anesu daka ca(sa) - caatut 105/106 1. ias 21- the effects of changes in foreign exchange rates 2....

Anesu Daka CA(SA) - CAA

FAC4863

4 August 2015


Tut 105/106

1. IAS 21- The effects of changes in foreign exchange rates

2. IAS32/39/IFRS9&7-Financial instruments

3. IAS 39-Hedging

4. IAS 33-Earnings per share

5. IAS 17- Leases


Forex Transactions: IAS 21


Effects in foreign exchange rates transactions

IAS 21


KEY CONCEPTS

The following key concepts are fundamental to this study unit:

1. The determination of the date of the foreign currency transaction and recording thereof at the spot exchange rate on that date.

2. Translating monetary items at reporting date and on settlement at the appropriate exchange rate.

3. The recognition of exchange differences in profit or loss for the period, other comprehensive income or the carrying amount of an asset or liability.

4. The presentation and disclosure of the effects of changes in foreign exchange rates.


Schematic Picture of IAS 21

Foreign Exchange Activities

Foreign currency transactions

IAS 21.20-37

Hedging foreign currency transactions

IAS 39.71-101

Foreign Operations

IAS 21.38-49

Hedge of a net investment in a foreign

operation

IAS 39.102


Exchange rate

• the ratio at which the currencies of two countries are exchanged.

Either: $1= R7 or R1=$0.1429 (watch-out for this)

• Naming rates:- selling/offer/ask rate is the rate at which the intermediary/bank is willing to sell foreign currency to the buyer (importer).

- buying/bid rate is the rate at which the intermediary/bank is willing to buy forex from a seller (exporter).

NB: the bid rate is always lower than the offer rate.

Use – IAS 39.AG 72- bid rate to value asset held or liability issued and ask rate for assets to be acquired and liability held


Types of Exchange rates

• Spot rate- is the exchange rate for immediate delivery of currencies to be exchanged at a particular time.

• Closing rate- is the spot rate at the reporting date.

• Forward rate- is the exchange rate for the exchange of two currencies at a future agreed date.


Identification of transaction date

In the context of the movement of assets between countries, certain generally accepted shipping and trade terms are used. f.o.b (“free on board [named port of shipping]”) (most used)

the seller accepts responsibility only for getting the asset safely on board the ship which will deliver the asset from the source country to the destination country. The buyer is responsible for the goods from the moment that the asset passes over the ship’s rail, and in addition bears all further costs of delivery. Therefore, the risks and rewards of ownership are transferred from the seller to the buyer at that point. Transaction date is therefore shipping date.

c.i.f (“cost,insurance and freight [named port of destination]”) the seller is responsible for paying the costs of delivering the asset to the named port of

destination. These costs include the costs of insuring the asset while it is in transit. Transaction date for c.i.f. sales is therefore also delivery date.

NB: if question says CIF without any further information – use delivery date

However, it is internationally accepted practice that the risks and rewards of ownership are, as is the case with f.o.b. contracts, still transferred from the seller to the buyer at the moment that the asset passes over the ship’s rail.

Transaction date for c.i.f. sales is therefore also shipping date, in this case.


Initial Recognition

• Recognise (record an asset or liability) when the risk and reward of ownership has passed.

• Risk and rewards of ownership passes on TRANSACTION DATE – date of shipment of F.O.B (free on board)

Dr Inventory/PPE, Bank e.t.c

Cr Foreign payable/Loan, e.t.c


Monetary VS Non-Monetary

Monetary items• Money held and assets and

liabilities to be received of paid in fixed or determinable amounts of money, e.g.: – all current assets except inventory,

– current liabilities (e.g. payables),

– long-term loans,

– debentures,

– deferred tax,

– dividends payable,

– convertible debentures into redeemable preference shares or convertible preference share into debenture

Non-monetary items• Assets and liabilities to be

received of paid NOT in fixed or determinable amounts of money, e.g:– Inventories, – PPE, – Investment in ordinary shares,– ordinary share capital, – payments in advance, – goodwill, – intangible assets, – reserves, – Convertible preference share or

debentures into ordinary or non-redeemable preference shares.


MeasurementInitial Measurement A foreign currency transaction should be recorded initially at the rate of

exchange at the date of the transaction (use of averages is permitted if they are a reasonable approximation of actual). [IAS 21.21-22]

Subsequent Measurement: [IAS 21.23] foreign currency monetary amounts (foreign payables, debtors, e.g.)

should be reported using the closing rate non-monetary items (inventory, PPE, e.g.) carried at historical cost should

be reported using the exchange rate at the date of the transaction non-monetary items carried at fair value should be reported at the rate

that existed when the fair values were determined (closing rate) e.g. use closing rate to determine NRV, Recoverable amount, FV, e.t.c


Recognition of Exchange differencesItem Description Recognition of exchange

differences

Monetary – IAS 21.28 Foreign payable, foreign loan, foreign debtor, e.t.c

Separate and recognise in P/L

Monetary item in a foreign operation – IAS 21.32 and 48 and 48C

Line items in SofP of a foreign operation- payables e.t.c

Translate the total Net Asset Value and recognise FCTR in OCI-Reclassify to P/L trhough OCI on disposal with loss of control of the foreign op.-Reattribute to NCI directly in SOCIE if control is not lost (partial disposal)

Non-monetary item: PPE, inventory, investment in shares, investment property, e.t.c

Do not recognise the exchange different separately. Recognise in P/L or OCI wherever appropriate for the item

Other Gains & losses Revaluation surplus Measure at spot rate at revaluation date & recognise in OCIAnesu Daka CA(SA) - CAA


Calculation of Exchange Gains and Losses on Debt Instruments

US$ Rate ZAR

Principal-Fair Value 1,000,000 8.00 8,000,000

Interest Expense 10% at avg rate 50,000 8.05 402,500

Pmt- coupon 10% at spot - 8.10 -

AmortisedCarrying Amt at 31 Dec 2012 1,050,000 8,402,500

Exchange loss (Balancing figure) 102,500

Carrying amount at 31 Dec 2012 1,050,000 8.10 8,505,000

Interest Expense 10% at avg rate 50,000 8.11 405,500

Pmt- coupon 10% at spot (100,000) 8.15 (815,000)

AmortisedCarrying Amt at 31 Dec 2012 1,000,000 8,095,500

Exchange loss (Balancing figure) 54,500

Carrying amount at 30 June 2013 1,000,000 8.15 8,150,000

Pmt- of Capital (1,000,000) 8.15 (8,150,000)

Carrying amount at 31 Dec 2013 - -

Disclosure IAS 21.51-57

• 52 An entity shall disclose: – the amount of exchange differences recognised in profit or loss except

for those arising on financial instruments measured at fair value through profit or loss in accordance with IFRS 9; and

– net exchange differences recognised in other comprehensive income and accumulated in a separate component of equity, and a reconciliation of the amount of such exchange differences at the beginning and end of the period.

• 53 When the presentation currency is different from the functional currency, that fact shall be stated, together with disclosure of the functional currency and the reason for using a different presentation currency.

• 54 When there is a change in the functional currency of either the reporting entity or a significant foreign operation, that fact and the reason for the change in functional currency shall be disclosed.


Apply IAS 21

• Q21.1 and Q21.3



Financial Instruments

• IAS 32 - Presentation

• IFRS 9 - Recognition & Measurement

• IFRIC 19 – Extinguishing Liabilities with Equity Instruments

• IFRS 7 - Financial Instruments: Disclosures


Examinability

Past CTA/FQE Exams:

- All most in all past exams (both FinAcc 1 and FinAcc 2 Questions)


Examinability2015 Possible areas of focus:

• New areas:– Classification- financial assets (amortised cost vs

Fair Value (FVTPL vs FVOCI)

– Reclassifications

– Hedging

– Impairment

• Compound financial Instruments + deferred tax is always important


Financial Instrument FrameworkIAS 32 Presentation:Classification into:

o Financial Instrumento Financial Asset

o Financial liabilities

o Equity Instruments

o Fair value – IFRS 13

Classification as equity or liability

Compound financial instruments

Treasury shares

Financial Instruments

• Introduction and Classification


Financial instrument

“A financial instrument is any contract that gives rise to a financial asset of one entity and

a financial liability or equity instrument of another entity.”

IAS 32, Para 11



Financial Instrument

a contract

that gives rise to a financial asset of one entity (Holder)

and a financial liability or equity instrument of another entity (Issuer).

Share Certificate

10 m shares

Bond

US$10 m


Financial Instrument Diagram

Financial Asset (inv in

shares or bonds)

Equity

Financial Liability

Contract- e.g. share

certificate or Bond

HOLDEROf Contract

ISSUER of contract

Financial asset

“A financial asset is any asset that is:

• Cash

• An Equity instrument of another entity

• A contractual right:

– To receive cash or another financial asset from another entity, or

– To exchange financial assets or financial liabilities with another entity under

conditions that are potentially favourable to the entity; or

• A contract that will or may be settled in the entity’s own equity instruments and is:

– A non-derivative for which the entity is or may be obliged to receive a variable

number of the entity’s own equity instruments; or

– A derivative that will or may be settled other than by the exchange of a fixed

amount of cash or another financial asset for a fixed number of the entity’s own

equity instruments…”

IAS 32, Para 11


Financial liability

“A financial liability is any liability that is:

• A contractual obligation:

– To deliver cash or another financial asset to another entity, or

– To exchange financial assets or financial liabilities with another entity under conditions that

are potentially unfavourable to the entity, or

• A contract that will or may be settled in the entity’s own equity instruments and is:

– A non-derivative for which the entity is or may be obliged to deliver a variable number of the

entity’s own equity instruments, or

– A derivative that will or may be settled other than by the exchange of a fixed amount of cash

or another financial asset for a fixed number of the entity’s own equity instuments…”

