Intermediate Financial Acct II Ch 1-7.pdf

Intermidate finance is a type of finance which studying about all type of finance in the country.

1. Course Title: Intermediate
Financial Acct.II

2. 13-2
CHAPTER 1
CURRENT LIABILITIES, PROVISIONS, AND
CONTINGENCIES

3. 13-3
Threeessentialcharacteristics:
1.Present obligation.
2.Arises from past events.
3.Results in an outflow of resources
(cash, goods, services).
CURRENT LIABILITIES
“WhatisaLiability?”
Liabilityisdefinedaspresentobligationofthecompany
arisingfrompastevents,thesettlementofwhichisexpected
toresultinanoutflowfromthecompanyofresources,
embodyingeconomicbenefits.

4. 13-4
Acurrentliabilityisreportedifoneoftwoconditionsexists:
1.Liabilityisexpectedtobesettledwithinitsnormaloperatingcycle;or
2.Liabilityisexpectedtobesettledwithin12monthsafterthereporting
date.
Theoperatingcycleistheperiodoftimeelapsingbetweentheacquisitionof
goodsandservicesandthefinalcashrealizationresultingfromsalesand
subsequentcollections.
CURRENT LIABILITIES
Recall:Currentassetsarecashorotherassetsthatcompanies
reasonablyexpecttoconvertintocash,sell,orconsumeinoperations
withinasingleoperatingcycleorwithinayear.
Currentliabilitiesare“obligationswhoseliquidationisreasonably
expectedtorequireuseofexistingresourcesproperlyclassifiedas
currentassets,orthecreationofothercurrentliabilities.”

5. 13-5
Typical Current Liabilities:
1.Accounts payable.
2.Notes payable.
3.Current maturities of long-
term debt.
4.Short-term obligations
expected to be refinanced.
5.Dividends payable.
6.Customer advances and
deposits.
7.Unearned revenues.
8.Sales and value-added
taxes payable.
9.Income taxes payable.
10.Employee-related liabilities.
CURRENT LIABILITIES

6. 13-6
Accounts Payable (trade accounts payable)
Balancesowedtoothersforgoods,supplies,orservices
purchasedonopenaccount.
Arisesbecauseoftimelagbetweenthereceiptofservices
oracquisitionoftitletoassetsandthepaymentforthem.
Termsofthesale(e.g.,2/10,n/30or1/10,E.O.M.)usually
stateperiodofextendedcredit,commonly30to60days.
Theseliabilitiestypicallyarenoninterest-bearingandare
reportedattheirfaceamounts.
CURRENT LIABILITIES

7. 13-7
Notes Payable
Written promises to pay a certain sum of money on a
specified future date.
Arise from purchases, financing, or other transactions.
Notes classified as short-term or long-term.
Notes may be interest-bearing or zero-interest-bearing.
CURRENT LIABILITIES

8. 13-8
Illustration:CastleNationalBankagreestolend€100,000on
March1,2015,toLandscapeCo.ifLandscapesignsa
€100,000,6percent,four-monthnote.Landscaperecordsthe
cashreceivedonMarch1asfollows:
Cash 100,000
Notes Payable 100,000
Interest-Bearing Note Issued
CURRENT LIABILITIES

9. 13-9
If Landscape prepares financial statements semiannually, it
makes the following adjusting entry to recognize interest
expense and interest payable at June 30, 2015:
Interest Expense 2,000
Interest Payable 2,000
(€100,000 x 6% x 4/12) = €2,000Interest calculation =
Interest-Bearing Note Issued

10. 13-10
At maturity (July 1, 2016), Landscape records payment of the
note and accrued interest as follows.
Notes Payable 100,000
Interest Payable 2,000
Cash 102,000
Interest-Bearing Note Issued

11. 13-11
Illustration:OnMarch1,Landscapeissuesa€102,000,four-month,
zero-interest-bearingnotetoCastleNationalBank.Thepresent
valueofthenoteis€100,000.Landscaperecordsthistransactionas
follows.
Cash 100,000
Notes Payable 100,000
OR
Zero-Interest-Bearing Note Issued
Thisnotedoesnotexplicitlystateaninterestrateonthe
faceofanote.Interestisstillcharged,however.At
maturity,theborrowermustpaybackanamountgreater
thanthecashreceivedatissuancedate.
CURRENT LIABILITIES
Cash 100,000
Discount on Notes Payable 2,000
Notes Payable 102,000

12. 13-12
If Landscape prepares financial statements semiannually, it
makes the following adjusting entry to recognize interest
expense and the increase in the note payable of €2,000 at
June 30.
Interest Expense 2,000
Notes Payable/Discount on N/P 2,000
At maturity (July 1), Landscape must pay the note, as follows.
Notes Payable 102,000
Cash 102,000
Zero-Interest-Bearing Note Issued

13. 13-13
E13-2:(AccountsandNotesPayable)Thefollowingareselected
2015transactionsofDarbyCorporation.
Sept.1-PurchasedinventoryfromOrionCompanyonaccount
for$50,000.Darbyrecordspurchasesgrossandusesa
periodicinventorysystem.
Oct.1-Issueda$50,000,12-month,8%notetoOrionin
paymentofaccount.
Oct.1-Borrowed$75,000fromtheShoreBankbysigninga
12-month,zero-interest-bearing$81,000note.
Prepare journal entries for the selected transactions.
CURRENT LIABILITIES
LO 1

14. 13-14
Sept.1-PurchasedinventoryfromOrionCompanyon
accountfor$50,000.Darbyrecordspurchasesgrossand
usesaperiodicinventorysystem.
Sept. 1Purchases 50,000
Accounts Payable 50,000
CURRENT LIABILITIES

15. 13-15
Oct. 1Accounts Payable 50,000
Notes Payable 50,000
Interest calculation =
Oct. 1-Issued a $50,000, 12-month, 8% note to Orion in
payment of account.
Dec. 31Interest Expense 1,000
Interest Payable 1,000
($50,000 x 8% x 3/12) = $1,000
CURRENT LIABILITIES

16. 13-16
Dec. 31Interest Expense 1,500
Notes Payable 1,500
Oct. 1Cash 75,000
Notes Payable 75,000
($6,000 x 3/12) = $1,500
Oct. 1-Borrowed $75,000 from the Shore Bank by signing a
12-month, zero-interest-bearing $81,000 note.
Interest calculation =
CURRENT LIABILITIES

17. 13-17
Portionofbonds,mortgagenotes,andotherlong-term
indebtednessthatmatureswithinthenextfiscalyear.It
categorizesthisamountascurrentmaturitiesoflong-termdebt
Excludelong-termdebtsmaturingcurrentlyiftheyaretobe:
Current Maturities of Long-Term Debt
1.Retiredbyassetsaccumulatedthathavenotbeenshownas
currentassets,
2.Refinanced,orretiredfromtheproceedsofanewdebtissue,or
3.Convertedintoordinaryshares.
CURRENT LIABILITIES

18. 13-18
Short-Term Obligations Expected to Be Refinanced
Refinancingashorttermobligationonalongtermbasis
meanseitherreplacingitwithalongtermobligationorequity
securitiesorrenewing,extendingorreplacingitwithshort
termobligationsforanuninterruptedperiodextendingbeyond
oneyear(orthenormaloperatingcycle)fromthedateofthe
company’sstatementoffinancialposition.
Excludefrom current liabilities if bothof the following conditions are
met:
1.Must intend to refinance the obligation on a long-term basis.
2.Must have an unconditional right to defer settlement of the liability
for at least 12 months after the reporting date.
CURRENT LIABILITIES

19. 13-19
E13-4(RefinancingofShort-TermDebt):TheCFOforYong
Corporationisdiscussingwiththecompany’schiefexecutive
officerissuesrelatedtothecompany’sshort-termobligations.
Presently,boththecurrentratioandtheacid-testratioforthe
companyarequitelow,andthechiefexecutiveofficeris
wonderingifanyoftheseshort-termobligationscouldbe
reclassifiedaslong-term.ThefinancialreportingdateisDecember
31,2014.Twoshort-termobligationswerediscussed,andthe
followingactionwastakenbytheCFO.
Instructions:Indicate how these transactions should be reported at
Dec. 31, 2014, on Yongs’ statement of financial position.
CURRENT LIABILITIES

20. 13-20
Short-TermObligationA:Yonghasa$50,000short-term
obligationdueonMarch1,2015.TheCFOdiscussedwithits
lenderwhetherthepaymentcouldbeextendedtoMarch1,2017,
providedYongagreestoprovideadditionalcollateral.An
agreementisreachedonFebruary1,2015,tochangetheloan
termstoextendtheobligation’smaturitytoMarch1,2017.The
financialstatementsareauthorizedforissuanceonApril1,2015.
Liability of
$50,000
Dec. 31, 2014
Statement
Issuance
Apr. 1, 2015
Liability due
for payment
Mar. 1, 2015
Refinance
completed
Feb. 1, 2015
CURRENT LIABILITIES

21. 13-21
Current Liability
of $50,000
Dec. 31, 2015
Since the agreement was not in place as of the reporting
date (December 31, 2015), the obligation should be
reported as a current liability.
CURRENT LIABILITIES
Short-TermObligationA:Yonghasa$50,000short-term
obligationdueonMarch1,2015.TheCFOdiscussedwithits
lenderwhetherthepaymentcouldbeextendedtoMarch1,2017,
providedYongagreestoprovideadditionalcollateral.An
agreementisreachedonFebruary1,2015,tochangetheloan
termstoextendtheobligation’smaturitytoMarch1,2017.The
financialstatementsareauthorizedforissuanceonApril1,2015.

22. 13-22
Refinance
completed
Dec. 18, 2014
Statement
Issuance
Mar. 31, 2015
Liability due
for payment
Feb. 15, 2015
Liability of
$120,000
Dec. 31, 2014
CURRENT LIABILITIES
Short-TermObligationB:Yongalsohasanothershort-term
obligationof$120,000dueonFebruary15,2015.Initsdiscussion
withthelender,thelenderagreestoextendthematuritydateto
February1,2016.TheagreementissignedonDecember18,
2014.Thefinancialstatementsareauthorizedforissuanceon
March31,2015.

23. 13-23
Refinance
completed
Dec. 18, 2014
Non-Current
Liability of
$120,000
Dec. 31, 2014
Since the agreement was in place as of
the reporting date (December 31, 2014),
the obligation is reported as a non-
current liability.
CURRENT LIABILITIES
Short-TermObligationB:Yongalsohasanothershort-term
obligationof$120,000dueonFebruary15,2015.Initsdiscussion
withthelender,thelenderagreestoextendthematuritydateto
February1,2016.TheagreementissignedonDecember18,
2014.Thefinancialstatementsareauthorizedforissuanceon
March31,2015.

24. 13-24
Illustration:OnDecember31,2014,AlexanderCompanyhad
$1,200,000ofshort-termdebtintheformofnotespayabledue
February2,2015.OnJanuary21,2015,thecompanyissued25,000
sharesofitscommonstockfor$36pershare,receiving$900,000
proceedsafterbrokeragefeesandothercostsofissuance.On
February2,2015,theproceedsfromthestocksale,supplementedby
anadditional$300,000cash,areusedtoliquidatethe$1,200,000
debt.TheDecember31,2014,balancesheetisissuedonFebruary
23,2015.
Instructions:
Show how the $1,200,000 of short-term debt should be presented on
the December 31, 2014, balance sheet, including note disclosure
Current Liabilities

25. 13-25
Amountowedbyacorporationtoitsstockholdersasaresultofboard
ofdirectors’authorization.
Becausecompaniesalwayspaycashdividendswithinoneyear
ofdeclaration(generallywithinthreemonths),theyclassify
themascurrentliabilities.
Undeclareddividendsoncumulativepreferencesharesnot
recognizedasaliability.Why?Becausepreferreddividendsin
arrearsarenotanobligationuntiltheboardofdirectors
authorizesthepayment.
Dividendspayableintheformofadditionalsharesarenot
recognizedasaliabilitybecausesuchstockdividendsdonot
requirefutureoutlaysofassetsorservices.
►Reportedinequitybecausetheyrepresentretained
earningsintheprocessoftransfertopaid-incapital.
CURRENT LIABILITIES: Dividends Payable

26. 13-26
Customer Advances and Deposits
Returnablecashdepositsreceivedfromcustomersand
employees.
Toguaranteeperformanceofacontractorserviceor
Asguaranteestocoverpaymentofexpectedfuture
obligations.
Note:Maybeclassifiedascurrentornon-currentliabilities.
Theclassificationoftheseitemsascurrentornoncurrentliabilities
dependsonthetimebetweenthedateofthedepositandthe
terminationoftherelationshipthatrequiredthedeposit.
CURRENT LIABILITIES

27. 13-27
Paymentreceivedbeforeprovidinggoodsorperforming
services.
Howdothesecompaniesaccountforunearnedrevenues?
1.Whenacompanyreceivesanadvancepayment,itdebitsCash,and
creditsacurrentliabilityaccountidentifyingthesourceofthe
unearnedrevenue.
2.Whenacompanyrecognizesrevenue,itdebitstheunearnedrevenue
account,andcreditsarevenueaccount.
CURRENT LIABILITIES: Unearned Revenues

28. 13-28
BE13-6:Sports Pro Magazine sold 12,000 annual subscriptions
on August 1, 2015, for €18 each. Prepare Sports Pro’s August 1,
2015, journal entry and the December 31, 2015, annual adjusting
entry.
Aug. 1Cash 216,000
Unearned Revenue 216,000
(12,000 x €18)
Dec. 31Unearned Revenue 90,000
Subscription Revenue 90,000
(€216,000 x 5/12 = €90,000)
CURRENT LIABILITIES
LO 2

29. 13-29
Consumptiontaxesaregenerallyeither
asalestaxor
avalue-addedtax(VAT).
Purposeistogeneraterevenueforthegovernment.
Thetwosystemsusedifferentmethodstoaccomplishthis
objective.
Sales and Value-Added Taxes Payable
CURRENT LIABILITIES

30. 13-30
Illustration:HaloSupermarketsellsloavesofbreadto
consumersonagivendayfor€2,400.Assumingasalestax
rateof10percent,HaloSupermarketmakesthefollowingentry
torecordthesale.
Sales Taxes Payable
Cash 2,640
Sales Revenue 2,400
Sales Taxes Payable 240

31. 13-31
Illustration:TheVATiscollectedeverytimeabusiness
purchasesproductsfromanotherbusinessintheproduct’ssupply
chain.Toillustrate,
1.HillFarmsWheatCompanygrowswheatandsellsitto
SunshineBakingfor€1,000.HillFarmsWheatmakesthe
followingentrytorecordthesale,assumingtheVATis10
percent.
Value-Added Taxes Payable
Cash 1,100
Sales Revenue 1,000
Value-Added Taxes Payable 100

32. 13-32
2.SunshineBakingmakesloavesofbreadfromthiswheatand
sellsittoHaloSupermarketfor€2,000.SunshineBaking
makesthefollowingentrytorecordthesale,assumingthe
VATis10percent.
Value-Added Taxes Payable
Cash 2,200
Sales Revenue 2,000
Value-Added Taxes Payable 200
Sunshine Baking then remits €100 to the government, not €200. The
reason: Sunshine Baking has already paid €100 to Hill Farms Wheat.

