H Ltd holds an investment in the unlisted shares of M (pty) Ltd. In the past H Ltd has fair valued its investment using a discounted enterprise value technique. During the current reporting period M (pty) Ltd converted itself to a public company and public trading of its shares commenced in the over-thecounter market. The decision of M (pty) Ltd to convert itself into a public company results in a new market for its shares being created. As such, a change in the valuation technique from an income approach to a market approach (based on recent transactions in the shares of the investee) may be appropriate. This would be the case as a market approach is more likely to maximise the use of observable inputs in determining fair value.

Any revisions resulting from a change in the valuation technique or its application should be accounted for prospectively as a change in accounting estimate in terms of lAS 8. However, IFRS 13 explicitly states that the disclosure requirements of lAS 8 with regard to changes in accounting estimates would not be required in such a case.

7.4.1

Single and multiple techniques

In some cases a single valuation technique would be sufficient and appropriate to determine fair value for a specific asset or liability. However, in other cases it may be more appropriate to use multiple valuation techniques to determine the fair value for an item. In such a case, the results of the multiple valuation techniques should be evaluated by the entity to ensure that the range of the results is reasonable. The standard requires that the fair value measurement in the case of multiple valuation teclmiques is the point within the range that is most representative of fair value under the circumstances. A simple example of a multiple-valuation-techniques approach is the use of a ''reasonableness test" in performing a valuation. An equity investment may be valued using a discounted cash flow teclmique, while the reasonableness of the valuation technique's results may be assessed using a net asset value or earnings multiple approach.

7.4.2

Using unobservable inputs

If a transaction price represents fair value upon initial recognition, the entity should consider whether the valuation technique it intends to use for fair value measurement uses unobservable inputs. If this

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is the case, the entity should ensure that its valuation technique is calibrated so that the result of the teclmique equals the transaction price at initial recognition. Calibrating the valuation teclmique in this manner ensures that it is accurate. When using a valuation technique(s) that makes use of llllobservable inputs, an entity should ensure that the valuation technique(s) used reflects observable market data at each measurement date throughout the lifetime of the asset or liability. This may be done, for example, by applying the valuation technique to a similar asset or liability for which observable data (e.g. a quoted price) is available and comparing the result of the valuation technique to the quoted price of that item. A material difference may indicate that the valuation teclmique is not accurate. Such an analysis is especially relevant when there are no quoted market prices for the item being measured, while quoted prices for similar items are available. It is important to note that this calibration is only applied when the transaction price at initial recognition represents fair value. In the case where the transaction price does not represent fair value, the valuation technique would be used to determine it. Any difference between the fair value and the transaction price will be recognised in profit or loss in terms of IFRS 13 unless the IFRS applicable to the specific item requires otherwise.

7.4.3

Inputs into valuation techniques

As mentioned earlier, any valuation technique applied must make the maximum use of relevant observable inputs. At the same time the use of llllobservable inputs must be minimised. Observable inputs may be obtained from a variety of markets: • Exchange markets, where closing prices are both readily available and generally representative of fair value. Any exchange in products where market-makers do not playa significant role would fall into this category, such as the JSE Limited. • Dealer markets, where market-makers playa significant role. Market-makers provide liquidity within a market, usually by holding inventories of the item traded. Quite often, bid and ask prices are more readily available than closing prices. The best example is a market in listed derivative instruments where the issuers ensure liquidity by standing ready to buy or sell the derivative instruments at any given time. The used equipment market may also be an example of a dealer market. • Brakered markets, where brokers attempt to match buyers with sellers but do not stand ready to trade for their own aCCOllllt. Accordingly, unlike a dealer market, brokers do not hold inventories of the item traded and are therefore not responsible for providing liquidity to the market. In a brokered market, the broker is quite often aware of the bid and asking prices of market participants, but maIket participants are not. The best example of such a maIket is the real estate market. • Principal-ta-principal markets, where agents or other intermediaries are eliminated and market participants trade directly with one another. Little public information about such trades is available. The market in shares of private companies is a good example of a principal-to-principal market.

An entity should select inputs that reflect characteristics of the asset or liability that market participants would take into accollllt in valuing the item. If a control premium is a factor that market participants would take into accollllt when valuing an asset, the fair value of the item may take this into aCCOllllt. However, such an adjustment is not allowed if the fair value measurement of the item is a level 1 fair value measurement (refer to section 7.4.7.1). In contrast, a fair value measurement may never incorporate an adjustment purely because of the size of an entity's holding. For example, if a quoted price of an asset may be affected by its sale, as the entity holds more units than the average daily volume would allow to be disposed of within a day, IFRS 13 prohibits an entity to take into accollllt the impact that a disposal of such a large holding may have on the quoted price.

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119

Market approach

The market approach involves using the prices and other information generated by market transactions for identical or similar assetslliabilities to determine the fair value of an item. The simplest example of a market approach would be to use quoted prices to value an investment in listed equity instruments. Using adjusted market multiples (e.g. adjusted per earnings ratios) to value an unlisted investment would also be a market approach to determining fair value. Various valuation techniques could be categorised as a market approach. One such technique mentioned within IFRS 13 is matrix pricing. Matrix pricing involves deriving the value of an asset or liability from quoted prices of a benchmark security, based on historical relationships between the two items. This technique eliminates the need to obtain quoted prices for all securities and is often used for financial instruments. It may be particularly useful where the asset or liability being valued is not frequently traded.

Example 7.7: Matrix pricing X Ltd holds a large investment portfolio consisting of listed corporate bonds. Most of these bonds, however, are not frequently traded and to obtain quoted prices for all of the bonds in the portfolio would require extensive efforts. However, X Ltd is able to obtain quoted prices for a key corporate bond that serves as a benchmark for corporate bond investors. The standard would allow X Ltd to use the quoted prices for the key corporate bond in a matrix pricing method to develop fair values for its investment portfolio. This would be effected by using the interest rate on the key corporate bond, adjusted for historical relationships, to discount the cash flows of the applicable bond. For example, suppose the quoted interest rate on the key corporate bond was 9%. For bond A, X Ltd might determine that a market-related interest rate would be 10%. This is based on historical relationships between the key bond and bonds of a similar risk and maturity to bond A. Discounting the expected cash flows of bond A at 10% leads to a value for this bond. The fair value of Bond B, with the same expected cash flows, but a market-related interest rate of 11%, could accordingly be determined to be 10% less [(11% - 10%) 110%] than that of Bond A, using a pricing matrix.

7.4.4.1

Bid, ruling and asking (offer) prices

Whenever a fair value measurement is based on a quoted price, the question arises as to which quoted price should be used. Generally speaking, the following three quoted prices would be available at any given time for an asset/liability that is frequently traded: • Bid price: The price at which buyers are willing to buy an asset on a specific date. Alternatively, for a liability, this would be the price at which a seller wishes to dispose of the liability on a specific date. • Asking (offer) price: The price at which sellers are willing to sell an asset on a specific date. Alternatively, for a liability, this would the price at which a buyer is willing to assume a liability on a specific date. • Ruling price: The last price at which the asset or liability traded in the market.

Example 7.8: Bid, ruling and asking prices F Ltd holds an investment of 1 000 ordinary shares in T Ltd. On a given date the following prices are available for one share in T Ltd: Ruling Asking Bid 10,00 10,50 11,00 If the investment relates to an investment that F Ltd holds, it would be able to sell the shares at R10,00 into the market, for a value of R10 000 (1 000 x R10,00). However, if the investment relates to shares that F Ltd sold short, it would need to buy back the shares it borrowed at the ask (offer) price of R 11,00 each, as it has a liability to buy back the shares. In such a case, whether F Ltd makes a profit or loss depends on the price it initially received when selling the shares short. The value of the shares based on the most recent transaction, however, is R10 500 (1 000 x R10,50).

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IFRS 13 does not specity which price should be used. However, as the definition of fair value refers to the price for which an asset may be sold or a liability transferred, a general practice would be to value assets at bid prices (the price for which it could be sold) and liabilities at asking prices (the price that should be paid in order to settle it). This practice is allowed, but not required in terms of the standard. Furthermore, the standard does not prohibit the use of mid-market pricing or other pricing conventions used by market participants as a practical expedient when determining fair values. Accordingly, as most stockbrokers value their clients' share portfolios using ruling prices, IFRS 13 would permit an entity to use such prices to value its portfolio for accOllllting purposes as well. In the authors' opinion, however, such a decision would need to be applied consistently as an accOllllting policy choice (at the very least to classes ofassetslliabilities) and would not be available on an itemby-item basis.

7.4.5

Cost approach

The cost approach to fair value measurement entails valuing an asset at the amount that would be required at the measurement date to replace its current service capacity (i.e. the current replacement cost). Using this approach, a building's fair value would, for example, be represented by the amount that would be necessary to reconstruct the building. However, fair value under the cost approach reflects the current service capacity at the date of measurement. A new building would have a greater service capacity than an old building. Accordingly a value obtained under the cost approach is adjusted for obsolescence in order to reflect the service capacity of the asset in its current condition. IFRS 13 determines that obsolescence is more than accounting or tax depreciation and encompasses physical deterioration, functional (i.e. teclmological) obsolescence and economic (i.e. external) obsolescence. Should current replacement cost be determined for a group of assets (such as land and buildings), it would subsequently be allocated to the component parts.

7.4.6

Income approach

The income approach encompasses various valuation techniques that convert expected future amounts (e.g. cash flows, income or expenses) to a single amount that reflects the present value of these future amounts. Examples of valuation techniques include: • present value techniques; • option-pricing models that reflect both the time value and intrinsic value of the option; and • the multi-period excess earnings method. Note: The multi-period excess earnings method is a method often used to value intangible assets. For example, a brand name would be valued as the discounted difference between expected branded product sales and what expected sales would be without the brand name. For illustration purposes IFRS 13 discusses the application of present value techniques in some detail. The standard explicitly states that it does not prescribe a specific method and does not limit present value teclmiques to those that it discusses. Which present value technique is selected depends on the surrounding facts and circumstances specific to the assetlliability and the availability of data. All present value techniques should, however, capture the following elements: • estimates of future cash flows; • expectations about the variability of these cash flows; • the time value of money (a risk-free interest rate); • compensation for bearing the uncertainties inherent in the cash flows (a risk premium); • other factors that market participants would take into account; and • for a liability, the non-performance risk relating to the liability (also refer to section 7.5.2 for further details on the fair value of liabilities). The sections that follow discuss the guidelines of IFRS 13 relating to the use of present value teclmiques as well as the examples of specific techniques contained in the standard.

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Application of present value techniques

IFRS 13 requires that any present value teclmique be applied in accordance with the following general principles: • cash flows and diSCOllllt rates used within the calculation should reflect assumptions of market participants for the asset or liability being measured; • only factors attributable to the asset or liability being measured should be taken into account; • the risk factors inherent to the cash flows should be consistent with assumptions underlying the discount rate; Note: This implies that risk factors should not be omitted. For example, it would be inappropriate to use a risk-free interest rate to discount cash flows where a risk of default exists. However, care should be taken that risk factors are not double counted. If cash flows have been adjusted to take into account default risk, the discount rate should not be adjusted for the same risk factor. • the assumptions underlying the cash flows and the discount rate should be internally consistent (pre-tax cash flows should, for example, be discounted by way of a pre-tax discount rate); and • discount rates should be consistent with the underlying economic factors of the currency in which the cash flows are denominated. It would be inappropriate, for example, to discount rand denominated cash flows using a US dollar discount rate, as the time-value of money and surrounding economic circumstances impacting on risk would be widely different.

7.4.6.2 Examples of present value techniques in IFRS 13 7.4.6.2.1 The discount rate adjustment technique The discount rate adjustment technique refers to a valuation technique where the discount rate is adjusted for uncertainties and risk factors, while a single set of cash flows (the contractual, promised or most likely) is used. In such cases the discount rate is an observable market interest rate for an asset or liability that is as closely comparable as possible to the asset!1iability being measured. Factors that need to be taken into consideration when determining comparability include • the nature of the cash flows (e.g. whether they are contractual or not); • whether the cash flows are secured by collateral; • contractual covenants; • liquidity of the assetslliabilities; and • credit risk. An observable market interest rate should be adjusted for differences between the assetlliability for which the interest rate is observable and the item being measured (for which an observable market interest rate is not available). However, the principle is that the discount rate reflects the uncertainties and risk factors associated with the item in question. Assuming that the contractual cash flows of an asset are available, applying a market interest rate of an identical asset to these cash flows would lead to a fair value measurement that reflects market participants' pricing of the expected variability of the cash flows. Adjusting the contractual cash flows in such a case would be UIlilecessary as the discount rate already takes the risk related to the cash flows into account.

Example 7.9: Discount rate adjustmenttechnique K Ltd holds an investment in unquoted debentures of M Ltd, which are carried at fair value in terms of the requirements of IFRS 9. The debentures are secured over the buildings of M Ltd and carry interest at a fixed rate of 10% per annum in terms of the debenture agreement. On reporting date the following market interest rates have been observed: 12,5% Similar debentures that are unsecured 9,5% Similar debentures with a variable interest rate Similar debentures that are secured 9,8%

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The interest rate that would be most comparable to the debentures held by K Ltd in this case would be

9,8%, as it holds a secured debenture with a fixed interest rate. As the debentures are otherwise similar, no further adjustments would need to be made when calculating the present value of future cash flows.

Should no obseIVable market interest rate be available for a closely comparable asset, it may be possible to determine an appropriate diSCOllllt rate by applying the risk-free interest rate (and the yield curve for the risk-free interest rate) to an interest rate that is obseIVable. A yield curve relates interest rates over different time periods, with longer-term interest rates being higher than short-term interest rates at most times. The adjustment technique is referred to as a "build-up approach" in the standard. Note: The risk-free interest rate refers to the interest rate of a risk-free asset. Although no asset is completely free from risk in reality, it is usually assumed that short-term government debt would represent the closest possible example of a risk-free asset. A government usually controls its own money supply and can raise taxes or other revenues to meet its obligations. Although longer-term government bonds are also backed by the same powers, these carry a somewhat larger risk of default (even by a government) due to the extended timeframe. However, quite often these bonds are also assumed to be risk-free assets when valuing assetslliabilities.

Example 7.10: Discount rate adjustmenttechnique: build-up approach

o

Ltd holds an investment in debentures of S Ltd. The debentures represent a contractual right to receive R10 000 in one year's time. A market interest rate of 12% is available for debentures of A Ltd that are similar in most respects; however, they represent a contractual right to receive R15 000 in three years' time. A build-up approach would start by relating the observable market interest rate on the debentures of A Ltd to the risk-free interest rate. Assuming the three-year risk-free interest rate is 8%, this would imply that the risk premium on A Ltd's (and the similar debentures of S Ltd) is 4%. Using a risk-free yield curve, the one year risk-free interest rate can be obtained. Supposing that this is 7%, the marketrelated interest rate on S Ltd's debentures would therefore be 11 % (7% + 4%) and the fair value of D Ltd's investment is then calculated to be R9 009 (R 10 000 11,11).

7.4.6.2.2 Expected present value technique The expected present value technique uses probability-weighted cash flows when determining the present value of future cash flows. As all possible cash flows are probability-weighted, the resulting expected cash flow is not conditional upon the occurrence of any specified event (lllllike the cash flows used in the discollllt rate adjustment technique discussed above). In other words, when using this teclmique, the cash flows are adjusted for llllcertainties rather than the discollllt rate. The discollllt rate will reflect the time value of money (represented by the risk-free interest rate) and, depending on the method used, a risk premium for bearing llllcertainties inherent to the cash flows. IFRS 13 discussed two methods that can be used when applying this technique. The first method adjusts expected cash flows of an asset to reflect a certainty-equivalent cash flow. A certaintyequivalent cash flow represents the point at which a market participant would be indifferent between holding a risky asset and holding a risk-free asset. This method therefore does not require a risk premium adjustment to the risk-free interest rate. Example 7.11: Certainty..,quivalent cash flow Assume that a risk-free asset that will pay R880 in a year's time is currently quoted at R800 (fair value), which implies a risk-free interest rate of 10%. If an asset's cash flow is receivable in one year and it is not risk-free, its certainty-equivalent cash flow would be the amount that a market participant would want to receive to be indifferent between the two assets. This implies that a higher interest rate would be necessary for the risky asset. Suppose the amount that a market participant would want to receive to be indifferent between the two assets is R920. This would lead to an interest rate of 15% in order for the risky asset to have a fair value of R800 (R920 11,15 = R800) and be equivalent to the risk-free asset The above relationship leads to the methodology to convert the cash flows of a risky asset to its certainty-equivalent cash flow. In the example the cash flow on the risky asset is R920. If the risk premium that a market participant would demand is known, this cash flow can be converted to its

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certainty-equivalent A risk factor of 1,045 (1,15/1,10) would convert the cash flow to its certaintyequivalent of R880 (R920 / 1,045). The present value would be the same (R800), regardless of whether R920 (expected cash flow) is discounted by a risk-adjusted rate (15%) or R880 (certaintyequivalent cash flow) is discounted by the risk-free interest rate (10%). Note that the risk factor is calculated using the risk adjusted interest rate and the risk-free interest rate as follows: (1 +15%)/(1 + 10%)= 1,045.

The second method of applying an expected present value technique uses expected cash flows without adjusting these to certainty-equivalent cash flows. Accordingly, a risk premium should be added to the risk-free interest rate when calculating present value. Theoretically, if the assumptions are correct, both methods should arrive at the same present (fair) value as illustrated in the example below.

Example 7.12: Comparison of expected present value methods Assume an asset with the following possible cash flows and probabilities, with cash flows taking place one yea r fro m now: Probability Possible cash flows Weighted cash flow R

1 000 1 200 1 500 Expected cash flow

R

20% 50% 30%

200 600 450 1 250

Suppose that it is known that the risk-free interest rate is 5% and the market risk premium is 2%. For the purposes of method one, the certainty-equivalent cash flow would first need to be calculated. The expected cash flow of R1 250 is adjusted by the risk factor of 1,01905 [(1 + 5% + 2%) / (1 + 5%)[ to arrive at a certainty-equivalent cash flow of R1 226,63. Discounting this cash flow by the risk-free interest rate results in a present value of R1 168,22 (R1 226,63/1,05). By comparison, method two would simply require the expected cash flow of R1 250 to be discounted using a risk-adjusted interest rate of 7% (5% + 2%). Accordingly the present value calculated using method two also results in a present value of R1 168,22 (R1 250/1,07). Note that the discount rate used in method two, although it includes a risk premium, would generally be lower than the discount rate used in the discount rate adjustment technique (illustrated in section 7.4.6.2.1). This is because the discount rate adjustment technique relates to conditional cash flows, while the expected present value technique relates to probability-weighted cash flows.

7.4.7

Fair value hierarchy

The standard distinguishes between three levels of fair value measurements, which classification depends largely on the degree to which observable market prices fonn the basis of the fair value measurement: • Levell fair value measurements are those that rely on quoted prices for identical assets in active markets that the entity can access at the measurement date. Quoted prices for Level 1 measurements are mostly lllladjusted prices.

Note: An active market is one in which transactions for the asset or liability in question takes place with sufficient frequency and volume for pricing information to be available on an ongoing basis. • Level 2 fair value measurements are those that rely on inputs (other than quoted prices included within Levell) that are observable for the asset or liability. These inputs may be observable either directly or indirectly. • Level 3 fair value measurements are those that make use of unobservable inputs.

The fair value of an asset or liability is not divided amongst different levels, i.e. it is categorised into one of the levels above. The level in the fair value hierarchy within which the fair value falls should be determined based on the lowest level input that is significant to the fair value measurement in its entirety. In other words, if the fair value measurement of a particular asset or liability relies on

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significant inputs from both Level 2 and Level 3, the fair value measurement in its entirety should be categorised within Level 3 of the hierarchy. Furthermore, should an observable input into a valuation model be adjusted using an llllobservable input and this has a significant impact on the resulting fair value, the resulting measurement would be classified within Level 3. For example, an adjustment to a market-based interest rate to reflect restrictions on the marketability of an asset would result in fair value measurements being categorised into Level 3 if such an adjustment has a significant impact on the resulting fair value measurement. Should the fair value be based solely on the unadjusted market-based interest rate and other observable inputs, the fair value measurement would have fallen into Level 2. It is important to note that the fair value hierarchy depends on the inputs to the valuation technique used and not the valuation teclmique itself. For example, an option-pricing model could be a Level 2 or Level 3 fair value measurement, depending on the llllderlying inputs. If all the information relates to obseIVable market data, the option model values would be Level 2 fair value measurements. However, should the data depend significantly on llllobseIVable data (e.g. the share price of a private company), the fair value measurement would fall into Level 3.

Should a particular IFRS require a measurement derived from fair value, but not fair value itself (e.g. fair value less costs to sell), these adjustments to fair value would not be taken into accollllt when determining the level of the fair value hierarchy into which a measurement falls. In other words, the level of the fair value hierarchy is dependent on the fair value measurement itself and is unaffected by subsequent adjustments required by other standards.

7.4.7.1

Level 1 inputs

As mentioned earlier, Level 1 fair value measurements are those that rely on quoted prices in active markets for identical assets that the entity can access at the measurement date. IFRS 13 states that quoted prices in active markets provide the most reliable evidence of fair value. Accordingly, in most cases, quoted prices may not be adjusted when determining fair values. However, adjustments are allowed in the following circumstances: • An active market is available but not readily accessible. An entity may hold a large number of similar (but not identical) assets or liabilities for which it would be difficult to obtain quoted prices for each individual asset. In such a case an alternative pricing method may be used. For example, a matrix method could be used where the quoted price of one asset or liability is used to estimate prices of other assets/liabilities based on known and expected relationships between them. •

The quoted price does not represent fair value. The standard requires an entity to establish and consistently apply a policy for the identification of events that would lead to a quoted price not reflecting fair value. This may be the case, for example, where the closing auction within a market significantly affects the quoted price.

•

The fair value of a liability is based on a price for an identical asset. The standard sometimes allows the fair value of a liability to be determined based on prices of an identical item held as an asset by other parties (refer to section 7.5.2). In such a case adjustments could be made, as the factors taken into account when pricing an asset may differ from factors impacting on the pricing of a liability.

Note that whenever an adjustment is made to a quoted price, the fair value measurement is no longer a Levell measurement and would therefore need to be classified as a lower level measurement in the fair value hierarchy. As an asset or liability may be priced in several markets on any given date, Levell prices are the prices determined with reference to• the principal market for the asset or liability; • ifno principal market exists, the most advantageous market for the asset or liability; and • the market the entity has access to. A Level 1 fair value measurement is dependent on a price in a market that an entity has access to, as an entity should be able to enter into a transaction on the measurement date. Should a more

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favourable market be available to which the entity does not have access, it may not be used to determine a Levell fair value measurement. A last important point is that, in the case of a group of identical assets or liabilities (or a single item) that is traded on the active market, the Level 1 fair value measurement will always be the number of items held multiplied by the quoted price for each item. This is the case even when the average daily trading volume would not be sufficient to absorb such a transaction and placing an order to effect a transaction would change the quoted price.

Example 7.13: Quoted prices V Ltd holds an investment of 100 million shares in S Ltd, which represents 5% of the issued share capital of the investee. V Ltd does not have significant influence or control over the investee. At reporting date, the ruling price for shares in S Ltd was R1,20 each. It is V Ltd's policy to use ruling prices to value its interests in quoted equities. Even though the size of the investment is quite large and it may be expected that placing an order to sell the shares would negatively affect the share price, the quoted price is unadjusted when determining the fair value of the investment. Accordingly V Ltd would carry its investment in S Ltd at R120 million (R100 million x 1,20) at reporting date.

7.4.7.2 Level 2 inputs Level 2 fair value measurements are those that rely on inputs (other than quoted prices included within Levell) that are observable for the asset or liability. These inputs may be observable either directly or indirectly. An entity should ensure that an input will be observable for substantially the entire contractual term of the asset or liability, if applicable. The following examples of Level 2 inputs are provided in the standard: • quoted prices in active maIkets for similar (but not identical) assets or liabilities; • quoted prices in markets that are not active for similar or identical assets or liabilities; • other observable inputs, including: - interest rates; -

implied volatilities; and

-

credit spreads;

• market-corroborated inputs - These are inputs that are derived principally from (or corroborated by) observable market data. -

Corroboration may be correlation between the input and observable market data or another observable relationship between changes in the input and observable market data.

Level 2 inputs are adjusted depending on factors specific to the asset or liability. Some factors that may, for example, be taken into accOllllt include • the condition or location of the asset; • the extent to which inputs relate to items that are comparable to the asset or liability (also refer to section 7.2.1 in this regard); and • the volume or level of activity in the markets from which the observable inputs are obtained. It is important to note that, should the adjustment of Level 2 inputs require the use of unobservable

inputs and these adjustments have a significant impact on the fair value measurement, the fair value measurement would be classified as a Level 3 fair value measurement. Some examples of Level 2 inputs provided within the standard include• using an observable market interest rate (such as the prime rate or JIBAR) to determine the fair value of an interest rate swap; • extrapolating observable volatility (based on maIket prices) of one and two year options in order to determine the expected volatility for a three year option; • using the royalty rate within a licensing agreement in order to determine the fair value of a licensing arrangement upon acquisition in a business combination;

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• usmg observed transaction prices for similar buildings in order to determine the fair value of investment property; and • using recent observed transactions in order to derive a market multiple for valuing a stream of earnings or cash flows.

7.4.7.3 Level 3 inputs Level 3 inputs are llllobservable inputs for the asset or liability. In other words Level 3 fair value measurements are those that depend on inputs that may not be classified as Levell or Level 2 inputs. IFRS 13 allows the use of llllobservable inputs to determine fair values only to the extent that observable inputs are llllavailable. Recall that, as a general principle, the standard requires valuation teclmiques that make the maximum use of observable inputs and limits the use of llllobservable inputs to a minimum. Regardless of the inputs used, the objective of the fair value measurement remains the same and fair value measurements should still reflect 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. Unobservable inputs should therefore reflect assumptions that market participants would use when pricing the asset or liability. As risk represents a very important consideration for market participants in most cases, an input would be adjusted for this. If market participants would consider risk when pricing an asset or liability and inputs do not take this into accOllllt, the resulting measurement would not be a fair value measurement that complies with the definition and requirements of IFRS 13. Unobservable inputs should be developed using the best available data, which may be the entity's own data if necessary. If an entity uses its own data, it should adjust the data if information that is reasonably available indicates that market participants would use different data. This may be simply because of differing risk perceptions, but may also reflect that synergies are available to the entity, which other maIket participants do not have access to. Some examples of Level 3 inputs that are provided within IFRS 13 include• interest rates that cannot be corroborated by observable market data for substantially the full contractual term of the asset or liability; • using historical volatility to price an option when measures of current expectations are not available; • using the entity's own data to determine the fair value of a decommissioning liability assumed in a business combination; and • using the entity's own financial forecasts in a discounted cash flow analysis (provided there is no reasonably available information that indicates that market participants would use different assumptions).

7.5 Specific applications of IFRS 13 IFRS 13 provides additional guidance to specific situations where the application of the general fair value guidance may prove complex. These include the fair value measurement of non-financial assets, liabilities, an entity's own equity instruments, and financial assets and financial liabilities with offsetting market or counterparty credit risks.

7.5.1

Non-financial assets

When determining the fair value of a non-financial asset, the fair value should be based on the highest and best use of the asset. The highest and best use may be based either on• a market participant's ability to use the asset in its highest and best use to generate economic benefits; or • a market participant's ability to sell the asset to another participant who would use the asset in its highest and best use.

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The highest and best use of a non-financial asset is the use of the asset by market participants in a way that would maximise the value of the asset or of the group of assets and liabilities within which the asset would be used. When determining the highest and best use of a non-financial asset, an entity should consider whether this use is: • Physically possible. The use determined by the entity should take into account the physical characteristics of the asset that market participants would take into account when pricing the asset.

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A simple example of physical characteristics is the size and location of a property.

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Physical damage to an asset or technical obsolescence is also a physical characteristic of an asset that an entity would need to take into accOllllt when determining fair value. For example, a piece of medical equipment based on teclmology that has been superseded does not have the same fair value as medical equipment in a similar condition that is based on the latest technology.

• Legally permissible. The use determined by the entity should take into account any legal restrictions on the use of the asset that market participants would take into account when pricing the asset.

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The example provided in IFRS 13 is that of wning restrictions on a property.

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Contractual agreements may also impact on the fair value of an asset. For example, if an entity owns a patent for which it has granted exclusive use in a particular area to a licensee, the fair value of the patent would be affected as any buyer must honour the contractual agreement.

• Financially feasible. The use determined by the entity should take into account whether this use (that is physically possible and legally permissible) generates sufficient cash flows to generate an investment return sufficient to meet the requirements of market participants when an asset is put to such a use.

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When determining whether a use is financially feasible, an entity should also consider the cost of converting an asset to that use. It is important to note that the test is not whether a use is merely profitable, but whether it is profitable enough to meet market participants' expectations.

There is a presumption that an entity's current use of a non-financial asset is its highest and best use (one would expect that a rational entity attempts to maximise the return on its assets). However, this may not always be the case. An entity may not intend to use the asset actively (or may put it to a use that is not the asset's highest and best) for strategic reasons. For example, an entity may have acquired a licence, not with the intention to use the licence, but rather to prevent others from competing with itself. This does not mean, however, that the fair value of the licence is zero. The entity should, in such a case, still measure the fair value of the non-financial asset by assuming its highest and best use by market participants.

7.5.1.1

Non-financial assets used in a group of assets and liabilities

As mentioned earlier, the highest and best use of a non-financial asset can be based on use of the asset on a standalone basis or on the use of the asset within a group of assets and liabilities: • If the highest and best use of a non-financial asset is to use it on a standalone basis, an entity determines the fair value with reference to a standalone use by market participants. • If the highest and best use of a non-financial asset is to use it in combination within a group of assets and liabilities, then: -

its fair value is determined with an assumption that the asset would be used with other assets and liabilities and that those assets and liabilities would be available to market participants (i.e. determine fair value with reference to the price that market participants would pay for the asset, assuming that they already hold the other assets and liabilities).

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liabilities included within the group are liabilities associated with the asset or complementary assets. These liabilities may include liabilities to fund working capital (such as trade creditors) but do not include liabilities to fund assets outside of the group being assessed.

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assumptions about the highest and best use are consistent for all assets within the group. This implies that once the highest and best use for an asset is determined to be in combination with other assets, fair value measurements for each of the assets in the group should assume that the assets are used in combination. Note that the fair value measurement must be consistent with the unit of aCcOllllt (i.e. the level of aggregation of assets) in the applicable IFRS (which is often an individual asset). Therefore, if the fair value of an individual asset has to be determined and its highest and best use is in combination with other assets and liabilities, measurement is still applied to the individual asset, as fair value measurement assumes that maIket participants already hold the complementrny assets and liabilities. If an entity has determined that the fair value of a non-financial asset should be determined (based on its highest and best use) as part of a group of assets and liabilities, the fair value measurement for the individual asset in question may have one of the following results: • The fair value of the asset is the same as the fair value of the asset determined on a standalone basis. It is possible that market participants would continue to use the asset in combination with other

assets and liabilities. As the fair value guidelines require an entity to assume that market participants have the complementrny assets and liabilities available, synergies from the entity's use of the asset would be available to all market participants. A simple illustration of such a situation arises when it is not possible to use an asset on a standalone basis. For example, a conveyor belt would require other manufacturing assets to be of use. Therefore its fair value remains its standalone fair value when used within a group of assets, as there is no other way in which the asset could be used. • The fair value of the asset is the standalone fair value adjusted for the combined use. Adjustments may be necessrny to the fair value of a similar asset to reflect the current condition and location of the asset being measured. The example provided in IFRS 13 is that of an installed machine. Should significant installation activities be required to be able to use an asset, the fair value of an asset that is already installed and ready for use may differ from one that is purchased but not installed. In such a case the fair value may be the fair value of a similar machine, adjusted for installation costs. • The assumptions of market participants used to determine the fair value of the asset already reflect its combined use. When determining the fair value of an asset, the standard requires that the assumptions that market participants would use to form part of the fair value measurement. Therefore, using the assumptions of market participants would result in a fair value measurement that reflects a combined use of the asset in this case. For example, assume an entity has an incomplete asset that it should measure at fair value. If there were no market for the asset unless it is complete, its fair value would need to be determined in a completed state and adjusted for its current condition. Accordingly, if it is impossible to complete the asset without the use of specialised machinery, the fair value measurement would assume that maIket participants would have to obtain this machinery through purchase or otherwise. • The valuation technique used to determine the fair value of the asset already reflects its combined use. The best example of this circumstance is the determination of the value of a brand. This is usually determined based on the excess sales that the branded product generates compared to an llllbranded competitor. Accordingly the valuation technique assumes that the entity has a group of assets and liabilities that are used in combination with the brand to generate the sales necessrny for the valuation to be performed. • The fair value of the asset is an allocated amOllllt.

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This should occur in more limited circumstances, most likely when it is difficult to allocate a separate fair value to a specific asset within a group of assets. The best example is property, where an increase in the value of the property is a combination of a rise in land values as well as the value of the improvements to the property. Should land and improvements be recognised separately, the fair value determined for the property as a whole may need to be allocated between its recognised components.

7.5.2

Liabilities and an entity's own equity instruments

Although liabilities and an entity's own equity instruments are seldom explicitly measured at fair value, there are instances where this may be applicable. An example (within the scope ofIFRS 13) is the case of a business combination, where the purchase consideration includes the fair value of equity instruments issued. Another example is financial liabilities that are required to be (or are designated) as at fair value through profit or loss in terms of IFRS 9. When an entity determines the fair value of a liability or its own equity instruments, it assumes that the item is transferred to a market participant at the measurement date. In turn this causes the following assumptions to llllderlie the fair value measurement: • the liability or equity instrument will remain outstanding; • the market participant will be required to fulfil the obligation associated with the liability (no settlement with the cOllllterparty takes place); and • the market participant will take on the rights and responsibilities associated with the equity instrument (no cancellation will take place). The determination of fair value for a liability or own equity instrument becomes difficult when there is no observable market for the item. This is often the case for liabilities when there is no observable market where buyers indicate the price they require to assume a seller's liability. However, the standard still requires the entity to maximise the use of observable inputs (and minimise the use of unobservable inputs) when determining the fair value of a liability or own equity instrument. Accordingly, in terms ofIFRS 13, an entity must identify if there is an observable market for the item where other parties hold it as an asset.

7.5.2.1

Liabilities and equity instruments held by other parties as assets

If other parties hold the identical liability or equity instrument as an asset, IFRS 13 requires an entity to determine the fair value of the item using the following hierarchy: • If there is a quoted price in an active market for an identical item held by another party as an asset, the entity is required to measure its liability or equity instrument using that quoted price. • If a quoted price in an active market is not available, an entity should use other observable inputs, such as an observable price for an identical item held as an asset in a market that is not active. • Ifno observable prices as above are available, an entity should use another valuation technique to value the item as an asset, upon which the fair value of the liability or equity instrument will be based. Such a valuation teclmique could be: - an income (present value) approach as discussed in section 7.4.6; or -

a market approach based on prices for similar (but not identical) liabilities or equity instruments held as assets by other parties as discussed in section 7.4.4.

It is critical to note, firstly, that should there be an observable market where buyers quote prices to

assume a specific liability, the fair value of the liability should be determined with reference to that market. This is the case even when other parties also hold the liability as an asset. Furthermore this market needs to be observable, but not necessarily active. Only if there is no observable market for the liability, will the above hierarchy be followed. Secondly, the fair value methodologies above are hierarchical. This implies that if there is a quoted price in an active market for an identical item held as an asset, this price must be used by the entity to determine the fair value of a liability. This applies, regardless of whether other measures of fair value relating to the item held as an asset may be available.

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Example 7.14: Fair value ofa liability: observable marketforthe liability G Ltd has a liability that it issued for R10 million. On its reporting date G Ltd must measure the liability at fair value. An observable market exists for liabilities of this nature, whereby insurance companies are willing to assume an entity's liability for a given upfront payment. The liability is also quoted as an asset and recent observable prices in the active market suggest that other parties are willing to pay R9,7 million to hold the item (as an asset). G Ltd determines, using recent transactions for similar liabilities between other entities and insurance companies, that the fair value of its liability is in the range of R9,5 million to R10,2 million. Using a probability distribution, G Ltd thereafter calculates that the fair value of its liability amounts to R9,9 million at reporting date. Because there is an observable market for the liability, G Ltd would determine the liability's fair value with reference to that market and carry the liability at R9,9 million. Note that the market for the liability is not necessarily active and that the liabilities are not identical to the liability being measured. However, the fair value of the liability is determined on the basis of its observable market, regardless of the fact that prices for the same item held as an asset would suggest that the fair value of the liability is lower.

Example 7.15: Fair value ofa liability: no observable marketforthe liability F Ltd issued 10 million debentures to the value of R20 million during the current reporting period and these debentures are carried at fair value. There is no observable market for liabilities of this nature. The debentures are quoted and on reporting date the quoted price was R2, 10 per debenture. Although the calculation of the fair value is straightforward (R2,10 x 10 million = R21 million), it is important to note that the fair value in this case has been determined from a market where the liability is held as an asset. This is not an observable market for the liability. Such a market would represent quotes by buyers to assume the obligations of F Ltd.

Example 7.16: Fair value of a liability: no observable marketfor the liability H Ltd has a liability that it issued for R5 million to an investment vehicle, which is the only asset of this vehicle. On its reporting date H Ltd is required to measure the liability at fair value. No observable market exists for the liability. The only instruments issued by the investment vehicle are equity instruments quoted in an active market, valued at R4,5 million in total. H Ltd would value its liability at R4,5 million on reporting date, using the prices for its identical liability traded as an asset. Note that the relationship does not have to be direct. In this case, the equity instruments of the investment vehicle are secured by its claim against H Ltd and it does not have any other assets. Therefore the equity claim of the investment vehicle's investors is essentially the same as a liability claim against H Ltd. Note that, should the market not be active, H Ltd would still be required to value the liability with reference to the value of the equity instruments issued by the securitisation vehicle. This could be with reference to an inactive market or a valuation technique (which may be based on market prices of similar equity instruments), in that order.

As the fair value of a liability or an entity's own equity instrument is often determined from markets that are related to (but not markets for) the specific item, quoted prices may not represent the best estimate of fair value. Accordingly IFRS 13 allows an entity to adjust the quoted price of the asset used to determine fair value. However, an entity may only adjust the quoted price of the asset ifthere are factors that are specific to the asset that are not applicable to the liability or own equity instrument. The following factors may indicate that a quoted price of an asset may need to be adjusted for applying it in a fair value measurement for a liability or own equity instrument: • There are restrictions on the sale of the asset, which affects its fair value . • The quoted price is for a similar liability (or equity instrument) held as an asset by another party, but it is not identical. - In such a case particular characteristics of the issuer may be affecting the fair value of the item (e.g. credit quality of the issuer). Adjustments should be made for such characteristics, as they are entity-specific.

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• The unit of accOllllt is not the same for the asset and the liability or equity instrument being measured. -

For example, market participants in the market for assets may take into account a credit enhancement, such as bond insurance. Credit enhancements that represent claims on third parties by market participants should not affect the fair value of an entity's liability.

Example 7.17: Credit enhancement K Ltd issued 10 million debentures to the value of R10 million during the current reporting period and these debentures are carried at fair value. There is no observable market for liabilities of this nature. The debentures are quoted and on reporting date the quoted price was RO,95 per debenture. At the date of issue of the debentures, the parent company of K Ltd guaranteed the payment of the debt up to RO,90 per debenture. The parent company is a large multinational with a high credit rating. At reporting date the fair value that investors are willing to pay to hold the debenture as an asset (RO,95) reflects the guarantee from the holding company as well as other market factors (such as the credit risk of K Ltd, liquidity risk, market interest rates etc). The liability should be measured at the fair value of the obligation of K Ltd, which is unaltered by the presence of the guarantee. Accordingly the quoted price per debenture would need to be adjusted. Assuming that a valuation technique places a fair value on the credit enhancement at RO,02 per debenture, the fair value of the liability would be R9,3 million [10 million x (RO,95 - RO,02)[.

7.5.2.2 Liabi[ities and equity instruments not held by other parties as assets Should there be no observable market for a liability or equity instrument, an entity would first determine whether there is a market for identical or similar items held by other parties as assets. Ifno such market exists, the fair value of the liability or own equity instrument should be determined using a valuation technique from the perspective of a market participant that owes the liability or has issued the claim on equity. The best example of when this may be the case, flows from the application of the accounting principles of business combinations. In a business combination an entity may acquire a dismantling provision that it must measure at fair value on acquisition date. Other parties would not hold such a liability as an asset. Accordingly an entity would need to determine the fair value of the liability using a valuation teclmique (most probably a present value technique) on acquisition date. The standard suggests that the following may be taken into account when using a present value teclmique to determine the fair value of a liability or own equity instrument: • the future cash flows that a market participant may expect to incur in fulfilling the obligation, including compensation that a market participant would demand for taking on the obligation; or • the amount that a maIket participant would receive when issuing an identical liability or equity instrument, using the assumptions that market participants would use in the principal (or most advantageous) market when pricing the item. When determining the fair value of a liability using a present value technique, IFRS 13 requires an entity to take into account the compensation that a market participant would demand for taking on the liability. In this regard, remember that the absence of an observable market does not mean that a market does not exist. For example, insurers may charge a premium for taking over an entity's liability from which a fair value would be determinable. If these prices were not made public, a market would exist that is not observable. With this in mind, the compensation that IFRS 13 refers to in these circumstances would include the return that a market participant would require for • undertaking the activity; -

This reflects compensation to the market participant for assuming the liability, when other uses were available in respect of the resources now committed to servicing the obligation.

• assuming the risk associated with the obligation. -

This refers to a risk premium that a market participant would demand for the risk that the actual cash outflows might differ from the expected cash outflows.

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As with all present value techniques, an entity can include adjustments for risk by either adjusting (reducing) the discount rate or adjusting (increasing) the cash flows but must ensure that adjustments for risk are neither omitted nor double-cOllllted (also refer to section 7.4.6).

7.5.2.3 Non-performance risk Any investor in a liability instrument of another party faces the risk that said other party will not fulfil its obligation (which can be financial or non-financial). This risk is referred to as non-performance risk. Non-performance risk includes, but is not necessarily limited to, the issuer's credit risk. Credit risk is defined in IFRS 7 as "the risk that one party to afinancial instrument will cause a financial loss for the other party by failing to discharge an obligation". This differs from nonperformance risk in that it remains llllaffected by other factors which impact on the risk of loss to a counterparty. A credit enhancement such as a third party guarantee, for example, would reduce nonperformance risk, but not credit risk. However, as discussed earlier (also refer to example 7.17), a credit enhancement is not taken into accollllt to determine the fair value of a liability, when the credit enhancement is accollllted for separately. These requirements are similar to those of lAS 37. When a re-imbursement right is recognised as an asset in terms of lAS 37, it is not offset against the provision to which it relates. Similarly, IFRS 13 requires that a liability measured at fair value represent the fair value of the gross obligation. This also applies when the credit enhancement is payable directly by the third party to investors and does not represent a potential asset (i.e. receivable) of the entity. When determining the fair value of a liability, an entity assumes that non-performance risk is the same before and after the assumed transfer. This implies, for example, that the fair value of a liability is not influenced by the credit risk of another party, even if all other market participants have lower credit risk than the entity in question. Accordingly, in contrast to the general guidelines of IFRS 13, non-performance risk is an entity-specific measure that is incorporated into the fair value calculation. An entity takes into accollllt the effect of changes in its own creditworthiness (credit risk) on the fair value of the liability as well as other factors that may cause the obligation to be llllfulfilled. The effect may differ, based on the nature of the liability. IFRS 13 mentions that the effect of nonperformance risk on fair value may differ between a financial liability and a liability to deliver goods or services (i.e. a non-financial liability).

Example 7.18: Factors impacting on non-performance risk The factors impacting on non-performance risk differ significantly based on the nature of the liability. Assume A Ltd has two liabilities: a liability relating to trade creditors (a financial liability) and a liability relating to an obligation to provide services, the delivery of which it is contractually bound to. Factors that impact on the fair value of the trade creditors will mainly relate to the entity's ability to generate (or otherwise obtain) sufficient cash flows to repay the financial liability when it falls due. As such, the largest part of non-performance risk would in this case relate to the entity's own creditworthiness (i.e. its credit risk). In contrast, the non-performance risk related to the contractual liability to provide services would be significantly influenced by the entity's ability to provide these services. Suppose the agreement is to provide the counterparty with electricity over a given period. In this case the fair value of the service liability would be impacted by the risk that the power plant may be damaged to such a degree that the service cannot be rendered during the contract period. This risk would also consider whether the entity has other power plants with capacity to provide the service should the main power plant be damaged. Credit risk in this scenario may be much less relevant in determining the fair value of the obligation than for the financial liability discussed above.

7.5.2.4 Restrictions on the transfer of the liability or own equity instrument In many cases an entity may be prevented by contractual terms from transferring a liability or own equity instrument. For example, loan covenants may determine that a bond is non-reflllldable. This means that the entity cannot issue new bonds and use the proceeds to repay the bond in issue. Such contractual provisions may limit the ability of the entity to transfer the liability or own equity

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instrument. However, to measure a liability or own equity instrument at fair value, an entity is required to assume precisely such a transfer. IFRS 13 therefore requires an entity to take into account the impact of restrictions on the fair value of a liability or own equity instrument transferred. However, the standard sets an explicit requirement that a separate adjustment may not be made to include the effect of restrictions on transfers in the fair value measurement. Rather, the impact of restrictions should be included as part of the other inputs used to determine fair value (by either explicitly or implicitly adjusting these inputs). The standard explains this requirement based on the initial transaction price for the liability or own equity instrument. At that date the issuer and the investor were both aware of the restriction of transfer and included it in the determination of the transaction price. No separate adjustment was therefore necessrny. Accordingly no separate adjustment should be necessrny when subsequently determining fair value. The requirement is specific to standard. However, in the authors' of assets as the initial transaction transfer thereof, analogous to the instruments.

financial liabilities and own equity instruments covered by the opinion, the requirement also applies to determining the fair value price for assets would also implicitly include restrictions on the argument of IFRS 13 with relation to liabilities and own equity

7.5.2.5 Financial liabilities with a demand feature In paragraph 47 of IFRS 13, one of the few restrictive requirements in the standard for determining fair value is set out: The fair value of a financial liability that is repayable on demand (a demand feature) is not less than the amount repayable on demand, discounted from the first date that the amount could be required to be paid. Accordingly the fair value of a financial liability that is repayable on demand at the reporting date cannot be less than the liability's face value. It is important to note that this requirement relates only to financial liabilities and not to non-financial liabilities or own equity instruments.

7.5.3

Financial assets and financial liabilities with offsetting market risk or counterparty credit risk

As part of a risk management strategy, many entities in the financial seIVices industry manage sets of financial assets and financial liabilities as a group. This enables the entity to consider risks on a net basis with regard to maIket risk or cOllllterparty credit risk. Net exposures in relation to financial assets and liabilities, however, are not limited to entities in the financial seIVices industry (although they are less often managed as such). For example, an entity that manufactures components on behalf of another may have a receivable for finished products delivered as well as a payable for raw materials purchased from the same counterparty. If an entity manages its risk on a net basis, IFRS 13 allows the entity to determine the fair value of the portfolio, rather than of the individual financial assets and financial liabilities as would normally be required. This implies that an entity would determine the fair value of the portfolio with reference to the way in which market participants would price the net exposure. However, measurement on a portfolio (i.e. net exposure basis) is only allowed if the entity complies with all of the following requirements: • the entity manages the portfolio on the basis of the entity's net exposure to particular market or counterparty risks; • this occurs in accordance with a documented risk management or investment strategy; • information relating to the portfolio is provided on a net basis to the entity's key management persOIlilel (as defined in lAS 24); and • the financial assets and financial liabilities of the portfolio are measured at fair value at the end of each reporting period (which may be because of a requirement or an election by the entity).

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All of the financial assets, financial liabilities and other contracts included in the portfolio measured on a net basis must fall within the scope and should be aCcOllllted for in terms of IFRS 9. The standard specifies that, should the entity decide to determine the fair value of a group on a net basis, this is an accOllllting policy choice in terms of lAS 8. Accordingly an entity is required to apply its accOllllting policy choice consistently from period to period for a specific portfolio. In other words, an entity is permitted an accOllllting policy choice for each of its portfolios managed on a net basis, but this choice must be applied consistently to a specific portfolio. It is important to note that the choice to measure a portfolio of financial assets and financial liabilities on a net basis does not affect the presentation requirements for the portfolio. In other words, the offsetting requirements in lAS 32 would have to be met before a portfolio can be presented on a net basis, regardless of how the fair value has been determined. As offsetting is allowed in very few circumstances (refer to the chapter on financial instruments), the fair value determined on a net basis would need to be allocated to the various financial assets and financial liabilities included within the portfolio. In such a case, an entity would need to allocate the fair value adjustment determined on a portfolio-level to the individual financial assets and liabilities included within the portfolio. IFRS 13 requires that this allocation be performed on a reasonable and consistent basis, using a methodology that is appropriate under the circumstances.

The financial assets and financial liabilities of a portfolio will have substantially differing characteristics. Accordingly, in the authors' opinion, it is extremely unlikely that their fair values would be appropriately adjusted using a simple proportional adjustment basis. Therefore an entity would need to make use of a method that takes these differences into accOllllt, which may be achieved by using a sensitivity analysis or matrix pricing method based on historical relationships.

7.5.3.1

Exposure to market risks

As mentioned earlier, one of the risks that an entity may be managing on a net basis is the market risk of a portfolio of financial assets and financial liabilities. If an entity elects to measure the portfolio on a net basis based on shared market risks, IFRS 13 requires it to use the price within the bid-ask spread that is most representative of the entity's net exposure to these market risks. Furthermore, an entity should ensure that the market risks, to which the portfolio of financial assets and liabilities is exposed, are substantially the same. For example, the price risk (sensitivity to interest rate changes) for long-dated interest-bearing assets is significantly different from the price risk of short-dated interest-bearing liabilities. If the contractual term of the assets and liabilities in a portfolio is sufficiently different, changes in the fair values of the assets and liabilities will not offset. Accordingly an entity cannot reasonably view this as an offsetting exposure and may therefore not measure fair value for the portfolio on a net basis. More obviously, the market risks attached to equity investments differ from risks attached to loans bearing interest at the prime interest rate. Accordingly, changes in the fair value of these financial assets and financial liabilities will not offset and an entity cannot reasonably manage or measure such a portfolio on a net basis.

7.5.3.2 Exposure to counterparty credit risk When the risks managed on a net basis include counterparty credit risk, an entity takes into account the net exposure when determining fair value. However, the net exposure is only considered if market participants would take into account arrangements that would mitigate credit risk exposure in the event of default. In other words, having offsetting exposures to the same counterparty is not sufficient. The entity must have the right to offset its positions in the event of default (by virtue of a master netting agreement, for example). If the entity would be legally required to settle its obligations first and join the queue of creditors with regard to its assets in the event of default, a net exposure does not exist. Another way in which a net exposure may arise is if the entity has a contractual arrangement with the counterparty, stipulating that whichever party has a net liability exposure provides collateral on a daily basis. In such a case a net exposure may arise even if the entity is legally required to first settle its obligation, as it would be a secured creditor in the event of default by the counterparty. Any fair

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value measurement, however, should also take into accOllllt market participants' expectations relating to the probability that the agreement would be legally enforceable should the need arise.

7.6 Financial statement presentation The disclosure requirements in IFRS 13 distinguish in many places between recurring and nonrecuning fair value measurements. Recuning fair value measurements are those where a standard requires or permits an entity to measure an asset or liability at fair value on each reporting date. The fair value measurement requirements for investment property (lAS 40) and many financial instruments (lFRS 9) are good examples. Non-recuning fair value measurements will be required or permitted by a standard as a once-off measurement when specific circumstances exist. For example, the recoverable amount of an asset may be based on fair value for impairment pmposes (lAS 36) or where it is held for sale (lFRS 5). Another instance where fair value measurement is non-recuning is the purchase method for a business combination where acquired assets and liabilities are measured at fair value (lFRS 3). The standard requires that the disclosures surrounding fair values meet the following objectives: • it should assist users in assessing the valuation techniques used and the inputs thereto for all fair value measurements (recuning and non-recuning) after initial recognition; and • it should assist users in assessing the impact of Level 3 fair value measurements on profit or loss (or other comprehensive income) for the period with regard to recuning fair value measurements. Should the minimum disclosures required by IFRS 13 and other standards applicable to a particular item be insufficient to meet the objectives as detailed above, the entity should make additional disclosures to ensure that the objectives are met. The minimum disclosures required in IFRS 13 are to be made in tabular format, unless another format is more appropriate. Furthermore these disclosures are made for each class of assets or liabilities. The same disclosures are also required for measures based on fair value, such as fair value less cost to sell. An entity should determine a class of assets or liabilities based on• the nature, characteristics and risks of the item; and • the level of the fair value hierarchy within which the fair value measurement is categorised. Sufficient information should be provided so that the amounts disclosed can be reconciled back to line items in the statement of financial position. If another IFRS specifies a class for an asset or liability, fair value disclosures may be made for such a class, provided that it meets the requirements in IFRS 13.

7.6.1

Assets and liabilities measured at fair value

The following are the minimum disclosures that the standard requires for each class of asset or liability measured at fair value after initial recognition: •

For both recuning and non-recuning fair value measurements: -

the fair value measurement at the end of the reporting period;

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if the highest and best use of a non-financial asset differs from its current use, that fact and the reason why;

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the level of the fair value hierarchy within which the fair value measurement falls in its entirety (Level 1,2 or 3);

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for Level 2 and 3 fair value measurements:

-

.:.

a description of the valuation techniques and the inputs used;

.:.

a description of changes in the valuation techniques from the prior reporting period (if any) and the reasons for the changes;

for Level 3 fair value measurements: .:.

quantitative information about the significant unobservable inputs used;

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Note: This disclosure is not necessrny when quantitative llllobservable inputs are not developed by the entity. However, if there are reasonably available quantitative llllobservable inputs that differ significantly from those used by the entity, they may not be ignored when making this disclosure . a description of the valuation processes used by the entity, including how an entity decides its valuation policies and analyses changes in fair value measurements; • for non-recurring fair value measurements: - the reasons for the measurement at fair value; •:.

• for recurring fair value measurements: - the amollllt of any transfers between Levelland Level 2 of the fair value hierarchy and the reasons for those transfers. Transfers into and out of a specific level may not be netted off quantitatively and must be discussed separately; - for fair value measurements in Level 3, a reconciliation from the opening balances to the closing balances, disclosing separately changes during the period attributable to the following: .:. total gains or losses for the period recognised in profit or loss and the line items in which those gains or losses have been recognised; .:. total gains or losses for the period recognised in other comprehensive income and the line items in which those gains or losses have been recognised; .:. purchases, sales, issues and settlements (each type of movement should be disclosed separately); .:. transfers into or out of Level 3 and the reasons for those transfers. Transfers into and out of Level 3 may not be netted off quantitatively and must be discussed separately; .:. the amollllt of the total fair value gains or losses included in profit or loss for the period that is attributable to unrealised gains or losses and the line items in which the unrealised gains or losses have been recognised; - for all fair value measurements in Level 3: .:.

-

a narrative description of the sensitivity of the fair value measurement to changes in llllobservable inputs if a change in the inputs might result in a significantly higher or lower fair value measurement; .:. should there be interrelationships between different llllobservable inputs an entity should describe these interrelationships and how they might impact on the effect of changes in the llllobservable input as disclosed; .:. at a minimum, disclosures should be made for each significant unobservable input used in the fair value measurement (as required to be disclosed for both recuni.ng and nonrecuni.ng fair value measurements); for fair value measurements in Level 3 that relate to financial assets and financial liabilities: .:.

.:. .:.

if changing one or more of the inputs to reasonably possible alternative assumptions would change the fair value significantly, the entity should state that fact and disclose the effect of the changes; the entity should disclose how the effect of a change to a reasonably possible alternative assumption was calculated; significance should be judged with respect to profit or loss and total assets or total liabilities, or, when changes in fair value are recognised in other comprehensive income, total equity.

Example 7.19: Fair value disclosures: measured assets The example below illustrates suggested fair value hierarchy disclosures as required by IFRS 13 for assets measured at fair value for a reporting entity with a reporting date of 31 December 20X8. These disclosures would also be required for all liabilities measured at fair value. The entity carries investment property under the fair value model in lAS 40 and property, plant and equipment under the cost model

137

Fair value measurement

in lAS 16, except for administrative land and buildings carried under the revaluation model. Comparative amounts have not been illustrated, but would be required in terms of lAS 1. Notes for the year ended 31 December 20X8

41. Fairva/ue measurements Assets measured at fair value (or measured based thereon) are categorised in terms of the fair value hierarchy as follows: par 93(a) & (b)

Financial assets at fair value

Investments in equity instruments at fair value

through

profit or loss 31 December 20X8 Level 1 Level 2 Level 3

R'OOO 2541 12254 1 452

Disposal Property, plant and

Investment

through oel R'OOO 107024

property R'OOO

$

15334

16247

121 265

15334

sale**

R'OOO

1872 • 14 241

Historical cost model Total

equipment Buildings Land R'OOO

# $

group held for R'OOO 847

147 • 2486

@

118245

80746

120 117

80893

3333

Note: The historical cost model line has been included to enable reconciliation back to the line items disclosed in the statement of financial position (through the property, plant and equipment note) as required by IFRS 13.

@

These values represent administrative land and buildings carried under the revaluation model in terms of lAS 16. The fair value of the land and buildings has been determined by an independent valuator, utilising a replacement cost approach, which is consistent with that used in the prior reporting period. The disposal group held for sale has been measured at the lower of its carrying amount and fair value less cost to sell. Refer to note 26 for further detail on the nature of the assets included in the disposal group. Included in the investment property total is an empty stand with a fair value of

par 93(a)

par 93(a)

R1 ,421 ,000 with a highest and best use of development land. The stand has been

#

acquired for defensive purposes to prevent high-rise developments in front of the company's seafront hotel and as such has not been developed to its full potential.

par 93(i)

All fair value measurements of non-financial assets have been determined on a net replacement cost basis with reference to recent market transactions.

par 93(d)

These Level 2 financial assets represent unquoted foreign exchange contracts and interest rate swaps. The fair value of foreign exchange contracts has been determined by applying quoted spot and forward exchange rates and a risk-free interest rate, based on quoted government debt instruments with a similar term, to the notional amount outstanding under the contract. The fair value of interest rate swaps has been determined by use of an interest option pricing model, using contractual interest rates and expected interest rates and volatility therein as observed from recent market transactions. The valuation techniques are unchanged from prior reporting periods. Level 3 financial assets represent unquoted equity instruments. Unquoted equity instruments have been measured at fair value using an earnings-multiple approach based on the prices of quoted equity instruments. Appropriate discount factors have been taken into account, based on historical correlation of unquoted equity instruments in the applicable industries with their quoted counterparts, as

par 93(d)

par 93(d)

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well as marketability discounts where applicable. The valuation technique applied has been changed from the prior reporting period from a discounted cash flow model to an enterprise value model based on an earnings-multiple approach. This change has been informed by the company's policy to follow valuation methodologies most commonly applied within its industry group to ensure comparability with similar enterprises. Reconciliation of recurring Level 3 fair value measurements

par 93(e) & 93(1)

Investments in Financial assets at equity instruments at fair value fair value through through oel prolit or loss Balance on 31 December 20X7 Purchases Sales Transfers into Level 3 Transfers out of Level 3 Gains and losses recognised: • in profit or loss (in the line item "Other income")

•

R'OOO

R'OOO

2300 215 (144)

15750 1117

(1 236)

Balance on 31 December 20X8

1 452

Investment property

R'OOO 15031 1 521

2417 (5784)

317

Ic205ll

Realised Unrealised ~ in other comprehensive income (in the line item "Mark-to-market reserve on investments in equity instruments")

par 93(d) & 93 (g)

1 218

D

(1218)

741 14241

Transfers into Level3: An equity investment previously categorised as a Level 1 fair value measurement has been transferred into Level 3 during the current reporting period as, upon the delisting of the equity investment from the securities exchange, quoted prices are no longer available for this investment.

15334

par 93(e)(iv)

Transfers out of Level 3: During the current reporting period, several of the entities in which the company holds investments, obtained listings on the securities exchange. Therefore, the company has determined the fair value of these investments with reference to quoted prices on the reporting date, which qualifies the investments to be categorised as Level 1 fair value measurements. Sensitivity affair values to unobsetvable inputs: The fair values of investment property are based on net replacement cost, which make use of estimated economic obsolescence. Estimates of such obsolescence are made by independent, experienced valuators, but are not observable from market data. Assuming a 1,00% average change in estimated economic obsolescence for all investment properties, would alter the fair value of the company's investment properties by 0,75%. The fair values of equity investments are based on an earnings-multiple valuation technique with marketability discounts ranging from 25% to 30% during the current reporting period. Changing the marketability discount so that all investments are valued at the minimum discount would lead to a 14,18% increase in the fair value of Level 3 investments, while applying the maximum discount would lead to an 18,24% decrease. The sensitivity calculations have been performed by replacing the discount factors used in fair value measurements with 25% or 30% and comparing the result to the measurement as reported.

par 93(h)(i)

par 93(d)

par 93(h)(ii)

Fair value measurement

139

Note: Although a large number of disclosures have been illustrated in this example, IFRS 13 requires some additional disclosures with regards to transfers between Levelland 2 fair value measurements and interrelationships between llllobservable inputs, which have not been included.

7.6.2

Assets and liabilities disclosed at fair value

For assets and liabilities which are not measured at fair value, but for which fair value is disclosed, IFRS 13 sets out somewhat lighter minimum disclosure requirements. These are • if the highest and best use of a non-financial asset differs from its current use, that fact and the reason why; • the level of the fair value hierarchy within which the fair value measurement falls in its entirety (Level 1,2 or 3); and • for Level 2 and 3 fair value measurements: - a description of the valuation teclmiques and the inputs used; -

a description of changes in the valuation techniques from the prior reporting period (if any) and the reasons for the changes.

Example 7.20: Fair value disclosures: disclosed assets The disclosure requirements for assets for which fair values are disclosed (but not recognised) are similar to those illustrated in example 7.19. However, the requirements are less onerous as the second part of the example (the Level 3 reconciliation) can be omitted for these assets. Examples of assets for which fair values are disclosed (but not recognised) includeinvestment property carried under the cost model; associates accounted for under the equity method for which quoted prices exist; and property, plant and equipment (this is a voluntary disclosure in terms of lAS 16).

7.6.3

Policy disclosures

IFRS 13 requires the following policy disclosures: • if an entity elected to fair value a group of financial assets and liabilities on a net basis, that fact; and • the policies that an entity uses to determine when transfers between levels of the fair value hierarchy have occurred. The policies with regard to transfers between the levels of the fair value hierarchy should be the same for transfers into the levels and for transfers out of the levels. These policies should furthermore be applied consistently over time. Examples of policies for determining the timing of transfers include• the date of the event or change in circumstances that caused the transfer; • the begiIliling of the reporting period; or • the end of the reporting period.

7.6.4

Other disclosures

Should a liability measured at fair value be issued with an inseparable third-party credit enhancement, an entity must disclose• the existence of the enhancement; and • whether the credit enhancement is reflected in the fair value measurement of the liability.

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Summary of IFRS 13, Fair value measurement Definition

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. Valuation approaches Market approach

Cost approach

Based on market prices for identical or similar assets.

Based on the cost to replace the current service capacity of the asset.

Income approach Based on the present value of an expected earnings, cash flow or expense stream.

Any valuation technique must make maximum use of observable market inputs and minimise the use of unobservable inputs Fair value hierarchy Level 1 Fair value measurements rely on quoted prices in active markets for identical assets that the entity can access at the measurement date.

Level 2 Fair value measurements rely on inputs (other than quoted prices included within Level 1) that are observable for the asset or liability.

Level 3 Fair value measurements depend on inputs that may not be classified as Level 1 or Level 2 inputs, as they are unobservable.

Specific applications Non-financial assets

Liabilities and awn equity instruments

Financial assets and financial liabilities with offsetting market or counterparty risk

Value according to highest and best use even if this is not its current use.

Value with reference to observable markets.

Value on a net basis.

Highest and best use must be physically possible, legally permissible and financially feasible.

If there are no observable markets, value with reference to observable markets where held as assets by other parties.

Must be managed on a net fair value basis in accordance with a documented risk or investment strategy and thus reported to key management.

Rebuttable presumption that current use by the entity is the highest and best use for the asset.

If not held as assets by other parties, value with valuation technique from perspective of market participant that owes the liability or has issued the equity.

The right to offset for presentation purposes is determined by other standards, even if measured net in terms of IFRS 13.

Applicable to all assets and liabilities

Should be able to reconcile

Disclosure based on fair value

measured at fair value or for vvhich it is disclosed.

disclosures back to statement of financial position.

hierarchy (Level 1, 2 and 3).