IAS 32, Para 11


Equity instrument

“An equity instrument is any contract that evidences a residual interest in the assets of an

entity after deducting all of its liabilities.” IAS 32, Para 11


Types of Financial Instruments

1. Equity Instruments:– shares

2. Debt Instruments– Loan

– Receivable

– Payable

– Debentures

– Preference shares

3. Derivatives: forwards, futures, options, swaps



Financial Instrument

Issuer

Liability Equity

Holder

Financial Asset


Classification as Liability or Equity

The FUNDAMENTAL PRINCIPLE of IAS 32 is that a financial instrument should be classified as either a financial liability or an equity instrument according to the :

substance of the contract, not its legal form, and

the definitions of financial liability or equity instrument. [IAS 32.15]


Classification as Liability or Equity A financial instrument is an equity instrument only if:

(a) the instrument includes NO contractual obligation to deliver cash or another financial asset to another entity and

(b) (b) if the instrument will or may be settled in the issuer's own equity instruments, it is either:

– a non-derivative that includes NO contractual obligation for the issuer to deliver a VARIABLE number of its own equity instruments (for fixed number of its own shares); or

– a derivative that will be settled only by the issuer exchanging a fixed amount of cash or another financial asset for a fixed number of its own equity instruments. [IAS 32.16]



Illustration – preference shares If an entity issues preference (preferred) shares that pay

a fixed rate of dividend and that have a mandatory redemption feature at a future date, the substance is that they are a contractual obligation to deliver cash and, therefore, should be recognised as a liability. [IAS 32.18(a)] In contrast, preference shares that do not have a fixed maturity, and where the issuer does not have a contractual obligation to make any payment are equity. In this example even though both instruments are legally termed preference shares they have different contractual terms and one is a financial liability while the other is equity.


Classification of preference Share CapitalCapital amount of preference shares

Preference dividendpayments

Classification as liabilityor equity

Non-redeemable Discretionary Equity instrument

Non-redeemable Compulsory Compound instrument

Compulsory redemption Discretionary Compound instrument

Compulsory redemption Compulsory Financial Liability

Redeemable at option of holder

Compulsory Financial Liability

Discretionary Compound instrument

Redeemable at option of issuer

Compulsory Compound instrument

Discretionary Equity instrument


Classification as Liability or EquityIllustration – issuance of fixed monetary amount of equity

instruments A contractual right or obligation to receive or deliver a

number of its own shares or other equity instruments that varies so that the fair value of the entity's own equity instruments to be received or delivered equals the fixed monetary amount of the contractual right or obligation is a financial liability. [IAS 32.20] Such instruments are financial liabilities.

EG:A $1million convertible debenture, convertible into ordinary shares at the market price at date of conversion.



Illustration – issuance of fixed monetary amount of equity instruments

If number shares are variable- financial liability

If number shares are fixed – Equity instrument



• Illustration - one party has a choice over how an instrument is settled (para 21-24)

• When a derivative financial instrument gives one party a choice over how it is settled (for instance, the issuer or the holder can choose settlement net in cash or by exchanging shares for cash), it is a financial asset or a financial liability unless all of the settlement alternatives would result in it being an equity instrument. [IAS 32.26]

Financial Liability vs Equity Instrument


Try the following Examples



Contingent Settlement Provisions- par 25

An entity may issue a financial instrument where the way it is settled depends on:

• The occurrence or non-occurrence of uncertain future events, or

• The outcome of uncertain circumstances,• that are beyond the control of both the issuer

and the holder of the instrument, such as a change in a stock market index, consumer price index, interest rate or taxation requirements, or the issuer’s future revenues, net income or debt-to-equity ratio.


Contingent Settlement Provisions….

Conclusion

• The issuer of such an instrument does not have the unconditional right to avoid delivering cash or another financial asset (or otherwise to settle it in such a way that it would be a financial liability).

• Therefore, it is a financial liability of the issuer unless the possibility of settlement is remote.


Compound Financial Instruments

Some financial instruments - sometimes called compound instruments - have both a liability and an equity component from the issuer's perspective. In that case, IAS 32 requires that the component parts be accounted for and presented separately according to their substance based on the definitions of liability and equity. The split is made at issuance and not revised for subsequent changes in market interest rates, share prices, or other event that changes the likelihood that the conversion option will be exercised. [IAS 32.29-30]


Interest, Dividends, and losses

Interest, dividends, gains, and losses relating to an instrument classified as a liability should be reported in profit or loss.

This means that dividend payments on preferred shares classified as liabilities are treated as expenses (finance cost).

On the other hand, distributions (such as dividends) to holders of a financial instrument classified as equity should be charged directly against equity (Retained Earnings), not against earnings. [IAS 32.35]

Transaction costs of an equity transaction are deducted from equity. Transaction costs related to an issue of a compound financial instrument are allocated to the liability and equity components in proportion to the allocation of proceeds and deducted as such.


Cost of issuing or re-acquiring equity

• Costs of issuing or reacquiring equity instruments (other than in a business combination) are accounted for as a deduction from equity, net of any related income tax benefit. [IAS 32.35]

• Dr Equity

• Dr Financial liability (Amortised Cost)

• Cr Bank/payables

• NB: if it’s a compound fin instrument the issue cost should be split in proportion to the components


Treasury Shares

• Identify: Treasury shares- arises when an entity reacquires (buy-back) its own equity instruments. Such buy-backs happen in two ways: 1) by the entity when it buys back its own shares from shareholders or 2) when other members of the consolidated group hold shares in other group companies, especially shares of the parent.

• Recognition: those instruments (‘treasury shares’) shall be deducted from equity.

• Gains/Losses on buy back: No gain or loss shall be recognised in profit or loss on the purchase, sale, issue or cancellation of an entity’s own equity instruments. Consideration paid or received shall be recognised directly in equity.


Example: Share buy-back

• A Ltd issued 100000 shares on 1Jan 2010 at $1.20. On 31 December 2011 25000 shares were bought back at $1.30 per share, where after the shares were cancelled. The transaction cost associated with the share buy-back is $2000.

• What are the Jes necessary to account for the share-buy back?


Example: Share buy-back

31 December 2011

Dr Share Capital (25000*1.2) 30000

Dr Share Premium/capital/RE (25000*(1.30-1.20) 2500

Cr Bank (25000*1.30) 32500

Dr Share Premium/capital/RE 2000

Cr Bank 2000


Offsetting

• IAS 32 also prescribes rules for the offsetting of financial assets and financial liabilities. It specifies that a financial asset and a financial liability should be offset and the net amount reported when, and only when, an entity: [IAS 32.42]

• has a legally enforceable right to set off the amounts; and

• intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. [IAS 32.48]


Summary

• Financial instruments issued to raise capital must be classified as liabilities or equity by the issuer;

• Classification of a financial instrument as a liability or equity depends on the following:– Substance of the contractual arrangement on initial recognition

NOT the legal form– Definition of financial liability and an equity instrument

• Critical feature of a financial liability: - is the obligation to deliver cash or another financial instrument.

• Compound financial instruments are split into equity and liability components and presented separately.

• Interest, dividends, losses and gains are treated according to whether they relate to equity or financial liability

IFRS9: Financial Instruments

Recognition and Measurement



FINANCIAL ASSETS

1. Initial Recognition

2. Classification

3. Initial Measurement

4. Subsequent Measurement

5. Impairment of Amortised Cost Financial Asset

6. Derecognition

7. Hedging


Classification

Financial Asset (inv in

shares or bonds)

Equity

Financial Liability

Contract- e.g. share

certificate or Bond

HOLDEROf Contract

ISSUER of contract

Financial assets are classified in IFRS 9

as amortised cost or Fair value thru P&L or OCI

Financial Liabilities are classified as Fv thru P&Lor other under IFRS 9

Classification as financial liabiltiy or equity is done in IAS

32

Initial recognition

An entity shall recognise a financial instrument in its statement of financial position when it becomes party to the contractual provisions of the instrument.

IFRS 9, Para 3.1.1

Initial measurement

At initial recognition, an entity shall measure a financial asset at its fair value, (with the exception of Trade Receivables in terms of IFRS 15, which are measured at their transaction price) plus, in the case of a financial asset not at fair value through P&L, transaction costs that are directly attributable to the acquisition or issue of the financial asset.

IFRS 9, Para 5.1.1

Initial recognition – Fair Value

• Price paid to acquire the asset

• Price received to assume the liability

IFRS 13, Para 57

“Entry price”


Definition of fair value:

• Price that would be received to sell an asset

• Price that would be paid to transfer a liability

• In an orderly transaction

• Between market participants

• At the measurement date

IFRS 13, Para 9

“Exit price”


“Entry price”

“Exit price”

The ‘entry price’ will typically equal the ‘exit price’ when the transaction to buy an asset takes place in the market in which the asset would be sold.


Transaction price

Fair Value

The best evidence of the fair value of a financial instrument at initial recognition is normally the transaction price (ie the fair value of theconsideration given or received, see also IFRS 13).

IFRS 9, Para B5.1.2 A


a) If that fair value is evidenced by a quoted price in an active market for an identical asset or liability (ie a Level 1 input) or based on a valuation technique that uses only data from observable markets. An entity shall recognise the difference between the fair value at initial recognition and thetransaction price as a gain or loss.

IFRS 9, Para B5.1.2 A (a)

Transaction price

Fair Value


b) In all other cases, the difference between the fair value at initialrecognition and the transaction price shall be deferred.

IFRS 9, Para B5.1.2 A (a)

Transaction price

Fair Value

Classification of Financial Assets on initial recognition

Amortised Cost

Collect only principal and cash on specified dates

Fair value

All other financial assets

IFRS 9, Para 4.1.1 - 4.1.5

Classification: Amortised Cost

• Financial assets may be measured at amortised cost:

– Business model is to hold assets in order to collect contractual cash flows; AND

– Cash flows arise on specified dates and are solely payments of principal and interest

– Interest should only be made up of time value of money, credit risk and other basic lending risks and costs

– Still, the entity may choose to irrevocably designate such a financial asset as measured at fair value (profit and loss)

• Eliminates or significantly reduces accounting mismatch

IFRS 9, Para 4.1.2 and 4.1.3

Debt Instruments!