33. 13-33
3.HaloSupermarketsellstheloavesofbreadtoconsumersfor
€2,400.HaloSupermarketmakesthefollowingentryto
recordthesale,assumingtheVATis10percent.
Value-Added Taxes Payable
Cash 2,640
Sales Revenue 2,400
Value-Added Taxes Payable 240
HaloSupermarketthensendsonly€40tothetaxauthorityasit
deductsthe€200VATalreadypaidtoSunshineBaking.

34. 13-34
Income Tax Payable
Businessesmustprepareanincometaxreturnandcomputethe
incometaxpayable.
Taxespayableareacurrentliability.
Corporationsmustmakeperiodictaxpayments.
Differencesbetweentaxableincomeandaccountingincome
sometimesoccur.Becauseofthesedifferences,theamountof
incometaxespayabletothegovernmentinanygivenyearmaydiffer
substantiallyfromincometaxexpenseasreportedonthefinancial
statements.
CURRENT LIABILITIES

35. 13-35
Employee-Related Liabilities
Amountsowedtoemployeesforsalariesorwagesare
reportedasacurrentliability.
Currentliabilitiesmayinclude:
Payrolldeductions.
Compensatedabsences.
Bonuses.
CURRENT LIABILITIES

36. 13-36
Payroll Deductions
Totheextentthatacompanyhasnotremittedtheamounts
deductedtotheproperauthorityattheendoftheaccounting
period,itshouldrecognizethemascurrentliabilities.
Taxes:
►Social Security Taxes
►Income Tax Withholding
Employee-Related Liabilities

37. 13-37
Illustration:Assumeaweeklypayrollof$10,000entirelysubjectto
SocialSecuritytaxes(8%),withincometaxwithholdingof$1,320and
unionduesof$88deducted.Thecompanyrecordsthewagesand
salariespaidandtheemployeepayrolldeductionsasfollows.
Wages and Salaries Expense 10,000
Withholding Taxes Payable 1,320
Social Security Taxes Payable 800
Union Dues Payable 88
Cash 7,792
Employee-Related Liabilities

38. 13-38
Illustration:Assumeaweeklypayrollof$10,000entirely
subjecttoSocialSecuritytaxes(8%),withincometax
withholdingof$1,320andunionduesof$88deducted.
Thecompanyrecordstheemployerpayrolltaxesas
follows.
Payroll Tax Expense 800
Social Security Taxes Payable 800
Theemployermustremittothegovernmentitsshareof
SocialSecuritytaxalongwiththeamountofSocial
Securitytaxdeductedfromeachemployee’sgross
compensation.
Employee-Related Liabilities

39. 13-39
Compensated Absences
Paidabsencesforvacation,illnessandmaternity,paternity,and
juryleaves.
Companiesshouldaccruealiabilityforthecostof
compensationforfutureabsencesifallofthefollowing
conditionsexist.
(a)Theemployer’sobligationrelatingtoemployees’rightsto
receivecompensationforfutureabsencesisattributableto
employees’servicesalreadyrendered.
(b)Theobligationrelatestotherightsthatvestoraccumulate.
(c)Paymentofthecompensationisprobable.
(d)Theamountcanbereasonablyestimated.
Employee-Related Liabilities

40. 13-40
Compensated Absences
Thefollowingconsiderationsarerelevanttotheaccountingfor
compensatedabsences.
Vestedrights-employerhasanobligationtomakepaymenttoan
employeeevenafterterminatinghisorheremployment.Thus,
vestedrightsarenotcontingentonanemployee’sfutureservice.
Accumulatedrights-employeescancarryforwardtofutureperiodsif
notusedintheperiodinwhichearned.
Non-accumulatingrights-donotcarryforward;theylapseifnot
used.
Companiesshouldrecognizetheexpenseandrelatedliabilityfor
compensatedabsencesintheyearearnedbyemployees.
Employee-Related Liabilities

41. 13-41
Illustration:AmutronInc.beganoperationsonJanuary1,2015.The
companyemploys10individualsandpayseach€480perweek.
Employeesearned20unusedvacationweeksin2015.In2016,the
employeesusedthevacationweeks,butnowtheyeachearn€540
perweek.Amutronaccruestheaccumulatedvacationpayon
December31,2015,asfollows.
Salaries and Wages Expense 9,600
Salaries and Wages Payable 9,600
In 2016, it records the payment of vacation pay as follows.
Salaries and Wages Payable 9,600
Salaries and Wages Expense 1,200
Cash 10,800
Employee-Related Liabilities

42. 13-42
Paymentstocertainorallemployeesinadditiontotheirregular
salariesorwages.
Frequentlythebonusamountdependsonthecompany’syearly
profit.
Acompanymayconsiderbonuspaymentstoemployeesas
additionalwagesandshouldincludethemasadeductionin
determiningthenetincomefortheyear.
Bonuses paid are an operating expense.
Unpaid bonuses should be reported as a current liability.
Profit-Sharing and Bonus Plans
Employee-Related Liabilities

43. 13-43
Provisionisaliabilityofuncertaintimingoramount.
Reportedeitherascurrentornon-currentliability.
Commontypesare
►Obligationsrelatedtolitigation(lawsuit).
►Warranteesorproductguarantees.
►Businessrestructurings.
►Environmentaldamage.
Uncertainty about the
timing or amount of the
future expenditure
required to settle the
obligation.
PROVISIONS

44. 13-44
Companiesaccrueanexpenseandrelatedliabilityfora
provisiononlyifthefollowingthreeconditionsaremet:
1.Companyhasapresentobligation(legalorconstructive)as
aresultofapastevent;
2.Probablethatanoutflowofresourceswillberequiredto
settletheobligation;and
3.Areliableestimatecanbemade.
Recognition of a Provision

45. 13-45
A reliable estimate of the amount of the obligation can be determined.
Recognition Examples
Recognition of a Provision
ILLUSTRATION 13-5
Recognition of a Provision—Warranty

46. 13-46
Constructiveobligationisanobligationthatderivesfroma
company’sactionswhere:
1.Byanestablishedpatternofpastpractice,published
policies,orasufficientlyspecificcurrentstatement,the
companyhasindicatedtootherpartiesthatitwillaccept
certainresponsibilities;and
2.Asaresult,thecompanyhascreatedavalidexpectation
onthepartofthoseotherpartiesthatitwilldischargethose
responsibilities.
Recognition Examples

47. 13-47
A reliable estimate of the amount of the obligation can be determined.
Recognition Examples
ILLUSTRATION 13-6
Recognition of a Provision—Refunds

48. 13-48
A reliable estimate of the amount of the obligation can be determined.
Recognition Examples
ILLUSTRATION 13-7
Recognition of a Provision—Lawsuit

49. 13-49
Howdoesacompanydeterminetheamounttoreportfora
provision?
IFRS:
Amountrecognizedshouldbethebestestimateofthe
expenditurerequiredtosettlethepresentobligation.
Bestestimaterepresentstheamountthatacompanywouldpay
tosettletheobligationatthestatementoffinancialpositiondate.
Measurement of Provisions

50. 13-50
Managementmustusejudgment,basedonpastorsimilar
transactions,discussionswithexperts,andanyotherpertinent
information.
Measurement Examples
Toyota warranties.Toyota might determine that 80
percent of its cars will not have any warranty cost, 12
percent will have substantial costs, and 8 percent will have a much
smaller cost. In this case, by weighting all the possible outcomes by
their associated probabilities, Toyota arrives at an expected value for
its warranty liability.
Measurement of Provisions

51. 13-51
Carrefourrefunds.Carrefoursellsmanyitemsat
varyingsellingprices.Refundstocustomersforproducts
soldmaybeviewedasacontinuousrangeofrefunds,witheachpoint
intherangehavingthesameprobabilityofoccurrence.Inthiscase,
themidpointintherangecanbeusedasthebasisformeasuringthe
amountoftherefunds.
Measurement of Provisions
Managementmustusejudgment,basedonpastorsimilar
transactions,discussionswithexperts,andanyotherpertinent
information.
Measurement Examples

52. 13-52
Measurementoftheliabilityshouldconsiderthetimevalueofmoney,
ifmaterial.Futureeventsthatmayhaveanimpactonthe
measurementofthecostsshouldbeconsidered.
Novartislawsuit.LargecompanieslikeNovartisare
involvedinnumerouslitigationissuesrelatedtotheir
products.Whereasingleobligationsuchasalawsuitisbeing
measured,themostlikelyoutcomeofthelawsuitmaybethebest
estimateoftheliability.
Measurement of Provisions
Measurement Examples

53. 13-53
Common Types:
1.Lawsuits
2.Warranties
3.Consideration payable
4.Environmental
5.Onerous contracts
6.Restructuring
IFRSrequiresextensivedisclosurerelatedtoprovisionsinthenotesto
thefinancialstatements.Companiesdonotrecordorreportinthenotes
generalriskcontingenciesinherentinbusinessoperations(e.g.,the
possibilityofwar,strike,uninsurablecatastrophes,orabusiness
recession).
Common Types of Provisions

54. 13-54
Litigation Provisions
Companiesmustconsiderthefollowingindetermining
whethertorecordaliabilitywithrespecttopendingor
threatenedlitigationandactualorpossibleclaimsand
assessments.
1.Thetimeperiodinwhichtheunderlyingcauseofaction
occurred.
2.Theprobabilityofanunfavorableoutcome.
3.Abilitytomakeareasonableestimateoftheamountof
loss.
Common Types of Provisions

55. 13-55
Withrespecttounfiledsuitsandunassertedclaimsand
assessments,acompanymustdetermine
1.thedegreeofprobabilitythatasuitmaybefiledora
claimorassessmentmaybeasserted,and
2.theprobabilityofanunfavorableoutcome.
Ifbothareprobable,ifthelossisreasonablyestimable,
andifthecauseforactionisdatedonorbeforethedate
ofthefinancialstatements,thenthecompanyshould
accruetheliability.
Litigation Provisions

56. 13-56
BE13-12:ScorceseInc.isinvolvedinalawsuitatDecember31,
2015.(a)PreparetheDecember31entryassumingitisprobable
thatScorcesewillbeliablefor900,000asaresultofthissuit.(b)
PreparetheDecember31entry,ifany,assumingitisnotprobable
thatScorcesewillbeliableforanypaymentasaresultofthissuit.
(a)Lawsuit Loss 900,000
Lawsuit Liability 900,000
(b)No entry is necessary. The loss is not accrued because it
is not probable that a liability has been incurred at
12/31/15.
Litigation Provisions

57. 13-57
Warranty Provisions
Promisemadebyasellertoabuyertomakegoodona
deficiencyofquantity,quality,orperformanceinaproduct.
Ifitisprobablethatcustomerswillmakewarrantyclaimsanda
companycanreasonablyestimatethecostsinvolved,the
companymustrecordanexpense.
Common Types of Provisions

58. 13-58
Companies often provide one of two types of warranties to
customers:
Assurance-TypeWarranty
Aqualityguaranteethatthegoodorserviceisfreefrom
defectsatthepointofsale.
Obligationsshouldbeexpensedintheperiodthe
goodsareprovidedorservicesperformed(inother
words,atthepointofsale).
Companyshouldrecordawarrantyliability.
Warranty Provisions

59. 13-59
Facts:DensonMachineryCompanybeginsproductionofanew
machineinJuly2015andsells100ofthesemachinesfor$5,000
cashbyyear-end.Eachmachineisunderwarrantyforoneyear.
Densonestimates,basedonpastexperiencewithsimilar
machines,thatthewarrantycostwillaverage$200perunit.
Further,asaresultofpartsreplacementsandservicesperformed
incompliancewithmachinerywarranties,itincurs$4,000in
warrantycostsin2015and$16,000in2016.
Question:Whatarethejournalentriesforthesaleandtherelated
warrantycostsfor2015and2016?
Assurance-Type Warranty

60. 13-60
Solution: For the sale of the machines and related warranty
costs in 2015 the entry is as follows.
1. To recognize sales of machines and accrual of warranty
liability:
July–December 2015
Assurance-Type Warranty
Cash 500,000
Warranty Expense 20,000
Warranty Liability 20,000
Sales Revenue 500,000

61. 13-61
Solution: For the sale of the machines and related warranty
costs in 2015 the entry is as follows.
2. To record payment for warranties incurred:
July–December 2015
Assurance-Type Warranty
Warranty Liability 4,000
Cash, Inventory, Accrued Payroll 4,000
TheDecember31,2015,statementoffinancialpositionreports
WarrantyLiabilityasacurrentliabilityof$16,000.Theincomestatement
for2015reportsWarrantyExpenseof$20,000.

62. 13-62
Assurance-Type Warranty
Warranty Liability 16,000
Cash, Inventory, Accrued Payroll 16,000
Solution: For the sale of the machines and related warranty
costs in 2015 the entry is as follows.
3. To record payment for warranty costs incurred in 2016
related to 2015 machinery sales:
January 1–December 31, 2016
At the end of 2016, no warranty liability is reported for the machinery
sold in 2015.