Disclosure

8

Taxation lAS 12 (Effective date 1 January 1998) SIC 25 (Effective date 15 July 2000) FRG 1 (Issue date December 2012) IFRIC 23 (Effective date 1 January 2019)

8.1 Introduction Entities may be subj ect to various income taxes, for example normal company tax and foreign taxes. lAS 12 deals with the accOllllting for all income taxes. For the purposes of the standard, income taxes include all domestic and foreign taxes which are based on taxable profits. Taxable profit is defined as the profit for the period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable. Income taxes also include taxes reported in the consolidated financial statements, such as withholding taxes, which may be payable by a subsidirny, associate or joint venture on distributions to the reporting entity (for example certain foreign withholding taxes). In South Africa, capital gains are included in the normal company tax calculation and disclosed as part of the normal current tax expense. (Refer to disclosure example 8.5.4.) Any taxes that are not within the scope of the standard should be accounted for in terms of lAS 37. For each income tax that an entity is subject to, the entity needs to consider the accOllllting treatment of both current tax and deferred tax. lAS 12 prescribes the accounting of both current tax and deferred tax. The income tax expense in the statement of profit or loss and other comprehensive income is the aggregate amount in respect of current tax and deferred tax.

8.2 Current tax Current tax is defined as the amount of income taxes payable or recoverable in respect of the taxable profit or tax loss for a period. Current tax for current and prior periods should be recognised as a liability to the extent that it is unpaid. If the amount already paid in respect of current and prior periods exceeds the amount due for those periods, the excess should be recognised as an asset. Current tax liabilities or assets should be measured at the amount expected to be paid to or recovered from the taxation authorities, using the effective tax rates and tax laws that have been enacted or substantively enacted by the reporting date. Current tax should be recognised as income or an expense and included in profit or loss, except to the extent that the tax arises from a transaction or event which is recognised outside of profit or loss, either in other comprehensive income or directly in equity. If an entity has an agreement with the tax authority to permit the entity to pay its current taxes due over a period of time, it is contended that the current taxes payable should be discounted when the effect of discounting is material. The extended credit granted by the taxation authority should then be treated as a government grant in accordance with lAS 20. Interest and penalties related to possible income tax exposures should not be presented as part of income tax, as they do not meet the definition of income taxes in lAS 12. An entity should recognise

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a provision in accordance with lAS 37 for its best estimate of any interest and penalties payable for previous tax periods.

Example 8.1: Currenttax An entity has a 31 December year-end. The following represents a summary of the transactions with the taxation authority: R 1/1/20X4 Amount due at 31/12/20X3 (LLO. 20X3 tax) 9840 (7500) 30/6/20X4 First provisional tax payment 1817120X4 Final payment of 20X3 assessment (including interest of R3 690 and penalties of R5 500 for late submission) (14600) 31112/20X4 Second provisional tax payment (9350) Provision for 20X4 tax 38635 31112/20X4 The journal entries for 20X4 are as follows: Dr Cr R R 30 June 20X4

Creditor: taxation authority Bank (First provisional tax payment)

7500

Creditor: taxation authority Finance costs other expenses (penalties) Income tax expense (over-provision prior year) Bank (Final payment of the 20X3 assessment) 31 December 20X4 Creditor: taxation authority Bank (Second provisional tax payment) 31 December 20X4 Income tax expense Creditor: taxation authority (Tax provision for 20X4)

9840 3690 5500

18 July 20X4

7500

4430 14600 9350 9350 38635 38635

The Income tax expense relating to current tax amounts to R34 205 (38 635 - 4 430). The Interest and penalties on the late submission of the tax return do not form part of the income tax expense line item in the statement of profit or loss and other comprehensive income.

8.3 Deferred tax One of the principal issues in accOllllting for income taxes is how to account for the future tax consequences of the recovery/settlement of the carrying amounts of assetslliabilities recognised in the statement of financial position. lAS 12 determines that a deferred tax liability should be recognised whenever recovery of the carrying amount of the asset/settlement of the liability would result in larger future tax payments. Conversely a deferred tax asset should be recognised whenever settlement of the carrying amount of the liabilitylrecovery of the carrying amount of the asset would result in smaller future tax payments. The recognition and measurement of deferred tax requires consideration of the following five steps: • The calculation of a temporary difference. • Consideration of the exemptions from the recognition of deferred tax for certain temporrny differences. • Consideration of the limitations for the recognition of a deferred tax asset for deductible temporrny differences and unused tax losses or credits. • Consideration of the appropriate tax rates (and tax laws).

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• Recognition of deferred tax income or expense. These steps are discussed in more detail below. It should be noted that deferred tax assets and liabilities should not be discOllllted, even if temporary differences will only reverse after a number of years.

8.3.1

The calculation of a temporary difference

Temporrny differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. As a result of differences between accounting standards and tax legislation, instances may arise where an item, which has been fully recognised in the statement of profit or loss and other comprehensive income for accounting purposes, may have a tax base (determined in accordance with tax legislation) even though it is not recognised as an asset or liability in the statement of financial position (i.e. it has no carrying amount). This is illustrated in example 8.11. lAS 12 defines the tax base of an asset, a liability and income received in advance. These definitions are discussed in the next sections.

8.3.1.1

Tax base of an asset

The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset in future periods. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount and no temporrny difference will arise.

Example 8.2: Tax base of an asset - future economic benefits taxable Machinery used in the production process has a cost of R1 000000. Wear and tear is allowed at 33 1h%. As the machine is used in the production process, the future economic benefits (i.e. the proceeds from the sale of the goods produced by the machine) will be taxable. The tax base of the machinery is as follows: At the end of Year 1 Year 2 Year 3 Cost Accumulated wear and tear Tax base (i.e. wear and tear to be claimed in future)

R

R

R

1 000000 333333

1 000000 666666

1 000000

666667

333334

NIL

1 000000

Example 8.3: Tax base of an asset - future economic benefits not taxable Trade receivables have a carrying amount of R50 000. The tax base is also R50 000, as the related revenue has already been taxed when the amount accrued to the entity (the future cash receipt from the debtor will thus have no further tax consequences as the revenue was already included in taxable income at date of sale).

8.3.1.2 Tax base of a liability The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods when the liability is settled.

Example 8.4: Tax base of a liability - future settlement deductible A provision for warranty costs has a carrying amount of R 1 500 000. The warranty costs will be deductible for tax purposes when paid in future. The tax base of the provision is Rnil, being R1 500000 (carrying amount) less R1 500000 (future tax deductions).

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Example 8.5: Tax base of a liability - future settlement not deductible A loan has a carrying amount of R2 000 000. The repayment of the loan will have no tax consequences. The tax base of the loan is R2 000 000, being R2 000 000 (carrying amount) less Rnil (future tax deductions).

Example 8.6: Tax base of a liability - future settlement partially deductible On 31 December 20X1 (year-end) an entity has a provision for a legal claim of R114 000. The legal claim consists of two elements, namely R14 000 for damages to property caused by the entity's employees at the year-end function (not tax-deductible) and R100 000 for breaching the contract with the event planner (tax deductible). At year-end the carrying amount of the liability is R 114 000. The tax base of the liability is calculated as follows: R Carrying amount 114000 Deductible in future (the damages to the property component is not deductible) (100000) Tax base

14000

8.3.1.3 Tax base of revenue received in advance In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amollllt, less any amount of the revenue that will not be taxable in future periods.

Example 8.7: Tax base of revenue received in advance - not taxable in future Service fee income of R10 000 was received in advance. The total amount was taxed on receipt thereof. The tax base of the service fee income is Rnil, being R10 000 (carrying amount) less R10 000 (R10 000 not taxable in future, as it was taxed on receipt).

Example 8.8: Tax base of revenue received in advance - taxable in future A deposit of R20 000 was received for goods still to be manufactured. If it is assumed that the deposit will be taxed in future when the goods are manufactured, the tax base of the deposit will be R20 000, being R20 000 (carrying amount) less Rnil (R20 000 will be taxed in future - no portion thereof will not be taxable in future).

Once a temporary difference has been calculated it is necessary to determine whether the temporary difference is a taxable or a deductible temporary difference.

8.3.1.4 Determining whether temporary differences are taxable or deductible Temporary differences may be either taxable temporary differences or deductible temporary differences: Taxable temporary dtfferences are temporary differences that will result in taxable amOllllts in determining the taxable profitl(tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. These taxable amounts will result in larger tax payments in the future. Taxable temporrny differences therefore result in the recognition of a deferred tax liability . • Deductible temporary dtfferences are temporrny differences that will result in amounts that are deductible in determining the taxable profitl(tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. The amounts which are deductible will result in smaller tax payments in the future. Deductible temporary differences therefore result in the recognition of a deferred tax asset (or a decrease in a deferred tax liability).

Taxation

145

Example 8.9: Manufacturing plant On 1 January 20X1 plant was purchased at a cost of R150 000. For 20X1 depreciation was R30 000 (20% per annum) and wear and tear (tax allowances) was R50 000 (33 1h% per annum). The year-end is 31 December. R Carrying amount (CA) (150 000 - 30 000) 120000 Tax base (TB) (150 000 - 50 000) 100000 Taxable temporary difference (CA > TB for assets)

20000

This temporary difference will result in taxable amounts when determining future taxable profit at the time when the carrying amount is recovered, as future economic benefits amounting to at least R 120 000 are expected from the plant, while the future tax deduction against these benefits amounts to only R100 000, leaving future taxable income of R20 000. The future taxable income of R20 000 will result in tax payable in the future and therefore a deferred tax liability has to be recognised.

Example 8.10: Interest receivable On 30 June 20X1 company A lends R300 000 to a third party at a market-related rate of 15% per annum. Interest is payable annually in arrears. The interest is taxable on a cash basis. At year-end (31 December 20X1) the position is as follows: R Carrying amount (CA) (interest receivable) (15% x 300 000 x 6/,2 ) 22500 Tax base (TB) NIL (Amount deductible for tax purposes when interest is received in future is nil) Taxable temporary difference (CA > TB for assets)

22500

This represents a taxable temporary difference, as the entity will be taxed in future on the R22500 when it is received in cash, while no tax deductions will be available in future. This R22 500 will result in tax payable in the future and therefore a deferred tax liability has to be recognised.

Example 8.11: Research expenditure Research expenditure incurred during 20X1 amounted to R600 000. The total amount was written off during 20X1 for accounting purposes. Assume that the allowance for tax purposes is 25% per annum. The tax allowance for 20X1 is 150000 (600 000 x 25%). R Carrying amount (CA) (600 000 - 600 000) Tax base (TB) (600 000 -150 000) 450000 Deductible temporary difference (CA < TB for assets)

450000

This temporary difference will result in amounts that are deductible in determining taxable profit/loss of future periods, as zero future economic benefits are expected from the research expenditure (carrying amount = 0) while a future tax deduction of R450 000 will be granted, resulting in a future tax saving based on R450 000. The future tax deduction of R450 000 will thus result in a decrease in tax payable in the future and therefore a deferred tax asset may have to be recognised. Note that in this example there is a temporary difference although the asset does not have a carrying amount for accounting purposes. This is due to the fact that some items have a tax base although these items are not recognised in the statement of financial position as assets or liabilities.

Example 8.12: Provision for guarantees A company provides a two-year guarantee on all of its products. The guarantees are not sold separately. At year-end, a provision of R25 000 is raised regarding repair costs that will have to be incurred after year-end (in respect of products sold before year-end). These costs will be allowed as a deduction for tax purposes only in the next year when incurred.

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Carrying amount (CA) Tax base (TB) [R25 000 CA less R25 000 (amount deductible for tax purposes in future periods)[ Deductible temporary difference eCA > TB for liabilities)

R 25000

25000

This represents a deductible temporary difference as the entity will be entitled to a tax deduction of R25 000 when the carrying amount of the liability is settled in the future, i.e. when the repairs are done. This future tax deduction of R25 000 will result in a decrease in tax payable in the future and therefore a deferred tax asset may have to be recognised.

Example 8.13: Allowance for expected credit losses (provision for doubtful debts) A new company was incorporated on 1 January 20X1. Sales for 20X1 amounted to R2 000 000. The allowance for expected credit losses account, determined in accordance with IFRS 9, is R100 000. The taxation authority allows R25 000 (25% x 100 000) as a deduction. R Carrying amount (CA) 100000 Tax base (TB) 25000 [R100 000 carrying amount less R75 000 (amount deductible for tax purposes in future periods) = balance per taxation authority] Deductible temporary difference (CA > TB for liabilities)

75000

This represents a deductible temporary difference, as the entity will be able to claim R75 000 as a tax deduction in the future when the receivables are written off. This future tax deduction of R75 000 will result in a decrease in tax payable in the future and therefore a deferred tax asset may have to be recognised.

Example 8.14: Revenue received in advance (contract liabilities) (taxed when received) A company receives sales proceeds of R100 on 31 December 20X1 in respect of a sale to be concluded during the next financial year. The relevant tax legislation determines that the company is taxed on income on the earlier of actual receipt thereof or unconditional entitlement thereto. The company has a year-end of 31 December 20X1. R Carrying amount (CA) 100 Tax base (TB) [R100 carrying amount less R100 (revenue of R100 not taxable in future period; was taxed when received)] Deductible temporary difference (CA > TB for liabilities)

100

In future periods the entity will recognise R100 revenue in the statement of profit or loss and other comprehensive income, but this amount will not be taxable in future periods as it has been taxed on receipt. If one therefore compares the accounting profit to the taxable profit of the future periods (when this amount is recognised in profit or loss), the accounting profit will be R 100 higher than the taxable profit. This temporary difference is therefore a deductible temporary difference as R100 will need to be deducted from the future accounting profit to reconcile to the future taxable profit.

8.3.2 Consideration of the exemptions from the recognition of deferred tax for certain temporary differences Although a temporary difference might exist, deferred tax is not necessarily recognised for all temporary differences. Paragraph 15 ofIAS 12 determines that a deferred tax liability should be recognised for all taxable temporary differences unless the liability arises from • the initial recognition of goodwill; or

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Taxation

• the initial recognition of an asset or liability in a transaction which: - is not a business combination, and -

at the time of the transaction, affects neither accOllllting profit, nor taxable profit.

Similarly, paragraph 24 of lAS 12 determines that a deferred tax asset should be recognised for all deductible temporary differences to the extent that it is probable that taxable income will be available against which the deductible temporary differences can be utilised, unless the deferred tax asset arises from the initial recognition of an asset or liability in a transaction that• is not a business combination, and • at the time of the transaction affects neither accounting nor taxable profit.

8.3.2.1

Initial recognition of goodwill

Goodwill may not be claimed as a deduction for tax pmposes in South Africa. Consequently the tax base (future tax deduction) of goodwill is zero. This gives rise to a temporary difference between its carrying amount and tax base. However, lAS 12.15 prohibits the recognition of deferred tax on this temporary difference, the reason being that this deferred tax will reduce the net asset value of the subsidiary, which in turn will increase the goodwill figure. This will result in an ongoing process of changes to the amount of deferred tax and goodwill. Subsequent reductions in this unrecognised deferred tax liability are also regarded as arising from the initial recognition of goodwill and are therefore not recognised in terms of paragraph 15 of lAS 12. For example, if an acquirer initially recognises goodwill of RIOO and subsequently impairs this by R20, no deferred tax adjustment is recognised, as the R20 decrease in taxable temporary difference relates to the original unrecognised deferred tax liability on the taxable temporary difference of RIOO.

8.3.2.2 Initial recognition of an asset or liability The following examples explain the application of the initial recognition exemption as set out in paragraphs 15 and 24 oflAS 12.

Example 8.15: Initial recognition - transaction not a business combination, affects accounting or taxable profit (research costs) Assume that research costs are expensed for accounting purposes when incurred, but are written off at a rate of 25% per annum for tax purposes. When the expenses are incurred, a temporary difference immediately arises between the carrying amount of zero and the tax base, which is equal to 100% of the expenditure incurred (total expenditure qualifies for future tax deduction). As the research expenses affect accounting profit (debit research costs in profit or loss, credit bank), the lAS 12.24 exemption does not apply, and as a result, a deferred tax asset may have to be raised in respect of this temporary difference.

Example 8.16: Initial recognition - transaction not a business combination, does not affect accounting or taxable profit (government grant) X Ltd receives a non-taxable government grant of R300 000, which is accounted for as deferred income. R100 000 of this grant is recognised in profit or loss during 20X1. The tax rate is 28%. R

Carrying amount (CA) (300 000 - 100000) Tax base (TB) IR200 000 CA less R200 000 (R200 000 not taxable in future, as grant is non-taxable)]

200000

Deductible temporary difference (CA > TB for liabilities)

200000

Deferred tax asset

NIL

When the non-taxable government grant of R300 000 is recognised initially in the statement of financial position as deferred income, the initial recognition thereof gives rise to a deductible temporary difference, as the tax base would be zero (carrying amount of R300 000 less amount not taxable in future of R300 000 = 0). However, as the government grant does not affect accounting profit on initial

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recognition (recognised in statement of financial position) and also does not affect taxable income (not taxable), no deferred tax asset may be raised in respect of the deductible temporary difference.

Example 8.17: Initial recognition - transaction not a business combination, does not affect accounting or taxable profit (land) Land was acquired at a cost of R500 000. Assume that no capital allowances are available for tax purposes. R

Carrying amount (CA) Tax base (TB) (Rnil of the cost of the land will be deductible for tax purposes in future)

500000

Taxable temporary difference eCA > TB for assets)

500000

Deferred tax liability

NIL

The temporary difference is exempt in terms of lAS 12.15 as the tax liability arises from the initial recognition of an asset in a transaction which, at the time of the transaction, affects neither accounting nor taxable profit. When the land is recognised for the first time in the statement of financial position, the carrying amount is equal to R500 000, while the future tax deduction (tax base) is equal to zero. This immediately gives rise to a temporary difference of R500 000, but as the initial acquisition of the asset (dr land, cr bank/liability) does not affect accounting profit or taxable income, deferred tax may not be raised in respect of the temporary difference. [Note that the above treatment assumes that the carrying amount of the land will be recovered through use. An alternative view is that the carrying amount of the land will be recovered through sale, in which case the tax base will be equal to the base cost that applies for capital gains tax purposes, i.e. R500 000. This is because the base cost of R500 000 will be allowed as a deduction against the proceeds when calculating the capital gain upon disposal. Under this view, no temporary difference will arise as both the carrying amount and tax base will be equal to R500 000, and the deferred tax liability will still be Rnil.l If the land is revalued in terms of lAS 16, the revaluation adjustment no longer relates to the initial recognition of the land. Consequently deferred tax should be raised on the revaluation adjustment (refer to chapter 9).

Example 8.18: Initial recognition - transaction not a business combination, does not affect accounting or taxable profit (office building) An entity acquires an office building, with a useful life of 20 years, at a cost of R 100 000. The tax rate is 28%. Assume that there is no tax allowance in respect of office buildings. When it recovers the carrying amount of the building, the entity will earn taxable income of at least R100 000 and pay tax of R28 000 (100 000 x 28%). On initial recognition of the building, the carrying amount is R100 000, while the tax base (future tax deductions) amounts to nil, immediately giving rise to a taxable temporary difference of R100 000. The initial recognition of the building (debit office building, credit bank/liability) affects neither accounting profit nor taxable income (no tax deduction). As all the requirements are met, the entity does not recognise the resulting deferred tax liability of R28000. In the following year, the carrying amount of the asset is R95 000. In earning taxable income of R95 000, the entity will pay tax of R26 600 (95 000 x 28%). The entity does not recognise the deferred tax liability of R26 600 because it results from the initial recognition of the asset. If the office building is revalued in terms of lAS 16, the revaluation adjustment no longer relates to the initial recognition of the office building. Consequently deferred tax should be raised on the revaluation adjustment (refer to chapter 9).

Example 8.19: Initial recognition - transaction a business combination (internally generated brand) If a parent entity acquires a subsidiary and the subsidiary owns an internally generated brand, this brand may be recognised in the consolidated financial statements (refer to chapter 23) even though it is not recognised in the subsidiary's own financial statements (an internally generated brand may not be recognised as an asset in the subsidiary's separate financial statements). Upon initial recognition of

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the brand in the consolidated statements, a temporary difference arises between the carrying amount (fair value) and the tax base, as the tax base would be zero (no tax deduction in respect of the brand's fair value). However, as this temporary difference arises from a business combination, there is no need to determine whether the transaction affects accounting profit or taxable income. Deferred tax must be raised on the total temporary difference, resulting in an increase in goodwill. It should be noted that if the brand was purchased by the parent entity (instead of acquiring the subsidiary owning the brand) and assuming there are no tax deductions for purchased brands, then no deferred tax would be provided for, as the temporary difference arises at initial recognition (which is not a business combination) and the acquisition of the brand affects neither accounting profit (debit brand, credit bank/liability) nor does it affect taxable income (no tax deduction).

8.3.3 Consideration of the limitations on the recognition of a deferred tax asset for deductible temporary differences and unused tax losses or credits A deferred tax asset should be recognised only to the extent that it is probable that taxable income will be available against which the deductible temporary differences or llllused tax losses/credits can be utilised. However, it is important that the entity also considers any restrictions that the tax laws place on its ability to use a deductible temporary difference. For example, in the South African context, capital losses may only be deducted from future capital gains and not from taxable profits in general. When tax laws place such restrictions on future tax deductions, the entity should combine deductible temporary differences of a specific type and consider whether a deferred tax asset may be recognised for these deductible temporary differences separately from other deductible temporary differences. By contrast, when tax laws place no restrictions on future tax deductions, the recognition of deferred tax assets may be considered in combination for all deductible temporary differences.

8.3.3.1

Assessment of deductible temporary differences

It is probable that taxable income will be available against which a deductible temporary dtfference

can be utilised when there are sufficient taxable temporary differences which are expected to reverse • in the same period as the expected reversal of the deductible temporary differences, or • in periods into which a tax loss arising from the deferred tax asset can be carried forward. When there are insufficient taxable temporary differences, the deferred tax asset is recognised to the extent that • tax planning opportunities are available that will create taxable income in the applicable period; or • it is probable that the entity will have sufficient taxable income in the same period as the reversals of the deductible temporary differences.

Example 8.20: Deductible temporary differences - probability offuture taxable income At the end of 20X2, the total taxable temporary differences of A Ltd amounted to R550 000, while the total deductible temporary differences amounted to R600 000. Assume a tax rate of 28%. In respect of deductible temporary differences of R550 000, one may assume that taxable income will be available in future to utilise the resulting deferred tax asset, as sufficient taxable temporary differences are available (if it is assumed that the taxable temporary differences and the deductible temporary differences will reverse in the same periods in the future). However, in respect of the remaining deductible temporary differences of R50 000, it will be necessary to make an estimate regarding the availability of future taxable income. If it is probable that sufficient taxable income will be available in future to utilise the deductible temporary differences of R50 000, then a deferred tax asset of R168 000 (600 000 x 28%) should be raised. (The balance on the deferred tax account will be a net debit of R14 000 after taking into

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account the deferred tax liability of R154 000 (550000 x 2S%) in respect of the taxable temporary differences of R550 000.) However, if there is uncertainty regarding future taxable income, the deferred tax asset will be limited to the deferred tax liability of R154 000, resulting in a net deferred tax balance of zero.

8.3.3.2 Assessment for unused tax losses and unused tax credits A deferred tax asset should be recognised for the carry fOIWard of llllused tax losses and llllused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and llllused tax credits can be utilised. Criteria to assess the probability that taxable profit will be available against which the unused tax losses or credits can be utilised are the following: • whether the entity has sufficient taxable temporary differences which will result in taxable amounts; • whether the entity will have taxable profits before the llllused tax losses or credits expire; • whether the llllused tax losses result from identifiable causes which are lllllikely to recur; and • whether tax planning opportunities are available which will create taxable profit against which llllused tax losses or credits can be utilised. The above criteria are the same as those relating to deductible temporary differences discussed in section 8.3.3.1. The existence of llllused tax losses often indicates that future taxable profit may not be available and as a result, if an entity has a history of recent losses, convincing evidence of future taxable profit is needed when raising a deferred tax asset in excess of the deferred tax liability in respect of taxable temporary differences.

8.3.3.3 Annual review of recognised and unrecognised deferred tax assets The carrying amollllt of a recognised deferred tax asset should be reviewed at each reporting date to assess its recoverability. Previously recognised deferred tax assets should be reduced to the extent that it is no longer probable that sufficient taxable profit will be available. At each reporting date an entity should also reassess unrecognised deferred tax assets. Previously umecognised deferred tax assets should be recognised to the extent that it has become probable that future taxable profit will allow the deferred tax asset to be recovered.

Example 8.21:

Unused tax loss

An entity has cumulative taxable temporary differences of R20 000 before taking into account an unutilised cumulative assessed loss of R30 000. It is uncertain as to whether future taxable profit will be available to utilise the benefit of the tax loss. Assume a tax rate of 28%. A deferred tax asset may only be recognised in respect of R20 000 of the assessed loss, as future taxable profit is not probable. Consequently the assessed loss will give rise to a deferred tax asset limited to R5 600 (20 000 x 28%), while the taxable temporary differences will give rise to a deferred tax liability of R5600. The net deferred tax balance in the statement of financial position will thus amount to zero (consisting of a deferred tax liability of R5 600 and a deferred tax asset of R5 600). If, during the next financial year, additional taxable temporary differences of R15 000 originate, and the cumulative assessed loss remains the same, then the cumulative assessed loss (R30 000) will be less than the cumulative taxable temporary differences of R35 000 (20 000 + 15000). Consequently the assessed loss will give rise to a deferred tax asset of R8 400, as the taxable temporary differences give rise to a deferred tax liability of R9 800. The deferred tax balance will thus amount to a credit of R1 400 (5 000 x 2S%). The movement in deferred tax will be a debit in profit or loss of R1 400 (closing balance of R 1 400 less opening balance of RO). This movement in profit or loss can be analysed into a debit of R4 200 (15 000 x 2S%) relating to the additional taxable temporary differences that originated during the year, as well as a credit of R2 SOD (10 000 x 2S%) relating to the additional R 10 000 of the assessed loss that now qualifies for recognition.

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8.3.4 The appropriate tax rates (and tax laws) Paragraph 47 of lAS 12 determines that deferred tax assets and liabilities should be measured at the tax rate (and using tax laws) that are expected to apply in future when the asset is realised or the liability is settled, provided that the tax rate (and tax laws) have been enacted or substantively enacted by the reporting date. In terms of paragraph 51, the measurement of deferred tax should reflect the tax consequences that would result from the manner in which the entity expects, at the reporting date, to recover or settle the carrying amount of its assets and liabilities.

8.3.4.1

Enacted or substantively enacted tax rates and tax laws

Whether tax rates (and tax laws) have been enacted is a matter of fact. However, it is more difficult to assess when substantive enactment takes place. SAICA issued FRG 1, Substantively enacted tax rates and tax laws, which provides guidance on when tax rates and tax laws are considered to be substantively enacted in South Afuca. The guide distinguishes between three types of changes in tax rates or tax laws, namely: • Changes in tax rates that are not inextricably linked to other changes in the tax laws. An example of this is the reduction in the corporate tax rate from 29% to 28% that was annOllllced by the Minister of Finance in his budget speech during Februrny 2008. • Changes in tax rates that are inextricably linked to other changes in tax laws. An example of this is the introduction of capital gains tax (CGT). When CGT was introduced in South Africa, the tax rate that applied to capital gains realised by companies effectively changed from 0% to 15% (now 22,4%). This effective capital gains tax rate is implied in the fact that only 80% of a capital gain realised is included in the taxable income of a company, which in tum is taxed at the corporate income tax rate of 28% (thus 80% x 28% = 22,4%). This change in the tax rate was inextricably linked to changes in the tax laws, and more specifically the establishment of the Eighth Schedule to the Income Tax Act. • Other changes in tax laws. The following summarises when these changes in tax rates and tax laws are considered to be substantively enacted in South Afuca: Change Substantive enactment AIlilouncement in terms of the Minister of Finance's Change in tax rate not inextricably linked Budget Statement to other changes in tax laws Approved by Parliament and signed by the President Change in tax rate inextricably linked to other changes in tax laws Other changes in tax laws Approved by Parliament and signed by the President

Example 8.22: Applicable tax rate for measurement In the budget speech delivered on 23 February 2005, the South African Minister of Finance announced a reduction in the company tax rate from 30% to 29%. The change in the company tax rate is effective for years of assessment ending on or after 1 April 2005. The following illustrates the impact: Financial periods Financial periods ending on or after Financial periods 23 February 2005 & ending before ending on or after 23 February 2005 1 April 2005 before 1 April 2005 Current tax 29% 30% 30% 30% 29% 29% Deferred tax Note that a company with a financial period ending before 23 February 2005 should disclose the effect of the reduction in the deferred tax balance from 30% to 29% as a non-adjusting event occurring after the reporting date (i.e. no adjustment, only disclosure).

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8.3.4.2 Expected manner of recovery lAS 12.51 determines that the measurement of deferred tax should reflect the tax consequences that would result from the manner in which the entity expects at the reporting date to recover or settle the carrying amount of its assets and liabilities. Several important aspects arise from paragraphs 51, 51A, SIB and SIC: • An asset may only be recognised if, amongst other things, it is probable that future economic benefits associated with the item will flow to the entity. The future economic benefits embodied in an asset is the potential to contribute, directly or indirectly, to the flow of cash and cash equivalents of the entity. The recognition of an asset in the statement of financial position therefore implies that a future stream of cash flows (or cash equivalents) is expected. One may thus conclude that, in essence, the carrying amount of an asset reflects the future cash flows and cash equivalents that the asset will generate. Although the carrying amount of an asset and, therefore the value placed in the financial statements on the expected future stream of cash flows, may be measured in various ways (for example: cost, depreciated cost, fair value, amortised cost, etc.), this does not change the general principle, namely that it is probable that the entity will receive a future stream of cash flows from the asset. • The standard requires one to consider the future stream of cash flows embodied in the asset and to measure deferred tax based on the tax consequences of those future cash flows. The manner in which an entity recovers (settles) the carrying amount of an asset (liability) may affect the tax rate applicable when the entity recovers (settles) the carrying amollllt of the asset (liability) and/or the tax base of the asset (liability). In such cases an entity measures deferred tax liabilities and deferred tax assets using the tax rate and the tax base that are consistent with the expected manner of recovery or settlement. The potential manner in which the carrying amollllt of an asset (apart from land, which is discussed later on) can be recovered are use, sale or a combination of use and sale: - An asset will be recovered through use if it has no residual value and is not classified as held for sale in terms of IFRS 5; - An asset will be recovered through sale when it is classified as held for sale in terms ofIFRS 5; -

An asset will be recovered through a combination of use and sale if it is not classified as held for sale and it has a residual value. The tax rate and tax base used in the calculation of deferred tax depend on whether the asset will be recovered through use, sale or a combination of use and sale. If an asset is to be recovered through use (and future economic benefits are taxable) the deferred tax on the revaluation surplus or fair value adjustment is calculated at the normal tax rate (currently 28%). However, if the asset is classified as held for sale in terms ofIFRS 5, the deferred tax on the portion of the temporary difference above the base cost of the asset is based on the rate applicable to capital gains (currently 28% x 80% = 22,4%).

• The measurement of deferred tax must reflect the manner of recovery of the carrying amount. The reduction in the value of an asset through use is caused by the passage of time. As time passes and the entity receives the cash flows generated by the asset, the remaining years over which the asset can generate cash flows normally decreases. lAS 16 allows for the revaluation of land and determines that land normally has an unlimited useful life. The question therefore arises as to how the term "recovery" should be interpreted in relation to an asset that is not depreciated and is subsequently revalued. lAS 12.51B states that any deferred tax asset or liability arising from a non-depreciable asset (such as land), carried llllder the revaluation model of lAS 16, shall be measured based on the tax consequences which will result from the sale of the relevant asset. If one therefore considers the carrying amount (value) of land to represent a stream of future cash flows, the present value of these cash flows does not decrease while the land is being used to generate cash, as the cash flow stream will continue into perpetuity (in other words the passing of time does not cause a reduction in the future stream of cash flows). Although the future stream of cash flows, for example, rental income, has future tax consequences, the carrying amollllt of the

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asset cannot be "recovered" through use. The only manner in which the carrying amollllt of the land can therefore be "recovered" is through sale. Hence, the deferred tax measurement should always reflect the tax consequences of sale, even if there is no intention of selling the asset. This means that when land is revalued, deferred tax should always be raised on the revaluation surplus, using the tax rate applicable to capital gains (currently 22,4%). • lAS 12.S1C determines that there is a rebuttable presumption that the carrying amollllt of investment property, measured using the fair value model in lAS 40, will be recovered through sale. Consequently, unless the presumption is rebutted, the measurement of deferred tax assets and liabilities arising from the fair value adjustments made to the carrying amollllt of investment property (both the land and building components) will reflect the tax consequences resulting from the recovery of the carrying amollllt of investment property entirely through sale. The presumption of recovery through sale can only be rebutted where the investment property is depreciable and held within a business model whose objective is to consume substantially all of the economic benefits embodied in the investment property over time rather than through sale. An entity that has rebutted the presumption of recovery through sale shall follow the guidance normally applied in determining the manner of recovery of the carrying amollllt of an asset (i.e. use or a combination of use and sale). Refer to chapter 9 on property, plant and equipment and chapter 24 on investment property for examples illustrating the above.

B.3.5 Recognition of the deferred tax income or expense Deferred tax should be recognised as income or an expense and included in profit or loss for the period except to the extent that the tax arises from • a transaction or event which is recognised outside profit or loss directly in other comprehensive income or in equity; or • a business combination.

8.3.5.1

Transaction recognised outside profit or loss

Deferred tax should be recognised outside profit or loss directly in other comprehensive income! equity if the tax relates to items recognised directly in other comprehensive income!equity in the same or in a different period. Examples of items recognised directly in other comprehensive income! equity are the following: • Revaluation of property, plant and equipment (recognised directly in other comprehensive income). • Adjustments to the opening balance of retained earnings resulting from a retrospective change in accollllting policy or correction of a prior period error (recognised directly in equity). • Exchange differences arising on the translation of the financial statements of a foreign operation (recognised directly in other comprehensive income). • Amollllts arising on the initial recognition of the equity component of a compolllld financial instrument (recognised directly in equity). • Fair value adjustments on financial assets at fair value through other comprehensive income (recognised directly in other comprehensive income). • Changes in the fair value of a hedging instrument used in a cash flow hedge (recognised directly in other comprehensive income). The tax effects of the items listed above should therefore be charged directly to other comprehensive income or equity, as appropriate.

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Example 8.23:

GAAP Handbook 2020: Volume 1

Revaluation of land

On 1 January 20X1 an entity acquired land for R350 000. At 31 December 20X1 (year-end) the land was revalued to R380 000. There are no wear-and-tear allowances available for tax purposes. Assume a tax rate of 28%. At year-end the carrying amount of the land is R380 000, while its tax base is R350 000 (future tax deduction equal to base cost for CGT purposes). A taxable temporary difference of R30 000 arises and a deferred tax liability of R6 720 (30 000 x 28% x 80%) is therefore recognised. The CGT percentage of 22,4% (28% x 80%) is used as lAS 12.51B determines that land can only be recovered through the ultimate disposal of the land, which will lead to capital gains taxable at 22,4%. This deferred tax is charged directly to other comprehensive income as it relates to the revaluation which has been recognised in other comprehensive income The journal entries are as follows· Dr R 1 January 20X1

Land Bank (Initial recognition of the land)

31 December 20X1 Land Revaluation surplus (OCI) (Revaluation of the land at the end of 20X 1) Revaluation surplus (OCI) Deferred tax (F/P) (Recognition of the deferred tax on the revaluation of the land)

Cr R

350000 350000 30000 30000 6720 6720

8.3.5.2 Business combination Temporrny differences may arise in a business combination. In accordance with IFRS 3, an entity recognises any resulting deferred tax assets or liabilities as identifiable assets and liabilities at the acquisition date. Consequently, those deferred tax assets and liabilities affect goodwill or the amount of any bargain purchase gain recognised by the acquirer.

Example 8.24: Fair value adjustments in a business combination X Ltd acquired an 80% interest in Z Ltd on 1 January 20X1, at a cost of R490 000. The statement of financial position of Z Ltd reflected a net asset value of R500 000. All the assets and liabilities of Z Ltd were considered to be fairly valued, except for plant which was undervalued by R100 000. Assume a tax rate of 28% and that the non-controlling interest is measured at their proportionate interest of the identifiable net assets of Z Ltd. For consolidation purposes, the plant should be reflected at fair value. Its carrying amount should thus increase by R100 000 on the acquisition date. This will automatically lead to an increase of R100000 in the temporary difference relating to plant in the consolidated financial statements, necessitating an additional deferred tax charge (credit in the consolidated statement of financial position) of R28 000. The net asset value now changes to R572 000 (500 000 + 100 000 - 28 000), resulting in goodwill of R32 400 [490 000 + (572 000 x 20%) - 572 000]. It should be noted that if the deferred tax was not raised, the goodwill would have been R 10 000 [490000 + (600 000 x 20%) - 600 0001. The difference of R22 400 (32 400 -10 000) represents 80% of the deferred tax of R28 000. The deferred tax on the fair value adjustment is therefore effectively journalised by debiting goodwill with R22400, debiting non-controlling interest with R5600 and crediting deferred tax (statement of financial position) with R28 000.

8.3.5.3 Changes in deferred tax balances without changes in temporary differences The carrying amollllt of deferred tax assets and liabilities may change even though there is no change in the amollllt of the related temporary differences, for example due to the following: • a change in tax rates or tax laws (refer to example 8.26); • a re-assessment of the recoverability of deferred tax assets (refer to example 8.21); or

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• a change in the expected manner of recovery of an asset (refer to chapter 9). The resulting deferred tax is recognised in profit or loss, except to the extent that it relates to items previously recognised outside profit or loss.

Example 8.25:

Change in the tax rate

The deferred tax balance of X Ltd amounted to R60 000 (credit) at the end of 20X1 (net taxable temporary differences of R200000). This balance was made up as follows (assume a tax rate of 30%): R

Accelerated wear and tear on vehicles* Revaluation surplus relating to vehicles* Lease liability

24000 21 000 15000 60000

[* Assume that the revalued carrying amount of the vehicles is R350 000, while the tax base is R200000. If the vehicles were accounted for under the cost model, the carrying amount would have been R280 000. The accelerated wear and tear line item is calculated as follows: (280000 - 200 000) x 30%. Tax on the revaluation surplus is calculated as follows: (350 000 - 280 000) x 30%.] At the beginning of 20X2 the tax rate decreases from 30% to 29%. The effect on the deferred tax account will be a debit (reduction) of R2 000 (1% 130% x 60 000 or 1% x 200 000). As a portion of the deferred tax balance relates to an item previously recognised outside profit or loss (revaluation surplus), a portion of the rate change should also be accounted for as part of other comprehensive income. The amount to be recognised outside profit or loss is R700 [(21 000 x 1% 130%) or (350000280000) x 1%]. The remaining R1 300 will be credited to profit or loss.

8.4 Specific issues 8.4.1 Changes in the tax status of an enterprise or its shareholders According to SIC 25 a change in the tax status of an entity or its shareholders does not give rise to increases or decreases in amounts recognised directly in equity. As a result, the current and deferred tax consequences of a change in tax status should be included in profit or loss for the period. The only exception is if the tax consequences relate to transactions and events that result in a direct credit or charge to other comprehensive income (equity) in the same or a different period (for example a revaluation surplus), in which case the tax consequences should also be charged directly to other comprehensive income (equity).

Example 8.26: Change in the tax status of an entity Megawatts was not liable for income tax in the past. The entity privatised during the current financial year, and will pay tax from this year onwards. At the beginning of the current year the carrying amount of the assets of Megawatts Ltd amounted to R 1 500 000, while the taxation authority allocated a value of R 1 250 000 to them. The total taxable temporary difference at the beginning of the current year therefore amounts to R250 000 (1 500000 - 1 250000) and gives rise to a deferred tax liability of R70 000 (250 000 x 28%), which is raised by debiting the tax expense in profit or loss for the current year and crediting the deferred tax liability. However, if it is assumed that the assets of Megawatts consist only of revalued power generation facilities and that the carrying amount of these facilities would have been R 1 450 000 under the cost model, then R50 000 (1 500 000 - 1 450 000) of the temporary difference of R250 000 relates to an amount charged to other comprehensive income, and consequently R14 000 (50000 x 28%) of the deferred tax should be debited to other comprehensive income, while the remainder of R56000 (200000 x 28%) is recognised in profit or loss.

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8.4.2 Changes in the carrying amount of investments in subsidiaries, branches, associates and joint ventures Temporrny differences arise when the carrying amount of an investment in a subsidiary, associate or joint venture differs from its tax base (which is often cost). The following are examples of typical temporary differences in this context: • lllldistributed profits of subsidiaries, associates and joint ventures included in the consolidated financial statements; • changes in exchange rates (parent and subsidirny based in different cOlllltries); and • a reduction in the carrying amollllt of an investment in an associate to its recoverable amount. It should be kept in mind that, in South Africa, normal income tax is not charged on local dividends, and local dividends received by companies are also exempt from dividends tax. As a result,

undistributed profits of local subsidiaries, associates and joint ventures will not result in temporary differences (the tax base of the investment is equal to the carrying amollllt, as future economic benefits are not taxable). Undistributed profits of foreign subsidiaries, associates and joint ventures may, however, result in temporary differences, provided that the relevant foreign dividends will be taxed in South Africa when distributed in future. The following discussion thus relates to foreign investments in subsidiaries, branches, associates and joint ventures that are not classified as held for sale (the effect of classification as held for sale is discussed later on in this section). A deferred tax liability should be recognised for all taxable temporrny differences associated with investments in subsidiaries, branches, associates and interests in joint ventures, except to the extent that both of the following conditions are satisfied: • the parent, investor or venturer is able to control the timing of the reversal of the temporrny difference, and • it is probable that the temporrny difference will not reverse in the foreseeable future. A parent company controls the dividend policy of its subsidirny and therefore controls the timing of the reversal of temporrny differences arising from lllldistributed profits. "When the parent has determined that profits will not be distributed in the foreseeable future, the parent does not recognise a deferred tax liability. This also applies to investments in branches. On the other hand, an investor in an associate does not control the dividend policy of the associate (no control over the timing of the reversal of the temporary difference) and should thus recognise the resulting deferred tax liability (except if an agreement prohibits the distribution of profits). Recognition of a deferred tax liability by a venturer in a joint venture, depends on whether the venturer has control over the distribution of profits in terms of the agreement between the venturers - if there is control, treatment is similar to a subsidiary; if no control, treatment is similar to an associate. An entity should recognise a deferred tax asset for all deductible temporary differences arising from investments in subsidiaries, branches, associates and interests in joint ventures to the extent that -

• the temporary difference will reverse in the foreseeable future, and • taxable income will be available against which the temporrny difference can be utilised. It should be noted that in the consolidated financial statements an investment in a subsidiary is represented by the parent's share of the net assets of the subsidirny. Therefore, even though there is no single line item in the consolidated financial statements relating to this investment, it still exists in the form of several line items, representing the individual assets and liabilities of the subsidirny.

Example 8.27: Investment in associate with deferred tax consequences On 1 January 20X1 SA Company invests R800 000 (F800 000) in a 30% share in a foreign associated company in Country A, with no retained earnings or other reserves. The year-end is 31 December 20X1.

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For 20X1 the profit after local income taxes equals F500 000. No dividends were distributed. In Country A, a 15% non-resident shareholders' tax on dividends distributed is applicable. The exchange rate remained at R1 = F1. R Investment in associate: 950000 Carrying amount [800 000 + (30% x 500 000)[ Tax base (800 000 + Nil) 800000 Taxable temporary difference

150000

Deferred tax liability (15% x 150000)

22500

The following pro forma consolidation journal entries are applicable· Dr R 31 December 20X1

Investment in associate Share of profit of associate (P/L) (Equity accounted profit from the associate) Income tax expense (deferred tax) (P/L) Deferred tax (F/P) (Deferred tax on the investment in the associate)

Cr R

150000 150000 22500 22500

When dividends of R150 000 are received at a future date, the Journal entry In the separate financial statements is as follows· Dr R Future date

Bank (150000 x 85%) Income tax expense (current tax) (P/L) (150 000 x 15%) Dividends received (Dividends received from associate)

Cr R

127500 22500 150000

At this pOint the following pro forma consolidation Journal entries will be required: Dr R Dividends received Investment in associate (Dividends received from associate) Deferred tax (F/P) Income tax expense (deferred tax) (P/L) (Reversal of deferred tax)

Cr R

150000 150000 22500 22500

Note that If dividends received from this foreign associated company are also taxed In South Africa, additional deferred tax will have to be raised on the taxable temporary difference at the tax rate that is expected to apply to these foreign dividends in future.

Once investments in subsidiaries, associates and j oint ventures (both local and foreign) are classified in terms of IFRS 5 as held for sale, their lllldistributed profits may give rise to a temporrny difference in respect of potential capital gains tax, provided that the parent, investor or venturer will be taxed on the capital gain to be realised upon disposal. If no deferred tax was accollllted for prior to the classification as held for sale (for example in respect of local associates as it was argued that the dividends would not be taxed, or in respect of foreign subsidiaries as it was argued that dividends would not be distributed), then deferred tax will now have to be raised on the temporrny difference, at the rate applicable to capital gains. If deferred tax was accollllted for prior to the classification as held for sale (for example in respect of a foreign associate), then this deferred tax balance should be adjusted to reflect the tax consequences that would follow from disposal of the investment (instead of reflecting the previously reported tax consequences of realisation of the investment by means of the receipt of dividends).

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8.4.3 Uncertainty over income tax treatment Various uncertainties arise when accOllllting for income taxes and frequently requires management to exercise judgement to determine the appropriate treatment. For example, management may have to exercise considerable judgement to determine whether it is probable that sufficient future taxable profits will be available against which unused tax losses can be utilised (refer to section 8.3.3) or what the expected manner of recovery of a temporrny difference will be (refer to section 8.3.4.2). In this respect, it is important to note that the preceding examples focus on dealing with llllcertainty in accOllllting for deferred tax. However, it is also possible that, at the time of preparation of the financial statements, management is uncertain how to deal with a specific item for current tax purposes (i.e. the impact on the entity's tax return for the current period is llllcertain). When it is llllclear if a particular tax treatment will be acceptable llllder tax law (i.e. whether the treatment for current tax purposes will be accepted by the tax authorities), the entity follows the guidance in IFRIC 23. Note that the uncertainty over the tax treatment could be considerable and may depend on a future decision by the tax authority or a court oflaw. Importantly, the interaction between current and deferred taxes means that the uncertainty could also affect the accollllting for deferred taxes. For example, if it is llllclear whether an expense should be deducted immediately or over a five-year period, this would also affect the tax base to be used in the deferred tax calculation. However, for IFRIC 23 to apply, the original llllcertainty must have arisen arolllld the treatment for current tax.

8.4.3.1

Grouping uncertain tax treatments

IFRIC 23 determines that the entity should first decide if the guidance should be applied separately to a specific llllcertain tax treatment or to two or more llllcertain tax treatments as a group. The entity chooses the approach which best predicts the resolution of the llllcertainty. Examples of factors that it considers in making this decision, include: • How the entity prepares its income tax filings and supports tax treatments; • How the entity expects the tax authority to make its examination and resolve potential issues arising from such an examination.

Example 8.28: Grouping uncertain tax treatments During the year ended 31 December 20X1, A Ltd earned revenue of R400 000 in cash for which it incurred cash expenses of R150 000. At 31 December 20X1, A Ltd is uncertain whether a section in the Income Tax Act is applicable to the revenue in terms of which the revenue would be tax free. This is an uncertain tax treatment to which IFRIC 23 would apply, as the uncertainty affects the current tax calculation for 20X1 (i.e. it affects the tax return for that year). Note that the tax uncertainty affects both the revenue and the expenses for this contract - if the revenue is tax free, the expenses are not tax deductible. Consequently, A Ltd decides that IFRIC 23 should be applied to the transaction as a group (i.e. the revenue and the expenses), rather than applying the interpretation to the revenue and expenses separately.

8.4.3.2 Accounting treatment of uncertain tax treatments Once an entity has determined whether an llllcertain tax treatment should be considered individually or grouped with other llllcertain tax treatments, the entity should consider whether it is probable that the tax authority will accept the llllcertain tax treatment. In doing so, the entity should assume that the tax authority will examine evidence for which it has the right to do so and that the tax authority will have full knowledge of any related matters. If the entity determines that it is probable that the tax authority will accept an llllcertain tax treatment, the entity should account for current and deferred taxes in a manner which is consistent with its tax return. In other words, if the entity believes that its tax return will probably be accepted by the tax authority, current tax expense as per the accollllting records will agree with its tax return.

Taxation

159

By contrast, if the entity determines that it is not probable that the tax authority will accept an llllcertain tax treatment, it should reflect the llllcertainty in the measurement of its current and deferred taxes. In this instance, current tax expense as per the accollllting records will differ from the tax return. Note that all of the following items will potentially be affected by the llllcertain tax treatment• taxable profit or loss (and the related current tax expense); • tax bases for deferred tax purposes; • llllused tax losses; and • the tax rate to apply (ifthere are differing possibilities). Also note that if an llllcertain tax treatment affects both current and deferred taxes, it is important that the entity makes consistent judgements and estimates for both. The effect of the llllcertainty for each llllcertain tax treatment should be reflected in the measurement of current and deferred tax using a method which best predicts the resolution of the uncertainty. IFRIC 23 allows two methods to be used: • the most likely amollllt; and - This refers to the single most likely amollllt in a range of outcomes (i.e. the outcome with the highest probability). It is appropriate to use this method when there are only two possible outcomes or most potential outcomes are concentrated on a specific amOllllt. • the expected value. - This refers to the sum of the probability-weighted amollllts (i.e. weighing each possible outcome by its probability and adding the resultant amounts). It is appropriate to use this method when there is a range of possible outcomes.

Example 8.29: Uncertain tax treatment: tax authority will probably accept During the year ended 31 December 20X1, A Ltd earned revenue of R400 000 in cash. At 31 December 20X1, A Ltd is uncertain whether a section in the Income Tax Act is applicable to the revenue in terms of which the revenue would be tax free. A Ltd decides to submit its tax return, showing the revenue as tax free. Based on legal advice on this date, A Ltd determines that it is probable that the tax authority will accept that the revenue is tax free. The tax return of A Ltd for the year ended 31 December 20X1 reflects taxable income of R800 000. The tax rate is 28%. A Ltd believes that it is probable that the tax authority will accept that the revenue is tax free. For accounting purposes, it therefore recognises current tax expense for the 20X1 year at an amount equal to that reflected on its tax return, i.e. R224 000 (RSOO 000 x 2S%). However, IFRIC 23 requires A Ltd to consider whether it would be necessary to disclose a contingent liability in accordance with lAS 37 in these circumstances.

Example 8.30: Uncertain tax treatment: most likely amount During the year ended 31 December 20X1, B Ltd received revenue in advance of R400 000 and prepaid R150 000 of related expenses in cash. At 31 December 20X1, B Ltd is uncertain whether a section in the Income Tax Act is applicable to the revenue in terms of which the revenue would be tax free. B Ltd concludes that it would be appropriate to apply IFRIC 23 to the revenue and expenses as a group. B Ltd decides to submit its tax return, showing the income as tax free (and the expenses as non-deductible). Based on legal advice on this date, B Ltd determines that it is not probable that the tax authority will accept that the revenue is tax free. The tax return of B Ltd for the year ended 31 December 20X1 reflects taxable income of R800 000. The tax rate is 28%. Assume that if the revenue is taxable, the prepaid expenses will only be deductible in future tax years. B Ltd believes that it is not probable that the tax authority will accept that the revenue is tax free. For accounting purposes, it therefore needs to recognise two elements of current tax expense for the 20X 1 year: Current tax expense for the 20X1 year equal to that reflected on its tax return, i.e. R224 000 (RSOO 000 x 2S%).

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An additional amount which reflects the measurement uncertainty of the uncertain tax treatment. There are only two possible outcomes in this case, either the tax authority accepts the revenue as tax free or it does not. B Ltd should therefore reflect an additional current tax expense based on the most likely outcome, which is that the revenue will be taxable. It therefore creates an additional current tax expense of R 112 000 (400 000 x 28%) for accounting purposes. The financial statements for the year ended 31 December 20X1 will therefore reflect current tax expense lor the current year 01 R336 000 (224 000 + 112000). Note, however, that the tax return lor the year ended 31 December 20X1 will only rellecttax payable 01 R224 000. In addition, as the uncertain tax treatment relates to revenue received in advance and prepaid expenses, B Ltd will also need to consider the impact on its deferred tax calculation. As its current tax (for accounting purposes) reflects that the revenue will be taxable, this is the assumption that it should apply in its deferred tax calculation:

Carrying amount Tax base * (Deductible) I taxable temporary difference

Revenue received in advance R (400000)

Prepaid expenses R 150000 150000

(400000)

* The tax base for revenue received in advance is zero, as the assumption for current tax (for accounting purposes) is that the revenue is taxable in the current year and therefore not taxable in the future. The tax base for prepaid expenses assumes that the expenses will be tax deductible in future tax years, as this is the assumption for current tax (for accounting purposes).

Example 8.31: Uncertain tax treatment: expected value During the year ended 31 December 20X1, C Ltd earned revenue of R400 000 in cash. At 31 December 20X1, C Ltd is uncertain whether a section in the Income Tax Act is applicable to the revenue in terms of which a portion of the revenue would be tax free. C Ltd decides to submit its tax return, showing half of the revenue as tax free. Based on legal advice on this date, C Ltd determines that it is not probable that the tax authority will accept that the revenue is tax free. The tax return of C Ltd for the year ended 31 December 20X1 reflects taxable income of R800 000. The tax rate is 28%. C Ltd believes that it is not probable that the tax authority will accept that the revenue is tax free. For accounting purposes, it therefore needs to recognise two elements of current tax expense for the 20X 1 year: Current tax expense for the 20X1 year equal to that reflected on its tax return, i.e. R224 000 (RSOO 000 x 2S%). An additional amount which reflects the measurement uncertainty of the uncertain tax treatment. There are several possible outcomes in this case, as the revenue could be entirely taxable or entirely tax free. C Ltd should therefore reflect an additional current tax expense based on the expected value. It is important to note, however, that the current tax expense per the tax return already included half of the revenue (R200 000) as taxable. Its calculation for additional tax expense should therefore only reflect the probability that the actual outcome differs from its assumption:

161

Taxation Probability

revenue revenue revenue revenue

is is is is

taxable taxable taxable taxable

(1) (2) (3) (4)

20% 30% 25% 25% 100%

Change to Weighted taxable income R (120000) (24000)

20% 50% 75% 80%

of of of of

(1)

R400 000 x 20% = R80 000; compare to revenue already included: R80 000 - R200 000

(2)

R400 000 x 50% = R200 000; compared to revenue already included: R200 000 - R200 000

(3)

R400 000 x 75% = R300 000; compared to revenue already included: R300 000 - R200 000

(4)

R400 000 x 80% = R320 000; compared to revenue already included: R320 000 - R200 000

100000 120000

25000 30000 31 000

C Ltd should therefore create an additional current tax expense of R8 680 (31 000 x 28%). The financial statements for the year ended 31 December 20X1 will therefore reflect current tax expense for the current year of R232 680 (224 000 + 8 680). Note, however, that the tax return for the year ended 31 December 20X1 will only reflect tax payable of R224 000. In this example, the uncertain tax treatment has no impact on the deferred tax calculation.

8.4.3.3 Changes in facts and circumstances IFRIC 23 requires the entity to reassess its judgements and assessments surrounding llllcertain tax treatments when the underlying facts and circumstances change or when new information emerges. Examples of such changes or new information include• the completion of examinations by the tax authority with a decision on the matter; • other actions by the tax authority, which may include decisions on similar matters of the entity or other entities (e.g. a court ruling in a similar case); • a change in rules (e.g. a new or changed tax interpretation note); or • the fact that the right of the tax authority to examine a tax treatment has expired. Note that the fact that the tax authority has not provided a decision on the llllcertain tax treatment does not in itself constitute a change in facts and circumstances. In other words, the fact that a court case is continuing without a ruling handed doWIl, for example, is not enough evidence by itself to require the entity to reassess its judgements and assessments. Any change that might be required is accounted for as a change in estimate in accordance with lAS 8 (refer to the chapter on accollllting policies, changes in accollllting estimates and errors). If the change in facts and circumstances occur after the reporting date, the entity should consider whether the change is an adjusting or non-adjusting event using the guidance in lAS 10 (refer to the chapter on events after the reporting period).

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8.4.3.4 Flow diagram illustrating the application of IFRIC 23

I

I

Decide whether an uncertain tax treatment should be considered separately or as a group

I I

I

Is it probable lbat lbe tax aulbority will accept the tax treatment applied by lbe entity?

I

I Yes

I

I ACCOllllt for current and deferred taxes consistent with the tax return

I Current tax expense per accOllllting records will agree with the tax return

I

I No

I

I Reflect the llllcertainty in the measurement of current and deferred taxes

I Current tax expense per accOllllting records will not agree with the tax return

8.4.4 Dividends tax (withholding tax on dividends) The Taxation Laws Amendment Act of 2009 introduced a Dividends Tax to replace the STC regime that was effective in South Africa prior to April 2012. In terms of the Dividends Tax, dividends are taxed in the hands afthe beneficial owner of the share (defined as the person entitled to the benefit of the dividend attaching to a share - thus the shareholder in most cases). The entity declaring and paying the dividend acts as an agent of the South African Revenue Service and is therefore required to pay the Dividends Tax over to the taxation authority on behalf of the shareholders. This amollllt is often referred to as a withholding tax. Despite the fact that the entity pays the tax to the taxation authority, a withholding tax is levied on the shareholder and not on the entity. Hence, the tax is an expense to the shareholder and not to the entity. The entity is required to recognise the withholding tax paid in equity as part of the dividend distribution. Dividends declared and paid to a shareholder that is a company, is exempted from the Dividends Tax and therefore no tax will arise on dividends declared in a group context.

Example 8.32: Withholding tax on dividends On 31 December 20X1 A Ltd, a company incorporated in South Africa, paid a dividend of R100 000 to its shareholder, Mr. A. A Ltd is legally required to withhold Dividends Tax of 15%. The tax was paid by A Ltd on 4 January 20X2. The following journal entries are applicable to A Ltd· Dr R 31 December 20X1 Dividends paid (equity) Bank Creditor: taxation (Dividends paid to shareholder) 4 January 20X2

Creditor: taxation Bank (Settlement of withholdinq tax)

Cr R

100000 85000 15000 15000 15000

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8.5 Financial statement presentation 8.5.1 lAS 1 requirements Deferred tax liabilities and deferred tax assets, as well as current tax assets and current tax liabilities, should be presented on the face of the statement of financial position. When an entity presents current and non-current assets, and current and non-current liabilities, as separate classifications on the face of the statement of financial position, it should not classify deferred tax assets and liabilities as current assets and liabilities. The income tax expense must be presented in the statement of profit or loss and other comprehensive income. An entity should disclose the amount of income tax relating to each component of other comprehensive income, including reclassification adjustments, either in the statement of profit or loss and other comprehensive income or in the notes. Note that llllcertain tax treatments (see section 8.4.3) might require application of the disclosure principles in lAS 1 regarding judgements made in the preparation of the financial statements as well as information about the assumptions and estimates made.

8.5.2 lAS 37 requirements If any tax-related contingent assets or liabilities arise, the entity applies lAS 37 (refer to the chapter on provisions, contingent liabilities and contingent assets) to determine whether any disclosure is required. For example, tax-related continent assets or liabilities could arise from llllcertain tax treatments which the entity believes the tax authority will probably accept.

8.5.3 lAS 12 requirements 8.5.3.1

Offsetting

An entity shall offset current tax assets and current tax liabilities only if the entity • has a legally enforceable right to set off the recognised amollllts, and • intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. It should be noted that entities are required to offset current tax assets and current tax liabilities when

the above requirements are met - i.e. offsetting is not elective.

Example 8.33: Offsetting of current tax assets and liabilities At 31 December 20X1 (year-end) X Ltd owes excise tax amounting to R20 000 to the taxation authority. The company's current tax expense for 20X1 amounts to R55 000, while provisional tax payments of R60 000 were made during 20X1. The company's statement of financial position currently reflects a net tax liability of R 15 000 (20 000 + 55 000 - 60 000). It is not acceptable to offset the excise tax liability against the amount receivable in respect of current tax (following the overpayment of provisional tax), as these amounts may not be settled on a net basis. As a result, the statement of financial position of X Ltd should reflect an excise tax liability of R20 000 and a current tax asset of R5 000.

An entity shall offset deferred tax assets and deferred tax liabilities only if • the entity has a legally enforceable right to set off current tax assets against current tax liabilities, and • the deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same taxation authority on either: - the same taxable entity, or -

different taxable entities that intend either to settle current tax liabilities and assets on a net basis, or to realise the assets and settle the liabilities simultaneously, in each future period in

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which significant amOllllts of deferred tax liabilities or assets are expected to be settled or recovered.

8.5.3.2 Presentation and disclosure The tax expense/income related to profit or loss from ordinrny activities should be presented as part of profit or loss in the statement of profit or loss and other comprehensive income. If an entity presents the components of profit or loss in a separate statement of profit or loss (as allowed by lAS 1), it should also present the income tax expense (income) related to profit or loss in that separate statement.

The major components of income tax expense/income should be disclosed separately and may include the following: • Current tax expense. • Adjustments recognised for current tax of prior periods. • Deferred tax expenselincome relating to the origination and reversal of temporary differences. • Deferred tax relating to changes in tax rates. • Amollllt of the benefit arising from a previously llllrecognised tax loss or tax credit or temporary difference that reduces the current tax expense. • Amollllt of the benefit arising from a previously llllrecognised tax loss or tax credit or temporary difference that reduces the deferred tax expense. • Deferred tax expenselincome arising from the write-down or reversal of a previous write-down of a deferred tax asset. The following should also be disclosed separately: • The aggregate current and deferred tax relating to items that were charged or credited directly to equity. • The amollllt of income tax relating to each component of other comprehensive income. • A tax reconciliation (in rands) or a tax rate reconciliation (in percentages) - refer below. • Explanation of changes in the applicable tax rate compared to the previous accollllting period. • The amollllt and expiry date, if any, of deductible temporary differences, llllused tax losses and llllused tax credits for which no deferred tax asset is recognised in the statement of financial position. • The aggregate amollllt of temporrny differences associated with investments in subsidiaries, branches, associates and interests in j oint ventures for which deferred tax liabilities have not been recognised. • In respect of each type of temporary difference, llllused tax loss and llllused tax credit: the amollllt of the deferred tax asset and liability recognised in the statement of financial position for each period presented, and the amollllt of the deferred tax expenselincome recognised in profit or loss if this is not apparent from the changes in the statement of financial position. • In respect of discontinued operations the tax expense relating to: the gainlloss on discontinuance, profitlloss from the ordinrny activities of the discontinued operation for each period presented. • The amollllt of income tax consequences of dividends to shareholders of the entity that were proposed or declared before the financial statements were authorised for issue, but are not recognised as a liability in the financial statements. • If a business combination results in a change in the amollllt recognised for the pre-acquisition deferred tax asset of the acquirer, the amollllt of that change.

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• If a deferred tax asset acquired in a business combination is not recognised at the acquisition date, but is recognised subsequently, a description of the event or change in circumstances. • The amollllt of a deferred tax asset and the nature of the evidence supporting its recognition when-

the utilisation of the deferred tax asset is dependent on future taxable profits in excess of the profits arising from the reversal of existing taxable temporary differences, and

-

the entity has suffered a loss in either the current or preceding period in the tax jurisdiction to which the deferred tax asset relates.

• The nature of the potential income tax consequences that would result from the payment of dividends to its shareholders as well as the amollllts of potential income tax consequences practicably determinable and whether there are any potential income tax consequences not practicably determinable.

8.5.3.3 Preparing the tax reconciliation or the tax rate reconciliation Paragraph 81(c) of lAS 12 requires an entity to disclose an explanation of the relationship between income tax expense/income and accollllting profit in either or both of the following forms: • A numerical reconciliation between income tax expense/income and the product of accollllting profit multiplied by the applicable tax rate (a tax reconciliation); or • A numerical reconciliation between the average effective tax rate and the applicable tax rate (a tax rate reconciliation). These disclosures enable users of financial statements to understand whether the relationship between income tax expenselincome and accounting profit is llllUSUal and to llllderstand the significant factors that could affect the relationship in the future. In explaining the relationship between income tax expenselincome and accollllting profit, an entity uses an applicable tax rate that provides the most meaningful information to the users of its financial statements. Often, the most meaningful rate is the domestic rate of tax in the COlllltIy in which the entity is domiciled. The tax reconciliation reconciles the product of the accollllting profit multiplied with the applicable tax rate to the income tax expense (or income) presented in profit or loss. In order to llllderstand which items will be reconciling items in the tax reconciliation, it is necessary to grasp the meaning of the result that is obtained by multiplying the accollllting profit with the applicable tax rate. The result from this calculation should be equal to the income tax expense in profit or loss if all of the following conditions are satisfied: • There are no non-deductible or non-taxable items for tax purposes reported in profit or loss, i.e. there are no "permanent" differences. • There are no llllder- or over-provisions relating to the current tax of prior years. • The applicable tax rate applies to all of the items reported in profit or loss, i.e. there are not any profits included in profit or loss that are taxed at a different rate. • There were no rate changes during the current year. • The entity does not operate in a jurisdiction with a dual-tax system. • A deferred tax asset was raised for all deductible temporary differences and llllused tax losses. For each of these conditions that are not met a reconciling item is required in the tax reconciliation.

Example 8.34:

The tax reconciliation

During 20X1 an entity earned a profit before tax of R1 00000, which includes the following: R 15 000 of foreign profits that are not taxable in South Africa, but are taxable in the USA at 20%. Non-deductible items for tax purposes of R5 000. Non-taxable items for tax purposes of R2 000.