Classification: Fair value through OCI

• Financial assets may be measured at fair value through OCI:

– Business model whose objective is achieved by both collecting contractual cash flows and selling financial assets and; AND

– The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding

– Interest should only be made up of time value of money, credit risk and other basic lending risks and costs

– Still, the entity may choose to irrevocably designate such a financial asset as measured at fair value through profit and loss

• Eliminates or significantly reduces accounting mismatch

IFRS 9, Para 4.1.2 A and 4.1.3

Debt Instruments!

Classification: Fair value through OCI continued

– An entity may make an irrevocable designation on initial recognition to classify a financial asset as subsequently measured at fair value through OCI of an investment in an equity instrument that is neither ‘held for trading’ nor represents contingent consideration (in terms of IFRS 3)

IFRS 9, Para 4.1.4 and 5.7.5

Equity Instruments!

IFRS 9’s debt instrument model

Amortised Cost FVOCI

FVPL

Is the objective of the entity’s business model to hold the financial asset to collect contractual cash

flows?

Is the financial asset held to achieve an objective by bothcollecting contractual cash flows and selling financial

assets?

Do contractual cash flows represent solely payments of principal and interest

Does the company apply the fair value option to eliminate an accounting mismatch?

NO NO

NO

YES YES

YES

NO

YES

NO

YES

Classification: Fair value through P&L

If these requirements are not met (i.e. the financial asset cannot be classified as either subsequently measured at amortised cost, or fair value through other comprehensive income), the financial asset is classified as subsequently measured at fair value

IFRS 9, Para 4.1.4

Classification of financial assets on initial recognition

Fair value (OCI)

Amortised Cost

Fair value (P+L)

IFRS 9, Para 4.1.4 and para 4.1.5

IFRS 9, para 4.1.2 and 4.1.3

IFRS 9, para 4.1.2A, 4.1.3 and para 5.7.5

Initial recognition - Transaction costs

Fair value (OCI)

Amortised Cost

Fair value (P+L)

Includetransaction costs in the value of the asset

Includetransaction costs in the value of the asset

Transaction costs are expensed in profit or loss

IFRS 9, Para 5.1.1

Subsequent measurement

Amortised Cost

Fair value (OCI)

Fair value (P+L)

IFRS 9, Para 5.2.1

Fair valueAmortised cost

CLASS EXAMPLE : FINANCIAL INSTRUMENTS

Required:a) Prepare Journal entries up to 31 December 20.11. Assuming the shares are held for

speculative purposes.b) Prepare journal entries up to 31 December 20.11. Assuming the equity instruments

are held for strategic purposes and are designated as a financial asset at fair value through other comprehensive income

EQUITY INSTRUMENT OF ANOTHER ENTITY THEREFORE ITS A

FINANCIAL ASSET


SUGGESTED SOLUTIONFV thru OCI

DR CR

DR CR

250 000Investment in shares (SFP) @12,50

Transaction costs (P/L)

1 June 20.11

Bank (SFP)

31 December 20.11

Investment in shares (SFP)

FV adjustment (P/L)20 000 X 11 – 250 000

2500

252 500

Investment in shares (SFP) @12,50 + 2 500

Bank (SFP)

30 000

30 000

1 June 20.11

31 December 20.11

Market to market Reserve (OCI)20 000 X 11 – 252 500

Investment in shares (SFP)

252 500

252 500

32 500

32 500

FV thru P&L



Subsequent Measurement

Amortised CostInitial recognitionDr Amortised Cost Fin Asset (FV + transaction costs)

Cr Bank

Subsequent measurementDr Amortised Cost Fin AssetCr Finance Income (P/L)

Dr BankCr Amortised Cost Fin Asset


Example

• A bond of $2 million is purchased, which matures 31 March 20X5 at face value. 10% is receivable every year over the 3 years. Market interest rate is 14%. Record the Bond.

Q- Calculate the present value


Solution

• N=3

• i=14%

• Pmt= (10% X 2m) 200k

• FV=2m

• PV=1,814,269


Subsequent Measurement

Amortised CostInitial recognition

Dr Amortised Cost Fin Asset (FV + transaction costs) 1814269Dr Fv adjustment (P/L) 185731

Cr Bank 2000000

Subsequent measurementDr Amortised Cost Fin Asset 253998

Cr Finance Income (P/L) (1814269*14%) 253998

Dr Bank (2000000*10%) 200000Cr Amortised Cost Fin Asset 200000

Reclassification adjustments from OCI

IFRS 9 – FV through OCI

• IFRS9.B5.7.1 does NOT require reclassification to P/L of cumulative gains & losses recognised in OCI upon sale or impairment of AFS asset.

• An entity can chose transfer within equity to RE or to leave the reserve as is.

• Dr Mark-to Mkt reserve (SOCIE)

• Cr Retained Earnings (SOCIE)

IAS 39- Available for Sale

• IAS 39 required reclassification to P/L of cumulative gains & losses recognised in OCI upon sale or impairment of AFS asset.

• Dr Mark-to Mkt reserve (OCI)

• Cr Reclassification adjustment (P/L)

• Dr Tax Expense

• Cr AFS reserve (OCI)

• NB: the reclassification was done before tax


Impairment of Financial Assets

Expected Credit Losses


IASB’s intention

Expected Loss Model

(IFRS 9)

Incurred Loss Model

(IAS 39)

Under the impairment approach in IFRS 9 it is no longer necessary for a credit event to have occurred before credit losses are recognised. Instead, an entity always accounts for expected credit losses, and changes in those expected credit losses. The amount of expected credit losses is updated at each reporting date to reflect changes in credit risk since initial recognition and, consequently, more timely information is provided about expected credit losses.

IFRS 9, IN 9

IASB’s intention - previously

Initial recognition

of a financial asset

!T1 T2 T3 T4 T5

Dr Impairment Expense (P&L)

Cr Financial Asset

IAS 39: recognise loss only on the occurrence of the ‘trigger loss event’

IASB’s intention – currently

Initial recognition

of a financial asset

!T1 T2 T3 T4 T5

IFRS 9: assess credit risk constantly and start recognising losses earlier

Dr Impairment Expense (P&L)

Cr Expected Credit Loss Allowance

• Financial assets measured at amortised cost;

Exception: Purchased / originated credit impaired financial assets

• Financial assets measured at FV through OCI;

• Trade receivables, contract assets and lease receivables;

IFRS 9 para 5.5.1.

Scope: which assets are subject to the ECL model?

Overview of requirements

Stage 1 Stage 2 Stage 3

No significant increase in credit risk

Significant increase in credit risk

Credit impaired

Performing Under-performing Non-performing

ECL Allowance

12 month expectedcredit losses

Lifetime expectedcredit losses

Lifetime expected credit losses

Interest revenue

Gross basis Gross basis Net basis


Stage 1 Stage 2 Stage 3



Credit impaired


ECL Allowance




Interest revenue


IFRS 9 Appendix A


Change in credit quality since initial recognition of financial asset

Stage 1(IFRS 9 par 5.5.5)

Stage 2 (IFRS 9 par 5.5.3)

Stage 3



Credit impaired


Expected Credit Losses Recognised (ECL Allowance)




Interest revenue


General deterioration of the credit quality of the financial asset

IFRS 9 5.5.9 –5.5.11

General approach

• Recognise a loss allowance for expected credit losses on all financial assets within the scope;

• If:

– Credit risk has increased significantly since initial recognition, the loss allowance will be at an amount equal to lifetime expected credit losses

– Credit risk has NOT increased significantly since initial recognition, the loss allowance will be at an amount equal to 12month expected credit losses

More useful terms

• Credit risk

….the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation.

IFRS 7 Appendix A

More useful terms

• Expected Credit Losses

IFRS 9 Appendix A

• Expected Credit Losses

General approach

IFRS 9 par 5.5.17

• Lifetime expected losses

General approach continued

IFRS 9 Appendix A

i.e. the loss which will arise should default take place!

• 12-month expected losses


IFRS 9 Appendix A


• Loss allowance:

– The expected credit loss / impairment is presented separately on the face of the Statement of P&L.

– The allowance is presented separately on the face of the Statement of Financial Position.

R

Dr Expected credit losses XXX

Cr Impairment allowance XXX

Recognition of an impairment in a financial asset

Measurement of Expected Credit Losses

PV of expected cash flows

(discounted at original EIR)

PV of contractual cash flows

(discounted at original EIR)

Credit losses


Credit lossesProbability of default event

taking place in the next 12

months

12-month expected credit losses

When are 12-month ECL recognised?

• The ECL allowance will reflect 12-month ECL :

– On initial recognition; or

– When the credit risk presented by the financial instrument is ‘low’; or

– When the credit risk presented by the financial instrument has not significantly increased since initial recognition / previous reporting date.


Credit lossesProbability of default event

taking place in lifetime of the

instrument


When are lifetime ECL recognised?

• The ECL allowance will reflect lifetime ECL when:

– The credit risk presented by the financial instrument is no longer ‘low’; or

– The credit risk presented by the financial instrument has significantly increased since initial recognition / previous reporting date.

