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Three pillars of IFRS in Europe

Standard setting

Endorsement

Enforcement

Requirements of standards

Understandability

Relevance

Reliability

Comparability

Information economics perspective

The more informative the set of accounting rules, the lower the costs of capital, emphasizes the valuation function of accounting

Contracting perspective

The higher the precision of a set of accounting rules the lower the respective contracting costs, emphasizes the stewardship function of accounting

Role conceptual framework

Attempts to provide a structured theory of accounting

Fundamental qualitative characteristics

Neutral, Complete, Free from error

Relevance (Capable of making a difference in the decisions made by users)

Core principle IFRS 15 revenue

Recognize revenue at an amount equal to the consideration expected to be received in exchange for goods or services provided to a customer

Revenue is recognized when a po is satisfied, when control over a good or service is transferred and when the customer directs the use and receives benefits from the good or service

Revenue recognition 5-step

Identify the contract

Identify the performance obligation

Determine the transaction price

Allocate the transaction price to po’s

Recognize revenue when po is satisfied

Main issues associated with revenue recognition

Inconsistent

Lack of framework

Comparability

Complexity

Disclosure requirements

Revenue recognition linked basis

Two or more po are so closely related that they should be accounted for as one. Happens when contracts are a package, and pricing depend on the other

Recognize revenue with the % of completion

Revenue recognition linked basis

The po’s do not depend on each other, mutual dependency. They are identified separately. Recognize immediately a loss if selling below cost.

Contract modification

New contract if new goods/services are distinct and pricing is independent and fair

Modification to existing contract if goods/services are not distinct, or pricing is discounted/bundled

Transaction price allocation

Compute the percentage of the standalone prices of the total. Translate the percentages to the allocated transaction price according to the contract

Items of inventory

Finished goods

Work-in-progress

Ra materials

Costs of inventory

Value in acquiring

Import and duty taxes (non-recoverable)

Transportation and handling

Conversion, direct cost of material and labor and overhead

Other directly attributable costs

- Trade discounts and rebates

Depreciation of used machinery

(storage only if bonded)

Periodic accounting inventory

Determined periodically through physical count

Ending balance = N * cost/N

COGS based on opening-closing inventory

Perpetual accounting inventory

Inventory records are updated each time a transaction involving inventory takes place

Cost of inventory is transferred to COGS directly on the sale of the item

Value inventory

FIFO or weighted average cost formula (IAS2 only allows)

End-of-period adjustments inventory

Goods in transit

Goods held in consignment or shipped on consignment

Unaccounted differences recorded as inventory loss

NRV inventory

Net amount an entity expects form the realization of inventory sales in the ordinary course of business. Not necessarily equal to fair value. Selling price - cost to sell - cost to complete. IAS 2 requires that written down happens item to item.

Which costs not to recognize in inventory

Wasted materials

Storage

Administrative overhead

Selling

Taxes (recoverable)

Exception impairment raw materials

Materials held for use in the production are not written down below cost if the finished product in which they will be incorporated are expected to be sold at or above cost

PPE

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

PPE initial cost

Recognition shall be measured at its cost

Purchase price including duties, non-refundable taxes, deduct trade discounts and rebates

Directly attributable costs of bringing the asset to location and condition

Initial estimated cost of dismantling and removal

Significant parts approach

Asset may be subdivided into significant parts/components based on expected benefits

Several components with different useful lives

Significant in relation tot the total cost, depreciated separately

Replacing is recognized if the recognition criteria are met

Not applied on costs of the day-to-day servicing

PPE maintenance and repairs

Costs are expensed when incurred

PPE improvements and betterments

Costs are capitalized and depreciated over the useful life. Capitalization requires increased probable future economic benefit.

Major inspections are treated like improvements

PPE depreciation

Allocation depreciable amount on a systematic basis that reflects the pattern of consumption of economic benefits

Straight-line method

Diminishing-balance method

Units-of-production method

PPE borrowing costs

Borrowing costs establishes criteria for the recognition of interest as a component of the carrying amount of a self-constructed item of ppe.