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The movement in temporary differences for 20X1 was R20 000 net taxable temporary differences. Assume a normal South African corporate tax rate of 28%. The current tax for normal South African corporate tax is calculated as follows: R

Profit before tax Foreign profits - not taxable in South Africa Non-deductible items Non-taxable items Movement in taxable temporary differences

100000 (15000) 5000 (2000) (20000)

Taxable profit

68000

Current tax at 28%

19040

The income tax expense in profit or loss is calculated as follows: R

Normal South African corporate tax - current tax - deferred tax (20 000 x 28%) Foreign tax - current tax (15 000 x 20%) Total income tax expense

19040 5600 3000 27640

The purpose of the tax reconciliation is to explain the difference betvveen the product of the accounting profit multiplied with the applicable tax rate (100000 x 28% = R28 000) and the income tax expense presented in profit or loss (R27 640). These two figures are not equal as: There are non-deductible items of R5 000 and non-taxable items of R2 000.

The applicable tax rate of 28% has not been applied to all the profits. Foreign profits of R 15 000 were subject to tax at a rate of 20% and not 28%. The following represents the tax reconciliation: R

Profit before tax

100 000

Tax at applicable tax rate of 28% Tax effect of expenses that are not deductible in determining taxable profit (5 000 x 28%) Tax effect of income that is not taxable in determining taxable profit (2 000 x 28%) Effect of different tax rates of profits taxed in other jurisdiction [15 000 x (28% - 20%)[

28000 1 400 (560) (1 200)

Income tax expense

27640

The tax rate reconciliation can be drafted from the tax reconciliation. In the tax rate reconciliation all the amOllllts are stated as a percentage of profit or loss before tax.

Example 8.35:

The tax rate reconciliation

Use the same information as in example 8.30. The purpose of the tax rate reconciliation is to explain the difference between the applicable tax rate of 28% and the effective tax rate of 27,64% (27 640 I 100 000 x 100). The following represents the tax rate reconciliation: % Applicable tax rate Tax effect of expenses that are not deductible in determining taxable profit [(5000 x 28%) 1100 000 x 100[ Tax effect of income that is not taxable in determining taxable profit [(2000 x 28%) 1100 000 x 100[ Effect of different tax rates of profits taxed in other jurisdiction [(15000 x 8%) 1100 000 x 100[

28,00

Effective tax rate (27 640 1100 000 x 100)

27,64

1,40 (0,56) (1,20)

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Taxation

Example 8.36:

The effect of unused tax losses on the tax reconciliation

On 1 January 20X1 the balance of an entity's deferred tax account is R84000 (cr). This balance consists of the tax effect of R112 000 (cr) of net taxable temporary differences and the tax effect of R28 000 (dr) of an unused assessed loss. The accounting loss for 20X1 (before tax) is R500 000, while the movement in temporary differences for 20X1 is R80000 net deductible temporary differences. There is uncertainty regarding the probability of future taxable profits. Assume a tax rate of 28%. The current tax calculation for 20X 1 is as follows: R Accounting loss before tax (500000) Net deductible temporary differences for the year 80000 Tax loss for the period Assessed loss brought forward (28 000/28%)

(420000) (100000)

Balance of assessed loss

(520000)

Current tax for 20X 1

NIL

At the end of 20X 1 the deferred tax is calculated as follows: Temporary difference R 31 December 20XO Net taxable temporary differences Unused assessed loss

31 December 20X1 Net taxable temporary differences (400 000 - 80 000) Unused assessed loss (520 000 limited to 320 000)

Deferred tax at 28% R

400000 (100000)

112000 (28000)

300000

84000

320000 (320000) NIL

89600 (89600) NIL

At the end of 20X1 there is uncertainty about the probability of future taxable profits. A deferred tax asset for the unused assessed loss may therefore only be recognised to the extent that the entity has sufficient taxable temporary differences available. Of the entity's unused tax loss of R520 000, only R320000 has been provided for in deferred tax, and at the end of 20X1 the entity therefore has an unrecognised tax loss of R200 000. The total tax income in profit or loss will be R84 000, which is the movement on the deferred tax account. The tax reconciliation will be as follows: R

Accounting loss for the period

(500000)

Tax at the applicable tax rate of 28% Tax losses for which deferred tax assets were not recognised (200 000 x 28%)

(140000) 56000

Income tax income

(84000)

The product of the accounting profit multiplied by the applicable tax rate assumes that all deferred tax assets have been recognised, in other words this figure reflects what the situation would have been if the entity recognised a deferred tax asset for the full unused assessed loss of R520 000. If the entity did provide deferred tax for the full assessed loss the balance on the deferred tax account would have been R56 000 (dr) and the movement through profit or loss would have been R140 000 (cr) (84000 + 56000). If that was the case, no reconciliation would have been necessary. The reconciliation therefore reflects that a deferred tax asset of R56 000 was not recognised. If the accounting profit before tax for 20X2 is R800000 and the net movement in temporary differences is R30 000 taxable temporary differences, the current tax for 20X2 is calculated as follows:

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Accounting profit before tax Net taxable temporary differences for the year

800000 (30000)

Tax profit for the period Assessed loss brought forward

770000 (520000) 250000

Taxable profit

Current tax for 20X2

70000

At the end of 20X2 the deferred tax is calculated as follows:

31 December 20X1 Net taxable temporary differences (400 000 - 80 000) Unused assessed loss (520 000 limited to 320 000)

Temporary difference R

tax at 28%

320000 (320000)

89600 (89600)

Deferred

NIL 31 December 20X2 Net taxable temporary differences (320 000 + 30 000) Unused assessed loss

R

NIL

350000

98000

350000

98000

The total tax expense in profit or loss will be R168 000, which is represented by the movement on the deferred tax account of R98 000 and the current tax of R70 000.

The tax reconciliation will be as follows: R

Accounting profit for the period

800000

Tax at the applicable tax rate of 28%

224000

Tax effect of the utilisation of tax losses for which deferred tax assets were not previously

recognised

(56000)

I ncome tax expense

168 000

The product of the accounting profit multiplied by the applicable tax rate assumes that a net deferred tax asset of R56000 has been recognised at the end of 20X1. This figure therefore reflects a

movement in deferred tax through profit or loss of R 154 000 (dr) (56 000 + 98 000), while the actual movement is only R98 000 (dr) (0 + 98 000). If a deferred tax asset of R56 000 was recognised at the end of 20X1, no reconciliation would have been necessary as the total tax expense in profit or loss

would then have been R224 000 (154000 + 70000). The reconciliation therefore reflects that a deferred tax asset of R56 000 was not recognised at the end of 20X 1.

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Taxation

8.5.4 Disclosure example The disclosure example relates to the following information (assume a tax rate of 28%): Carrying Tax 20X3 amount base R'OOO R'OOO Allowance for expected credit losses 3000 750 Right-of-use assets 2800 2550 Lease liabilities Plant 4750 3840 25000 Section 24 allowance (instalment sale agreements)

Temporary difference R'OOO (2250) 2800 (2550) 910 25000 23910

Deferred taxation liability at 28%

20X4 Allowance for expected credit losses Right-of-use assets Lease liabilities Plant Section 24 allowance (instalment sale agreements)

6695 Carrying amount R'OOO 3600 2100 2062 3250

Tax base R'OOO 900

Temporary difference R'OOO (2700) 2100 (2062) 1 210 31 000

2040 31 000

29548 Deferred tax liability at 28%

8274

Movement in profit or loss (8 274 - 6695)

1 579

The taxable income is R51,8 million for the year ended 31 December 20X4. Taxable income includes R 1,8 million relating to the taxable capital gain (80% of R2,25 million) arising from the sale of an investment. Current taxation is R14,504 million (R51,8 million x 28%). Provisional tax payments for 20X4 amounted to R11 million. For the 20X3 year-end an amount of R2 million is included under current assets which is still due from SARS. There is no difference betvveen the current taxation provided and the assessment from SARS for 20X3. Included in profit before tax are fines paid by the company amounting to R500000 (not tax deductible) and dividends received amounting to R1 700000 (not taxable). Statement of profit or loss and other comprehensive income for the year ended 31 December 20X4 Notes R'OOO Revenue XXXXX Cost of sales XXXXX G ross profit Other expenses Profit before tax I ncome tax expense

XXXXX XXXXX

3

59088 (16083)

Profit after tax Other comprehensive income for the year, net of tax

43005 XXXXX

Total comprehensive income for the year

XXXXX

Statement offinancial position as at 31 December 20X4

Non-cutrent liabilities Deferred taxation Current liabilities SARS (14 504 - 2 000 - 11 000)

Notes

R'OOO

8

8274 1504

170

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Notes for the year ended 31 December 20X4

R'OOO 3. Income tax expense SA normal taxation Current Deferred

14504 1579 16083

Tax rate reconciliation Accounting profit

59088

Tax at the standard tax rate of 28% Tax effect of: Capital gain (20%) not taxable (2,25m x 20% x 28%) Expenses not deductible for tax purposes (O,5m x 28%) Dividends not taxable (1 ,7m x 28%)

16545

Taxation expense

16083

(126) 140 (476)

The standard tax rate is the rate announced by the South African tax authority.

8. Deferred taxation Allowance for expected credit losses (2 700 x 28%) Lease agreements for tax purposes [(2 100 - 2 062) x 28% [ Accelerated wear and tear for tax purposes (1 210 x 28%) Instalment credit agreements (31 000 x 28%)

(756) 11 339 8680 8274

8.5.5 Comprehensive illustrative disclosure example 1. Accounting policies 1.13

Cutrentanddeferredtaxation Current and deferred tax is recognised as income or an expense and included in profit or loss for the period, except when the tax relates to items that are recognised outside profit or loss or to a business combination. Tax that relates to items that are recognised in other comprehensive income is also recognised in other comprehensive income. Tax that relates to items that are recognised directly in equity is also recognised directly in equity. Deferred tax Deferred tax is generally recognised for all temporary differences using the statement of financial position method and based on tax rates that have been enacted or substantively enacted by the reporting date. The measurement of deferred tax reflects the tax consequences that would follow from the manner in which the Group expects to recover or settle the carrying amount of its assets and liabilities at the reporting date. Temporary differences are differences be1:vl/een the carrying amounts of assets and liabilities (used in the financial statements) and the corresponding tax bases used in the calculation of taxable profit. Deferred tax liabilities are recognised for all taxable temporary differences, unless the deferred tax liability arises fromthe initial recognition of goodwill; or the initial recognition of an asset and liability in a transaction which: - is not a business combination; and - at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss). Deferred tax liabilities are recognised for taxable temporary differences arising on investments in subsidiaries, branches, associates and joint ventures, except where the Group is able to con-

171

Taxation

trol the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future. Deferred tax assets are recognised for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised, unless the deferred tax asset arises on the initial recognition of an asset and liability in a transaction which• is not a business combination; and • at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss). A deferred tax asset is recognised for the carry-forward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilised. The carrying amount of deferred tax assets is reviewed at each reporting date and is reduced to the extent that it is no longer probable that sufficient taxable profit will be available to utilise the benefit. Deferred tax assets and liabilities are offset when the Group has a legally enforceable right to offset current tax assets and liabilities and when they relate to income taxes levied by the same taxation authority on either the same taxable entity or different taxable entities (when the taxable entities intend to settle current tax assets and liabilities on a net basis). Cutrent tax

Current tax payable is based on the taxable profit for the year, calculated in terms of the Income Tax Act. Taxable profit differs from the profit for the period as reported in the statement of profit or loss and other comprehensive income, as it excludes items of income or expense that are taxable or deductible in a different period or that are never taxable or deductible. The liability for current tax is calculated using tax rates that have been enacted or substantively enacted by the reporting date. Current tax assets and liabilities are offset when the Group has a legally enforceable right to set off the recognised amounts and intends either to settle on a net basis or to realise the asset and settle the liability simultaneously.

14.

Defetred taxation

Analysis of temporary differences: Property, plant and equipment Accelerated wear and tear for tax purposes Revaluation, net of related depreciation I nvestment property I nvestments in equity instruments at fair value through other comprehensive income Post-retirement benefit obligation Allowance for expected credit losses Cash flow hedges Assessed loss for normal tax Net deferred tax liability

2008 R

2007 R

XXX

XXX

lAS 12.81(g)

[J[J [J[J XXX

XXX

XXX

XXX

XXX (XXX) (XXX) XXX (XXX)

XXX (XXX) (XXX) XXX (XXX)

XXX

XXX

In line with the Group's accounting policy, certain deferred tax liabilities and assets may not be offset. The amounts presented in the statement of financial position are as follows:

Deferred tax liabilities Deferred tax assets Net deferred tax liability

2008 R XXX (XXX)

2007 R XXX (XXX)

XXX

XXX

lAS 12.82

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Various South African companies which form part of the Group have a balance relating to an assessed loss for normal tax purposes, for which a deferred tax asset has been recognised due to tax planning opportunities that will generate taxable income in future. The deferred tax assets recognised are presented in the analysis of temporary differences above.

lAS 12.82

Various South African companies which form part of the Group have a balance relating to an assessed loss for normal tax purposes for which no deferred tax asset has been recognised, due to uncertainty regarding the probability of future taxable profits. The unrecognised losses are as follows: 2008 2007 R R Unutilised assessed loss for which no deferred tax asset has been recognised xxx _.:,:X.:,:XX:.:...._IAS 12.81(e)

The aggregate amount of temporary differences associated with the undistributed earnings of subsidiaries for which no deferred tax liabilities have been recognised is RXXX (2007: RXXX).The Group has not recognised a liability for these temporary differences because the Group can control the timing of the reversal of the temporary difference and it is probable that these differences will not reverse in the foreseeable future. lAS 12.81 (n

173

Taxation

17.

Income tax expense 2008 R

2007 R

XXX XXX

XXX XXX

Major components of tax expense: SA normal taxation Current taxation Current year Prior years Deferred tax Origination and reversal of temporary differences Change in tax rate Foreign taxation

lAS 12.79

[][] [][] XXX XXX XXX

lAS 12.81 (e)

Accounting profit

XXX

XXX

Tax at the applicable tax rate of 28% Tax effect of expenses that are not deductible in determining taxable profit Tax effect of income that is not taxable in determining taxable profit Tax losses for which deferred assets have not been recognised Tax effect of utilisation of tax losses for which deferred tax assets were not previously recognised Effect of different tax rates of subsidiaries in other jurisdictions Effect of change in tax rates

XXX

XXX

XXX

XXX

(XXX)

(XXX)

XXX

XXX

(XXX)

(XXX)

XXX XXX XXX

XXX XXX XXX

The applicable tax rate is the rate announced by the South African tax authority.

Current tax Deferred tax

lAS 12.80(e) lAS 12.80(d)

XXX XXX

Tax reconciliation

The aggregate tax relating to items that are charged or credited directly to equity

lAS 12.80(b)

XXX

[Z[J [][] XXX XXX XXX XXX

lAS 12.80(a)

lAS 12.81 (e)

2008

2007

R

R

XXX

XXX

fXXxl I XXX XXX I ~

lAS 12.80(e)

lAS 12.81(a)

Current tax Definition

Temporary differences

The amount of income taxes payable (recoverable) in respect of taxable profit (tax loss) for a period.

Differences between the carrying amount of an asset or liability and its tax base

Recognition

• •

Recognise a liability to the extent unpaid. Recognise an asset to the extent that the amounts paid exceed the amount due.

Measurement

• •

Measure at the amount expected to be paid to or recovered from the taxation authority. Measurement based on tax rates that have been enacted or substantiveIy enacted by the reporting date.

00

Deferred tax

Ol

Tax base of an asset

r-

I Taxable temporary differences

Deductible temporary differences

Will result in taxable amounts in future when the carrying amount of the asset or liability is recovered or settled.

Will result in deductible amounts in future when the carrying amount of the asset or liability is recovered or settled.

Recognise liabilities for all taxable temporary differences, except to the extent that it arises from -

Recognise assets for all deductible temporary differences, unused tax losses and tax credits, to the extent that it is probable that taxable profit will be available, except for a temporary difference that arises from initial recognition of asset/liability that is not a business combination and does not affect accounting or tax profit. Regarding investments in subsidiaries, branches, associates and joint ventures, recognise asset to the extent that it is probable that temporary difference will reverse in the foreseeable future and taxable profit will be available.

• Initial recognition of goodwill; • Initial recognition of asset/liability that is not a business combination and does not affect accounting or tax profit; and • Investm ents in subsidiaries, branches, associates and joint ventures where the entity can control the timing of the reversal of the temporary difference and it is probable that it will not reverse in the foreseeable future.

....

Tax base of a liability

~

Revenue received in advance The carrying amount less any amount of revenue that will not be taxable in future.

~easurement • Measure at tax rates that will apply in future when asset is realised / liability is settled and that have been enacted or substantively enacted by the reporting date. • Measurement should reflect the expected manner of recovery or settlement. • No discounting. • Recognised and unrecognised deferred tax assets reviewed at each reporting date. Recognise current and deferred tax in profit or loss, unless it relates to a transaction previously recognised outside profit or loss (then in Oel/equity) or a business combination (then goodwill).

""

en

The amount that will be deductible for tax purposes against any taxable future economic benefits. If those economic benefits will not be taxable, the tax base equals the carrying amount.

The carrying amount less any amount that will be deductible for tax purposes in respect of that liability.

~

-.l

~

en

...... ,

I\.)

~ ~

§; o

~ w

~

'"

.-6i ~

•

~

9

Property, plant and equipment lAS 16 (Effective date 1 January 2005) lFRIC 1 (Effective date 1 September 2004)

9.1 Introduction 9.1.1 Objectives Property, plant and equipment are defined in lAS 16 as tangible items that-

• are held for use in the production or supply of goods or services, for rental to others or for administrative purposes; and • are expected to be used during more than one period. An important feature of this definition is that the asset is expected to be used during more than one period, in contrast to a current asset that is expected to be used or realised within the next accounting period or operating cycle. Property, plant and equipment often comprise a major portion of an entity's total assets, especially in asset-intensive industries, with a resulting significant impact on an entity's financial position. lAS 16 prescribes the accOllllting treatment for property, plant and equipment, so that users of the financial statements can obtain information of the entity's investment in property, plant and equipment, and also of changes in this investment that took place during the reporting period. Principles embodied in The Conceptual Framework (2010) clearly reflect on lAS 16 and impact on two essential issues related to accounting for property, plant and equipment• the recognition; and • the measurement (initial and subsequent) of such assets. As an item of expenditure is either an asset or an expense, the classification thereof can have a significant effect on an entity's results. lAS 16.7 requires an item of property, plant and equipment to be recognised as an asset when it satisfies the definition and recognition criteria for assets as stipulated in The Conceptual Framework (2010).

9.1.2 Exclusions lAS 16 does not apply to exploration and evaluation assets related to mining activity, biological assets related to agricultural activity (other than bearer plants - refer below), and mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources. Property, plant and/or equipment that are used to develop or maintain the aforesaid assets do, however, fall within the ambit of lAS 16. Also excluded from the scope of lAS 16 are property, plant and equipment classified as held for sale in terms oflFRS 5. Bearer plants are within the scope of lAS 16 and are defined as living plants that are used in the production or supply of agricultural produce, are expected to bear produce for more than one period and have a remote likelihood of being sold as agricultural produce, except for incidental scrap sales. Bearer plants will include, for example, grape vines. Although the bearer plant (grape vine) is within the scope of lAS 16, the produce of the bearer plant (grapes) will be accOllllted for in terms of lAS 41. Although the definition of property, plant and equipment refers to assets held for rental to others, these assets do not include investment property, which is to be accounted for in terms of lAS 40. 175

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However, if an entity uses the cost model to aCcOllllt for investment property that it owns, it should apply the cost model as per the requirements of lAS 16.

9.2 Recognition issues 9.2.1 Recognition of property, plant and equipment In keeping with The Conceptual Framework (2010), an item of expenditure is recognised as an asset when it satisfies the relevant definition and recognition criteria of The Conceptual Framework (2010). Therefore, an item of property, plant and equipment should be recognised as an asset when• it is probable that future economic benefits associated with the item will flow to the entity; and • the cost of the item can be measured reliably. The above recognition criteria should be applied to all costs incurred in respect of property, plant and equipment, irrespective of whether these costs are incurred initially to acquire or construct the item, or subsequently to add to, replace part of, or service it. Note that application of this recognition principle requires that day-to-day servicing costs (i.e. repairs and maintenance) should be expensed as incurred. Judgement is required in deciding whether to apply the recognition criteria to each individual item or alternatively to groups of similar items. Depending on the entity's circumstances, it might be appropriate to group individually insignificant items, such as tools, and then apply the criteria to this aggregate value.

9.2.2 Spare parts, stand-by equipment and servicing equipment Normally spare parts and servicing equipment are carried as consumables (i.e. inventories) and included llllder current assets. An expense is recognised when the spare part or servicing equipment is consumed. This treatment reflects the fact that, owing to their nature, these items do not usually meet the definition of property, plant and equipment. However, should spare parts, stand-by equipment or servicing equipment meet the definition of property, plant and equipment, these items should be accollllted for as such. Classifying spare parts, stand-by equipment and servicing equipment as property, plant and equipment raises the question as to when depreciation on these items should commence. The authors are of the opinion that this depends on whether or not the item requires major installation. Major installation requirements would imply that, until the item is installed, it is not yet available for use as intended by management. In such a case no depreciation would be recognised before installation is completed. However, if installation is not required or is insignificant in nature, depreciation should commence as soon as the item is acquired.

9.2.3 Separate components and major inspections Upon the acquisition of an item of property, plant and equipment, the cost thereof should be allocated to its significant parts (components), after which each component is depreciated separately. For example, the cost of an aircraft may be allocated to its frame and engines, and each of these components would then be depreciated separately. The reason for the allocation is that each component may have a useful life that differs significantly from the rest of the item. Some components may require replacement at regular intervals, while others will be replaced less frequently. When a replacement takes place, the recognition criteria will determine whether the amollllt incurred should be capitalised or expensed. If the amount is capitalised, the carrying amount of the part that is being replaced should be derecognised, regardless of whether the replaced part had been depreciated separately. If it is not practicable to determine the carrying mOllllt of the replaced part, the cost of the replacement may be used as an indication of what the cost of the replaced part was at the time that it was acquired.

177

Property, plant and equipment

Example 9.1: Component approach Alpha Ltd acquires an aircraft at a cost of R2 000 000. It is estimated that 45% of the cost is attributable to the frame of the aircraft, which has an expected useful life of 20 years. The remainder of the cost is attributable to the engines, which need to be replaced every five years. The annual depreciation on the aircraft will be calculated as follows: R

Frame (2 000 000 x 45%) 120 Engines (2 000 000 x 55%) 15

45000 220000 265000

If the engines are replaced at the end of year 4 at a cost of R1 300000 (earlier than expected due to an accident on the runway), then the remaining carrying amount of R220 000 [1 100000 - (220 000 x 4)[ should be de recognised, while the cost of R1 300000 is capitalised to property, plant and equipment. If the engines were never identified as a separate component, but the cost incurred to replace the engines at the end of year 4 qualifies for recognition as an asset, the "deemed" carrying amount of the replaced engines will have to be de recognised. This "deemed" carrying amount will be calculated by using the cost of the new engines as an indication of what the cost of the replaced engines was: 1 300000 - (1 300000/20' x 4) = 1 040000 Assuming that the entire aircraft was depreciated over 20 years. An amount of R1 040000 will therefore be derecognised, while an amount of R1 300 000 will be capitalised to property, plant and equipment at the end of year 4.

Some assets, for example ships, require major inspections at regular intervals to allow continued use of the assets, regardless of whether parts of the item are replaced as a result. When acquiring such an asset, the inspection cost should be accOllllted for as a separate component. This is done by allocating a portion of the cost of the asset to the inspection component, while simultaneously reducing the cost of those components that require inspection (on a pro-rata basis). The authors are of the opinion that the amount allocated to the inspection component should be the current market price of the inspection at the date when the asset is acquired, and not the expected future cost. This inspection component is then depreciated over the period until the inspection is performed. When the first inspection is performed, the actual cost incurred should be capitalised to the asset, provided the recognition criteria are met. The remaining carrying amount of the inspection component that was identified when the asset was acquired should be derecognised. If the inspection was not identified as a separate component when the asset was acquired, a "deemed" carrying amount, based on the cost of the current inspection, will be derecognised - refer to example 9.1 for an illustration of the calculation of a "deemed" carrying amount.

Example 9.2: Major inspection A machine is acquired at a cost of R500 000. This machine consists of two components, namely component A, with a cost of R300 000 and useful life of 15 years, and component B, with a cost of R200000 and useful life of 12 years. A major inspection, covering both components, needs to be performed every three years. On acquisition of the machine, an inspection, similar to the one that will be performed after three years, costs R20 000. The annual depreciation for the first three years is calculated as follows: R

I nspection component (20 000 13) Component A [300 000 - (20 000 x 300 000 1 500 000)[ 115 Component B [200 000 - (20000 x 200 000 1500 000)[ 112

6667 19200 16000 41867

Assume that, at the end of the third year, the inspection is performed at a cost of R22 000. This amount should be capitalised to the cost of the machine, while the remaining carrying amount (if any) of the previous inspection component should be de recognised. As the previous inspection component of R20000 has already been fully depreciated, there is no remaining carrying amount to derecognise. Note that if the inspection is performed before the end of the third year, the remaining carrying amount

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of the inspection component will have to be removed. The amount of R22 000 capitalised to the machine is again depreciated over a period of three years. The annual depreciation for the next three years is calculated as follows: R

Inspection (22 000 13) Component A [300 000 - (20 000 x 300 000 1 500 000)[ 115 Component B [200 000 - (20000 x 200 000 1500 000)[ 112

7333 19200 16000 42533

9.2.4 Safety and environmental equipment Safety equipment or environmental equipment does not generate future economic benefits of their However, such equipment may enable an entity to obtain greater economic benefits from the related assets (than would have been the case had the safety equipment not been acquired). In such cases, this equipment should be recognised as an asset. The combined carrying amount of the safety equipment and the related asset(s) should, however, be reviewed for impairment after recognition (by comparing it with the recoverable amollllt). This recoverable amount would be determined by viewing the safety equipment and related asset(s) as a single cash generating unit. Therefore the safety equipment is capitalised in full, before an impairment test is subsequently conducted. Refer to the chapter on impairment of assets for further discussion of impairment tests. OwIl.

Example 9.3: Safety equipment X Ltd installed a new water filtering system in its factory at a cost of R50 000, in order to avoid spillage of chemicals into a nearby river. The carrying amount of the factory is R1 200000, while its recoverable amount is R 1 220000. The recoverable amount of the water filtering system and its related asset (factory) is R1 220000, while the combined carrying amount is R1 250000 (1200000 + 50 000). The water filtering system will therefore be capitalised, after which an impairment loss of R30 000 (1 250 000 - 1 220 000) will be recognised as the water filtering system and factory are treated as a cash generating unit. This impairment loss will be allocated to the factory and water filtering system on a pro rata basis, based on their respective carrying amounts: R

Factory (1 200000/1 250000 x 30 000) Water filtering system (50 000 11 250000 x 30 000)

28800 1200 30000

9.3 Cost determination 9.3.1 Elements of cost Property, plant and equipment should initially be measured at cost. Cost is defined as the amollllt of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction or, where applicable, the amollllt attributed to that asset when initially recognised in accordance with the specific requirements of other IFRSs. The cost of an asset will comprise of the following: • the purchase price, including import duties (e.g. customs duty) and non-reflllldable purchase taxes ( e.g. VAT on passenger vehicles), after deducting trade discollllts (e.g. settlement discollllts) and rebates; • any costs directly attributable to bringing the asset to the location and condition necessrny for it to be capable of operating in the manner intended by management, for example: -

costs of employee benefits (including share-based payments) arising directly from the construction or acquisition of the asset;

Property, plant and equipment

-

179

costs of site preparation (including the costs of demolishing existing buildings on newly acquired land in order to construct new buildings);

-

initial delivery and handling costs;

-

installation and assembly costs;

-

costs of testing whether the asset is fllllctioning properly, but only after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (e.g. samples produced when testing equipment); and professional fees (e.g. architects and engineers); and

-

• the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located (refer to section 9.8 for the accounting treatment of subsequent changes in this estimate). This obligation may arise either when the item is acquired or as a consequence of having used the item during a particular period, provided it was not used to produce inventories during that period. If the item was used to produce inventories, such costs arise because of this production and will be capitalised to the inventories and not to the item itself.

9.3.2 Costs that are excluded Examples of costs that are not regarded as costs of an item of property, plant and equipment are• costs of opening a new facility; • costs of introducing a new product or service (including advertisement costs); • costs of conducting business in a new location or with a new class of customer (including the cost of training staff); and

• administration and other general overhead costs. Capitalisation of costs ceases when the asset is in the location and condition necessary for it to be capable of operating in the manner intended by management. As a result, any costs incurred in using or redeploying an item of property, plant and equipment are not included in the carrying amollllt of that item. The following costs are therefore excluded from the cost of an asset: • costs incurred while an item capable of operating in the manner intended by management has yet to be brought into use or is operated at less than full capacity; • initial operating losses, such as those incurred while demand for the item's output builds up; and • costs of relocating or reorganising part or all of an entity's operations.

Example 9.4: Cost of property, plant and equipment ABC Ltd bought a machine at a cost of R570 000 (VAT inclusive) (this is before laking into account a trade discount of 5%). The machine was transported to ABC Ltd's premises at a cost of R5 000, after which it was installed by an independent engineer, who charged R500 per hour - installation took five hours to complete. After installation, the machine was tested at a cost of R10 000. Fortunately the samples manufactured during testing could be sold for R6 000. Once management was satisfied that the machine was functioning properly, they spent R50 000 on advertising the product to be manufactured by the machine and then commenced with manufacturing activities. Initially the demand for the product was very low, resulting in operating losses of R30 000 during the first three months. Thereafter the machine was operating at a profitable level.

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The cost of the machine is calculated as: Purchase price (570 000 x 10°/ 114 ) Discount (500000 x 5%) Transport costs I nstaliation costs (500 x 5) Costs of testing the machine (10 000 - 6000) Advertising costs Operating losses

R

500000 (25000) 5000 2500 4000

486500

9.3.3 Incidental operations Some operations occur in cOImection with the construction or development of an item of property, plant and equipment, but are not necessary to bring the item to the required location and condition for it to be capable of operating in the manner intended by management. Such operations are often referred to as incidental operations, and may occur before or during the construction or development of the asset. Because incidental operations are not necessary to bring an item to the required location and condition for it to be capable of operating in the manner intended by management, the income and related expenses should be recognised in profit or loss for the period. For example, if a building site is rented out as a parking area before commencement of construction on the site, the rental income (and any associated costs) should be recognised in profit or loss.

9.3.4 Abnormal credit terms The granting of abnormal credit terms by a supplier of an item of property, plant or equipment indicates the inclusion of an implicit interest component in the purchase price. Under these circumstances the cost of the item would be the cash price equivalent (i.e. the present value of the amollllt payable). Accordingly, the interest portion should be eliminated from the purchase price and expensed over the credit period (unless the item meets the requirements of a qualitying asset, in which case borrowing costs should be capitalised to the cost of the asset). It should be noted that this treatment is in line with IFRS 9, which requires payables to be discollllted to a present value (fair value) at initial recognition whenever the effect of discollllting is material. It is suggested that the granting of abnormal credit terms will result in the effect of discollllting being material.

Example 9.5: Deferred settlementterms and dismantling costs ABC Ltd leases a manufacturing building. In terms of the lease agreement any machinery installed in the building has to be dismantled at the end of the lease term, which is at the end of year 10. At the beginning of year 2, a machine was acquired at a price of R800 000. It is normal practice that settlement of the purchase price should occur immediately, but the supplier agreed to postpone settlement till the end of year 2. It is estimated that it will cost R 100 000 to dismantle the machine at the end of year 10. A fair discount factor is 8% per annum (before tax, compounded annually). The cost of the machine will be calculated as follows: R Cash equivalent of purchase price (800 000 x 100/108 ) 740741 Dismantling costs (present value of R1 00000 at 8% for nine years) 50025

790766

9.3.5 Construction of property, plant and equipment When items of property, plant and equipment are produced or constructed rather than purchased, all directly attributable costs should be included in the production cost. The production cost should be determined in the same way as the cost of inventories (see chapter 3), i.e. abnormal wastage of materials or labour and internal profits are excluded from the production cost. Borrowing costs directly attributable to the construction or production of a qualifying asset should also be capitalised as part of the cost of the asset.

Property, plant and equipment

181

Bearer plants (e.g. grape vines) are accOllllted for in the same way as self-constructed items of property, plant and equipment. In respect of bearer plants, "construction activities" will cover all those activities that are necessary to cultivate the bearer plants before they are in the location and condition necessary to be capable of operating in the manner intended by management

9.3.6 Exchange of assets Assets are sometimes acquired through an exchange transaction, i.e. an item of property, plant and equipment is acquired in exchange for another non-monetary asset (or a combination of monetary and non-monetary assets). As a general rule, the cost of the newly acquired asset should be measured at fair value, with two exceptions, discussed below. The fair value of an asset is the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. The fair value in an exchange transaction will be determined with reference to the fair value of the asset given up (and not the fair value of the asset acquired). The fair value of the asset acquired will, however, be used ifit is more clearly evident than the fair value of the asset given up. There are two exceptions to the rule that an asset acquired in an exchange transaction should be measured at fair value, namely• when the fair value of neither the asset received nor the asset acquired can be measured reliably, or • when the transaction lacks commercial substance. When either one of these exceptions applies, the cost of the acquired asset is measured at the carrying amount of the asset given up. An entity determines whether an exchange transaction has commercial substance by considering the extent to which its future after tax cash flows are expected to change as a result of the transaction. An exchange transaction has commercial substance if • the configuration (risk, timing and amount) of the cash flows of the asset received differs from the configuration of the cash flows of the assettransferred; or • the entity-specific value of the portion of the entity's operations affected by the transaction changes as a result of the exchange (the entity-specific value is the present value of the post-tax cash flows an entity expects to arise from the continuing use of an asset and from its disposal at the end of its useful life); and • the difference in the above is significant relative to the fair value of the assets exchanged. It should be noted that if the configuration of the cash flows of two assets are identical, their entity-

specific values may still differ due to different discount rates being used and/or differences in tax cash flows. Therefore it is necessary to consider both the configuration of the cash flows of the assets and their entity-specific values when evaluating commercial substance.

Example 9.6: Exchange of assets If A Ltd exchanges machine A (with a carrying amount of R10 000 and fair value of R15 000) for machine B (with a fair value of R16 000), then machine B will be recognised at a cost of R15 000 (fair value of machine A). If the fair value of machine B is, however, more clearly evident than that of machine A, then machine B will be recognised at a cost of R16 000 (its own fair value). This might happen, for example, ifthere is an active market for machine B and not for machine A. Should it happen that it is not possible to determine the fair value of either machine A or B, then machine B will be recognised at a cost of R10 000 (carrying amount of machine A). If the transaction lacks commercial substance (for example if the future cash flows of the two machines are identical), then machine B will be recognised at a cost of R10 000 (carrying amount of machine A).

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9.4 Depreciation 9.4.1 Economic benefits consumed An item of property, plant and equipment is capitalised as an asset when its cost can be measured reliably and it is probable that future economic benefits associated with that asset will flow to the entity. It follows, therefore, that the carrying amollllt of the asset should be reduced over time to reflect the consumption of economic benefits embodied in the asset. This is achieved by recognising depreciation expense, which represents the systematic allocation of the depreciable amollllt of an asset over its useful life. The depreciable amollllt of an asset is its cost, or other amollllt substituted for cost, less the asset's residual value. This depreciation expense should, as far as possible, match the consumption of economic benefits. It should be noted that depreciation is to be recognised even iftheJair value of the asset exceeds its carrying amollllt, as the economic benefits embodied in the asset are still consumed through use of the asset. However, if the asset's residual value exceeds its carrying amollllt, no depreciation should be recognised, as the asset's residual value reflects the portion of the carrying amollllt of the asset that will not be consumed through use (i.e. it will realise through sale). Repair and maintenance or an increase in the fair value of an asset does not negate the need to depreciate it, although it may impact on the useful life or residual value of the asset. The depreciation charge for a period is usually recognised in profit or loss. However, if the item of property, plant and equipment is utilised to produce another asset, the depreciation charge constitutes part of the cost of the other asset and is included in its carrying amOllllt. For example, the depreciation of manufacturing plant and equipment is included in the cost of conversion of inventories. Similarly, depreciation of property, plant and equipment used for development activities may be capitalised as part of development costs (an intangible asset). In order to calculate the depreciation charge, consideration should be given to the asset's cost (discussed in section 9.3), useful life, residual value and its separate components, as well as to the point in time when depreciation should commence and cease.

9.4.1.1

Useful life

The useful life of an asset is either • the period over which that asset is expected to be available for use by an entity; or • the number of production or similar units expected to be obtained from that asset by an entity. Economic benefits are consumed when an asset is used. In addition, other factors such as obsolescence may result in a diminution of the originally estimated economic benefits. The following factors, therefore, need to be considered when assessing an asset's useful life: • Expected usage of the asset - for example, whether the asset will be used for eight or twelve hours per day. • Expected physical wear and tear of the asset - for example, a chair may be subject to more wear and tear in a factory building than in an office building. • Technical obsolescence - for example, electronic equipment usually have a relatively short useful life due to technical obsolescence. It should be noted that expected future reductions in the selling price of items produced by an asset could indicate expected technical or commercial obsolescence, which in tum might reflect a reduction of future economic benefits embodied in the asset. • Legal or other limits on the use of the asset - for example, if a licence is needed to use a certain machine then the useful life of the machine cannot exceed the period for which the licence has been granted. The estimate of an asset's useful life is a subjective exercise and is based on judgement. It should be noted that the useful life of an asset may be shorter than its economic life. The economic life refers to the total period during which an asset is in a usable condition, while the useful life is assessed in terms of the asset's expected utility to one specific entity. For example, a company may have a policy

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to replace their delivery vehicles every three years (resulting in a three-year useful life) even though the vehicles may have an economic life of six or more years. U sefullives should be reviewed at least at the end of each financial year. Any change in useful life should be accOllllted for as a change in estimate.

Example 9.7: Depreciation charge adjusted for change in useful life A company purchased an asset three years ago for R450 000. The original expected useful life was six years. The asset was depreciated on the straight-line basis (over six years) during the first two years. At the end of the third year it becomes apparent that the asset will only be used for a total period of five years. Accordingly, the depreciation charge is adjusted as follows: Carrying amount at end of year 2 = R300 000 [450 000 - (450 000 x 2/6)[ Remaining useful life

= three years

Adjusted annual depreciation charge = R100 000 The asset is therefore depreciated on the following basis over the five-year useful life: Year 1 75000 Year 2 75000 Year 3 100 000 Year 4 100 000 Year 5 100 000 450000 The change in estimate in year 3 will amount to an increase in depreciation of R25 000 (100000 75000). The cumulative future impact of the change in estimate at the end of year 3 will be a decrease in depreciation of R25000, as the total future depreciation at the end of year 3 now amounts to R200 000 (100 000 x 2), whereas it would have been R225 000 (75 000 x 3) before the change.

Although land and buildings are often acquired as a combined asset, lAS 16.58 states that land and buildings are separable assets and should be dealt with separately for accounting purposes. Buildings have a limited useful life and should therefore be depreciated, while land is assumed to have an indefinite economic life in most cases (there are a few exceptions such as quani.es and sites used for landfills where the land can only be used for a limited number of years). An increase in the value of the land, on which a building stands, should have no effect on the depreciable amount of the building. If the cost of land includes the costs of site dismantlement, removal and restoration, the restoration cost portion of the land is depreciated over the period of benefits obtained by incuni.ng those costs. If the land itself has a limited useful life (such as quarries and sites used for landfills), it should be depreciated in a manner that reflects the benefits to be derived from it.

9.4.1.2 Residua[ value The depreciable amount of an asset is determined after deducting its residual value from its cost (or other amount substituted for cost). The residual value of an asset is defined as the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. It should be noted that the residual value of an asset is a current value which ignores the effect of future inflation. In practice, the residual value of an asset is often insignificant and therefore immaterial in (i.e. omitted from) the calculation of the depreciable amount. The residual value of an change should be accounted asset increases to an amount recognised until the residual amount.

asset should be reviewed at least at each financial year-end and any for as a change in an accounting estimate. If the residual value of an equal to or greater than the asset's carrying amount, no depreciation is value subsequently decreases to an amount below the asset's carrying

Example 9.8: Change in residual value At the beginning of year 1, A Ltd acquired a vehicle at a cost of R 150 000. At that date the residual value and useful life of the vehicle were estimated to be R30 000 and five years respectively. These

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estimates remained unchanged at the end of year 1, but at the end of year 2 the estimate of the residual value changed to R35 000. Depreciation for year 1 will amount to R24 000 [(150 000 - 30 000) 15[. Depreciation for year 2 will amount to R22 750 [(150 000 - 24000 - 35 000) 14[ of which R1 250 (24 000 - 22 750) represents a change in estimate (decrease in depreciation) in year 2. The cumulative future effect of the change in estimate at the end of year 2 is a decrease in depreciation of R3 750, as the total future depreciation at the end of year 2 now amounts to R68 250 (22 750 x 3), whereas it would have been R72 000 (24 000 x 3) before the revision of the residual value. The same result of R3 750 is achieved if the decrease in the depreciable amount of R5 000 (35 000 - 30 000) due to the change in residual value is reduced by the portion of the decrease already recognised in the current year (R 1 250).

Assuming that the residual value of the vehicle remains unchanged until the end of year 4, the carrying amount of the vehicle will amount to R57 750 at the end of year 4 [150 000 - 24000 - (22 750 x 3)]. If the residual value of the vehicle increases to R60 000 at the end of year 5, no depreciation will be accounted for in year 5, as the residual value of R60 000 exceeds the vehicle's carrying amount of R57750.

9.4.1.3 Components An entity should allocate the amollllt initially recognised in respect of an item of property, plant and equipment to its significant parts and then depreciate each significant part separately. An entity may also choose to depreciate separately the insignificant parts of an item of property, plant and equipment. If a significant part of an item of property, plant and equipment has a useful life and a depreciation method that are the same as the useful life and the depreciation method of another significant part of that same item, then these parts may be grouped in determining the depreciation charge. Once costs have been allocated to the significant components, the balance of the cost represents the cost of the remainder of the item, which should also be depreciated separately. The remainder therefore consists of those components of the item that are individually not significant. Should an entity have varying expectations regarding the consumption pattern or useful lives of these remaining components, approximation techniques will have to be used in order to calculate the depreciation charge in respect of the remainder of the item. If an entity acquires property, plant and equipment subj ect to an operating lease where it becomes the lessor as a result of the transaction, it may be appropriate to depreciate separately amollllts reflected in the cost of that item that are attributable to favourable or llllfavourable lease terms relative to market terms. This is illustrated in the following example.

Example 9.9:

Favourable component of lease contract where entity is the lessor

On 1 January 20X2 B Ltd entered into an operating lease agreement with C Ltd to lease a machine to C Ltd for a period of 11 years, at an annual rental of R220 000, payable in arrears. On 1 January 20X3 B Ltd sold the machine to A Ltd for R2 225000. Due to legal requirements, A Ltd must continue to honour the lease agreement with C Ltd. A market-related rental for this type of machine amounted to R 180000 per annum on 1 January 20X3. The remaining useful life of the machine was 25 years at that date. Assume a fair discount rate of 12%. As A Ltd acquires a machine subject to an operating lease where it becomes the lessor as a result of the transaction, it may be appropriate to depreciate the favourable component of the existing lease contract separately. The lease contract is favourable to A Ltd as it receives more than market-related rent. The present value of the favourable component of the lease contract with C Ltd amounts to R226 009 (Pmt = 220000 - 180000; i = 12%; n = 10). As the favourable component of R226 009 of the machine will realise over the remaining lease period of 10 years, it would be appropriate to depreciate this component over 10 years, while the remainder of the machine (2225000 - 226009) should be depreciated over 25 years. The annual depreciation will therefore amount to R102 561 [(1 998991/25) + (226 009/10)[ for the first 10 years of the machine's useful life.

Similar considerations apply when a parent company acquires a subsidirny that is a lessor of items of property, plant and equipment. For consolidation purposes all the assets and liabilities of the subsidiary should be accollllted for at fair value at acquisition date. If the subsidiary is a lessor of items of property, plant and equipment, the fair value of these items will take existing lease contracts

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into aCCOllllt. In other words, the fair value of these assets will reflect favourable or unfavoumble elements of existing lease contracts. Similar to the example above, it may be appropriate for consolidation purposes to depreciate these favourable and unfavourable components separately from the remainder of the asset. Refer to the chapter on business combinations for an example illustrating this issue.

9.4.1.4 Commencement or cessation of depreciation Depreciation of an asset begins when it is available for use, i.e. when it is in the location and condition necessrny for it to be capable of operating in the manner intended by management. It is important to note that an asset may be available for use even before actual use of the asset commences. Accordingly, depreciation may commence before actual use of the asset under certain circumstances. Depreciation of an asset ceases at the earlier of • the date that the asset is classified as held for sale in terms of IFRS 5; and • the date that the asset is derecognised. This means that depreciation will not necessarily cease when an asset becomes idle or is retired from active use, unless the carrying amount is zero or equal to the residual value. If, however, depreciation is based on the number of units manufactured (i.e. the unit of production method) the depreciation charge will be zero during periods when no production takes place.

9.4.2 Depreciation methods As noted earlier, the depreciation charge of an asset should be allocated on a systematic basis that matches the expected pattern of economic benefits to be derived from that asset. A number of different methods can be applied in calculating the depreciation of an asset. lAS 16 highlights the three more common methods of depreciation, namely the straight-line method, the diminishing (or reducing) balance method and the unit of production method. lAS 16 also points out that it is not acceptable to base a depreciation method on the revenue generated by an asset, as revenue could be affected by many factors, such as inflation. It will therefore not be appropriate to allocate the depreciable amount of an asset pro-mta based on revenue generated over its useful life. The three acceptable methods mentioned in lAS 16, as well as the sum-of-the-digits method (similar to the diminishing balance method), are illustrated below.

9.4.2.1

Straight-line

This is the simplest and easiest method to apply. The depreciable amount is written off in equal parts over the asset's useful life.

Example 9.10: Straight-line method An asset is purchased for R99 000 and is expected to last for six years with a residual value of R9 000. Accordingly, the depreciable amount is R90 000 (99 000 - 9 000), giving an annual depreciation charge of R 15 000 (90 000 /6).

9.4.2.2 Diminishing balance This method, more commonly known in South Africa as the reducing balance method, is based on the argument that greater economic benefits are derived from an asset during the early years of its use. This could be because of teclmological obsolescence or merely due to higher repairs and maintenance cost arising in the later years of an asset's useful life. In order to reflect the pattern of consumption of economic benefits accurately, less depreciation is therefore charged in later years. The depreciation charge is determined by applying a percentage to the current carrying amount of an asset.

Example 9.11: Diminishing balance method An asset with a cost of R90 000 is to be depreciated at 25% per annum using the diminishing balance method. The depreciation in year 1 is R22 500 eR90 000 x 25%). This leaves a carrying amount of R67 500, which will result in a depreciation charge of R16 875 (R67 500 x 25%) in the second year.

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The process continues in a similar way each year. The carrying amount of the asset will never reach zero as the depreciation charge is a constant proportion of the carrying amount and becomes less and less each year.

9.4.2.3 Unit of production method This method ensures that the asset is written off in line with its total estimated output. The depreciable amollllt of the asset is multiplied by relevant annual output divided by the total expected output from that asset during its useful life. The unit of production method is the only depreciation method for which the depreciation charge is zero during a period when the asset is idle.

Example 9.12: Unit of production method An asset costing R85 000 with a residual value of R5 000 is expected to produce a total output of 200 000 units. In the first year the actual output is 30 000. The depreciation charge in the first year is R12 000 (R80 000 x 30 000 1200 000). In the second year the actual output is 40 000, therefore the depreciation charge will be R16 000 (R80 000 x 40 000 1200 000).

9.4.2.4 Sum-of-the-digits This method is a variation of the diminishing balance method, ensuring that the depreciation charge is higher in the early years of using the asset, while the depreciation charge falls by a fixed amount each year. The method comprises four steps: 1. Number each year of the asset's useful life. 2. Add these digits.

3. Calculate the depreciation rate for each year by dividing the respective digits arranged in reverse order by the sum of the digits. 4. Multiply the depreciable amollllt by the appropriate rate to determine the annual depreciation charge.

Example 9.13: Sum-f-the. 1 period

I

I

To produce or supply goods or services

I

To rent to others

For admin purposes

Recoanition (initial and subseauent costs)

• • • •

Probable that future economic benefits will flow to the entity (also consider safety and environmental equipment) Cost can be measured reliably Important: Aggregate individually insignificant items but account for significant components separately Important: Expense day-to-day servicing but regard major inspections as a separate component Initial measurement at cost

• •

Deferred payment - use cash price equivalent Exchange of assets measured at fair value of asset given up, else fair value of asset received. If no fair value or no commercial substance, measure at carrying amount of asset given up

Include

Exclude

•

Purchase price, import duties (deduct discounts, rebates)

•

Directly attributable costs

•

Employee benefits, site preparation, delivery, handling, installation, assembly, testing (deduct proceeds of samples), professional fees

•

Dismantling and restoration costs

• • •

Costs to open new facility, initial operating losses, costs of relocating I reorganising operations, advertising and promotional activities Staff training, admin and general overheads Costs incurred while capable of operating as intended but not yet used Incidental operations

Subseauent measurement

•

Depreciation: Commences vvhen asset is available for use. Ceases when asset is derecognised or classified as held for sale. Recognise in P/L, unless capitalised to another asset

-

Change in residual value, useful life, depreciation method = change in estimate No depreciation if residual value> carrying amount Land and buildings separable assets - depreciate buildings, usually not land

Cost model Cost less accumulated depreciation and impairment

Revaluation model (only if reliably measurable) Fair value less subsequent accumulated depreciation and impairment

• •

Surplus to OCI, unless reversal of devaluation recognised in P/L, then P/L Deficit to P/L, unless remaining balance on revaluation surplus, then OCI

General

• • •

Fair value

Revalue regularly Revalue entire class Beginning or end of year

•

Market, cost or income approach in terms of IFRS 13

Treatment of asset

•

Adjust or eliminate

Realisation of surplus

•

Annually or when sold

Derecognition

• •

Recognise net gain or loss in other income or other expenses On disposal or vvhen no future economic benefits are expected from use or disposal

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IFRS 16 (Effective date 1 January 2019)

10.1 Introduction 10.1.1 Objective An entity purchasing an asset for use in its business acquires both the legal title to the asset and the risks and rewards of ownership. In order to finance the acquisition of the asset, the entity may, inter alia • use existing cash resources,

• utilise an overdraft facility, • utilise the proceeds of a medium- or long-term unsecured loan, or • utilise the proceeds of a loan to be secured on the asset. Whichever financing method is used, the accOllllting implications are fairly simple; the asset is recognised in the statement of financial position and the other side of the entry is either an increase in a liability or a reduction in cash resources.

However, an entity can also decide to lease an asset, instead of purchasing it outright. In substance, when an entity leases an asset, it is acquiring the right to use the asset. This is an essential characteristic of a lease agreement in IFRS 16, which is defined as a contract (or part of a contract) which conveys the right to use an asset for a period of time in exchange for consideration. There are a number of reasons why an entity might choose to lease instead of purchase an asset: • Leasing may be the only means of obtaining the asset. • Insufficient fllllds to purchase the asset. • Temporary use of the asset is required. • The avoidance of potential teclmological and obsolescence factors. • Potential tax benefits.

10.1.2 Exclusions IFRS 16 is not applicable to the following specialised types ofleases: • Lease agreements to explore for or use minerals, oil, natural gas and similar non-regenerative resources. • Leases of biological assets within the scope ofIAS 41 held by a lessee. • Service concession arrangements dealt with by IFRIC 12. • Licences of intellectual property granted by a lessor that are within the scope ofIFRS 15. • Rights held by a lessee under licencing agreements for items such as motion picture films, video recordings, plays, manuscripts, patents and copyrights (the standard on intangible assets (lAS 38) will apply to these agreements). If an intangible asset held by a lessee is not specifically excluded from the scope of IFRS 16 as detailed above, the lessee may elect (but is not required) to apply IFRS 16 to the specific intangible asset.

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10.1.3 Fundamental concepts Before considering the detail contained in IFRS 16, it is essential to have a proper llllderstanding of the following flllldamental concepts relating to leases.

10.1.3.1

Inception of a lease versus commencement of the lease

The inception date of the lease is defined as the earlier of the date of the lease agreement or of a commitment by the parties to the principal terms and conditions of the lease. At this date, the parties to the contract should assess whether the contract in fact contains a lease. However, the lease is not recognised or measured on this date. The date on which the lease is initially recognised and measured is referred to as the commencement date, which is defined as the date on which the lessor makes the underlying asset available for use by a lessee.

10.1.3.2 Lease term The lease term is the non-cancellable period for which the lessee has the right to use an llllderlying asset together with both: • further periods for which the lessee has the option to extend the lease if the lessee is reasonably certain to exercise the option; and • further periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise the option. The lease term begins at the commencement date and includes any rent-free periods provided to the lessee by the lessor.

10.1.3.2.1

Non·cancellable period of a lease

A contract is an agreement which creates enforceable rights and obligations. The entity should therefore consider the period for which the contract is enforceable when it determines the noncancellable period of a lease. The standard determines that a lease is no longer enforceable when the lessee and the lessor both have the right to terminate the lease without permission from the other party with no more than an insignificant penalty. For example, if a lease agreement stipulates a ten year lease period, but either party (i.e. the lessee or the lessor) can cancel the agreement without penalty at any time after eight years have passed, the non-cancellable period of the lease is only eight years. If only the lessor has the right to terminate a lease, the non-cancellable period of the lease includes the period covered by the option to terminate the lease. In other words, it is always assumed that the lessor will not exercise its right to terminate a lease agreement. By contrast, if only the lessee holds the right to terminate the lease agreement, the entity should consider whether the lessee has an economic incentive to exercise this option (refer to section 10.1.3.2.2).

10.1.3.2.2

Extension and termination options held by the lessee

The lease term is affected by extension and termination options held by the lessee only when there is reasonable certainty about whether or not such an option will be exercised. The entity should consider all relevant facts and circumstances in making this assessment and specifically whether or not an economic incentive has been created for the lessee to exercise an extension option (or refrain from exercising a termination option). In addition, the entity should also consider expected changes in facts and circumstances from the commencement date lllltil the exercise date of the option. The standard provides the following examples of facts and circumstances that an entity should take into consideration when determining whether it is reasonably certain that a lessee will exercise its option (or refrain from doing so): • The contractual terms and conditions for the optional periods compared with market rates, such as: the amollllt of payments for the lease during the optional period; the amollllt of variable or contingent payments for the lease (e.g. termination penalties); and

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the terms and conditions of options that are exercisable after the initial optional period (e.g. a purchase option at a below market rate, which only becomes available if the lease term has been extended). • Leasehold improvements to be lllldertaken: If, for example, a lessee is expected to lllldertake significant leasehold improvements during the initial term of the contract, the lessee will be more likely to extend the lease term (or refrain from terminating the contract early), as such improvements are likely to increase the economic benefits of the llllderlying asset to the lessee. Leasehold improvements could also increase the likelihood that an option to purchase the asset at the end of the lease term will be exercised. • Cost related to the termination of the lease: Such costs are not limited to penalties for terminating the contract. The entity should also consider costs such as costs to acquire a replacement asset and costs associated with restoring the llllderlying asset to a contractually agreed condition or location. The higher such costs, the more likely it will be that the lessee will extend the lease (refrain from terminating the contract early). • The importance of the llllderlying asset to the lessee's operations: Here the entity should consider factors such as the nature of the asset (whether or not it is specialised), the location of the asset and the availability of suitable alternatives. • The conditions attached to the exercise of an option: Some options can only be exercised when specific conditions are met (e.g. market interest rates reach a certain level). If this is the case, the entity should consider the likelihood that these conditions will be met. • The length of the non-cancellable period of the lease: The shorter the non-cancellable period of a lease, the more likely a lessee is to exercise an option to extend the lease period (or refrain from terminating the lease). The reason is that the costs associated with obtaining a replacement asset are proportionately higher the shorter the non-cancellable period. • The lessee's past practice: One aspect of the lessee's past practice is the period over which it has typically used similar assets (owned or leased) in the past and its economic reasons for doing so. For example, if a lessee typically replaces specific equipment every five years to avoid teclmological obsolescence, it could indicate that the lessee is not likely to extend the lease term for similar equipment to a longer period. Another aspect is the frequency with which the lessee has exercised options on leases of similar llllderlying assets in the past. This could provide an indication of the likelihood that the lessee might do so again.

10.1.3.2.3 Guaranteed return In some contracts a lessee guarantees a minimum or fixed return to the lessor. When the guarantee ensures that the return on the lease agreement is substantially the same regardless of whether or not the option has been exercised, the entity must always assume that the lease will last for the maximum potential lease period. In other words, the entity will assume that the lessee will exercise options to extend the lease and refrain from terminating the lease. The reasoning behind this is that if a lessee has guaranteed a return to the lessor, the lessee will bear the same cost irrespective of whether or not the lessee obtains the economic benefits from using the asset. Consequently, it will be in the economic interest of the lessee to retain the use of the asset for the full lease period so that the cost of the contract is at least offset by whatever economic benefits can be obtained from the asset.

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Reassessment of extension and termination options held by the lessee

A lessee should reassess whether it is still reasonably certain that it will exercise an extension option (or refrain from terminating the lease) when a significant event occurs (or there is a significant change in circumstances) which: • is within the control of the lessee; and • affects whether the lessee is reasonably certain about whether or not the option will be exercised. The standard provides the following examples of such significant events or changes in circumstances: • Significant leasehold improvements have been made which were not anticipated at the commencement date. • The asset has been significantly modified or customised which was not anticipated at the commencement date. • A sublease has been entered into with a lease term which will require the entity to extend the main lease. • A business decision has been made which is directly relevant to whether or not the option will be exercised (e.g. a decision to discontinue an operation).

10.1.3.2.5 Reassessment of the lease term An entity must revise the lease term when there is a change in the non-cancellable period of a lease. This will be the case when, for example: • The lessee exercises an option which was not included in the original assessment of the lease term; • The lessee fails to exercise an option which was included in the original assessment of the lease term; • An event, which was not expected to occur at the original assessment of the lease term, occurs and it contractually obliges the lessee to exercise an option or prohibits the lessee from doing so. The accounting requirements when a lease term is revised are discussed in section 10.4.1.5.2.

10.1.3.3 Guaranteed versus unguaranteed residual values In essence, a residual value is the amollllt that a lessor will receive at the end of the lease term if the underlying asset is disposed of. Generally speaking, the residual value will be an estimate and the lessor will not be certain what the disposal value of the asset will be (i.e. the residual value will not be guaranteed). However, it is possible that a lessor can have a contractual agreement which offers the lessor certainty about what the minimum residual value of the llllderlying asset will be at the end of the contract (i.e. a residual value guarantee). More formally, the standard defines an unguaranteed residual value as that portion of the residual value of the llllderlying asset, the realisation of which by the lessor is not assured or is guaranteed solely by a party related to the lessor. By its nature, an llllguaranteed residual value is an estimate and therefore a fluctuating amOllllt. By contrast, a guaranteed residual value is a residual value where a residual value guarantee has been made to the lessor. A residual value guarantee is a guarantee made to a lessor by a party unrelated to the lessor that the value (or part of the value) of an underlying asset at the end of the lease will be at least a specified amOllllt. Should the value of the llllderlying asset be less than the amollllt that was guaranteed, the provider of the residual value guarantee will be liable to pay the difference. A residual value guarantee is therefore a minimum amollllt that will be received (in the form of the value of the asset and, should the value of the asset be lower than the residual value guarantee, a cash payment for the difference between the value of the asset and the residual value guarantee). When the party that has issued the residual value guarantee to the lessor is the lessee, the amollllt expected to be paid by the lessee in terms of the residual value guarantee forms part of the lease payments of the lessee (also refer to section 10.1.3.4).

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10.1.3.4 Lease payments The lease payments are the payments made by a lessee to a lessor relating to the right to use an underlying asset during the lease term and comprise the following: • Fixed payments (including in-substance fixed payments) less any lease incentives; • Variable lease payments which depend on an index or rate; • The exercise price of a purchase option if it is reasonably certain that the lessee will exercise that option; and • Payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease. In addition, lease payments also include the following: • in the case of the lessee, amOllllts payable by the lessee under residual value guarantees. Note that lease payments do not include payments allocated to non-lease components of the lease contract if the accounting policy of the lessee is to account for lease and non-lease components separately. If, however, the lessee's accounting policy is to account for lease and non-lease components as a single combined component, lease payments will include the full payments allocated to the combined component. For further details on the accounting policy choices of the lessee, refer to section 10.4. • in the case of the lessor, residual value guarantees. These guarantees need not be provided by the lessee, but could also be provided by a party related to the lessee or a third party unrelated to the lessor who is capable of discharging the obligations under the guarantee. Because the lessor always has to account for the lease and non-lease components of a contract separately, lease payments never include payments allocated to non-lease components of the contract.

10.1.3.5 Economic life versus useful life The economic life of an asset is either • the period over which that asset is expected to be economically usable by one or more users, or • the number of production or similar units expected to be obtained from the asset by one or more users. The useful life of an asset is the period over which an asset is expected to be available for use by an entity or the number of production or similar units expected to be obtained from an asset by an entity. From these definitions it should be clear that the useful life of an asset refers to the period during which one specific entity will use the asset, while the economic life refers to the total period over which the asset is available for use, irrespective of the number of entities that will be using it.

10.1.3.6 Interest rates Most of the accounting requirements for leases make use of discounted amounts. IFRS 16 makes reference to two interest rates used when accounting for leases, namely the interest rate implicit in the lease and the lessee's incremental borrowing rate. The interest rate implicit in the lease is the rate of interest that causes the present value of • the lease payments from the perspective of the lessor, and • the unguaranteed residual value to be equal to the sum of • the fair value of the underlying asset, and • any initial direct costs of the lessor.

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The lessee's incremental borrowing rate is the rate of interest that the lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessrny to obtain an asset of similar value to the right-of-use asset in a similar economic environment. (The right-of-use asset represents a lessee's right to use an underlying asset for the lease term). Both the lessee and the lessor should use the interest rate implicit in the lease when accOllllting for leases (i.e. the same rate). However, in many cases the lessee will not have sufficient information to calculate the interest rate implicit in the lease, as the calculation of this interest rate is tailored specifically for a lessor - only the lessor knows how much the llllguaranteed residual value and initial direct costs amollllt to. If it is not possible for the lessee to determine the lessor's interest rate implicit in the lease, the lessee should use the incremental borrowing rate instead.

10.2 Identifying a lease If a contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration, the contract represents or contains a lease. The entity should assess at the inception of the contract whether the contract conveys the right to control the use of an identified asset, by assessing whether the customer (i.e. the potential lessee) has both of the following throughout the period of use: • The right to obtain substantially all of the economic benefits from use of the identified asset. • The right to direct the use of the identified asset. Each of the above elements of assessment is discussed separately in the sections which follow.

10.2.1 The period of use The period of use is the total period of time that an asset is used to fulfil a contract with a customer. In addition, the time period does not have to be continuous, but can be intenupted. For example, if a contract provides an asset for the use of a customer from 1 Janurny to 31 March and again from 1 July to 30 September, the period of use is six months. In practice, several contracts might be combined into one contract for efficiency purposes. A possible result of this could be that a customer has the right to control the use of an asset for only a portion of the total contractual term. In such a case, the contract contains a lease for that portion of the contractual term only. For the rest of the contractual term, the contract will be accounted for in terms of other applicable standards. Another possibility that arises when several contracts are combined is that more than one lease agreement could be contained within a single contract. Alternatively, lease agreements could be combined with other types of contracts with the same contractual term (e.g. maintenance contracts) in a single document. In these cases, the entity should assess each element of the contract separately to determine whether it is a lease. IFRS 16 refers to such elements in a contract as potential lease components. The assessment oflease components is discussed in further detail in section 10.3. It is important to note that the period of use can be described with reference to time, but also with reference to usage. For example, a period of use can be defined as the number of units which a piece of machinery will be used to produce.

10.2.2 Identified asset Essentially, an asset is an identified asset if the contract can only be fulfilled with a specific asset. In other words, the customer (lessee) obtains the right to use a specific asset and can prevent other parties from using this asset during the period of use. In most instances, the asset is explicitly identified within the contract, i.e. the contract provides sufficient information about the asset in question that it is clearly an identified asset. For example, a contract could specity the registration number of the vehicle to be supplied to the customer. However, it is also possible that an asset could be implicitly specified at the time that the asset is made available for use. In other words, although the contract does not contain much detail about the specific asset to

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be supplied, once the asset has been made available to the customer (the lessee) the customer can effectively prevent other parties from using the asset during the period of use.

Example 10.1: Implicit identification of an asset A Ltd signs a contract in terms of which B Ltd will provide A Ltd with the right to use a cargo ship with 100 ton capacity for a period of three months from 1 January. A Ltd will use the cargo ship to transport goods internationally. At the end of the three months, A Ltd must return the cargo ship to the Durban harbour, where all B Ltd's operations are located. B Ltd owns tvventy different cargo ships with a 100 ton capacity. This contract does not explicitly identify the asset to be provided to A Ltd, as B Ltd can provide any one of its tvventy cargo ships to A Ltd. However, once the cargo ship has been provided to A Ltd on 1 January, the asset has become implicitly specified. Once A Ltd starts using the cargo ship and it leaves the harbour, it is not possible for another party to obtain use of the ship before the end of the period of use.