Exceptions to the general approach

• Trade receivables, contract assets and lease receivables; and

• Purchased / Originated Credit-impaired Financial Assets

IFRS 9 5.5.15

IFRS 9 5.5.13


Reclassification (FA)

• Reclassification allowed when business model for the managing of financial assets changes. But should be:

– Significant

– Infrequent

– Demonstrable to external parties

• The following are not changes to a business model:

– A change in intention related to the financial assets

– Temporary disappearance of a market

– Transfer of financial assets between parts of the entity with different business models

• Reclassification shall apply prospectively from reclassification date (first day from next reporting period)

Financial instruments


Reclassification (FA)

Amortised cost reclassified to Fair value

Determine the fair value at reclassification dateDifference between previous carrying amount and fair value – P/L

Fair value reclassified to Amortised cost

Determine fair value at reclassification dateFV at the reclassification date becomes the new carrying amount

Financial instruments

• Only financial assets

• Only when an entity changes its business model

• Change is demonstrable and significant to the entity’s operations

• Apply prospectively – 1st day of the reporting period

(no restatement of previous gains / losses / interest)

• Reallocate CA before FV adjustment from one category to another

• Determine FV at reclassification date

• Restate previous CA to the FV on reclassification date

• Gains / losses recognised in P/L


RECLASSIFICATION FROM : AMORTISED COST TO A FAIR VALUE THROUGH PROFIT OR LOSS

A Ltd owns an investment in unlisted bonds. As the objective of the applicable business model was to hold assets to collect contractual cash flows, the bonds were accounted for at amortised cost. The bonds were acquired at the beginning of year 1 at fair value and mature at the end of year 4, when the principal amount will be R1 mil. The coupon rate is 10% per annum while the fair interest rate amounted to 11% at the beginning of year 1, 15% at the end of year 1/beginning of year 2 and 12% at the end of year 2.

During year 1, A ltd purchased a large investment banking operation. As a result, A Ltd combined all the debt investments it holds in the banking portfolio. The investment banking operation's portfolio is actively managed and accordingly its business model had the objective of realising fair value gains through sale, which is now the objective of the combined portfolio.

A Ltd distinguishes between interest income and other fair value adjustments for disclosure and recording purposes. (method 1)

REQUIRED: JOURNAL ENTRIES YEAR 1 AND YEAR 2


SUGGESTED SOLUTIONYEAR 1 DR CR

J1 Financial asset at amortised cost (SFP) 968 975

Bank (SFP) (FV=1mil; pmt =100 000, n =4; i=11%)

968 975

Initial recognition of investment

J2 Bank (SFP) 100 000

Financial asset at amortised cost (SFP 6 588

Interest income (P/L) (968 975 X 11%) 106 588

NO ADJUSTMENT TO FAIR VALUE -CARRIED AT AMORTISED COST


SUGGESTED SOLUTIONYEAR 2 DR CR

J1 Financial asset at FVTPL (SFP) (1st day of reporting period) 975 563

Financial asset at amortised cost (SFP) 975 563

RECLASSIFICATION (968 975 + 6 588)

J2 Fair Value adjustment (P/L) 89 724

Financial asset at FVTPL (SFP) 89 724

(FV=1mil; pmt =100 000, n =3; i=15%)= R885 839 – 975 563

J3 Bank (SFP) 100 000

Financial asset at FVTPL (SFP) 7 312

Interest income (P/L) (975 563 X 11%) 107 312

J4 Financial asset at FVTPL (SFP) 73 048

Fair Value adjustment (P/L)

(FV=1mil; pmt =100 000, n =2; i=12%)= R966 199– (885 839 + 7 312)

73 048

CALCULATE NEW FAIR VALUE

ORIGINAL EIR


IFRS 7.12B: DICLOSURE

Financial assets measured at amortised cost reclassified to be measured at fair value

On 1 January 2011, after a change in the applicable business model the entity reclassifiedfinancial assets, with a carrying amount of R975 563 at this date, previously measured atamortised cost, to be measured at fair value.

The entity no longer holds the financial asset to collect contractual cash flows, however this isnow actively managed to realise fair value gains through sale by the entity's investment bankingdivision.

The reclassification has lead to a decrease in financial assets at amortised cost and an increase infinancial assets mandatorily held at fair value through profit or loss with a resulting fair valuegain, both upon reclassification and through subsequent measurement, being recorded.

NB: ALSO NOTE DISCLOSURE FOR RECLASSICATION FROM FAIR VALUE TO AMORTISED COST



Disclosures

• Financial instruments disclosures are in IFRS 7 Financial Instruments: Disclosures, and no longer in IAS 32.

• The disclosures relating to treasury shares are in IAS 1 Presentation of Financial Statementsand IAS 24 Related Parties for share repurchases from related parties. [IAS 32.34 and 39]


FINANCIAL LIABILITY

1. Classification

2. Initial Measurement

3. Subsequent Measurement

4. Impairment of Amortised Cost Financial Asset

5. Derecognition


FINANCIAL LIABILITY

1. Classification


Classification Of Financial Liability

• Financial Liabilities shall be classified at either:

– At FVTPL, or

– Financial Liabilities at Amortised Cost

• A financial liability is classified as FVTPL if:

– It is held for trading

– Upon initial recognition it is designated at FVTPL


Measurement of Financial Assets [para 5.1.1-5.1.2]

Initial Measurement• Measure the following liabilities at FV less

transaction costs:– Amortised Cost

• Measure the FVTPL:– at FV only, exclude the transaction costs– Transaction cost must expensed in P/L

• Subsequent measurement:– Use FV- if classified as FVTPL– Use Amortised Cost- if not classified as FVTPL

Initial recognition – Measurement

bases

Fair value (P+L)Amortised Cost

ALL financial liabilities

Derivative liabilities

Asset management purposes

Avoiding inconsistent measurement

OR

ORIRREVOCABLE designation

IFRS 9, Para 4.2.1

IFRS 9, Para 4.2.1.a

IFRS 9, Para 4.2.2

NOTE Other exceptions (IFRS

9, para 4.2.1)


Initial recognition – Hybrid

contracts

Non-derivative host (NOT a financial asset)

Embedded derivative

ONLY if:

• Economic characteristics and risks of the two items are NOT closely related

• Embedded derivative meets the definition of a derivative

• Hybrid contract is NOT measured at fair value (P+L)

Fair value (P+L)

Amortised cost

IFRS 9, Para 4.3 Anesu Daka CA(SA) - CAA

Initial recognition – Transaction

costs

Amortised Cost

Include transaction

costs in the value of

the asset

Fair value (P+L)

If transaction price

does not equal fair

value, recognise a

“day one gain / loss”

(in profit and loss) IFRS 9, Para 5.1.1

IFRS 9, Para 5.1.1AAnesu Daka CA(SA) - CAA

Subsequent measurement

Amortised Cost Fair value (P+L)

IFRS 9, Para 5.3

Fair valueAmortised cost


Subsequent measurement –

Change in credit risk• Issuer’s own discount rate:

31 December 2012

Risk-free interest rate

7%

Credit risk

2%

31 March 2013

Risk-free interest rate

8.2%

Credit risk

2.8%



Change in credit risk

• Fair value of loan has decreased by 2% (11-9)

• Market interest rates have increased (7% to 8.2%)

– G Mac’s credit rating has worsened

• Portion relating to market movements

• Portion relating to credit risk movements

P+L

OCI

IFRS 9, Para 5.7.7• Credit risk movements will ONLY be included in P+L

– Another corresponding financial instrument exists

– Equal and opposite movement in P+L

IFRS 9, Para 5.7.8



Change in credit risk

• To isolate the credit rating effect:

– Calculate the PV (fair value) of the loan

assuming that market interest rates had

NOT changed



Classification and measurement of financial liabilities

Held for trading?

Amortised cost

Fair value through OCI

Fair value throughprofit or loss

Other fair value changes?

YES

YES

NO

YES

Changes due to own credit?

YES

NO

FVO used?

1. Managed on FV basis?

2. Accounting mismatch?

3. Embedded derivative?

Includes embedded derivatives?

NO

Fair value through profit or loss

Separate embedded derivative using IAS 39

Host debt Embedded derivative

Extinguishing Financial Liabilities with Equity Instruments

IFRIC 19


Background

• A debtor and creditor might renegotiate the terms of a financial liability,

• with the result that the debtor extinguishes the liability fully or partially by issuing equity instruments to the creditor.

• These transactions are sometimes referred to as ‘debt for equity swaps’.


Scope

• IFRIC 19 applies to:– the accounting by an entity (debtor) when the terms of a financial

liability are renegotiated and result in the entity issuing equity instruments to a creditor of the entity to extinguish all or part of the financial liability. It does not address the accounting by the creditor.

• An entity shall NOT apply this Interpretation to transactions in situations where:– the creditor is also a direct or indirect shareholder and is acting in its

capacity as a direct or indirect existing shareholder.– the creditor and the entity are controlled by the same party or parties

before and after the transaction and the substance of the transaction includes an equity distribution by, or contribution to, the entity.

– extinguishing the financial liability by issuing equity shares is in accordance with the original terms of the financial liability.


Issue(s)

4 This Interpretation addresses the following issues:1. Are an entity’s equity instruments issued to extinguish all or part

of a financial liability ‘consideration paid’ in accordance with paragraph 3.3.3 of IFRS 9? (recognition of equity issued)

2. How should an entity initially measure the equity instruments issued to extinguish such a financial liability? (measurement of equity issued)

3. How should an entity account for any difference between the carrying amount of the financial liability extinguished and the initial measurement amount of the equity instruments issued? (recognition of the diff between the CA of financial liability and the value of the equity issued to extinguish it- in P/L or OCI or directly in Equity)


Recognition

• If a debtor issues equity instruments to a creditor to extinguish all or part of a financial liability, those equity instruments are 'consideration paid' in accordance with paragraph 3.3.3 of IFRS 9. Accordingly, the debtor should derecognise the financial liability fully or partly.

Dr Financial Liability- CA

Dr Loss on settlement

Cr Share Capital-equity

Cr Gain on settlement


Measurement

• The debtor should measure the equity instruments issued to the creditor at fair value of equity issued, unless fair value is not reliably determinable, in which case the equity instruments issued are measured at the fair value of the liability extinguished.

Dr Financial Liability- CADr Loss on settlement

Cr Share Capital-equity Cr Gain on settlement

NB: the loss or gain on settlement arises when the equity is measured at the fair value of the equity issued, which is either greater or lesser than the CA of liability.