Costs that an entity incurs in connection with the borrowing of funds

Capitalization if directly attributable to the acquisition, construction or production of a qualifying asset

Qualifying asset takes a substantial time to get ready for its intended use or sale

Revaluation model FV>BV

Increase of revaluation reserve in OCI

Except: Recognition of a revaluation loss in prior periods, a reverse revaluation loss, recognize an increase in P&L to the extent of the prior loss

Revaluation model FV<BV

Revaluation loss recognized in P&L

Exception: Recognition of a revaluation increase in OCI in prior periods, eliminate revaluation surplus before recognizing an additional revaluation expense

Exercise cost model to revaluation with tax

Step 1: establish the timeline

Step 2: calculate depreciation first period, than carrying amount, than difference with fv

Step 3: calculate deferred tax by multiplying the difference with tax rate and establish the asset revaluation surplus (or loss)

Step 4: calculate depreciation second period, than carrying amount, than difference with fc

Step 5: calculate second time deferred tax by multiplying the difference with tax rate and establish the asset revaluation surplus (or loss)

Step 6: Calculate total asset revaluation surplus and depreciation expense

Provisions (IAS 37)

A liability of uncertain timing or amount

Liability is a present obligation from past events, the settlement of which is expected to result in an outflow

An obligating event is an event that creates a legal or constructive obligation

Uncertainty is key distinction from other type of liabilities

Provision recognition

There is a present obligation as a result of a past event

It is probable that an outflow of resources will be required

A reliable estimate can be made

Provision for group of similar obligations

Probability is determined by considering the class of obligations as a whole

Criterion fulfilled even if outflow probability of any item is small

Warranties, rights of return

Contingent liability

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

b) A present obligation that arises from past events but is not recognized because it is not probable that an outflow will be required or/and the amount of the obligation cannot be measured reliable.

Always mentioned in the notes, never on the balance sheet

Measurement of provisions

Best estimate

Determined by judgement

If time value of money has a material effect, measure the amount at the pv of expected expenditures

Measurement of provisions future events

Shall be reflected when there is evidence

Future changes in tech not to be considered if only believed by the entity

New legislations, most often not sufficient until enacted

Measurement of provision reimbursements

Shall be treated as a separate asset

Only recognized if virtually certain

Amount recognized for reimbursement cannot exceed the amount of the provision

May be netted in the statement of comprehensive income

Occurrence non-business combination restructuring

Sale or termination line of business

Closure of locations

Changes in management structure

Fundamental reorganizations

Restructuring provisions criteria

1: A present obligation must exist, no obligation towards a third party

2: Costs must be directly and necessarily caused by the restructuring and not associated with the ongoing activities

3: If restructuring involves the sale of an operation, a binding sale agreement is needed before a provision can be recognized

Onerous contract

A contract where the unavoidable costs of meeting the obligations exceed the expected economic benefits

Measured at the lower of: The costs of fulfilling the contract and the costs of not fulfilling the contract

IAS 38 intangibles

An intangible asset is an identifiable non-monetary asset without physical substance

Separability IAS 38

Intangible is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset, or liability

Key criteria recognition intangibles

Identifiability

Control, the company has the power to obtain economic benefits generated by the asset; and the ability to deny access to those benefits to all other parties

Future economic benefits probable, the asset generates either revenues from the sale of products or services or cost savings

Reliable measurement of costs, may depend on how the intangible asset is acquired, initial recognition at cost

Intangibles recognition exceptions

Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognized

Internally generated goodwill

When acquired externally they can be recognized

Acquisition methods intangibles

Separate acquisition

Acquisition as part of a business combination

Acquisition through a government grant

Recognition research expenses

Always recognized as expense

Recognition development expenses requirements

An asset if met

a) Technical feasibility

b) Intention to complete and to use/sell

c) Ability to use or sell

d) Demonstration of how asset will generate eco benefits

e) Availability of resources to complete development

f) Ability to measure reliably the expenditure

Cost model finite useful life intangible amortization

Residual value assumed to be zero unless: There is a commitment by a third party to purchase the asset at the end of useful life or there is an active market