63. 13-63
Companies often provide one of two types of warranties to
customers:
Service-TypeWarranty
Anextendedwarrantyontheproductatanadditionalcost.
UsuallyrecordedinanUnearnedWarrantyRevenue
account.
Recognizerevenueonastraight-linebasisovertheperiod
theservice-typewarrantyisineffect.
Warranty Provisions

64. 13-64
Facts:YoupurchaseanautomobilefromHamlinAutofor€30,000
onJanuary2,2014.Hamlinestimatestheassurance-typewarranty
costsontheautomobiletobe€700(Hamlinwillpayforrepairsfor
thefirst36,000milesorthreeyears,whichevercomesfirst).You
alsopurchasefor€900aservice-typewarrantyforanadditional
threeyearsor36,000miles.Hamlinincurswarrantycostsrelated
totheassurance-typewarrantyof€500in2014and€200in2015.
Hamlinrecordsrevenueontheservice-typewarrantyonastraight-
linebasis.
Question: What entries should Hamlin make in 2014 and 2017?
Service-Type Warranty

65. 13-65
Solution:
1. To record the sale of the automobile and related warranties:
January 2, 2014
Service-Type Warranty
Cash (€30,000 + €900) 30,900
Warranty Expense 700
Warranty Liability 700
Unearned Warranty Revenue 900
Sales Revenue 30,000

66. 13-66
Solution:
2. To record warranty costs incurred in 2014:
January 2–December 31, 2014
Service-Type Warranty
Warranty Liability 500
Cash, Inventory, Accrued Payroll 500

67. 13-67
Solution:
3. To record revenue recognized in 2017 on the service-type
warranty:
January 1–December 31, 2017
Service-Type Warranty
Unearned Warranty Revenue (€900 ÷3) 300
Warranty Revenue 300

68. 13-68
Consideration Payable
Companiesoftenmakepayments(provideconsideration)to
theircustomersaspartofarevenuearrangement.
Companiesofferpremiums,couponoffers,andrebatesto
stimulatesales.
Companiesshouldchargethecostsofpremiumsand
couponstoexpenseintheperiodofthesalethatbenefits
fromtheplan.
Common Types of Provisions

69. 13-69
Facts:FluffyCakeMixCompanysellsboxesofcakemixfor£3per
box.Inaddition,FluffyCakeMixoffersitscustomersalarge
durablemixingbowlinexchangefor£1and10boxtops.The
mixingbowlcostsFluffyCakeMix£2,andthecompanyestimates
thatcustomerswillredeem60percentoftheboxtops.The
premiumofferbeganinJune2015.During2015,FluffyCakeMix
purchased20,000mixingbowlsat£2,sold300,000boxesofcake
mixfor£3perbox,andredeemed60,000boxtops.
Question:WhatentriesshouldFluffyCakeMixrecordin2015?
Consideration Payable

70. 13-70
Solution:
1. To record purchase of 20,000 mixing bowls at £2 per bowl:
Premium Inventory (20,000 bowls x £2) 40,000
Cash 40,000
Consideration Payable

71. 13-71
Solution:
2.Before Fluffy Cake Mix makes the entry to record the sale of
the cake mix boxes, it determines its premium expense and
related premium liability. This computation is as follows.
Consideration Payable

72. 13-72
Solution:
2.The entry to record the sale of the cake mix boxes and
premium expense and premium liability is as follows.
Consideration Payable
Cash (300,000 boxes x £3) 900,000
Premium Expense 18,000
Sales Revenue 900,000
Premium Liability 18,000

73. 13-73
Solution:
3.To record the actual redemption of 60,000 box tops, the
receipt of £1 per 10 box tops, and the delivery of the mixing
bowls:
Consideration Payable
Cash [(60,000 ÷10) x £1] 6,000
Premium Liability 6,000
Premium Inventory [(60,000 ÷10) x £2] 12,000

74. 13-74
Estimatestocleanupexistingtoxicwastessitesaresubstantial.
Inaddition,costestimatesofcleaningupourairandpreventing
futuredeteriorationoftheenvironmentrunevenhigher.
Acompanymustrecognizeanenvironmentalliabilitywhenithas
anexistinglegalobligationassociatedwiththeretirementofa
long-livedassetandwhenitcanreasonablyestimatetheamount
oftheliability.
Environmental Provisions
Common Types of Provisions

75. 13-75
ObligatingEvents.Examplesofexistinglegalobligations,
whichrequirerecognitionofaliabilityinclude,butarenot
limitedto:
►Decommissioningnuclearfacilities,
►Dismantling,restoring,andreclamationofoilandgas
properties,
►Certainclosure,reclamation,andremovalcostsofmining
facilities,
►Closureandpost-closurecostsoflandfills.
Environmental Provisions

76. 13-76
Measurement. Acompanyinitiallymeasuresan
environmentalliabilityatthebestestimateofitsfuturecosts.
RecognitionandAllocation.Torecordanenvironmental
liabilityacompanyincludes
►thecostassociatedwiththeenvironmentalliabilityinthe
carryingamountoftherelatedlong-livedasset,and
►recordsaliabilityforthesameamount.
Environmental Provisions

77. 13-77
Illustration:OnJanuary1,2015,WildcatOilCompanyerectedanoil
platformintheGulfofMexico.Wildcatislegallyrequiredtodismantle
andremovetheplatformattheendofitsusefullife,estimatedtobe
fiveyears.Wildcatestimatesthatdismantlingandremovalwillcost
$1,000,000.Basedona10percentdiscountrate,thefairvalueof
theenvironmentalliabilityisestimatedtobe$620,920($1,000,000x
.62092).WildcatrecordsthisliabilityonJan.1,2015asfollows.
Drilling Platform 620,920
Environmental Liability 620,920
Environmental Provisions

78. 13-78
Illustration:Duringthelifeoftheasset,Wildcatallocatestheasset
retirementcosttoexpense.Usingthestraight-linemethod,Wildcat
makesthefollowingentriestorecordthisexpense.
Depreciation Expense ($620,920 ÷5) 124,184
Accumulated Depreciation—Plant Assets 124,184
December 31, 2015, 2016, 2017, 2018
Environmental Provisions

79. 13-79
Illustration:Inaddition,Wildcatmustaccrueinterestexpenseeach
period.Wildcatrecordsinterestexpenseandtherelatedincreasein
theenvironmentalliabilityonDecember31,2015,asfollows.
Environmental Provisions
Interest Expense ($620,920 x 10%) 62,092
Environmental Liability 62,092
December 31, 2015

80. 13-80
Illustration:OnJanuary10,2020,WildcatcontractswithRig
Reclaimers,Inc.todismantletheplatformatacontractpriceof
$995,000.Wildcatmakesthefollowingjournalentryto
recordsettlementoftheliability.
Environmental Provisions
Environmental Liability 1,000,000
Gain on Settlement of Environmental Liability 5,000
Cash 995,000
January 10, 2020

81. 13-81
“Theunavoidablecostsofmeetingtheobligationsexceedthe
economicbenefitsexpectedtobereceived.”
Anexampleofanonerouscontractisalossrecognizedon
unfavorablenoncancelablecommitmentsrelatetoinventoryitems.
Theexpectedcostsshouldreflecttheleastnetcostofexitingfrom
thecontract,whichisthelowerof
1.thecostoffulfillingthecontract,or
2.thecompensationorpenaltiesarisingfromfailuretofulfillthe
contract.
Onerous Contract Provisions
Common Types of Provisions

82. 13-82
Illustration:SumartSportsoperatesprofitablyinafactorythatit
hasleasedandonwhichitpaysmonthlyrentals.Sumart
decidestorelocateitsoperationstoanotherfacility.However,
theleaseontheoldfacilitycontinuesforthenextthreeyears.
Unfortunately,Sumartcannotcanceltheleasenorwillitbeable
tosubletthefactorytoanotherparty.Theexpectedcoststo
satisfythisonerouscontractare€200,000.Inthiscase,Sumart
makesthefollowingentry.
Loss on Lease Contract 200,000
Lease Contract Liability 200,000
Onerous Contract Provisions

83. 13-83
AssumethesamefactsasabovefortheSumartexampleand
theexpectedcoststofulfillthecontractare€200,000.However,
Sumartcancanceltheleasebypayingapenaltyof€175,000.In
thiscase,Sumartshouldrecordtheliabilityasfollows.
Loss on Lease Contract 175,000
Lease Contract Liability 175,000
Onerous Contract Provisions

84. 13-84
Self-insuranceisnotinsurance,butriskassumption.
Thereislittletheoreticaljustificationfortheestablishmentofa
liabilitybasedonahypotheticalchargetoinsuranceexpense.
ConditionsforaccrualstatedinIFRSarenotsatisfiedpriorto
theoccurrenceoftheevent.
Self-Insurance
Common Types of Provisions

85. 13-85
A company must provide a reconciliation of its beginning to
ending balance for each major class of provisions, identifying
what caused the change during the period.
In addition,
►Provision must be described and the expected timing of
any outflows disclosed.
►Disclosure about uncertainties related to expected
outflows as well as expected reimbursements should be
provided.
Disclosure Related to Provisions

86. 13-86
Contingentliabilitiesarenotrecognizedinthefinancial
statementsbecausetheyare
1.Apossibleobligation(notyetconfirmed),
2.Apresentobligationforwhichitisnotprobablethat
paymentwillbemade,or
3.Apresentobligationforwhichareliableestimateofthe
obligationcannotbemade.
CONTINGENCIES
Contingent Liabilities/Loss Contingencies
“Anexistingcondition,situation,orsetofcircumstances
involvinguncertaintyastopossiblegain(gaincontingency)
orloss(losscontingency)toanenterprisethatwill
ultimatelyberesolvedwhenoneormorefutureeventsoccur
orfailtooccur.”

87. 13-87
AccountingProbability
Accrue
Footnote
Ignore
Probable
Reasonably
Possible
Remote
Loss Contingencies
and reasonably estimable

88. 13-88
Illustration 13-16 presents the general guidelines for the
accounting and reporting of contingent liabilities.
Contingent Liabilities
ILLUSTRATION 13-16
Contingent Liability
Guidelines

89. 13-89
Acontingentassetisapossibleassetthatarisesfrompast
eventsandwhoseexistencewillbeconfirmedbythe
occurrenceornon-occurrenceofuncertainfutureeventsnot
whollywithinthecontrolofthecompany.Typicalcontingent
assetsare:
1.Possiblereceiptsofmoniesfromgifts,donations,bonuses.
2.Possiblerefundsfromthegovernmentintaxdisputes.
3.Pendingcourtcaseswithaprobablefavorableoutcome.
Contingent assets are not recognized on the statement of financial position.
CONTINGENCIES
Contingent Assets/Gain Contingencies

90. 13-90
Contingent assets are disclosed when an inflow of economic benefits
is considered more likely than not to occur (greater than 50 percent).
Contingent Assets
The general rules related to contingent assets are presented
in Illustration 13-18.
ILLUSTRATION 13-18
Contingent Asset Guidelines

91. 13-91
Presentation of Current Liabilities
Usually reported at their full maturity value.
Difference between present value and the maturity
value is considered immaterial.
PRESENTATION AND ANALYSIS

92. 13-92
LIABILITIES
U.S.GAAPandIFRShavesimilardefinitionsforliabilities.In
addition,theaccountingforcurrentliabilitiesisessentiallythe
sameunderbothIFRSandU.S.GAAP.
GLOBAL ACCOUNTING INSIGHTS

93. 13-93
Relevant Facts
Similarities
•U.S.GAAPandIFRShavesimilarliabilitydefinitions.Bothalso
classifyliabilitiesascurrentandnon-current.
•BothU.S.GAAPandIFRSrequirethebestestimateofaprobable
loss.InU.S.GAAP,theminimumamountinarangeisused.
UnderIFRS,ifarangeofestimatesispredictedandnoamountin
therangeismorelikelythananyotheramountintherange,the
midpointoftherangeisusedtomeasuretheliability.
•BothU.S.GAAPandIFRSprohibittherecognitionofliabilitiesfor
futurelosses.
GLOBAL ACCOUNTING INSIGHTS

94. 13-94
Relevant Facts
Differences
•UnderU.S.GAAP,companiesmustclassifyarefinancingascurrentonlyif
itiscompletedbeforethefinancialstatementsareissued.IFRSrequires
thatthecurrentportionoflong-termdebtbeclassifiedascurrentunlessan
agreementtorefinanceonalong-termbasisiscompletedbeforethe
reportingdate.
•U.S.GAAPusesthetermcontingencyinadifferentwaythanIFRS.A
contingencyunderU.S.GAAPmaybereportedasaliabilityundercertain
situations.IFRSdoesnotpermitacontingencytoberecordedasaliability.
•U.S.GAAPusesthetermestimatedliabilitiestodiscussvariousliability
itemsthathavesomeuncertaintyrelatedtotimingoramount.IFRS
generallyusesthetermprovisions.
GLOBAL ACCOUNTING INSIGHTS

95. 13-95
Relevant Facts
Differences
•U.S.GAAPandIFRSaresimilarinthetreatmentof
environmentalliabilities.However,therecognitioncriteriafor
environmentalliabilitiesaremorestringentunderU.S.GAAP:
Environmentalliabilitiesarenotrecognizedunlessthereisa
presentlegalobligationandthefairvalueoftheobligationcan
bereasonablyestimated.
•U.S.GAAPusesthetermtroubleddebtrestructuringsand
developsrecognitionrulesrelatedtothiscategory.IFRS
generallyassumesthatallrestructuringsshouldbe
consideredextinguishmentsofdebt.
GLOBAL ACCOUNTING INSIGHTS

96. Chapter Two
Non-Current Liabilities
6/18/2023 1

97. Introduction
Non-currentliabilitiesconsistofanexpected
outflowofresourcesarisingfrompresent
obligationsthatarenotpayablewithinayearorthe
operatingcycleofthecompany,whicheveris
longer.
Bondspayable,long-termnotespayable,mortgages
payable,pensionliabilities,andleaseliabilitiesare
examplesofnon-currentliabilities.
6/18/2023 2

98. Cont’d
BondsPayable
Acorporation,peritsbylaws,usuallyrequiresapprovalbythe
boardofdirectorsandtheshareholdersbeforebondsornotes
canbeissued.
Long-termdebthasvariousrestrictionsthatprotectboth
lendersandborrowers.
Theindentureoragreementoftenincludestheamounts
authorizedtobeissued,interestrate,duedate(s),call
provisions,propertypledgedassecurity,sinkingfund
requirements,workingcapitalanddividendrestrictions,and
limitationsconcerningtheassumptionofadditionaldebt.
Manybondholderssufferconsiderablelosseswhencompanies
addmoredebttothecapitalstructure.
6/18/2023 3

99. Cont’d
IssuingBonds
Abondarisesfromacontractknownasabondindenture.
Abondrepresentsapromisetopay
1.Asumofmoneyatadesignatedmaturitydate
2.Periodicinterestataspecifiedrateonthematurityamount(face
value).
Individualbondsareevidencedbyapapercertificateandtypically
havea€1,000facevalue.Companiesusuallymakebondinterest
paymentssemiannuallyalthoughtheinterestrateisgenerally
expressedasanannualrate.
Themainpurposeofbondsistoborrowforthelongtermwhenthe
amountofcapitalneededistoolargeforonelendertosupply.
Acompanymaysellanentirebondissuetoaninvestmentbank,
whichactsasasellingagentintheprocessofmarketingthebonds.
6/18/2023 4