10.2.2.1

Substantive substitution rights

A contract is only a lease if the customer (lessee) has the right to use a specific asset. If the supplier of the asset can replace the asset that the customer is using with a different asset at any time during the contract term (i.e. substitute the asset), the customer does not have the right to use a specific asset. In other words, the contract is not a lease and does not fall within the scope of IFRS 16. Importantly, even if the contract explicitly specifies the asset to be provided to the customer, this does not automatically mean that the supplier does not have the right to substitute the asset at any time during the period of use. On the other hand, even if the supplier has the legal right to substitute the asset, the economic reality might render this right meaningless. Therefore, the standard distinguishes between rights of substitution which are substantive and those that are not. If a supplier has a substantive right to substitute the asset llllder the contract with another asset, the customer does not have the right to use a specific asset and the contract is not a lease. Conversely, if the right to substitute the asset llllder the contract is not substantive, the contract is a lease within the scope of IFRS 16 (provided the other criteria are met). A supplier has a substantive right to substitute the asset llllder the contract with another asset, when both of the following conditions apply: • The supplier has the practical ability to substitute alternative assets throughout the period of use; and This means that the customer cannot prevent the supplier from substituting the asset and that the supplier can readily obtain alternative assets within a reasonable period of time (usually because the supplier already has access to these assets). Note that the right to substitute the asset is only substantive when the supplier has this right throughout the period of use. Therefore, if the right or obligation of substitution applies only on or after specific dates, it is not a substantive substitution right. Similarly, a substitution right is not substantive if the right or obligation of substitution applies only if specific events occur (i.e. it is contingent on future events). • The supplier would benefit economically from the exercise of its right to substitute the asset. This means that the economic benefits from substituting the asset should exceed the costs associated with doing so. The costs associated with substitution are more likely to exceed the benefits from doing so when the asset to be substituted is not located at the supplier's premises (i.e. the asset is kept on the customer's premises or elsewhere). The entity should evaluate whether the supplier of the asset has a substantive substitution right at the inception of the contract. This means that the entity considers the facts and circumstances which exist at that date and that future events that are not considered to be likely to occur as at the date of the assessment are ignored. IFRS 16 provides the following examples of events which would not be considered likely to occur when this assessment is performed:

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• That another customer will be willing to pay an above market rate for use of the asset in the future; • That new teclmology will be introduced when the new teclmology is not substantially developed at the inception of the contract; • That the customer will use the asset in a way which is substantially different from what is considered likely at the inception of the contract; • That the performance of the asset will be substantially different from what is considered likely at the inception of the contract; or • That the market price of the asset will reach a level which is substantially different from what is considered likely at the inception of the contract. If a customer has considered all of the above and cannot readily determine whether or not the supplier has a substantive substitution right, the customer must presume that the right is not substantive. In other words, provided the other criteria are met, the contract will be a lease contract within the scope oflFRS 16. Note: A substantive substitution right means that the supplier effectively retains control over a specific asset and has not transferred the right to use the asset to the customer. This differs from an obligation of the supplier to repair or maintain the asset. If the supplier has the right or obligation to substitute the asset if it is not operating properly or needs a technical upgrade, this by itself does not make the substitution right substantive.

Example 10.2: Substantive substitution right (1) C Ltd has a contract to bottle 1 million litres of beverages per month for a five year period on behalf of o Ltd. 0 Ltd delivers the beverages as bulk liquid to C Ltd's premises which contains several bottling machines. Each of the bottling machines has a capacity of 1 million litres of beverages and can bottle liquids in the containers which 0 Ltd requires. C Ltd has a substantive substitution right. As the bottling machines are all kept at the company's premises, the substitution of one bottling machine for another is practical at a negligible cost throughout the period of use. The contract therefore does not transfer the right to use an identified asset and is not a lease contract within the scope of IFRS 16.

Example 10.3: Substantive substitution right (2) E Ltd has the right to use 1 000 square metres of retail space in a shopping mall under a contract with F Ltd for a six year period at R4 million per year. If E Ltd uses the space to retail food products, F Ltd has the right to move E Ltd to another location in the shopping mall with equivalent space at any time during the six year period. E Ltd has a franchise agreement with its parent company which prevents it from selling anything other than clothing in its store. F Ltd does not have a substantive substitution right. At the inception of the contract, E Ltd will only have to relocate if it uses the retail space in contravention of its contract with its parent company. Therefore, the contract will be a lease contract if all the other criteria of IFRS 16 are met.

Note: The illustrative examples to IFRS 16 contain further examples of when substitution rights could be considered substantive.

10.2.2.2

Portions of assets

Some contracts do not transfer the right to use an entire asset to the customer. In these circumstances, a portion of an asset is an identified asset if it is physically distinct from the rest of the asset. This means that, for example, a contract which transfers the right to use two floors of a ten story building, transfers the right to an identified asset. If all the other criteria are met, this contract would therefore be a lease contract. By contrast, if the contract does not transfer the right to use a portion of the asset which is physically distinct, the asset is not an identified asset. This means that a contract which allows a customer to use ten percent of the capacity of an oil pipe line does not provide the right to use an identified asset and is not a lease contract. However, IFRS 16 allows that, if the portion which is transferred represents substantially all of the capacity of the asset, the contract will be a lease contract even if the portion of the asset is not

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physically distinct. For example, if a customer is allowed to use 95 percent of the capacity of an oil pipe line, this would be an identified asset and could be a lease contract if all the other criteria are met. The reason is that the customer has the right to substantially obtain all of the economic benefits from use of the asset llllder these circumstances.

Example 10.4: Rightto use a portion of an asset G Ltd has three contracts which provide it with the right to use part of the capacity of three different fibre optic cables: The contract with H Ltd determines that G Ltd has the right to use 15 percent of the data capacity of the fibre optic cable each month at a fixed fee for a three year period. Once data transmitted by G Ltd exceeds this capacity, H Ltd closes its access to the fibre optic cable for the month. I n this contract G Ltd does not have the right to use an identified asset. The portion of the cable that it is entitled to use is not determined with reference to a physical aspect of the cable (Le. 15 percent of the data capacity is not physically distinct). As G Ltd does not have the right to use an identified asset, the contract is not a lease contract within the scope of IFRS 16. The contract with I Ltd determines that G Ltd has the right to use the data capacity of three of the ten strands within a blended fibre optic fibre cable at a fixed fee for a two year period. In this contract G Ltd has the right to use a physically distinct portion of the asset (three specific strands of the larger cable). As a result, G Ltd has the right to use an identified asset and, provided the other criteria are met, this will be a lease contract within the scope of IFRS 16. The contract with J Ltd determines that G Ltd has the right to use 96 percent of the data capacity of the fibre optic cable each month at a fixed fee for a five year period. Once data transmitted by G Ltd exceeds this capacity, J Ltd closes its access to the fibre optic cable for the month. I n this contract the portion of the cable that G Ltd is entitled to use is not physically distinct, as it is not determined with reference to the physical aspects of the cable. However, the standard determines that when a contract transfers to right to use substantially all of the capacity of an asset, the right of use still relates to an identified asset. As 96 percent arguably represents substantially all of the capacity of the fibre optic cable, this contract will be a lease contract within the scope of IFRS 16 if the other criteria are met.

10.2.3 Right to obtain substantially all of the economic benefits When a customer controls the use of an identified asset, the contmct is a lease agreement. For this to be the case, the customer must have the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use. This usually means that the customer can prevent any other party from using the asset at any time during the period of use. The economic benefits from use of an asset include its primary output and its by-products and other economic benefits from using the assets which could be realised through transactions with third parties. For example, if an entity leases a drilling machine, the economic benefits from using the drilling machine include the oil that could be produced through the drilling as well as fees from third parties if the entity were to use the machine to drill on behalf of its own customers. The entity can therefore obtain the economic benefits from use of an asset in many different ways, including using, holding or sub-leasing the asset. An entity should consider whether the customer (lessee) is obtaining substantially all of the economic benefits from use of an asset within the defined scope of a customer's right to use the asset. The standard provides the following examples in this regard: • If a contract limits the use of a motor vehicle to one particular area during the period of use, the entity should consider only the economic benefits from using the vehicle within that area. • If the contract limits the number of miles that a customer can drive a motor vehicle during the period of use, the entity should only consider the economic benefits from using the vehicle for the permitted mileage and not beyond.

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The following implication should be noted from the above examples: an entity does not consider whether the customer has substantially all of the economic benefits from the use of an asset by comparing it with an asset which is legally owned by the customer. Instead, the entity should consider only the portion of economic benefits that are available within the scope of the contract and whether the customer has the right to substantially obtain all of these. Consider the above examples again: • If an entity owns a motor vehicle, it may be driven anywhere the entity desires. In contrast, if a contract limits the areas to which the motor vehicle may be driven, this does not mean that the customer does not have the right to substantially all of the economic benefits from the use of the asset throughout the period of use. The entity should consider what portion of the economic benefits of the asset is available during the contract period (driving the motor vehicle in a specific area, for example a certain province) and whether anyone else will have access to those benefits during the contract period. • In a similar vein, when an entity owns a motor vehicle, it may be driven as far as the entity desires and the capacity of the vehicle allows. In contrast, if the contract limits the number of kilometres to 10 000, the entity should consider whether the first ten thousand kilometres that the vehicle is driven will be available to anyone else during the contract period. If a portion of the cash flows derived from use of an asset has to be paid over to the supplier or another party, those cash flows are still considered to be part of the economic benefits obtained from use of the asset. Refer to the example below in this regard.

Example 10.5: Right to gross economic benefits K Ltd has a contract with L Ltd to lease a thousand square metres of retail space within a shopping mall at R1 million per month. If the revenue from K Ltd's store exceeds R10 million in any given month, it must pay an additional R500 000 for each R1 million of revenue in excess of R10 million. K Ltd should assess whether or not it has the right to substantially all of the economic benefits from the use of the asset with reference to the gross economic benefits. In other words, K Ltd considers the economic benefits purely with reference to the revenue to be generated from using the retail space. The fact that some of these economic benefits will have to be paid over to L Ltd is a cost of obtaining the economic benefits, but does not mean that K Ltd did not have the right to these benefits to begin with.

10.2.4 Right to direct the use of the identified asset A customer has the right to direct the use of an identified asset throughout the period of use only if either of the following cases apply: • The customer has the right to direct how and for what purpose the asset is used throughout the period of use; or • The relevant decisions about how and for what purpose the asset is used have been predetermined and the customer has the right to operate the asset throughout the period of use (or to direct others to do so in a manner that it determines) without the supplier having the right to change those operating instructions; or the customer designed the asset (or specific aspects thereof) in a way that predetermines how and for what purpose the asset will be used throughout the period of use.

10.2.4.1

Right to direct how and for what purpose the asset is used

To determine whether the customer has the right to direct how and for what purpose the asset is used throughout the period of use, the entity should consider the decision-making rights which are most relevant to changing how and for what purpose the asset is used. If the customer has the right to change how and for what purpose the asset is used, the right to direct how and for what purpose the asset is used belongs to the customer.

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The entity should in this context only consider decision-making rights which affect the economic benefits to be derived from use of the asset. These rights are likely to differ between contracts, as they depend on the nature of the asset and the terms and conditions of the contract. The standard provides examples of decision-making rights which change the economic benefits to be derived from an asset and are therefore relevant in determining whether the customer has the right to direct how and for what purpose the asset is used. These include the following decision -making rights: • The right to change the type of output that the asset produces; • The right to change when the output is produced; • The right to change where the output is produced; • The right to change whether the output is produced; and • The right to change the quantity of output produced. By contrast to the above, rights that are limited to operating or maintaining the asset are not decisionmaking rights which change the economic benefits to be derived from an asset. For example, a supplier might have the right to force a customer to provide access to the asset for regular maintenance. However, the frequency and extent of the maintenance required depends on how and for what purpose the asset is being used. However, when the relevant decisions about how and for what purpose the asset is to be used have been predetermined, the right to operate the asset becomes a significant factor. Therefore, in these cases, if the customer has the right to operate the asset, it then also has the right to direct the use of the asset. The relevant decisions can be predetermined in a number of ways, for example by contract or the design of the asset.

10.2.4.2 Decisions during and before the period of use When an entity determines whether or not a customer has the right to direct the use of an asset, it should only consider rights to make decisions about the use of the asset during the period of use. This means that decisions made before the period of use do not affect the right of the customer to direct the use of an asset. For example, a contract may determine that a given amollllt of output must be produced before the period of use and delivered to the customer. Such a contract merely provides the customer the same rights as anyone purchasing products from the supplier and the supplier of the asset still controls the asset.

10.2.4.3 Protective rights Protective rights are contractual rights which are designed to protect the supplier's interest in its assets, to protect its staff, or to ensure compliance with laws or regulations. These rights therefore define the scope of what a customer might do with an asset, but do not (at least not by themselves) prevent the customer from having the right to direct the use of the asset. One reason for protective rights could be, for example, tax or insurance consequences for the supplier if the customer changes the way in which the asset operates or does not comply with laws and regulations. The standard provides the following examples of protective rights: • A maximum amollllt of use to which the asset may be put; • A limit in the contract as to where or when the customer may use the asset; • A requirement to follow specific operating procedures; or • A requirement to inform the supplier if the manner in which the asset will be used changes.

10.2.5 Reassessment of a contract An entity assesses whether or not a contract is or contains a lease at the inception of the contract. It only reassesses the contract if the terms and conditions of the contract are changed.

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10.2.6 Identification now diagram The standard contains a flow diagram to assist entities in deciding whether a contract is (or contains) a lease. For ease of reference, it is reproduced below:

I

Is there an identified asset?

No

1

Yes

Does the customer have the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use?

No

1

Yes

Does the customer, the supplier or neither party have the right to direct how and for what pmpose the asset is used throughout the period of use?

eus tomer

1

Neither

Supplier

**

Does the customer have the right to operate the asset throughout the period of use, without the supplier having the right to change those operating instructions?

Yes

1

No

Did the customer design the asset in a way that predetermines how and for what purpose the asset will be used throughout the period of use?

No

1

Yes

I **

The contract contains a lease

I I

The contract does not contain a lease

If neither party has the right to direct how and for what purpose the asset is to be used, it will be because this has been predetermined.

10.3 Lease components 10.3.1 Identifying components within a contract Lease components arise from a principle similar to that in IFRS 15 (refer to the chapter on revenue from contracts with customers), namely that several components can potentially be combined within a

I

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single contract. When this happens, IFRS 16 requires (in most cases) that each component be accOllllted for separately. From the perspective of IFRS 16, when several components are combined into a single contract, the following scenarios could arise: • All of the components contain a lease; • Some of the components contain a lease, while others transfer goods or services to the customer which do not fall within the scope of IFRS 16; or • Some of the components do not transfer any goods or services to the customer, while others contain a lease. The implications of each of the scenarios are discussed in the sections below.

10.3.1.1

All of the components contain a lease

When all of the components within the contract contain a lease, the entity should consider whether these components should be accounted for separately or as a single contract. To make this determination, the standard requires the entity to consider whether the right to use an underlying asset is a separate lease component. This will be the case if both the following apply: • The lessee can benefit from use of the underlying asset on its own or together with other resources that are readily available to the lessee; and Readily available resources are goods or services that are sold or leased separately (by the lessor or other suppliers) or resources that the lessee has already obtained (from the lessor or others). • The underlying asset is neither highly dependent on, nor highly interrelated with, the other underlying assets in the contract. Essentially this means that if the lessee can omit a specific underlying asset from the contract without significantly affecting its rights to use other underlying assets in the contract, the asset is not highly dependent on, or interrelated with, the rest of the contract. Once the entity has identified the separate lease components in the contract, it can then determine whether they should be accounted for separately or as a single agreement (refer to section 10.3.2).

10.3.1.2 Some of the components contain a lease and others do not Some contracts contain components which transfer the right to use an underlying asset (lease components) as well as other components which transfers goods or services to the customer, but do not transfer the right to use an underlying asset to the customer (non-lease components). In such instances, the entity will have to determine whether the lease components and non-lease components should be accounted for separately (refer to section 10.3.2).

10.3.1.3 Some of the components do not transfer any goods or services to the customer A contract can sometimes include amounts payable by the lessee which do not transfer goods or services to the lessee (such as a fee for administrative costs). These amounts do not form a separate component of the contract, but is considered to form part of the total consideration which is allocated to the separately identified components of the contract.

10.3.2 Accounting for components within a contract When a contract contains lease components, the standard sets out specific accounting requirements to apply. Some of these requirements apply only to the lessee or the lessor, while others apply to both parties. The various requirements are discussed separately in the sections below.

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10.3.2.1

Portfolio accounting (lessee and lessor)

In general, IFRS 16 requires that each lease agreement (and lease component) should be aCcOllllted for individually. However, the standard allows that an entity may apply the standard to a portfolio with similar characteristics (i.e. this is an optional accOllllting treatment). To do so, the entity must reasonably expect that the impact on its financial statements of applying the standard to the portfolio would not differ materially from applying the standard to the individual leases (or lease components). When the entity applies the standard to a portfolio of lease contracts (or lease components), it must use estimates and assumptions which reflect the size and composition of the portfolio.

10.3.2.2 Combination of contracts (lessee and lessor) As mentioned above, the general rule of IFRS 16 is that each lease agreement should be accOllllted for individually. In contrast to portfolio accounting, which an entity can voluntarily elect to apply, there are instances where the standard requires an entity to combine contracts for accounting purposes. Specifically, the standard requires that an entity must combine two or more contracts and account for them as if they are a single contract if: • The contracts are entered into at or near the same time; • The contracts are entered into with the same counterparty (or the counterparties are related to each other); and • One of the following criteria is met: The contracts have been negotiated as a package with an overall commercial objective that can only be understood by considering the contracts together; The amount of consideration to be paid in one contract depends on the price or performance of the other contract; or The rights to use underlying assets conveyed in the contracts (or some rights from each contract) form a single lease component. The reason for the requirement to combine contracts under these circumstances is to prevent entities from achieving predetermined outcomes by splitting what is essentially one lease agreement into different contracts.

10.3.2.3 Accounting for lease components: the lessee When a contract contains lease components and non-lease components, a lessee has an accounting policy choice. The lessee is allowed to elect one of the following accounting policies: • To account for each lease component within the contract separately from non-lease components; or Under this accounting policy, the lessee should allocate the consideration in the contract to each lease component based on the relative stand-alone price of the lease component and the aggregate stand-alone price of the non-lease components. The relative stand-alone price should be determined as the price that the lessor (or similar supplier) would charge the lessee for that lease component (or similar lease component) separately. Stand-alone prices should be determined using obseIVable data. However, if this not available, the lessee should estimate the stand-alone prices. This estimate should maximise the use of obseIVable information. Under this accounting policy, the lessee would account for non-lease components using other applicable standards. • To account for each lease component and any associated non-lease components as a single lease component. Under this accounting policy, lease components and non-lease components are not separated, which can simplify the accounting requirements.

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However, an entity is not allowed to apply this accOllllting policy to contracts which contain embedded derivatives that are required to be separated from their host contracts in terms of IFRS 9 (refer to the chapter on financial instruments). The lessee should make this election by class of underlying asset and apply its accounting policy consistently to each class of underlying asset.

Example 10.6: Accounting for lease components M Ltd is a long-distance haulage company. To expand its operations, it entered into a lease contract in terms of which it will lease a truck and a trailer, which can be used together or with similar assets which M Ltd already owns. In addition, the counterparty has agreed to maintain the assets. The total consideration payable under the contract is R300 000 per annum for five years. M Ltd determines that this contract consists of tvvo separate lease components (the lease of the truck and the lease of the trailer) as each asset can be used together with other available assets and could be obtained separately from the supplier. In addition, the contract contains tvvo non-lease components (i.e. the maintenance of the truck and the maintenance of the trailer). The accounting policy of M Ltd determines the treatment of the lease components: If the accounting policy of M Ltd is not to separate lease components from associated non-lease components, M Ltd will have to separately account for tvvo components. The first is the lease of the truck with its maintenance and the second is the trailer with its maintenance. M Ltd will have to allocate the total consideration of R300 000 per annum on the basis of the relative stand-alone prices for lease contracts combined with maintenance contracts. If the accounting policy of M Ltd is to separate lease components and non-lease components, M Ltd will have to separately account for four components. The first is the lease of the truck, the second the lease of the trailer, the third is the maintenance of the truck and the last component is the maintenance of the trailer. M Ltd will have to allocate the total consideration of R300 000 per annum on the basis of the total relative stand-alone price for tvvo five-year maintenance contracts (say R50000 per annum) and the relative stand-alone prices of the truck (say R200000 per annum) and the trailer (say R75000 per annum). The annual consideration will therefore be allocated as follows: Allocated consideration per annum Maintenance contracts (50/325 x 300 000) Truck (200 1325 x 300 000) Trailer (75 1325 x 300 000)

Stand-alone price

R 46154 184615 69231

R 50000 200000 75000

300000

325000

The allocation of the consideration betvveen the two non-lease components (i.e. the tvvo maintenance contracts) is not determined by IFRS 16, but by other applicable standards.

10.3.2.4 Accounting for lease components: the lessor Unlike the lessee, the lessor does not have an accounting policy choice when contracts combine lease and non-lease components. When a contract contains a lease component and one or more additional lease or non-lease components, the lessor must allocate the consideration in the contract in accordance with the principles of IFRS 15 (refer to the chapter on revenue from contracts with customers).

10.4 Recognition and measurement: the lessee The accounting requirements for leases applicable to the lessee result in three different possibilities: • Applying the general lease accounting requirements;

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• Applying a different accOllllting policy to short-term leases ofa class ofllllderlying assets (i.e. this accOllllting policy must be applied to leases of the entire class of assets once selected); or • Applying an elective accOllllting choice to leases oflow value assets (i.e. this selection is available on a lease-by-lease basis). The implications of each of these possible outcomes are discussed separately in the sections which follow.

10.4.1 The general lease accounting requirements Under the general lease accOllllting requirements, the lessee will recognise a right-of-use asset and a lease liability at the commencement date.

10.4.1.1

Initial measurement of the right-of-use asset

The lessee must initially measure the right-of-use asset at cost on the commencement date. The cost of a right-of-use asset comprises the following amOllllts: • The amount of the initial measurement of the lease liability (refer to section 10.4.1.2); • Any lease payments made at or before the commencement date (e.g. a deposit) less any lease incentives received; Lease incentives are payments by the lessor to the lessee associated with a lease or the reimbursement or assumption by the lessor of costs of the lessee. • Any initial direct costs incurred by the lessee; and Initial direct costs for a lessee are incremental costs of obtaining the lease which would not have been incurred if the lease had not been obtained. • An estimate of costs to be incurred by the lessee to dismantle and remove the underlying asset, to restore the site on which it is located, or to restore the underlying asset to the condition required by the terms and conditions of the lease. The lessee must have incurred the obligation for these costs either at the commencement date or as a result of having used the asset during a particular period for a purpose other than the production of inventories. The lessee must apply lAS 2 (refer to the chapter on inventories) if these costs result from using the right-of-use asset to produce inventories. The obligations which arise as a result of this requirement are accounted for as dismantling or restoration provisions in accordance with lAS 37 (refer to the chapter on provisions). Note from the above that the costs to be capitalised to the right-of-use asset does not include leasehold improvements (costs that the lessee incurs related to the construction or design of a rightof-use asset). This does not mean that such costs are therefore to be expensed, but rather that they should be considered for capitalisation in terms of another standard (e.g. lAS 16).

Example 10.7: Cost of a right-of-use asset The lease on N Ltd's factory building expired on 31 December 20XO and it had to find new premises from 1 January 20X1, as there was no possibility to renew the existing lease. The company decided to sign a lease contract for a new factory building with 0 Ltd, as 0 Ltd was willing to reimburse N Ltd's relocation cost. N Ltd will lease the new factory building for a period of ten years, starting on 1 January 20X1. Some modifications are required to the factory building to install N Ltd's machinery. Although the lease contract allows this, it also determines that N Ltd must restore the new factory building to its original condition at the end of the lease term. Based on the contract, the commencement date of the lease is 1 January 20X1. On this date N Ltd will recognise a right-of-use asset for the factory building. The following information about the lease is available:

225

Leases

R 56231 488 Initial measurement of the lease liability Deposit paid on 14 December 20XO to secure the lease 4122300 Relocation cost paid 31 December 20XO 566400 Relocation cost reimbursed by 0 Ltd on 1 January 20X1 (566400) Costs of obtaining the lease: 45000 • Allocated salary of internal legal advisor for time spent on finalising the lease contract 15600 • Fee of external legal advisor to check the work of the internal legal advisor Fee of external legal advisor partially reimbursed by 0 Ltd on 1 January 20X1 (10 000) Cost of modifying the factory building for N Ltd's machinery 112000 2412000 Estimated future cost of restoring the factory building to its original condition at the end of the lease term (an appropriate pre-tax discount rate is 10% per annum). The right of use asset will therefore be initially recognised at the following amount (cost) in accordance with IFRS 16: R 56231 488 Initial measurement of the lease liability Deposit paid on 14 December 20XO to secure the lease 4122300 Relocation cost (The relocation cost would not be regarded as initial direct costs, as these costs would have been incutred even if the lease was not entered into. This is because the existing lease expired and the assets had to be relocated, itrespective of whether a lease agreement was entered into) Relocation cost reimbursed by 0 Ltd (566400) (The reimbursement of the relocation cost is a lease incentive) I nitial direct costs 15600 (Initial direct costs must be incremental. Therefore, the cost of a salaried internal legal advisor cannot be capitalised to the cost of a right-of-use asset) Fee of external legal advisor partially reimbursed by 0 Ltd on 1 January 20X1 (10 000) (The reimbursement is a lease incentive) Cost of modifying the factory building for N Ltd's machinery (This cost is a leasehold improvement. In terms of IFRS 16, the cost of leasehold improvements is not capitalised to the right-of-use asset. The entity will therefore have to account for these costs in terms of lAS 16) Dismantling and restoration provision 929930 (FV=2412000, N= 10, i= 10%, PV=?) (This obligation does not arise because of the production of inventories and can therefore be capitalised to the cost of the right-of-use asset). Total cost of right-of-use asset 60722918

10.4.1.2 Initial measurement of the lease liability The lessee must measure the lease liability at the commencement date at the present value of the lease payments which are unpaid at that date. The present value calculation should discount the lease payments using the interest rate implicit in the lease (if the rate can be readily determined). If the rate implicit in the lease cannot be readily determined, the present value should be calculated using the lessee's incremental borrowing rate. The lease payments which should be included in the initial measurement of the lease liability at the commencement date include the following payments (if they are llllpaid at the commencement date): • Fixed payments less any lease incentives receivable (i.e. not yet received at the commencement date);

• In-substance fixed payments; In-substance fixed payments are lease payments which superficially contain variability, but that are unavoidable in substance. In other words, the clauses in the contract which specify the variability have no real economic substance.

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Payments will be fixed in-substance if payments are structured as variable, but there is no genuine variability in those payments. This will be the case, for example, when payments only have to be made on the occurrence of an event with no genuine possibility of not occurring. Payments will also be fixed in-substance if the lessee is allowed to choose between more than one set oflease payments, but only one set is realistic (in other words, variability is introduced by the choice of the lessee, but in fact there is only one realistic choice). In such a case, the entity should use the realistic set of payments to be the lease payments. Payments will also be fixed in-substance if there is more than one set of realistic lease payments and the lessee has to make at least one set of the payments. In this scenario, the realistic outcome is that the lessee will select the lowest set of payments. Accordingly, the standard determines that the lessee should use the set of payments that adds up to the lowest amollllt (on a discollllted basis) as the lease payments. • Variable lease payments that depend on an index or rate; Such lease payments will, for example, include lease payments linked to a consumer price index (i.e. inflation rate), a benchmark interest rate (e.g. the prime lending rate) or payments that vrny to reflect changes in market rental rates. • Amollllts that the lessee expects to pay under residual value guarantees; With a residual value guarantee, if the market value of the llllderlying asset is less than a specified amollllt at the end of the lease term, the lessee will have to pay the difference to the lessor. • The exercise price of a purchase option (if the lessee is reasonably certain that the option will be exercised); and • Penalties for terminating the lease (if the lessee is reasonably certain that an option to terminate the lease will be exercised).

Example 10.8: In-substance fixed payments P Ltd has a lease agreement in terms of which it leases a machine for a period of five years. In terms of the lease agreement, P Ltd can choose between different sets of lease payments. P Ltd can decide to make an annual payment of R150 000 at the end of each year, or to make monthly payments of R 12 000 instead. Assume that the present value of the monthly payments amounts to R540 000, while the present value of the annual payments amounts to R542 000. In this case, the lessee has a choice between two sets of lease payments, both of which are realistic. As both sets of payments are realistic, P Ltd should use the monthly lease payments to measure the lease liability at initial recognition. The reason is that, on a discounted basis, this adds up to the lowest amount.

Example 10.9: Initial measurement ofthe lease liability The lease on Q Ltd's factory building expired on 31 December 20XO and it had to find new premises from 1 January 20X1. The company decided to sign a lease contract for a new factory building with R Ltd. Q Ltd will lease the new factory building for a period of ten years, starting on 1 January 20X1. At the end of the lease term, Q Ltd has guaranteed a residual value of at least R75 million for the factory building. On 1 January 20X1, Q Ltd expects that it will have to make a payment of R25 million under the residual value guarantee. Q Ltd does not have sufficient information to determine the interest rate implicit in the lease - Q Ltd's incremental borrowing rate is 12% per annum. Based on the contract, the commencement date of the lease is 1 January 20X 1. On this date Q Ltd will recognise a lease liability for the factory building. The following additional information about the lease is available: R

Annual lease payment, payable in arrears Deposit paid on 14 December 20XO to secure the lease Initial direct cost paid by Q Ltd on 31 December 20XO and reimbursed by R Ltd on 1 January 20X1

7500000 1122300 266400

227

Leases

Q Ltd should initially recognise the lease liability at the present value of the unpaid lease payments

using its incremental borrowing rate of 12% per annum, which is R50 426 004 (FV = 25000000, N = 10, PMT = 7 500 000, i = 12%, PV = ?). The journal entries for the initial recognition of the right-of-use asset an d th e Iease rla bTt I IIV WImh eref ore be th e f 0 II oWln~r Dr Cr R R

14/12/20XO

31/12/20XO

01/01/20X1

Lease deposit debtor Bank (Pay deposit on lease before commencement date) Right-of-use asset Bank (Initial direct cost paid) Right-of-use asset Lease deposit debtor Lease liability (Recognise right-of-use asset and lease liability)

Bank Right-of-use asset (Recognise lease incentive received)

1 122300 1 122300 266400 266400 51 548304 1 122300 50426004 266400 266400

In the examples thus far, it has been assumed that lease incentives have been received by the commencement date of the lease. This is important as lease incentives which have been received before or at the commencement date are deducted from the initial measurement of the right-af-use asset. By contrast, lease incentives not yet received at commencement date (lease incentives which are receivable) reduce the initial measurement of the lease liability. This is illustrated in the example below.

Example 10.10: Lease incentives received and receivable Use the information in example 10.9, but assume that the initial direct cost which R Ltd has agreed to reimburse will not be paid in cash to Q Ltd. Instead, R Ltd has agreed that Q Ltd can reduce its first lease instalment with that amount. The implication is that the lease incentive will only be receivable after the commencement of the lease term. Consequently, at initial recognition Q Ltd should reduce the fixed payments to be made with the lease incentive which is receivable: R Lease liability 50426004 (FV = 25 000 000, N = 10, PMT = 7500000, i = 12%, PV =?) Lease incentive receivable (266 400 11,12) (237857) Lease liability at initial recognition

50188147

The iournal entries to account for the lease at initial recoqnition will therefore be the followinq: Dr R

14/12/20XO

31/12/20XO

01/01/20X1

Lease deposit debtor Bank (Pay deposit on lease before commencement date) Right-of-use asset Bank (Initial direct cost paid) Right-of-use asset Lease deposit debtor Lease liability (Recognise right-of-use asset and lease liability)

Cr R

1 122300 1 122300 266400 266400 51 310447 1 122300 50188147

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10.4.1.3 Subsequent measurement of the right-of-use asset After initial recognition, the lessee will measure its right-of-use assets applying one of the following models: • A cost model; • A revaluation model, provided certain requirements are met; or • A fair value model, provided certain requirements are met. The requirements for each of these models are discussed below.

10.4.1.3.1

Cost model

Most right-of-use assets will be measured under a cost model. This means that, subsequent to initial measurement, the asset will be measured at cost less any accumulated depreciation and accumulated impairment losses. However, it is possible that the cost of the asset may need to be adjusted after initial recognition when the lease liability is required to be remeasured (refer to section 10.4.1.5). The depreciation of right-of-use assets should be determined and accOllllted for in accordance with the requirements of lAS 16 (refer to the chapter on property, plant and equipment). However, IFRS 16 has specific requirements relating to the depreciation period which override the requirements ofIAS 16 if they should conflict. These are that: • The right-of-use asset is depreciated from the commencement date over its useful life if ownership transfers to the lessee at the end of the lease term; • The right-of-use asset is depreciated from the commencement date over its useful life if the cost of the right-of-use asset reflects that the lessee will exercise a purchase option; and • The right-of-use asset is depreciated from the commencement date to the earlier of the end of the useful life and the end of the lease term in all other cases. Impairment losses on right-of-use assets are determined and accounted for in accordance with lAS 36 (refer to the chapter on impairment of assets).

Example 10.11: Depreciation period for the right-of-use asset S Ltd leases a machine under a lease contract for a period of three years. The useful life of the machine is seven years and there are no options contained within the lease contract. If the lease contract determines that ownership passes to S Ltd at the end of the lease term, the machine will be depreciated over its useful life of seven years. If the lease contract does not pass ownership to S Ltd at the end of the lease term, the right-ofuse asset will be depreciated over the lease term of three years (as it is shorter than the useful life).

10.4.1.3.2

Revaluation model

If a right-of-use asset relates to a class of property, plant and equipment to which the lessee applies the revaluation model in respect of assets that it owns, the lessee is allowed to elect to apply the revaluation model to all of the right-of-use assets which relate to that same class of property, plant and equipment. Note that this is an accounting policy choice. The entity is allowed to carry right-of-use assets under the cost model and revalue owned assets in the same class of property, plant and equipment. However, this election is not available on an asset-by-asset basis. If the entity decides to revalue a right-of-use asset it must carry all of its right-of-use assets in the same class under the revaluation model. It is also important to note that, for a right-of-use asset to be carned under the revaluation model, the entity must also own assets in that same class of property, plant and equipment to which it applies the revaluation model. In other words, if the entity does not own assets in that same class of property, plant and equipment, it will have no choice but to account for the right-of-use asset under the cost model.

Leases 10.4.1.3.3

229 Fair value model

If the right-of-use asset meets the definition of investment property in lAS 40 (refer to the chapter on investment property), the entity should consider its accOllllting policy for investment property that it owns. When an entity applies the fair value model to investment property that it owns, it must also apply the fair value model to right-of-use assets classified as investment property. Note that, unlike the revaluation model discussed in the previous section, this is a compulsory accounting treatment.

10.4.1.4 Subsequent measurement of the lease liability After initial recognition, the lessee must measure the lease liability by• increasing the carrying amount to reflect interest on the lease liability; • reducing the carrying amount to reflect the lease payments made; and • remeasuring the carrying amount to reflect reassessments of the lease liability, lease modifications or revised in-substance fixed lease payments (refer to sections 10.4.1.5 and 10.4.1.6). Interest on the lease liability is recognised so that a constant periodic rate of interest on the outstanding balance of the lease liability is achieved. This interest rate is usually the interest rate used to discount the lease liability at initial recognition (i.e. the interest rate implicit in the lease or, if that rate is not determinable, the incremental borrowing rate of the lessee). However, if the interest rate is a variable interest rate, if certain reassessments of the lease liability have taken place, or if the lease agreement has been modified, the revised (latest) interest rate should be used. Interest on the lease liability is usually recognised in profit or loss unless another standard, for example lAS 23, allows or requires its capitalisation to the cost of an asset. Example 10.12: Lessee: general lease accounting requirements (payment in arrears; coincides with year-end) Usage Ltd leased a new item of plant (fair value of R400 000) from Finles Ltd on 1 January 20X3 in return for five annual payments, in arrears, of R90000 each, as well as a balloon payment of R100000. payable on 31 December 20X7. Usage Ltd incurred direct negotiating costs of R6 000 to secure the lease arrangement and paid this amount in cash. The terms of the lease indicate that ownership of the asset will pass to Usage Ltd upon payment of the balloon payment and that the interest rate implicit in the lease is 10,2846%. [Note that the interest rate implicit in the lease can be calculated as follows: n = 5; PV = -400 000; PMT = 90 000; FV = 100 000; i =?] Usage Ltd considers the plant to have a scrap value of R10 000 at the end of its six year useful life. Depreciation is recognised on the straight-line basis. Both companies have a 31 December reporting date. The right-of-use asset (plant) and the liability are recognised at the present value of the lease payments. which amounts to R400 000 (FV = 100000; PMT = 90000; n = 5; i = 10.2846%; PV = ?). The right-of-use asset should be capitalised at R400 000 plus the initial direct costs of R6 000. The payments made over five years to settle the liability amount to R550 000 (5 x R90 000 plus the balloon payment of R100 000) and the difference of R150 000 (R550 000 payments less R400 000 liability) represents finance charges. These charges should be recognised on a systematic basis over the lease term. The finance charges relating to a specific period should be determined by applying the interest rate implicit in the lease to the outstanding balance of the lease liability. Using this method, the following amortisation table is computed: Capital Interest at Capital Date Period b!fwd Payment Capital 10.2846% c!fwd R R R R R 31/12/20X3 1 400000 (90000) 48862 41 138 351 138 31112/20X4 2 351 138 53887 36113 (90000) 297251 31/12/20X5 3 30571 237822 297251 59429 (90000) 31/12/20X6 4 237822 65541 24459 172 281 (90000) 31/12/20X7 5 (90000) 172 281 72 281 17719 100000 31/12/20X7 5 100000 (100000) 100000 (550000)

150000

Note that the interest for period 1 (R41 138) is calculated by multiplying R400 000 w ith the interest rate of 10.2846%. The capital portion for period 1 (R48 862) then represents the difference between the total instalment of R90 000 and the interest of R41 138. In period 2 the interest is based on the capital

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of R400 000 less the capital repayment in period 1 of R48 862. This process continues until the end of period 5 The underlying journal entries in the books of Usage Ltd w ill be as follows· Dr Cr R R 01/01/20X3 Right-of-use asset: plant 406000 Lease liability 400000 Bank 6000 (Recognition of right-of-use asset) 31/12/20X3 Lease liability 48862 I nterest expense 41 138 Cash 90000 (Pavment of first instalment) 31/12/20X3 Depreciation 66000 Right-of-use asset: plant 66000 (Depreciation for the vear) ('h x (406 000 - 10 000)) 31112/20X4 Lease liability 53887 I nterest expense 36113 Cash 90000 (Pavment of second instalment) 31112/20X4 Depreciation 66000 Right-of-use asset: plant 66000 (Depreciation for the vear) 31/12/20X5 Lease liability 59429 I nterest expense 30571 Cash 90000 (Pavment of third instalment) 31/12/20X5 Depreciation 66000 Right-of-use asset: plant 66000 (Depreciation for the vear) 31/12/20X6 Lease liability 65541 I nterest expense 24459 Cash 90000 (Payment of fourth instalment) 31/12/20X6 Depreciation 66000 Right-of-use asset: plant 66000 (Depreciation for the vear) 31/12/20X7 Lease liability (100 000 + 72 281) 172 281 I nterest expense 17719 Cash 190000 (Payment of fifth instalment and balloon payment) 31/12/20X7 Depreciation 66000 Right-of-use asset: plant 66000 (Depreciation for the year) 31/12/20X8 Depreciation 66000 Right-of-use asset: plant 66000 (Depreciation for the vear) Note that the depreciation IS calculated over a period of SIX years as there IS certainty that ownership will pass to Usage Ltd. If there was no certainty that ownership will pass, the depreciation would have been calculated over the shorter of the lease term (five years) and the useful life (six years), therefore five years. Using the above journals, the following accounting implications may be derived:

231

Leases 20X8 R Finance charges Depreciation Right-of-use asset Lease liability Total Current

66000 10000

20X7 R 17719 66000 76000

20X6 R 24459 66000 142000

20X5 R 30571 66000 208000

20X4 R 36113 66000 274000

20X3 R 41 138 66000 340000

172 281 172 281

237822 65541

297251 59429

351 138 53887

172 281

237822

297251

Non-current

Total R 150000 396000

In the previous example the payment of the instalment coincides with the financial year-end. If the lease agreement was entered into in the middle of the financial year and the annual instalments are payable in the middle of the financial year, interest relating to six months will have to be accrued for at year-end. This is illustrated in the next example.

Example 10.13: Lessee: general lease accounting requirements (payment in arrears; does not coincide with year- (113352) 0; "9481 0-

" " 0

(3904)
Cash outflow or inflow for the investor as a result of the issue of additional shares by the investee

-'

Depending on scenario the difference IS recognised in profit or loss, directly in equity or as goodwill (or bargain purchase gam or excess)

In addition to the recognition of the difference between the change in the investor's share of the consolidated net asset value of the investee and the cash outflow or cash inflow for the investor, IFRS also requires the fair value adjustment of certain previously held interests to be recognised in profit or loss (refer to the surnmrny in section 7. 1).

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Example 7.1: Increase of an interest in an existing subsidiary On 1 January 20X1 A Ltd acquired an 80% interest in the 150 000 issued shares of B Ltd for R540 000. A Ltd elected to measure non-controlling interest at the date of the acquisition at their fair value of R135 000. On 1 August 20X5, B Ltd issued an additional 50 000 shares at R2,50 per share. Of the 50 000 shares, 48 000 shares were taken up by A Ltd and the remainder of the shares were taken up by non-controlling shareholders. It is the policy of A Ltd to measure investments in subsidiaries at cost in its separate financial statements. The equity of B Ltd consisted of the following items on various dates: 1/8/20X5 1/8/20X5 before after share 1/1/20X1 1/1/20X5 share issue issue 31/12/20X5 R R R R R Share capital 150000 150000 150000 275000 275000 Retained earnings 500000 1 000000 1 250000 1 250000 1 500000 650000

1 150000

1 400000

1 525000

1 775000

Before the issue of the additional 50 000 shares by B Ltd, A Ltd had an 80% interest in B Ltd. After the issue of the additional 50 000 shares by B Ltd, A Ltd has an 84% interest [(150 000 x 80% + 48 000) I (150000 + 50 000) x 1~O] in B Ltd. As B Ltd is a subsidiary of A Ltd at the reporting date (31 December 20X5), the consolidation process commences by adding the financial statements of A Ltd and B Ltd together on a line-by-line basis. The consolidation journal entries will therefore focus on the elimination of at-acquisition equity and the inclusion of non-controlling interest. On 1 January 20X1 A Ltd acquired control over B Ltd. On this date IFRS 3 should be applied. All the identifiable assets and liabilities of B Ltd should be recognised and measured in terms of IFRS 3. The goodwill (or bargain purchase gain) is determined as follows: R

Consideration transferred (80%) Non-controlling interest (20% at fair value)

540000 135000

Value for 100% interest Fair value of 100% of net assets

675000 650000

Goodwill

25000

Attributable to: ONners of the parent[540 000 - (650000 x 80%)] Non-controlling interest [135000 - (650 000 x 20%)]

20000 5000 25000

The following consolidation journal entry should be processed in 20X5 relating to the initial 80% investment: Journal 1 Share capital Retained earnings Investment in B Ltd Non-controlling interest (F/P) Goodwill

Dr R 150000 500000

Cr R

540000 135000 25000 675000

675000

At-acquisition elimination of the initial 80% interest) Since acquIsition to the beginning of the current financial year, the equity of B Ltd Increased by R500 000 (1 150000 - 650 000). Adding the financial statements on a line-by-line basis has the effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 20% should be allocated to the non-controlling shareholders:

269

Change in interests in investments - other Journal 2

Dr R

Retained earnings [(1 000000 500000) x 20%[ Non-controlling interest (F/P) (Allocation of since acquisition reselVes to noncontrollinq shareholders)

Cr R

100000 100000

From the beginning of the year to the date that the additional shares were Issued, B Ltd made a profit of R250 000 (1 250000 - 1 000000). Adding the financial statements on a line-by-line basis has the effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 20% should be allocated to the non-controlling shareholders: Journal 3

Dr

Cr

R

R

50000

Non-controlling interest (P/L) Non-controlling interest (F/P) (250000 x 20%) (Allocation of the profit for the first seven months to noncontrollinq shareholders)

50000

On 1 August 20X5 B Ltd issues an additional 50 000 shares and the net asset value of B Ltd increases by R125 000 (50 000 x 2,50). A Ltd purchases 48 000 of these shares and increases the investment in the subsidiary in its separate financial statements with R120 000 (48000 x 2,50). As a result of the transaction, the controlling and the non-controlling shareholders' interest in the net asset value of B Ltd changes as follows: Non-controlling interest

A Ltd I nterest after the share issue

R

R

1 302000

248000

(1 140000)

(285000)

162000

(37000)

Net asset value (1 525000 x 84%); (1 525000 x 16%) Goodwill [20 000 + (5 000 x 4/20)[; (5 000 x 16/201' I nterest before the share issue Net asset value (1 400000 x 80%); (1 400000 x 20%) Goodwill Increase/(decrease) in interest in the subsidiary Cash outflow for the investor (48000 x 2,50)

(120000)

Gain on the issue of additional shares by the subsidiary

42000

At acquisition date the non-controlling interest owned R5 000 of the goodwill. This goodwill related to their 20% interest. As their interest now decreases to 16%, a pro rata portion of the goodwill should be transferred to A Ltd, i.e. R5000 x 4 I 20 = R1 000. Their remaining interest in the goodwill is therefore only R4 000 (R5 000 x 16/20). The consolidation journal entry necessary to record the issue of the additional shares by the subsidiary is as follows: rJ~o~u=rn~a~/'4------------------------------------rD~r-------rC~r---'

R Share capital Non-controlling interest (F/P) I nvestment in B Ltd Retained earnings

120000 42000 162000

(Consolidation journal entry on the issue of additional shares by the subsidiary)

R

125000 37000

162000

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The following should be noted from this consolidation journal entry: The issue of the additional 50 000 shares gave rise to an increase of R 125 000 in share capital in B

Ltd's separate financial statements. This amount should be eliminated upon consolidation. The above journal eliminates the portion of the share capital attributable to A Ltd against A Ltd's investment in B Ltd, while allocating the remainder of the share capital to the non-controlling interest. No additional goodwill is recognised as part of the transaction. The original goodwill of R25 000 is still reflected in the consolidated statement of financial position. However, the interest in this goodwill did change as a result of the transaction. Previously the controlling shareholder (A Ltd) owned R20000 of the goodwill and the non-controlling shareholders R5000. As part of the transaction the non-controlling shareholders relinquished R 1 000 of the goodwill to the controlling shareholder After the transaction the parent owns R21 000 (20000 + 1 000) and the noncontrolling shareholders R4 000 (5 000 - 1 000) of the goodwill. The gain of R42 000 is recognised directly in equity (retained earnings). This is due to the fact that the transaction did not result in the loss of control, and as such the parent has merely transacted with the non-controlling shareholders. From the date of the issue of the additional shares to the end of the year, B Ltd made a profit of

R250000 (1 500000 - 1 250000). Adding the financial statements on a line-by-line basis has the effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 16% should be allocated to the non-controlling shareholders: Journal 5

Dr

Cr R

R

Non-controlling interest (P/L) Non-controlling interest (F/P) (250000 x 16%) (Allocation of the profit for the last five months to noncontrollinq shareholders)

40000 40000

After processing all the consolidation Journal entries, the non-controlling Interest In the statement of financial position is reflected as R288 000 [135000 Unl 1) + 100000 Unl 2) + 50000 Un13) - 37000 Unl 4) + 40 000 Unl 5)[. This amount can also be calculated as follows: R

Net asset value at the end of the year

(1 775000 x 16%) Goodwill

284000 4000 288000

The above calculations can also be combined by making use of the following analysis of equity: Total

At Since RE NCI (80%-84%) (80%-84%) (20%-16%)

R

R

Net asset value Goodwill

150000 500000 650000 25000

520000 20000

130000 5000

Consideration + NCI

675000

540000

135000

At acquisition Share capital Retained earnings

Since acquisition Retained earnings (1 000000 - 500 000)

Total elf

500000 1 175000

540000

R

R

400000

100000

400000

235000

Change in interests in investments - other

271

Total Total clf

At Since RE NCI (80% - 84%) (80%- 84%) (20%-16%)

R 1 175 000

R 540 000

R 400 000

R 235 000

200 000

50 000

1 425 000

540 000 42 000

600 000 42 000

285 000 (37 000)

125 000

'105 000 (120 000)

250 000

210 000

40 000

1 800 000

852 000

288 000

Current period Profit 1/1 - 3117 (1250 000 -1 000 000)

250 000

Gain on share issue Acquisition of 4% Share capital

3S7000

Paid (48 000 x 2,5) Profit 1/8 - 31/12 (1 500 000 -1250 000)

, 285 000 x 4/20 = 57 000 b 125 000 x 84% = 105 000 c 125 000 x 16% = 20 000

The following represents extracts from the statement of changes in equity which reflect only items relating to B Ltd:

A Ltd Group Consolidated Statement of Changes in Equity for the year ended 31 December 20X5 Attributable to owners of the parent Noncontrolling Retained Total interest earnings

Issue of shares by subsidiary Unl 4)

R 400 000 ' 410000 3 42 000

R 400 000 410 000 42 000

R 235 000 2 90 0004 (37 000)

Closing balance

852 000

852 000

288 000

Opening balance Profit and total comprehensive income for the year

Total R 635 000 500 000 5 000 5 1 140 000

1 000 000 (separate) - 500 000 Unl 1) - 100 000 Unl 2) = 400 000 or (1 000 000 - 500 000) x 80% = 400 000 1 150 000 x 20% + 5 000 (goodwill) = 235 000 500 000 (separate) - 50 000 Unl 3) - 40 000 Unl 5) = 410 000 or (250 000 x 80%) + (250 000 x 84%) = 410 000 50 000 Unl 3) + 40 000 Unl 5) = 90 000

Note that the RS 000 represents the net cash inflow for the group. The subsidiary received cash for the issue of shares of R125 000 (50 000 x 2,50), while the parent paid cash of R120 000 (48 000 x 2,50). stated differently, the net cash inflow for the group relates to the 2 000 shares taken up by the non-controlling shareholders (2 000 x 2,50).

Example 7.2: Decrease of an interest in an existing subsidiary (control not lost) On 1 January 20X1 A Ltd acquired an 80% interest in the 1S0 000 issued shares of B Ltd for RS10000. A Ltd elected to measure non-controlling interest at the date of the acquisition at their proportionate share of the net fair value of the identifiable assets and liabilities. On 1 August 20XS, B Ltd issued an additional SO 000 shares as part of a rights issue at R2,SO per share. Of the SO 000 shares, 32000 shares were taken up by A Ltd and the remainder of the shares were taken up by noncontrolling shareholders. A Ltd sold the remainder of its rights to the non-controlling shareholders at RO,80 per right Each right entitled the shareholders to take up one share. It is the policy of A Ltd to

measure investments in subsidiaries at cost in its separate financial statements. The equity of B Ltd consisted of the following items on various dates:

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Share capital Retained earnings

1/1/20X1 R 150000 500000

1/1/20X5 R 150000 1 000000

1/8/20X5 before share issue R 150000 1 250000

650000

1 150000

1 400000

1/8/20X5 after share issue R 275000 1 250000

31/12/20X5 R 275000 1 500000

1 525000

1 775000

Before the issue of the additional 50 000 shares by B Ltd, A Ltd had an 80% interest in B Ltd. After the issue of the additional 50000 shares by B Ltd, A Ltd has a 76% interest [(150 000 x 80% + 32 000) I (150000 + 50 000) x 1OO[ in B Ltd.

As B Ltd is a subsidiary of A Ltd at the reporting date (31 December 20X5), the consolidation process commences by adding the financial statements of A Ltd and B Ltd together on a line-by-line basis. The consolidation journal entries will therefore focus on the elimination of at-acquisition equity and the inclusion of non-controlling interest. On 1 January 20X1 A Ltd acquired control over B Ltd. On this date IFRS 3 should be applied. All the identifiable assets and liabilities of B Ltd should be recognised and measured in terms of IFRS 3. The goodwill (or bargain purchase gain) is determined as follows: R

Consideration transferred (80%) Non-controlling interest (20%) (650000 x 20%)

510000 130000

Value for 100% interest Fair value of 100% of net assets

640000 650000

Bargain purchase gain

(10 000)

Attributable to: ONners of the parent[510 000 - (650000 x 80%)[ Non-controlling interest [130000 - (650 000 x 20%)[

(10 000) (10 000)

The following consolidation journal entry should be processed in 20X5 relating to the initial 80% investment:

Journal 1 Share capital Retained earnings I nvestment in B Ltd Non-controlling interest (F/P) Retained earnings (bargain purchase gain)

Dr R 150000 500000

Cr R

510000 130000 10 000 650000

650000

At-acquisition elimination of the initial 80% interest) Since acquisition to the beginning of the current financial year the equity of B Ltd increased by R500 000 (1 150000 - 650 000). Adding the financial statements on a line by line basis has the effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 20% should be allocated to the non-controlling shareholders:

Journal 2 Retained earnings [(1 000000 500000) x 20%[ Non-controlling interest (F/P) (Allocation of since acquisition reserves to noncontrolling shareholders)

Dr

Cr

R

R

100000 100000

From the beginning of the year to the date that the additional shares were issued, B Ltd made a profit of R250 000 (1 250000 - 1 000000). Adding the financial statements on a line by line basis has the

Change in interests in investments - other

273

effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 20% should be allocated to the non-controlling shareholders:

Journal 3

Dr R

Non-controlling interest (P/L) Non-controlling interest (F/P) (250000 x 20%) (Allocation of the profit for the first seven months to noncontrolling shareholders)

Cr R

50000 50000

On 1 August 20X5 B Ltd issues an additional 50 000 shares and the net asset value of B Ltd increases by R125 000 (50 000 x 2,50). A Ltd purchases 32 000 of these shares and increases the investment in the subsidiary in its separate financial statements with R80 000 (32 000 x 2,50). In addition A Ltd sells the remainder of its rights to the non-controlling shareholders at RO,BO per right. A Ltd recognises a gain in its separate financial statements of R6 400 [(50 000 x 80% - 32 000) x 0,80[. As a result of the transaction, the controlling and the non-controlling shareholders' interest in the net asset value of B Ltd changes as follows:

A Ltd R 1159000

I nterest after the share issue Net asset value (1 525000 Goodwill

x 76%); (1 525000 x 24%)

I nterest before the share issue Net asset value (1 400000 Goodwill

1115~000 I 136~000 I (1 120000)

(280000)

~

x 80%); (1 400000 x 20%)

I ncrease of interest in the subsidiary

Noncontrolling interest R 366000

39000

Cash outflow for the investor (32000 x 2,50) Proceeds on sale of rights (8 000 x 0,80)

(80000) 6400

Loss on the issue of additional shares by the subsidiary

(34600)

86000

The consolidation journal entry necessary to record the issue of the additional shares by the subsidiary is as follows:

Journal 4 Share capital Gain on sale of rights (separate) (P/L) Non-controlling interest (F/P) Investment in B Ltd Retained earnings

Dr R 125000 6400

Cr R

86000 80000 34600 166000

166000

(Consolidation journal entry on the issue of additional shares bv the subsidiary) The following should be noted from this consolidation journal entry: The issue of the additional 50 000 shares gave rise to an increase of R 125000 in share capital in B Ltd's separate financial statements. This amount should be eliminated upon consolidation. The above journal eliminates the portion of the share capital attributable to A Ltd against A Ltd's investment in B Ltd, while allocating the remainder of the share capital to the non-controlling interest. The loss of R34 600 is recognised directly in equity (retained earnings). This is due to the fact that the transaction did not result in the loss of control, and as such the parent has merely transacted with the non-controlling shareholders.

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From the date of the issue of the additional shares to the end of the year, B Ltd made a profit of R250000 (1 500000 - 1 250000). Adding the financial statements on a line-by-line basis has the effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 24% should be allocated to the non-controlling shareholders: Journal 5

Dr R 60000

Non-controlling interest (P/L) Non-controlling interest (F/P) (250000 x 24%)

Cr R

60000

(Allocation of the profit for the last five months to noncontrollinQ shareholders) After processing all the consolidation jnl entries, the non-controlling interest in the statement of financial position is reflected as R426 000 [130000 Unl 1) + 100000 Unl 2) + 50000 Unl 3) + 86000 Unl 4) + 60000 UnI5)[. This amount can also be calculated as follows: R 426000

Net asset value at the end of the year (1 775000 x 24%) Goodwill

426000 The above calculations can also be combined by making use of the follo w ing analysis of equity: Total R

At Since RE NCI (80% - 76%) (80% - 76%) (20% - 24%) R R R

At acquisition Share capital Retained earnings

150000 500000

Net asset value Bargain purchase gain

650000 (10000)

520000 (10000)

130000

Consideration + NCI Bargain purchase gain eliminated from "total" and "at" columns

640000

510000

130000

10000

10000

Since acquisition Retained earnings

500000

400000

100000

(1 000000 - 500000) 230000 Current period Profit 1/1 - 3117

250000

200000

50000

600000 (34600)

280000 86000

250000

190000

60000

1 775000

755400

426000

(1 250000 -1 000000) 1 400000 Loss on share issue Disposal of 4% Share capital Paid (32 000 x 2,5) Sale of rights

125000

520000 (34600) '(56000) '95000 (80000) 6400

[(50000 x 80%) - 32000] x 0,8 Profit 1/8 - 31/12 (1 500000 -1 250000) , (520 000 + 600 000) x 4/80 = 56 000 b 125000 x 76% = 95 000 c 125000 x 24% = 30 000 The following represents extracts from the statement of changes in equity which reflect only items relating to B Ltd:

Change in interests in investments - other

275

A Ltd Group Consolidated Statement of Changes in Equity for the year ended 31 December 20X5 Attributable to owners of the parent Noncontrolling Retained Total interest earnings R

R

R

Opening balance Profit and total comprehensive income for the year Issue of shares by subsidiary Unl 4)

410000 ' 390000 3 (34600)

410000 390000 (34600)

230000 2 1100004 86000

Closing balance

765 400

765 400

426 000

Total R

640000 500000 51 400 5 1 191 400

1 000000 (separate) - 500 000 Un11) + 10 000 Unl 1 - bargain purchase gain) - 100 000 Unl 2) = 410 000 or (1000000- 500 000) x 80% + 10 000 Un11) = 410 000 1 150000 x 20% = 230 000 500000 (separate) - 50 000 Un13) - 60 000 Un15) = 390 000 or (250000 x 80%) + (250 000 x 76%) = 390 000 50000 Unl 3) + 60 000 Unl 5) = 110000

Note that the R51 400 represents the net cash inflow for the group. The subsidiary received cash for the issue of shares of R125 000 (50 000 x 2,50), while the parent paid cash of R80 000 (32 000 x 2,50) and received cash of R6 400 on the sale of rights. Stated differently, the net cash inflow for the group relates to the 18000 shares taken up by the non-controlling shareholders (18 000 x 2,50) plus the cash received on the sale of rights of R6 400.

Example 7.3: Step acquisition of a subsidiary as a result of additional shares being issued by the investee On 1 January 20X1 A Ltd acquired a 40% interest (an associate) in the 150000 issued shares of B Ltd for R320 000. On 1 August 20X5, B Ltd issued an additional 50 000 shares at R2,50 per share. Of the 50000 shares, 48000 shares were taken up by A Ltd and the remainder of the shares were taken up by other parties. As a result of the share issue A Ltd obtained control of B Ltd. All the assets and liabilities of B Ltd were fairly valued at 1 August 20X5, except for land that was understated by R554 124. A Ltd elected to measure non-controlling interest at the date of the acquisition (1 August 20X5) at their fair value of R890 000. The fair value of the previously held 40% interest was R800 000 on 1 August 20X5. It is the policy of A Ltd to measure investments in subsidiaries and associates at cost in its separate financial statements. The equity of B Ltd consisted of the following items on various dates (excluding the adjustment to the value of land): 1/8/20X5 1/8/20X5 before after share share issue 1/1/20X1 1/1/20X5 issue 31/12/20X5 R R R R R Share capital 150000 150000 150000 275000 275000 Retained earnings 500000 1 000000 1 250000 1 250000 1 500000 650000

1 150000

The profit for the year of B Ltd was earned as follows: 1/1/20X5 1/8/20X531/7/20X5 31/12/20X5

1 400000

1 775000

Total

R

R

R

1 000000 (600 000)

1 200000 (650 000)

2200000 (1 250000)

G ross profit Other expenses

400000 (52800)

550000 (202800)

950000 (255600)

Profit before tax I ncome tax expense

347200 (97200)

347200 (97200)

694400 (194400)

Profit for the year

250000

250000

500000

Revenue Cost of sales

1 525000

Before the issue of the additional 50 000 shares by B Ltd, A Ltd had a 40% interest in B Ltd. After the issue of the additional 50000 shares by B Ltd, A Ltd has a 54% interest [(150 000 x 40% + 48 000) I

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(150000 + 50 000) X 100] in B Ltd. B Ltd therefore changes from an associate to a subsidiary. The movements in the equity of B Ltd while it was an associate can be analysed as follows: At Since RE Total (40%) (40%)

At acquisition Share capital Retained earnings Net asset value Cost of investment

150000 500000 650000

Goodwill

260000 320000 60000

Since acquisition Retained earnings (1 000000 - 500 000) Current period Profit 1/1/20X3 - 31/7/20X3

500000

200000

250000 1 400000

100000 320000

300000

As B Ltd is a subsidiary of A Ltd at the reporting date (31 December 20X5), the consolidation process commences by adding the financial statements of A Ltd and B Ltd together on a line-by-line basis. The consolidation journal entries will therefore focus on the elimination of at-acquisition equity and the inclusion of non-controlling interest. Due to the fact that all equity items as at 1 August 20X5 (acquisition date) will be eliminated from the consolidated financial statements by means of the atacquisition journal entry, it is necessary to include in the consolidated financial statements the portion of B Ltd's equity that accrued to A Ltd while B Ltd was an associate - this will be done by means of pro forma consolidation journals.

The following consolidation journal entry should be processed in 20X5 relating to the opening equity of the original 40% investment: Journal 1

Investment in B Ltd Retained earnings ](1000000 - 500 000) x 40%] (Recognition of opening equity while the investment was still an associate) .

Dr R 200000

Cr R

200000

For the first seven months B Ltd made a profit of R250 000:

Journal 2

Investment in B Ltd Share of profit of associate (P/L) (250 000 x 40%) I(Share of profit of associate for the first seven months)

Dr R 100000

Cr R

100000

On 1 August 20X5 the carrying amount of the 40% Investment IS R620 000 ]320 000 cost + 200 000 Unl 1) + 100000 Unl 2) = 620 000 or 1 400000 x 40% + 60 000 (goodwill) = 620 ODD]. The investment should be adjusted to its fair value of R800 000 on 1 August 20X5. The following consolidation journal entry is necessary to record this:

Journal 3

Investment in B Ltd Fair value adjustment (P/L) (800 000 - 620 000) I(Fair value adjustment on the date of obtaining control)

Dr R 180000

Cr R

180000

On 1 August 20X5 A Ltd acquired control over B Ltd. On this date IFRS 3 should be applied. All the identifiable assets and liabilities of B Ltd should be recognised and measured in terms of IFRS 3. A journal entry is necessary to adjust the carrying amount of land to its fair value on the acquisition date:

Change in interests in investments - other

277

Journal 4

Dr R 554 124

Land Deferred tax (554124 x 22,4%) Revaluation surplus

Cr R 124 124 430000

554 124

554124

Revaluation of land at the acquisition date) The goodwill (or bargain purchase gain) IS determined as follows on 1 August 20X5: R 120000 800000 890000

Consideration transferred (24%) (48 000 x 2,50) Fair value of previously held interest (40%) Non-controlling interest (46% at fair value)

1 810000 1 955000

Value for 100% interest

Fair value of 100% of net assets (1 525000 + 430 000) Bargain purchase gain

(145000)

Attributable to: ONners of the parent [920000 - (1 955000 x 54%)[ Non-controlling interest [890000 - (1 955000 x 46%)[

(135700) (9300) (145000)

The bargain purchase gain can also be calculated by making use of the following analysis of equity:

Tolal

At (54%)

Since RE (54%)

NCI (46%)

At acquisition Share capital Retained earnings Profit 1/1 - 31/7 Revaluation surplus

275000 1 000000 250000 430000

Net asset value Bargain purchase gain

1 955000 (145000)

1 055700 (135700)

899300 (9300)

Consideration + NCI Bargain purchase gain eliminated from "total" and "at" columns Profil 1/8 - 31/12

1810000

920000

890000

145000 250000

135700

2205000

1 055700

135000

115 000

135000

1 005000

The consolidation journal entry necessary to eliminate the investment at acquisition date is as follows:

Journal 5 Share capital Retained earnings Revaluation surplus Revenue* Cost of sales* other expenses* Income tax expense*

Dr

Cr

R 275000 1 000000 430000 1 000000

R

600000 52800 97200 890000 920000 145000

Non-controlling interest (F/P) Investment in B Ltd (800 000 + 120 000) Bargain purchase gain 2705000

2705000

Elimination of investment at acquisition date) Note: Adding the financial statements on a line-by-line baSIS has the effect that revenue, cost of sales, other expenses and the income tax expense are reflected in the consolidated financial statements for the entire year. However, the profit earned while the investment was still an

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associate has already been accounted for in journal 2. To avoid double counting, and as the profit earned during the first seven months forms part of the at-acquisition equity for purposes of IFRS 3, the profit should be eliminated (with reference to the individual line items) on the date when control is obtained.