Accounting for the difference

• The difference between the carrying amount of the financial liability (or part of a financial liability) extinguished, and the consideration paid, shall be recognised in profit or loss, in accordance with paragraph 3.3.3 of IFRS 9.

Dr Financial Liability- CADr Loss on settlement (P/L)

Cr Share Capital-equity Cr Gain on settlement (P/L)

An entity shall disclose a gain or loss recognised in accordance with paragraphs 9 and 10 as a separate line item in profit or loss or in the notes.


Partial extinguishment

• If only part of a liability is extinguished, the debtor must determine whether any part of the consideration paid relates to modification of the terms of the remaining liability.

• If it does, the debtor must allocate the fair value of the consideration paid between the liability extinguished and the liability retained.

• If the remaining liability has been substantially modified, the entity shall account for the modification as the extinguishment of the original liability and the recognition of a new liability as required by paragraph 3.3.2 of IFRS 9.


EXAMPLE 1: Question

• Friendly Ltd has 5 000 000 authorised ordinary shares and an outstanding creditor with a fair value of R200 000 owing to Happy Ltd. Of the 5 000 000 ordinary shares, 4 500 000 have been issued. Since the company is growing rapidly and is experiencing some cash flow challenges, it was decided to approach Happy Ltd with the proposal of issuing ordinary shares in Friendly Ltd to Happy Ltd in full and final settlement of the R200 000 owing to Happy Ltd. Happy Ltd agreed to the proposal and shares in Friendly Ltd were issued at their fair value of R5,00 per share to Happy Ltd on the date on which the creditor was supposed to be settled (1 July 20.12).

Q- Record the above transaction in Friendly Ltd’s books


EXAMPLE 1: Solution

The journal entry illustrating how to account for the transaction will as follows:

1 July 20.12

Dr Financial liability: Happy Ltd 200000

Cr Share capital (40 000 x R5,00) 200000

Extinguishing the financial liability owing to Happy Ltd by issuing shares in Friendly Ltd in full and final settlement.


EXAMPLE 2: Question

• Friendly Ltd has 5 000 000 authorised ordinary shares and an outstanding creditor with a fair value of R200 000 owing to Happy Ltd. Of the 5 000 000 ordinary shares, 4 500 000 have been issued. Since the company is growing rapidly and is experiencing some cash flow challenges, it was decided to approach Happy Ltd with the proposal of issuing ordinary shares in Friendly Ltd to Happy Ltd in full and final settlement of the R200 000 owing to Happy Ltd. Happy Ltd agreed to the proposal and 45000 shares in Friendly Ltd were issued at their fair value of R5,00 per share to Happy Ltd on the date on which the creditor was supposed to be settled (1 July 20.12).

Q- Record the above transaction in Friendly Ltd’s books


EXAMPLE 2: Solution

The journal entry illustrating how to account for the transaction will as follows:

1 July 20.12

Dr Financial liability: Happy Ltd 200000

Dr Loss on settlement (P/L) 25000

Cr Share capital (45 000 x R5,00) 225000

Extinguishing the financial liability owing to Happy Ltd by issuing shares in Friendly Ltd in full and final settlement.


Hedging

• Use the notes in the TUT 106 and practice with the attached examples


Earnings Per Share

IAS 33


Background


• Required for quoted/listed entities• Earnings per share (EPS) is a ratio widely used by most user

groups, in particular financial analysts and the financial press.

• The users of financial statements use EPS and dividends per share (DPS) to evaluate the current performance and the performance over time of an entity and to compare it with the performance of other entities.

• Diluted earnings per share assist the users of financial statements to evaluate the sensitivity of EPS with regard to future changes in the capital structure of the enterprise.

Earnings Per Share


Earnings per share includes:

• Basic Earnings Per Share (BEPS)

• Diluted Earnings Per Share (DEPS)

• Head-line Earnings Per Share (HEPS)

• Dividend Per Share (DPS)

KEY CONCEPTS


• The following key concepts are fundamental to this study unit:– The calculation of basic earnings per share for:

• Profit attributable to ordinary equity holders of the parent entity.• Profit from continuing operations attributable to ordinary equity

holders of the parent entity.

– The calculation of diluted earnings per share for:• Profit attributable to ordinary equity holders of the parent entity.• Profit from continuing operations attributable to ordinary equity

holders of the parent entity.

– Calculation of headline earnings per share (level 1)– The calculation of dividend per share.– The presentation and disclosure of earnings, head-line earnings

and dividends per share amounts.

Basic Earnings Per Share (BEPS) (33.9-29)


• Objective - to provide a measure of the interests of each ordinary share of a parent entity in the performance of the entity over the reporting period.

• Calculate BEPS for continuing operations if so required.

• See formula in next slide



• BEPS =Basic Earnings

WANOS*

*Weighted Average Number of Ord’ Shares

Approach:- Always put the formula down first and calculate

each component one-by-one.- NB: most marks are on the WANOS



Basic Earnings (33.12)• For the purpose of calculating basic earnings per

share, the amounts attributable to ordinary equity holders of the parent entity in respect of: (a) profit or loss from continuing operations attributable to the parent entity; and(b) profit or loss attributable to the parent entity

• shall be the amounts in (a) and (b) adjusted for the after-tax amounts of preference dividends, differences arising on the settlement of preference shares, and other similar effects of preference shares classified as equity.

BEPS- Continuing Example


A company has a profit from continuing operations amounting to R520 000 and a loss from discontinued operations amounting to R110 000. A non-cumulative preference dividend of R20 000 was declared during the year. 100 000 ordinary shares were in issue throughout the year.

Impact of pref share on Basic Earnings


• If Pref share are classified as financial liabilities-pref dividend is a finance cost – no impact on earnings as already deducted as a finance cost in the P/L;

• If preference shares classified as equity- deduct from profit for the period as follows:– After tax Cumulative dividend- deduct even if

dividend not declared & paid

– After Tax-Non-cumulative dividend- deduct only if dividend has been declared

Weighted Average Number of Ordinary Shares (WANOS)


• Use WANOS for BEPS• The rationale behind using a weighted average number of ordinary

shares outstanding is to reflect the proportionate change in earnings in comparison with the capital (resources) that was available to generate it.

• For example, if an entity had 10 000 shares in issue throughout year 1 and at the start of year 2 issued a further 10 000 shares for cash, the company had more capital (resources) available with which earnings could be generated in year 2 compared to year 1. By using 10 000 as the denominator in year 1 and 20 000 as the denominator in year 2, this relative change in the resources available to generate earnings is reflected in the EPS figures. This method improves the comparability of EPS figures from year to year.

Weighted Average Number of Ordinary Shares (WANOS)-IAS 33.19-29


• For BEPS, the number of ordinary shares shall be the WANOS outstanding during the period.

When do share issue impact WANOS?• Shares are usually included in the WANOS from the date

consideration is receivable (which is generally the date of their issue), for example: – ordinary shares issued in exchange for cash are included when cash is

receivable; (new shares issued X N/12, where N= period in issue)– ordinary shares issued on the voluntary reinvestment of dividends on

ordinary or preference shares are included when dividends are reinvested; (shares in issue at issue X capitalisation issue ratio)

– ordinary shares issued as a result of the conversion of a debt instrument to ordinary shares are included from the date that interest ceases to accrue; (new shares issued X N/12, where N= period in issue)



– ordinary shares issued in place of interest or principal on other financial instruments are included from the date that interest ceases to accrue;

– ordinary shares issued in exchange for the settlement of a liability of the entity are included from the settlement date;

– ordinary shares issued as consideration for the acquisition of an asset other than cash are included as of the date on which the acquisition is recognised; and

– ordinary shares issued for the rendering of services to the entity are included as the services are rendered.



– Ordinary shares issued as part of the consideration transferred in a business combination are included in the WANOS from the acquisition date.

– Ordinary shares on conversion of a mandatorily convertible instrument are included in WANOS from the date the contract is entered into.

– Contingently issuable shares are treated as outstanding and are included in WANOS only from the date when all necessary conditions are satisfied

WANOS


New share issues (with a change in resources)

• Impact BEPS

• Adjust proportionately for the time it was in issue during the year. E.g. if 1200 new shares were issued for cash on 30 September for a December Y/E, BEPS WANOS shall be increased by 300 (1200*3/12)

WANOS


Share buy back (with a change in resources)

• Impact BEPS

• Adjust proportionately for the time it was NOT in issue during the year. E.g. if 1200 new shares were issued for cash on 30 September for a December Y/E, BEPS WANOS shall be decreased by 300 (1200*3/12)

WANOS


Example: New share issues (with a change in resources)

• A company earned profit of R8 million during the year and had 10 million ordinary shares in issue at 1 January. On 30 September a further 8 million shares were issued, while 1 million shares were bought back at 30 November. The company’s year-end is 31 December.

WANOS


Mandatorily/Compulsory Convertible InstrumentsIAS33.23 Ordinary shares that will be issued

upon the conversion of a mandatorily convertible instrument are included in the calculation of BEPS from the date the contract is entered into.

• For the purposes of diluted EPS, mandatorily convertible instruments are not potential ordinary shares, as it is not a contract that may entitle its holder to ordinary shares.

• It is a contract that definitely entitles its holder to ordinary shares.

WANOS


Example: Mandatorily/Compulsory Convertible Instruments

• During the year A Ltd earned profit of R580 000, while 200 000 ordinary shares were in issue throughout the year. Halfway through the year 5 000 debentures of R10 each were issued by A Ltd, which will be converted into ordinary shares after five years on the basis of three ordinary shares for every debenture held. Conversion is mandatory and there is no option for cash settlement. Assume that the interest expense relating to these debentures amounted to R4 500 (before tax).

WANOS


Example: Mandatorily/Compulsory Convertible Instruments• Earnings………………………… 580,000• WANOS:

– Shares in issue……………………. 200,000– Mandatory Convertible shares…… 7,500

207,500BEPS = 580000/207,500

= 2.80NB: No adjustment is made for the interest paid on the

debentures as basic earnings, per definition, includes all income and

expenses recognised in profit or loss.