100. Types and Ratings of Bonds
TypesofBonds
Someofthemorecommontypesofbondsfoundinpracticeareasfollows:
SecuredandUnsecuredBonds:Securedbondsarebackedbyapledgeof
somesortofcollateral.Mortgagebondsaresecuredbyaclaimonrealestate.
Collateraltrustbondsaresecuredbysharesandbondsofothercorporations.
Bondsnotbackedbycollateralareunsecured.
Term,SerialBonds,andCallableBonds:Bondissuesthatmatureona
singledatearecalledtermbonds;issuesthatmatureininstallmentsarecalled
serialbonds.Seriallymaturingbondsarefrequentlyusedbyschoolor
sanitarydistricts,municipalities,orotherlocaltaxingbodiesthatreceive
moneythroughaspeciallevy.Callablebondsgivetheissuertherighttocall
andretirethebondspriortomaturity.
6/18/2023 5

101. Cont’d
Convertible,Commodity-Backed,andDeep-DiscountBonds:Ifbondsare
convertibleintoothersecuritiesofthecorporationforaspecifiedtimeafterissuance,
theyareconvertiblebonds.Twotypesofbondshavebeendevelopedinanattemptto
attractcapitalinatightmoney
1.Commodity-backedbonds(alsocalledasset-linkedbonds)areredeemablein
measuresofacommodity,suchasbarrelsofoil,tonsofcoal,orouncesofraremetal.
2.Deep-discountbonds,alsoreferredtoaszero-interestdebenturebonds,aresoldata
discountthatprovidesthebuyer’stotalinterestpayoffatmaturity.
RegisteredandBearer(Coupon)Bonds:Bondsissuedinthenameoftheowner
areregisteredbondsandrequiresurrenderofthecertificateandissuanceofanew
certificatetocompleteasale.Abearerorcouponbond,however,isnotrecordedin
thenameoftheownerandmaybetransferredfromoneownertoanotherbymere
delivery.
IncomeandRevenueBonds:Incomebondspaynointerestunlesstheissuing
companyisprofitable.Revenuebonds,socalledbecausetheinterestonthemispaid
fromspecifiedrevenuesources,aremostfrequentlyissuedbyairports,school
districts,counties,toll-roadauthorities,andgovernmentalbodies.
6/18/2023 6

102. Cont’d
ValuationofBondsPayable
Theissuanceandmarketingofbondstothepublicdoesnot
happenovernight.Itusuallytakesweeksorevenmonths.
First,theissuingcompanymustarrangeforunderwritersthatwill
helpmarketandsellthebonds.
Then,itmustobtainregulatoryapprovalofthebondissue,
undergoaudits,andissueaprospectus(adocumentthatdescribes
thefeaturesofthebondandrelatedfinancialinformation).
Finally,thecompanymustgenerallyhavethebondcertificates
printed.
Thesellingpriceofabondissueissetbythesupplyand
demandofbuyersandsellers,relativerisk,market
conditions,andthestateoftheeconomy.Theinvestment
communityvaluesabondatthepresentvalueofitsexpected
futurecashflows.
6/18/2023 7

103. Cont’d
Theinterestratewritteninthetermsofthebondindenture
(andoftenprintedonthebondcertificate)isknownas
Stated,
Coupon,or
Nominalrate.Theissuerofthebondssetsthisrate.
Thestatedrateisexpressedasapercentageofthefacevalueof
thebonds(alsocalledtheparvalue,principalamount,or
maturityvalue).
BondsIssuedatPar
Iftherateemployedbytheinvestmentcommunity(buyers)is
thesameasthestatedrate,thebondsellsatpar.Thatis,thepar
valueequalsthepresentvalueofthebondscomputedbythe
buyers.
6/18/2023 8

104. Cont’d
6/18/2023 9

105. Cont’d
BypayingR$100,000(theparvalue)atthedateofissue,investors
realizeaneffectiverateoryieldof9percentoverthefive-yearterm
ofthebonds.Santosmakesthefollowingentrywhenitissuesthe
bonds.
January1,2015
Cash 100,000
BondsPayable 100,000
SantosrecordsaccruedinterestexpenseofR$9,000(R$100,000x
0.09)atDecember31,2015(year-end),asfollows:
December31,2015
InterestExpense 9,000
InterestPayable 9,000
Itrecordsthefirstinterestpaymentasfollows:
January1,2016
InterestPayable 9,000
Cash 9,000
6/18/2023 10

106. Cont’d
BondsIssuedatDiscountorPremium
Iftherateemployedbytheinvestmentcommunity(buyers)
differsfromthestatedrate,thepresentvalueofthebonds
computedbythebuyers(andthecurrentpurchaseprice)will
differfromthefacevalueofthebonds.
Thedifferencebetweenthefacevalueandthepresentvalueof
thebondsdeterminestheactualpricethatbuyerspayforthe
bonds.Thisdifferenceiseitheradiscountorpremium.
Ifthebondssellforlessthanfacevalue,theysellata
discount.
Ifthebondssellformorethanfacevalue,theysellata
premium.
Therateofinterestactuallyearnedbythebondholdersiscalled
theeffectiveyieldormarketrate.
6/18/2023 11

107. Cont’d
Toillustrate,assumenowthatSantosissuesR$100,000
inbonds,dueinfiveyearswith9percentinterest
payableannuallyatyear-end.Atthetimeofissue,the
marketrateforsuchbondsis11percent.
Theactualprincipalandinterestcashflowsare
discountedatan11percentrateforfiveperiods,as
shownbelow:
PVof the principal (R$100,000 x 0.593451328) R$59,345.00
PV of the interest payments (R$9,000 x 3.695897018) 33,263.10
PV (selling price) of the bonds R$92,608.10
6/18/2023 12

108. Cont’d
Effective-InterestMethod
Bypayingmoreorlessatissuance,investorsearnaratedifferentthan
thecouponrateonthebond.Recallthattheissuingcompanypaysthe
contractualinterestrateoverthetermofthebondsbutalsomustpay
thefacevalueatmaturity.
Ifthebondisissuedatadiscount,theamountpaidatmaturityis
morethantheissueamount.
Ifissuedatapremium,thecompanypayslessatmaturityrelativeto
theissueprice.
Thecompanyrecordsthisadjustmenttothecostasbondinterest
expenseoverthelifeofthebondsthroughaprocesscalled
amortization.
Amortizationofadiscountincreasesbondinterestexpense.
Amortizationofapremiumdecreasesbondinterestexpense.
Therequiredprocedureforamortizationofadiscountorpremiumis
theeffectiveinterestmethod.
6/18/2023 13

109. Cont’d
Undertheeffective-interestmethod,companies:
1.Computebondinterestexpensefirstbymultiplyingthecarryingvalue
(bookvalue)ofthebondsatthebeginningoftheperiodbytheeffective-
interestrate.
2.Determinethebonddiscountorpremiumamortizationnextbycomparing
thebondinterestexpensewiththeinterest(cash)tobepaid.
Thecomputationoftheamortizationispresentedasfollows:
6/18/2023 14

110. Cont’d
BondsIssuedataDiscount
Toillustrateamortizationofadiscountundertheeffective-interestmethod,Evermaster
Corporationissued€100,000of8percenttermbondsonJanuary1,2015,dueonJanuary
1,2020,withinterestpayableeachJuly1andJanuary1.Becausetheinvestorsrequiredan
effective-interestrateof10percent,theypaid€92,278forthe€100,000ofbonds,creating
a€7,722discount.Evermastercomputesthe€7,722discountasfollows:
Maturity value of bonds payable €100,000
PVof€100,000duein5yearsat10%,interestpayablesemiannually€61,391
[FV(PVF10,5%);(€100,000x0.61391)]
PVof€4,000interestpayablesemiannuallyfor5yearsat10%annually
[R(PVF-OA10,5%);(€4,000x7.72173)] 30,887
Proceeds from sale of bonds (92,278)
Discount on bonds payable € 7,722
6/18/2023 15

111. Cont’d
Thefive-yearamortizationscheduleappearsbelow:
6/18/2023 16

112. Cont’d
Evermasterrecordstheissuanceofitsbondsatadiscounton
January1,2015,asfollows:
Cash 92,278
BondsPayable 92,278
ItrecordsthefirstinterestpaymentonJuly1,2015,and
amortizationofthediscountasfollows:
InterestExpense 4,614
BondsPayable 614
Cash 4,000
EvermasterrecordstheinterestexpenseaccruedatDecember31,
2015(year-end),andamortizationofthediscountasfollows.
InterestExpense 4,645
InterestPayable 4,000
BondsPayable 645
6/18/2023 17

113. Cont’d
BondsIssuedataPremium
Nowassumethatforthebondissuedescribedabove,investorsare
willingtoacceptaneffective-interestrateof6percent.Inthat
case,theywouldpay€108,530orapremiumof€8,530,computed
asfollows:
Maturity value of bonds payable €100,000
oPV of €100,000 due in 5 years at 6%, interest/P semiannually €74,409
FV (PVF10,3%); (€100,000 x 0.74409)
oPV of €4,000 interest/P semiannually for 5 years at 6% annually 34,121
(R(PVF-OA10,3%);(€4,000x8.53020)
oProceeds from sale of bonds (108,530)
oPremium on bonds payable € 8,530
6/18/2023 18

114. Cont’d
Thefive-yearamortizationscheduleappearsbelow:
6/18/2023 19

115. Cont’d
Evermasterrecordstheissuanceofitsbondsatapremiumon
January1,2015,asfollows:
Cash 108,530
BondsPayable 108,530
EvermasterrecordsthefirstinterestpaymentonJuly1,2015,and
amortizationofthepremiumasfollows:
InterestExpense3,256
BondsPayable 744
Cash 4,000
Evermastershouldamortizethediscountorpremiumasan
adjustmenttointerestexpenseoverthelifeofthebondinsucha
wayastoresultinaconstantrateofinterestwhenappliedtothe
carryingamountofdebtoutstandingatthebeginningofanygiven
period.
6/18/2023 20

116. Cont’d
Accruing Interest
Inourpreviousexamples,theinterestpaymentdatesandthedatethe
financialstatementswereissuedwereessentiallythesame.For
example,whenEvermastersoldbondsatapremium,thetwointerest
paymentdatescoincidedwiththefinancialreportingdates.However,
whathappensifEvermasterpreparesfinancialstatementsattheendof
February2015?Inthiscase,thecompanyproratesthepremiumbythe
appropriatenumberofmonthstoarriveattheproperinterestexpense,
asfollows:
Interestaccrual(€4,000x2/6) €1,333.33
Premiumamortized(€744x2/6) (248.00)
Interestexpense(Jan.–Feb.) €1,085.33
Ever master records this accrual as follows:
InterestExpense 1,085.33
BondsPayable 248.00
InterestPayable 1,333.33
6/18/2023 21

117. Cont’d
Ifthecompanypreparesfinancialstatementssixmonthslater,it
followsthesameprocedure.Thatis,thepremiumamortizedwould
beasfollows:
Premiumamortized(March–June)(€744x4/6) €496.00
Premiumamortized(July–August)(€766x2/6) 255.33
Premium amortized (March–August 2015) €751.33
6/18/2023 22

118. Cont’d
BondsIssuedBetweenInterestDates
Companiesusuallymakebondinterestpaymentssemiannually,ondatesspecifiedinthe
bondindenture.
Whencompaniesissuebondsonotherthantheinterestpaymentdates,bondinvestors
willpaytheissuertheinterestaccruedfromthelastinterestpaymentdatetothe
dateofissue.
Thebondinvestors,ineffect,paythebondissuerinadvanceforthatportionofthefull
six-months’interestpaymenttowhichtheyarenotentitledbecausetheyhavenotheld
thebondsforthatperiod.
Then,onthenextsemiannualinterestpaymentdate,thebondinvestorswillreceive
thefullsix-months’interestpayment.
BondsIssuedatPar:
Toillustrate,assumethatinsteadofissuingitsbondsonJanuary1,2015,Evermaster
issueditsfive-yearbonds,datedJanuary1,2015,onMay1,2015,atpar(€100,000).
Evermasterrecordstheissuanceofthebondsbetweeninterestdatesasfollows:
May1,2015
Cash 100,000
BondsPayable 100,000
(Torecordissuanceofbondsatpar)
6/18/2023 23

119. Cont’d
Cash 2,667
InterestExpense(€100,000x0.08x4/12)2,667
(Torecordaccruedinterest;InterestPayablemightbecreditedinstead)
BecauseEvermasterissuesthebondsbetweeninterestdates,it
recordsthebondissuanceatpar(€100,000)plusaccruedinterest
(€2,667).Thatis,thetotalamountpaidbythebondinvestorincludes
fourmonthsofaccruedinterest.
OnJuly1,2015,twomonthsafterthedateofpurchase,Evermaster
paystheinvestorssixmonths’interest,bymakingthefollowing
entry.
July1,2015
InterestExpense(€100,000x0.08x1/2)4,000
Cash 4,000
(Torecordfirstinterestpayment)
6/18/2023 24

120. Cont’d
BondsIssuedatDiscountorPremium
TheillustrationabovewassimplifiedbyhavingtheJanuary1,2015,
bondsissuedonMay1,2015,atpar.However,ifthebondsareissued
atadiscountorpremiumbetweeninterestdates,Evermastermustnot
onlyaccountforthepartialcashinterestpaymentbutalsotheamount
ofeffectiveamortizationforthepartialperiod.
Toillustrate,assumethattheEvermaster8-percentbondswereissued
onMay1,2015,toyield6percent.Thus,thebondsareissuedata
premium;inthiscase,thepriceis€108,039.6Evermasterrecordsthe
issuanceofthebondsbetweeninterestdatesasfollows:
May1,2015
Cash 108,039
BondsPayable 108,039
(Torecordthepresentvalueofthecashflows)
Cash 2,667
InterestExpense(€100,000x0.08x4/12) 2,667
(Torecordaccruedinterest;InterestPayablemightbecreditedinstead)
6/18/2023 25

121. Cont’d
The computation, using the effective-interest rate of 6 percent is as follows:
InterestExpense
Carryingvalueofbonds €108,039
Effective-interestrate(6%x2/12) x1%
Interestexpensefortwomonths €1,080
Thebondinterestexpensethereforeforthetwomonths(MayandJune)is
€1,080.
Thepremiumamortizationofthebondsisalsoforonlytwomonths.Itis
computedbytakingthedifferencebetweenthenetcashpaidrelatedtobond
interestandtheeffective-interestexpenseof€1,080.Thecomputationofthe
partialamortization,usingtheeffective-interestrateof6percentisasfollows:
CashinterestpaidonJuly1,2015(€100,000x8%x6/12) €4,000
Less:CashinterestreceivedonMay2,2015 2,667
Netcashpaid €1,333
Bondinterestexpense(attheeffectiverate)fortwomonths (1,080)
Premiumamortization €253
6/18/2023 26