From the date of the issue of the additional shares to the end of the year, B Ltd made a profit of R250 000. Adding the financial statements on a line-by-line basis has the effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 46% should be allocated to the non-controlling shareholders: Journal 6 Non-controlling interest (P/L) Non-controlling interest (F/P) (250 000 x 46%) (Allocation of the profit for the last five months to noncontrolling shareholders)

Dr R 115000

Cr R 115 000

After processing all the consolidation journal entries the non-controlling interest in the statement of financial position is reflected as R1 005000 [890 000 Un15) + 115 000 UnI6)[. This amount can also be calculated as follows: Net asset value at the end of the year [(1 775000 + 430 000) x 46%[ Bargain purchase gain

R 1014300

(9300) 1 005000

The following represents extracts from the statement of profit or loss and other comprehensive income which reflect only items relating to B Ltd: A Ltd Group Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 20X5

Revenue [2 200 000 - 1 000000 Unl 5)[ Cost of sales [1 250000 - 600 000 UnI5)[ G ross profit Other expenses [255 600 - 52 800 Unl 5)[ Other income Unl 5 - bargain purchase gain) Fair value adjustment Unl 3) Share of profit of associate Unl 2)

Consolidated R 1 200000 (650000) 550000 (202800) 145000 180000 100000

Profit before tax Income tax expense [194 400 - 97 200 UnI5)[

772200 (97200)

Profit and total comprehensive income for the year

675000

Profit and total comprehensive income attributable to: ONners of the parent * Non-controlling interest Un16)

560000 115000 675000

Note that the bargain purchase gain of R145 000 is fully attributed to the parent (acquirer) in terms of paragraph 34 of IFRS 3. The following represents extracts from the statement of changes in equity which reflect only items relating to B Ltd:

Change in interests in investments - other

279

A Ltd Group Consolidated Statement of Changes in Equity for the year ended 31 December 20X5 Attributable to owners of the parent Noncontrolling Retained earnings Total interest Opening balance Profit and total comprehensive income for the year

R 200000 ' 560000

R 200000 560000

Acquisition of subsidiary Un15) Closing balance

760000

760000

R 115000 890000 1 005000

Total R 200000 675000 890000 1 765000

1 000000 (separate) + 200 000 Un11) -1 000000 Un15) - 200 000 or (1 000000 - 500 000) x 40% = 200 000

Example 7.4: Decrease of an interest in a subsidiary (control is lost) On 1 January 20X1 A Ltd acquired a 54% interest in the 150000 issued shares of B Ltd for R390 000. A Ltd elected to measure non-controlling interest at the date of the acquisition at their proportionate share of the net fair value of the identifiable assets and liabilities. On 1 August 20X5, B Ltd issued an additional 50000 shares as part of a rights issue at R2,50 per share. Of the 50000 shares, 9000 shares were taken up by A Ltd and the remainder of the shares were taken up by other parties. A Ltd

sold the remainder of its rights to the other parties at RO,80 per right Each right entitled the shareholders to take up one share. From 1 August 20X5 A Ltd exercised significant influence over the financial and operating policies of B Ltd. On 1 August 20X5 the fair value of the remaining 45% interest was R750 000. It is the policy of A Ltd to measure investments in subsidiaries and associates at cost in its separate financial statements. The equity of B Ltd consisted of the following items on various dates: 1/8/20X5 1/8/20X5 before after share 1/1/20X1 1/1/20X5 share issue issue 31/12/20X5 R R R R R Share capital 150000 150000 150000 275000 275000 Retained earnings 500000 1 000000 1 250000 1 250000 1 500000 650000 1 150000 1 400000 1 525000 1 775000 The profit for the year of B Ltd was earned as follows:

1/1/20X5 31/7/20X5 R 1 000000 (600000)

1/8/20X5 31/12/20X5 R 1 200000 (650000)

2200000 (1 250000)

G ross profit Other expenses

400000 (52800)

550000 (202800)

950000 (255600)

Profit before tax I ncome tax expense

347200 (97200)

347200 (97200)

694400 (194400)

Profit for the year

250000

250000

500000

Revenue Cost of sales

Total

Before the issue of the additional 50 000 shares by B Ltd, A Ltd had a 54% interest in B Ltd. After the issue of the additional 50000 shares by B Ltd, A Ltd has a 45% interest [(150 000 x 54% + 9000) I (150000 + 50 000) x 1~O] in B Ltd.

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The goodwill (or bargain purchase gain) is determined as follows on 1 January 20X1: Consideration transferred (54%) Non-controlling interest (46%) (650 000 x 46%)

R 390000 299000

Value for 100% interest Fair value of 100% of net assets

689000 650000

Goodwill

39000

Attributable to: ONners of the parent[390 000 - (650 000 x 54%)] Non-controlling interest ]299000 - (650 000 x 46%)]

39000 39000

As B Ltd is an associate of A Ltd at the reporting date (31 December 20X5), the consolidation process commences with the financial statements of A Ltd only. The consolidation journal entries will therefore

focus on the inclusion of the relevant items of B Ltd in the consolidated financial statements. The relevant items to be included w ill consist of items that accumulated while B Ltd was a subsidiary as well as items that accumulated while B Ltd was an associate. The following consolidation journal entry should be processed in 20X5 relating to the opening equity of the original 54% investment:

Journal 1 Investment in B Ltd Retained earnings ](1000000 - 500 000) x 54%] (Recognition of opening equity while the investment was still a subsidiary)

Dr R 270000

Cr R 270000

For the first seven months B Ltd made a profit of R250 000. For this period B Ltd was a subsidiary and the consolidation journal entry should therefore include each individual line item as well as noncontrolling interest: rJ~0-u-rn-a~/~2----------------------------------~D~r--------~C~r---'

R Investment in B Ltd (250 000 x 54%) Revenue Cost of sales other expenses Income tax expense Non-controlling interest (P/L) (250 000 x 46%)

R

135000 1 000000 600000 52800 97200 115000 1 000000

1 000000

Consolidation of profit for the first seven months) On 1 August 20X5 B Ltd issues an additional 50 000 shares and the net asset value of B Ltd increases by R 125 000 (50 000 x 2,50). A Ltd purchases 9 000 of these shares and increases the investment in the investee in its separate financial statements with R22 500 (9 000 x 2,50). In addition A Ltd sells the remainder of its rights to the non-controlling shareholders at RO,BO per right. A Ltd recognises a gain in its separate financial statements of R14 400 ](50000 x 54% - 9000) x 0,80]. As a result of the transaction A Ltd loses control and its interest in the net asset value of B Ltd changes as follows:

Change in interests in investments - other

281 A Ltd R

I nterest after the share issue

718750

Net asset value (1 525000 x 45%) Goodwill (39 000 x 4%4) I nterest before the share issue Net asset value (1 400000 x 54%) Goodwill Decrease of interest in the investee Cash outflow for the investor (9000 x 2,50) Cash inflow on the sale of rights

(76250) (22500) 14400

Loss on rights issue

(84350)

The loss on the rights issue is included in the consolidated financial statements with the following consolidation journal entry: Dr R 84350 14400

Journal 3 Loss on rights issue (P/L) Gain on sale of rights (separate) (P/L) Investment in B Ltd

Cr R

98750 98750

98750

Consolidation of the loss on the riQhts issue) On 1 August 20X5 the carrying amount of the investment in the consolidated financial statements is R718 750 [390 000 (separate) + (9000 x 2,50 (separate)) + 270 000 Un11) + 135000 Un12) - 98 750 Unl 3)]. This represents 45% of the net asset value after the rights issue, i.e. 1 525000 x 45% + 39 000 x 45 I 54 (goodwill) = R718 750. As control is lost, IFRS 10 requires that this investment should be remeasured to fair value and that the adjustment should be recognised in profit or loss: Journal 4 Investment in B Ltd Fair value adjustment (P/L) (750000 - 718 750) (Adjustment of the remaining 45% interest to fair value on the date that control is lost)

Dr

Cr

R

R

31250 31250

The total loss arising from the loss of control is therefore R53 100 (84350 - 31 250). This amount can also be supported by the methodology of paragraph 698 of IFRS 10: R

Derecognise the assets and liabilities (including goodwill) (1 400000 + 39 000) Derecognise non-controlling interest (1 400000 x 46%) Fair value of consideration Distribution of shares Fair value of remaining interest Total loss on the loss of control

(1 439000) 644000 14400 (22500) 750000 (53 100)

For the last five months B Ltd earned a profit of R250 000, while it was an associate of A Ltd: Journal 5 Investment in B Ltd Share of profit of associate (P/L) (250000 x 45%) Equity account profit for the last five months)

Dr

Cr

R

R

112500 112500

Journals 1 to 5 above do not account for non-controlling interest in the statement of financial position. As B Ltd is not a subsidiary of A Ltd at year end, the statement of financial position as at 31 December 20X5 will not reflect any non-controlling interest relating to B Ltd. However, for purposes of

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presentation of the non-controlling interest in the statement of changes in equity, it is necessary to account for the opening balance and movements relating to the non-controlling interest. The opening balance of the non-controlling interest amounted to R529 000 (1 150 000 net assets x 46%) at 1 January 20X5. The only movements that took place during the year are the interest in profit amounting to R115 000 Uournal 2) and the derecognition of the balance at 1 August 20X5, amounting to R644 000 (1 400 000 net assets x 46%). This information will be journalised as follows:

Journal 6

Dr

Cr

R

R

644000

Non-controlling interest - loss of control (F/P) Non-controlling interest - opening balance (F/P)

529000 115000

Non-controlling interest - share of profit (F/P) 644000

644000

Recognition and derecognition of NCI)

At 31 December 20X5 the consolidated balance of the investment in the associate is R862500 [750000 + 112500[. This amount consists of: Net asset value at the end of the year (1 775000 x 45%) Goodwill (39 000 x 45 / 54 ) Fair value adjustment

R 798750 32500 31 250

862500 The above calculations can also be combined by making use of the following analysis of equity: Total

R

At Since RE Nel (54% - 45%) (54%- 45%) (46% - 55%) R R R

At acquisition Share capital Retained earnings

150000 500000

Net asset value Goodwill

650000 39000

351 000 39000

299000

Consideration + NCI

689000

390000

299000

Since acquisition Retained earnings (1 000 000 - 500 000)

500000

270000

230000 529000

Current period Profit 1/1 - 3117

250000 1 439000

Loss on share issue Disposal of 9% Share capital

125000

Paid (9 000 x 2,5) Sale of rights

390000 (84350)

135000

115 000

405000 (84350)

644000 N/A

'(132500) '56250 (22500) 14400

[(50000 x 54%) - 9 OOO[ x 0,8 Profit 1/8 - 31/12

250000

112 500

N/A

1814000

433150

N/A

, (390 000 + 405 000) x 9/54 = 132 500 b 125000 x 45% = 56 250 Carrying amount of remaining investment = 390 000 at + 405 000 RE - 132 500' + 56 250 b = 718 750. Fair value adjustment = fair value of 750 000 less carrying amount of 718 750 = 31 250. The following represents extracts from the statement of profit or loss and other comprehensive income which reflect only items relating to B Ltd:

Change in interests in investments - other

283

A Ltd Group Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 20X5 Consolidated R 1 000000 (600000)

Revenue Unl 2) Cost of sales Unl 2) G ross profit Other expenses Unl 2) Loss on rights issue Unl 3) Fair value adjustments Unl 4) Share of profit of associate Unl 5)

400000 (52 SOO) (S4350) 31 250 112500

Profit before tax Income tax expense Un12)

406600 (97200)

Profit and total comprehensive income for the year

309400

Profit and total comprehensive income attributable to: OVVners of the parent Non-controlling interest Un12)

194400 115000 309400

The following represents extracts from the statement of changes in equity which reflect only items relating to B Ltd:

A Ltd Group Consolidated Statement of Changes in Equity for the year ended 31 December 20X5

Opening balance Un11, 6) Profit and total comprehensive income for the year Loss of control of subsidiary Unl 6) Closing balance

Attributable to owners of the parent NonRetained controlling Total interest earnings R R R 270000 270000 529000 194400 194400 115000 (644000) 464400

464400

Total R 799000 309400 (644000) 464400

Example 7.5: Decrease of an interest in an existing associate (significant influence is not lost) On 1 January 20X1 A Ltd acquired a 45% interest in the 150000 issued shares of B Ltd for R325 000 and exercised significant influence over the financial and operating policies of B Ltd from that date. On 1 August 20X5, B Ltd issued an additional 50000 shares at R2,50 per share. Of the 50000 shares, 12500 shares were taken up by A Ltd and the remainder of the shares were taken up by other parties. It is the policy of A Ltd to measure investments in associates at cost in its separate financial statements. The equity of B Ltd consisted of the following items on various dates:

Share capital Retained earnings

1/1/20X1 R 150000 500000

1/1/20X5 R 150000 1 000000

1/S/20X5 before share issue R 150000 1 250000

650000

1 150000

1 400000

1/S/20X5 after share issue R 275000 1 250000

31/12/20X5 R 275000 1 500000

1 525000

1 775000

Before the issue of the additional 50 000 shares by B Ltd, A Ltd had a 45% interest in B Ltd. After the issue of the additional 50000 shares by B Ltd, A Ltd has a 40% interest [(150 000 x 45% + 12500) I (150000 + 50 000) x 1OO[ in B Ltd.

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The goodwill (or excess) is determined as follows on 1 January 20X1:

R Cost of the investment Proportionate share of the net assets (650 000 x 45%) Goodwill

325000 292500 32500

As B Ltd is an associate of A Ltd at the reporting date (31 December 20X5), the consolidation process commences with the financial statements of A Ltd only. The consolidation journal entries will therefore focus on the inclusion of the relevant items of B Ltd in the consolidated financial statements. The following consolidation journal entry should be processed in 20X5 relating to the opening equity of the original 45% investment" Journal 1 Dr Cr

R Investment in B Ltd Retained earnings [(1000000 - 500 000) x 45%]

R

225000 225000

(Recognition of opening equity of the investment in the associate) For the first seven months B Ltd made a profit of R250 000. For this period B Ltd was an associate and the consolidation journal entry should therefore include the share of the profit of the associate:

Journal 2 Investment in B Ltd Share of profit of associate (P/L) (250 000 x 45%) [(Equity account profit for the first seven months)

Dr

Cr

R

R

112500 112500

On 1 August 20X5 B Ltd issues an additional 50 000 shares and the net asset value of B Ltd increases by R125 000 (50 000 x 2,50). A Ltd purchases 12500 of these shares and increases the investment in the investee in its separate financial statements with R31 250 (12500 x 2,50). A Ltd's interest in the net asset value of B Ltd changes as follows:

A Ltd R I nterest after the share issue Net asset value (1 525000 Goodwill (32 500 x 4%5)

638889

x 40%)

I nterest before the share issue Net asset value (1 400000 Goodwill

x 45%)

Decrease of interest in the investee Cash outflow for the investor (12 500

x 2,50)

Loss on share issue

(23611) (31 250) (54861)

The loss on the share issue is included in the consolidated financial statements with the following consolidation journal entry:

Journal 3 Loss on share issue by associate (P/L) I nvestment in B Ltd Recognition of the loss on the rights issue)

Dr

Cr

R

R

54861 54861

On 1 August 20X5 (after the rights issue) the carrying amount of the investment in the consolidated financial statements is R638 889 [325 000 (separate) + (12500 x 2,50 (separate)) + 225 000 Unl 1) + 112500 Unl 2) - 54 861 Unl 3)]. This represents 40% of the net asset value after the share issue, i.e. (1 525000 x 40%) + (32 500 x 4%5 (goodwill)) = R638 889.

Change in interests in investments - other

285

For the last five months B Ltd earned a profit of R250 000, while it was an associate of A Ltd:

Journal 4 Investment in B Ltd Share of profit of associate (P/L) (250 000 x 40%) Equity account profit for the last five months)

Dr

Cr

R

R

100000 100000

At 31 December 20X5 the consolidated balance of the investment in the associate is R738889 [638889 + 100000[. This amount consists of: Net asset value at the end of the year (1 775000 x 40%) Goodwill (32 500 x 4%5)

R 710000 28889

738889 The above calculations can also be combined by making use of the following analysis of equity: Total

R At acquisition Share capital Retained earnings Net asset value Cost of investment

At (45% - 40%) R

Since RE (45% - 40%) R

150000 500000 650000

292500 325000 32500

Goodwill Since acquisition Retained earnings (1 000000 - 500 000)

500000

225000

Current period Profit 1/1 - 3117 (1250000 -1 000000)

250000

112500

1 400000 Loss on share issue Disposal of 5% Share capital

Paid (12 500 x 2,5) Profit 1/8 - 31/12

125000

325000 (54861 )

337500 (54861)

'(73611) '50000 (31 250)

250000

100000

1 775000

382639

, (325000 + 337 500) x 5/45 = 73 611 b 125000 x 40% = 50 000 The follow ing represents extracts from the statement of profit or loss and other comprehensive income which reflect only items relating to B Ltd:

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A Ltd Group Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 20X5 Consolidated R

XXXX (XXXX)

Revenue Cost of sales G ross profit Other expenses Loss on share issue by associate Unl 3) Share of profit of associate [112 500 Un12) + 100000 UnI4)[

XXXX (XXXX) (54861) 212500

Profit before tax I ncome tax expense

157639 (XXXX)

Profit and total comprehensive income for the year

157639

Profit and total comprehensive income attributable to: ONners of the parent Non-controlling interest

157639 157639

The following represents extracts from the statement of changes in equity which reflect only items relating to B Ltd: A Ltd Group Consolidated Statement of Changes in Equity for the year ended 31 December 20X5 Retained earnings Opening balance Un11) Profit and total comprehensive income for the year Closing balance

Total

R

R

225000 157639 382639

225000 157639 382639

Example 7.6: Decrease of an interest in an associate (significant influence is lost) Note: This example ignores the income tax consequences of the remaining investment in the separate and consolidated financial statements, as well as the income tax consequences of the disposal of the investment. On 1 January 20X1 A Ltd acquired a 20% interest in the 150000 issued shares of B Ltd for R220 000 and exercised significant influence over the financial and operating policies of B Ltd from that date. On 1 August 20X5, B Ltd issued an additional 50 000 shares at R2,50 per share to other parties, on which date A Ltd lost its significant influence over B Ltd. The fair value of A Ltd's interest in B Ltd on 1 August 20X5 was R310 000 and on 31 December 20X5 it was R340 000. It is the policy of A Ltd to measure investments in associates at cost in its separate financial statements and A Ltd classified the remaining investment as a financial asset at fair value through other comprehensive income from 1 August 20X5. The equity of B Ltd consisted of the follow ing items on various dates: 1/8/20X5 1/8/20X5 before after share 1/1/20X1 1/1/20X5 share issue issue 31/12/20X5 R R R R R Share capital 150000 150000 150000 275000 275000 Retained earnings 500000 1 000000 1 250000 1 250000 1 500000 650000

1150000

1 400000

1 525000

1 775000

Before the issue of the additional 50 000 shares by B Ltd, A Ltd had a 20% interest in B Ltd. After the issue of the additional 50 000 shares by B Ltd, A Ltd has a 15% interest[(150 000 x 20%) I (150000 + 50 000) x 1OO[ in B Ltd.

Change in interests in investments - other

287

The goodwill (or excess) is determined as follows on 1 January 20X1: Cost of the investment Proportionate share of the net assets (650000 x 20%)

R 220000 130000

Goodwill

90000

As B Ltd is a normal IFRS 9 investment of A Ltd at the reporting date (31 December 20X5), the consolidation process commences with the financial statements of A Ltd only. The consolidation journal entries will therefore focus on the inclusion of the relevant items of B Ltd in the consolidated financial statements. Although A Ltd does not have significant influence over B Ltd at year end, it is still necessary to prepare consolidated (equity accounted) financial statements as A Ltd had significant influence over B Ltd from 1 January until 31 July in the current year. Furthermore, the previous year's closing balances have to be equal to the current year's opening balances. The following consolidation journal entry should be processed in 20X5 relating to the opening equity of the original 20% investment:

Journal 1 Investment in B Ltd Retained earnings [(1000000 - 500 000) x 20%[ (Recognition of opening equity of the investment in the associate)

Dr R 100000

Cr R 100000

For the first seven months B Ltd made a profit of R250 000. For this period B Ltd was an associate and the consolidation journal entry should therefore include the share of the profit of the associate:

Journal 2 Investment in B Ltd Share of profit of associate (P/L) (250000 x 20%) Equity account profit for the first seven months)

Dr

Cr

R

R

50000 50000

On 1 August 20X5 B Ltd issues an additional 50 000 shares and the net asset value of B Ltd increases by R125 000 (50000 x 2,50). A Ltd purchases none of these shares. A Ltd's interest in the net asset value of B Ltd changes as follows: A Ltd R 296250

I nterest after the share issue Net asset value (1 525000 Goodwill (90 000 x 151,0)

x 15%)

I nterest before the share issue Net asset value (1 400000 Goodwill Loss on share issue

x 20%) (73750)

The loss on the share issue is included in the consolidated financial statements with the following consolidation journal entry:

Journal 3 Loss on share issue by associate (P/L) I nvestment in B Ltd Recognition of the loss on the rights issue)

Dr R 73750

Cr R 73750

On 1 August 20X5 the carrying amount of the investment in the consolidated financial statements is R296 250 [220000 (separate) + 100000 Unl 1) + 50 000 Unl 2) - 73 750 Unl 3)[. This represents 15% of the net asset value after the share issue, i.e. (1525000 x 15%) + (90000 x 15 / 20 (goodwill)) = R296250.

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On 1 August 20X5 A Ltd recognised a fair value adjustment of R90 000 (310 000 fair value - 220 000 cost) in profit or loss in its separate financial statements, regarding its investment in B Ltd. The consolidated financial statements should reflect a fair value adjustment of only R 13 750 (310 000 fair value - 296 250 carrying amount):

Journal 4

Dr R 90000

Fair value adjustment (separate) (P/L) Fair value adjustment consolidated (P/L) Investment in B Ltd (Recognition of consolidated fair value adjustment and

Cr R 13750 76250

elimination of amount recognised in separate financial

statements) At 31 December 20X5 the fair value of the investment is R340 000. A fair value adjustment of R30 000 (340 000 - 310 000) is required in other comprehensive income, as this is now a normal IFRS 9 investment. As this adjustment has already been recognised in A Ltd's separate financial statements,

no consolidation journal entry is necessary. The above calculations can also be combined by making use of the following analysis of equity: Total R

At acquisition Share capital Retained earnings Net asset value Cost of investment

Current period Profit 1/1 - 3117 (1250 000 -1 000 000)

650 000

130 000 220 000 90 000

100 000

500 000

250 000 1 400 000

Loss on share issue Disposal of 5% Share capital

Since RE (20%-15%) R

150 000 500 000

Goodwill

Since acquisition Retained earnings (1 000000 - 500 000)

At (20%-15%) R

50 000 220 000 (73750)

150 000 (73750)

125 000 1 525 000

76250

, (220 000 + 150 000) x 5/20 = 92 500 b 125000 x 15% = 18750 Carrying amount of remaining investment = 220000 at + 150000 RE - 92 500' + 18 750 b = 296250. Fair value adjustment = fair value of 310000 less carrying amount of 296 250 = 13750

289

Change in interests in investments - other

The following represents extracts from the statement of profit or loss and other comprehensive income which reflect only items relating to B Ltd:

A Ltd Group Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended

31 December 20X5 Consolidated R

XXXX (XXXX)

Revenue Cost of sales

Fair value adjustment [90 000 (A Ltd) - 76250 Unl 4)] Share of profit of associate Unl 2)

XXXX (XXXX) (73750) 13750 50000

Loss before tax I ncome tax expense

(10 000) (XXXX)

Loss for the year Other comprehensive income: Items that will not be reclassified: I nvestments at FV through OCI

(10 000)

G ross profit Other expenses Loss on share issue by associate Unl 3)

Gains arising during the year (A Ltd)

30000 20000

Total comprehensive income for the year Loss attributable to: OVVners of the parent Non-controlling interest

(10 000) (10 000)

Total comprehensive income attributable to: OVVners of the parent Non-controlling interest

20000 20000

The following represents extracts from the statement of changes in equity which reflect only items

relating to B Ltd: A Ltd Group Consolidated Statement of Changes in Equity for the year ended 31 December 20X5 Retained earnings R

Opening balance Un11) Total comprehensive income: Loss for the year Other comprehensive income Closing balance

100000 (10 000)

I (10000)1 90000

Mark-tomarket reserve R

30000 1300001 30000

120000

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GAAP Handbook 2020: Volume 2

7.3 Share buy-back by the investee An investee can repurchase its issued share capital from existing shareholders. A share buy-back results in a decrease in the net asset value of the investee. From the perspective of the investee's separate financial statements, a share buy-back represents a transaction with owners in their capacity as owners, and as such is recognised directly in equity (in the statement of changes in equity). Entities would generally attempt to reduce the impact of a share buy-back on its distributable reserves. Therefore, a share repurchase is normally made from share capital first before any other distributable reserves are utilised. The investee records the following iournal entry in its own records: Share capital other reserves (e.g. retained earnings) Bank Recordina of the share buy-back bv the investee)

Dr

Cr

R xxxx

R

XXXX XXXX

If shares are bought back from the investor, the investor recognises the transaction as a normal sale of a financial asset. The investor will record the following i OUillal entry in its own financial statements:

Bank I nvestment in investee Profit/(Ioss) on sale of shares Recording of sale of shares in the investee)

Dr

Cr

R

R

XXXX XXXX XXXX

If the investor measures the investment at fair value in its separate financial statements in terms of IFRS 9, any fair value adjustments previously accumulated in equity (via other comprehensive income), may be transferred to retained earnings on the disposal of the shares:

Mark-to-market reserve (SoC E) Retained earnings (SoC E) (Transfer of fair value gains to retained earnings on disposal of shares)

Dr R XXXX

Cr R XXXX

Or

Retained earnings (SoC E) Mark-to-market reserve (SoC E) (Transfer of fair value losses to retained earnings on disposal of shares)

Dr R XXXX

Cr R XXXX

Depending on which investors shares are repurchased from, the investor's interest in the investee could remain llllchanged, it could increase or it could decrease. In order to accollllt for the transaction in the consolidated financial statements it is necessrny to compare the amollllt of the investor's share in the net asset value of the investee both before and after the share buy-back. The increase or decrease in the investor's share of the net asset value is compared to the net cash flow for the investor as part of the transaction (cash inflow received from the share buy-back). Depending on the scenario, the resulting difference is booked either in profit or loss or directly in equity. This could be illustrated as follows:

Change in interests in investments - other

291

% interest held before the share buy-back

% interest held after the share buy-back

X consolidated net asset value of investee immediately prior to the share buy-back

X consolidated net asset value of investee immediately after the share buy-back

"

)

y Increase or decrease in the investor's share of the consolidated net asset value of the investee

r---

>Cash inflow for the investor as a result of the share buy-back by the investee

Depending on scenario the difference is recognised in profit or loss or directly in equity

f-'

In addition to the recognition of the difference between the change in the investor's share of the consolidated net asset value of the investee and the cash inflow for the investor, IFRS also requires the fair value adjustment of certain previously held interests to be recognised in profit or loss (refer to the smnmrny in section 7.1).

Example 7.7: Increase of an interest in an existing subsidiary On 1 January 20X1 A Ltd acquired an 80% interest in the 150000 issued shares of B Ltd for R540 000. A Ltd elected to measure non-controlling interest at the date of the acquisition at their fair value of R135 000. On 1 August 20X5, B Ltd repurchased 50000 shares at R2,50 per share. Of the 50000 shares, 36000 shares were repurchased from A Ltd and the remainder of the shares were repurchased from non-controlling shareholders. It is the policy of A Ltd to measure investments in subsidiaries at cost in its separate financial statements. The equity of B Ltd consisted of the following items on various dates:

Share capital Retained earnings

1/1/20X1 R 200000 450000

1/1/20X5 R 200000 950000

1/8/20X5 before buy-back R 200000 1 200000

650000

1 150000

1 400000

1/8/20X5 after buyback R 100000 1 175000

31/12/20X5 R 100000 1 425000

1 275000

1 525000

Before the repurchase of the 50000 shares by B Ltd, A Ltd had an 80% interest in B Ltd. After the repurchase of 50000 shares by B Ltd, A Ltd has an 84% interest [(150 000 x 80% - 36 000) I (150 000 - 50 000) x 100[ in B Ltd. As B Ltd is a subsidiary of A Ltd at the reporting date (31 December 20X5), the consolidation process commences by adding the financial statements of A Ltd and B Ltd together on a line-by-line basis. The consolidation journal entries will therefore focus on the elimination of at-acquisition equity and the inclusion of non-controlling interest.

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On 1 January 20X1 A Ltd acquired control over B Ltd. On this date IFRS 3 should be applied. All the identifiable assets and liabilities of B Ltd should be recognised and measured in terms of IFRS 3. The goodwill (or bargain purchase gain) is determined as follows: R

Consideration transferred (80%) Non-controlling interest (20% at fair value)

540000 135000

Value for 100% interest Fair value of 100% of net assets

675000 650000

Goodwill

25000

Attributable to: OWners of the parent[540 000 - (650 000 x 80%)] Non-controlling interest ]135000 - (650 000 x 20%)]

20000 5000 25000

The following consolidation journal entry should be processed in 20X5 relating to the initial 80% investment: Journal 1 Share capital Retained earnings Investment in B Ltd Non-controlling interest (F/P) Goodwill

Dr R 200000 450000

Cr R

540000 135000 25000 675000

675000

At-acquisition elimination of the initial 80% interest)

Since acquisition to the beginning of the current financial year, the equity of B Ltd increased by R500 000 (1 150000 - 650 000). Adding the financial statements on a line-by-line basis has the effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 20% should be allocated to the non-controlling shareholders: Journal 2 Retained earnings ](950 000 450000) x 20%] Non-controlling interest (F/P) (Allocation of since acquisition reserves to noncontrollinq shareholders)

Dr

Cr

R

R

100000 100000

From the beginning of the year to the date that the additional shares were Issued, B Ltd made a profit of R250 000 (1 200000 - 950000). Adding the financial statements on a line by line basis has the effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 20% should be allocated to the non-controlling shareholders: Journal 3 Non-controlling interest (P/L) Non-controlling interest (F/P) (250 000 x 20%) (Allocation of the profit for the first seven months to non-controlling shareholders)

Dr

Cr

R

R

50000 50000

On 1 August 20X5 B Ltd repurchased 50000 shares and the net asset value of B Ltd decreases by R125 000 (50000 x 2,50). B Ltd repurchases 36000 shares from A Ltd. In its separate financial statements A Ltd de recognises R162 000 ]540000 I (150 000 x 80%) x 36 ODD] of the investment in the subsidiary and reports a loss of R72 000 ]36000 x 2,50 - 162 ODD] in profit or loss. As a result of the transaction the controlling and the non-controlling shareholders' interest in the net asset value of B Ltd changes as follows:

293

Change in interests in investments - other

A Ltd

Noncontrolling interest

R

R

1 092000

208000

(1 140000)

(285000)

(48000)

(77 000)

I nterest after the share buy-back Net asset value (1 275000 x 84%); (1 275000 x 16%) Goodwill (20 000 + 5 000 x 41,0); (5 000 x 161,01' I nterest before the share buy-back Net asset value (1 400000 x 80%); (1 400000 x 20%) Goodwill Decrease of interest in the subsidiary Cash inflow for the investor (36000 x 2,50)

90000

Gain on the share buy-back by the subsidiary

42000

At acquisition date the non-controlling interest owned R5 000 of the goodwill. This goodwill related to their 20% interest. As their interest now decreases to 16%, a pro rata portion of the goodwill should be transferred to A Ltd, i.e. R5 000 x 4ho = R1 000. Their remaining interest in the goodwill is therefore only R4 000 (R5 000 x 16 / 20 ). The consolidation journal entry necessary to record the issue of the additional shares by the subsidiary = ____=_-, is as follow,,,s,,' Journal 4 Dr Cr R R Share capital* 100000 Retained earnings* 25000 Non-controlling interest (F/P) 77 000 Investment in B Ltd# 162000 Retained earnings (consolidated gain) 42000 Loss on sale of shares (separate) (P/L)' 72 000

-==--;-_________________

239000

239000

(Consolidation journal entry on the share buy-back by the subsidiary)· The following should be noted from this consolidation journal entry: No goodwill is derecognised as part of the transaction. The original goodwill of R25 000 is still reflected in the consolidated statement of financial position. However, the interest in this goodwill changed as a result of the transaction. Previously the controlling shareholders owned R20 000 of the goodwill and the non-controlling shareholders R5000. As part of the transaction the noncontrolling shareholders relinquished R1 000 of the goodwill to the controlling shareholders. After the transaction the parent owns R21 000 (20000 + 1 000) and the non-controlling shareholders R4 000 (5 000 - 1 000) of the goodwill. The gain of R42 000 is recognised directly in equity (retained earnings). This is due to the fact that the transaction did not result in the loss of control, and as such the parent has merely transacted with the non-controlling shareholders. The line items marked with * reverse the entry booked in the separate financial statements of B Ltd (apart from cash). (Share capital was debited with R200000 in journal 1. At reporting date (31 December 20X5) the share capital amounts to only R100000 in B Ltd's separate financial statements. After journal 1 has been processed, the share capital thus reflects a debit balance of R100000. This debit balance is eliminated in journal 4. The same applies for the retained earnings.) The line items marked with # reverse the entry booked in the separate financial statements of A Ltd (apart from cash). (The investment was credited with R540000 in journal 1. At reporting date (31 December 20X5) the investment amounts to only R378 000 in A Ltd's separate financial

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GAAP Handbook 2020: Volume 2 statements. After journal 1 has been processed, the investment thus reflects a credit balance of R162 000. This credit balance is eliminated in journal 4.)

From the date of the share buy-back to the end of the year, B Ltd made a profit of R250 000 (1 425000 - 1 175 000). Adding the financial statements on a line-by-line basis has the effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 16% should be allocated to the non-controlling shareholders:

Journal 5

Dr R

Cr R

40000

Non-controlling interest (P/L) Non-controlling interest (F/P) (250 000 x 16%) (Allocation of the profit for the last five months to noncontrollinQ shareholders)

40000

After processing all the consolidation journal entries, the non-controlling interest in the statement of financial position is reflected as R248 000 [135 000 Unl 1) + 100000 Unl 2) + 50000 Unl 3) - 77 000 Unl 4) + 40 000 Unl 5)[. This amount can also be calculated as follows: R Net asset value at the end of the year (1 525000 x 16%) Goodwill

244000 4000 248000

The above calculations can also be combined by making use of the following analysis of equity: Total R

At Since RE NCI (80% - 84%) (80% - 84%) (20% -16%) R R R

At acquisition Share capital Retained earnings

200 000 450 000

Net asset value Goodwill

650 000 25 000

520 000 20 000

130 000 5 000

Consideration + NCI

675 000

540 000

135 000

Since acquisition Retained earnings (950 000 - 450000)

500 000

Current period Profit 1/1 - 31/7 (1200 000 - 950 000)

200 000

50 000 285 000 (77 000)

250 000

210 000

40 000

1 550 000

852 000

248 000

540 000 42 000

(125 000)

'(105 000)

357000

90 000

Received (36000 x 2,5) Profit 1/8 - 31/12

100 000 235 000

600 000 42 000

250 000 1 425 000

Gain on buy-back Acquisition of 4% Share capital and RE

400 000

(1425 000 -1 175 000) , 285 000 x 4/20 = 57 000 b 125000 x 84% = 105000 c 125000 x 16% = 20 000

Change in interests in investments - other

295

The following represents extracts from the statement of changes in equity which reflect only items relating to B Ltd: A Ltd Group Consolidated Statement of Changes in Equity for the year ended 31 December 20X5 Attributable to owners of parent NonRetained controlling earnings Total interest R

R

R

Opening balance Profit and total comprehensive income for the year Repurchase of shares by subsidiary Un14)

400000 ' 410000 3 42000

400 000 410000 42 000

235 000 2 90000 4 (77 000)

Closing balance

852000

852000

248000

Total R

635000 500000 (35 ODD? 1 100000

950000 (separate) - 450 000 Un11) - 100 000 Un12) - 400 000 or (950 000 - 450 000) x 80% = 400 000 1 150 000 x 20% + 5 000 (goodwill) = 235 000 500000 (separate) - 50 000 Unl 3) - 40 000 Unl 5) = 410 000 or (250000 x 80%) + (250 000 x 84%) = 410 000 50000 Unl 3) + 40 000 Unl 5) = 90 000 Note that the R35 000 represents the net cash outflow for the group. The subsidiary paid cash of R125 000 (50000 x 2,50) for the share repurchase, while the parent received cash of R90000 (36000 x 2,50). Stated differently, the net cash outflow for the group relates to the 14000 shares that were repurchased from the non-controlling shareholders (14 000 x 2,50).

Example 7.8: Decrease of an interest in an existing subsidiary (control not lost) On 1 January 20X1 A Ltd acquired an 80% interest in the 150000 issued shares of B Ltd for R510000. A Ltd elected to measure non-controlling interest at the date of the acquisition at their proportionate share of the net fair value of the identifiable assets and liabilities. On 1 August 20X5, B Ltd repurchased 50000 shares at R2,50 per share. Of the 50000 shares, 44000 shares were repurchased from A Ltd and the remainder of the shares were repurchased from the non-controlling shareholders. It is the policy of A Ltd to measure investments in subsidiaries at cost in its separate financial statements. The equity of B Ltd consisted of the following items on various dates:

Share capital Retained earnings

1/1/20X1 R 200000 450000

1/1/20X5 R 200000 950000

1/8/20X5 before buy-back R 200000 1 200000

650000

1 150000

1 400000

1/8/20X5 after buyback R 100000 1175000

31/12/20X5 R 100000 1 425000

1 275000

1 525000

Before the repurchase of the 50000 shares by B Ltd, A Ltd had an 80% interest in B Ltd. After the repurchase of the 50000 shares by B Ltd, A Ltd has a 76% interest [(150000 x 80% - 44000) I (150000 - 50 000) x 100[ in B Ltd. As B Ltd is a subsidiary of A Ltd at the reporting date (31 December 20X5), the consolidation process commences by adding the financial statements of A Ltd and B Ltd together on a line-by-line basis. The consolidation journal entries will therefore focus on the elimination of at-acquisition equity and the inclusion of non-controlling interest. On 1 January 20X1 A Ltd acquired control over B Ltd. On this date IFRS 3 should be applied. All the identifiable assets and liabilities of B Ltd should be recognised and measured in terms of IFRS 3. The goodwill (or bargain purchase gain) is determined as follows:

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Consideration transferred (80%) Non-controlling interest (20%) (650 000 x 20%)

510000 130000

Value for 100% interest Fair value of 100% of net assets

640000 650000

Bargain purchase gain

(10 000)

Attributable to: ONners of the parent[510 000 - (650 000 x 80%)] Non-controlling interest ]130000 - (650 000 x 20%)]

(10 000) (10 000)

The following consolidation journal entry should be processed in 20X5 relating to the initial 80% investment: Journal 1 Share capital Retained earnings Investment in B Ltd Non-controlling interest (F/P) Retained earnings (bargain purchase gain)

Dr R 200000 450000

Cr R

510000 130000 10000 650000

650000

At-acquisition elimination of the initial 80% interest)

Since acquisition to the beginning of the current financial year the equity of B Ltd increased by R500 000 (1 150000 - 650 000). Adding the financial statements on a line-by-line basis has the effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 20% should be allocated to the non-controlling shareholders: Journal 2

Retained earnings ](950 000 450000) x 20%] Non-controlling interest (F/P) (Allocation of since acquisition reserves to noncontrolling shareholders)

Dr

Cr

R

R

100000 100000

From the beginning of the year to the date that the additional shares were issued, B Ltd made a profit of R250 000 (1 200000 - 950000). Adding the financial statements on a line by line basis has the effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 20% should be allocated to the non-controlling shareholders:

Journal 3

Non-controlling interest (P/L) Non-controlling interest (F/P) (250000 x 20%) (Allocation of the profit for the first seven months to non-controllinq shareholders)

Dr

Cr

R

R

50000 50000

On 1 August 20X5 B Ltd repurchases 50 000 shares and the net asset value of B Ltd decreases by R125 000 (50000 x 2,50). B Ltd repurchases 44 000 of these shares from A Ltd. A Ltd decreases the investment in the subsidiary in its separate financial statements with R187 000 ]510000 I (150 000 x 80%) x 44000]. In addition A Ltd recognises a loss on the sale of the 44000 shares of R77 000 (44000 x 2,50 - 187000). As a result of the transaction the controlling and the non-controlling shareholders' interest in the net asset value of B Ltd changes as follows:

Change in interests in investments - other

297

A Ltd

Noncontrolling interest

R

I nterest after the share buy-back Net asset value (1 275000 Goodwill

969000

x 76%); (1 275000 x 24%)

I

I nterest before the share buy-back Net asset value (1 400000 Goodwill

96! 000

(1 120000)

Cash inflow for the investor (44000

x 2,50)

Loss on the share buy-back by the subsidiary

I I 30~ I 000

(280000)

~

x 80%); (1 400000 x 20%)

(Decrease)/increase in interest in the subsidiary

R

306000

(151 000)

26000

110000 (41000)

The consolidation journal entry necessary to record the share buy-back by the subsidiary is as follows: Journal 4

Dr

R Share capital* Retained earnings* Non-controlling interest (F/P) Investment in B Ltd# Retained earnings (consolidated loss) Loss on sale of shares (separate) (P/L)'

Cr

R 100000 25000 26000

187000 41 000 77 000 228000

228000

(Consolidation journal entry on the share buy-back by the subsidiary)· The following should be noted from this consolidation journal entry: The loss of R41 000 is recognised directly in equity (retained earnings). This is due to the fact that the transaction did not result in the loss of control, and as such the parent has merely transacted with the non-controlling shareholders. The line items marked with * reverse the entry booked in the separate financial statements of B Ltd (apart from cash). (Share capital was debited with R200000 in journal 1. At reporting date (31 December 20X5) the share capital amounts to only R100 000 in B Ltd's separate financial statements. After journal 1 has been processed, the share capital thus reflects a debit balance of R100000. This debit balance is eliminated in journal 4. The same applies for the retained earnings.) The line items marked with # reverse the entry booked in the separate financial statements of A Ltd (apart from cash). (The investment was credited with R510 000 in journal 1. At reporting date (31 December 20X5) the investment amounts to only R323 000 in A Ltd's separate financial statements. After journal 1 has been processed, the investment thus reflects a credit balance of R187 000. This credit balance is eliminated in journal 4.) From the date of the share buy-back to the end of the year, B Ltd made a profit of R250 000 (1 425000 - 1 175000). Adding the financial statements on a line-by-line basis has the effect that this amount is reflected as being fully attributable to the controlling shareholder (A Ltd). To correct the situation 24% should be allocated to the non-controlling shareholders: Journal 5

Non-controlling interest (P/L) Non-controlling interest (F/P) (250 000 x 24%) (Allocation of the profit for the last five months to noncontrollinQ shareholders)

Dr

Cr

R

R

60000 60000

298

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After processing all the consolidation journal entries, the non-controlling interest in the statement of

financial position is reflected as R366 000 [130 000 Unl 1) + 100000 Unl 2) + 50 000 Unl 3) + 26000 Unl 4) + 60 000 Unl 5)]. This amount can also be calculated as follows: R

Net asset value at the end of the year (1 525000 x 24%) Goodwill

366000

366000

The above calculations can also be combined by making use of the following analysis of equity: Total

R

At Since RE (80% - 76%) (80% - 76%) R R

NCI (20% - 24%) R

At acquisition Share capital Retained earnings

200000 450000

Net asset value Bargain purchase gain

650000 (10000)

520000 (10000)

130000

Consideration + NCI Bargain purchase gain eliminated from "total" and "at" columns

640000 10000

510000 10000

130000

Since acquisition Retained earnings (950 000 - 450 000)

500000

400000

100000 230000

Current period Profit 1/1 - 3117 (1200000 - 950000)

250000

200000

50000

600000 (41 000)

280000 26000

250000

190000

60000

1 525000

749000

366000

1 400000

520000 (41000)

Loss on buy-back Disposal of 4% Share capital and RE

(125000)

'(56000) '(95000) 110 000

Received (44 000 x 2,5)

Profit 1/8 - 31/12 (1425000 -1 175000) , (520 000 + 600 000) x 4/80 = 56 000 b 125000 x 76% = 95 000 c 125000 x 24% = 30 000

The following represents extracts from the statement of changes in equity which reflect only items

relating to B Ltd: A Ltd Group Consolidated Statement of Changes in Equity for the year ended 31 December 20X5

Attributable to owners of parent

Non-

Opening balance Profit and total comprehensive income for the year Share buy-back by subsidiary Unl 4)

earnings R 410000 ' 390000 3 (41000)

controlling Total interest R R 410000 230000 2 390000 1100004 (41000) 26000

Closing balance

759000

759000

Retained

366000

Total R 640000 500000 (15 ODD? 1 125000

299

Change in interests in investments - other 950000 (separate) - 450 000 Un11) + 10000 Unl1 - bargain purchase gain) - 100 000 Un12) = 410 000 or [(950 000 - 450 000) x 80%[ + 10000 Un11) = 410 000 1 150000 x 20% = 230 000 500000 (separate) - 50 000 Un13) - 60 000 Un15) = 390 000 or 250 000 x 80% + 250 000 x 76% = 390 000 50000 Unl 3) + 60 000 Unl 5) = 110000

Note that the R 15 000 represents the net cash outflow for the group. The subsidiary paid cash for repurchase of the shares of R 125 000 (50 000 x 2,50), while the parent received cash of R 11 0 000 (44000 x 2,50). Stated differently, the net cash outflow for the group relates to the 6000 shares repurchased from the non-controlling shareholders (6 000 x 2,50).

Example 7.9: Step acquisition of a subsidiary as a result of shares being repurchased by the investee On 1 January 20X1 A Ltd acquired a 40% interest (an associate) in the 150000 issued shares of B Ltd for R320 000. On 1 August 20X5, B Ltd repurchased 50 000 shares at R2,50 per share. Of the 50 000 shares, 6000 were repurchased from A Ltd and the remainder of the shares were repurchased from other shareholders. As a result of the share buy-back, A Ltd obtained control of B Ltd. All the assets and liabilities of B Ltd were fairly valued at 1 August 20X5, except for land that was understated by R554 124. A Ltd elected to measure non-controlling interest at the date of the acquisition (1 August 20X5) at their fair value of R680 000. The fair value of a 54% interest was R800 000 on 1 August 20X5. It is the policy of A Ltd to measure investments in subsidiaries and associates at cost in its separate financial statements. The equity of B Ltd consisted of the following items on various dates (excluding the adjustment to the value of land): 1/8/20X5 1/8/20X5 before after buy1/1/20X1 1/1/20X5 buy-back back 31/12/20X5 R R R R R Share capital 200000 200000 200000 100000 100000 Retained earnings 450000 950000 1 200000 1175000 1 425000 650000

1 150000

1 400000

The profit for the year of B Ltd was earned as follows: 1/1/20X5 1/8/20X53117120X5 31/12/20X5

1 275000

Total

R

R

R

1 000000 (600 000)

1 200000 (650 000)

2200000 (1 250000)

G ross profit Other expenses

400000 (52800)

550000 (202800)

950000 (255600)

Profit before tax I ncome tax expense

347200 (97200)

347200 (97200)

694400 (194400)

Profit for the year

250000

250000

500000

Revenue Cost of sales

1 525000

Before the share buy-back of the 50 000 shares by B Ltd, A Ltd had a 40% interest in B Ltd. After the share buy-back of the 50000 shares by B Ltd, A Ltd has a 54% interest [(150 000 x 40% - 6 000) I (150000 - 50000) x 100[ in B Ltd. B Ltd therefore changes from an associate to a subsidiary. The movements in the equity of B Ltd while it was an associate can be analysed as follows:

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300

At Since RE (40% - 54%) (40% - 54%) R R

Total R At acquisition Share capital Retained earnings

200000 450000 650000

Net asset value Cost of investment

260000 320000 60000

Goodwill Since acquisition Retained earnings (950 000 - 450 000)

500000

200000

Current period Profit 1/1120X3 - 3117120X3

250000

100000

1 400000 Gain on buy-back Acquisition of 14% Share capital and retained earnings Received (6 000 x 2,5)

(125000)

320000 143500

300000 143500

a196 000 '(67500) 15000

443500

1 275000

'1400000x 14%= 196000 b 125000 x 54% = 67 500 Carrying amount of remaining 54% investment = 320000 at + 300000 RE + 196 OOOa - 67 500b = 748500. Fair value adjustment = fair value of 800000 less carrying amount of 748500 = 51 500. As B Ltd is a subsidiary of A Ltd at the reporting date (31 December 20X5), the consolidation process commences by adding the financial statements of A Ltd and B Ltd together on a line-by-line basis. The consolidation journal entries will therefore focus on the elimination of at-acquisition equity and the inclusion of non-controlling interest. Due to the fact that all equity items as at 1 August 20X5 (acquisition date) will be eliminated from the consolidated financial statements by means of the atacquisition journal entry, it is necessary to include in the consolidated financial statements the portion of B Ltd's equity that accrued to A Ltd while B Ltd was an associate - this will be done by means of pro forma consolidation journals. The following consolidation journal entry should be processed in 20X5 relating to the opening equity of the original 40% investment" Journal 1 Cr Dr R

Investment in B Ltd Retained earnings [(950 000 - 450 000) x 40%[ (Recognition of opening equity while the investment was still an associate)

R

200000 200000

For the first seven months B Ltd made a profit of R250 000: Journal 2 Investment in B Ltd Share of profit of associate (P/L) (250000 x 40%) Share of profit of associate for the first seven months)

Dr

Cr

R

R

100000 100000

On 1 August 20X5 B Ltd repurchases 50 000 shares and the net asset value of B Ltd decreases by R125 000 (50 000 x 2,50). B Ltd repurchases 6000 of these shares from A Ltd. A Ltd decreases the investment in the subsidiary in its separate financial statements with R32 000 [320000 I (150 000 x 40%) x 6 000[. In addition A Ltd recognises a loss on the sale of the shares of R17 000 (6 000 x 2,5032000). As a result of the transaction A Ltd's' interest in the net asset value of B Ltd changes as follows:

Change in interests in investments - other

301 A Ltd R

I nterest after the share buy-back

748500

Net asset value (1 275000 x 54%) Goodwill I nterest before the share buy-back

(620000)

Net asset value (1 400000 x 40%) Goodwill Cash inflow for the investor (6000 x 2,50)

128500 15000

Gain on the share buy-back by B Ltd

143500

I ncrease of interest in the associate

The consolidation journal entry necessary to record the share buy-back by B Ltd is as follows:

Journal 3 Investment in B Ltd

Dr

Cr

R

R

160500

Loss on sale of shares (separate) (P/L) Gain on share buy-back (consolidated) (P/L)

17000 143500 160500

160500

(Consolidation journal entry on the share buy-back by B

Ltd) On 1 August 20X5 (after the buy-back) the carrying amount of the 54% investment is R748 500 [320000 (separate) - 32 000 (buy-back) + 200 000 Un11) + 100 000 Un12) + 160500 Un13) = 748 500 or 1 275000 x 54% + 60 000 (goodwill) = 748500[. The investment should be adjusted to its fair value of R800 000 on 1 August 20X5. The following consolidation journal entry is necessary to record this:

Journal 4 Investment in B Ltd

Dr

Cr

R

R

51 500

Fair value adjustment (P/L) (800 000 - 748 500)

51 500

Fair value adjustment on the date of obtaininQ control)

On 1 August 20X5 A Ltd acquired control over B Ltd. On this date IFRS 3 should be applied. All the identifiable assets and liabilities of B Ltd should be recognised and measured in terms of IFRS 3. A journal entry is necessary to adjust the carrying amount of land to its fair value on the acquisition date:

Journal 5 Land Deferred tax (554124 x 22,4%)

Dr

Cr

R

R

554124 124 124 430000

Revaluation surplus

554124

554124

Revaluation of land at the acquisition date) Note that this represents a business combination without the transfer of consideration as described in paragraphs 43 and 44 of IFRS 3. To determine the amount of goodwill in a business combination in which no consideration is transferred, the acquirer should use the acquisition-date fair value of the acquirer's interest in the acquiree in place of the consideration transferred. The goodwill (or bargain purchase gain) is determined as follows on 1 August 20X5:

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302

R

Consideration transferred (54%) Fair value of previously held interest Non-controlling interest (46% at fair value)

800000 680000

Value for 100% interest Fair value of 100% of net assets (1 275000 + 430 000)

1 480000 1 705000

Bargain purchase gain

(225000)

Attributable to: ONners of the parent [800000 - (1 705000 x 54%)[ Non-controlling interest [680000 - (1 705000 x 46%)[

(120700) (104300) (225000)

The bargain purchase gain can also be calculated by making use of the following analysis of equity: Total R At acquisition Share capital Retained earnings (950 000 - 25 000 buy-back)

Profit 1/1 - 31/7 Revaluation surplus

At (54%) R

Since RE

(54%) R

NCI (46%) R

100000 925000 250000 430000

Net asset value Bargain purchase gain

1 705000 (225000)

920 700 (120700)

784300 (104300)

Consideration + NCI Bargain purchase gain eliminated from "total" and "at" columns Profit 1/8 - 31/12

1 480000

800000

680000

225000 250000

120700

1 955000

920700

135000

115 000

135000

795000

The consolidation journal entry necessary to eliminate the investment at acquisition date is as follows:

Journal 6 Share capital Retained earnings (950 000 - 25000) Revaluation surplus Revenue* Cost of sales* other expenses* Income tax expense* Non-controlling interest (F/P) Investment in B Ltd Bargain purchase gain

Dr

Cr

R

R

100000 925000 430000 1 000000 600000 52800 97200 680000 800000 225000 2455000

2455000

Elimination of investment at acquisition date) Note: Adding the financial statements on a line-by-line basis has the effect that revenue, cost of sales, other expenses and the income tax expense are reflected in the consolidated financial statements for the entire year. However, the profit earned while the investment was still an associate has already been accounted for in journal 2. To avoid double counting, and as the profit earned during the first seven months forms part of the at-acquisition equity for purposes of IFRS 3, the profit should be eliminated (with reference to the individual line items) on the date when control is obtained. From the date of the share buy-back to the end of the year, B Ltd made a profit of R250 000. Adding the financial statements on a line-by-line basis has the effect that this amount is reflected as being fully

Change in interests in investments - other

303

attributable to the controlling shareholder (A Ltd). To correct the situation 46% should be allocated to the non-controlling shareholders:

Journal?

Non-controlling interest (P/L) Non-controlling interest (F/P) (250 000 x 46%)

Dr

Cr

R

R

115000 115000

(Allocation of the profit for the last five months to non-

controllinq shareholders) After processing all the consolidation Journal entries the non-controlling Interest In the statement of

financial position is reflected as R795 000 [680000 Uournal6) + 115000 Uournal 7)]. This amount can also be calculated as follows: R

Net asset value at the end of the year [(1 525000 + 430 000) x 46%] Bargain purchase gain

899300 (104300) 795000

The following represents extracts from the statement of profit or loss and other comprehensive income which reflect only items relating to B Ltd:

A Ltd Group Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 20X5 Consolidated R

Revenue [2 200 000 - 1 000000 Unl 6)] Cost of sales [1 250000 - 600 000 UnI6)] G ross profit

Other expenses [255 600 - 52 800 Unl 6)] Other income Unl 6 - bargain purchase gain)

Gain on share buy-back [17 000 (A Ltd) - 17 000 Un13) + 143500 UnI3)] Fair value adjustment Unl 4) Share of profit of associate Unl 2)

1 200000 (650000) 550000 (202800) 225000 143500 51 500 100000

Income tax expense [194 400 - 97 200 UnI6)]

867200 (97200)

Profit and total comprehensive income for the year

770000

Profit before tax

Profit and total comprehensive income attributable to: ONners of the parent *

Non-controlling interest Un17)

655000 115000 770000

Note that the bargain purchase gain of R225 000 is in terms of paragraph 34 of IFRS 3 fully attributed to the parent (acquirer). The following represents extracts from the statement of changes in equity which only reflect items

relating to B Ltd:

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304

A Ltd Group Consolidated Statement of Changes in Equity for the year ended 31 December 20X5 Attributable to owners of parent NonRetained controlling earnings Total interest R R R R R R Opening balance 200000 ' 200000 Profit and total comprehensive income for the year 655000 655000 115000 Acquisition of subsidiary Un16) 680000 Closing balance 855000 855000 795000

Total R R 200000 770000 680000 1 650000

925000 (separate) + 200 000 Un11) - 925 000 Un16) - 200 000 or (950000 - 450 000) x 40% = 200 000

Example 7.10: Decrease of an interest in a subsidiary (control is lost) On 1 January 20X1 A Ltd acquired a 54% interest in the 150000 issued shares of B Ltd for R390 000. A Ltd elected to measure non-controlling interest at the date of the acquisition at their proportionate share of the net fair value of the identifiable assets and liabilities. On 1 August 20X5, B Ltd repurchased 50 000 shares at R2,50 per share. Of the 50 000 shares, 36 000 shares were repurchased from A Ltd and the remainder of the shares were repurchased from other parties. From 1 August 20X5 A Ltd exercised significant influence over the financial and operating policies of B Ltd. On 1 August 20X5 the fair value of the remaining interest was R750 000. It is the policy of A Ltd to measure investments in subsidiaries and associates at cost in its separate financial statements. The equity of B Ltd consisted of the following items on various dates: 1/8/20X5 1/8/20X5 before after buy1/1/20X1 1/1/20X5 buy-back back 31/12/20X5 R R R R R Share capital 200000 200000 200000 100000 100000 Retained earnings 450000 950000 1 200000 1 175000 1 425000 650000 1 150000 1 400000 1 275000 1 525000

The profit for the year of B Ltd was earned as follows: 1/1/20X5 1/8/20X53117120X5 31/12/20X5

Total

R

R

R

1 000000 (600 000)

1 200000 (650 000)

2200000 (1 250000)

G ross profit Other expenses

400000 (52800)

550000 (202800)

950000 (255600)

Profit before tax I ncome tax expense

347200 (97200)

347200 (97200)

694400 (194400)

Profit for the year

250000

250000

500000

Revenue Cost of sales

Before the repurchase of the 50000 shares by B Ltd, A Ltd had a 54% interest in B Ltd. After the repurchase of the 50000 shares by B Ltd, A Ltd has a 45% interest [(150000 x 54% - 36000) I (150000 - 50 000) x 100[ in B Ltd.

Change in interests in investments - other

305

The goodwill (or bargain purchase gain) is determined as follows on 1 January 20X1: R

Consideration transferred (54%) Non-controlling interest (46%) (650000 x 46%)

390000 299000

Value for 100% interest Fair value of 100% of net assets

689000 650000

Goodwill

39000

Attributable to: ONners of the parent[390 000 - (650 000 x 54%)] Non-controlling interest ]299000 - (650 000 x 46%)]

39000 39000

As B Ltd is an associate of A Ltd at the reporting date (31 December 20X5), the consolidation process commences with the financial statements of A Ltd only. The consolidation journal entries will therefore focus on the inclusion of the relevant items of B Ltd in the consolidated financial statements. The relevant items to be included will consist of items that accumulated while B Ltd was a subsidiary as well as items that accumulated while B Ltd was an associate. The following consolidation journal entry should be processed in 20X5 relating to the opening equity of the original 54% investment: Journal 1 Investment in B Ltd Retained earnings ](950 000 - 450 000) x 54%] (Recognition of opening equity while the investment was still a subsidiarv)

Dr R 270000

Cr R

270000

For the first seven months B Ltd made a profit of R250 000. For this period B Ltd was a subsidiary and the consolidation journal entry should therefore include each individual line item as well as noncontrolling interest: rJ~0~u~rn~a~/~2----------------------------------~D~r~------~C~r~--;

R Investment in B Ltd (250 000 x 54%) Revenue Cost of sales other expenses Income tax expense Non-controlling interest (P/L) (250 000 x 46%)

R

135000 1 000000 600000 52800 97200 115000 1 000000

1 000000

Consolidation of profit for the first seven months) On 1 August 20X5 B Ltd repurchases 50 000 shares and the net asset value of B Ltd decreases by R125 000 (50 000 x 2,50). B Ltd repurchases 36 000 of these shares from A Ltd. A Ltd derecognises R173 333]390000 I (150 000 x 54%) x 36 ODD] of the investment and records a loss on the sale of shares of R83 333 (36 000 x 2,50 - 173333) in profit or loss in its separate financial statements. As a result of the transaction A Ltd loses control and its interest in the net asset value of B Ltd changes as follows:

306

GAAP Handbook 2020: Volume 2

Interest after the share buy-back

A Ltd R 606250

Net asset value (1 275000 x 45%) Goodwill (39 000 x 45/54)

Interest before the share buy-back Net asset value (1 400000 Goodwill

(795000)

x 54%)

Decrease of interest in the investee Cash inflow for the investor (36 000 x 2,50) Loss on share buy-back

(188750) 90000 (98750)

The loss on the share buy-back is included in the consolidated financial statements with the following consolidation journal entry: Journal 3 Loss on share buy-back (consolidated) (P/L) Loss on sale of shares (separate) (P/L) Investment in B Ltd

Dr R

Cr R

98750 83333 15417 98750

98750

Recognition of the loss on the rights issue) On 1 August 20X5 the carrying amount of the investment in the consolidated financial statements is R606250 [390000 - 173333 (separate) + 270000 Unl 1) + 135000 Unl 2) - 15 417 Unl 3)[. This represents 45% of the net asset value after the rights issue, i.e. (1 275000 x 45%) + (39 000 x 45/54 (goodwill)) = R606 250. As control is lost, IFRS 10 requires that this investment should be remeasured

to fair value and that the adjustment should be recognised in profit or loss: Journal 4

Dr R

Investment in B Ltd 143750 Fair value adjustment (P/L) (750 000 - 606 250) (Adjustment of the remaining 45% interest to fair value on the date that control is lost)

Cr R 143750

The total gain on the loss of contrails therefore R45 000 (143750 - 98 750). This amount can also be supported by the methodology of paragraph 698 of I FRS 10:

Derecognise the assets and liabilities (including goodwill) (1 400000 + 39 000) Derecognise non-controlling interest (1 400000 x 46%) Fair value of consideration Distribution of shares Fair value of remaining interest Total loss on the loss of control

R (1 439000)

644000 90000 750000 45000

For the last five months B Ltd earned a profit of R250 000, while it was an associate of A Ltd: Journal 5

Investment in B Ltd Share of profit of associate (P/L) (250000 x 45%) Equity account profit for the last five months)

Dr

Cr

R

R

112500 112500

Journals 1 to 5 above do not account for non-controlling interest in the statement of financial position. As B Ltd is not a subsidiary of A Ltd at year-end, the statement of financial position as at 31 December 20X5 will not reflect any non-controlling interest relating to B Ltd. However, for purposes of

Change in interests in investments - other

307

presentation of the non-controlling interest in the statement of changes in equity, it is necessary to account for the opening balance and movements relating to the non-controlling interest. The opening balance of the non-controlling interest amounted to R529 000 (1 150 000 net assets x 46%) at 1 January 20X5. The only movements that took place during the year are the interest in profit amounting to R115 000 Uournal 2) and the derecognition of the balance at 1 August 20X5, amounting to R644 000 (1 400000 net assets x 46%). This information will be journalised as follows:

Journal 6 Non-controlling interest - loss of control (F/P) Non-controlling interest - opening balance (F/P) Non-controlling interest - share of profit (F/P)

Dr

Cr

R

R

644000 529000 115000 644000

644000

Recognition and derecognition of NCI) At 31 December 20X5 the consolidated balance of the investment in the associate is R862500 [750000 + 112500[. This amount consists of: R 686250 32500 143750

Net asset value at the end of the year (1 525000 x 45%) Goodwill (39 000 x 4 5/ 54 ) Fair value adjustment

862500 The above calculations can also be combined by making use of the follow ing analysis of equity: Total R

At Since RE NCI (54% - 45%) (54% - 45%) (46% - 55%) R R R

At acquisition

Share capital Retained earnings

200000 450000

Net asset value Goodwill

650000 39000

351 000 39000

299000

Consideration + NCI

689000

390000

299000

Since acquisition Retained earnings (950 000 - 450 000)

500000

270000

230000 529000

Current period Profit 1/1 - 3117

250000

135000

115 000

390000

405000

644000

(98750)

(98750)

N/A

250000

112 500

N/A

1 564000

418750

N/A

1 439000 Loss on share issue Disposal of 9% Share capital and RE Received (36 000 x 2,5) Profit 1/8 - 31/12

(125000)

'(132500) '(56250) 90000

, (390 000 + 405 000) x 9/54 = 132 500 b 125000 x 45% = 56 250 Carrying amount of remaining investment = 390 000 at + 405 000 RE - 132500' - 56 250 b = 606250. Fair value adjustment = fair value of 750 000 less carrying amount of 606 250 = 143 750 The following represents extracts from the statement of profit or loss and other comprehensive income which reflect only items relating to B Ltd:

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308

A Ltd Group Consolidated Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 December 20X5 Consolidated R

Revenue Unl 2) Cost of sales Unl 2)

1 000000 (600000)

G ross profit Other expenses Unl 2) Loss on share buy-back [83 333 (A Ltd) - 83 333 Unl 3) + 98 750 Unl 3)[ Fair value adjustments Unl 4) Share of profit of associate Unl 5)

400000 (52800) (98750) 143750 112500

Profit before tax Income tax expense Un12)

504700 (97200)

Profit and total comprehensive income for the year

407500

Profit and total comprehensive income attributable to: Owners of the parent Non-controlling interest Unl 2)

292500 115000 407500

The following represents extracts from the statement of changes in equity which reflect only items relating to B Ltd: A Ltd Group Consolidated Statement of Changes in Equity for the year ended 31 December 20X5

Opening balance Un11, 6) Profit and total comprehensive income for the year

Attributable to owners of parent NonRetained controlling earnings Total interest R R R 270000 270000 529000

292500

292500

562500

562500

P Closing balance

Total R 799000

115000 407500 (644000) (644000) 562500

Change in interests in investments - other

309

7.4 Summary of share issues and share buy-backs

Additional shares issued

~

/ Fresh issue

Shares repurchased

I

Rights issue

Investee:

Investee:

• Dr Bank • Cr Share capital

• Dr Bank • Cr Share capital

I Investee: • Dr Share capital

• Dr Other reserves • CrBank

! Investor: • Dr Investment

Investor: • Dr Investment

• CrBank

• CrBank • Dr Bank • Cr Proceeds from rights

Investor:

• Dr Bank • Cr Investment • Cr Profit or Dr Loss

! Consolidation: Gain/loss =

Consolidation: Gain/loss =

Consolidation: Gain/loss =

Interest after issue

Interest after issue

Less: Interest before Issue

Less: Interest before Issue

Interest after buyback

Less: Paid for additional shares

Less: Paid for additional shares Plus: Proceeds on sale of rights

Less: Interest before buy-back Plus: Received for shares

8

Foreign operations lAS 21 (Effective date 1 January 2005)

8.1 Introduction A South African company may establish a UK branch to deal with the marketing and selling of its products in Europe. Although a subsidiary or a division of the South African company, the UK branch would normally maintain its own accOllllting records in pOllllds. In order to consolidate or incorporate the results of the branch with the financial statements of the South African company, the results have to be translated into rand. lAS 21, The effects of changes in foreign exchange rates, provides guidance for the treatment of the translation of foreign operations into the functional or presentation currency of the parent. A foreign operation is defined as a subsidiary, associate, joint arrangement or branch of a reporting entity, of which the activities are based or conducted in a country or currency other than those of the reporting entity.