WANOS


Capitalisation or bonus issues:• In a capitalisation or bonus issue, ordinary shares are issued to

existing shareholders for no additional consideration. • Therefore, the number of ordinary shares outstanding is increased

without an increase in resources. • The number of ordinary shares outstanding before the event is

adjusted for the proportionate change in the number of ordinary shares outstanding, as if the event had occurred at the beginning of the earliest period presented. (see example)

• NB: Always adjust the prior year BEPS as capitalisation are regarded as issued at incorporation in proportion to the shares outstanding.

WANOS


Example: Capitalisation issue

• A company’s issued share capital consisted of 10 million shares at 1 January 20X2. During 20X2 a one for four capitalisation issue took place out of retained earnings.

• Earnings in 20X2 amounted to R5 million while EPS in 20X1 was 45 cents.

WANOS


Example: Capitalisation issue• EPS for 20X2 would be calculated as R5m/12,5m = 40 cents (2,5m shares were

issued by way of the one-for-four capitalisation issue). The comparative EPS (i.e. 20X1) requires restatement in proportion to the revised number of shares in issue, i.e. 45 cents x 10m/12,5m = 36 cents. (This can also be calculated by taking earnings of R4,5m in 20X1 (EPS 45c x 10m shares) and shares of 12,5m, i.e. R4,5m/12,5 = 36 cents.) The comparative figures are adjusted to provide a more meaningful comparison between the current year's EPS which, despite there being no increase in total equity, is based on the increased number of shares in issue. Therefore, the increased number of shares in issue is also taken into account for the comparative period. This is in contrast to an issue for value where the increased shares in issue are expected to generate increased earnings in the current year and as a result, the current year EPS is based on the increased number of shares in issue, but the comparative EPS is not adjusted.

• Where shares are issued for value prior to a capitalisation issue, the effect of the new issue, which has been weighted for purposes of the EPS calculation, should be taken into account when calculating the effect of the capitalisation issue.

WANOS


Example: Capitalisation issue after shares issued at fair value

• A company had issued share capital of 10 million shares at 1 January 20X2. On 1 March 20X2 there was an issue of 300 000 shares at fair value. On 1 September 20X2 a one for four capitalisation issue took place.

WANOS


Example: Capitalisation issue after shares issued at fair value

WANOS- current year: Outstanding on 1 January…………….. 10 000 000New issue-FV on 1/3/12(300k*10/12 250 000

10 250 000Cap issue ¼*10250000 2 562 000

12 812 500Note that the comparative basic EPS figure will be

recalculated using a weighted average number of shares of 12 500 000 [10 000 000 + (10 000 000 / 4)].

WANOS


Share Split• Where shares are split there is no effect on the

company’s overall capital. Therefore, the treatment is identical to that applied to capitalisation or bonus issues.

• Consolidation of shares• A consolidation of ordinary shares generally reduces

the number of ordinary shares outstanding without a corresponding reduction in resources.

• Therefore, EPS is based on the decreased number of ordinary shares after the share consolidation and comparatives are proportionately adjusted.

WANOS


Rights Issue Refer to IE 4 in IAS 33• Rights issues can take place at or below the fair value of the shares. • Where a rights issue takes place at fair value, it is treated in the same way

as a new share issue for value. • Where a rights issue takes place at less than the fair value, it involves two

components: an issue of shares for full value and a bonus issue.• The number of ordinary shares to be used in calculating basic earnings

per share for all periods prior to the rights issue is the number of ordinary shares outstanding prior to the issue, multiplied by the adjusting factor:

Adjusting factor =Fair value per share immediately prior to the exercise of rights

Theoretical ex-rights fair value per share

WANOS


Rights Issue• The theoretical ex-rights fair value per share is calculated by adding

the aggregate fair value of the shares immediately prior to the exercise of the rights to the proceeds from the exercise of the rights, and dividing by the number of shares outstanding after the exercise of the rights.

• Where the rights themselves are to be publicly traded separately from the shares prior to the exercise date, fair value for the purposes of this calculation is measured at the close of the last day on which the shares are traded together with the rights.

Theoretical Ex-rights fair value per share =Fair value of all issued shares prior to the exercise of rights + total proceeds received from exercise of rights

Number of shares in issue prior to the exercise + number of shares issued in the exercise

What does the EPS future look like?


Diluted Earnings Per Share para 30-63


DEPS=Diluted EarningsDiluted WANOS

NB: Objective- to estimate possible future reduction in EPS

DEPS is calculated for:• Profit attributable to parent:

– Profit/loss from continuing operations if presented– Profit/loss from discontinued operations

Diluted Earnings- para 33


• Diluted earnings=

– Basic Earnings adjusted by the after-tax effect of:

• dividends saving on items of dilutive instruments (e.g. dividends on convertible preference shares)

• Interest saving on conversion of debt instruments

• Other changes in income that would result from dilutive instruments (transaction costs and discounts on conversion)

Diluted WANOS


• Diluted WANOS = Basic WANOS + effects of dilutive (potential ordinary shares) instruments

• NB: Only potential ordinary shares are dilutive

• Dilutive instruments shall be deemed to be issued as:– at the beginning of the year (if issued in prior

years) or

– from the issue date if issued in the current year

Diluted WANOS


decrease earnings per share or

increase loss per share

USE to calculate DEPS

increase earnings per share or

decrease loss per share

IGNORE FOR DEPS calculation

• Dilutive potential Ord Shares • Anti-dilutive potential OrdShares

Options, warrants and their equivalents


• The dilutive potential ordinary shares are those that arise from no value/free shares.

• Free shares are calculated as follows =Average Market Price for the yr less Exercise PriceX # of shares on optionsXn/12

Average market price

The free share can therefore be added on the Diluted WANOS

NB: Options and Warrants usually do not have impact on Earnings

Do Example 5 in IAS 33B

Options, warrants and their equivalents


Average Market Price for the yr less Exercise Price X # of shares on options X n/12

Average market price

= (20-15)/20 X 100000 X 12/12 = 25000

Diluted WANOS = 500 000 + 25 000

= 525 000

Share-based payment- Options


• In a share based payment arrangement employees are usually required either to:– 1st to work fore the share and then pay an exercise price on exercise date.

Which means the consideration arises from work and exercise price.

• The free shares on share based payment are therefore calculated as follows:

AVP less (EP+ SBPFV*n/N) X # of shares on options X n/12AVP

AVP= annual average market price of the shareEP = exercise priceSBPFV = share based payment fair value still to be worked for

n= remaining vesting periodN= total vesting period

E.G-Share-based payment- Options


Vesting Condition-Service Condition

• At the beginning of year 1 X Ltd grants 1 000 options to an employee, conditional upon the employee remaining in X Ltd’s employment until the end of year 3. These options entitle the employee to acquire one X Ltd share for each option at R1,50 per share. The average market price of X Ltd’s shares during year 1 was R2 per share. The fair value per option at the beginning of year 1 was R0,30.

Answer


The free shares at end of year 1 are:

AVP less (EP+ SBPFV*n/N) X # of shares on options Xn/12

AVP

= 2- (1.5+0.3*2/3) X 1000 X 12/12

2

= 150 shares

Share-based payment- Options


• Vesting Condition-Service + Performance Condition– If the vesting condition includes a performance (market or

non-market) condition it is regarded as a contingently issuable share.

– It shall only included in diluted earnings per share if the contingent event has occurred, with no consideration whether it is a market or non-market condition.

E.G if the share price has to increase to 20c per share:• -if share price not achieved at year end do not include in WANOS

• - if share price achieved at yr end include in WANOS

E.G-Share-based payment- Options


Vesting Condition-Service + Performance Condition• At the beginning of year 1 X Ltd grants 1 000 options to an

employee, conditional upon the employee remaining in X Ltd’s employment until the end of year 3 and that the share price should increase to 20 cents per share. . These options entitle the employee to acquire one X Ltd share for each option at R1,50 per share. The average market price of X Ltd’s shares during year 1 was R2 per share. The fair value per option at the beginning of year 1 was R0,30. The share price is 18 cents at year end.

• Q how many shares are dilutive a) if share price is 18 cents, (b) if share price is 21 cents

Answer


a) – the performance condition (growth of share price to 20 cents) is a contingent event and the share is therefore contingently issuable. Contingent issuable can only be included in WANOS when the contingent event has been achieved. Since 18c is less than 20c then therefore NOT included in EPS.

b) The free shares at end of year 1 are:AVP less (EP+ SBPFV*n/N) X # of shares on options Xn/12

AVP

= 2- (1.5+0.3*2/3) X 1000 X 12/122

= 150 shares

Contingently issuable shares


• contingently issuable ordinary shares are treated as outstanding and included in the calculation of diluted earnings per share if the conditions are satisfied (ie the events have occurred).

• included from the beginning of the period (or from the date of the contingent share agreement, if later).

Convertible instruments


• Examples include Convertible debenture and preference shares.• Convertible dilutive instruments may affect earnings through

interest and dividends.• Impact:

– Increase the earnings with the after-tax effect of interest or dividends that will be saved in future when the debentures or shares are converted.

– Increase the weighted average number of shares with the expected future increase in ordinary shares resulting from the conversion.

• Interest is calculated on the liability component using the effective rate after taking transaction costs.

• Do Example 6 in IAS 33B

Ranking dilutive instruments


• Perform a ranking order with the most dilutive first.

• Options are usually the most dilutive instruments

• After ranking start by including the most dilutive instrument

• Do Example 9 in IAS 33B

Dividend per share (DPS)


• DPS is not covered under IAS 33. IAS 1.107 requires that the DPS be presented together with EPS.