122. Cont’d
EvermasterthereforemakesthefollowingentriesonJuly1,2015,
torecordtheinterestpaymentandthepremiumamortization.
July1,2015
InterestExpense4,000
Cash 4,000
(Torecordfirstinterestpayment)
BondsPayable 253
InterestExpense 253
(Torecordtwo-months’premiumamortization)
TheInterestExpenseaccountnowcontainsadebitbalanceof
€1,080(€4,000–€2,667–€253),whichrepresentstheproper
amountofinterestexpense—twomonthsataneffectiveannual
interestrateof6percenton€108,039.
6/18/2023 27

123. Illustration 3.1
ForemanCompanyissued€800,000of10%,20-yearbondson
January1,2015,at119.792toyield8%.Interestispayable
semiannuallyonJuly1andJanuary1.
Instructions
Preparethejournalentriestorecordthefollowing.
(a)Theissuanceofthebonds.
(b)ThepaymentofinterestandtherelatedamortizationonJuly1,2015.
(c)TheaccrualofinterestandtherelatedamortizationonDecember31,
2015.
(d)Assumethesameinformationasabove,exceptthatthebondswere
issuedat84.95toyield12%.Preparethejournalentriestorecordthe
following.(1)Theissuanceofthebonds.(2)Thepaymentofinterest
andrelatedamortizationonJuly1,2015.(3)Theaccrualofinterest
andtherelatedamortizationonDecember31,2015.(Roundtothe
nearesteuro.)
6/18/2023 28

124. LONG-TERM NOTES PAYABLE
Thedifferencebetweencurrentnotespayableandlong-termnotes
payableisthematuritydate.
Short-termnotespayablearethosethatcompaniesexpecttopay
withinayearortheoperatingcycle—whicheverislonger.
Long-termnotesaresimilarinsubstancetobondsinthatbothhave
fixedmaturitydatesandcarryeitherastatedorimplicitinterestrate.
However,notesdonottradeasreadilyasbondsintheorganized
publicsecuritiesmarkets.
Accountingfornotesandbondsisquitesimilar.Likeabond,anote
isvaluedatthepresentvalueofitsfutureinterestandprincipal
cashflows.
Thecompanyamortizesanydiscountorpremiumoverthelifeofthe
note,justasitwouldthediscountorpremiumonabond.
6/18/2023 29

125. Cont’d
NotesIssuedatFaceValue
Toillustratethediscountingofanoteissuedatfacevalue,assume
thatScandinavianImportsissuedatfacevalue€10,000,three-year
notebearinginterestat10percentannuallytoBigelowCorp.The
marketrateofinterestforanoteofsimilarriskisalso10percent.
Becausethepresentvalueofthenoteanditsfacevaluearethe
same,€10,000,Scandinavianwouldrecognizenopremiumor
discount.
Cash 10,000
NotesPayable 10,000
ScandinavianImportswouldrecognizetheinterestincurredeach
yearasfollows:
InterestExpense(€10,000x0.10) 1,000
Cash 1,000
6/18/2023 30

126. Cont’d
NotesNotIssuedatFaceValue
Zero-Interest-BearingNotes
Ifacompanyissuesazero-interest-bearing(non-interest-bearing)note
solelyforcash,itmeasuresthenote’spresentvaluebythecashreceived.
Theimplicitinterestrateistheratethatequatesthecashreceived
withtheamountstobepaidinthefuture.Theissuingcompany
recordsthedifferencebetweenthefaceamountandthepresentvalue
(cashreceived)asadiscountandamortizesthatamounttointerest
expenseoverthelifeofthenote.
Toillustratetheentriesandtheamortizationschedule,assumethat
TurtleCoveCompanyissuedthethree-year,$10,000,zero-interest-
bearingnotetoJeremiahCompany.Theimplicitratethatequatedthe
totalcashtobepaid($10,000atmaturity)tothepresentvalueofthe
futurecashflows($7,721.80cashproceedsatdateofissuance)was9
percent.(Thepresentvalueof$1forthreeperiodsat9percentis
$0.77218.)
Cash 7,721.80
NotesPayable 7,721.80
6/18/2023 31

127. Cont’d
Schedule of note discount amortization are as follows:
6/18/2023 32

128. Cont’d
InterestExpense($7,721.80x9%) 694.96
NotesPayable 694.96
Thetotalamountofthediscount,$2,278.20inthiscase,representsthe
expense.
Illustration 3.3
OnDecember31,2015,FaitalCompanyacquiredacomputerfromPlato
Corporationbyissuinga£600,000zero-interest-bearingnote,payablein
fullonDecember31,2019.FaitalCompany’screditratingpermitsitto
borrowfundsfromitsseverallinesofcreditat10%.Thecomputeris
expectedtohavea5-yearlifeanda£70,000residualvalue.
Instructions
(a)PreparethejournalentryforthepurchaseonDecember31,2015.
(b)Prepareanynecessaryadjustingentriesrelativetodepreciation(use
straight-line)andamortizationonDecember31,2016.
(c)Prepareanynecessaryadjustingentriesrelativetodepreciationand
amortizationonDecember31,2017.
6/18/2023 33

129. Cont’d
Interest-BearingNotes
Toillustrateamorecommonsituation,assumethatMarie
Co.issuedforcasha€10,000,three-yearnotebearing
interestat10percenttoMorganCorp.Themarketrateof
interestforanoteofsimilarriskis12percent.Inthiscase,
becausetheeffectiverateofinterest(12%)isgreaterthanthe
statedrate(10%),thepresentvalueofthenoteislessthan
thefacevalue.
Thatis,thenoteisexchangedatadiscount.
Cash 9,520
NotesPayable 9,520
MarieCo.thenamortizesthediscountandrecognizes
interestexpenseannuallyusingtheeffective-interest
method.
6/18/2023 34

130. Cont’d
Scheduleofnotediscountamortizationareasfollows:
6/18/2023 35

131. Cont’d
MarieCo.recordspaymentoftheannualinterestandamortizationofthediscount
forthefirstyearasfollows(amountsperamortizationschedule).
InterestExpense 1,142
NotesPayable 142
Cash 1,000
Illustration 3.4
SabonisCosmeticsCo.purchasedmachineryonDecember31,2014,paying
$50,000downandagreeingtopaythebalanceinfourequalinstallmentsof
$40,000payableeachDecember31.Anassumedinterestof8%isimplicitin
thepurchaseprice.
Instructions
Preparethejournalentriesthatwouldberecordedforthepurchaseandfor
thepaymentsandinterestonthefollowingdates.
(a)December31,2014
(b)December31,2015
(c)December31,2016
(d)December31,2017
(e)December31,2018.
6/18/2023 36

132. SPECIAL ISSUES RELATED TO NON -CURRENT LIABILITIES
Reportingofnon-currentliabilitiesisoneofthemost
controversialareasinfinancialreporting.Becausenon-
currentliabilitieshaveasignificantimpactonthecash
flowsofthecompany.
Fouradditionalreportingissuesrelatedtonon-current
liabilitiesareaddressedinthissection:
1.Extinguishmentofnon-currentliabilities
2.Fairvalueoption
3.Off-balance-sheetfinancing
4.Presentationandanalysis.
6/18/2023 37

133. Cont’d
ExtinguishmentofNon-CurrentLiabilities
Howdocompaniesrecordthepaymentofnon-currentliabilities—
oftenreferredtoasextinguishmentofdebt?Ifacompanyholds
thebonds(oranyotherformofdebtsecurity)tomaturity,the
answerisstraightforward:Thecompanydoesnotcomputeany
gainsorlosses.Itwillhavefullyamortizedanypremiumor
discountandanyissuecostsatthedatethebondsmature.Asa
result,thecarryingamount,thematurity(face)value,andthefair
valueofthebondarethesame.Therefore,nogainorlossexists.
Inthissection,wediscussextinguishmentofdebtunderthree
commonadditionalsituations:
1.Extinguishmentwithcashbeforematurity,
2.Extinguishmentbytransferringassetsorsecurities,and
3.Extinguishmentwithmodificationofterms.
6/18/2023 38

134. Cont’d
Extinguishment with Cash before Maturity
Acompanyextinguishesdebtbeforeitsmaturitydate.Theamountpaidon
extinguishmentorredemptionbeforematurity,includinganycallpremiumand
expenseofreacquisition,iscalledthereacquisitionprice.
Onanyspecifieddate,thecarryingamountofthebondsistheamountpayable
atmaturity,adjustedforunamortizedpremiumordiscount.
Anyexcessofthenetcarryingamountoverthereacquisitionpriceisagain
fromextinguishment.
Theexcessofthereacquisitionpriceoverthecarryingamountisalossfrom
extinguishment.
Atthetimeofreacquisition,theunamortizedpremiumordiscountmustbe
amortizeduptothereacquisitiondate.
Toillustrate,weusetheEvermasterbondsissuedatadiscountonJanuary1,
2015.Thesebondsaredueinfiveyears.Thebondshaveaparvalueof
€100,000,acouponrateof8percentpaidsemiannually,andweresoldtoyield
10percent.TheamortizationschedulefortheEvermasterbondsispresentedas
follows:
6/18/2023 39

135. Cont’d
6/18/2023 40

136. Cont’d
6/18/2023 41Two years after the issue date on January 1, 2017, Evermaster calls the entire issue at 101 and
cancels it. As indicated in the amortization schedule, the carrying value of the bonds on January
1, 2017, is €94,925.
Computation of loss on redemption of bonds is as follows:

Evermaster records the reacquisition and cancellation of the bonds as follows.
Bonds Payable 94,925
Loss on Extinguishment of Debt 6,075
Cash 101,000

137. Cont’d
ExtinguishmentbyExchangingAssetsorSecurities
Inadditiontousingcash,settlingadebtobligationcaninvolveeitheratransferof
noncashassets(realestate,receivables,orotherassets)ortheissuanceofthedebtor’s
shares.Inthesesituations,thecreditorshouldaccountforthenon-cashassetsor
equityinterestreceivedattheirfairvalue.
Thedebtormustdeterminetheexcessofthecarryingamountofthepayableoverthefair
valueoftheassetsorequitytransferred(gain).Thedebtorrecognizesagainequaltothe
amountoftheexcess.Inaddition,thedebtorrecognizesagainorlossondispositionof
assetstotheextentthatthefairvalueofthoseassetsdiffersfromtheircarryingamount
(bookvalue).
TransferofAssets
AssumethatHamburgBankloaned€20,000,000toBonnMortgageCompany.Bonn,in
turn,investedthesemoniesinresidentialapartmentbuildings.However,becauseoflow
occupancyrates,itcannotmeetitsloanobligations.HamburgBankagreestoaccept
fromBonnMortgagerealestatewithafairvalueof€16,000,000infullsettlementofthe
€20,000,000loanobligation.Therealestatehasacarryingvalueof€21,000,000onthe
booksofBonnMortgage.Bonn(debtor)recordsthistransactionasfollows:
6/18/2023 42

138. Cont’d
NotesPayable(toHamburgBank) 20,000,000
LossonDisposalofRealEstate(€21,000,000–€16,000,000)5,000,000
RealEstate 21,000,000
GainonExtinguishmentofDebt(€20,000,000–€16,000,000) 4,000,000
BonnMortgagehasalossonthedispositionofrealestateintheamountof€5,000,000(the
differencebetweenthe€21,000,000bookvalueandthe€16,000,000fairvalue).Inaddition,it
hasagainonsettlementofdebtof€4,000,000(thedifferencebetweenthe€20,000,000
carryingamountofthenotepayableandthe€16,000,000fairvalueoftherealestate).
GrantingofEquityInterest
NowassumethatHamburgBankagreestoacceptfromBonnMortgage320,000ordinary
shares(€10par)thathaveafairvalueof€16,000,000,infullsettlementofthe€20,000,000
loanobligation.BonnMortgage(debtor)recordsthistransactionasfollows.
NotesPayable(toHamburgBank) 20,000,000
ShareCapital—Ordinary 3,200,000
SharePremium—Ordinary 12,800,000
GainonExtinguishmentofDebt 4,000,000
6/18/2023 43

139. Cont’d
ExtinguishmentwithModificationofTerms
Practicallyeveryday,theWallStreetJournalortheFinancial
Timesrunsastoryaboutsomecompanyinfinancialdifficulty,such
asNakheel(ARE)orParmalat(ITA).
Inmanyofthesesituations,thecreditormaygrantaborrower
concessionswithrespecttosettlement.Thecreditoroffersthese
concessionstoensurethehighestpossiblecollectionontheloan.
Forexample,acreditormayofferoneoracombinationofthe
followingmodifications:
1.Reductionofthestatedinterestrate.
2.Extensionofthematuritydateofthefaceamountofthedebt.
3.Reductionofthefaceamountofthedebt.
4.Reductionordeferralofanyaccruedinterest.
6/18/2023 44

140. Chapter Three
Financial Instrument
(Long Term Debt and Investment)
1

141. Basic Concepts and Terminologies
Financial instrument
Anycontractthat gives rise to:
•A financial asset of one entity; and
•A financial liability or equity instrument of another entity
2

142. Basic Concepts and Terminologies
Financial asset
•Cash
•A contractual right to receive cash or another financial asset
•A contractual right to exchange financial assets or liabilities with another
entity on potentially favourable terms
•An equity instrument (e.g. Ordinary shares of another entity).
•Example: Cash, A/c Receivable, Notes Receivable, derivatives, investments
3

143. Basic Concepts and Terminologies
Financial liability
•A contractual obligation to deliver cash or another financial asset
•A contractual obligation to exchange financial assets or liabilities with
another entity on potentially unfavourable terms.
•Example: a/c payable, notes payable, bank overdraft, loans payable, certain
preference shares, derivatives
Equity instrument
•A contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities.
•Example: Ordinary shares, certain preference shares
4

144. 5
BASIC CONCEPTS AND TERMINOLOGIES

145. 6
Initial Recognition
An entity shall recognise a financial asset/liability in its statement of financial
position [SOFP] when, and only when, the entity becomes party to the
contractual provisions of the instrument as a consequence, has a legal right to
receive/pay cash or another financial instrument.
Contract Period
Beginning of contract End of contract
Compare this with the recognition criteria for non-financial assets.