8.2 Identifying the functional currency When accOllllting for foreign operations, the first step is to identity the functional currency of each entity in the group. The functional currency is defined as the currency of the primary economic environment in which the entity operates. In a group situation it might happen that the functional currencies of some of the subsidiaries, associates, joint arrangements or branches are different from that of the parent company. Should this be the case, the financial statements of those subsidiaries, associates, joint arrangements or branches have to be translated from their functional currencies into the functional currency of the parent or, if the financial statements of the group are presented in a currency different from the functional currency of the parent, then into the group's presentation currency. This translation process is explained in section 8.3. [Note that if the presentation currency of the group is different from the parent's functional currency, the parent's financial statements also need to be translated into the presentation currency of the group following the principles in section 83] The standard provides primary as well as secondary indicators that should be used to determine an entity's functional currency. A list of additional factors is provided to determine the functional currency of a foreign operation, and whether its functional currency is the same as that of the reporting entity (being the entity that has the foreign operation as its subsidiary, branch, associate or joint arrangement). When the indicators are mixed and the functional currency is not obvious, management must use its judgement to determine the functional currency that most faithfully represents the effects of the underlying transactions, events and conditions. When a reporting entity prepares financial statements, lAS 21 requires each individual entity included in the reporting entity - whether it is a stand-alone entity, an entity with foreign operations (such as a parent) or a foreign operation (such as a subsidiary or branch) - to determine its functional currency, based on the indicators provided in the standard, and to measure its results and financial position in that currency. From this, the following should be noted: • An entity (whether a stand-alone entity or a foreign operation) does not have a free choice of a functional currency. The functional currency of an entity must be determined based on the indicators provided in the standard.

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• A group (for example, a parent with subsidiaries) cannot have a single fllllctional currency, as each individual entity in the group needs to determine its own fllllctional currency. A group can therefore only have a presentation currency.

8.2.1 Primary and secondary indicators The standard provides the following as primary indicators of an entity's fllllctional currency: • The currency that mainly influences sales prices for goods and services (this will often be the currency in which sales prices for goods or services are denominated and settled). • The currency of the COlllltry whose competitive forces and regulations mainly determine the sales price of its goods and services. • The currency that mainly influences labour, material and other costs of providing goods or services (this will often be the currency in which such costs are denominated and settled). If, after considering the primary indicators, it is not clear which currency is the entity's fllllctional currency, further consideration should be given to the following secondary indicators: • The currency in which fllllds from financing activities (i.e. issuing debt and equity instruments) are generated. • The currency in which receipts from operating activities are usually retained.

8.2.2 Additional factors for a foreign operation The standard provides a list of additional factors to be considered in determining the functional currency of a foreign operation. If it is however clear, based on the primary indicators above, what the fllllctional currency of the foreign operation is, then there is no need to consider any of the following factors: • Whether the activities of the foreign operation are carned out as an extension of the reporting entity, rather than being carned out with a significant degree of autonomy, as the fonner would indicate the same fllllctional currency as the reporting entity, while the latter would indicate different functional currencies. An example of the fonner is when the foreign operation sells only goods imported from the reporting entity and remits the proceeds to it. An example of the latter is when the operation accumulates cash and other monetrny items, incurs expenses, generates income and arranges borrowings, all substantially in its local currency. • Whether transactions with the reporting entity are a high or a low proportion of the foreign operation's activities. If high, this might indicate the same fllllctional currency as that of the reporting entity. • Whether cash flows from the activities of the foreign operation directly affect the cash flows of the reporting entity and are readily available for remittance to it, as this might indicate the same fllllctional currency as that of the reporting entity. • Whether cash flows from the activities of the foreign operation are sufficient to service existing and normally expected debt obligations without fllllds being made available by the reporting entity. This would be an indication of a fllllctional currency different from that of the reporting entity.

8.3 Foreign subsidiaries - the closing rate method The method used to translate the results and financial position of a foreign subsidirny into the fllllctional or presentation currency of the parent is referred to as the closing rate method. The following principles apply when using the closing rate method: • Assets and liabilities for each statement of financial position presented (i.e. including comparatives) should be translated at the closing rate at the date of that statement of financial position.

313

Foreign operations

• Income and expenses for each statement of profit or loss and other comprehensive income or separate statement of profit or loss presented (i.e. including comparatives) should be translated at exchange rates at the dates of the transactions (for practical reasons a rate that approximates the exchange rates at the dates of the transactions, for example an average rate for the period, is often used to translate income and expense items. However, if exchange rates fluctuate significantly, the use of the average rate for a period is inappropriate). • Equity existing at acquisition date should be translated at the exchange rate ruling at acquisition date. • Components of equity arising after acquisition date should be translated at exchange rates that were applicable when those components arose. For example, if an asset was revalued at a specific date after acquisition, the revaluation surplus will be translated at the exchange rate ruling at the date of the revaluation. Similarly, if shares were issued by the subsidirny after the acquisition date, the share capital will be translated at the exchange rate ruling on the date of the issue. • All resulting exchange differences should be recognised in a separate component of equity through other comprehensive income. This reserve is often referred to as the foreign currency translation reserve (FCTR). These exchange differences result from the fact that income and expenses are translated at the actual exchange rates while assets and liabilities are translated at closing rates, as well as from the fact that opening net assets are translated at the end of the current year at a closing rate that differs from the prior year's closing rate. As these exchange differences have no effect on future cash flows from operations, they should not be recognised in profit or loss for the period.

8.3.1 Basic principles for a wholly owned subsidiary The following example illustrates the process to be followed when translating the financial statements of a wholly owned subsidirny. The example ignores goodwill and the effect of tax on revaluations.

Example 8.1: Wholly owned subsidiary, no goodwill p Ltd, with a functional and presentation currency of Rand, acquired a 100% interest (control) in S Ltd on 31 December 20X1, at a cost of R8 100 000. S Ltd has a functional currency of US Doliar ($). The trial balance of S Ltd was as follows at acquisition date:

Land Machinery (carrying amount) Debtors Cuh Creditors Share capital Retained earnings

Dr/(Cr) $'000 500 400 200 100 (300) (500) (400)

S Ltd bought inventory for $60000 on 31 May 20X2. The cost of 60% of the inventory was settled immediately, while the other 40% was still outstanding at year-end. All the inventory was sold on 31 August 20X2 for $100 000. Eighty percent of the proceeds were received immediately, while the remainder was still outstanding at year-end. Land was revalued with $70 000 on 30 September 20X2, while the depreciation for the year amounted to $50 000. If it is assumed that these were the only transactions during the year ended 31 December 20X2, the trial balance at 31 December 20X2 will be as follows:

Land (500 opening + 70 revaluation) Machinery (carrying amount) (400 opening - 50 depreciation) Debtors (200 opening + 20 sales) Cash (100 opening - 36 purchases + 80 sales) Creditors (300 opening + 24 purchases) Share capital Retained earnings Revaluation surplus on land

Dr/(Cr) $'000 570 350 220 144 (324) (500) (400) (70)

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GAAP Handbook 2020: Volume 2

Sales

Dr/(Cr) $'000 (100) 60 50

Purchases Depreciation

Assume that the following exchange rates applied: 31 December 20X1 $1 = R9 31 May 20X2 $1 = R9,7 31 August 20X2 $1 = R9,2 30 September 20X2 $1 = R9,8 31 December 20X2 $1 = R10 Average for 20X2 $1 = R9,5 In order to translate the financial statements of a foreign operation, a translation trial balance CQuid be used. A translation trial balance is prepared by taking the foreign operation's trial balance in the foreign currency, and then applying the closing rate method to each of the individual items in the trial balance. The FCTR can then be taken as the balancing amount in the trial balance. The translation trial balance

of S Ltd at 31 December 20X2 will be as follows:

Land (570 x 10 ' ); (500 x 9) Machinery (350 x 10 ' ); (400 x 9) Debtors (220 x 10 ' ); (200 x 9) Cash (144 x 10 ' ); (100 x 9) Creditors (324 x 10 ' ); (300 x 9) Share capital (500 x 92 ) Retained earnings (400 x 92) Revaluation surplus (70 x 9,8 3 ) Depreciation (50 x 9,54 ) Sales (100 x 9,2 3 ) Purchases (60 x 9,7 3 ) Foreign currency translation reserve (FCTR) (balancing) 1

Closing rate for assets and liabilities

2

Rate at acquisition date for at-acquisition equity I nco me and expenses at actual rates Average rate for transactions that occurred evenly

3

4

20X2 Dr/(Cr) R'OOO 5700 3500 2200 1 440 (3240) (4500) (3600) (686) 475 (920) 582

20X1 Dr/(Cr) R'OOO 4500 3600 1 800 900 (2700) (4500) (3600)

(951)

The FCTR combines the effect of exchange movements on all assets and liabilities and can be analysed as follows:

Land [500 opening x (10 - 9)[ + [70 revaluation x (10 - 9,8)[ Machinery [400 opening x (10 - 9)[ - [50 depreciation x (10 - 9,5)[ Debtors [200 opening x (10 - 9)[ + [20 sales x (10 - 9,2)[ Cash [64 unused x (10 - 9)[ + [36 purchases x (9,7 - 9)[ + [80 sales x (10 - 9,2)[ Creditors [300 opening x (10 - 9)[ + [24 purchases x (10 - 9,7)[

R'OOO 514,0 375,0 216,0 153,2 (307,2) 951

From the above analysis it should be clear that there are tvvo reasons for the exchange differences, namely the restatement to closing rate of the net assets that existed at the end of the previous year, as well as income and expenses that arose during the current year and that were translated at the actual exchange rates, while the related assets and liabilities were translated at closing rates. Instead of translating the individual assets and liabilities by using a translation trial balance, the FCTR can also be calculated by translating net equity. Translating net equity will give the same result as the translation of assets and liabilities due to the accounting equation of equity = assets - liabilities. The net equity method can be illustrated as follows:

315

Foreign operations $'000

Equity at 31 December 20XI: Share capital Retained earnings

R'OOO

Rate

500 400

9,0 9,0

4500 3600

Total equity at closing rate Equity movements for 20X2: Sales Purchases Depreciation Revaluation FCTR (balancing)

900

9,0

8100

100 (60) (50) 70

9,2 9,7 9,5 9,8

Total equity at closing rate

960

10,0

920 (582) (475) 686 951 9600

Once the balance and movements of the FCTR have been calculated, the consolidated financial statements can be prepared. Before any consolidation journal entries are processed, it is important to determine what the starting point of the consolidation process is. As S Ltd is a subsidiary of P Ltd at the reporting date (31 December 20X2), the consolidation process commences by combining the financial statements of the parent and the subsidiary line by line by adding together items of assets, liabilities, equity, income and expenses. It is important to note that with a foreign subsidiary, the consolidation commences with the combined effect of the parent's amounts and the subsidiary's translated amounts. This means that a consolidation journal is not required to account for the translation process, as the translated amounts are already combined with those of the parent. The consolidation journal entries will therefore focus on the elimination of at-acquisition equity and the recording of non-controlling interest (if not a wholly owned subsidiary). The journal entry necessary to eliminate the at-acquisition equity and the investment in the subsidiary will be as follows:

Share capital Retained earnings Investment in S Ltd At-acauisition elimination iournal entrv)

Dr R'OOO 4500 3600

Cr R'OOO

8100

If it is assumed that the only Items reflected In P Ltd's financial statements are share capital amounting to R8 100000 and an investment in S Ltd amounting to R8 100000, the consolidated financial statements will be as follows:

Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2 20X2 R'OOO Revenue 920 Cost of sales (582) G ross profit 338 Other expenses (475) Loss for the year (137) 1 637 Other comprehensive income: Items that will not be reclassified to profit or loss Revaluation of land Items that may be reclassified to profit or loss Translation of foreign operations Total comprehensive income for the year

686

~ 951

~ 1 500

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316

Statement of changes in equity for the year ended 31 December 20X2 (extracts only)

Balance 1 January 20X2 Total comprehensive income Profit for the year other comprehensive income Balance 31 December 20X2

Share capital R'OOO 8100

FCTR

R'OOO

Revaluation surplus R'OOO

Retained earnings

R'OOO (137)

8100

951

686

951

686

(137)

Statement offinancial position at 31 December 20X2 20X2 R'OOO Assets Non-current assets Property, plant and equipment (5 700 + 3 500); (4 500 + 3 600) Current assets Trade receivables Cash Equity and liabilities Equity attributable to owners of the parent Share capital Retained earnings Foreign currency translation reserve Revaluation surplus Current liabilities Trade payables

20X1 R'OOO

9200

8100

2200 1 440

1 800 900

12840

10800

8100 (137) 951 686

8100

3240

2700

12840

10800

8.3.2 Non-controlling interest The non-controlling interest relating to a foreign subsidiary can be measured at acquisition date either at fair value or alternatively at the proportionate share of the subsidirny's identifiable net assets. Note that this section of the chapter deals only with non-controlling interest measured at the proportionate share of the subsidirny's identifiable net assets. If the non-controlling interest is measured at fair value, it may give rise to goodwill or a bargain purchase gain - goodwill and non-controlling interest measured at fair value are addressed in section 8.3.3. If a subsidirny is not wholly owned, the exchange differences arising from the restatement of assets and liabilities (and accumulated in the FCTR) should be allocated between the parent and the noncontrolling shareholders in the profit-sharing ratio. The following example illustrates the impact of non-controlling interest when accounting for a foreign operation.

Example 8.2: Non-controlling interest, no goodwill Handy Ltd purchased an 80% share in Brunich Gmbh on 1 January 20X1, upon incorporation of the latter. The non-controlling interest in Brunich was measured at acquisition date at their proportionate share of the net identifiable assets of Brunich. The trial balances of the two companies at 31 December 20X5 are set out below:

317

Foreign operations Handy R'OOO 480

Share capital Retained earnings (opening) Deferred taxation Long-term liabilities Operating profit (including dividends received)

I nvestment in Brunich at cost Land and buildings Plant and machinery Accumulated depreciation Current assets Depreciation I nterest paid Dividends paid 31 December 20X5 Taxation

200

Brunich FC'OOO 200 425 70 300 228

680

1 223

480 250 357 (136)

572 45 22 50 63

200 680

1 223

In order to translate the trial balance of Brunich, it is necessary to obtain the average exchange rate for 20X5 and the closing rates at 31 December 20X4 and 20X5. Assume the exchange rates are as follows (FC1 ,00 = R): R 3,00 4,80 5,00 4,90

01/01/20X1 31112/20X4 31/12/20X5 Average for 20X5

In addition, it is necessary to determine the rand value of the post-acquisition increase in the subsidiary's reserves up to the start of the current year (20X5). Brunich has only one reserve, namely retained earnings, and the opening consolidated retained earnings attributable to Brunich can easily be obtained from the 20X4 consolidated financial statement workings. Assume that the opening retained earnings amounts to R1 915000. This balance may, for example, be made up as follows:

Profit for the Profit for the Profit for the Profit for the

year year year year

ended ended ended ended

31 31 31 31

December December December December

20X1 20X2 20X3 20X4

(earned (earned (earned (earned

evenly) evenly) evenly) evenly)

FC'OOO 109 110 90 116 425

Average rate 4,24 4,7 4,6 4,5

R'OOO 462 517 414 522 1 915

Note that the amount of R1 915000 represents the rand value of 100% of Brunich's retained earnings that was consolidated in the period from 20X1 to 20X4. Once the opening balance of the retained earnings has been determined, it is possible to proceed with the translation of Brunich's financial data. A useful starting point is the translation of its trial balance into SA rand, by using the closing rate method: Share capital Retained earnings (opening) Deferred tax Long-term liabilities Operating profit FCTR (balancing figure)

FC'OOO 200 425 70 300 228 1 223

Rate 3,00 3 5,00 5,00 4,90 2

R'OOO 600,00 1 915,00 350,00 1 500,00 1117,20 619,80 6102,00

318

GMP Handbaak 2020: Volume 2 FC'OOO 250 357 (136) 572 45 22 50 63

Land and buildings Plant and machinery Accumulated depreciation Current assets Depreciation I nterest paid Dividends paid Taxation

Rate 5,00 5,00 5,00 5,00 4,90 4,90 5,00 ' 4,90

1 223

R'OOO 1 250,00 1 785,00 (680,00) 2860,00 220,50 107,80 250,00 308,70 6102,00

This rate is not calculated - it is a composite rate from prior years that gives rise to a translated retained earnings of R1 915 000 which is obtained from the prior year consolidation workings. Dividends paid are translated at the actual rate at date of receipt/declaration (Handy Ltd is reflecting dividend income of R200 000); this ensures that intra-group dividends are netted off and eliminated. Profit is translated at the average rate, assuming that it accrued evenly during the year. Equity at acquisition date is translated at the rate ruling at acquisition date to ensure that goodwill or a bargain purchase gain is not recognised in subsequent years solely due to exchange rate movements (if the equity changes but the cost of the investment remains the same, goodwill or a bargain purchase gain may arise - this is prevented by translating the at-acquisition equity at the same rate every year). According to the above translation trial balance the balance of the FCTR amounted to R619 800 at 31 December 20X5. However, for consolidation purposes it is also necessary to determine what the opening balance of the FCTR was at 31 December 20X4. This can be obtained from prior years' consolidation workings, or alternatively it can be calculated as follows, using an analysis of equity (note that if the assets and liabilities as at 31 December 20X4 were given, a translation trial balance could have been prepared at that date - in the absence of assets and liabilities, the calculation is based on net equity): Total FC'OOO Rate

At acquisition Share capital

Total R'OOO

At (80%)

Since RE

Since FCTR

NCI (20%)

200

3,00

600,00

480

120,00

Net asset value Goodwill

200

3,00

600,00

480

120,00

Consideration Since acquisition Retained earnings to 31112/20X4

200

3,00

600,00

480

120,00

425

Prior 1 915,00 years 485,00

Equity 31112/20X4 at closing rate Current period Profit (228 profit - 45 depreciation 22 interest - 63 tax) Dividends paid FCTR (balancing)

625

4,80

3000,00

98

4,90

Equity 31/12/20X5 at closing rate

673

FCTR (balancing)

(50) 5,00 5,00

1 532,00

383,00 388,00

97,00

1 532,00

388,00 600,00

480,20

384,16

96,04

(250,00) 134,80

(200,00)

3365,00

480

107,84 480

1716,16

(50,00) 26,96

495,84 673,00

The total equity of Brunich at 31 December 20X4 was translated at the closing rate at 31 December 20X4 (i.e. 625 000 x 4,80) to give equity in rand of R3 000 000. This gave rise to an exchange difference of R485 000 (the balancing figure in the 100% column) that was recognised in other comprehensive income (FCTR) in prior years. The movement for the current year amounts to R134 800, of which 80% (R107 840) is attributable to the parent. Once the translation of the financial statements has been done and the opening retained earnings and FCTR balances have been calculated, the next step would be to process consolidation journal entries. As Brunich is a subsidiary of Handy at the reporting date (31 December 20X5), the consolidation process commences by adding the financial statements of Brunich and Handy together

319

Foreign operations

on a line by line basis. The financial statements of Handy have thus already been combined with the translated financial statements of Brunich, and therefore the consolidation journal entries will focus on the elimination of at-acquisition equity and the recording of non-controlling interest. The following consolidation journal entry should be processed in 20X5 in order to eliminate the investment account and the at-acquisition equity: Journal 1 Share capital I nvestment in Brunich Non-controlling interest (F/P) At-acquisition elimination)

Dr R'OOO 600

Cr R'OOO 480 120

Since the date of acquisition, the retained earnings of Brunich increased by R1 915 000. Adding the financial statements of Handy and Brunich on a line by line basis has the effect that this amount is reflected as being fully attributable to Handy. To correct this situation, 20% should be allocated to the non-controlling shareholders: Journal 2 Retained earnings (1 915000 x 20%) Non-controlling interest (F/P) (Allocation of 20% of since acquisition retained earninQs to non-controllinQ shareholders)

Dr R'OOO 383

Cr R'OOO 383

The opening balance of the FCTR was calculated as R485 000. As the non-controlling shareholders own 20% of the net assets of Brunich, they are entitled to 20% of the exchange differences accumulated in the FCTR: Journal 3 Opening FCTR (SoC E) (485 000 x 20%) Non-controlling interest (F/P) (Allocation of 20% of opening balance of FCTR to noncontrolling shareholders)

Dr R'OOO 97

Cr R'OOO 97

Brunich's translated profit for 20X5 amounts to R480 200 (1 117200 profit - 220500 depreciation 107800 interest - 308 700 tax). The non-controlling shareholders are entitled to 20% of this profit: Journal 4 Non-controlling interest (P/L) (480 200 x 20%) Non-controlling interest (F/P) Allocation of 20% of profit to non-controllinQ interest)

Dr R'OOO 96,04

Cr R'OOO 96,04

The movement in the FCTR during 20X5 amounted to R134 800. The non-controlling shareholders are entitled to 20% of this movement, as they own 20% of the net assets of Brunich: Journal 5 Non-controlling interest (OCI) (134 800 x 20%) Non-controlling interest (F/P) (Allocation of 20% of FCTR movement to noncontrollinQ interest)

Dr R'OOO 26,96

Cr R'OOO 26,96

Brunich declared a dividend of R250 000 at 31 December 20X5. This dividend represents an intragroup transaction and should be eliminated with the following consolidation journal entry: Journal 6 Operating profit (250000 x 80%) Non-controlling interest (F/P) (250 000 x 20%) Dividends declared Elimination of dividends declared by Brunich)

Dr R'OOO 200 50

Cr R'OOO

250

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320

Using the translated trial balance and the above journal entries, it is a straightforward process to draft the consolidated financial statements: Statement of profit or loss and other comprehensive income for the year ended 31 December 20X5 Brunich Journals Consolidated Handy

R'OOO 200

R'OOO 1 117,2 (220,5) (107,8)

Profit before tax Income tax expense

200

788,9 (308,7)

788,9 (308,7)

Profit for the year Other comprehensive income: Items that may be reclassified to profit or loss Translation of foreign operations

200

480,2

480,2

134,8

134,8

Total comprehensive income for the year

200

615,0

615,0

Operating profit Depreciation Interest paid

Profit attributable to: ONners of the parent Non-controlling interest

R'OOO 200

96,04

Dr Unl 6)

Dr Unl 4)

R'OOO 1 117,2 (220,5) (107,8)

384,16 96,04 480,20

Total comprehensive income attributable to: OVVners of the parent Non-controlling interest

~ 26,96

Statement of changes in equity for the year ended 31 December 20X5 Attributable to owners of parent Share Retained capital FCTR earnings Total

Opening balance Total comprehensive income

R'OOO 480

R'OOO 388,00 ' 107,84

Dividends

R'OOO 2400,00 492,00

(200,00)

480

495,84

485000 - 97 000 Unl 3) or 485 000 x 80% 2 134800 - 26 960 Un15) or 134 800 x 80% 3 1 915000 - 383 000 Un12) or 1 915000 x 80% 4 625000 x 4,8 x 20% 5 673000x5x20% 1

R'OOO 1 532,00 3 384,16

P/L Dr Unl 5) 615,0

Noncontrolling interest

R'OOO 600,004 123,00

Total R'OOO 3000,00 615,00

111384:161 I96:04l ~ L---.J L..."':"":-'-:-:' ~ L..."':"":-'-','

Profit for the period Other comprehensive income

Closing balance

492,0 123,0

123,00

1 716,16

(50,00) --,-'-,...,..c-:-::-'

2692,00

673,00 5

3365,00

321

Foreign operations Statement of financial position at 31 December 20X5

R'OOO Assets Non-current assets Property, plant and equipment (1 250 land + 1 785 plant - 680 acc depr) Current assets Current assets

2355,00 2860,00 5215,00

Equity and liabilities Equity attributable to owners of the parent Share capital Retained earnings FCTR Non-controlling interest Non-current liabilities Long-term loans Deferred tax

480,00 1 716,16 495,84 673,00 1 500,00 350,00 5215,00

8.3.3 Goodwill Any goodwill arising on the acquisition of a foreign operation is regarded as an asset of the foreign operation. As a result, the goodwill should be expressed in the fllllctional currency of the foreign operation and should be translated at the closing rate, as with all other assets and liabilities. The exchange difference that arises from the restatement of the goodwill should be recognised in the FCTR (i.e. through other comprehensive income). Note that, although a consolidation journal is not required to accollllt for the FCTR relating to the restatement of the other assets and liabilities, such a journal entry is required for the restatement of goodwill. The reason for this is that the translation trial balance deals only with assets and liabilities recognised in the subsidirny's own financial statements. Any assets and liabilities that are recognised only for consolidation purposes (for example goodwill) are created through consolidation journal entries and any restatement of these assets and liabilities also need to be accollllted for by means of consolidation journals.

Example 8.3: Goodwill (non-controlling interest measured proportionately) Assume the same information as in example 8.2, except that the cost of the investment in Brunich amounted to R510 000 (FC170 000). It is the accounting policy of the group to measure any noncontrolling interest at acquisition date at the non-controlling shareholders' proportionate interest in the identifiable net assets of the acquiree. At the date of acquisition, Brunich's equity consisted of share capital of FC200 000. Its net assets thus also amounted to FC200 000, which was equal to R600 000 if translated at the rate of FC1 = R3 ruling at acquisition date. The goodwill or bargain purchase gain can be calculated as follows: FC R Consideration transferred (80%) 170000 510000 Non-controlling interest (20% x 200 000); (20% x 600 000) 40000 120000 Value of 100% Fair value of identifiable net assets Goodwill

210000 200000

630000 600000

10000

30000

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GAAP Handbook 2020: Volume 2

The consolidation journal entry to eliminate the investment and the at-acquisition equity will now be as follows:

Journal 1

Dr R

Cr R

600000 30000

Share capital

Goodwill I nvestment in Brunich Non-controlling interest (F/P) At-acquisition elimination journal entry)

510000 120000

Goodwill is expressed in the functional currency of Brunich (Fe) and amounts to FC10 000. At each reporting date, the goodwill needs to be restated to the spot rate effective at that date, with any exchange differences being recognised directly in the FCTR (through DCI). For ease of reference the exchange rates given in example 8.2 are repeated below: R

01/01/20X1 3,00 31112/20X4 4,80 31/12/20X5 5,00 Average for 20X5 4,90 At the end of 20X4 the goodwill would have been carried at R48 000 (10000 x 4,80) in the consolidated statement of financial position. As the goodwill was recognised at acquisition date at R30000, the restatement of goodwill from R30 000 to R48 000 would have resulted in an additional exchange difference of R18 000. This exchange difference would have been recognised in the FCTR. The following journal entry is required in 20X5 to correct the opening balance of the FCTR:

Journal 2 Goodwill Opening FCTR (SoC E) [10 000 x (4,80 - 3,00)[ Opening adjustment of goodwill and FCTR)

Dr

Cr

R

R

18000 18000

It should be noted that no allocation of this amount (recognised in the FCTR) is made to the noncontrolling interest, the reason being that the non-controlling interest was measured at acquisition date at their proportionate share of Brunich's identifiable net assets (i.e. the goodwill relates only to the parent's interest). As the non-controlling interest did not contribute to goodwill, they will not share in any of the exchange differences relating to goodwill. At the end of 20X5 the goodwill should be carried at R50 000 (10000 x 5,00) in the consolidated statement of financial position. The goodwill should thus be restated from the balance at the end of 20X4 of R48 000 to R50 000 and the resulting exchange difference should be recognised in the FCTR. The following consolidation journal entry will be required in 20X5 to restate the goodwill to R50 000: Journal 3 Goodwill FCTR. Exchange differences arising during the year (OCI) [10000 x (5,00 - 4,80)[ Adiustment of qoodwill and FCTR for the current period)

Dr

Cr

R

R

2000 2000

The information In example 8.2, without taking the effect of goodwill Into account, resulted in an opening balance on the foreign currency translation reselVe (FCTR) of R485 000 for the year ended 31 December 20X5 and a closing balance of R619 800 (per the trial balance). The movement on the FCTR for 20X5 thus amounted to R134800 (619800 - 485000) and was accounted for in other comprehensive income. This movement needs to be added to the movement resulting from the restatement of goodwill (refer journals above) and the total amount should then be disclosed under other comprehensive income.

323

Foreign operations

Extract from the consolidated statement of profit or loss and other comprehensive income for the year ended 31 December 20X5 (note that this extract ignores the effect of profit for the year): R

Profit for the year Other comprehensive income: Items that may be reclassified to profit or loss Exchange differences on translating foreign operations - arising during the year [134 SOD (example S.2) + 2 000 Uournal3 above)]

136 SOD

Total comprehensive income for the year

136 SOD

Total comprehensive income attributable to: Owners of the parent[(134 SOD x SO%) + 2 ODD] Non-controlling interest (134 SOD x 20%)

109 S40 26960 136 SOD

If an analysis of equity is used to assist with the preparation of the consolidated financial statements, this analysis will be as follows (the amounts that are different from those amounts used in example 8.2 are indicated in bold italic font). Note that the analysis combines the FCTR arising from the restatement of the normal assets and liabilities as well as the FCTR arising from the restatement of the goodwill: At Since Since NCI Total Total FC'OOO Rate R'OOO (SO%) RE FCTR (20%) At acquisition Share capital 200 3,00 600,00 4S0 120,00 Net asset value

3,00 3,00

600,00

4S0

10

30,00

30

Consideration

210

3,00

630,00

510

Since acquisition Retained earnings to 31112/20X4

425

Prior years

1 915,00

Goodwill

200

Current period Profit (22S profit - 45 depreciation - 22 interest - 63 tax) Dividends paid FCTR (balancing) Equity 31/12/20X5 at closing rate

120,00 1 532,00

503,00

FCTR (balancing) Equity 31112/20X4 at closing rate

120,00

635

4,SO

3048,00

9S

4,90

4S0,20

3S4,16

(50)

5,00

(250,00)

(200,00)

510

1 532,00

136,80

683

5,00

3415,00

3S3,00

'406,00

97,00

406,00

600,00 96,04

**109,84

510

1 716,16

515,84

(50,00) 26,96 673,00

• {503 000 - [10 000 x (4,SO - 3,00)]} x SO% + [10 000 x (4,SO - 3,00)] •• {136 SOD - [10000 x (5,00 - 4,SO)]} x SO% + [10 000 x (5,00 - 4,SO)]

In the above example the non-controlling interest was measured at acquisition date at their proportionate share of the subsidirny's net identifiable assets. If the non-controlling interest is measured at fair value at acquisition date and this fair value is higher or lower than the proportionate share of the identifiable net assets, it will impact on the amollllt of goodwill recognised. Furthermore, because the non-controlling shareholders contribute to goodwill, they will now share in exchange differences relating to the goodwill. Unfortunately lAS 21 does not give any guidance on the portion of the exchange differences relating to goodwill that should be allocated to the non-controlling shareholders. The authors recommend that the allocation be done in the profit-sharing ratio. This is illustrated in the following example.

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GAAP Handbook 2020: Volume 2

Example 8.4: Goodwill (non-controlling interest measured at fair value) Assume the same information as in example 8.2, except that the cost of the investment in Brunich amounted to R510 000 (FC170 000). The non-controlling interest was measured at acquisition date at fair value, which amounted to FC42 500.

At the date of acquisition, Brunich's equity consisted of share capital of FC200 000. Its net assets thus also amounted to FC200 000, which was equal to R600 000 if translated at the rate of FC1 = R3 ruling at acquisition date. The goodwill or bargain purchase gain can be calculated as follows: Consideration transferred (80%)

Non-controlling interest (20%) (42 500

x 3)

Value of 100% Fair value of identifiable net assets

Goodwill

FC 170000 42 500

R 510000 127 500

212500 200000

637500 600000

12500

37500

The consolidation journal entry to eliminate the investment and the at-acquisition equity will now be as follows: Journal 1

Cr

Dr R

Share capital Goodwill I nvestment in Brunich Non-controlling interest (F/P) At-acquisition elimination journal entry)

R

600000 37500 510000 127500

Goodwill is expressed in the functional currency of Brunich (FC) and amounts to FC12 500. At each reporting date, the goodwill needs to be restated to the spot rate effective at that date, with any exchange differences being recognised directly in the FCTR (OCI). For ease of reference the exchange rates given in example 8.2 are repeated below: R

01/01/20X1 3,00 4,80 31112/20X4 5,00 31/12/20X5 Average for 20X5 4,90 At the end of 20X4 the goodwill would have been carried at R60 000 (12 500 x 4,80) in the consolidated statement of financial position. As the goodwill was recognised at acquisition date at R37 500, the restatement of goodwill from R37 500 to R60 000 would have resulted in an additional exchange difference of R22 500. This exchange difference would have been recognised in the FCTR. The following journal entry is required in 20X5 to correct the opening balance of the FCTR:

Journal 2 Goodwill [12 500 x (4,80 - 3,00)[ Opening FCTR (SoC E) (22 500 x 80% D Non-controlling interest (F/P) (22 500 x 20%) Opening adjustment of goodwill and FCTR)

Dr

Cr

R

R

22500 18000 4500

It should be noted that the exchange difference relating to goodwill (recognised in the FCTR) is allocated between the parent and the non-controlling interest in the profit-sharing ratio, the reason being that the non-controlling interest was measured at acquisition date at fair value and therefore contributed to goodwill. At the end of 20X5 the goodwill should be carried at R62 500 (12 500 x 5,00) in the consolidated statement of financial position. The goodwill should thus be restated from the balance at the end of 20X4 of R60 000 to R62 500 and the resulting exchange difference should be recognised in the FCTR. The following consolidation journal entry will be required in 20X5 to restate the goodwill to R62 500.

325

Foreign operations Journal 3 Goodwill [12 500 x (5,00 4,80)[ FCTR: Exchange differences arising during the year (OCI) Non-controlling interest (OCI) (2 500 x 20%) Non-controlling interest (F/P) Adjustment of goodwill and FCTR for the current period)

Dr R 2500

Cr R

2500 500 500

The information in example 8.2, without taking the effect of goodwill into account, resulted in an opening balance on the foreign currency translation reserve (FCTR) of R485 000 for the year ended 31 December 20X5 and a closing balance of R619 800 (per the trial balance). The movement on the

FCTR for 20X5 thus amounted to R134800 (619800 - 485000) and was accounted for in other comprehensive income. This movement needs to be added to the movement resulting from the restatement of goodwill (refer journals above) and the total amount should then be disclosed under other comprehensive income. Extract from the consolidated statement of profit or loss and other comprehensive income for the year ended 31 December 20X5 (note that this extract ignores the effect of profit for the year): R Profit for the year Other comprehensive income: Items that may be reclassified to profit or loss Exchange differences on translating foreign operations - arising during the year

[134800 (example 8.2) + 2 500 Uournal3 above)[

137300 137300

Total comprehensive income for the year Total comprehensive income attributable to:

OWners of the parent[(134 800 + 2 500) x 80% [ Non-controlling interest [(134800 + 2 500) x 20%[

109840 27460 137300

If an analysis of equity is used to assist with the preparation of the consolidated financial statements, this analysis will be as follows (the amounts that are different from those amounts used in example 8.2 are indicated in bold italic font). Note that the analysis combines the FCTR arising from the restatement of the normal assets and liabilities as well as the FCTR arising from the restatement of the

goodwill: At (80%)

NCI (20%)

Total FC'OOO

Rate

Total R'OOO

Share capital

200,00

3,00

600,00

480

120,00

Net asset value

200,00

600,00

37,50

480 30

120,00

12,50

3,00 3,00

Consideration

212,50

3,00

637,50

510

127,50

Since acquisition Retained earnings to 31112/20X4

425,00

Prior years

Since

RE

Since FCTR

At acquisition

Goodwill

Current period Profit (228 profit - 45 depreciation - 22 interest - 63 tax) Dividends paid

637,50

4,80

3060,00

98,00 (50,00)

4,90 5,00

480,20 (250,00)

510

1 532,00

685,50

• 507 500 x 80% and 507 500 x 20% •• 137 300 x 80% and 137 300 x 20%

5,00

3427,50

383,00

'406,00

'101,50

406,00

612,00

**109,84

96,04 (50,00) **27,46

515,84

685,50

384,16 (200,00)

137,30

FCTR (balancing) Equity 31/12/20X5 at closing rate

1 532,00

507,50

FCTR (balancing) Equity 31112/20X4 at closing rate

1 915,00

7,50

510

1716,16

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8.3.4 Fair value adjustments Any fair value adjustments made to the carrying amounts of assets and liabilities of a foreign operation upon its acquisition, are regarded as assets and liabilities of the foreign operation. As a result, these adjustments should be expressed in the functional currency of the foreign operation and should be translated at the closing rate. The exchange difference that arises from the restatement of these adjustments should be recognised in the FCTR (i.e. through other comprehensive income). Note that, although a consolidation journal is not required to aCcOllllt for the FCTR relating to the restatement of the carrying amounts of assets and liabilities as per the subsidiary's financial statements, such a journal entry is required for the restatement of any acquisition date fair value adjustments in respect of these assets and liabilities. The reason for this is that the translation trial balance deals with the carrying amOllllts of assets and liabilities as per the subsidirny's own financial statements. Any adjustments to these carrying amounts that are recognised for consolidation purposes only (for example revaluations of PPE at acquisition date) are effected through consolidation journal entries, and therefore any restatement of these assets and liabilities also need to be accounted for by means of consolidation journals.

Example 8.5: Fair value adjustments [This example ignores the effect of deferred tax on revaluations.] P Ltd acquired a 70% interest in S Ltd on 1 January 20X1, at a cost of R240000. S Ltd has a functional currency of US$. The statement of financial position of S Ltd reflected net assets with a carrying amount of $50 000 at acquisition date. All these assets and liabilities were fairly valued, except for land that was undervalued with $150. The non-controlling interest was measured at acquisition date at their proportionate share of the identifiable net assets of S Ltd. The following exchange rates were applicable ($1 = R): R

01/01/20X1 31/12/20X1 Average for 20X 1

6,00 7,80 7,50

The trial balance of S Ltd for the year ended 31 December 20X1 was as follows: Dr/(Cr)

$ Land Buildings Long-term loans Bank Share capital Retained earnings Profit for the year (earned evenly)

25000 38000 (20000) 22000 (20000) (30000) (15000)

In order to consolidate S Ltd, the first step would be to prepare a translation trial balance, by applying the closing rate method: Dr/(Cr) Rate Dr/(Cr) $ R Land 25000 7,80 195000 Buildings 38000 7,80 296400 Long-term loans (20000) 7,80 (156000) Bank 22000 7,80 171 600 Share capital (20000) 6,00 (120000) Retained earnings (30000) 6,00 (180000) Profit for the year (15000) 7,50 (112500) FCTR (balancing)

(94500)

The above trial balance does not take into account the adjustment of land to fair value. Therefore the next step would be to account for the revaluation of the land by means of a consolidation journal:

327

Foreign operations Journal 1 Land (150 x 6)

Dr

Cr

R

R

900 900

Revaluation surplus

Adiustment of land to fair value) The total equity of S Ltd at acquisition date amounts to $50 150 (50000 net assets + 150 revaluation) or R300 900 (120000 share capital + 180000 retained earnings + 900 revaluation surplus). As the equity of S Ltd is now stated at fair value, the goodwill or bargain purchase gain can be calculated as follows: Consideration transferred (70%)

Non-controlling interest (50150 x 30%) (30% x 300 900) Value of 100% Fair value of identifiable net assets

Goodwill

$ 40000 15045

R 240000

55045 50150 4895

330270 300900 29370

90270

Once the goodwill amount is known, the at-acquisition equity and the investment in the subsidiary can be eliminated as follows:

Journal 2 Share capital Retained earnings

Revaluation surplus (J1) Goodwill Investment in S Ltd Non-controlling interest (F/P)

Dr

Cr

R

R

120000 180000 900 29370 240000 90270

At-acquisition elimination journal entry) The translated profit for the year amounted to R 112 500. The non-controlling Interest IS entitled to 30%

of this profit: rJ~0~u~rn~a~/~3----------------------------------~D~r------~C~r~'

Non-controlling interest (P/L) (112 500 x 30%) Non-controlling interest (F/P)

R 33750

R 33750

Allocation of 30% of profit to non-controlling interest) The movement in the FCTR during 20X1 amounted to R94500 according to the translation trial balance. The non-controlling shareholders are entitled to 30% of this movement: ~~~4

Non-controlling interest (OCI) (94 500 x 30%) Non-controlling interest (F/P)

Dr

Cr

R

R

28350 28350

Allocation of 30% of FCTR to non-controllinQ interest)

The goodwill of $4 895 should be restated to the closing rate of R7,80, i.e. R38 181. This will give rise to an additional exchange difference of R8 811 (38181 - 29 370), which should be recognised in the FCTR (other comprehensive income). Note that the non-controlling shareholders do not share in this exchange difference as their interest is measured at their proportionate share of the net identifiable assets:

Journal 5 Goodwill FCTR: Exchange gains arising during the year (OCI) [4895 x (7,80 - 6)[ Adjustment of goodwill and FCTR for the current period)

Dr

Cr

R

R

8811 8811

Land was revalued with $150 (R900) in journal 1. This portion of the land should be restated to closing rate, as it was not dealt with in the translation trial balance. The exchange difference arising from this

GAAP Handbook 2020: Volume 2

328

restatement is recognised in the FCTR (other comprehensive income). This restatement is done by means of the following consolidation journal: Journal 6

Land FCTR: Exchange gains arising during the year (OCI) [150 x (7,80 - 6)[ Adiustment of land and FCTR for the current period)

Dr

Cr

R

R

270 270

As the non-controlling Interest owns 30% of the net assets of S Ltd, they are entitled to 30% of the exchange difference on the revalued portion of the land: Journal 7

Non-controlling interest (OCI) (270 x 30%) Non-controlling interest (F/P) (Allocation to non-controlling interest of 30% of FCTR on revalued portion of land)

Dr

Cr

R

R

81 81

Taking into account the above information, extracts from the consolidated financial statements will be as follows: Statement of profit or loss and other comprehensive income for the year ended 31 December 20X1

S Ltd (translated) R Profit for the year Other comprehensive income: Items that may be reclassified to profit or loss Translation of foreign operations

Journals R'OOO

112500

94500

112500

9081

Profit attributable to: OVVners of the parent Non-controlling interest

207000

103581

~

Cr Unl 5) Cr Unl 6)

33 750

Dr Unl 3)

270

Total comprehensive income for the year

Consolidated R

216081

78750 33750 112500

Total comprehensive income attributable to: OVVners of the parent Non-controlling interest

153 62181

62181 33750 28350 81

P/L Dr Unl 4) Dr Unl 7) 216081

The balance of the non-controlling interest in the statement of financial position amounts to R 152 451 at 31 December 20X1. This can be calculated as 30% of the net asset value of $65 150 (20 000 share capital + 30 000 retained earnings + 15000 profit + 150 revaluation) translated at R7,80. Alternatively it can be calculated as 90 270 Un12) + 33 750 Un13) + 28 350 Un14) + 81 UnI7).

The land will be reflected in the consolidated statement of financial position at R196 170 [(25000 carrying amount + 150 revaluation) x 7,80], which can also be calculated as R195 000 (translation trial balance) + R900 Un11) + R270 UnI6). If an analysis of equity is used to assist with the preparation of the consolidated financial statements, this analysis will be as follows. (Note that the analysis combines the FCTR arising from the restatement

329

Foreign operations

of the assets and liabilities as per the subsidiary's own financial statements, as well as the FCTR arising from the restatement of the goodwill and the revalued portion of the land): Total $'000

Rate

Total R'OOO

20,000 30,000 0,150

6,00 6,00 6,00

120,000 180,000 0,900

50,150 4,895

6,00 6,00

300,900 29,370

210,63 29,37

90,27

Consideration Current period Profit FCTR (balancing)

55,045

6,00

330,270

240,00

90,27

15,000

7,50

112,500 103,581

Equity 31/12/20X1 at closing rate

70,045

At acquisition Share capital Retained earnings Revaluation surplus Net asset value Goodwill

7,80

546,351

At (70%)

Since RE

Since FCTR

75,15'

33,75 "28,431

75,15

152,451

78,75 240,00

78,75

NCI (30%)

'{103 581 - [4 895 x (7,80 - 6,00)[} x 70% + [4 895 x (7,80 - 6,00)[ "{1 03581 - [4 895 x (7,80 - 6,00)[} x 30%

8.3.5 Intra-group monetary asset or liability From example 8.2 it is evident that the incorporation of the results and financial position ofa foreign operation with those of the reporting entity follows normal consolidation procedures, such as the elimination of intra-group balances and intra-group transactions of a subsidiary. An intra-group monetary item (such as a loan) may be denominated in the reporting entity's functional currency (in which case the foreign operation's financial statements will reflect an exchange difference), or it may be denominated in the foreign operation's currency (in which case the reporting entity's financial statements will reflect an exchange difference), or it may be denominated in a currency other than the fllllctional currency of the reporting entity or the foreign operation (in which case both sets of financial statements will reflect an exchange difference). Such an intra-group monetary asset (or liability), whether short-term or long-term, cannot be eliminated against the corresponding intragroup liability (or asset) without showing the results of currency fluctuations in the consolidated financial statements. Accordingly, in the consolidated financial statements of the reporting entity, such an exchange difference continues to be recognised in profit or loss (even though the related loan is eliminated) or, if the exchange difference relates to the net investment in the foreign operation (refer to section 8.5), it is recognised in other comprehensive income and accumulated in a separate component of equity (FCTR) lllltil the disposal of the foreign operation. Recognition of this exchange difference in the group statements is appropriate as the exchange difference arises from the fact that one of the companies has a foreign currency commitment, and not from the fact that the loan is intragroup. It should be noted that IFRS 9 allows the foreign currency risk of an intra-group monetary item to be a hedged item in the consolidated financial statements, as the foreign exchange gains or losses are not eliminated upon consolidation, and therefore presents a risk that could affect the consolidated profit or loss.

Example 8.6: Exchange difference on intra-group loan A local parent company owed $1 000 to its US based subsidiary throughout the year (ignore the time value of money). The exchange rate changed from $1 = R6 to $1 = R5 during the year. The parent will report a R1 000 exchange difference (gain) in its separate financial statements, as well as a liability of R5 000 (translated at closing rate). Once translated into rand, the financial statements of the subsidiary will reflect an asset of R5 000 (translated at closing rate). For purposes of the consolidated statement of financial position, the liability of R5 000 will be eliminated against the asset of the subsidiary as an intra-group balance. The exchange difference (gain), on the other hand, will be reported in the consolidated statement of profit or loss and other comprehensive income (in profit or loss) without any elimination. It should be kept in mind that the total exchange difference arising from the translation of the financial statements of the subsidiary will be recognised in other comprehensive income. This exchange difference will include a loss relating to the translation of the loan (from the subsidiary's

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330

perspective). These exchange differences accumulate in equity via the consolidated statement of changes in equity and represent a separate component of equity (FCTR).

8.4 Foreign associates and joint ventures - the closing rate method When translating the financial statements of a foreign associate or joint venture, the principles are very similar to the translation of a foreign subsidirny. The closing rate method is also used for associates and joint ventures, with the result that assets and liabilities are translated at the closing rate, while income and expenses are translated at exchange rates ruling at the date of the transaction. However, the translation of foreign associates and j oint ventures is far simpler than foreign subsidiaries, as goodwill, fair value adjustments at acquisition date and non-controlling interest are not accOllllted for. This is illustrated in the following example.

Example 8.7: Foreign associate P Ltd acquired a 35% interest in S Ltd on 1 January 20X1, at a cost of R120 000 ($20 000). S Ltd has a functional currency of US$. The statement of financial position of S Ltd reflected net assets with a carrying amount of $50 000 at acquisition date. All the assets and liabilities were fairly valued, except for land that was undervalued with $150. The following exchange rates were applicable ($1 = R): 01/01/20X1 31/12/20X1

R 6,00 7,80

Average for 20X1 7,50 The trial balance of S Ltd for the year ended 31 December 20X1 was as follows:

Land Buildings Long-term loans Bank Share capital Retained earnings Profit for the year (earned evenly)

Dr/(Cr) $ 25000 38000 (20000) 22000 (20000) (30000) (15000)

P Ltd's interest in the fair value of the net assets of S Ltd at 1 January 20X1 amounted to $17 553 [(50000 + 150) x 35%[. P Ltd paid $20000 for this interest, which means that goodwill of $2 447 is included in the cost of the investment. However, this goodwill is not accounted for separately. Similarly, the revaluation of the land is also already included in the cost of the associate and is not accounted for separately. If it is P Ltd's policy to account for investments in associates at cost in its separate financial statements, the investment in S Ltd will be reflected at a carrying amount of R120 000 at 31 December 20X1. When equity accounting for the investment, the profit for 20X1 should be translated at the average rate of R7,50. This translated profit amounts to R112 500 (15 000 x 7,50) of which 35% should be allocated to P Ltd: Journal 1 Investment in associate (112 500 x 35%) Share of profit of associate (P/L) [IRecognition of 35% of S Ltd's profit for the year)

Dr

Cr

R

R

39375 39375

Once the profit for the year has been recognised, the carrying amount of the investment in the associate is R 120000 cost + 39 375 Unl 1) = R159 375. The carrying amount of the investment in US$ however amounts to $25 250 [20 000 cost + (15 000 profit x 35%)[. If this carrying amount is translated at the closing rate of R7,BO it amounts to R196 950. In order to increase the carrying amount of the investment from R159 375 to R196 950 an amount of R37 575 should be recognised in the FCTR, as follows:

331

Foreign operations Journal 2 Investment in associate FCTR: Exchange gains arising during the year (OCI) IrRecoqnition of FCTR relatinq to S Ltd)

Dr R 37575

Cr R 37575

8.5 Net investment in a foreign operation A net investment in a foreign operation is the amollllt of the reporting entity's interest in the net assets of that operation. An entity may have a monetary item that is receivable from or payable to a foreign operation, for example a loan. If settlement of this monetrny item is neither planned nor likely to occur in the foreseeable future, it is, in substance, a part of the entity's net investment in that foreign operation (note that a loan to the foreign operation will increase the net investment, whereas a loan from the foreign operation will decrease the net investment). The monetrny items referred to include long-term receivables or loans, but not trade receivables or trade payables. In the separate financial statements of the reporting entity, or the individual financial statements of the foreign operation, any exchange differences arising on such a monetrny item are recognised in profit or loss. However, in the financial statements that include both the foreign operation and the reporting entity, for example consolidated financial statements, these exchange differences should be recognised tlrrough other comprehensive income, i.e. the foreign currency translation reserve (FCTR). A consolidation journal entry will thus be required to transfer the exchange difference from profit or loss to the FCTR. It should be noted that the transfer to the FCTR is made upon consolidation only if the item is a monetary item and it forms part of the net investment in the foreign operation. For example, if a parent entity grants a "loan" to its foreign subsidirny, and that "loan" is classified as equity in the financial statements of the subsidirny in terms of lAS 32, then the item is a nonmonetrny item and no transfer is made to the FCTR. A monetrny item for which settlement is neither planned nor likely to occur in the foreseeable future is similar to an equity investment in a foreign operation. Therefore, the principle to recognise exchange differences arising on such a monetrny item initially tlrrough other comprehensive income, effectively results in the exchange differences on the monetrny item being accollllted for in the same way as the exchange differences on the translation of the net assets (the equity investment) of the foreign operation when consolidated financial statements are prepared. Upon disposal of the net investment, the accumulated exchange difference in equity should be reclassified from equity to profit or loss in the manner prescribed by lAS 21 (see section 8.6).

Example 8.8: Net investment in a foreign operation - denominated in the functional currency of the foreign operation X Ltd (with a rand functional currency) has a 100% interest in Z Ltd (with the US dollar as functional currency). At the start of year 1 X Ltd lend $10 000 to z Ltd, which is not expected to be repaid in the foreseeable future (ignore the time value of money). The exchange rate was $1 = R7 at the beginning of year 1 and $1 = R7,50 at the end of year 1. The loan is denominated in US dollars, which is also the functional currency of Z Ltd. In its separate financial statements, X Ltd records the loan initially as follows:

Journal 1 Loan Bank (Initial recognition of a $10 000 loan at an exchange rate of R7,00)

Dr R 70000

Cr R 70000

In the separate financial statements of X Ltd, a gain of R5 000 will be recognised in profit or loss for year 1 1(7,50 - 7) x $10 000]. The US dollar financial statements of Z Ltd will not reflect any exchange difference, as the loan is denominated in US dollars. The following journal entry will be processed in the separate records of X Ltd:

GAAP Handbook 2020: Volume 2

332 Journal 2 Loan

Dr R 5000

Cr R

5000

Foreign exchange gain (P/L) (Foreign exchange gain on the restatement of the foreign currency receivable)

The total receivable in the records of X Ltd amounts to R75 000. This amount will be eliminated against the translated payable in the records of Z Ltd of R75 000 ($10000 x R7,50). The foreign exchange gain of R5000 will however not be eliminated on consolidation. In the consolidated financial statements the amount of R5 000 will be removed from profit or loss and taken to other comprehensive income by means of the following consolidation journal:

Journal 3 Foreign exchange gain (P/L) FCTR: Exchange gains arising during the year (OCI) (Transfer of gain on loan which forms part of net investment in a foreian operation)

Dr R 5000

Cr R

5000

Example 8.9: Net investment in a foreign operation - denominated in the functional currency of the parent Use the same information as in example 8.8, except that the loan had been denominated in the equivalent amount of rand at the start of year 1 (i.e. R70 000). In this case the foreign exchange difference will arise in the individual financial statements of the foreign operation. No exchange difference will arise in the separate financial statements of X Ltd, as the loan is denominated in rand. In its separate financial statements, Z Ltd records the loan initially as follows:

Journal 1 Bank

Dr $ 10000

Loan (Initial recognition of a R70 000 loan at an exchange rate of R7,00)

Cr

$ 10000

At the end of year 1, the individual financial statements of Z Ltd will reflect a gain of $667 ($10 000(70000/7,50)), which will be recognised as follows:

Journal 2 Loan Foreign exchange gain (P/L) (Foreign exchange gain on the restatement of the foreign currency receivable)

Dr

Cr

$

$

667 667

The total payable in the records of Z Ltd amounts to $9 333 ($10 000 - $667) at the end of year 1. As part of the translation of the financial statements of Z Ltd to rand, for inclusion in the consolidated financial statements of X Ltd, this payable will be translated to R70 000 ($9333,33 x R7,50) and will eliminate against the receivable of R70 000 in the records of X Ltd. However, the exchange gain of $667 recognised in the separate financial statements of Z Ltd will not be eliminated on consolidation. As part of the translation of the financial statements of Z Ltd into rand, for inclusion in the consolidated financial statements of X Ltd, this exchange gain needs to be translated at the average exchange rate of $1 = R7,25 [(7,50 + 7,00) I 2[, if it is assumed that the deterioration occurred evenly during the period]. The translated exchange gain will therefore amount to R4833 ($666,7 x 7,25) and should be recognised through other comprehensive income for consolidation purposes:

333

Foreign operations Journal 3

Foreign exchange gain (P/L) FCTR: Exchange gains arising during the year (OCI) (Transfer of gain on loan which forms part of net investment in foreign operation)

Dr R 4833

Cr R 4833

It should be kept in mind that the translation of all the assets, liabilities, revenue and expense items of Z Ltd will result in a further exchange difference (the normal translation difference) which will also be taken directly to the FCTR. Included in this translation difference w ill be a gain of R167 [$667 x (7,507,25)], w hich results from the fact that the exchange gain of $667 was translated at the average rate, while the related loan was translated at the closing rate. In total an exchange gain of R5 000 (R4 833 + R 167) is included in the FCTR, which is the same amount as in example 8.8.

The monetary item may be denominated in any currency, i.e. it is not a requirement that the monetary item must be denominated in the functional currency of the reporting entity or the fllllctional currency of the foreign operation. (Note that the requirements of separating an embedded derivative in IFRS 9 might be applicable when the currency in which the contract is denominated modifies the cash flows of the contract and the economic risks and characteristics of the derivative are not closely related to that of the host contract.)

Example 8.10: Net investment in a foreign operation - denominated in a different currency as the functional currency of the parent or the subsidiary Use the same information as in example 8.8, except that the loan is denominated in the equivalent amount of UK sterling. Assume that £1 = R10,20 at the start of the year and that £1 = R10,80 at the end of the year. This means that a loan of £6862,745 (R70 000 110,20) was granted. X Ltd will recognise in its separate financial statements a gain of R4 117,646 (£6 862,745 x 10,8070000) in profit or loss. In the consolidated financial statements, this amount will be included in the FCTR. The following represents the journal entries for X Ltd:

Loan Bank (Initial recognition of a £6 862,745 loan at an exchange rate of R 10,20) Loan Foreign exchange gain (P/L) (Foreign exchange gain on the restatement of the foreign currency receivable')

Dr R 70000

Cr R 70000

4117,646 4117,646

Z Ltd will initially recognise its liability to X Ltd at $10 000 (£6 862,745 x 10,20/7,00). At reporting date the translated amount is $9882,353 (£6862,745 x 10,80 I 7,50) resulting in an exchange gain of $117,647. The following journal entries will be processed by Z Ltd:

Bank Loan (Initial recognition of a £6862,745 loan at an exchange rate of R10,20/R7,00) Loan Foreign exchange gain (P/L) (Foreign exchange gain on the restatement of the foreign currencv pavable)

Dr $ 10000

Cr $ 10000

117,647 117,647

The total payable In the records of Z Ltd amounts to $9882,353 ($10000 - $117,647) at the end of year 1. As part of the translation of the financial statements of Z Ltd to rand, for inclusion in the consolidated financial statements of X Ltd, this payable w ill be translated to R74 118 ($9882,353 x R7,50) and will eliminate against the receivable of R74 118 (R70 000 + R4 118) in the records of X Ltd.

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However, the foreign exchange gains in the separate financial statements of X Ltd and Z Ltd will not be eliminated on consolidation. As part of the translation of the financial statements of Z Ltd to rand, for inclusion in the consolidated

financial statements of X Ltd, the exchange gain of $117,647 needs to be translated at the average exchange rate of $1 = R7,25 [(7,50 + 7,00) I 2[, if it is assumed that the deterioration occurred evenly during the period[. In other words the translated exchange gain is R852,942 (117,647 x 7,25). On consolidation the total foreign exchange gain of R4 970,588 (R852,942 + R4 117,646) will be taken to the FCTR as follows: Dr R

Foreign exchange gain (P/L) FCTR: Exchange gains arising during the year

Cr R

4970,588 4970,588

(OCI) (Transfer of gain on loan which forms part of net investment in foreign operation)

A further gain of R29,412 (117,647 x 7,50 - 852,942) will form part of the total translation difference which arises upon translation of all the assets, liabilities, revenue and expenses of Z Ltd. This amount

will be taken to the FCTR as part of the translation process, being the difference between the exchange difference included in Z Ltd's profit or loss translated at the average rate and the loan translated at the closing rate. The total gain in the FCTR is once again R5000 (R4 117,646 + R852,942 + R29,412).

Note that the entity that has a monetrny item receivable from or payable to a foreign operation may also be a subsidiary of the group. In other words, it is not necessrny that the monetrny item receivable or payable relates to the parent entity.

Example 8.11: Net investment in a foreign operation - monetary items between subsidiaries denominated in the functional currency ofthe foreign operation Use the same information as in example 8.8, except that the loan has not been granted by X Ltd, but by a 100% subsidiary (Y Ltd) of X Ltd, that also has the rand as its functional currency. In this case the exchange gain of R5 000 arises in the individual financial statements of Y Ltd and not in the separate financial statements of X Ltd. On consolidation of Y Ltd, the amount will be removed from profit or loss and be included in the FCTR. The fact that y Ltd has granted the loan (and not X Ltd) is irrelevant, as long as the repayment of the loan is neither planned nor likely to occur.

A net investment in a foreign operation may quality as a hedged item in a hedge of a net investment. The hedge accOllllting principles for such hedges are discussed in chapter 18 of volume 1.

8.6 Disposal or partial disposal of a foreign operation 8.6.1 Disposal of a foreign operation When a foreign operation is disposed of, the cumulative amount of the exchange differences recognised in other comprehensive income and accumulated in a separate component of equity (FCTR) relating to that specific foreign operation, should be reclassified from equity to profit or loss when the gain or loss on disposal is recognised. Note that the total amount in the FCTR should be reclassified. These principles apply irrespective of whether the foreign operation is a subsidirny, associate or joint arrangement. In addition to disposing of the entire interest in a foreign operation, the following partial disposals are also treated as full disposals: • The loss of control of a subsidirny that includes a foreign operation regardless of whether a noncontrolling interest is retained; and

335

Foreign operations

• The partial disposal of an interest in a joint arrangement or in an associate that includes a foreign operation when the retained investment (after the partial disposal) is a financial asset that includes a foreign operation. As the abovementioned disposals are treated as full disposals, the total balance in the FCTR is reclassified to profit or loss irrespective of the fact that a portion of the investment in the fonner subsidiary, associate or j oint arrangement is retained. When an entity disposes of a subsidiary that includes a foreign operation, the entity should derecognise the cumulative amollllt of the foreign exchange differences relating to that foreign operation, including the amollllt attributable to the non-controlling interest. The amount attributable to the parent is reclassified to profit or loss, but the entity may not reclassifY to profit or loss the amollllt attributable to the non-controlling interest. The amollllt attributable to the non-controlling interest is derecognised as part of the total balance of the non-controlling interest when calculating the gain or loss on disposal. Example 8.12: Disposal offoreign subsidiary The information provided in example 8.4 (including 8.2) resulted in the following information regarding the foreign currency translation reserve (FCTR) for the year ended 31 December 20X5: Extract from the statement of changes in equity for the year ended 31 December 20X5 (reflecting only information relating to the FCTR)

Balance at 31 December 20X4 Other comprehensive income for the year Balance at 31 December 20X5

Attributable to owners of parent FCTR Total R R 406000' 406000 109840 109840 515840 515840

Noncontrolling interest R 101500' 27460 128960

Total R 507500' 137300 644800

, R485 000 (example 8.2) + R22 500 Unl 2 example 8.4) = R507 500 , [(R485 000 x 20%) (example 8.2) + R4 500 Unl 2 example 8.4)[ = R101 500 , [(R485 000 x 80%) (example 8.2) + R18 000 Unl 2 example 8.4)[ = R406 000 If Handy Ltd were to sell its entire (80%) interest in Brunich at the end of business on 31 December 20X5, the following needs to happen with the cumulative FCTR balance and the FCTR allocated to the non-controlling interest: The FCTR attributable to Handy Ltd should be de recognised by reclassifying it to profit or loss. The amount of the FCTR that was allocated to the non-controlling interest may not be reclassified to profit or loss but should be derecognised. Extract from the consolidated statement of profit or loss and other comprehensive income for the year ended 31 December 20X5 R

Other income (including FCTR (gain) in respect of former subsidiary amounting to R515 840 reclassified to P/L) Profit before tax I ncome tax expense Profit for the year Other comprehensive income: Items that may be reclassified to profit or loss Foreign currency translation reserve Exchange differences arising during the year on translating foreign operations [example 8.4[ Reclassification of FCTR attributable to former foreign subsidiary Total comprehensive income for the year

xxx xxx (XXX) XXX

(378540) 137300 (515840) XXX

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8.6.2 Partial disposal of a foreign operation A partial disposal of an entity's interest in a foreign operation is any reduction in the ownership interest of the entity in a foreign operation, excluding those disposals discussed above in section 8.6.1. Partial disposals include the following: • A reduction in the interest of a subsidirny without losing control; • a reduction in the interest of an associate without losing significant influence; and • a reduction in the interest of a joint arrangement without losing j oint control.