Dividend per share = Dividend for the year

Total actual Issued Shares

Looking for maintainable growth


Headline Earnings Per Share (HEPS)


• Not covered by IAS 33• Rather calculated in terms of Circular 03/09, Headline

Earnings issued by SAICA• Request of the JSE Limited. Section 8.63(c) of the JSE

Listing Requirements• States that listed entities must disclose headline HEPS

for the current financial year and the immediately preceding financial year and

• that the headline earnings must be disclosed with a detailed reconciliation to the IAS 33 basic EPS number.

• NB: The ZSE listing rules also requires disclosure of HEPS, hence, it is applicable in Zimbabwe.

Why HEPS


• Basic earnings per share is EPS based on earnings for the year. Basic earnings include both maintainable earnings and earnings from extra-ordinary non-maintainable items.

• HEPS presents only EPS based on maintainable earnings of an entity which is more useful to the user than the basic earnings.

HEPS


• HEPS =

Headline Earnings

Basic WANOS

NB: Headline Earnings= Basic WANOS +/- non-maintainable earnings effects

Approach:- focus on what should not be included in headline earnings and exclude these from the basic earnings. See next slide for excluded items. These are found in Circular 03/09 which is taken to the exam.

Example


Answer


Leases: IAS 17

Anesu Daka CA (SA) - Chartered Accountants Academy

219

Examinability

2015 Possible areas of focus:

Finance lease- Lessor + Lessee

Sale and lease back

Deferred tax implications

Presentation and Disclosure


220

Determining Whether an Arrangement Contains a Lease

IFRIC 4

Exam Approach- IFRIC 4

Approach:

Issue – Is the arrangement a lease agreement

Application: Comment that an assessment is required of whether the

arrangements has the substance of a lease as defined by IAS 17. (copy and paste IFRIC 4.6)

Define a lease

Apply the scenario to prove existence of the following indicators: fulfilment of the arrangement is dependent on the use of a

specific asset or assets (IFRIC 4.7-8); and

the arrangement conveys a right to use the asset (IFRIC 4.9a-c).

Adavanced Accounting Academy - Anesu Daka CA (SA)

Exam Approach

• Conclude whether the arrangement is a lease arrangement or not

• Apply the classification criteria as per IAS 17.10 – 18 to determine whether the lease is a finance or operating lease.

• Conclude on the lease classification



224


225


226

Accounting Treatment of GRV

• Treat exactly as a lease payment or GRV is a part of minimum lease payment,

• May be equivalent to the market value of the asset at end of the lease

• Acc/Treat- amortise over the lease payment by treating the GRV as the FV on calculation of the PV of the lease.

• Use GRV as FV on calculation of the rate implicit in the lease and payment/lease instalments.

Refer to Example 12.3 on pg 257 of Descriptive Accounting


Accounting Treatment of URV

Lessee• Include as FV in calculating the rate implicit in the

lease and lease installment• Do NOT treat it as FV in calculating the PV of the

lease (Just IGNORE the URV)Lessor• Include as FV in calculating the rate implicit in the

lease and lease installment• Include the URV in the Gross investment in

lease/Lease debtor


Classification of Leases

• A lease is classified as a finance lease if it transfers substantially all the risks and rewards incident to ownership.

• All other leases are classified as operating leases.

• Classification is made at the inception of the lease. [IAS 17.4]


Finance Lease Key indicators

• Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form. Situations that would normally lead to a lease being classified as a finance lease include the following: [IAS 17.10] – the lease transfers ownership of the asset to the lessee by the end of the lease

term – the lessee has the option to purchase the asset at a price which is expected to

be sufficiently lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the option will be exercised

– the lease term is for the major part of the economic life of the asset, even if title is not transferred ( > 75%)

– at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset ( > 90%)

– the lease assets are of a specialised nature such that only the lessee can use them without major modifications being made


Finance Lease other indicators

• Other situations that might also lead to classification as a finance lease are: [IAS 17.11] – if the lessee is entitled to cancel the lease, the lessor's

losses associated with the cancellation are borne by the lessee

– gains or losses from fluctuations in the fair value of the residual fall to the lessee (for example, by means of a rebate of lease payments)

– the lessee has the ability to continue to lease for a secondary period at a rent that is substantially lower than market rent


Example 1

• X Ltd leases a machine, with a total economic life of ten years, from Z Ltd, for a period of five years. X Ltd has the option to continue the lease for another three years, without any payment during this three year period. It is reasonably certain that X Ltd will exercise this option.

Required: Classify the lease


Exam Tech

• Issue: Whether the lease is a finance or operating lease?

• Assessment of whether the lease is finance or operating lease is dependent on the substance rather the form. The lease would be a finance lease if it meets the following (always discuss the apparent indicators first);– Lease term is for the major economic life even if title is not

transferred;• Lease is 8 including the extension, resulting 80% of the economic

life. The extended period is rent free.

Conclusion- Lease is Finance lease.


Classifying a lease of land and buildings

• In classifying a lease of land and buildings,– Seperate land and buildings elements – Allocate the minimum lease payments between the land and

buildings elements in proportion to their relative fair values. – The land element is normally classified as an operating lease

unless title passes to the lessee at the end of the lease term. – The buildings element is classified as an operating or finance

lease by applying the classification criteria in IAS 17. [IAS 17.15] – However, separate measurement of the land and buildings

elements is not required if the lessee's interest in both land and buildings is classified as an investment property in accordance with IAS 40 and the fair value model is adopted. [IAS 17.18]


Accounting by Lessees

Finance Lease• at commencement of the lease term, finance leases should be recorded as an asset and a liability at the lower of

the fair value of the asset and the present value of the minimum lease payments (discounted at the interest rate implicit in the lease, if practicable, or else at the entity's incremental borrowing rate) [IAS 17.20]

Dr Asset (- IAS 16)Cr Lease Liability

• finance lease payments should be apportioned between the finance charge and the reduction of the outstanding liability (the finance charge to be allocated so as to produce a constant periodic rate of interest on the remaining balance of the liability) [IAS 17.25]

Dr Lease liability Dr Finance Cost

Cr Bank

• the depreciation policy for assets held under finance leases should be consistent with that for owned assets. If there is no reasonable certainty that the lessee will obtain ownership at the end of the lease - the asset should be depreciated over the shorter of the lease term or the life of the asset [IAS 17.27]

Dr Depreciation Expense Cr Accumulated Depreciation


Finance lease (lessee)

• Finance lease (lessee)• 1 January 20.5: Entered into finance lease

contract for manufacturing machine.Cost (VAT of R21 000 included) R171 000Interest rate 18% per

annumLease term 4 yearsInstalments (p.a in arrears) R63 567Depreciation 20% per annum on costOwnership will pass at the end of the lease term.


Amortisation Table

Amortisation Table

Date Instalment Interest Capital Balance

1 January 20.5 $170,999

31 December 20.5 $63,567 $30,780 $32,787 $138,212

31 December 20.6 $63,567 $24,878 $38,689 $99,523

31 December 20.7 $63,567 $17,914 $45,653 $53,870

31 December 20.8 $63,567 $9,697 $53,870 $0

$254,268 $83,269 $170,999


JE Passed in 20.5

Dr Asset 150000Dr VAT Input 21000

Cr Lease Liability 171000Recognition of leased asset and liability

Dr Lease liability 32787Dr Finance Costs 30780

Cr Bank 63567Amortisation of lease liability

Dr Depreciation Expense 30000Cr Acc Depreciation (20%X150,000) 30000


Reguired

Q: Calculate the CA and TB for B/S method

Q: Which amts are needed for the I/S method?


TB of Finance Lease balances in lessee’s books

B/S methodCA TB TD DT IS

Plant (150k-30k) 120K 0 120kLease Liability (138,212) (15,750) (122,462)

(2462) (739) (739)TB = CA less amt deductible in future

= 138,212 less 122,462 (allowed for income tax but 15,750 is not allowed because it is another tax (VAT) as per Sec 23A)= 15,750

NB: TB of lease liability is the future VAT payable (21000X3/4 or 63567/254268) in the books of the lessee.

Conclusion: TB of a liability is the amt not deductible for tax purposes in future, which is future VAT payable on future instalments.


Accounting by Lessees

Operating Lease

• for operating leases, the lease payments should be recognised as an expense in the income statement over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user's benefit [IAS 17.33]

Dr Operating lease expense (sum of all pmts/lease term)

Dr Operating lease debtor (SofP)

Cr Operating lease accrual (SoFP)

Cr Bank


Operating lease

An operating lease has deferred tax implications if the lease payments are spread unequally over the lease term and the entity recognise it evenly for accounting purposes.

1 January 20.5: Commencement of operating lease agreement with a term of 3

years. Lease installments:

VAT included VAT excluded

R R

31 December 20.5 22 800 20 000 31 December 20.6 34 200 30 000 31 December 20.7 45 600 40 000

90 000


Operating lease in lessee

Temporary difference will arise as follows: Accounting for operating lease expense (IAS 17.33) or

operating lease income (IAS17.50) requires straight-lining of the payments over the lease term after VAT (90K/3 = $30k per year)Dr Operating Lease exp 30000 Dr Vat Input 2800

Cr Bank 22800Cr Operating lease creditor 10000

Tax man will allow deduction of $20K, whereas the accountant deducted $30K in PBT.


TB of operating lease in lessee

B/S method

CA TB TD DT IS

Op lease creditor 10k 0 10K 3K 3k

Dr Deferred Tax asset 3k

Cr Tax Expense 3k


Accounting by Lessor

Finance lease• at commencement of the lease term, the lessor should

record a finance lease in the balance sheet as a receivable, at an amount equal to the net investment in the lease [IAS 17.36]

•

Dr Gross investment in leaseCr Unearned Finance incomeCr Asset Leased-Cost (Plant, vehicle, e.tc)

Dr Asset Leased- Accumulated DepreciationCr/(Dr) Gain/(loss) on disposal



Finance lease• the lessor should recognise finance income based

on a pattern reflecting a constant periodic rate of return on the lessor's net investment outstanding in respect of the finance lease [IAS 17.39]

• Dr Bank• Cr Gross investment in lease•

• Dr Unearned Finance Income• Cr Finance income


Finance lease (lessor)

• 1 January 20.5:

• Lease machine in terms of a finance lease to customer.