146. 7
INITIAL RECOGNITION

147. 8
Classification of Financial Assets
The initial as well as subsequent measurement of financial assets is subject to their
classification.
Classification category
1.Financial assets measured at FVTPL
2.Financial assets measured at fair value through other comprehensive income
(FVTOCI)
with gains and losses remaining in other comprehensive income (OCI) without
subsequent reclassification to profit or loss.
with cumulative gains and losses reclassified to profit or loss upon
derecognition.
3.Financial assets measured at amortised cost

148. Cash flows are solely
payments of principal
and interest (SPPI)
Hold to collect
Hold to collect
and Sell
Other business
model
Other types of cash
flows
Amortised cost FVOCI
FVTPL FVTPL
FVTPL
FVTPL
I.Business Model Test
Classification/Measurement Bases
of Financial Assets
II.Cash
Flows
Test
Criteria
9

149. Initial Measurement
10
Initial
carrying
amount
Measured at
FVTPL
Initial
carrying
amount
Measured
at other
than FVTPL
Fair value
Adjusted for
transaction costs
Asset Asset or Liability Liability
Initial
carrying
amount
=
Measured
at other
than FVTPL
Transaction costs: fees and commission paid to agents, advisers, brokers and
dealers, levies by regulatory agencies and security exchanges, and transfer
taxes and duties
10

150. 11
Initial recognition = fair value + transaction costs
Transaction costs include:
Fees and commissions
Levies by regulatory agencies and securities exchanges
taxes and duties
Transaction costs do not include:
Debt premiums or discounts
Financing costs
Internal administrative costs
Measurement at Initial Recognition

151. Fair value versus transaction price
Best evidence of the fair value of a financial instrument at initial recognition is
normally the transaction price.
If fair value at initial recognition differs from transaction price recognise (day 1) the
difference between the fair value at initial recognition and the transaction price as a
gain or loss if fair value is evidenced by:
i.a quoted price in an active market for an identical asset or liability (i.e. Level 1); or
ii.based on valuation technique that uses onlydata from observable markets (i.e.
some Level 2)
Initial Measurement
12

152. Subsequent Measurement of Financial Asset
Amortised Cost (DebtInstruments)
Statement of
financial position
Amortised cost
Profit or loss
Interest revenue using
effective interest method
Impairment
Foreign exchange gains &
losses
Gain or loss on
derecognition
Other
Comprehensive
Income
Nil
13

153. Non-currentliabilities(long-termdebt)consistofan
expectedoutflowofresourcesarisingfrompresent
obligationsthatarenotpayablewithinayearorthe
operatingcycleofthecompany,whicheverislonger.
Examples:
►Bonds payable
►Long-term notes payable
►Mortgages payable
►Pension liabilities
►Lease liabilities
Long-term debt has various covenants
or restrictions.
DebtInstruments

154. Bondcontractknownasabondindenture.
Representsapromisetopay:
(1)sumofmoneyatdesignatedmaturitydate,plus
(2)periodicinterestataspecifiedrateonthematurity
amount(facevalue).
Papercertificate,typicallya€1,000facevalue.
Interestpaymentsusuallymadesemiannually.
Usedwhentheamountofcapitalneededistoolargeforone
lendertosupply.
Issuing Bonds

155. Valuation of Bonds Payable @ Issuance
Issuance and marketing of bondsto the public:
Usually takes weeks or months.
Issuing company must
►Arrange for underwriters.
►Obtain regulatory approval of the bond issue, undergo
audits, and issue a prospectus.
►Have bond certificates printed.

156. Valuation of Bonds Payable
Selling price of a bond issueis set by the
supply and demand of buyers and sellers,
relative risk,
market conditions, and
state of the economy.
Investment communityvalues a bond at the present valueof its
expected future cash flows, which consist of (1) interestand (2)
principal.

157. Interest Rate
Stated, coupon, or nominal rate= Rate written in the terms of the bond
indenture.
►Bond issuer sets this rate.
►Stated as a percentage of bond face value (par).
Market rate oreffective yield = Rate that provides an acceptable return
commensurate with the issuer’s risk.
►Rate of interest actually earned by the bondholders.
Valuation of Bonds Payable

158. How do you calculate the amount of interest that is actually paid to
the bondholder each period?
How do you calculate the amount of interest that is actually
recorded as interest expense by the issuer of the bonds?
Valuation of Bonds Payable
(Stated rate x Face Value of the bond)
(Market rate x Carrying Value of the bond)

159. Bonds Sold AtMarket Interest
6%
8%
10%
Premium
Par Value
Discount
Assume Stated Rate of 8%
Valuation of Bonds Payable

160. Debenturebonds.Debenturebondsarebondsthatarenotsecuredbyspecificproperty.
Theirmarketabilityisbasedonthegeneralcreditratingofthecompany.Generally,a
companymusthavealong-periodofearningsandcontinuedfavorablepredictionsof
futureearningsandliquiditytoselldebenturebonds.Debenturebondholdersare
consideredtobegeneralcreditors,withthesamerightsasothercreditorsiftheissuer
failstopaytheinterestorprincipalanddeclaresbankruptcy.
MortgageBonds.Mortgagebondsarebondsthataresecuredbyalienagainstspecific
propertyofthecompany.Ifthecompanybecomesbankruptandisliquidated,the
holdersofthesebondshavefirstclaimagainsttheproceedsofthesaleoftheassetsthat
securedtheirdebt.Iftheproceedsfromthesaleofpledgedassetsarenotsufficientto
repaythedebt,mortgagebondholdersbecomegeneralcreditorsforthebalanceofthe
unpaid debt.
Types of Bonds

161. RegisteredBonds.Registeredbondsarebondswhoseownershipis
registeredwiththecompany.Thatis,thecompanymaintainsarecordofthe
holderofeachbond.Therefore,oneachinterestpaymentdate,interestis
paidtotheindividualslistedonthecorporaterecordsasownersofthe
bonds.Whenanownersellsregisteredbonds,theissuerortransferagent
mustbenotifiedsothatinterestwillbepaidtotheproperperson.
CouponBonds.Couponbondsareunregisteredbondsonwhichinterestis
claimedbytheholderpresentingacoupontothecompany.Thesebonds
canbetransferredbetweenindividualswithoutthecompanyoritsagent
being notified.

162. Zero-CouponBonds.Zero-couponbonds(alsocalleddeep-discountbonds)arebondson
whichtheinterestisnotpaiduntilthematuritydate.Thatis,thebondsaresoldataprice
considerablybelowtheirfacevalue,interestaccruesuntilmaturity,andthenthe
bondholdersarepaidtheinterestalongwiththeprincipalatmaturity.
CallableBonds.Callablebondsarebondsthatarecallablebythecompanyata
predeterminedpriceforaspecifiedperiod.Thatis,thecompanyhastherighttorequire
thebondholderstoreturnthebondsbeforethematuritydate,withthecompanypaying
the predetermined price and interest to date.

163. ConvertibleBonds.Convertiblebondsarebondsthatareconvertibleintoa
predeterminednumberofshares.Thatis,theownerofeachbondhastherightto
exchange it for a
predeterminednumberofsharesofthecompany.Thus,uponconversion,the
bondholderbecomesastockholderofthecompany.
SerialBonds.Serialbondsarebondsissuedatonetime,butportionsofthetotalface
valuematureinperiodicinstallmentsatdifferentfuturedates.Bondswithseveral
maturities.
TermBonds.Termbondsarebondsthatpaytheentireprincipalononedate,i.e.atthe
maturitydate.Bondswithsinglematurity.
Income(Revenue)Bonds.Thesearebondswhosepaymentofinterestisconditionalonincome.

164. Subsequent Measurement of Financial Asset
Fair Value Through OCI (FVOCI DebtInstruments)
Statement of
financial
position
Fair value
Profit or loss
Interest revenue using
effective interest method
Impairment
Foreign exchange gains
& losses
Other Comprehensive
Income
Fair value change other
than those recognisedin
profit or loss
(amounts accumulated
are recycled to P&L
upon derecognition)
25

165. Outright control?
Consolidation (IFRS 10)
Yes No
Joint control?
Yes No
Determine type of joint arrangement
(IFRS 11)
Significant influence?
Joint Operation Joint Venture
Account for assets, liabilities, revenues and
expenses (IFRS 11)
Equity accounting
(IAS 28)
Financial asset
accounting (IAS
39/IFRS 9)
Yes No
IFRS 12 IFRS 7
Determining the accounting for interests in other entities
(Interaction of IFRS 10, 11, 12 and IAS 28)
Subsequent Measurement of Investments in
Equity Instruments
26

166. Statement of
financial position
Fair value
Profit or loss
Dividends
Other Comprehensive Income
Changes in fair value and
foreign exchange component
(amounts accumulated never
recycledto P&L → may be
transferred within equity)
Fair value through OCI (investments in equity instruments)
Subsequent Measurement of Investments in
Equity Instruments
27

167. Statement of financial
position
Fair value
Profit or loss
Changes in Fair
value
Gain or loss on
derecognition
Other comprehensive
income (OCI)
Nil
Fair value through profit or loss
Subsequent Measurement of Investments in
Equity Instruments
28

168. 29
Removal of a previously recognised financial asset from an entity’s statement of financial position.
A financial asset is derecognized when and only when:
1.The contractual rights to the cash flows from the financial asset expire; or
2.The financial asset is transferred and the transfer qualifies for derecognition.
A financial asset is transferred when:
An entity transfers the contractual rights to receive the cash flows of the financial asset, or
An entity retains the contractual rights to receive the cash flows of the financial asset, but assumes a
contractual obligation to pay the cash flows to one or more recipients (pass through of cash flows);
Transfer of financial asset qualifies for derecognition:
if the entity transfers substantially all the risks and rewards of ownership of the financial asset, or
if the entity has not retained control
Derecognition of Financial Assets

169. 30
Derecognition
Continued recognition
Continuing
involvement
Have
rights to
cash
flows
expired?
Transferred
substantiall
y all risks
and
rewards?
Retained
substantiall
y all risks
and
rewards?
Retained
control of
the asset?
Have rights
to cash
flows been
transferred
?
Yes
No
Obligatio
n to ‘pass
through’
of cash
flows
No
Yes Yes
Yes
No
No
No
Yes
No
Yes
Derecognition of Financial Assets
30

170. 31
Cases
1.A company sells an investment in shares, but retains the right to repurchase the
shares at any time at a price equal to their current fair value.
(Derecognise the asset. )
2.If the company sells an investment in shares and enters into an agreement whereby
the buyer will return any increases in value to the company and the company will
pay the buyer interest plus compensation for any decrease in the value of the
investment.
(Do not derecognise the asset as it has retained substantially all the risks and
rewards.)
Derecognition of Financial Assets

171. The purpose of disclosures prescribed by IFRS 7 is to assist users in assessing the
nature and extent of risksrelated to financial instruments: Qualitative &
Quantitative Disclosures about:
Market risk
Credit risk
Liquidity risk
32
Disclosure

172. CHAPTER FOUR
LEASES
1

173. Definition and Identification of Leases
IFRS16definesLeaseasacontractthatconveystothecustomer
(‘lessee’)therighttouseanidentifiedassetinexchangefor
considerationforagreedperiodoftime.
Period of time can also be expressed in terms of use of the
asset.
2

174. By way of illustration:
anentitymightwanttotransportaspecifiedcargobyship
fromlocationAtolocationB,inaccordancewithastated
timetable,foraperiodoffiveyears.Toachievethis,it
couldeithercharterashipoverthisperiodoritcould
contracttobuythetransportservicefromafreight
carrier/operator(forexample,throughacontractof
affreightment).Inbothcases,thegoodswillarriveat
locationB—buttheaccountingmightbequitedifferent.
3

175. Identifying Leases
IFRS 16 provides more guidance for the identification of
Leases
Criteria
I.There is an identifiable asset-can be portion of an asset
II.Lessee obtains economic benefits-including benefit from
sub lease.
III.Lessee directs the use –how to use and for what purpose
The guidance helps to assesses whether the lease conveys the
right to control the use of an identified asset to the customer.
4

176. Identification of lease
No
- Yes
- No
Yes
Yes No
No
Yes Yes No
5
Is there an Identified asset?
Does the lessee have the right to obtain substantially all of the economic
benefits from the use of the asset through out the period of use?
Does the lessee have the right to Direct the use of the asset? i.e. how and for
what purpose the asset is used given the scope of lease contract
It is a Lease
Does the Lessee have the right to operate the
asset,without the lessor having the right to
change those operating instruction?
Did the Lessee design the asset in a way that
predetermines how and for what purpose
the asset will be used?
It is not
Lease

177. Cont...
Anassetistypicallyidentifiedbybeingexplicitlyspecifiedinacontract.
However,anassetcanalsobeidentifiedbybeingimplicitlyspecifiedina
contract.
Ifanarrangementidentifiestheassettobeused,butthesupplierhasa
substantivecontractualrighttosubstitutethatasset,thearrangementdoesnot
containanidentifiedasset.
Asubstitutionrightissubstantiveif(a)thesuppliercanpracticallyuseanother
assettofulfilthearrangementthroughoutthetermofthearrangement,and(b)
itiseconomicallybeneficialforthesuppliertodoso.
Thesupplier’srightorobligationtosubstituteanassetforrepairs,maintenance,
malfunction,ortechnicalupgradedoesnotprecludethecustomerfromhaving
therighttouseanidentifiedasset.
6

178. Cont...
Anidentifiedassetmustbephysicallydistinct.Aphysicallydistinctassetmight
beanentireassetoraportionofanasset.
Forexample,abuildingisgenerallyconsideredphysicallydistinct,butone
floorwithinthebuildingcouldalsobeconsideredphysicallydistinctifitcan
beusedindependentlyoftheotherfloors(forexample,pointofentryorexit,
accesstolavatories,etc).
Acapacityportionofanassetisnotanidentifiedassetif(a)theassetisnot
physicallydistinct(forexample,thearrangementpermitsuseofaportionofthe
capacityofanoiltanker),and(b)acustomerdoesnothavetherightto
substantiallyalloftheeconomicbenefitsfromtheuseoftheasset(forexample,
severalcustomersshareanoiltanker,andnosinglecustomerusessubstantially
allofthecapacity).
7

179. Cont...
Acustomercontrolstheuseoftheidentifiedassetbypossessing
therightto:
(a)obtainsubstantiallyalloftheeconomicbenefitsfromtheuseof
suchasset(‘economics’criterion);and
(b)directtheuseoftheidentifiedassetthroughouttheperiodof
use(‘power’criterion).
Acustomermeetsthe‘power’criterionifitholdstherightto
makedecisionsthathavethemostsignificantimpactonthe
economicbenefitsderivedfromtheuseoftheasset.
8