When an entity partially disposes of its interest in a subsidiary that includes a foreign operation, the entity should transfer to non-controlling interest the proportionate share of the cumulative exchange differences (FCTR) that is disposed of

When an entity partially disposes of its interest in an associate or joint arrangement, the entity should reclassify to profit or loss the proportionate share (% ) of the FCTR disposed of. Example 8.13:

Partial disposal offoreign subsidiary

Use the same information as in example 8.12 except that Handy Ltd disposes of only 20% of its interest in Brunich at 31 December 20X5 (i.e. a partial disposal). If an entity disposes of a partial interest in a subsidiary, it should transfer to the non-controlling interest a proportionate share of the exchange differences accumulated in other comprehensive income. Extract from the consolidated statement of changes in equity for the year ended 31 December 20X5 (reflecting only information relating to the FCTR)

Balance at 31 December 20X4 Other comprehensive income for the year Disposal of portion of subsidiary

Attributable to owners of parent FCTR RE R R 406000' 109840

llZ

I (~)I

Equity given up Proceeds received Transfer of 20% of FCTR to retained earnings Balance at 31 December 20X5

(103168?

1031685

412672

AAA

Noncontrolling interest R 101 500' 27460 XXX

Total R 507500' 137300

yyy

~ [;] BBB

CCC

R485 000 (example 8.2) + R22 500 Unl 2 example 8.4) - R507 500 [(R485 000 x 20%) (example 8.2) + R4 500 Unl 2 example 8.4)[ = Rl0l 500 [(R485 000 x 80%) (example 8.2) + R18 000 Unl 2 example 8.4)[ = R406 000 When accounting for the gain or loss on disposal (recognised in equity), the non-controlling interest is allocated 20% of all the equity previously owned by Handy. This equity is removed from retained earnings and is then transferred to the non-controlling interest. The amount transferred from retained earnings to the non-controlling interest would include Rl03 168 [(406000 + 109840) x 20%] relating to the FCTR, as this transfer includes 20% of all reserves. In order to compensate the retained earnings for the reduction relating to the FCTR, a transfer is made from the FCTR back to retained earnings.

8.6.3 Method of disposal or partial disposal Disposal or partial disposal may be through sale, liquidation, repayment of share capital, abandonment, or the receipt of dividends paid from pre-acquisition profits. It should be noted that a write-down of the carrying amollllt of a foreign operation, either because of its own losses or an impairment recognised by the investor, does not constitute a partial disposal, with the result that no part of the foreign exchange gain or loss recognised in a separate component of equity through other comprehensive income is reclassified to profit or loss at the time of a write-down.

Foreign operations

337

8.7 Non-coterminous year ends When the financial year-end of a foreign operation differs from that of the reporting entity, the foreign operation often prepares additional statements as of the same date as the reporting entity's year-end. If this cannot be done, IFRS 10 allows the use of a different reporting date provided that the difference is not greater than three months, and provided that adjustments are made for the effects of any significant transactions or other events that occur between the different dates. Should the reporting dates differ, the question arises as to whether the exchange rate used for the translation of the assets and liabilities of the foreign operation should be the rate at the reporting date of the foreign operation, or the rate at the reporting date of the reporting entity. lAS 21 states that the assets and liabilities of the foreign operation should be translated at the exchange rate at the reporting date of the foreign operation. However, adjustments are to be made for significant changes in exchange rates up to the reporting date of the reporting entity. The same approach is used in applying the equity method to associates and j oint ventures.

8.8 Books and records not kept in functional currency A foreign operation may have the same fllllctional currency as the parent but may prefer to keep its books and records in a currency other than its fllllctional currency (e.g. the currency of the country where it is domiciled). At the time when the foreign operation prepares its individual financial statements, or when the group prepares consolidated financial statements, all amounts of the foreign operation should be translated into its fllllctional currency (which is the same as that of the parent) in accordance with the principles that apply to foreign currency transactions. This produces the same amollllts in the functional currency as would have been reported had the items been recorded initially in the fllllctional currency. For example, monetary items are translated into the fllllctional currency using the closing rate, and non-monetary items that are measured on a historical cost basis are translated using the exchange rate at the date of the transaction that resulted in their recognition. All resulting exchange differences are recognised in profit or loss.

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8.9 Summary of translation of foreign operations Identifying the functional currency Primary indicators

Secondary indicators

•

Currency that mainly influences sales prices

•

Currency in which financing is raised

•

Currency of country whose competitive forces and regulations mainly determine the sales price

•

Currency in which activities are retained.

•

Currency that mainly influences labour, material and other costs.

Closing rate method

"Full" disposals

•

Assets and liabilities for each reporting period translated at the spot rate at the end of that reporting period

•

•

Income and expenses translated at the exchange rate on the date of the transaction

•

All exchange differences recognised in other comprehensive income (FCTR).

Intnrgroup monetary asset or liability •

The balance will eliminate on consolidation

•

Exchange differences consolidation

•

If part of the net investment, transfer to the FCTR on consolidation.

not

eliminate

from

operating

Disposals and partial disposals

Translation of financial statements

will

receipts

Reclassify 100% of FCTR attributable to parent to profit or loss

•

Derecognise FCTR attributable to non-controlling interest (if subsidiary) Full disposals include:

•

Disposal of total interest

•

The loss of control of a subsidiary that includes a foreign operation

•

The partial disposal of an interest in a joint arrangement or in an associate that includes a foreign operation, when the retained investment (after the partial disposal) is a financial asset that includes a foreign operation.

on

Partial disposals

•

Goodwill and fair value adjustments

Any reduction in the ownership interest in a foreign operation excluding all of the above "full" disposals. V\r17en partially dis(XJsing of subsidiary

•

Regarded as assets and liabilities of the foreign operation

•

•

Translated at closing rate.

Transfer the % disposed of out of FCTR to noncontrolling interest All ciher partial disposals •

Reclassify the % of the FCTR sold to profit or loss.

Methods of disposal or partial disposal

• •

Sale Liquidation

•

Repayment of share capital

• •

Abandonment Receipt of dividends from pre-acquisition profits.

9

Consolidated statement of cash flows lAS 7 (Effective date 1 January 1994)

9.1 Introduction Where consolidated financial statements are prepared, a consolidated statement of cash flow information should also be presented. A consolidated statement of cash flows, like a consolidated statement of profit or loss and other comprehensive income or statement of financial position, deals only with transactions that are external to the group. The consolidated statement of cash flows can be prepared either by combining the separate statements of cash flows of each company in the group or by using the consolidated statement of profit or loss and other comprehensive income and statement of financial position. The second approach is cornmon practice among South African groups as the elimination of intra-group transactions has already been performed. The basic approach followed for a consolidated statement of cash flows is similar to an individual company's statement of cash flows, namely that each line item in the statement of financial position is reconstructed by taking into accOllllt information from the statement of profit or loss and other comprehensive income, in order to identity cash flows. Certain issues are, however, unique to a consolidated statement of cash flows and are addressed in this chapter, namely: • Dividends received from associates and joint ventures • Acquisitions and disposals of associates and joint ventures • Dividends paid to non-controlling shareholders • Acquisitions and disposals of subsidiaries • Share-issues and share buy-backs by subsidiaries • Foreign operations.

9.2 Associates and joint ventures 9.2.1 Equity accounting If an investment in an associate or a joint venture is accounted for by means of the equity method, cash flow reporting should be restricted to cash flows between the investor and the investee, for example dividends paid by the investee to the investor, or advances made by the investor to the investee. The dividends received by the investor can be accounted for either as an investing or operating activity (as with any other dividends received), while cash flows relating to advances should be accounted for as an investing activity.

Example 9.1: Equity accounting p Ltd has a 30% investment in A Ltd. The consolidated financial statements of P Ltd reflect the following at 31 December 20X2:

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340

Statement of financial position at 31 December 20X2 (extracts only) 20X2 R

20X1 R

Assets Investment in associate

95000

120000

-Investment in ordinary shares - Loan to associate

Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2 (extracts only) 20X2 R

XXX (XXX) 30000

other expenses Finance costs Share of profit of associate

The share of the profit of the associate does not represent cash flow. The only cash flow in respect of the investment in the ordinary shares of A Ltd will be the dividends received. This can be calculated by reconstructing the investment in associate account as follows: I nvestment in ordinar shares of associate Opening balance 80000 Dividends (balancing) Share of profit of associate 30000 Closing balance

10000 100000

110000

110000

If it is known that A Ltd repaid an amount of R7 000 on the loan, the additional advance made during the year by P Ltd can be calculated as follows: Opening balance Advance made (balancing)

Loan to associate 15000 Repayment 12 000 Closing balance

7000 20000

27000

27000

This information will be presented as follows in the consolidated statement of cash flows:

Statement of cash flows for the year ended 31 December 20X2 (extracts only) R

Cash flows from operating activities Dividends received

10 000

Cash flows from investing activities Advances to associate Repayment of loan by associate

(12000) 7000

9.2.2 Acquisitions of associates or joint ventures Investments made during the year in new associates or joint ventures should be disclosed as an investing activity. The same applies if additional investments are made in existing associates or joint ventures provided these associates or joint ventures do not become subsidiaries (associates that become subsidiaries are addressed in section 9.3.5).

Example 9.2: Acquisition of associate P Ltd acquired a 30% investment in A Ltd on 30 April 20XO. During the current financial year (20X2) P Ltd acquired an additional 5% interest in A Ltd for R17 000, when the net asset value of A Ltd (fairly valued) was R380000. The consolidated financial statements of P Ltd reflect the following at 31 December 20X2:

341

Consolidated statement of cashjlows Statement of financial position at 31 December 20X2 (extracts only)

Assets Investment in associate

20X2

20X1

R

R

120000

80000

Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2 (extracts only) 20X2 R

(25000) (XXX) 30000

other expenses Finance costs Share of profit of associate

The amount of R17 000 paid for the additional interest in A Ltd should be presented as an investing activity. The net asset value acquired during the current financial year amounts to R19 000 (380 000 x 5%), which means that the acquisition of the additional 5% gave rise to an excess of R2 000 (19 00017 000), recognised in profit or loss. This excess does not represent cash flow and should be eliminated from operating activities for cash flow purposes. Assume for purposes of this example that the excess was set off against other expenses (all cash) of R27 000. The dividends received during the current year can be calculated as follows: Investment in associate Opening balance 80000 Dividends (balancing) Acquisition of additional interest 17000 Closing balance 2000 Excess Share of profit of associate 30000

129000

9000 120000

129000

This information will be presented as follows in the consolidated statement of cash flows:

Statement of cash flows for the year ended 31 December 20X2 (extracts only) R

Cash flows from operating activities Payments to suppliers and employees (25 000 + 2 000 excess) Dividends received

(27000) 9000

Cash flows from investing activities I nvestment in associate

(17 000)

9.2.3 Disposals of associates or joint ventures If the total investment in an associate or a j oint venture is disposed of, the proceeds should be presented as an investing activity. The gain/loss on the disposal recognised in profit or loss should be eliminated from operating activities for cash flow purposes, as the total proceeds are reflected as an investing activity. The same applies if only a portion of the investment is sold and the retained investment remains an associate or a joint venture - the gainlloss should be eliminated from operating activities as the total proceeds are reflected as an investing activity. If only a portion of the investment is disposed of and significant injluenceljoint control is lost, the total proceeds should still be presented as an investing activity. However, in addition to the recognition of the gainlloss on the portion of the investment disposed of, the retained investment should be adjusted to fair value. Both the fair value adjustment and the gainlloss on disposal are accOllllted for in profit or loss and should be eliminated from operating activities for cash flow purposes, as the gainlloss relates to an investing activity, while the fair value adjustment does not represent cash flow. Note that the cash flow effects of disposals of associates or j oint ventures may not be set off against the cash flow effects of acquisitions of associates or j oint ventures.

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Example 9.3: Disposal of associate The following information relates to the consolidated financial statements of P Ltd for the year ended 31 December 20X5: Statement of financial position at 31 December 20X5 (extracts only)

Assets Investment in associate Financial assets (equity investments) at fair value through other comprehensive income

20X5

20X4

R

R

120000 110000

195000 50000

Statement of profit or loss and other comprehensive income for the year ended 31 December 20X5 (extracts only) 20X5 R

other expenses Share of profit of associate other comprehensive income Items that will not be reclassified to profit or loss - Mark-to-market reserve: Gains arising during the year

(50000) 30000

14000

Assume that a portion of an investment in an associate was sold during the year for R50 000, whereby significant influence was lost. The retained investment was classified as at fair value through other comprehensive income. The loss on the sale was included in other expenses. The fair value adjustment (gain) on the retained investment amounted to R5000 and was netted off against other expenses. Dividends amounting to R1 0000 were received from associates during the current year. No financial assets at fair value through other comprehensive income were bought or sold during the year. The effect of tax should be ignored. When calculating the payments to suppliers and employees, the fair value adjustment of R5000 (netted off against other expenses) should be eliminated, as this does not represent cash flow. Furthermore the loss on the sale of the shares should also be eliminated from other expenses, as this relates to an investing activity. To calculate the loss on the sale, it is necessary to determine the carrying amount at disposal date of the investment disposed of: Opening balance Share of profit of associate

Investment in associate 195 000 Dividends 30000 Disposal (balancing) Closing balance 225000

10000 95000 120000 225000

The carrying amount of the total investment therefore amounted to R95 000 at the date of disposal. As only a portion of this investment was disposed of, the carrying amount should be split into the portion sold and the portion retained. The carrying amount of the retained investment can be calculated by reconstructing the financial assets at fair value through other comprehensive income account, as the retained investment is now a normallFRS 9 investment: Financial assets at fair value throu h other com rehensive income Opening balance 50000 Closing balance 110000 Fair value adjustments (Oel) 14 000 Retained investment (balancing) 46000 110000

110000

The retained investment was recognised as an investment at fair value through other comprehensive income at an initial fair value of R46 000. However, this fair value includes a fair value adjustment of R5 000, which means that the carrying amount of the retained investment was R41 000 before the fair value adjustment. The carrying amount of the total investment in the associate amounted to R95 000 at the date of disposal, of which R41 000 was retained. This implies that the carrying amount of the investment disposed of amounts to R54000 (95000 total - 41 000 retained), resulting in a loss on disposal of R4 000 (54 000 carrying amount - 50 000 proceeds).

343

Consolidated statement of cashjlows This information will be presented as follows in the consolidated statement of cash flows:

Statement of cash flows for the year ended 31 December 20X5 (extracts only) R

Cash flows from operating activities Cash paid to suppliers and employees (50 000 - 4 000 loss + 5 000 gain) Dividends received

(51 000) 10000

Cash flows from investing activities Disposal of part of associate - significant influence lost

50000

9.2.4 Share issues or share buy-backs by associates or joint ventures If an associate or joint venture has a share issue and the investor takes up some or all of the shares, the amollllt paid for these shares by the investor should be reported as an investing activity. In the case of a rights issue, if the investor sells any of the rights, the proceeds from the sale should also be reported as an investing activity. The total gain/loss resulting from the share issue (recognised in profit or loss) should be eliminated from operating activities, as it does not represent cash flow. If an associate or j oint venture has a share buy-back and some of the shares are bought back from the investor, the amollllt received by the investor should be reported as an investing activity. The total gaiIVloss resulting from the buy-back (recognised in profit or loss) should be eliminated from operating activities, as it does not represent cash flow.

9.3 Subsidiaries 9.3.1 Basic principles When preparing a consolidated statement of cash flows, cognisance is taken of the entity concept and total group cash flows are recognised, i.e. without deducting the non-controlling shareholders' interest in the llllderlying cash flows. If interests in subsidiaries remained llllchanged during the year (i.e. no acquisitions or disposals of subsidiaries and no share issues or share buy-backs by subsidiaries), the preparation of a consolidated statement of cash flows is no different from that of an individual company, apart from cash flows between the group and the non-controlling shareholders. These cash flows, for example dividends paid by subsidiaries to non-controlling shareholders, should be reported in the consolidated statement of cash flows.

Example 9.4: Dividends paid The following information relates to the consolidated financial statements of P Ltd for the year ended 31 December 20X2:

Statement of financial position at 31 December 20X2 (extracts only) 20X2 Equity and liabilities Non-controlling interest Shareholders for dividends* • p Ltd declared dividends of R25 000 during 20X2.

20X1

R

R

600000 6000

500000 5000

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GAAP Handbook 2020: Volume 2

Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2 (extracts only) 20X2 R Total comprehensive income attributable to: OVVners of the parent 800000 Non-controlling interest 115000 915000 In order to calculate the total dividends paid by the group, it is necessary to determine the noncontrolling interest in dividends declared during the year by subsidiaries. This can be done by reconstructing the non-controlling interest account: Dividends declared (balancing) Closing balance

Non-controllin interest 15000 Opening balance 600 000 Interest in total income

500000 comprehensive

615000

115000 615000

The non-controlling interest in dividends declared by subsidiaries therefore amounts to R15 000. The total dividends paid in cash by the group can now be calculated by reconstructing the shareholders for dividends account: Shareholders for dividends Dividends paid (balancing) 39000 Opening balance 5000 Closing balance 6 000 Dividends declared by P Ltd 25000 Dividends declared by subsidiaries 15000

45000

45000

This information will be presented as follows in the consolidated statement of cash flows:

Statement of cash flows for the year ended 31 December 20X2 (extracts only) R Cash flows from operating activities Dividends paid

(39000)

9.3.2 Acquisition of new subsidiary When a parent obtains control of a subsidiary, it acquires control over various assets and liabilities that are used to generate future revenue. In the parent's own statement of cash flows this transaction is shown as an acquisition of shares llllder investing activities. In the consolidated statement of cash flows, the acquisition of the investment is shown as a single line item llllder investing activities and a note to the statement of cash flows provides details of the • assets and liabilities acquired, • the amollllt of the consideration paid, • the portion of the consideration consisting of cash and cash equivalents, and • the amollllt of the cash and cash equivalents of the subsidiary. The amollllt reflected as investing activity in the consolidated statement of cash flows should be net of cash and cash equivalents acquired. For example, if a parent pays RlOO 000 for a 70% interest in a subsidiary and the subsidiary owns cash and cash equivalents amollllting to R20 000, the net cash flow of R80 000 (outflow of RIOO 000 and inflow of R20 000) is disclosed in the consolidated statement of cash flows. If the subsidiary has a bank overdraft of R20 000 instead of a favourable bank balance, the amollllt disclosed as investing activity will be R120 000, consisting of an outflow of R 100 000 to acquire the subsidiary plus an outflow of R20 000 representing the impact of the bank overdraft on the group's cash balance (i.e. a reduction in the net cash balance). An acquisition of a subsidiary during the accollllting period unfortunately complicates the preparation of the group statement of cash flows. Since the acquisition of the subsidiary is accollllted

345

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for as a single entry, many of the movements during the accOllllting period in the statement of financial position items cannot be calculated solely by comparing the balances of the current and prior period. This is due to the fact that the acquisition of the subsidiary results in an increase in the individual assets and liabilities of the group, and these increases need to be eliminated when calculating movements for purposes of the statement of cash flows. The movements could be calculated on the following basis, using cash receipts from customers as an example:

Opening balance (excluding subsidiary) Debtors acquired through subsidiary Sales (parent + subsidiary after acquisition date)

Debtors 700 000 Closing balance (including subsidiary) 100 000 Cash receipts (balancing) 500000 1 300000

1 000000 300000

1 300000

The implication of the above calculation is that the only part of the cash receipts attributable to the new subsidiary is the receipts from acquisition date to year-end, i.e. movements in the subsidiary's working capital are only reflected in the group statement of cash flows after acquisition of the subsidiary. Similar adjustments must be made to all other items appearing in the statement of financial position. When a new subsidirny is acquired, there will be an increase in the non-controlling interest, which should be kept in mind when reconstructing the non-controlling interest account. Furthermore the acquisition will give rise to either goodwill or a bargain purchase gain. The latter is recognised in profit or loss and, as it does not represent cash flow, it should be eliminated from operating activities for cash flow purposes. The cash flow effects of disposals of subsidiaries may not be off set against the cash flow effects of acquisitions of subsidiaries. The separate disclosure of the cash flow effects of acquisitions and disposals of subsidiaries as single line items, together with separate disclosure of the amounts of assets and liabilities acquired or disposed of, helps to distinguish those cash flows from the cash flows arising from the other operating, investing and financing activities of the group.

Example 9.5: Acquisition of a new subsidiary p Ltd acquired a 100% interest in S Ltd on 31 December 20X1, at R5 000. The fair value and carrying amount of S Ltd's net assets were as follows on this date: R

Land Patent Cash

3500 500 800 4800

If it is assumed that this is P Ltd's only transaction for the year ended 31 December 20X1 and that the only two items reflected in P Ltd's statement of financial position before this transaction (and therefore also at the end of 20XO) were share capital of R10000 and a bank balance of R10000, the consolidated statement of financial position at 31 December 20X1 will be as follows:

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346 Statement of financial position at 31 December 20X1

Assets Property, plant and equipment Intangible assets Goodw ill (5 000 cost - 4 800 net assets) Cash (10 000 P Ltd - 5 000 consideration + 800 S Ltd)

Equity and liabilities Share capital

20X1

20XO

R

R

3500 500 200 5800

10 000

10 000

10 000

10 000

10 000

If the movements in the asset and liability accounts are analysed, it may seem as though the group acquired PPE of R3 500 and intangible assets of R500 during the year. However, the increase in PPE and intangible assets resulted from the acquisition of a subsidiary and, instead of showing the individual assets and liabilities acquired, the acquisition should be shown as a single line item under investing activities. The amount disclosed in respect of the acquisition will be R5 000 paid less the acquisition date cash of S Ltd amounting to RBOO, i.e. R4 200. The calculation of additions to PPE and intangible assets can be illustrated as follows: Opening balance Acquisition of subsidiary Other additions (balancing)

PPE Closing balance

3500

3500 3500

3500

Opening balance Acquisition of subsidiary Other additions (balancing)

I ntan ible assets Closing balance

500

500 500

500

From the above calculations it should be clear that there were no cash additions during the year to either PPE or intangible assets. The above information will be presented as follows in the consolidated statement of cash flows:

Statement of cash flows for the year ended 31 December 20X1 Notes

Cash flows from investing activities Additions to property, plant and equipment and intangible assets Acquisition of subsidiary (5 000 - 800) Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period

R

(4200) (4200) 10000 5800

347

Consolidated statement of cashjlows Notes

1. Acquisition of subsidiary During the year the group acquired a 100% interest in subsidiary S Ltd. The fair value of assets acquired and liabilities assumed were as follows: R

Property, plant and equipment Intangible assets Cash Net assets acquired Goodwill

3500 500 800 4800 200

Total consideration settled in cash Less cash and cash equivalents of subsidiary

5000 (800)

Net cash outflow

4200

(Note that if the purchase price is not known, it can be calculated by adding the goodwill to the net assets acquired.)

If a subsidiary is acquired by the issue of shares, then the consideration settled in cash would be zero, but the cash and cash equivalents of the subsidiary should still be reported on the face of the statement of cash flows llllder investing activities as a cash inflow. The note indicating the assets and liabilities acquired and the mechanism for settling the consideration should still be disclosed.

Example 9.6: Acquisition of subsidiary through the issue of shares P Ltd acquired an 80% interest in S Ltd on 30 June 20X1 for R40 000. The purchase consideration was settled by issuing shares. The non-controlling interest was measured at acquisition date at their proportionate share of S Ltd's identifiable net assets. The carrying amount and fair value of S Ltd's assets and liabilities were as follows on 30 June 20X1: R

PPE Inventory Trade debtors Cash Loan Trade creditors

28000 8000 5000 4000 (10 000) (5000) 30000

Assume that the consolidated statement of financial position reflected PPE at a carrying amount of R 110000 at 31 December 20X1 (R75 000 - 31 December 20XO). The depreciation for the year ended 31 December 20X1 amounted to R22000 in the consolidated statement of profit or loss and other comprehensive income. The additions to PPE can be calculated by reconstructing the PPE account: Opening balance Acquisition of S Ltd Additions (balancing)

PPE carr in amount 75000 Depreciation 28 000 Closing balance 29000 132000

22000 110000 132000

(Note that the above calculation will apply to all the assets and liabilities of S Ltd that existed at acquisition date, i.e. inventory, trade debtors, trade creditors and loans.) When calculating the cash payments to suppliers and employees, the depreciation will have to be eliminated as this represents a non-cash item. Even though the investment in S Ltd was acquired in exchange for shares, the inflow of S Ltd's favourable bank balance into the group's cash and cash equivalents should be reported in the statement of cash flows.

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The above information will be presented as follows in the consolidated statement of cash flows:

Statement of cash flows for the year ended 31 December 20X1 (extracts only) Notes

R

Cash flows from operating activities Cash payments to suppliers and employees (XXX - 22 000 depreciation)

XXX

Cash flows from investing activities Additions to property, plant and equipment Acquisition of subsidiary

(29000) 4000

Notes

1. Acquisition of subsidiary During the year the group acquired an 80% interest in subsidiary S Ltd. The fair value of assets acquired and liabilities assumed were as follows: Property plant and equipment Inventory Trade debtors Cash Loan Trade creditors Net assets acquired Non-controlling interest (30 000 x 20%) Goodwill (40 000 consideration + 6 000 NCI - 30000 net assets) Total consideration Consideration paid by issuing shares

R 28000 8000 5000 4000 (10 000) (5000)

30000 (6000) 16000 40000 (40000)

Consideration settled in cash Less cash and cash equivalents of subsidiary

(4000)

Net cash inflow

(4000)

Note that if the non-controlling interest was measured at acquisition date at a fair value of R6 500, the non-controlling interest in the above note would have amounted to R6 500, while the goodwill would have increased to R16 500. The remainder of the note would have remained unchanged. If S Ltd did not have any cash or cash equivalents at acquisition date and the purchase price was settled in shares, no amount (cash flow) would have been disclosed on the face of the statement of cash flows. However, the event would still have been disclosed under non-cash investing and financing activities, including the above note detailing the assets and liabilities (up to the consideration settled in cash of zero).

9.3.3 Disposal of total interest in subsidiary Disposals of investments in subsidiaries involve the recognition of the disposal proceeds as a single line item shown llllder investing activities (net of the cash and cash equivalents of the subsidiary disposed of). Similar to the acquisition of subsidiaries, the notes to the statement of cash flows will disclose information about the underlying assets and liabilities that were disposed of, as well as the mechanism for settling the consideration. Any profitlloss on disposal recognised in profit or loss should, for cash flow purposes, be eliminated from operating activities, as this profitlloss on disposal relates to investing activities. Since the disposal of a subsidirny is accollllted for as a single entry, many of the movements during the accollllting period in the statement of financial position items cannot be calculated solely by comparing the balances of the current and prior period. This is due to the fact that the disposal of the subsidiary results in a decrease in the individual assets and liabilities of the group, and these decreases need to be eliminated when calculating movements for purposes of the statement of cash flows. The movements could be calculated on the following basis, using cash receipts from customers as an example:

349

Consolidated statement of cashjlows Debtors 700 000 Closing balance (excluding subsidiary) 800000 Debtors disposed of through subsidiary Cash receipts (balancing)

Opening balance (including subsidiary) Sales (parent + subsidiary up to disposal date)

1 000000

100000 400000

1 500000

1 500000

A situation similar to the acquisition of a subsidirny arises on the disposal of a subsidirny, in that the movement in working capital items consists of two parts: • The movement from the previous reporting date to the disposal date including the subsidirny, and • the movement from the date of disposal to the current reporting date excluding the subsidirny. A similar calculation is performed for all working capital items as well as any other assets or liabilities relating to the subsidirny disposed of. The disposal of an interest in a subsidirny will impact on the balance of the non-controlling interest, as the non-controlling interest relating to that subsidirny will be derecognised at date of disposal. This should be remembered when reconstructing the non-controlling interest aCCOllllt. The same derecognition principles apply to any goodwill relating to the subsidirny disposed of.

Example 9.7: Disposal oftotal interest in a subsidiary P Ltd owned a 100% interest in S Ltd. This investment was acquired in 20X1 for R3 500 and gave rise to goodwill of R500. On 1 January 20X5 this investment was disposed of for R6 000. The consolidated carrying amounts of S Ltd's assets and liabilities (excluding goodwill) were as follows on disposal date: R

Land Patent Cash

3500 500 800 4800

The consolidated statement of profit or loss and other comprehensive income will reflect a profit of R700 on the sale of the interest [6 000 proceeds - (4 800 assets + 500 goodwilill Assume that this amount was set off against other expenses. If it is assumed that this was the group's only transaction for the year ended 31 December 20X5, and that P Ltd's cash balance amounted to R6 500 before the sale, the consolidated statement of financial position at 31 December 20X5 will be as follows: Statement of financial position at 31 December 20X5

Assets Property, plant and equipment Intangible assets Goodwill Cash (6 500 P Ltd + 6 000 proceeds); (6500 P Ltd + 800 S Ltd)

Equity and liabilities Share capital (assume) Retained earnings (1 800 assumed opening balance + 700 gain)

20X5 R

20X4 R

12500

3500 500 500 7300

12500

11 800

10 000 2500

10000 1 800

12500

11 800

If the movements in the asset and liability accounts are analysed, it may seem as though the group disposed of PPE with a carrying amount of R3 500 and intangible assets with a carrying amount of R500. However, the decrease in PPE and intangible assets resulted from the disposal of a subsidiary, and instead of showing the individual assets and liabilities disposed of, the disposal should be shown

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as a single line item under investing activities. The amount disclosed for the disposal will be R6 000 received less the disposal date cash balance of S Ltd amounting to RBDO, i.e. R5 200. The calculation of additions to PPE and intangible assets will be done as follows: Opening balance

Other additions (balancing)

PPE 3500 Disposal of subsidiary Closing balance

3500

3500

3500

I ntanqible assets Opening balance Other additions (balancing)

500

Disposal of subsidiary

500

Closing balance

500

500

The above information will be presented as follows in the consolidated statement of cash flows:

Statement of cash flows for the year ended 31 December 20X5 Notes Cash flows from operating activities Cash payments to suppliers and employees (XXX + 700 gain) Cash flows from investing activities Disposal of property, plant and equipment and intangible assets Disposal of subsidiary Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period

R XXX

5200 5200 7300 12500

Notes 1. Disposal of subsidiary During the year the group disposed of a 100% interest in subsidiary S. The consolidated carrying amounts of the assets and liabilities disposed of were as follows: R

Property, plant and equipment Intangible assets Cash

3500 500 800

Net assets disposed of Goodwill Gain on disposal

4800 500 700

Total consideration received in cash Less cash and cash equivalents of subsidiary

6000 (800)

Net cash inflow

5200

(Note that if the proceeds are not known, it could be calculated by adding the net assets, goodwill and gain arising from the disposal.)

If a subsidiary is disposed of in exchange for assets other than cash and cash equivalents, then the cash considemtion would be nil but the cash and cash equivalents of the subsidiary should still be reported on the face of the statement of cash flows llllder investing activities as a cash outflow. A note indicating the assets and liabilities disposed of and the mechanism for settling the disposal proceeds should still be disclosed.

Example 9.8: Disposal of subsidiary in exchange for debentures p Ltd acquired an 80% interest in S Ltd on 30 June 20X1 for R40 000. Goodwill of R16 000 arose in respect of the acquisition. The non-controlling interest was measured at acquisition date at their proportionate share of S Ltd's identifiable net assets. The total interest in S Ltd was disposed of on

351

Consolidated statement of cashjlows

30 June 20X2 in exchange for debentures in a foreign listed company, with a fair value of R50 000. The consolidated carrying amounts of S Ltd's assets and liabilities (excluding goodwill) were as follows on 30 June 20X2: R

PPE

42000 12000 8000 6000 (15000) (8000)

Inventory Trade debtors Cash Loan Trade creditors

45000 Assume that the consolidated statement of financial position reflected PPE at a carrying amount of R90 000 at 31 December 20X2 (R120 000 - 31 December 20X1). The depreciation for the year ended 31 December 20X2 amounted to R22000 in the consolidated statement of profit or loss and other comprehensive income. The cash additions to PPE can be calculated by reconstructing the PPE account: PPE carr in amount 120000 Depreciation Opening balance Additions (balancing) 34 000 Disposal of S Ltd Closing balance

22000 42000 90000

154000

154000

(Note that the above calculation will apply to all the assets and liabilities of S Ltd that existed at disposal date, i.e. inventory, trade debtors, trade creditors and loans.) Included in the consolidated statement of profit or loss and other comprehensive income is a loss on the disposal of the interest in S Ltd amounting to R2 000 [50000 proceeds - (45000 net assets + 16000 goodwill - 9000 non-controlling interest)]. Assume that this amount is included in other expenses. When calculating the cash payments to suppliers and employees, the depreciation will have to be eliminated as this represents a non-cash item. The loss on the sale of S Ltd should also be eliminated from cash payments to suppliers, as this loss relates to an investing activity. Even though the investment in S Ltd was disposed of in exchange for a non-cash asset (debentures), the outflow of S Ltd's favourable bank balance from the group's cash and cash equivalents should be reported in the statement of cash flows. The above information will be presented as follows in the consolidated statement of cash flows: Statement of cash flows for the year ended 31 December 20X2 (extracts only) Notes Cash flows from operating activities Cash payments to suppliers and employees (XXX - 22 000 depreciation - 2000 loss) Cash flows from investing activities Additions to property, plant and equipment Disposal of subsidiary

R

XXX

(34000) (6000)

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Notes

1. Disposal of subsidiary During the year the group disposed of an 80% interest in subsidiary S Ltd. The carrying amount of assets and liabilities disposed of were as follows: R

Property, plant and equipment Inventory Trade debtors Cash Loan Trade creditors Net assets disposed of Non-controlling interest (45 000 x 20%) Goodwill Loss on sale Total disposal consideration Consideration received in the form of debentures

42000 12000 8000 6000 (15000) (8000) 45000 (9000) 16000 (2000) 50000 (50000)

Consideration received in cash Less cash and cash equivalents of subsidiary

(6000)

Net cash outflow

(6000)

Note that if the non-controlling interest was measured at acquisition date at fair value and amounted to R 10 000 at disposal date, the non-controlling interest line item in the above note would have amounted to R10 000, while the goodwill would have increased to R17 000. The remainder of the note would have remained unchanged.

If S Ltd did not have any cash or cash equivalents at disposal date and the disposal proceeds was settled in debentures, no cash flow would have been disclosed on the face of the statement of cash flows. However, the event would still have been disclosed under non-cash investing and financing activities, including the above note detailing the assets and liabilities (up to the consideration received in cash of zero). If S Ltd had an unfavourable bank balance of R6000 at disposal date, this would have been reported as a net cash inflow, as the group then benefits by transferring the unfavourable balance to a third party.

9.3.4 Additional interest in existing subsidiary or disposal of part of subsidiary without losing control A parent may acquire an additional interest in an existing subsidiary, or dispose of a portion of a subsidiary without losing control. Such a transaction is accOllllted for as an equity transaction (i.e. a transaction with owners in their capacity as owners). The only effect that such a transaction has on the statement of cash flow is that the total amount paid/received should be disclosed as a financing activity. The reason for disclosing the transaction as a financing activity is that all transactions with owners in their capacity as owners are regarded as financing activities, for example the issue and buyback of shares, the payment of dividends, etc. It is important to note that the amount paid/received will not be disclosed net of the cash and cash equivalents of the subsidiary, as 100% of the subsidiary's cash balance is included in the consolidated cash balance both before and after the acquisition/disposal of the interest. Similarly the acquisition/disposal of the interest will have no impact on PPE, debtors, creditors, etc, as 100% of the subsidiary's balances are included in the consolidated balances both before and after the acquisition/disposal. The acquisition/disposal will not impact on the goodwill recognised in the statement of financial position, but will impact on the noncontrolling interest. This should be remembered when reconstructing the non-controlling interest account.

353

Consolidated statement of cashjlows

Example 9.9: Additional interest in existing subsidiary and disposal without losing control p Ltd acquired a 60% interest in S Ltd on 1 July 20X2. On 30 June 20X3, when the non-controlling interest relating to S Ltd amounted to R100 000, P Ltd acquired an additional 20% interest for R55 000. Furthermore P Ltd owned a 90% interest in T Ltd, which was acquired on 1 August 20X2. On 30 September 20X3 a 30% interest in this subsidiary was disposed of for R123 000. The consolidated net assets of T Limited (excluding goodwill) amounted to R350 000 on this date, while the goodwill of T Ltd attributable to P Ltd amounted to R60 000. The acquisition of the 20% interest in S Ltd and the disposal of the 30% interest in T Ltd will be accounted for as follows in the consolidated statement of changes in equity:

Acquisition of additional interest in subsidiary Disposal of part of subsidiary 1 100000 x 2%0 = 50 000 255000-50000=5000 3 (350000 x 30%) + (60 000 x 3%0) = 125000 4 123000 -125 000 = 2000

Retained earnings

Non-controlling interest

R

R

(5000)' (2000)4

(50000)' 125000 3

Total R

(55000) 123000

This information will be disclosed as follows in the consolidated statement of cash flows: Statement of cash flows for the year ended 31 December 20X3 (extracts only) R

Cash flows from financing activities Acquisition of additional interest in existing subsidiary Disposal of part of a subsidiary without losing control

(55000) 123000

(Note that the disclosure regarding the total assets and liabilities of the subsidiaries and the mechanism for settling the consideration is not required, as these assets and liabilities were included in the consolidated balances both before and after the interests were acquired/disposed of.)

9.3.5 Associate becomes subsidiary An investor may acquire an additional interest in an associate whereby the associate becomes a subsidiary. The cash flow implications are very similar to where an investment in a new subsidiary is acquired. The amollllt paid for the additional interest should be disclosed as a single line item under investing activities, net of the cash and cash equivalents of the subsidiary. The acquisition of the subsidiary results in an increase in the individual assets and liabilities of the group, and these increases need to be eliminated when calculating cash flow movements for the group (similar to where an investment in a new subsidiary is acquired). The note detailing the net assets and liabilities acquired and the mechanism for settling the consideration should be provided - this note will contain one additional reconciling item, namely the previously held investment in the associate. On the date when the associate becomes a subsidiary, the previously held investment should be fair valued and this fair value adjustment should then be recognised in profit or loss. As this fair value adjustment does not represent cash flow, it should be eliminated from operating activities for cash flow purposes. When an associate becomes a subsidiary, it will clearly impact on the investment in associate accollllt, as the investment will be removed from this aCCOllllt. The fact that there is a reduction in the investment in associate account without receiving cash in return should be kept in mind when reconstructing the investment in associate aCCOllllt. Furthermore there will be an increase in the noncontrolling interest, which should be kept in mind when analysing movements relating to the noncontrolling interest. The acquisition will give rise to either goodwill or a bargain purchase gain. The latter is recognised in profit or loss and, as it does not represent cash flow, it should be eliminated from operating activities for cash flow pUIposes.

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Example 9.10: Associate becomes subsidiary P Ltd acquired a 40% interest in S Ltd on 31 December 20X1 for R60 000, when the equity of S Ltd (fairly valued) amounted to R145 000. At 31 December 20X2 P Ltd acquired an additional 24% interest in S Ltd for R70 000 and obtained control of S Ltd. The fair value of the previously held 40% investment amounted to R125 000 at that date. The non-controlling interest was measured at acquisition date at their proportionate share of the identifiable net assets of S Ltd. The fair values of the assets acquired and liabilities assumed of S Ltd were as follows on 31 December 20X2: PPE Inventory Trade debtors Cash Trade creditors

R 200000 45000 87000 8000 (35000)

305000 Assume that this was the group's only transaction for the year ended 31 December 20X2 and that the statement of financial position at 31 December 20X1 reflected the following, in addition to the investment in associate of R60 000: A cash balance of R40 000, share capital of R80 000, and retained earnings of R20 000. The consolidated financial statements for the year ended 31 December 20X2 will be as follows: Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2

Fair value adjustment [125000 fair value - (60000 cost + 64 000 share of profit)[ Bargain purchase gain [70000 consideration + 125000 fair value + (305 000 x 36%) NCI- 305 000 net assets[ Share of profit of associate [(305 000 -145 000) increase in equity x 40%[ Profit for the year

20X2 R 1 000 200 64000 65200

Statement of financial position at 31 December 20X2

Assets Property, plant and equipment Investment in associate Inventory Debtors Cash

Equity and liabilities Share capital Retained earnings (20 000 opening + 65 200 profit) Non-controlling interest (305000 net assets x 36%) Creditors Bank overdraft (40 000 P Ltd - 70 000 consideration paid + 8 000 S Ltd)

20X2

20X1

R

R

200000 60000 45000 87000 40000 332 000

100 000

80000 85200 109800 35000 22000

80000 20000

332 000

100 000

If the movements in the asset and liability accounts are analysed, it may seem as though the group acquired PPE of R200 000, inventory of R45 000, debtors of R87 000 and creditors of R35 000 during the year. However, the increase in these accounts resulted from the acquisition of a subsidiary, and instead of showing the individual assets and liabilities acquired, the acquisition should be shown as a

355

Consolidated statement of cashjlows

single line item under investing activities. The amount disclosed in respect of the acquisition of the subsidiary will be R70 000 paid less the acquisition date cash balance of S Ltd amounting to R8 000, i.e. R62000. The cash additions to PPE for the group should be calculated as follows:

PPE Opening balance Acquisition of subsidiary other additions (balancing)

Closing balance

200000

200000 200000

200000

The purchases of inventory will be calculated as follows: Inventor Opening balance Closing balance Acquisition of subsidiary 45000 Purchases (balancing)

45000

45000

45000

The cash payments to trade creditors will be calculated as follows: Creditors Opening balance Cash payments (balancing) Closing balance 35 000 Acquisition of subsidiary Purchases (from inventory account) 35000

35 000 35000

The cash receipts from debtors will be calculated as follows: Debtors Opening balance Cash receipts (balancing) Acquisition of subsidiary 87000 Closing balance

87000

87000

87000

The movements on investments in associates can be analysed as follows: Investment in associate 60000 Associate becomes subsidiary 124000 Opening balance Profit from associate 64000 Disposals of investments (balancing) Closing balance 124000

124000

From the above calculations it should be clear that there were no cash movements relating to PPE, inventory, creditors, debtors and investments in associates. Furthermore all the amounts recognised in profit or loss (share of profit of associate, fair value adjustment, bargain purchase gain) do not represent cash flow and should be eliminated from operating activities. The above information will be presented as follows in the consolidated statement of cash flows: Statement of cash flows for the year ended 31 December 20X2

Notes

R

Cash flows from operating activities Cash receipts from customers Cash payments to suppliers and employees Cash flows from investing activities Additions to property, plant and equipment Disposal of investments in associates Acquisition of additional interest in associate thereby obtaining control

(62000)

Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of period

(62000) 40000

Cash and cash equivalents at end of period

(22000)

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Notes

1. Associate becomes subsidiary During the year an additional interest was acquired in associate S Ltd, resulting in it becoming a 64% held subsidiary. The fair value of assets acquired and liabilities assumed were as follows: R Property, plant and equipment 200000 Inventory 45000 Trade debtors 87000 Cash 8000 Trade creditors (35000) Net assets acquired Non-controlling interest (305000 x 36%) Fair value of investment previously accounted for as associate Bargain purchase gain Total consideration settled in cash Less cash and cash equivalents of subsidiary Net cash outflow

305000 (109800) (125000) (200) 70000 (8000) (62000)

9.3.6 Subsidiary becomes an associate A parent may sell a portion of its interest in a subsidiary whereby the subsidiary becomes an associate. The cash flow implications are very similar to where the total investment in a subsidirny is disposed of. The amount received for the interest disposed of should be disclosed as a single line item under investing activities, net of the cash and cash equivalents of the subsidirny. The disposal of the subsidirny results in a decrease in the individual assets and liabilities of the group, and these decreases need to be eliminated when calculating cash flow movements for the group (similar to where the total investment in a subsidirny is disposed of). The note detailing the net assets and liabilities disposed of and the mechanism for settling the consideration should be provided - this note will contain one additional reconciling item, namely the retained investment in the former subsidirny. On the date when the subsidirny becomes an associate, the retained investment should be fair valued and this fair value adjustment should be recognised in profit or loss. As this fair value adjustment does not represent cash flow, it should be eliminated from operating activities for cash flow purposes. The gaiIVloss arising from the disposal of part of the investment is also recognised in profit or loss and as it relates to investing activities, it has to be eliminated from operating activities. When a subsidirny becomes an associate, it will clearly impact on the investment in associate accOllllt, as the investment in the associate account will increase with the fair value of the retained investment. This should be remembered when reconstructing the investment in associate account, as this increase will not coincide with an outflow of cash. Furthermore there will be a decrease in the non-controlling interest, which should be kept in mind when analysing movements relating to the non-controlling interest. The disposal will result in derecognition of goodwill (if any) relating to the subsidirny.

Example 9.11: Subsidiary becomes an associate P Ltd acquired a 75% interest in S Ltd on 31 December 20XO for R226 000, when the equity of S Ltd (fairly valued) amounted to R300 000. The acquisition gave rise to goodwill of R1 000. The noncontrolling interest was measured at acquisition date at their proportionate share of S Ltd's net identifiable assets. At 1 January 20X2 P Ltd sold a 45% interest in S Ltd for R538 000. The fair value of the retained investment amounted to R315 000 at that date. The consolidated carrying amount of the assets and liabilities of S Ltd (excluding goodwill) were as follows on 1 January 20X2:

357

Consolidated statement of cashjlows R

PPE Inventory Trade debtors Bank overdraft Trade creditors

590000 180000 420000 (30000) (120000) 1 040000

Assume that this was the group's only transaction for the year ended 31 December 20X2 and that the only other asset in the group at 31 December 20X1 was P Ltd's cash balance amounting to R574 000. The consolidated financial statements for the year ended 31 December 20X2 will be as follows: Statement of profit or loss and other comprehensive income for the year ended

31 December 20X2 20X2 R

Fairvalue adjustment{315 000 fair value of retained investment- [(1040000 x 30%) net assets retained + (1 000 x 3Ohs) goodwill retainedl} Gain on disposal of interest in subsidiary {538 000 consideration - [(1 040000 x 45%) net assets sold + (1 000 x 45/75 ) goodwill soldl}

2600 69400

Share of profit of associate (assume)

150000

Profit for the year

222000

Statement of financial position at 31 December 20X2

20X2

20X1

R

R

Assets

Property, plant and equipment Goodwill Investment in associate (315 000 fair value + 150 000 share of profit)

590000 1 000 465 000

1 112000

180000 420000 544000

1 577 000

1 735 000

800000 777000

800000

Inventory Debtors

Cash (574 000 P Ltd + 538 000 proceeds); (574 000 P Ltd - 30 000 S Ltd)

Equity and liabilities

Share capital (assume) Retained earnings (222 000 profit for the year + 555 000 opening); [(1 040000 - 300 000) increase in equity x 75%[ Non-controlling interest (1 040000 net assets x 25%)

555000 260000 120000

Creditors

1 577 000

1 735 000

If the movements in the asset and liability accounts are analysed, it may seem as though the group disposed of PPE with a carrying amount of R590 000, inventory with a carrying amount of R180 000, debtors with a carrying amount of R420 000 and creditors with a carrying amount of R120 000 during the year. However, the decrease in these accounts resulted from the disposal of a subsidiary and, instead of showing the individual assets and liabilities disposed of, the disposal should be shown as a single line item under investing activities. The amount disclosed in respect of the disposal will be

R538 000 received plus the bank overdraft of R30 000 of S Ltd, i.e. R568 000. The cash additions to PPE for the group should be calculated as follows: Opening balance

590000

Additions (balancing)

PPE Disposal of subsidiary

590000

Closing balance

590000

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The purchases of inventory will be calculated as follows: Inventor 180 000 Disposal of subsidiary Opening balance Purchases (balancing) Closing balance

180000 180000

180000 The cash payments to creditors will be calculated as follows: Creditors 120 000 Opening balance Disposal of subsidiary Cash payments (balancing) Purchases (from inventory account) Closing balance

120000

120 000

120000

The cash receipts from debtors w ill be calculated as follows: Debtors 420000 Disposal of subsidiary Opening balance Cash receipts Closing balance

420000

420000

420000 The movements on investments in associates can be analysed as follows: Investment in associate Closing balance Opening balance Subsidiary becomes associate 315000 Share of profit of associate 150000 Acquisition of investments (balancing)

465000

----I 465000

465000

From the above calculations it should be clear that there were no cash movements relating to PPE, inventory, creditors, debtors and investments in associates. Furthermore all the amounts recognised in profit or loss (share of profit of associate, fair value adjustment, gain on disposal) do not represent cash flow and should be eliminated from operating activities. The above information will be presented as follows in the consolidated statement of cash flows:

Statement of cash flows for the year ended 31 December 20X2 Notes

R

Cash flows from operating activities Cash receipts from customers Cash payments to suppliers and employees Cash flows from investing activities Additions to property, plant and equipment Acquisition of investments in associates Disposal of part of subsidiary thereby losing control

568 000

Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period

568 000 544 000

Cash and cash equivalents at end of period

1 112 000

359

Consolidated statement of cashjlows Notes

1. Subsidiary becomes an associate During the year a portion of the interest in subsidiary S Ltd was disposed of, resulting in it becoming a 30% held associate. The consolidated carrying amount of assets and liabilities disposed of were as follows: R

Property, plant and equipment Inventory Trade debtors Bank overdraft Trade creditors Net assets disposed of Non-controlling interest (1 040000 x 25%) Goodwill disposed of Fair value of retained investment Total gain on disposal (69 400 gain + 2 600 fair value adjustment)

590000 180000 420000 (30000) (120000) 1 040000 (260000) 1 000 (315000) 72 000

Total consideration received in cash Plus bank overdraft of subsidiary

538000 30000

Net cash inflow

568000

Note that if the non-controlling interest was measured at fair value at acquisition date and amounted to R270000 at 1 January 20X2, the non-controlling interest line item in the above note would have amounted to R270000, while the goodwill would have amounted to R11 000. The remainder of the note would have remained unchanged.

9.3.7 Share issues A subsidiary may issue additional shares, either in the form of a fresh issue, or alternatively in the form of a rights issue. Depending on the number of shares taken up by the parent, a share issue may result in the following: • An increase in the interest in an existing subsidiary: The amollllt received from the noncontrolling shareholders for shares taken up by them, should be reported as afinancing activity. The amollllt received from the parent for shares taken up does not represent cash flow for the group and should not be reported in the statement of cash flows. Any gain or loss on the transaction will be recognised directly in equity and will not affect the statement of cash flows. The transaction will impact on the balance of the non-controlling interest, which should be kept in mind when reconstructing the non-controlling interest aCCOllllt. The transaction will have no effect on the individual assets and liabilities of the group (including goodwill). • A decrease in the interest in an existing subsidiary (control not lost): The amollllt received from the non-controlling shareholders for shares taken up by them, should be reported as a financing activity. The amollllt received from the parent for shares taken up does not represent cash flow for the group and should not be reported in the statement of cash flows. Any gain or loss on the transaction will be recognised directly in equity and will not affect the statement of cash flows. The transaction will impact on the balance of the non-controlling interest, which should be kept in mind when reconstructing the non-controlling interest aCCOllllt. The transaction will have no effect on the individual assets and liabilities of the group (including goodwill). • A subsidiary becomes an associate/investment (control is lost): An accollllting problem arises due to the fact that the share issue and the loss of control occur simultaneously. The authors recommend that, for cash flow purposes, the loss of control be accounted for first, and thereafter the share issue. This has the effect that the amollllt received from the share issue is not reported in the statement of cash flows, as the subsidiary no longer forms part of the group when the cash is received. The removal of the subsidiary's cash and cash equivalent balance (amollllt before the share issue) is presented in the statement of cash flows as an investing activity. If shares are taken up by the parent, the amount paid by the parent should be disclosed as an investing activity. Any

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gain or loss on the transaction will be recognised in profit or loss and should be eliminated from operating activities for cash flow purposes. The retained investment is remeasured to fair value and the fair value adjustment is recognised in profit or loss. This fair value adjustment should be eliminated from operating activities as it does not represent cash flow. The transaction will impact on the balance of the non-controlling interest, which should be kept in mind when reconstructing the non-controlling interest aCCOllllt. Furthermore the transaction will result in a decrease in the individual assets and liabilities of the group (including goodwill), which should be taken into aCcOllllt when reconstructing these aCcOllllts. As control is lost, the note disclosure detailing the assets and liabilities of the subsidiary and the mechanism for settling the consideration should be provided. • An associate/investment becomes a subsidiary: An accOllllting problem arises as the share issue and the obtaining of control occurs simultaneously. The authors recommend that, for cash flow purposes, the share issue be accounted for first, and thereafter the obtaining of control. Therefore the shares taken up by the investor should be accounted for as an investing activity (outflow), after which the total bank balance of the subsidiary (amount after the share issue) should be reported separately as an investing activity (inflow). The previously held investment is measured at fair value and if the investment was previously an investment in an associate, the fair value adjustment is recognised in profit or loss. This fair value adjustment should be eliminated from operating activities as it does not represent cash flow. If the acquisition of the subsidiary results in the recognition of a bargain purchase gain, the gain will be recognised in profit or loss and as it does not represent cash flow, it should be eliminated from operating activities. The transaction will impact on the balance of the non-controlling interest, which should be kept in mind when reconstructing the non-controlling interest account. Furthermore the transaction will result in an increase in the individual assets and liabilities of the group (including goodwill), which should be taken into account when reconstructing these accounts. As control is obtained, the note disclosure detailing the assets and liabilities of the subsidiary and the mechanism for settling the consideration should be provided.

Example 9.12: Rights issue - subsidiary becomes investment [Note that this example ignores the effect of tax.[ P Ltd acquired a 75% interest in S Ltd on 31 December 20XO for R226 000, when the equity of S Ltd (fairly valued) amounted to R300 000. The non-controlling interest was measured at acquisition date at their proportionate share of S Ltd's net identifiable assets. Goodwill amounting to R 1 000 arose from this acquisition. At 1 January 20X2 S Ltd had a rights issue of one share for every three shares held, at R2,50 per share. P Ltd did not take up any of its rights, with the result that its interest decreased to only 15%. The non-controlling shareholders took up 50 000 shares. The fair value of P Ltd's retained investment in S Ltd amounted to R180 000 at 1 January 20X2 and to R190 000 at 31 December 20X2. This investment was classified as at fair value through other comprehensive income. The consolidated carrying amounts of the assets and liabilities of S Ltd (excluding goodwill) were as follows on 1 January 20X2 (before the rights issue): Property, plant and equipment Inventory Trade debtors Bank overdraft Trade creditors

R 590000 180000 420000 (30000) (120000)

1 040000 Assume that this was the group's only transaction for the year ended 31 December 20X2 and that the only other asset in the group at 31 December 20X1 was P Ltd's cash balance amounting to R574 000.

361

Consolidated statement of cashjlows The loss from the rights issue will be calculated as follows: R

I nterest after rights issue

174950

Net assets [1040000 + (50 000 x 2,50)[ x 15% Goodwill (1 000 x 15/75 ) Interest before rights issue Net assets (1 040000 x 75%) Goodwill Loss

(606050)

The consolidated financial statements for the year ended 31 December 20X2 will be as follows: Statement of profit 31 December 20X2

or

loss

and

other

comprehensive

income

for

the

year

ended

20X2 R 5050

Fair value adjustment (180000 fair value - 174 950 carrying amount of retained investment) Loss from rights issue by subsidiary

(606050)

Loss for the year Other comprehensive income: Items that will not be reclassified to profit or loss Mark-to-market reserve: Gains arising during the year (190 000 -180 000)

(601 000)

Total comprehensive income for the year

(591 000)

10000

Statement of financial position at 31 December 20X2

20X2 R Assets Property, plant and equipment Goodwill Financial assets (equity investments) at fair value through other comprehensive income Inventory Debtors Cash (574 000 P Ltd - 30 000 S Ltd)

Equity and liabilities Share capital (assume) Retained earnings (555 000 opening - 601 000 loss for the year); [(1 040000 - 300 000) increase in equity x 75%[ Mark-to-market reserve on equity investments Non-controlling interest (1 040000 net assets x 25%) Creditors

20X1 R 590000 1 000

190000

574000

180000 420000 544000

764000

1 735000

800000 (46000)

800000 555000

10 000 260000 120000 764000

1 735000

If the movements in the asset and liability accounts are analysed, it may seem as though the group disposed of PPE with a carrying amount of R590 000, inventory with a carrying amount of R180 000, debtors with a carrying amount of R420 000 and creditors with a carrying amount of R120 000 during the year. However, the decrease in these accounts resulted from the loss of control of a subsidiary and, instead of showing the individual assets and liabilities "disposed" of, the "disposal" should be shown as a single line item under investing activities. The amount disclosed in respect of the disposal will consist only of the bank overdraft of S Ltd, amounting to R30 000.

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The cash additions to PPE for the group should be calculated as follows:

PPE Opening balance Additions (balancing)

590000

Disposal of subsidiary Closing balance

590000

590000

590000

The purchases of inventory will be calculated as follows: Inventor 180 000 Disposal of subsidiary Opening balance Purchases (balancing) Closing balance

180000

180000

180000

The cash payments to creditors will be calculated as follows: Creditors 120000 Opening balance Disposal of subsidiary Cash payments (balancing) Purchases (from inventory account) Closing balance

120000

120000

120000

The cash receipts from debtors will be calculated as follows: Debtors 420000 Disposal of subsidiary Opening balance Cash receipts (balancing) Closing balance

420000

420000

420000

The movements on financial assets at fair value through other comprehensive income can be analysed as follows: Financial assets at fair value throu h other com rehensive income Closing balance Opening balance 190000 Subsidiary becomes investment 180000 Mark-to-market reserve (OCI) 10000 Acquisition of investments (balancing) --:-:-::-:-::-::i

190000

190000

From the above calculations it should be clear that there were no cash movements relating to PPE, inventory, creditors, debtors and investments at fair value through other comprehensive income. Furthermore all the amounts recognised in profit or loss (fair value adjustment, loss from rights issue) do not represent cash flow and should be eliminated from operating activities. The above information will be presented as follows in the consolidated statement of cash flows:

Statement of cash flows for the year ended 31 December 20X2 Notes

Cash flows from operating activities Cash receipts from customers Cash payments to suppliers and employees Cash flows from investing activities Additions to property, plant and equipment Additions to investments at fair value through other comprehensive income Loss of control due to rights issue by subsidiary

R

30000

Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period

30000 544000

Cash and cash equivalents at end of period

574000

363

Consolidated statement of cashjlows Notes

1. Subsidiary becomes investment due to rights issue During the year subsidiary S Ltd had a rights issue resulting in the group losing control, as only a 15% investment in S Ltd was retained. The consolidated carrying amount of assets and liabilities given up were as follows: R

Property, plant and equipment Inventory Trade debtors Cash Trade creditors Net assets disposed of Non-controlling interest (1 040000 x 25%) Goodwill disposed of Fair value of retained investment Total loss on disposal (606 050 loss - 5050 fair value adjustment)

590000 180000 420000 (30000) (120000) 1 040000 (260000) 1 000 (180000) (601 000)

Total consideration received in cash Plus bank overdraft of subsidiary

30000

Net cash inflow

30000

9.3.8 Share buy-backs A subsidirny may buy back shares from existing shareholders. Depending on the number of shares bought back from the parent, a share buy-back may result in the following: • An increase in the interest in an existing subsidiary: The amollllt paid to the non-controlling shareholders for shares bought back from them, should be reported as a financing activity. The amount paid to the parent for shares bought back from the parent does not represent cash flow for the group and should not be reported in the statement of cash flows. Any gain or loss on the transaction will be recognised directly in equity and will not affect the statement of cash flows. The transaction will impact on the balance of the non-controlling interest, which should be kept in mind when reconstructing the non-controlling interest aCCOllllt. The transaction will have no effect on the individual assets and liabilities of the group (including goodwill). • A decrease in the interest in an existing subsidiary (control not lost): The amollllt paid to the noncontrolling shareholders for shares bought back from them, should be reported as a financing activity. The amollllt paid to the parent for shares bought back from the parent does not represent cash flow for the group and should not be reported in the statement of cash flows. Any gain or loss on the transaction will be recognised directly in equity and will not affect the statement of cash flows. The transaction will impact on the balance of the non-controlling interest, which should be kept in mind when reconstructing the non-controlling interest aCCOllllt. The transaction will have no effect on the individual assets and liabilities of the group (including goodwill). • A subsidiary becomes an associate/investment (control is lost): An accollllting problem arises due to the fact that the share buy-back and the loss of control occur simultaneously. The authors recommend that, for cash flow purposes, the loss of control be accounted for first, and thereafter the buy-back. This has the effect that the amollllt paid for the shares is not reported in the statement of cash flows, as the subsidirny no longer forms part of the group when the cash is paid. The removal of the subsidirny's cash and cash equivalent balance (amollllt before the buy-back) is presented in the statement of cash flows as an investing activity. If shares are bought back from the parent, the amollllt received by the parent should be disclosed as an investing activity. Any gain or loss on the transaction will be recognised in profit or loss and should be eliminated from operating activities for cash flow purposes. The retained investment is remeasured to fair value and the fair value adjustment is recognised in profit or loss. This fair value adjustment should be eliminated from operating activities as it does not represent cash flow. The transaction will impact on the balance of the non-controlling interest, which should be kept in mind when reconstructing the noncontrolling interest aCCOllllt. Furthermore the transaction will result in a decrease in the individual

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assets and liabilities of the group (including goodwill), which should be taken into aCcOllllt when reconstructing these aCcOllllts. As control is lost, the note disclosure detailing the assets and liabilities of the subsidirny and the mechanism for settling the consideration should be provided. • An associate/investment becomes a subsidiary: An accOllllting problem arises as the buy-back and the obtaining of control occurs simultaneously. The authors recommend that, for cash flow purposes, the buy-back be aCcOllllted for first, and thereafter the obtaining of control. Therefore the shares bought back from the investor should be accounted for as an investing activity {inflow}, where after the total bank balance of the subsidirny (amount after the buy-back) should be reported separately as an investing activity {inflow}. The gain or loss arising from the buy-back is recognised in profit or loss, and should be eliminated from operating activities for cash flow purposes. The investment is measured at fair value at acquisition date and if the investment was previously an investment in an associate, the fair value adjustment is recognised in profit or loss. This fair value adjustment should be eliminated from operating activities as it does not represent cash flow. If the acquisition results in the recognition of a bargain purchase gain, the gain will be recognised in profit or loss and as it does not represent cash flow, it should be eliminated from operating activities. The transaction will impact on the balance of the non-controlling interest, which should be kept in mind when reconstructing the non-controlling interest aCCOllllt. Furthermore the transaction will result in an increase in the individual assets and liabilities of the group (including goodwill), which should be taken into account when reconstructing these accounts. As control is obtained, the note detailing the assets and liabilities of the subsidiary and the mechanism for settling the consideration should be provided.