Allocated on a systematic basis over its useful life

Cost model indefinite useful life

No amortization

Periodic review to determine whether the asset is still indefinite

Required to test for impairment by comparing recoverable amount with carrying amount: annually and whenever there is an indication that the intangible asset may be impaired

Disclosure requirements intangibles

Each class has to be disclosed separately

Internally generated intangibles also disclosed separate form others

Purpose of impairments

Necessary to ensure that assets are not overstated

Overstated when the carrying amount exceeds the recoverable amount

Impairment vs straight-line amortization

Impairments provide more relevant information

Impairments logical step towards information economics and valuation approach

Straight-line amortization is easier to apply, less time consuming and costly and more verifiable than impairment test

Allows prediction of amortization’s impact on earnings with greater accuracy

Steps impairment test

Identification of assets

Measuring recoverable amount

Recognition of impairment loss

Reversal

Impairment scope

Within scope of IAS 36: PPE, intangibles and goodwill

Outside of scope: Inventory, assets from construction contracts, deferred tax assets, financial instruments and insurance contracts, investment property, biological assets, assets held for sale

When to impair

External and/or internal sources of information that might indicate the possibility of impairment

Exception: IAS 38 yearly impairment tests for intangibles with indefinite useful live, intangibles not yet available for use, specific regulations for cash generating units with goodwill

Impairment of goodwill

Goodwill is a residual balance, not individually identified or separately recognized assets. Not possible to identify recoverable amount. Goodwill testing at the CGU level.

Requirement IAS 36

Annual goodwill impairment test

Each unit or group of units to which the goodwill is so allocated shall represent the lowest level within the entity at which the goodwill is monitored

The impairment test

Step 1 determine the recoverable amount equal to the higher of FV less cost of disposal and Value in use

Step 2 compare recoverable amount and carrying amount.

If recoverable < carrying, an impairment loss

If recoverable > carrying, no further action is required

Value in use

PV of the future cash flows expected to be derived from an CGU

Five elements have to be reflected

An estimate of the future CF

Expectations about possible variations in the amount or timing of those future CF

The time value of money

The price for bearing the uncertainty inherent in the asset

Other factors

Estimating future cash flows

Managements’ best estimate

Most recent financial budgets and forecasts

External evidence

Cash inflows and outflows should include

Those from the continuing use of the asset

Those expected on the disposal of the asset

Do not include CF from financing activities or tax

Rule impairment goodwill and PPE

In allocating the impairment loss, we first have to write-down goodwill before allocating anything to the other assets in the CGU

Fair value 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

Principal market

Market with the greatest volume and level of activity

Market in which the entity usually enters to sell this type of asset/liability

Most advantageous market

Market that maximizes the amount received for sold asset or minimizes amount paid for transferred liability after deducting transaction and transportation costs

Valuation technique market approach

Based on market transactions involving identical or similar assets or liabilities

Valuation technique income approach

Based on future amounts that are converted to a single present amount

Valuation technique cost approach

Based on the amount required to replace the service capacity of an asset

Fair value hierarchy

Level 1: Markt-to-Market, quoted prices in active markets for identical assets or liabilities

Level 2: Markt-to-Model, inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly

Level 3: Markt-to-Model, unobservable inputs for the asset or liability

Most observable inputs to least observable inputs

Least subjective to most subjective

Highest and best use of a non-financial asset

The use of a non-financial asset by market participants that would maximize the value of the asset or the group of assets and liabilities within which the asset would be used

Potential uses must be:

Physically possible

Legally permissible

Financially feasible

Stand-alone valuation premise

Fair value is determined under this premise where market participants would obtain maximum benefit principally through using the asset on a stand-alone basis

In-combination valuation premise

Fair value is determined under this premise where market participants would obtain maximum benefit principally through using the asset in combination with other assets and liabilities as a group

The asset will be sold as an individual asset, not as a group, but the asset will be used by the market participant in conjunction with other assets

Approach to measure fair value of liability

Is there a corresponding item hold by another party as an asset?