180. Cont...
Thestandardgivesseveralexamplesofrelevantdecision-makingrights.The
followingquestionsneedtobeconsideredwhenevaluatingwhichpartyholds
therelevantdecision-makingrightsintheshippingindustry:
Whichpartydecides…
whichgoodsaretransported?
howoftengoodsaretransported?
wheregoodsaretransported?
howoftentheassetisused?
theminimumcapacityatwhichtheassetoperates?
whichrouteistaken?
Iftheleaseemakestheabovedecisions,thecontractwillmeetthedefinitionofa
lease.
9

181. Cont...
Insomecases,theabovedecisionsarepre-determinedinthe
contract.Iftheuseoftheassetispre-determined,thecontract
containsaleaseifthechartererhastherighttodirecttheoperationsof
theassetwithouttheownerhavingtherighttochangethoseoperating
instructions,orifthechartererhasdesignedtheassetinawaythat
pre-determineshowandforwhatpurposetheassetwillbeused
throughouttheperiodofuse.
10

182. Cont...
Therecanbetermsinthecontractthatareprotectiveinnature.
Suchtermsmightbeincludedtoprotectthesupplier’sasset,the
supplier’spersonnelandtocomplywithregulations.
Forexample,achartererisnormallypreventedfromsailingaship
intowaterswithahighriskofpiracyorfromtransporting
dangerousmaterials/cargo.
Theexistenceofsuchprotectiverightsalonedoesnotpreventa
customerfromhavingtherighttodirecttheuseofanasset.
11

183. Facts 1:
Chartererentersintoacontractwithshipownerforthetransportationofcargo
fromRotterdamtoSydney.Theshipisexplicitlyspecifiedinthecontract,and
shipownerdoesnothavesubstitutionrights.Chartererhasnotspecifiedany
modificationstotheship.Thecargowilloccupysubstantiallyallofthe
capacityoftheship.Thecontractspecifiesthecargotobetransportedonthe
shipandthedatesofloadinganddischarging.Shipowneroperatesand
maintainstheshipandisresponsibleforthesafepassageofthecargoonboard
theship.Chartererisprohibitedfromhiringanotheroperatorfortheshipor
operatingtheshipitselfduringthetermofthecontract.Also,charterercannot
altertheroutesorthedatesforthetransportation.
12

184. Cont...
Discussion:Thecontractdoesnotcontainalease.
Thereisanidentifiedasset.Theshipisexplicitlyspecifiedinthe
contract,andshipownerdoesnothavetherighttosubstitutethat
specifiedship.
Chartererhastherighttoobtainsubstantiallyalloftheeconomic
benefitsfromuseoftheshipovertheperiodofuse.Itscargowill
occupysubstantiallyallofthecapacityoftheship,thereby
preventingotherpartiesfromobtainingeconomicbenefitsfromuse
oftheship.
13

185. Cont...
However,chartererdoesnothavetherighttocontroltheuseofthe
ship,becauseitdoesnothavetherighttodirectitsuse.Charterer
doesnothavetherighttodirecthowandforwhatpurposetheshipis
used.Howandforwhatpurposetheshipwillbeusedispre-
determinedinthecontract(thatis,thetransportationofspecified
cargofromRotterdamtoSydneywithinaspecifiedtimeframe),and
chartererdidnotdesigntheship.Chartererhasnorighttochange
howandforwhatpurposetheshipisusedduringtheperiodofuse.
14

186. Fact 2:
Chartererentersintoacontractwithshipownerfortheuseofaspecifiedship
forafive-yearperiod.Theshipisexplicitlyspecifiedinthecontract,andship
ownerdoesnothavesubstitutionrights.Chartererdecideswhatcargowillbe
transported,andwhether,whenandtowhichportstheshipwillsail,
throughoutthefive-yearperiodofuse,subjecttorestrictionsspecifiedinthe
contract.Thoserestrictionspreventchartererfromsailingtheshipintowaters
atahighriskofpiracyorcarryinghazardousmaterialsascargo.Shipowner
operatesandmaintainstheshipandisresponsibleforthesafepassageofthe
cargoonboardtheship.Chartererisprohibitedfromhiringanotheroperator
fortheshiporoperatingtheshipitselfduringthetermofthecontract.
15

187. Cont...
Discussion:Thecontractcontainsalease.Chartererhastherighttousethe
shipforfiveyears.
Thereisanidentifiedasset.Theshipisexplicitlyspecifiedinthe
contract,andshipownerdoesnothavetherighttosubstitutethat
specifiedship.
Chartererhastherighttocontroltheuseoftheshipthroughoutthe
five-yearperiodofuse,because:
a)Chartererhastherighttoobtainsubstantiallyalloftheeconomic
benefitsfromuseoftheshipoverthefive-yearperiodofuse.
Chartererhasexclusiveuseoftheshipthroughouttheperiodofuse.
16

188. Cont...
b)Chartererhastherighttodirecttheuseoftheship,becausetheconditionsinparagraph
B24(a)ofIFRS16exist.Thecontractualrestrictionsaboutwheretheshipcansail,andthe
cargotobetransportedbytheship,limitthescopeofcharterer’srighttousetheship.
However,theyareprotectiverightsthatprotectshipowner’sinvestmentintheshipandship
owner’spersonnel.Withinthescopeofitsrightofuse,charterermakestherelevant
decisionsabouthowandforwhatpurposetheshipisusedthroughoutthefive-yearperiod
ofuse,becauseitdecideswhether,whereandwhentheshipsails,aswellasthecargothatit
willtransport.Chartererhastherighttochangethesedecisionsthroughoutthefive-year
periodofuse.
Althoughtheoperationandmaintenanceoftheshipareessentialtoitsefficientuse,ship
owner’sdecisionsinthisregarddonotgiveittherighttodirecthowandforwhatpurpose
theshipisused.Instead,shipowner’sdecisionsaredependentoncharterer’sdecisionsabout
howandforwhatpurposetheshipisused.
17

189. Components, contract consideration and
allocation
Anarrangementmightcontainleaseandnon-leasecomponents
thataresubjecttodifferentaccountingmodels.Non-lease
componentsarethoseitemsoractivitiesthattransferagoodor
servicetothelessee.
Arrangementsmightalsocontainmultipleleasecomponents.
IFRS16requireseachseparateleasecomponenttobeidentified
andaccountedforseparately.
18

190. Fact 3
Chartererentersintoatimecharterwithshipownerinwhichshipownerwill
providetransportationservicestochartererforafive-yearperiod,usingaship
thatisexplicitlyspecifiedinthecontract.Shipownerdoesnothavesubstitution
rightsinrelationtotheshipthatisspecifiedinthecontract.Shipowneris
responsibleforoperatingtheshipusingitsowncrew,maintainingtheshipand
insuringit.Also,shipownerisresponsibleforprovidingcleaningservices
(‘holdscleaning’)throughoutthecontractperiod.Chartererwillprovidethe
datesoftravelandthearrivalanddeparturelocations.Shipownercannotuse
theshipforanyotherpurposewhenitisnotbeingusedbycharterer.Charterer
willpaytoshipowner:(a)afixedamountperdayforcharteringtheship;(b)a
fixedamountpermonthforCVE(communication/victuals/entertainment);
and(c)afixedamountforeachholdscleaning.
Question:Whatarethecomponentsinthisarrangement?
19

191. Cont...
Discussion:Thecontractcontainsoneleasecomponent,whichistheleaseoftheship,and
twonon-leasecomponents,whicharetheservicestooperatetheshipandcleaningservices.
Insurancedoesnotrepresentaseparategoodorservice.Therefore,theelementof
thefixedpaymentperdayforcharteringtheship,whichcoverstheship’s
insurance,isnotconsideredaseparatecomponent,anditinsteadformspartofthe
overallcontractconsiderationtobeallocatedtotheleaseandnon-lease
components.
Charterercaneither:
a)separatetheleasefromthenon-leasecomponentsandallocateconsiderationto
eachcomponentor;
b)applythepracticalexpedientandaccountforboththeleaseandtheassociated
non-leasecomponentsasasinglecombinedleasecomponent.
20

192. Then, how lessee account for leases?
InthebookofLessee,IFRS16requiresthat:
allleasesaretreatedasiflesseeacquired“therightofuseasset.”
and
Lesseerecognizesandreportsleaseasset(Rightofuse)andlease
liability(ifpaymentmadeovertime)onthebalancesheet.

193. Cont..
ShouldallLeasesreportedonB/sheetasanasset(right-of-use)andliability?
Exemptions:OptionaltoexcludefromB/Sheet.i.e.lesseecanelectnottorecognizeassetsandliabilities(rules).Both
ofthefollowingqualifyforexemption
LeasepaymentsarereportedasanoperatingexpensesinP/L,oneither
straightlinebasisorothersystematicbasis.
Short term leases
•of Less than 12 months
•But consider the likelihood of
renewal option
Leases of low value
•Leasedassetsinorderofmagnitude
of<$5,000(<+ETB100,000),
•assessedindependently
•Eg. Tablet, PC, Small office
furniture

194. Recognition & Measurement of Leases-Lessee
Lessees will recognize almost all leases on the balance sheet (as a
“right of-use asset "and “lease liability”)-Single model
The lessee recognizes:
a lease liability at the present value of future lease payments;
a right-of-use asset at an amount prepaid plus lease liability plus initial
direct costs
Subsequently: Recognize depreciation on ROU-Asset and Interest expense
on Lease liability. Apply IAS 36 for impairment of ROU asset.
Practical expedient: for Short term lease and lease of low value assets
23

195. Initial measurement and recognitions of leases
I. LESSEE
Initialmeasurementandrecognition
Thelesseerecognizes,atcommencementdate,therighttouseas‘anasset’atcostanda
leaseliabilityatpresentvalue.
Howmuchisthecost?
Right-ofuseasset=LeaseLiability…………………………………………………………… .XX
+InitialDirectcost……………………………………………………… XX
+Prepaidleasepayment…………………………………………… .XX
-leaseincentives……………………………………………………… (XX)
+Estimatedcosttodismantle,removeorrestore………..XX
Rightofuseasset………………………………………………………………… XXX
LeaseLiability=PresentValueofrentalpayments+PresentvalueofguaranteedResidualvalue
24

196. Initial measurement and recognitions of leases -
Lessee
DiscountratetocomputethePVofleaseliability:
ImplicitrateorIncrementalborrowingrate(ifthelesseecannotdeterminetheformer)
Leaseterm(discountingperiod):
non-cancellableperiodofleasecontractplusanyadditionalperiodofrenewaloption(if
extensioniscertain).
Oncecostisdetermined,initialrecognition:
Debit:Right-of-useasset(lease)……..XX
Credit:Cash/LeaseLiability……………………………… XX
25

197. Subsequent measurement and recognition -Lessee
Alesseemeasuresrightofuseassetandleasesliabilityasfollows:
Subsequentmeasurement
26
Right-of-use
•Apply cost model or
•Elect to apply Revaluation model
•Accumulated Depreciationapplying
IAS 16 and Accumulated
impairment loss applying IAS 36
•Depreciation period:
•Usefullifeifownershiptransfersor
exercisablepurchaseoptionor
•TheearlierofleasetermorUL
•Reportdepreciationexpenseinp/L
Lease liability
•Determinethecarryingvalue
applyingamortizedcost
approach
•Increaseleaseliabilityby
amountofinterestanddecrease
byprincipalpayment(rent)
•Usetherateusedfor
determinationofPVofliability
•ReportInterestexpense(finance
charge)inP/L

198. Examples on measurement and recognition of leases -
Lessee
Example1:Initialmeasurementandrecognition
ESCentersintoa10yearnoncancellableleaseofabuilding,withexpectedULof20years.
Leasepaymentis50,000ETBperyearpayableatthebeginningofeveryyear.Toobtainalease
ESCincurredinitialdirectcostof20,000Birr,ofwhich15,000ETBisrelatedtopaymentforthe
formertenantoccupyingthatthebuildingand5,000ETBrelatestothecommissionforbroker
thatarrangedthelease.AsanincentivethelessorreimbursetotheESC,thebroker’s
commissionof5000ETBandESC’sleaseholdimprovementof7000ETB.Theinterestrate
implicitintheleaseisnotreadilydeterminable.Theincrementalborrowingrateis5%per
annum.PVOAof1for9rentsat5%=7.1078
HowdoestheESCinitiallymeasuresandrecognizestheassetandliabilityinrelationtothis
lease?
27

199. Examples on measurement and recognition of leases -
Lessee
Example1:Solution
Atthecommencementdate,ESCmakesleasepaymentforthefirstyear,incursinitialdirectcosts,
receivesleaseincentive(notethatreimbursementforleaseholdimprovementisnotanincentive)
andmeasureleaseliabilityasthepresentvalueoftheremainingninepaymentsof50,000ETB,
discountedat5%equaltoETB355,391.
Leaseliability=50,000*7.1078=ETB355,391
Rightofuseasset=355,391+50,000+20,000–5000=420,391ETB
InitialRecognitionshownasfollows:
Dr.Right-of-useasset(lease)……..405,391
Cr.Leaseliability………………….355,391
Cr.Cash……………………………… ..50,000
28

200. Examples on measurement and recognition of leases -
Lessee
Dr.Rightofuseassets…20,000
Cr.Cash………………………..20,000
(initialdirectcost)
Dr.Cash………5000
Cr.Right-of-useasset……..5000
(leaseincentivesreceivedbylessee)
Note:ESCaccountsforthereimbursementofleaseholdimprovementsfromlessorapplyingother
standardsandnotasleaseincentive.Becausethecostsincurredonleaseholdimprovementsare
notincludedwithinthecostoftheright-of-useasset.
29

201. Examples on measurement and recognition of leases -Lessee
Example:Subsequentmeasurement-forLeaseliabilityandRightofuse-Schedulefor1
st
5years
30
Lease liability Right-of-use asset(leased
building)
Beginni
ng of
year
periodic payt.
at the
beginning
Principal
payment
Beg. Liability
balance after
principal
payment
Interest
expense(5
%) at the
end of
Bal. with
accrued
interest at
the end of
Beg. Bal.Depreciati
on
End Bal.
1 - - 355,391 17,770 373,161 420,391 (42,039) 378,352
2 50,000 32,230 323,161 16,158 339,319 378,352 (42,039) 336.313
3 50,000 33,842 289,319 14,466 303,785 336,313 (42,039) 294,274
4 50,000 35,534 253,785 12,689 266,474 294,274 (42,039) 252,232
5 50,000 37,311 216,474 10,823 227,297 252,232 (42,039) 210,196
10 50,000 0 0 0 42,039 (42,039) 0