Example 9.13: Share buy-back - associate becomes subsidiary P Ltd acquired a 40% interest in S Ltd on 31 December 20X1 for R60 000, when the equity of S Ltd (fairly valued) amounted to R145 000. The goodwill included in the investment in associate amounted to R2 000. At 31 December 20X2 S Ltd bought back 30 000 shares from other shareholders at R2,50 per share, resulting in P Ltd's interest increasing to 64%. The fair value of the 64% investment amounted to R160 000 at that date. The non-controlling interest at acquisition date was measured at their proportionate share of the identifiable net assets of S Ltd. The fair value of the assets acquired and liabilities assumed of S Ltd were as follows on 31 December 20X2 (before the buy-back): R

PPE Inventory Trade debtors Cash Trade creditors

200000 45000 87000 8000 (35000) 305000

Assume that this was the group's only transaction for the year ended 31 December 20X2 and that the statement of financial position at 31 December 20X1 reflected the following, in addition to the investment in associate of R60 000: A cash balance of R40 000, share capital of R80 000, and retained earnings of R20 000. The profit from the share buy-back will be calculated as follows: 149 200 I nterest after buy-back Net assets [305 000 - (30000 x 2,50)[ x 64% Goodwill I nterest before buy-back Net assets (305 000 x 40%) Goodwill Profit

25200

365

Consolidated statement of cashjlows The consolidated financial statements for the year ended 31 December 20X2 will be as follows: Statement of profit or loss and other comprehensive income for the year ended 31 December 20X2 20X2 R Fair value adjustment 10800 (160000 fair value - 149 200 carrying amount of investment) Profit from share buy-back by associate 25200 Share of profit of associate [(305 000 -145 000) increase in equity x 40%[ 64000

100000

Profit for the year Statement of financial position at 31 December 20X2

Assets Property, plant and equipment Investment in associate Goodwill [160 000 fair value + (230 000' x 36%) NCI - 230 000' net assets[ Inventory Debtors Cash

Equity and liabilities Share capital Retained earnings (20 000 opening + 100 000 profit for the year) Non-controlling interest (230000* net assets x 36%) Creditors Bank overdraft [40 000 P Ltd + (8 000 S Ltd - 75000 paid for shares)[

20X2

20X1

R

R

200000 60000 12800 45000 87000 40000 344800

100000

80000 120000 82800 35000 27000

80000 20000

344800

100000

Note that the net assets are calculated as R305 000 before the buy-back less R75 000 paid for the shares bought back. If the movements in the asset and liability accounts are analysed, it may seem as though the group acquired PPE of R200 000, inventory of R45 000, debtors of R87 000 and creditors of R35 000 during the year. However, the increase in these accounts resulted from the acquisition of a subsidiary, and instead of showing the individual assets and liabilities acquired, the acquisition should be shown as a single line item under investing activities. The amount disclosed in respect of the acquisition of the subsidiary will be the bank overdraft of S Ltd after the share buy-back, amounting to R67 000 (8000 before buy-back - 75 000 paid for shares). The cash additions to PPE for the group should be calculated as follows: PPE Closing balance Opening balance Acquisition of subsidiary 200000 other additions (balancing)

200000 The purchases of inventory will be calculated as follows: Inventor Closing balance Opening balance Acquisition of subsidiary 45000 Purchases (balancing)

45000

200000

200000

45000

45000

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The cash payments to creditors will be calculated as follows: Creditors Opening balance Cash payments (balancing) Closing balance 35 000 Purchases (from inventory account) Acquisition of subsidiary

35000

35 000 35000

The cash receipts from debtors will be calculated as follows: Debtors Cash receipts (balancing) Opening balance Acquisition of subsidiary 87 000 Closing balance

87000

87000

87000

The movements on investments in associates can be analysed as follows: Investment in associate 60 000 Associate becomes subsidiary 124 000 Opening balance Share of profit of associate 64000 Disposals of investments (balancing) Closing balance

124000

124000

From the above calculations it should be clear that there were no cash movements relating to PPE, inventory, creditors, debtors and investments in associates. Furthermore all the amounts recognised in profit or loss (fair value adjustment, profit from buy-back, share of profit of associate) do not represent cash flow and should be eliminated from operating activities. The above information will be presented as follows in the consolidated statement of cash flows:

Statement of cash flows for the year ended 31 December 20X2 Notes

R

Cash flows from operating activities Cash receipts from customers Cash payments to suppliers and employees Cash flows from investing activities Additions to property, plant and equipment Disposal of investments in associates Obtaining control over subsidiary due to share buy-back

(67000)

Net decrease in cash and cash equivalents Cash and cash equivalents at beginning of period

(67000) 40000

Cash and cash equivalents at end of period

(27000)

367

Consolidated statement of cashjlows Notes

1. Obtaining control over subsidiary due to share buy-back During the year an associate S Ltd bought back shares from other investors, resulting in it becoming a 64% held subsidiary. The fair value of assets acquired and liabilities assumed were as follows: R

Property, plant and equipment Inventory Trade debtors Bank overdraft (S 000 - 75 000) Trade creditors Net assets acquired Non-controlling interest (230000 x 36%) Fair value of interest at acquisition date Goodwill

200000 45000 S7000 (67000) (35000) 230000 (S2 SOD) (160000) 12 SOD

Total consideration paid in cash Plus bank overdraft of subsidiary

67000

Net cash outflow

67000

9.4 Foreign operations In terms ofIAS 7.26 the cash flows of aforeign subsidiary should be translated at the exchange rates ruling on the dates of the respective cash jlows. As with the translation of profit and loss items, an average rate that approximates the actual rates during the accounting period may be used. However, it is not permissible to use the exchange rate ruling at the reporting date to report cash flows that occurred during the year. When translating the financial statements of a foreign operation, the assets and liabilities of the foreign operation are translated at closing rate, while income and expense items are translated at exchange rates ruling at the date of the transaction. Exchange differences arising from this translation process are recognised in other comprehensive income. The component of equity in which these exchange differences accumulate is referred to as the foreign currency translation reserve (FCTR). Movements on this reserve do not represent cash flow and should be taken into accOllllt when analysing movements on assets and liabilities, as can be seen in the following example.

Example 9.14: Foreign operations P Ltd, with a functional and presentation currency of Rand, acquired a 100% interest in S Ltd on 31 December 20X1, at a cost of RS 100. S Ltd has a functional currency of US Dollar ($). The exchange rate on 31 December 20X1 was $1 = R9. The trial balance of S Ltd was as follows at acquisition date: Dr/(Cr) $ 900 Land 200 Debtors Cash 100 Creditors (300) Share capital (500) Retained earnings (400) Assume that the only transaction that occurred during the year ended 31 December 20X2 was sales on 30 April 20X2 amounting to $50, when the exchange rate was $1 = R9,20. This amount was still outstanding on 31 December 20X2. The exchange rate amounted to $1 = R10 on 31 December 20X2. The translation trial balance of S Ltd will be as follows:

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Land (900 x 10); (900 x 9) Debtors [(200 + 50) x 10[; (200 x 9) Cash (100 x 10); (100 x 9) Creditors (300 x 10); (300 x 9) Share capital (500 x 9) Retained earnings (400 x 9) Sales (50 x 9,20) Foreign currency translation reserve (FCTR) (balancing)

20X2 Dr/(Cr) R 9000 2500 1 000 (3000) (4500) (3600) (460) (940)

20X1 Dr/(Cr) R 8100 1 800 900 (2700) (4500) (3600)

From the above information it should be clear that there was no cash flow in respect of S Ltd during the year ended 31 December 20X2. However, w hen comparing the opening and closing balances (in R) of the statement of financial position accounts, it seems as though there was in increase in assets and liabilities, for example land increased from R8 100 to R9 000. These increases arise from movements in the exchange rate and do not represent cash flow. The FCTR combines the effect of exchange movements on all assets and liabilities and can be analysed as follows: R 900 240 100 (300)

Land [900 x (10 - 9)[ Debtors [(200 x (10 - 9)[ + [50 x (10 - 9,20)[ Cash [100 x (10 - 9)[ Creditors [300 x (10 - 9)[

(940) When reconstructing the asset and liability accounts to identify cash flows, the exchange differences (movement for the current year) should be taken into account as non-cash movements: Opening balance Exchange gain (FCTR) Additions (balancing)

Opening balance Sales Exchange gain (FCTR)

Cash payments (balancing) Closing balance

Land 8 100 Closing balance 900

9000

9000

9000

Debtors 1 800 Cash receipts (balancing) 460 Closing balance 240

2500

2500

2500

Creditors Opening balance 3 000 Exchange loss (FCTR)

2700 300

3000

3000

The above information will be presented as follows in the consolidated statement of cash flows:

Statement of cash flows for the year ended 31 December 20X2 R

Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities U nrealised exchange gains on foreign cash balances*

100

Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period

100 900

Cash and cash equivalents at end of period

1000

369

Consolidated statement of cashjlows

Note that the effect of exchange rate movements on cash and cash equivalents held in a foreign currency should be reported separately from operating, investing and financing activities in order to reconcile from the opening balance of cash and cash equivalents to the closing balance. To simplify the treatment of the FCTR, entities often allocate the total exchange difference to a single non-current asset or non-current liability, for example land. As can be seen from this example, this will distort amounts reported, for example if the total FCTR movement of R940 was debited to land, the general ledger account for land will have to reflect disposals of R40 in order to balance, which is not a true reflection of the events that occurred. This treatment is acceptable only if the amounts involved are not material.

9.5 Discontinued operations IFRS 5 requires disclosure of the net cash flows attributable to the operating, investing and financing activities of a discontinued operation. However, this disclosure is not required for newly acquired subsidiaries classified as held for sale. The disclosure may be presented either in the notes or on the face of the statement of cash flows. Note that there is no need to split the entire statement of cash flows into a continuing and discontinued operations section. The required disclosure can be done as follows on the face of the statement of cash flows, using operating activities as an example: R'OOO Net cash flow from operating activities - continuing operations 450 Net cash flow from operating activities - discontinued operations (50) Net cash flow from operating activities - total entity

400

Cash receipts from customers Cash payments to suppliers and employees

] 000 (300)

Cash generated by operations Interest paid Taxation paid

700 (100) (200)

Alternatively the amollllt of R50 000 relating to the discontinued operation may be disclosed as follows in the notes: 20X] Notes for the year ended 31 December 20X2 20X2 16. Cashjlows of discontinued operations Operating activities Investing activities Financing activities

R

R

(50000) XXX XXX

XXX XXX XXX

XXX

XXX

The operating activity section on the face of the statement of cash flows will then look as follows: R'OOO Net cash flow from operating activities 400 Cash receipts from customers Cash payments to suppliers and employees

] 000 (300)

Cash generated by operations Interest paid Taxation paid

700 (100) (200)

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9.6 Comprehensive examples The following two comprehensive examples contain some of the principles illustrated in this chapter. The first example deals with acquisitions, while the second example deals with disposals.

9.6.1 Acquisitions Example 9.15 covers the following regarding the acquisition of investments: • Acquisition of associates • Acquisition of additional interest in existing subsidiary • Acquisition of new subsidiary • Investment becomes subsidiary

Example 9.15: Comprehensive example on acquisitions The following represents the consolidated financial statements of P Ltd for the year ended 31 December 20X3:

Statement of financial position at 31 December 20X3

Assets Non-current assets Property, plant and equipment Goodwill Investments in associates Financial assets (equity investments) at fair value through other comprehensive income Current assets Inventory Trade receivables Cash

Equity and liabilities Equity attributable to owners of the parent Share capital Retained earnings Mark-to-market reserve on equity investments Non-controlling interest Non-current liabilities Long-term loans Deferred tax Current liabilities Trade payables Shareholders for dividends Tax payable

20X3 R

20X2 R

2500000 121 200 400000

1 550000 60000 300000

150000

250000

300000 572 000 924200

400000 800000 500000

4967400

3860000

600000 1 745000 88135 1 023200

600000 1 315000 80000 400000

900000 299065

850000 120000

250000 32000 30000

400000 50000 45000

4967400

3860000

371

Consolidated statement of cashjlows

Statement of changes in equity for the year ended 31 December 20X3 (extracts only) Mark-toNonShare market Retained controlling capital reserve earnings interest R

Balance 1 January 20X3 Total comprehensive income Profit for the year other comprehensive income Additional interest in existing subsidiary (X Ltd) Acquisition of new subsidiary (Z Ltd) Transfer from mark-to-market reserve I nvestment becomes subsidiary (Y Ltd) Dividends declared

600000

Balance 31 December 20X3

600000

R

R

80000

R

1 315000

400000

440000

210000

43135 5000 (35000)

35000 (50000)

88135

(20000) 33200

1 745000

430000 (30000) 1 023200

Statement of profit or loss and other comprehensive income for the year ended 31 December 20X3 20X3 R

Revenue Cost of sales

2500000 (890000)

Gross profit other income other expenses Finance charges Share of profit of associate

1610000 15000 (690000) (85000) 130000

Profit before tax Income tax expense Profit for the year other comprehensive income: Items that will not be reclassified to profit or loss Investments at fair value through other comprehensive income Gains arising during the year Tax effect of gains arising during the year Reversal of deferred tax

980000 (330000) 650000

43135 45000 (8392 6527

Total comprehensive income for the year

693 135

Profit for the year attributable to: Owners of the parent Non-controlling interest

440000 210000 650000

Total comprehensive income attributable to: Owners of the parent Non-controlling interest

483 135 210000 693 135

Additional information: 1. P Ltd acquired a 70% interest in X Ltd on 1 January 20XO. On 30 April 20X3 the company acquired an additional 10% interest in exchange for a cash payment. 2. P Ltd acquired a 15% interest in Y Ltd during 20X1 at a cost of R140 000. This investment was classified as at fair value through other comprehensive income. On 30 June 20X3 P Ltd acquired an additional 50% interest in Y Ltd at a cost of R460 000, paid in cash. The non-controlling interest was measured at acquisition date at a fair value of R430 000. The fair values of Y Ltd's assets acquired and liabilities assumed were as follows:

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R

PPE

600000 80000 250000 158000 (15000)

Trade receivables Inventory Bank Deferred tax

1 073000 The fair value of the former 15% investment in Y Ltd amounted to R175 000 on 30 June 20X3. The acquisition gave rise to a bargain purchase gain, w hich is included in other income. 3.

p Ltd acquired a 90% interest in Z Ltd on 30 November 20X3 in exchange for a cash payment of R360 000. The non-controlling interest was measured at acquisition date at their proportionate share of the fair value of Z Ltd's net assets. The fair value of Z Ltd's assets acquired and liabilities assumed were as follows on that date: R

PPE Trade receivables Loans Bank overdraft

360000 92000 (100000) (20000) 332000

4. Additional investments were made during the year in financial assets (equity instruments) at fair value through other comprehensive income and associates. Dividends received on investments at fair value through other comprehensive income are included in other income. This is the only other income apart from the items mentioned in point 2. Dividends received from associates amounted to R63000. 5. The group's depreciation for the year amounted to R315 000 and is included in other expenses. Required Prepare the consolidated statement of cash flows for the P Ltd Group, for the year ended 31 December 20X3. Comparative amounts and notes are not required.

373

Consolidated statement of cashjlows

Example 9.15: Suggested solution Statement of cash flows for the year ended 31 December 20X3 R

Cash flows from operating activities

1 539200

Cash receipts from customers [C1] Cash payments to suppliers and employees (690 000 other expenses + 690 000 cash payments to creditors [C2[ - 315 000 depreciation)

2900000

Cash generated by operations Dividends received (63 000 associates + 7 000 other investments [C3]) Taxation paid [C4 [ Dividends paid [C5[ I nterest paid Cash flows from investing activities

(1 065000) 1 835000 70000 (182800) (98000) (85000) (1 050000)

Additions to PPE [C6[ New investments acquired in associates [C7[ New financial assets at fair value through other comprehensive income [CB] Investment at fair value through other comprehensive income becomes subsidiary (460000 consideration - 158 000 cash of Y Ltd) Acquisition of new subsidiary (360 000 consideration + 20 000 bank overdraft of Z Ltd)

(305000) (33000) (30000) (302000) (380000) '--"'-----'-'

Cash flows from financing activities

(65000)

Repayment of loans [C9[ Acquisition of additional interest in subsidiary X Ltd (20000 reduction in NCI - 5 000 gain)

(50000) (15000)

Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period

424200 500000

Cash and cash equivalents at end of period

924200

Calculations

C 1. Cash receipts from customers Opening balance y Ltd becomes subsidiary Acquisition of Z Ltd Sales

Trade receivables 800 000 Cash receipts (balancing) 80 000 Closing balance 92000 2500000

2900000 572 000

3472 000

3472 000

C2. Cash payments to creditors Opening balance y Ltd becomes subsidiary Purchases (balancing)

Inventor 400 000 Cost of sales 250000 Closing balance 540000 1190000

Cash payments (balancing) Closing balance

890000 300000 1 190000

Trade a abies 690000 Opening balance 250000 Purchases (from inventory account)

400000 540000

940000

940000

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C3. Dividends received

Other income Bargain purchase gain (175000 fair value + 460 000 consideration + 430 000 NCI- 1 073000 net assets) Dividends received

15000 (8000) 7000

C4. Taxation paid

Reversal of deferred tax Closing balance

Payment of tax (balancing) Closing balance

Deferred tax 6527 Opening balance 299065 Y Ltd becomes subsidiary Deferred tax on fair value gains (OCI) Deferred tax in profit or loss (balancing)

120000 15000 8392 162200

305592

305592

Tax a able 182800 Opening balance 30000 Current tax (330 000 total tax - 162 200 deferred tax) 212800

45000 167800 212800

C5. Dividends paid

Dividends paid (balancing) Closing balance

Shareholders for dividends 98000 Opening balance 32 000 Declared (50000 P Ltd + 30 000 subsidiaries) 130000

50000 80000 130000

C6. Additions to PPE

Opening balance y Ltd becomes subsidiary Acquisition of Z Ltd Other additions (balancing)

PPE 1 550 000 Depreciation 600000 Closing balance 360000 305000

315000 2500000

2815000

2815000

C7. Additions to investments in associates Investments in associates Opening balance 300 000 Dividends Share of profit of associates 130000 Closing balance Additions (balancing) 33000 463000

63000 400000 463000

CB. Additions to investments at fair value through other comprehensive income Investments at fair value throu h other com rehensive income 250 000 y Ltd becomes subsidiary Opening balance Mark-to-market reserve (OCI) 45000 Closing balance Additions (balancing) 30000

325000

175000 150000 325000

Cg. Repayment of long-terms loans Lon -term loans Loans repaid (balancing) Closing balance

50000 900 000 950000

Opening balance Acquisition of Z Ltd

850000 100000 950000

375

Consolidated statement of cashjlows

9.6.2 Disposals Example 9.16 covers the following regarding the disposal of investments: • Disposals of associates • Disposal of a portion of an interest in an existing subsidiary (without losing control) • Subsidiary becomes associate (control lost) • Disposal of total interest in subsidiary.

Example 9.16: Comprehensive example on disposals The following represents the consolidated financial statements of P Ltd for the year ended 31 December 20X3:

Statement offinancial position at 31 December 20X3

Assets Non-current assets Property, plant and equipment Goodwill Investments in associates Financial assets (equity investments) at fair value through other comprehensive income Current assets Inventory Trade receivables Cash

Equity and liabilities Equity attributable to owners of the parent Share capital Retained earnings Mark-to-market reserve on equity investments Non-controlling interest Non-current liabilities Long-term loans Deferred tax Current liabilities Trade payables Shareholders for dividends Tax payable

20X3

20X2

R

R

1 345000 108200 800000 240000

2500000 121 200 400000 150000

150000 800000 2317900

300000 572 000 924200

5761 100

4967400

600000 2172 000 121 141 991900

600000 1 745000 88600 1 023200

1 100000 441 059

900000 298600

300000 15000 20000

250000 32000 30000

5761 100

4967400

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Statement of changes in equity for the year ended 31 December 20X3 (extracts only) Mark-toNonShare market Retained controlling capital reserve earnings interest Balance 1 January 20X3 Total comprehensive income Profit for the year other comprehensive income Disposal of portion of interest in existing subsidiary without losing control (X Ltd) Disposal of total interest in subsidiary (Z Ltd) Subsidiary (Y Ltd) becomes associate Dividends declared Balance 31 December 20X3

R 600000

R 88600

R 1 745000

R 1 023200

475000

210000

2000

30000

(50000)

(134000) (107300) (30000)

2172000

991 900

32541

600000

121 141

Statement of profit or loss and other comprehensive income for the year ended 31 December 20X3 20X3 R 2500000 Revenue Cost of sales (890000) G ross profit Other income Other expenses Finance charges Share of profit of associate

1610000 50000 (690000) (85000) 130000

Profit before tax I ncome tax expense

1015000 (330000)

Profit for the year Other comprehensive income: Items that will not be reclassified to profit or loss Investments at fair value through other comprehensive income

685000

32541

Gains arising during the year Tax effect of gains arising during the year Total comprehensive income for the year

717541

Profit for the year attributable to: OVVners of the parent Non-controlling interest

475000 210000 685000

Total comprehensive income attributable to: OVVners of the parent Non-controlling interest

507541 210000 717541

Additional information: 1. p Ltd acquired a 70% interest in X Ltd on 1 January 20XO. On 30 April 20X3 the company sold a 10% interest in X Ltd for cash. 2. P Ltd acquired a 90% interest in Y Ltd during 20X1. Goodwill amounting to R10 000 arose from this acquisition. The non-controlling interest was measured at acquisition date at their proportionate share of Y Ltd's identifiable net assets. On 30 June 20X3 P Ltd sold a 50% interest in Y Ltd for R550 000 cash. The consolidated carrying amounts of Y Ltd's assets and liabilities were as follows at that date:

377

Consolidated statement of cashjlows

PPE Trade receivables Inventory Bank Deferred tax

R 600000 80000 250000 158000 (15000)

1 073000

The fair value of the retained 40% investment in Y Ltd amounted to R440 000 on 30 June 20X3. Both the fair value adjustment and gain on disposal are included in other income. 3. P Ltd acquired a 60% interest in Z Ltd during 20XO. The non-controlling interest was measured at acquisition date at fair value. Goodwill amounting to R3 000 arose from this acquisition, of which R1 800 was attributable to P Ltd's interest, while the remainder related to the non-controlling interest. This investment was sold on 30 November 20X3 in exchange for a cash payment of R202 000. The consolidated carrying amount of Z Ltd's assets and liabilities were as follows on 30 November 20X3:

PPE Trade receivables Loans Bank overdraft

R 360000 92000 (100000) (20000)

332000

4. Investments in associates were sold during the year at a profit of R8000 (included in other income). Dividends received from associates amounted to R63 000. 5. Additional investments were made during the year in financial assets (equity instruments) at fair value through other comprehensive income. Dividends received on investments at fair value through other comprehensive income are included in other income. This is the only other income apart from items mentioned above. 6. The group's depreciation for the year amounted to R315 000 and is included in other expenses. Required

Prepare the consolidated statement of cash flows for the P Ltd Group, for the year ended 31 December 20X3. Comparative amounts and notes are not required.

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Example 9.16: Suggested solution Statement of cash flows for the year ended 31 December 20X3 R

Cash flows from operating activities

502700

Cash receipts from customers [C1] Cash payments to suppliers and employees (690 000 other expenses + 940 000 cash payments to creditors [C2[ - 315 000 depreciation) Cash generated by operations Dividends received (63 000 associates + 26 700 other investments [C3]) Taxation paid [C4 [ Dividends paid [C5[ I nterest paid

Cash flows from investing activities

2100000 (1315000) 785000 89700 (190000) (97000) (85000) 559000

Additions to property, plant and equipment [C6[ Disposals of investments in associates (107 000 carrying amount [e7l + 8 000 profit) New financial assets at fair value through other comprehensive income [CB] Subsidiary becomes associate (550 000 consideration - 158 000 cash of Y Ltd) Disposal of subsidiary (202 000 consideration + 20 000 bank overdraft of Z Ltd)

(120000) 115000 (50000) 392000 222000

Cash flows from financing activities

332000

Proceeds from loans [C9[ Disposal of interest in subsidiary X Ltd without losing control (2000 profit + 30 000 increase in NCI)

300000 32000

Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period

1 393700 924200

Cash and cash equivalents at end of period

2317900

Calculations C 1. Cash receipts from customers Opening balance Sales

Trade receivables 572 000 y Ltd becomes associate 2 500 000 Disposal of Z Ltd Cash receipts (balancing) Closing balance

80000 92000 2100000 800000

3072 000

3072 000

C2. Cash payments to creditors Opening balance Purchases (balancing)

Inventor 300 000 Cost of sales 990 000 Y Ltd becomes associate Closing balance 1 290000

Cash payments (balancing) Closing balance

Trade a abies 940000 Opening balance 300000 Purchases (from inventory account) 1 240000

890000 250000 150000 1 290000

250000 990000 1 240000

379

Consolidated statement of cashjlows C3. Dividends received Other income Profit on sale of Y Ltd {550 000 - [(1 073000 x 50%) + (10000 x 50/90)]} Fair value adjustment on Y Ltd {440 000 - [(1 073000 x 40%) + (10 000 x 40/90)]} Profit on sale of Z Ltd {202 000 - [(332 000 x 60%) + 1 800]} Profit on sale of associates

50000 (7944) (6356) (1 000) (8000)

Dividends received

26700

R

C4. Taxation paid Y Ltd becomes associate Closing balance

Payment of tax (balancing) Closing balance

Deferred tax 15000 Opening balance 441 059 Deferred tax on fair value gains (OCI) Deferred tax in profit or loss (balancing)

298600 7459 150000

456059

456059

Tax a able 190000 Opening balance 20000 Current tax (330 000 total tax - 150 000 deferred tax) 210000

30000 180000 210000

C5. Dividends paid Dividends paid (balancing) Closing balance

Shareholders for dividends 97000 Opening balance 15 000 Declared (50000 P Ltd + 30 000 subsidiaries) 112000

32000 80000 112000

C6. Additions to PPE

Opening balance Additions (balancing)

2 500 000 120 000

PPE Depreciation Y Ltd becomes associate Disposal of Z Ltd Closing balance

2620000

C7. Additions to investments in associates Investments in associates Opening balance 400 000 Dividends Share of profit of associates 130 000 Disposals (balancing) y Ltd becomes associate 440000 Closing balance 970000

315000 600000 360000 1 345000 2620000

63000 107000 800000 970000

CB. Additions to investments at fair value through other comprehensive income

Opening balance Mark-to-market reserve (OCI) Additions (balancing)

150000 40000 50000

240000

240000

240000

Cg. Repayment of long-terms loans Disposal of Z Ltd Closing balance

Lon -term loans 100000 Opening balance 1 100 000 Loans raised (balancing) 1100000

900000 300000 1 100000

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9.7 Summary of Consolidated Statement of Cash Flows Cash flows from operating activities

xxx xxx

Profit before tax Eliminate: Excess or bargain purchase gain Share of profit of associate Gain/loss on disposal of associate Gain/loss on disposal of total interest in subsidiary Fair value adjustment if associate becomes subsidiary Fair value adjustment if subsidiary becomes associate or investment Gain/loss on disposal if subsidiary becomes associate or investment Gain/loss on share issue by subsidiary (if recognised in profit or loss) Gain/loss on share buy-back by subsidiary (if recognised in profit or loss)

(XXX) (XXX) XXX XXX XXX XXX XXX XXX XXX

Cash generated by operations Dividends received from associate Dividends paid to non-controlling shareholders

XXX XXX (XXX)

Cash flows from investing activities

Acquisition of investment in associate Disposal of investment in associate Loan to associate Repayment of loan by associate Acquisition of new subsidirny Disposal of total interest in subsidirny Acquisition of additional interest in investment or associate, so that it becomes subsidirny Sale of portion of subsidirny so that it becomes associate or investment Cash flows from financing activities

Additional interest in existing subsidirny Sale of portion of subsidirny without losing control Shares issued by subsidirny (provided control is not lost) Shares bought back by subsidirny (provided control is not lost)

XXX (XXX) XXX (XXX) XXX (XXX) XXX (XXX) XXX XXX

~ ~

Exchange gains on foreign cash balances

XXX

Net increase in cash and cash equivalents Cash and cash equivalents at the beginning of the period

XXX XXX

Cash and cash equivalents at the end of the period

XXX

10

Disclosure of interests in other entities IFRS 12 (Effective date 1 January 2013)

10.1 Objective The objective of IFRS 12 is to prescribe information that a reporting entity discloses regarding its interests in other entities. These disclosures should enable users of the entity's financial statements to evaluate: • The nature of (and risks associated with) the entity's interests in other entities. • The effects of those interests on the entity's financial position, financial performance and cash flows. Although IFRS 12 prescribes minimum disclosures, it is important to note that, if the required disclosures are insufficient to meet the objective of the disclosures as described above, the standard requires an entity to disclose any additional information that may be necessrny in order to meet the objective.

10.2 Scope The disclosure requirements ofIFRS 12 apply when an entity has an interest in any of the following: Interest

Short definition

Measurement

Subsidiaries

Investees controlled by the entity.

IFRS 10

J oint operations

Joint control, where the entity has rights to the assets and obligations for the liabilities of the ioint arrangement.

IFRS II

J oint ventures

Joint control, where the entity has rights to the net assets of the arrangement.

IFRS 11 & lAS 28

Associates

Investees significantly influenced by the entity.

lAS 28

Unconsolidated structured entities

Structured entities are investees where voting or similar rights are not the dominant factor m deciding who controls the entity. Unconsolidated structured entities are not controlled by the entity.

IFRS 9, IFRS 11 or lAS 28

The requirements of IFRS 12 also apply to an entity's interests listed above that are classified (or included in a disposal group that is classified) as held for sale or discontinued operations in accordance with IFRS 5. IFRS 12 does not apply to the following: • Benefit plans to which lAS 19, Employee benefits applies. • An entity's separate financial statements prepared in accordance with lAS 27, Separate financial statements. 381

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Note that lAS 27 includes disclosure requirements for subsidiaries, joint ventures and associates to be provided in the separate financial statements. If an entity prepares separate financial statements as its only financial statements, it is required to make the IFRS 12 disclosures relating to llllconsolidated structured entities in these separate financial statements.

An investment entity that prepares financial statements in which all of its subsidiaries are measured at fair value through profit or loss, should present the disclosures relating to investment entities required by IFRS 12. • An interest held by an entity that participates in ajoint arrangement without the entity having joint control, unless -

the entity has significant influence over the j oint arrangement (i.e. it is an associate); or

-

the entity's interest in the j oint arrangement is an interest in a structured entity.

• Financial instruments accOllllted for in terms of IFRS 9, unless the financial instrument is an interest in an associate or joint venture accounted for at fair value through profit or loss in terms of lAS 28; or the financial instrument represents an interest in an unconsolidated structured entity.

10.3 Interest in another entity For the purposes ofIFRS 12, an interest in another entity is defined as• contractual and/or non-contractual involvement • that exposes an entity to variability of returns from the performance of the other entity. Note: Variability of returns should be determined with reference to IFRS 10 - refer to the chapter on consolidated financial statements. This broad definition thus includes any interest that an entity holds through which it controls, jointly controls or significantly influences another entity. However, for the purposes of IFRS 12 (which also applies to structured entities) interests in other entities are not limited to the holding of equity or debt instruments and include other forms of involvement that absorb variability in performance. Other forms of involvement include, for example, the provision of funding, liquidity support and guarantees for liabilities. When a reporting entity considers whether or not it has an interest in another entity, the standard suggests that consideration of the purpose and design of the other entity may be helpful. Such an assessment would include determining which risks the other entity was designed to create and which of these risks it was designed to pass on to other parties (including the reporting entity).

Example 10.1: Purpose and design ofthe other entity M Ltd provides credit insurance for the loan portfolio of a structured entity that has no other assets, by issuing a credit default swap to the structured entity. In terms of the swap agreement any credit losses on the loan portfolio are fully reimbursed by M Ltd. The performance of the structured entity depends entirely on the performance of the loan portfolio. Likewise, variability in performance of the loan portfolio would also directly reflect the variability in performance of the structured entity. The credit default swap provided by M Ltd effectively absorbs all the variability in performance of the structured entity and was therefore designed to pass on the risk of variability of returns. M Ltd has an interest in the structured entity, regardless of whether or not it controls it.

Although the standard includes a wide range of interests in other entities, note that an entity does not necessarily have an interest in another entity solely because of a typical customer-supplier relationship.

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10.4 Structured entity Structured entities are investees where voting or similar rights are not the dominant factor in deciding who controls the entity. These entities are quite often formed for a specific purpose, such as the securitisation of an entity's debtors' book with a limited lifetime. The existence of a so-called "autopilot" feature is not llllcommon amongst structured entities. In order to assist with the identification of a structured entity, IFRS 12 suggests that a structured entity often has some or all of the following features: • Restricted activities. • A narrow and well-defined objective. • Insufficient equity to finance its activities without subordinated financial support. • Financing in the form oftranches of instruments, i.e. instruments that create concentrations of risk. It is important to note that a vehicle whose relevant activities are directed by voting rights can never

be a structured entity, even if, for example, it receives subordinated financial support.

10.5 Level of aggregation An entity applies an appropriate level of aggregation when presenting the disclosures required by IFRS 12 so that useful information is not obscured. Useful information could be obscured by aggregating items with different characteristics or by providing a large amollllt of insignificant detail. Accordingly the standard determines that an entity may aggregate required disclosures if aggregation is consistent with the disclosure objective and does not obscure useful information. At a minimum, an entity must disclose information separately for its interests in each of the following: • Subsidiaries; • joint ventures; • joint operations; • associates; and • llllconsolidated structured entities. When considering whether or not to aggregate information, an entity should consider • quantitative and qualitative information about the different risk and return characteristics of each entity it is considering for aggregation; and • the significance of each entity to the reporting entity as a whole. The following aggregation levels (within the minimum classes as discussed above) might be appropriate: • Nature of activities (e.g. research and development, distribution etc). • Industry classification (e.g. retail, manufacturing, banking, insurance etc). • Geography (e.g. COlllltIy or region). If an entity has aggregated interests in similar entities, it discloses how it has aggregated these interests.

Example 10.2: Aggregation for disclosure purposes H Ltd and other entities in its group operate in the retailing sector across the country. H Ltd controls 57 subsidiaries, representing each of its 57 retail stores (50 clothing stores and 7 furniture stores). In addition H Ltd holds interests in two associates, P Ltd and Q Ltd, that operate rival clothing chains. The carrying amount of the equity accounted investment in P Ltd represents 10% of the net asset value of consolidated group equity, while that of Q Ltd is insignificant. When considering aggregation, H Ltd must disclose information about its subsidiaries and associates separately. It would therefore not be appropriate to aggregate P Ltd and Q Ltd together with its 50 subsidiaries operating clothing stores, even though all the entities operate in the same industry. As P Ltd is significant to the group as a whole, it should be disclosed separately from Q Ltd when disclosures regarding associates are made, despite the fact that both operate clothing stores.

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As far as the subsidiaries are concerned, H Ltd may consider whether it is appropriate to provide disclosures in aggregate for clothing and furniture stores respectively. It is unlikely that an individual store (subsidiary) would be significant to the consolidated financial statements and therefore H Ltd would be permitted to aggregate the information. However, should any individual store (subsidiary) be particularly significant or exposed to significantly different risk or return factors from other stores, disclosures would need to be made about the subsidiary on an individual basis.

10.6 Significant judgements and assumptions Judgement is frequently required during the application of IFRS. IFRS 12 requires an entity to disclose information about significant judgements and assumptions (including changes therein) that it has made relating to its interests in other entities. This disclosure includes information about how the entity has determined that: •

It controls another entity.

An entity would disclose, for example, significant judgements and assumptions that it has made in determining .:. that it has control, although it does not hold a majority of the voting rights; or .:.

that it does not have control, although it holds a majority of the voting rights.

An entity should also disclose information about how it has determined whether it is an agent or principal in terms of IFRS 10 (refer to the chapter on consolidated financial statements). •

It has significant influence over another entity.

An entity would disclose, for example, significant judgements and assumptions that it has made in determining .:.

that it has significant influence, although it holds less than 20 percent of the voting rights; or

.:.

that it does not have significant influence, although it holds 20 percent or more of the voting rights. • It has j oint control of an arrangement. An entity must disclose significant judgements and assumptions that it has made in determining the type of joint arrangement (i.e. joint operation or joint venture) when the joint arrangement has been structured through a separate vehicle. •

It meets the definition of an investment entity.

An entity must disclose significant judgements and assumptions that it has made in determining that it is an investment entity. If an entity has concluded that the entity is an investment entity, even though the entity does not have one or more of the typical characteristics of an investment entity, it shall disclose its reasons for concluding that it is nevertheless an investment entity. When facts and circumstances change in a way that alters the conclusion regarding control, joint control or significant influence during the current reporting period, judgement and assumptions about these changes should be disclosed by the entity.

10.7 Specific disclosure requirements IFRS 12 provides specific disclosure requirements for each of the following categories of interests in other entities: • Subsidiaries; • joint arrangements and associates; and • llllconsolidated structured entities. Each of these disclosure requirements are discussed separately in the sections that follow.

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10.7.1 Subsidiaries The disclosures required in respect of subsidiaries are provided in the consolidated financial statements only, as IFRS 12 does not apply to separate financial statements prepared in terms of lAS 27 (refer section 10.2).

10.7.1.1

The composition of the group

An entity should disclose information that assists the users of its consolidated financial statements in understanding the composition of the group. This may include, for example, disclosing whether or not the parent is solely a holding company or has operations of its own, as well as the industries within which the group operates.

10.7.1.2 The interest that non-controlling interests have in the group's activities and cash flows For each subsidiary that has non-controlling interests that are material to the reporting entity, the following should be disclosed: • The name of the subsidiary. • The principal place of business (and COlllltry of incorporation, if different) of the subsidiary. • The proportion of ownership interests and, if different, the proportion of voting rights, held by non-controlling interests. • The profit or loss allocated to non-controlling interests of the subsidiary during the reporting period. • Dividends paid to non-controlling interests. • Accumulated non-controlling interests of the subsidiary at the end of the reporting period. • Smnmarised financial information about the subsidiary. The smnmarised financial information should enable users to understand the interest that noncontrolling interests have in the group's activities and cash flows. IFRS 12 requires that the information presented should be before intra-group eliminations. Accordingly all adjustments made as a result of transactions between the subsidiary and its parent during the reporting period should be ignored when disclosing this information. Note that intra-group eliminations do not include adjustments made to reflect consistent accounting policies, nor do they include fair value adjustments (or consequential adjustments in later years) made at the acquisition of the subsidiary in terms of IFRS 3. Accordingly the smnmarised financial information should be presented after these have been taken into account. The summarised financial information could be limited to subtotals such as current assets, current liabilities, non-current assets, non-current liabilities, revenue, profit or loss and total comprehensive income. However, an entity would need to apply judgement in determining whether further information is required to meet the disclosure objectives of the standard. The above disclosure is per material non-controlling interest. Accordingly, it would not be appropriate to aggregate amounts from two subsidiaries, if either has a non-controlling interest that is material to the group as a whole. Note that it is not required to disclose the dividends paid to non-controlling interests nor the smnmarised financial information required by IFRS 12 if a subsidiary has been classified (or included in a disposal group that is classified) as held for sale in terms of IFRS 5.

Example 10.3: Disclosure for non-controlling interests in subsidiaries The following example illustrates some of the disclosure requirements in respect of non-controlling interests. Note that not all requirements are illustrated and that complying with the minimum disclosure requirements of IFRS 12 may not be enough to meet the disclosure objective of the standard. Although required by lAS 1, comparative amounts have not been illustrated for purposes of this example.

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Notes for the year ended 31 December 20X4 Non-controlling interests Subsidiary $ Interest held by non-controlling interests # IFRS 12.12(0)

X Ltd Y Ltd Other subsidiaries* Group total

Profit allocated

Dividend paid

Accumulated noncontrolling interests at yearend

R

R

R

R

IFRS 12.12(c)

IFRS 12.12(e)

IFRS 12.B10(0)

IFRS 12.12(D

XX% XX% XX%

XXX XXX XXX

XXX XXX XXX

XXX XXX XXX

XXX

XXX

XXX

$ All subsidiaries operate principally in Southern Africa and

have been incorporated in South Africa. # Voting interests and ownership interests are equal in all of the subsidiaries of the group. Subsidiaries with non-controlling interests that are not material to the group have been aggregated. Note that summarised financial information as discussed in this section should also be disclosed, although this has not been illustrated in the example.

IFRS 12.12(b) IFRS 12.12(d)

10.7.1.3 Nature and extent of significant restrictions An entity should disclose: • Significant restrictions on its ability to access or use the assets and settle the liabilities of the group. Significant restrictions may be statutory, contractual or regulatory in nature. Examples of restrictions include: .:. Restrictions (e.g. loan covenants or solvency rules) that prevent the payment of dividends or other capital distributions . •:. Restrictions that prevent the transfer of cash or assets between entities in the group, either as part of a sale or a loan transaction. • The nature and extent to which protective rights of non-controlling interests can significantly restrict the reporting entity's ability to access or use the assets and settle the liabilities of the group. Protective rights are those rights that are designed to protect the interest of the party holding the rights, without giving the party power over the entity to which the rights relate (refer to the chapter on consolidated financial statements for a full discussion). Examples of restrictive protective rights of non-controlling interests include: .:. Where approval of the non-controlling interests is required for certain transactions . •:. Where the parent is obliged to settle the liabilities of the subsidiary before settling its OwIl. • The carrying amOllllts in the consolidated financial statements of the assets and liabilities to which the restrictions apply. Note that carrying amounts in the consolidated financial statements are after appropriate consolidation adjustments have been made (e.g. the elimination of umealised intra-group gains).

10.7.1.4 Nature of the risks associated with interests in structured entities that are consolidated An entity should disclose any contractual terms that could require the parent or its subsidiaries to provide financial support to a consolidated structured entity (i.e. to a structured entity that it controls). Specifically, events or circumstances that could expose the reporting entity (i.e. the parent) to a loss should be disclosed.

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Which events or circumstances could expose the reporting entity to a loss, are best considered from the point of view of an investor that holds ordinary equity in the parent. For example, if a parent guarantees the bank overdraft of a wholly owned structured entity, the ordinary equity holders of the parent will have an equal share in the equity of the group regardless of whether or not the parent settles the bank overdraft of the structured entity. In contrast, should the structured entity be partially owned, a settlement of its bank overdraft by the parent effectively represents a partial transfer of the cash paid from the ordinary equity holders of the parent to the non-controlling interests in the structured entity, who benefit from this transfer. Some examples of contractual terms that could require the parent or its subsidiaries to provide financial support include: • Contractual triggers (e.g. a specified debt to equity ratio) that require the reporting entity to purchase assets of the structured entity or provide financial support. • Contractual agreements to act as a market-maker for the structured entity (i.e. to stand ready to buy or sell the securities issued by the entity at any time). In addition to disclosing contractual terms arOlllld potential financial support, IFRS 12 also requires an entity to disclose: • Financial (e.g. a loan) or other support (e.g. purchasing assets of the structured entity) provided to a consolidated structured entity during the reporting period by a parent or any of its subsidiaries when there was no contractual obligation to do so. In this respect, the entity disclosesthe type and amount of support provided, including situations where the support provided was to assist the structured entity in obtaining financial support; and the reasons for providing the support. • Financial or other support provided to a previously unconsolidated structured entity during the reporting period by a parent or any of its subsidiaries with the result that the entity subsequently controls the structured entity. - In this respect the entity also discloses an explanation of the relevant factors that led to the decision to provide financial or other support to the structured entity. • Any current intentions to provide financial or other support to a consolidated structured entity. This includes intentions to assist the structured entity in obtaining financial support. Note: It is extremely important to realise that the disclosure requirements discussed in this section relate to a consolidated structured entity, i.e. a structured entity that the reporting entity controls. Unconsolidated structured entities, i.e. structured entities that the reporting entity does not control, have their own disclosure requirements, which are discussed in section 10.7.3.

10.7.1.5 Consequences of changes in ownership interests that do not result in a loss of control Should a parent's ownership interest in a subsidiary change without a loss of control, it accounts for the transaction directly in equity. The transaction is considered to be a transfer of equity from (to) the parent to (from) the non-controlling interest. Changes in ownership interests that do not result in a loss of control are discussed and illustrated in chapter 5, 6 and 7 of this volume. IFRS 12 requires a reporting entity to disclose a schedule showing the effects on the equity attributable to the owners of the parent of any changes in its ownership interest in a subsidiary that do not result in a loss of control. For an example of what information this schedule may include, refer to chapter 6 of this volume.

10.7.1.6 Consequences of losing control of a subsidiary If an entity loses control of a subsidiary, a gain or loss will be recognised in profit or loss (refer to chapter 6 and 7 of this volume for a detailed discussion). IFRS 12 requires the following disclosure when control of a subsidiary has been lost during the reporting period: • The amount of the gain or loss.

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• The portion of the gain or loss attributable to remeasuring any investment retained in the fonner subsidirny to fair value upon the loss of control.

• The line item in profit or loss in which the gain or loss has been included.

10.7.1.7 Differences in reporting dates When the reporting date (or period) of the financial statements of a subsidirny used to compile the consolidated financial statements differs from the reporting date of the consolidated financial statements, an entity should disclose: • The reporting date of the subsidirny's financial statements used. • The reason for using a different date or period.

10.7.1.8 Consequences of becoming or ceasing to be an investment entity IFRS 12 requires an entity that becomes an investment entity, or ceases to be an investment entity, to disclose the fact that the status changed, as well as the reasons for the change. If an entity becomes an investment entity, the entity must show the effect of the change (which is a deemed disposal at fair value) on the financial statements, including: • The fair value of the subsidiaries, which will no longer be consolidated, as at the date when the entity's status changed. • The amollllt of the gain or loss. • The line item in profit or loss in which the gain or loss has been included.

10.7.1.9 Interests in unconsolidated subsidiaries (investment entities) IFRS 12 requires an investment entity to provide certain disclosure in respect of its unconsolidated subsidiaries. When an entity is classified as an investment entity, the investment entity's subsidiaries will not be consolidated, but will be measured at fair value through profit or loss. The fact that the subsidiaries are not consolidated, but are measured at fair value through profit or loss, should be disclosed by the investment entity. Other disclosures required by IFRS 12 include: • The name, principal place of business (and COlllltIy of incorporation if different) and proportion of ownership interest (and proportion of voting rights if different) of each unconsolidated subsidiary. • If a parent investment entity controls a subsidiary investment entity, the abovementioned disclosure will also be included in the parent's financial statements for investments controlled by the subsidiary. • If the llllconsolidated subsidiary does not have the ability to transfer fllllds (for example dividends, repayment ofloans, advances made) to the investment entity, the investment entity shall disclose the nature and extent of any such restrictions, if significant. • The investment entity shall disclose any commitments (or intentions) it has to assist the llllconsolidated subsidiary in obtaining financial support, as well as any current commitments (or intentions) it has to provide financial support to the llllconsolidated subsidirny. • If financial or other support was provided to an llllconsolidated subsidiary without having a contractual obligation to do so, the investment entity should disclose the amount and type of support as well as the reasons. This applies irrespective of whether the support was provided by the investment entity itself or any of its subsidiaries. • Should the investment entity, or any of its llllconsolidated subsidiaries, have a contractual obligation that could require it to provide financial support to an unconsolidated, controlled, structured entity, the investment entity should disclose the terms of the contractual arrangement, including circumstances or events that could expose the entity to a loss. • If, during the reporting period, an investment entity obtained control of an llllconsolidated, structured entity by providing financial or other support, without having the contractual obligation to do so, the investment entity shall disclose an explanation of the relevant factors in reaching the

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decision to provide that support. This disclosure will also be required if any of the investment entity's llllconsolidated subsidiaries provided the support.

10.7.2 Joint arrangements and associates Note that IFRS 12 applies to both types of joint arrangements (i.e. joint operations and joint ventures). Accordingly, in the case of joint operations, which will be accounted for in the joint operator's separate financial statements, some disclosure requirements of IFRS 12 would be applicable to the separate financial statements. However, in the case of joint ventures or associates, IFRS 12 only applies to the financial statements in which equity accollllting has been applied, as the standard does not apply to separate financial statements prepared in terms of lAS 27 (refer section 10.2).

10.7.2.1

Nature, extent and financial effects of an entity's interests in joint arrangements and associates

10.7.2.1.1 All joint arrangements and associates An entity discloses the following for each interest that is material to the reporting entity: • The name of the investee. • The nature of the entity's relationship with the investee. - For example, the nature of the investee's activities and whether or not they are strategic to the entity. • The principal place of business (and COlllltIy of incorporation, if different). • The proportion of ownership interest and, if different, the proportion of voting rights, held.

10.7.2.1.2

Joint ventures and associates

An entity (excluding an investment entity) discloses the following for each interest that is material to the reporting entity: • Whether the investment is measured using the equity method or at fair value. • If there are quoted market prices for an investment that is measured using the equity method, the fair value of the investment. • The amollllt of dividends received from the investee. • Smnmarised financial information about the investee. The summarised financial information should reflect the total amollllts included in the financial statements of the j oint venture or associate. Accordingly they reflect 100% of the amollllt and not only the entity's share therein. The smnmarised financial information is, however, adjusted to reflect adjustments made by the entity when applying the equity method. These include adjustments made to the fair value of assets and liabilities upon acquisition of the investee (including consequential adjustments) and adjustments made to reflect consistent accollllting policies. However, adjustments for intragroup transactions since acquisition (e.g. sales ofinventOIY or property, plant and equipment) are excluded. An important implication of the requirement to disclose 100% of the investee's amollllts is that the pro-forma journals passed by the entity cannot be directly applied to the financial information of the investee as these reflect adjustments made based on the entity's share of the items affected. Therefore each journal would need to be "grossed up" in order to reflect the correct adjustment. Furthermore, equity accollllting generally makes use of net journals (e.g. net of tax) while different assets or liabilities are affected, so that the amollllts in the pro-forma journals cannot be utilised directly for disclosure purposes. These principles are illustrated in example 10.4. Should the associate or joint venture prepare its financial statements on a basis other than IFRS, an entity may, llllder certain circumstances, disclose the required summarised financial

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information on the basis of the joint venture's or associate's financial statements (i.e. without adjusting for equity accounting requirements). Such disclosure may be provided if it would cause lllldue cost or be impracticable to prepare financial statements on the basis of IFRS and the entity measures its interest in the j oint venture or associate at fair value through profit or loss. In such a case, the entity should also disclose the basis on which the smnmarised financial information has been prepared. Note: This exemption is only available if the associate or joint venture does not prepare its financial statements using IFRS. Should the entity measure its interest at fair value when the associate or joint venture prepares IFRS financial statements, it would accordingly have to disclose the summarised financial information "as if' it had equity accOllllted the investee. Furthermore, the exemption is not available if the entity equity accounts for its interest in the investee. The reason is that equity accounting should be applied to financial statements prepared in terms of IFRS and therefore the entity should have the information available. The specific summarised financial information includes, at a minimum, the following for each material j oint venture or associate: .:. Current assets, non-current assets, current liabilities and non-current liabilities . •:. Revenue . •:. •:.

Profit or loss from continuing operations . Post-tax profit or loss from discontinued operations .

•:.

Other comprehensive income and total comprehensive income.

If the investee is a joint venture, the smnmarised financial information must, at a minimum also include the following: .:. Cash and cash equivalents . •:. Current financial liabilities that are not trade and other payables or provisions . •:. •:.

Non-currentfinancialliabilities that are not trade and other payables or provisions .

•:.

Income tax expense.

Depreciation, amortisation, interest income and interest expense .

The minimum disclosure of smnmarised financial information may not be sufficient to meet the disclosure objective, in which case the entity discloses additional information. Finally an entity should provide a reconciliation of the summarised financial information disclosed to the carrying amount of its interest in the joint venture or associate (illustrated in example 10.5).

Example 10.4: Adjustments for summarised financial information This example illustrates the principle that prO-forma journals passed for the purposes of equity accounting should be "grossed up" when determining the amounts to be disclosed as summarised financial information. Assume that an entity considered the fair value of an office building of an associate with a remaining useful life of 20 years to exceed its carrying amount by R400 000 upon acquisition of its 40% interest. Since acquisition three years have passed. The associate and the group applies the cost model to property, plant and equipment and the tax rate is 28%. The entity passes the following prO-forma journal entries (in addition to recognising increases in the net assets of the associ ate) when equity accountinQ the associate: Cr Dr R R Retained earnings (400 000 120 x 40% x 72% x 2) 11520 Investment in associate 11520 Recognition of additional depreciation of prior two years) Share of profit of associate (400 000 120 x 40% x 72%) 5760 Investment in associate 5760 Recognition of additional depreciation of the current year) The above Journal entries effectively Impact two line Items of the statement of financial position of the associate, namely deferred tax and property, plant and equipment. For the purposes of this example, it

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is assumed that the minimum disclosure requirements of IFRS 12 are sufficient and therefore noncurrent assets and non-current liabilities will be disclosed as part of the summarised financial information, rather the individual line items. When the investor discloses non-current assets as part of the summarised financial information of the associate, it will adjust the amount disclosed by the associate with the effect of the journals passed, adjusted to reflect a 100% interest. Assume the associate discloses non-current assets of R1 000000 and that its only non-current liability is a deferred tax liability of R50 000. The investor will calculate the amounts to be disclosed as follows: Non-current Non-current assets liabilities R R Amounts per associate 1 000000 50000 Revaluation at acquisition 400000 112000 Accumulated depreciation (40000) (11 200) [11520 Unl) 172% 140% or 400 000 120 x 2[ (20000) (5600) Depreciation for the current year [5760 Unl) 172% 140% or 400 000 120[ Amounts for IFRS 12 disclosure

1 340000

145200

Example 10.5: Disclosure of reconciliation for material joint ventures This example illustrates the disclosure of the reconciliation between the summarised financial information of material joint ventures and the carrying amount of these investees (including some of the other requirements that could effectively be combined with the reconciliation). Disclosure for material associates would be similar, although fewer items are required, at a minimum, to be disclosed. This example assumes that the minimum disclosures of IFRS 12 are sufficient to meet its disclosure objective and that all joint ventures prepare financial statements that comply with IFRS. Note that comparative amounts, although not illustrated, would be required in terms of lAS 1.

Notes for the year ended 31 December 20X4 44. Material joint ventures Summarised financial information of the material joint ventures of the group, reconciled with their carrying amounts, is as follows: Measured Measured at fair value through under equity profit or loss method IFRS 12.21(b)(i) IFRS 12.21(a)(i) M Ltd N Ltd 50% held IFRS 12.21(a)(iv) 25% held R'OOO R'OOO Non-current assets 100000 50000 IFRS 12.B12(b)(ii) 250000 IFRS 12.B12(b)(i) Current assets 25000 IFRS 12.B13(a) Cash and cash equivalents

other IFRS 12.B12(b)(iv)

Non-current liabilities

IFRS 12.B13(c)

Financial liabilities

other Current liabilities

(10 000)

IFRS 12.B12(b)(iii) IFRS 12.B13(b)

Financial liabilities

other Equity of the joint venture

240000

62000

I nterest of the company in the equity Net adjustments for intra-group transactions Cumulative difference due to recognition at fair value through profit or loss

120000 (12000)

15500 (500) #

Carrying amount of the joint venture

108000

17000

2000 IFRS 12.B14(b)

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# These adjustments reflect intra-group transactions since acquisition. Note that fair value adjustments at acquisition (and adjustments relating to differences in accounting policies) are included in the individual subtotals that are disclosed (as illustrated in example 10.4). The table above CQuid be continued to include the items of the statement of profit or loss and other comprehensive income that are required to be disclosed by IFRS 12, as well as other disclosures not illustrated above.

Note that an entity does not have to disclose smnmarised financial information (nor dividends received) of a joint venture or associate if the investee (or a portion thereof) has been classified (or included in a disposal group that is classified) as held for sale in terms ofIFRS 5. An entity (excluding an investment entity) discloses summarised financial information, in aggregate, for all interests that are not individually material to the reporting entity. This financial information should be disclosed in aggregate for all individually immaterial joint ventures and, separately, in aggregate for all individually immaterial associates. Also note that disclosure of smnmarised financial information terms of IFRS 12 is not required if a joint venture or associate (or portion thereof) has been classified (or included in a disposal group that is classified) as held for sale in accordance with IFRS 5. The summarised financial information that an entity should disclose in terms of IFRS 12, includes the following: • The aggregate carrying amollllt of equity accounted joint ventures and, separately, of equity accollllted associates. • The entity's share of the following items in aggregate: Profit or loss from continuing operations. Post-tax profit or loss from discontinued operations. Other comprehensive income. Total comprehensive income. As the requirement is for an entity to disclose its share of the line items, the authors are of the opinion that an entity has to take into accollllt all adjustments necessrny for equity accollllting, including adjustments for intra-group transactions. This treatment requires additional adjustments when compared to the requirements for material joint ventures and associates discussed earlier (where only fair value adjustments at acquisition and differences in accollllting policies are adjusted for). Note: For immaterial joint ventures and associates, the entity discloses its aggregate share of certain totals and subtotals in the statement of profit or loss and other comprehensive income. This is in contrast to material associates and joint ventures, where the entity discloses the total amollllts as per the financial statements of the separate investees. An entity should disclose the nature and extent of any significant restrictions on the ability of investees to transfer fllllds to the entity. • Significant restrictions may be statutory, contractual or regulatory in nature. • Examples of restrictions include: Restrictions (e.g. loan covenants or solvency rules) that prevent the payment of dividends or other capital distributions. Restrictions that prevent the transfer of cash or assets between entities in the group, either as part of a sale or a loan transaction. The following disclosures are specific to j oint ventures and associates accollllted for llllder the equity method: • The unrecognised share of losses of an investee (if applicable), both for the reporting period and cumulatively.

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• When the reporting date of the financial statements of an investee to which the equity method is applied differs from the reporting date of the entity, an entity should disclose: -

The reporting date of the investee's financial statements used. The reason for using a different date or period.

10.7.2.2 Risks associated with an entity's interests in joint ventures and associates In respect of risks associated with its interests in joint ventures and associates, the standard requires an entity to disclose: • Commitments it has relating to its joint ventures (separately from the amollllt of other commitments ). Commitments are decisions that may lead to a future outflow of cash or other resources, but do not result in recognised elements in the financial statements. The entity discloses commitments made by itself as well as its share of commitments made collectively with other investors in its joint ventures. Examples of commitments to be disclosed include commitments to contribute fllllding or resources to an investee (e.g. additional loans, equity contributions or obligations to utilise the investee as a supplier), which may be conditional upon certain future events (e.g. product milestones being achieved or management of the joint venture requesting the fllllding). Commitments to be disclosed also include commitments to acquire another party's ownership interest (or portion thereof) if a particular future event occurs (or does not occur). • Contingent liabilities in respect of its interests injoint ventures or associates, including its share of contingent liabilities incurred collectively with other investors in its joint ventures or associates (separately from the amollllt of other contingent liabilities). As with all other contingent liabilities, this disclosure is not required if the probability ofloss is remote. Note that many of the disclosures required above may also be required in terms of lAS 24, Related party disclosures, and need not be repeated if already addressed in the lAS 24 disclosures to the financial statements.

10.7.3 Interests in unconsolidated structured entities In addition to disclosures for interests in subsidiaries, joint arrangements and associates, IFRS 12 specifies required disclosures for an entity's interests in unconsolidated structured entities. Unconsolidated in this context should be interpreted narrowly, i.e. as any structured entity that is not controlled by the reporting entity. Therefore, equity accollllted structured entities (i.e. joint ventures or associates) would also be subject to the disclosure requirements discussed in this section. The standard also requires disclosures in respect of an entity's interests in consolidated structured entities - refer to section 10.7.1.4. It is important to note that the disclosure relating to llllconsolidated structured entities are not required for a controlling interest that an investment entity has in an llllconsolidated structured entity, provided the investment entity gives the disclosures as discussed in section 10.7.1.9. The disclosures made by an entity in respect of its interests in llllconsolidated structured entities should enable users of its financial statements to llllderstand the nature and extent of these interests and to evaluate the nature of (and changes in) risks associated with the entity's interests.

10.7.3.1

Nature of interests in unconsolidated structured entities

An entity is required to disclose qualitative and quantitative information about its interests unconsolidated structured entities. It should disclose information about • the nature of the structured entity; • the purpose of the structured entity; • the size and activities of the structured entity; and

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• how the structured entity is financed.

10.7.3.2 Risks associated with an entity's interests in unconsolidated structured entities Structured entities may expose an entity to a great deal of risk, sometimes not accurately reflected in accOllllting requirements when an entity does not have control. Accordingly, IFRS 12 requires an entity to disclose in respect of its interests in llllconsolidated structured entities: • The carrying amollllt of the assets and liabilities recognised in its financial statements relating to its interests. • The line items in the statement of financial position in which these assets and liabilities have been included. • The amollllt that best represents the entity's maximum exposure to loss from its interests. An entity should also disclose how it has determined its maximum exposure. If an entity cannot quantify its maximum exposure, it should disclose that fact together with the reasons why. • The disclosure should reflect a comparison of the carrying amOllllts of the assets and liabilities recognised with the entity's maximum exposure to loss. The above disclosures should be in a tabular format, unless another format is more appropriate. If an entity currently has or previously had an interest in an unconsolidated structured entity, it may provide financial (e.g. a loan) or other support (e.g. purchasing assets of the structured entity) to the structured entity. Should the entity have provided such support during the current reporting period, without having a contractual obligation to do so, it should disclose• the type and amount of support provided, including situations where the support provided was to assist the structured entity in obtaining financial support; and • the reasons for providing the support. An entity should also disclose any current intentions to provide financial or other support to an unconsolidated structured entity. This includes intentions to assist the structured entity in obtaining financial support. In addition to the disclosures discussed above, the standard requires an entity to provide any further information that may be necessary for a user of the financial statements to evaluate the nature of (and changes in) the risks associated with its interests in unconsolidated structured entities. Some examples of information to be provided as a result of this requirement include: • The terms of an arrangement that could require the entity to provide financial support to an unconsolidated structured entity, for example: a description of events or circumstances that could expose an entity to loss; whether there are any terms that would limit the obligation; and whether there are other parties that provide financial support to the structured entity and how the entity's obligation ranks compared to those of other parties. • Whether an entity is required to absorb losses of the structured entity before other parties. The maximum amount of the losses that the entity could be required to absorb should be disclosed. The exposure of other parties to absorb potential losses and the ranking of these obligations, if these other parties rank lower than the entity. • Losses incurred by the entity during the reporting period related to its interests in structured entities. • The types of income received by the entity during the reporting period from its interests in unconsolidated structured entities.

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The income received from structured entities may include fees, interest, dividends and realised or unrealised gains or losses on interests the entity holds.

• Information about arrangements (e.g. liquidity arrangements, guarantees or commitments) with third parties that may affect the fair value or risk of the entity's interests in llllconsolidated structured entities. • Any difficulties that an llllconsolidated structured entity has experienced in financing its activities during the reporting period. • The forms of fllllding of an llllconsolidated structured entity and their weighted average life. -

If the llllconsolidated structured entity funds longer-term assets by way of shorter-term fllllding, maturity analyses of its assets and funding are also required. Note that the disclosures discussed in this section also apply to structured entities with which the entity had contractual involvement in previous periods, even though it no longer has such involvement at the end of the current reporting period. This may be the case, for example, if the reporting entity sponsored the structured entity in a previous period but no longer holds any interests in the structured entity. This requirement would therefore imply that the entity provides the disclosures discussed above for the comparative amollllts where applicable (e.g. the requirements relating to carrying amounts and line items). The standard does not specify the period for which an entity should continue to provide disclosures relating to previous involvement. However, in the authors' opinion such disclosure should continue for as long as the period of involvement is included in comparatives to the financial statements.

10.7.3.3 Structured entities for which risk disclosures are not applicable In certain instances, an entity would not provide the required disclosures discussed in section 10.7.3.2 above. This would be the case, for example, where the entity sponsors a structured entity during the current period, but does not hold an interest in the structured entity at reporting date, or never held an interest in the structured entity. In such instances, an entity should disclose: • How it has determined which unconsolidated structured entities it has sponsored. • The amollllt of income received from llllconsolidated structured entities that it has sponsored, including a description of the type of income received. • The carrying amollllt (at the time of transfer) of all assets transferred to unconsolidated structured entities that it has sponsored during the reporting period. The above disclosures should be in a tabular format, unless another format is more appropriate. Sponsoring activities may be aggregated if appropriate, taking into consideration the aggregation guidance provided in IFRS 12 (refer to the discussion in section 10.5). Note: The disclosures in this section relate specifically to sponsoring a structured entity during the current reporting period where the reporting entity does not hold an interest in the structured entity at reporting date or where the sponsoring entity never held any interest in the structured entity. If interests in a structured entity that had been sponsored in a previous period were disposed of during the current reporting period, the disclosure requirements as discussed in section 10.7.3.2 would apply.

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10.8 Summary of IFRS 12, Disclosure of interests in other entities Disclosure objective IFRS 12 disclosures should enable users of the entity's financial statements to evaluate: • The nature of (and risks associated with) the entity's interests in other entities . • The effects of those interests on the entity's financial position, financial performance and cash flows . If the minimum disclosures are insufficient, an entity discloses additional information to meet the objective. Interest in another entity Contractual and/or non-contractual involvement that exposes an entity to variability of returns from the performance of the other entity. AQQreQation In the maximum level of aggregation, an entity discloses information separately for subsidiaries, joint ventures, joint operations, associates and unconsolidated structured entities. Significant judgements and assumptions An entity discloses information about significant judgements and assumptions (including changes therein) that it has made relating to its interests in other entities (e.g. in determining control, joint control, significant influence, the type of joint arrangement, or whether it meets the definition of an investment entity). Specific disclosure requirements that apply generally Equity accounted investments Consolidated entities (subsidiaries) (associates and joint ventures) General N am e of the investee The principal place of business For material associates and joint (and country of incorporation, if ventures (as well as joint operations). different) Note that the nature of the This information is disclosed where Proportion of ownership interests relationship is also disclosed. non-controlling interests are material and, if different, the proportion of to the group. Specifically dividends, voting rights carrying amounts and ownership Financial information This information is disclosed for all disclosures relate to each material Summarised financial information material associates and joint non-controlling interest. The share in Dividends ventures, including whether the profit or loss of each material nonCarrying amounts (investm ent or carrying amount is based on fair controlling interest is also disclosed. non-controlling interest) value or the equity method. Note that

Significant restrictions

Differences in reporting dates

Specific requirements

Structured entities

a shorter version of summarised financial inform ation is required for immaterial investees. All equity accounted investees: • Preventing payment of dividends or distributions. • Preventing transfers of cash or assets between group entities. All equity accounted investees: • What the reporting date is. • The reason for the difference. • Commitments and contingent liabilities. • Unrecognised share of losses of equity accounted investees.

Specific requirements for unconsolidated structured entities, focusing on exposure to losses.

All subsidiaries: • Access to assets and liabilities. • Protective rights of noncontrolling interests. • Carrying amounts of relevant assets and liabilities. All subsidiaries: • What the reporting date is. • The reason for the difference. • Composition of the group. • Impact on equity due to changes in ownership interest. • Gain or loss upon losing control, gain or loss on retained investment and the line item in which this was included. Specific requirements for consolidated structured entities, focusing on financial and other support.