Cost of machine (VAT excluded) 70 000

Normal selling price (VAT included) 114 000

Lease period 4 years

Instalments payable annually in arrears 42 378

Interest rate 18%

Depreciation over 5 years on cost

Wear and tear amounts to 10% per annum on cost


Amortisation Table

Amortisation Table

Date Instalment Interest Capital Balance

1 January 20.5 $113,999

31 December 20.5 $42,378 $20,520 $21,858 $92,141

31 December 20.6 $42,378 $16,585 $25,793 $66,349

31 December 20.7 $42,378 $11,943 $30,435 $35,914

31 December 20.8 $42,378 $6,464 $35,914 $0

$169,512 $55,513 $113,999


Journals 20.5:

Dr Gross investment in lease (42 378 x 4) 169,512 Cr VAT Output (Invoice price X14/114) 14,000Cr Unearned finance income 55,512Cr Profit on sale of asset 30,000Cr Asset 70,000

Recognition of lease debtor

Dr Bank 42,378Cr Gross investment in lease 42,378

Dr Unearned Finance Income 20,520Cr Finance income 20,520


Answer


Plant 0 75,600 (75,600)Lease debtor 127,134 0 127,134

UF Income (34992) 0 (34,992) 16,542 4,963 4,963

TB of Plant = The initial tax base of the asset is the cost of R70 000 plus the VAT amount of R14 000. (SARS allows wear and tear on the cost plus the VAT on the selling price. At the same time the instalments, which include VAT on the selling price, are taxed. The VAT being taxed as part of the lease instalments and the VAT claimed as part of wear and tear, will therefore contra out over the lease period.) Lessor applies Sec 23C



Operating leases• assets held for operating leases should be presented in the

balance sheet of the lessor according to the nature of the asset. [IAS 17.49]

• Lease income should be recognised over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern in which use benefit is derived from the leased asset is diminished [IAS 17.50]

Dr BankDr Lease prepayment

Cr Lease accrualCr Operating lease income (sum of pmts/lease term)


Operating lease in lessor

Temporary difference will arise as follows: Accounting for operating lease expense (IAS 17.33) or

operating lease income (IAS17.50) requires to straight line the payments over the lease term after VAT (90K/3 = $30k per year)Dr Bank 22800 Dr Operating lease receivable 10000

Cr Vat Output 2800Cr Operating Lease income 30000

Tax man will allow tax of $20K, whereas the accountant accrue $30K in PBT.


Operating lease

An operating lease has deferred tax implications if the lease payments are spread unequally over the lease term and the entity recognise it evenly for accounting purposes.

1 January 20.5: Commencement of operating lease agreement with a term of 3 years. Lease installments:

VAT included VAT excluded

R R

31 December 20.5 22 800 20 000 31 December 20.6 34 200 30 000 31 December 20.7 45 600 40 000

90 000Required: Give JE for recording the lease in Lessor


TB of operating lease in lessor


Operating lease 10k 0 10K 3K 3k

I/S MethodTemporary differences (10k)Add operating lease income (30k)Less Pmt – actually received 20k

Dr Tax Expense 3kCr Deferred Tax liability 3k



Manufacturer Dealer leases• Manufacturers or dealer lessor should include selling profit

or loss in the same period as they would for an outright sale. If artificially low rates of interest are charged, selling profit should be restricted to that which would apply if a commercial rate of interest were charged. [IAS 17.42]

•

• Dr Gross investment in lease (all pmts + GRV + URV)• Cr Unearned Finance income• Cr Sales (lower of the FV and PV of MLP)• Cr Vat Output



Manufacturer Dealer leases• Dr Cost of sales• Cr Inventories

• Dr Revenue• Cr Cost of sales- PV of URV-IAS 17.44

• Dr Selling expenses• Cr Bank- para 42& 46- costs incurred by the

lessor


Example

• X Ltd leased a new item of plant to Z Ltd on 1 January 20X3 in return for five annual payments, in arrears, of R90 000 each, as well as a guaranteed residual amount of R100 000, payable 31 December 20X7. The plant was manufactured by X Ltd at a cost of R320 000. The terms of the lease indicate that ownership of the asset will pass to Z Ltd upon payment of the guaranteed residual and that the market interest rate is 10,2846%. The plant has a fair value of R400000 on 1 January 20X3



Manufacturer Dealer leases• Dr Gross investment in lease(5X90000)+100k 550000 • Cr Unearned Finance income 150000• Cr Sales 400000

• Dr Cost of sales 320000• Cr Inventories 320000

• Dr Revenue.. Only where there is URV• Cr Cost of sales- PV of Unguaranteed Residual Value-

IAS 17.44



Manufacturer Dealer leases• Dr Bank 90000• Cr Gross investment in lease 90000

• Dr Unearned Finance income 41138• Cr Other Income/Revenue-Finance Income

41138

• i=?, PV=-400000, pmt=90000, FV=100000, n=5• i= 10.2846%


Initial direct costs

• Under the 2003 revisions to IAS 17, initial direct and incremental costs incurred by lessors in negotiating leases must be recognised over the lease term. They may no longer be charged to expense when incurred. This treatment does not apply to manufacturer or dealer lessors where such cost recognition is as an expense when the selling profit is recognised. – Lessee – capitalise to the cost of the asset-IAS17.20– Other Lessors – Add to the PV and amortise over the lease

term-IAS17.38 (revise the rate – using the PV)– Manufacturer Dealer Lessor – expense in period incurred-

IAS17.42


Sale and Leaseback Transactions

General• Nature- sale of an asset and leasing back the

same asset.• Reason- To improve cash flows by obtain finance

now and use the asset as security.• The asset should be sold at its market value• Classification- like all leases the lease should be

classified as per IAS 17.10-18• Applies to lessee only as for lessor it’s a normal

lease


Sale and Leaseback Transactions (only in lessee)

Sale and Finance Lease back• Not a sales transaction in substance. Lessee gives asset as security

to obtain funds.• No profit or loss recognised immediately.• Carrying amount of asset adjusted to selling price.• Recognise long-term liability.• Initial direct costs added to the carrying amount of asset.• Recognise depreciation and finance cost.• For a sale and leaseback transaction that results in a finance lease,

any excess of proceeds (Selling Price) over the carrying amount (CA) is deferred and amortised over the lease term. [IAS 17.59]

• Reclassify asset to be a leased asset


Sale and leaseback – finance lease

Dr Plant –Cost (Leased Assets) Cr Plant Cost (Owned assets)

Reclassification of asset as a leased asset after the sale and lease back.

Dr Plant Cost (Leased asset)Cr Deferred Profit

Adjustment of CA of asset and recognition of defer profit

Dr Bank (Selling Proceeds at market value)Cr Finance Lease Liability



Dr Finance CostsDr Finance Lease liability

Cr Bank Payment of lease instalmentDr Deferred profit

Cr Profit on sale and lease back amortised (Other Incom)

Amortisation of deferred profitDr Depreciation

Cr Acc Depreciation



• On 1/1/20X1 a company sells a machine with a carrying amount of R52 000 for R60 000 and leases it back under a finance lease for four years.

• The instalments amount to R18 928 per annum, payable in arrears, while the interest rate relating to the lease is 10%.

• The machine has a remaining useful life of four years.



Dr Plant Cost (60k-52k) 8000Cr Deferred Profit 8000

Adjustment of CA of asset and recognition of defer profit

Dr Plant –Cost (Leased Assets) 60000Cr Plant Cost (Owned assets) 60000

Reclassification of asset as a leased asset after the sale and lease back.

Dr Bank (Selling Proceeds at market value) 60000Cr Finance Lease Liability 60000



Dr Finance Costs 6000Dr Finance Lease liability 12928

Cr Bank 18928Payment of lease instalmentDr Deferred profit (8000/4) 2000

Cr Profit on sale and lease-back (Other Income) 2000

Amortisation of deferred profitDr Depreciation expense (60000/4) 15000

Cr Acc Depreciation 15000


Disclosure - Lessee

Lessees - Finance Lease [IAS 17.31]

• carrying amount of asset • reconciliation between total minimum lease payments and their present

value • amounts of minimum lease payments at balance sheet date and the

present value thereof, for: – the next year – years 2 through 5 combined – beyond five years

• contingent rent recognised as an expense • total future minimum sublease income under noncancellable subleases • general description of significant leasing arrangements, including

contingent rent provisions, renewal or purchase options, and restrictions imposed on dividends, borrowings, or further leasing


Disclosure - Lessee

Operating Lease [IAS 17.35]

• amounts of minimum lease payments at balance sheet date under noncancellable operating leases for: – the next year – years 2 through 5 combined – beyond five years

• total future minimum sublease income under noncancellablesubleases

• lease and sublease payments recognised in income for the period • contingent rent recognised as an expense • general description of significant leasing arrangements, including

contingent rent provisions, renewal or purchase options, and restrictions imposed on dividends, borrowings, or further leasing


Disclosure - Lessor

Finance Lease [IAS 17.47]

• reconciliation between gross investment in the lease and the present value of minimum lease payments;

• gross investment and present value of minimum lease payments receivable for: – the next year – years 2 through 5 combined – beyond five years

• unearned finance income • unguaranteed residual values • accumulated allowance for uncollectible lease payments receivable • contingent rent recognised in income • general description of significant leasing arrangements


Disclosure - Lessor

• Operating Lease [IAS 17.56]

• amounts of minimum lease payments at balance sheet date under non-cancellable operating leases in the aggregate and for: – the next year – years 2 through 5 combined – beyond five years

• contingent rent recognised as in income • general description of significant leasing

arrangements


Apply IAS 17

• TUT 106


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