Yes: Measure fair value from the perspective of a market participant that holds the asset

No: Measure fair value using a valuation technique from the perspective of a market participant that owes that liability (PV technique)

Determine fair value in inactive market

Significant decrease in volume?

No: Transaction price is fair value

Yes:

Orderly transaction?

No: Little or not weight on transaction price

Yes: Transaction price is considered fair value. However changes in valuation technique may be necessary

Cannot determine: Consider transaction price, but place more weight on other orderly transactions

When can you apply offset under IFRS 13

The entity manages a group of financial assets and liabilities on a net exposure basis

This approach is part of a documented risk management strategy

Under this exception you measure the net exposure using mid-market pricing, or other prices consistent with how the portfolio is managed

Employee benefits definition

All forms of consideration given by an entity in exchange for service rendered by employees or for the termination of employment

Four categories of employee benefits

ST, payable within 12 months, wages, paid annual leave, sick leave, profit-sharing bonuses, non-monetary benefits

Post-employment, payable after completion of employments, pension, retirement benefits, life insurance and medical care

Other LT, Not payable within 12 months, sabbatical leave, jubilee, disability benefits, profit sharing bonusses and deferred compensation

Termination benefits, resulting from the entity’s decision to terminate employment or the employee’s decision to accept the entity’s offer of benefits in exchange for termination of employment

PEP

Employer pays contribution to pension fund, pays renumeration to employees and renders service from them

Pension fund receives contributions from employer and from employees and pays benefits to members/employees

Employees receive renumeration for services and pays contribution to pension fund for which it receives benefits

Accounting for defined contribution plan

The employer’s obligation is limited to the amount they agree to contribute to a pension fund, risk is for employee

Employer pays fund every quarter, if payments < actual expense, create a liability representing the future payment

If the payments > actual expense, create an asset (prepaid expense) representing a reduction in the future

Accounting for defined benefit plan

The employer guarantees a specific benefit and bears the risk

1. Determine the defined benefit obligation (DBO), estimate future benefits and discount them

2. Determine the fair value of plan assets, these are investments set aside to pay the benefits

3. Calculate the net defined benefit liability or asset, Net DB position = PV obligation - FV of plan assets

4. Recognize the service costs and net interests in P&L

5. Recognize the remeasurements in OCI, actuarial gains/losses and return on plan assets

Asset ceiling definition

The recognized surplus of a defined benefit plan tot the amount the company can actually benefit from, through refunds or reduced future contributions.

Termination benefits recognition

Recognition of a liability for the termination of an employment contract:
− When the entity can no longer withdraw the offer of the benefits; or
− When the entity recognizes costs for a restructuring within the scope of IAS 37

Equity settled share based payment

Entity receives goods or services as consideration for its own equity instruments

Cash settled share based payment

Entity acquires goods or services by incurring a liability to transfer cash or other assets to the supplier of those goods for amount that are based on the price of the equity instruments

Recognition equity settled share based payment

Company purchases in exchange for shares (asset)

Company receives services from employees for stock options (expense)

Debit asset or expense

Credit equity

Measured at fair value, at grant date

Recognition cash settled share based payment

Company receives services from employee, who gets a cash bonus depending on whether share price reaches a certain price, obligation for the company

Debit asset or expense

Credit liability

Measured at fair value of the liability, must be remeasured at the end of each reporting period and at the date of settlement, any changes in fair value are recognized in P&L

Vesting conditions

Does the condition determine whether the entity receives the service that entitle the counterparty to the share-based payment?

No: Non-vesting condition

Yes

Does the condition require only a specified period of service to be completed?

No: Performance condition

Yes: Service condition

When does a liability arise for ST compensation

A liability arises when:

• The absence accumulates (can be carried forward), and

• The employee has earned the right through past service

• The benefit is probable to be taken or paid

✅ Examples: Unused vacation leave

Non-vesting absences are paid absences that do not entitle the employee to a payout if they leave the company — in other words, they lose unused days if they resign.