202. Examples on measurement and recognition of leases -
Lessee
Example:Subsequentrecognitionandreportingassumingthatthefirmrecognizesfinance
chargeonthedateofpayment
Endoffirstyear/Beginningof2
nd
year:
Dr.Leaseliability………………….32,230
Dr.Financecharge(interest)…….17,770
Cr.Cash…………….50,000
Dr.Depreciationexpense….42,039
Cr.Accumulateddepreciation…..42,039
Endof2
nd
year/Beginningof3
rd
year:
Dr.Leaseliability………………..33,842
Dr.Financecharge(interest)..16,158
Cr.Cash………………………50,000
31

203. Examples on measurement and recognition of leases -Lessee
Example:Subsequentreporting
ForFirstyear:
InthestatementofP/L:
InterestExpense……………….ETB17,770
DepreciationExpense………………42,039
InthestatementofF/P:
Assets
Non-current(PPE)
Right-of-useasset(leasedbuilding)…..ETB420,391
Accumulateddepreciation…………………….(42,039)
CarryingValue(BookValue)……………………378,352
Liability
Current-Leaseliability(50,000-16,158)……………….33,842
Non-current-Leaseliability(323,161-33,842)………289,319
Total………………………………………………………………… .ETB323,161
32

204. CNHCapitalandIvanhoeMinesLtd.signaleaseagreementdatedJanuary1,
2015,thatcallsforCNHtoleaseafront-endloadertoIvanhoebeginningJanuary
1,2015.Thetermsandprovisionsoftheleaseagreementandotherpertinent
dataareasfollows.
•Thetermoftheleaseisfiveyears.Theleaseagreementisnon-cancelable,
requiringequalrentalpaymentsof$23,981.62atthebeginningofeachyear
(annuity-duebasis).
•Theloaderhasafairvalueattheinceptionoftheleaseof$100,000,an
estimatedeconomiclifeoffiveyears,andnoresidualvalue.
•Theleasecontainsnorenewaloptions.TheloaderrevertstoCNHatthe
terminationofthelease.
•Ivanhoe’sincrementalborrowingrateis11percentperyear.
•Ivanhoedepreciatessimilarequipmentthatitownsonastraight-linebasis.
Exercise

205. LessorAccounting-No significant change
IFRS16requiresthatLessorclassifiesleasesintotwo:FinancingLease
andanOperatingLease
₋Aleaseisclassifiedasafinanceleaseifittransferssubstantiallyall
therisksandrewardsincidentaltoownershipofanunderlyingasset.
Otherwise,OperatingLease.
Finance leases-de-recognize the asset and recognize a lease receivable
Operating leases-continue to recognize the underlying asset and rent
income
34

206. Finance Lease-If any of the following indicators exist
Finance
Lease
Is there a
transfer of
ownership?
Is there an
exercisable
bargain
Purchase
option?
Is the lease
term for the
major part of
economic life
of an asset?
Is the present value of
the lease payment
equal to substantially
all of the fair value of
the asset?
Is an asset has a
specialized nature that
only the lessee can use
it?
35

207. IAS 12
Chapter Five
Deferred Taxation
1

208. Learning Objectives
Atthecompletionofstudyingthischapter,youwill
beableto:
Definetaxbaseandcarryingamount
Explainthedifferencebetweentaxableincomeand
accountingincome
Determinethetemporarytaxableanddeductible
difference
Calculatethedeferredtaxes
Identifythepresentationanddisclosurerequirements
relatedtoincometaxes
2

209. IFRS requires an entity to recognize, at each
reporting date, the tax consequences expected
to arise in future periods in respect of:
the recovery of its assets,
settlement of its liabilities, and
other transactions and events
of current period recognized at that date.
3

210. Basic Concepts
Income tax: It includes all domestic and foreign taxes
which are based on taxable profits.
Accounting profit: It is profit or loss for a period
determined in accordance with IFRS
Taxable profit (tax loss): It is the profit (loss) for a
period, determined in accordance with income tax
law
4

211. Difference
between AI
and TI
Permanent Temporary
Deductible Taxable
5

212. Temporarydifferencesarisewhenthereisa
differencebetweenthetaxbaseandthe
carryingamountofassetsandliabilities.
Permanentdifferencesaredifferences
betweenthetaxandfinancialreportingof
revenueorexpenseitemswhichwillnotbe
reversedinfuture.
Sincetheyareirreversible,permanent
differencesdonotgiverisetodeferredtax
assetsorliabilities.
6

213. Temporary differences
Taxable temporary differences Deductible temporary differences
Differences that will increase
future taxable profitand so
give rise to taxable income in
the future
Differences that will decrease
future taxable profitand so
give rise to deductible amounts
in the future
Accounting base
Tax base

214. Balance Sheet Approach
IAS 12 considers deferred tax by taking a “balance
sheet approach” to the accounting problem
It considers temporary differences between the
carrying values and the tax base of assets and liabilities.
The tax base: The amount attributed to that asset or
liability for tax purposes
Carrying amount: The amount attributed to that asset
or liability as per IFRS
8

215. 9

216. Carrying
Amount
Tax Base Assessment
Asset A 10 8 There is taxable temporary difference
(i.e., the entity recognizes a deferred
tax liability).
Asset B 8 10
There is deductible temporary
difference (i.e., the entity recognizes a
deferred tax asset).
Liability A 10 8
There is deductible temporary
difference (i.e., the entity recognizes a
deferred tax asset).
Liability B 8 10
There is taxable temporary difference
(i.e., the entity recognizes a deferred
tax liability).
10

217. Current tax:
income taxes payable (current tax
expense)or
the amount of income taxes recoverable
(current tax income)in respect of the tax loss
for a period
Tax expense(tax income): It is a combination of
current tax expense (current tax income)
and
deferred tax expense (deferred tax income).
11

218. Example 1
An asset that costs Br 600,000 has a carrying
amount of Br 430,000. Cumulative depreciation for
tax purposes is Br 200,000 and the tax rate is 30%.
1.What is the tax base of the asset?
2.What is the temporary difference?
3.Is it taxable or deductible temporary difference?
4.What is the deferred tax?
5.Is it a deferred tax asset or liability?
12

219. Example 1 Solution
1. TB= Br 600,000-Br 200,000=400,000
2. TD= Br 430,000-Br 400,000= 30,000
3. Taxable temporary difference
4. DT= Br 30,000 x 30%= 9,000
5. Deferred tax liability
13

220. Example 2
At the beginning of 2013, GK Company purchased
equipment for Br 200,000. The equipment had a
carrying amount of Br 180,000 at the beginning of 2014
and Br 160,000 at the end of 2014. The accumulated
depreciation of the item as per the income tax law is Br
50,000 at the beginning of 2014 and Br 80,000 at the
end of 2014. The tax rate is 30%. The accounting
income before tax is Br 700,000 for 2013 and Br
900,000 for 2014.
14

221. 1.What was the tax base of the equipment for 2013
and 2014?
2.What is the taxable income for 2013 and 2014?
3.What is the temporary difference for 2013 and 2014?
Is it taxable or deductible temporary difference?
4.What is the deferred tax for 2013 and 2014? Is it
deferred tax asset or deferred tax liability?
5.What is the current tax expense for 2013 and 2014?
6.What is the deferred tax expense for 2013 and 2014?
7.What is the appropriate journal entry for 2013 and
2014?
15

222. Example 2 Solutions
End of 2013 End of 2014
Carrying value Br 180,000 Br 160,000
Tax base 150,000 120,000
Taxable temporary difference 30,000 40,000
Deferred tax liability (30%)9,000 12,000
Taxable income 670,000 860,000
16

223. Journal entry at the end of 2013
Income tax expense—Current ………………. 201,000
Income tax expense—Deferred ……………... 9,000
Deferred tax liability…………………………….…………….... 9,000
Income taxes payable …………………………………………201,000
Journal entry at the end of 2014
Income tax expense—Current……………… 258,000
Income tax expense—Deferred ………...... 3,000
Deferred tax liability………………………………………….... 3,000
Income taxes payable …………………………………………258,000
17

224. 18

225. Example 3
In 2014, its first year of operation, North Company
has pretax financial income of Br 250,000, a total of
Br 28,000 of taxable temporary differences, and a
total of Br 8,000 of deductible temporary
differences. The tax rate is 30%.
In 2015, North Company has pretax financial income
of Br 450,000, aggregate taxable and deductible
temporary differences of Br 75,000 and Br 36,000,
respectively, and the tax rate remains 30%.
19

226. Required:
1.Determine the taxable income for 2014
2.Make the necessary journal entries for 2014 to
record the deferred taxes
3.Determine the taxable income for 2015
4.Make the necessary journal entries for 2015 to
record the deferred taxes
20

227. Example 3 Solution
Taxable income for 2014 is computed as follows:
Pretax financial income Br 250,000
Taxable temporary differences (28,000)
Deductible temporary differences 8,000
Taxable income Br 230,000
21

228. The journal entry to record required amounts for 2014
is:
Income tax expense—Current…. 69,000
Income tax expense—Deferred .. 6,000
Deferred tax asset…………..….……… 2,400
Deferred tax liability……………….………..8,400
Income taxes payable ………….…………69,000
22

229. Taxable income for 2015 is computed as follows:
Pretax financial incomeBr 450,000
Taxable temporary differences (75,000)
Deductible temporary differences 36,000
Taxable income Br 411,000
23

230. For 2015
Deferred tax liability
Required balance at Dec 31, 2015 (Br 75,000 ×30%)…..Br 22,500
Balances at Dec 31, 2014…………………………………………….. 8,400
Adjustment required ………………………………………………..Br 14,100
Deferred tax asset
Required balance at Dec 31, 2015 (Br 36,000 ×30%)…..Br 10,800
Balances at Dec 31, 2014…………………………………………………. 2,400
Adjustment required…………………………………………………… Br 8,400
Deferred tax expense (Br 14,100 -Br 8,400)……………. Br 5,700
24

231. The journal entry to record the deferred amounts for
2015 is:
Income tax expense—Current…. 123,300
Income tax expense—deferred….. 5,700
Deferred tax asset……………………. 8,400
Deferred tax liability………………………… 14,100
Income taxes payable ………….…………123,300
25

232. Example 4
Loan receivables has a carrying amount of Br 8 million
for which general bad debt provisions amounting to Br
100,000 have been made. These provisions have not
yet been deducted for tax purposes but are expected
to give rise to future deductible amounts.
1.What is the tax base of the receivable?
2.Is the temporary difference taxable or deductible?
26

233. Example 4 Solution
The tax base of the loan receivable is Br 8.1
million which results in a deductible
temporary difference of Br 100,000.
27

234. Example 5
Current liabilities include accrued fines and penalties
with a carrying amount of Br 500,000. What is the tax
base of such liabilities?
28

235. Example 5 Solution
Since it represents permanent difference (as
fines and penalties are not deductible for tax
purposes), the tax base of the accrued fines and
penalties is the carrying amount itself which
yields zerodifference.
29

236. Assets carried at fair value: The difference between
the carrying amount of a revalued asset and its tax
base is a temporary difference and gives rise to a
deferred tax liability or asset
Example6
AcompanyhasrevalueditspropertyonDecember31,
2015.TherevaluedamountwasBr10million.The
carryingvalueofthepropertybeforerevaluationwas
Br8millionandthetaxbaseofthepropertywasBr6
million.Theprofittaxrateis30%.
Whatisthedeferredtaxliabilityonthepropertyas
ofthatdate?
30

237. Example 6 Solution
The carrying value after revaluation is Br 10
million, the tax base is Br 6 million, and the
income tax is 30%; therefore, the deferred tax
liability is Br 1.2 million (i.e., Br 10 million minus
Br 6 million multiplied by 30%).
31

238. Loss carry-forward
A deferred tax asset shall be recognized for the
carry forward of unused tax losses if it is
probable (“more likely than not”) that future
taxable profit will be available against which the
unused tax losses can be utilized.
32

239. Example 4
An entity has a tax loss of Br 8 million which can be
carried forward for 5 years. The estimated cumulative
taxable profits for the next five years are Br 6 million. It
is estimated that Br 2 million of the tax loss will expire
unused. The tax rate is 30%.
1.What is the deferred tax asset?
2.What is the journal entry?
33

240. Example 4 Solution
The entity recognizes a deferred tax asset of Br
1.8 million (Br 6 million x 30%)
Deferred Tax Asset…………… 1,800,000
Deferred Tax Income…………………1,800,000
34

241. Presentation
Current tax payable is always shown as a current
liability.
Deferred tax items cannot be shown as current
assets or current liabilities.
Current and deferred tax balances are to be shown
as separate items (offsetting is not allowed).
Deferred tax assets or liabilities should not be
discounted
35

242. Disclosure
current tax expense (or income);
any adjustments recognized in the period:
for current tax of prior periods;
from a previously unrecognized tax loss
from a previously unrecognized temporary
difference
the amount of deferred tax expense (or
income)
36

243. an explanation of the relationship between
tax expense (or income) and accounting
profit
a numerical reconciliation between the
average effective tax rate and the applicable
tax rate
37

244. Chapter Six
Revenue from Contracts with
Customers

245. II. Revenue Recognition

246. Fundamentals of
Revenue Recognition
Both the IASB and the FASB have indicated that the state
of reporting for revenue was unsatisfactory.
Recently, the IASB issued a converged standard on
revenue recognition entitled Revenue from Contracts
with Customers.
LO 1
Background
LEARNING OBJECTIVE 1
Understand the fundamental
concepts related to revenue
recognition and measurement.

247. New Revenue Recognition Standard
LO 1
Revenue from Contracts with Customers, adopts an asset-
liability approach.
Companies account for revenue based on the asset or
liability arising from contracts with customers.
Companies analyze contracts with customers because
contracts initiate revenue transactions.
►Contracts indicate terms of the transaction,
►provide the measurement of the consideration, and
►specify the promises that must be met.
Revenue Recognition

248. LO 1
New Revenue Recognition Standard
ILLUSTRATION 18.1 Key Concepts of Revenue Recognition
Performance Obligation is Satisfied

249. LO 1
Overview of the Five-Step Process
A contract is an agreement between two parties
that creates enforceable rights or obligations. In
this case, Airbus has signed a contract to deliver
airplanes to Cathay Pacific.
Assume that Airbus(FRA) Corporation signs a contract to sell
airplanes to Cathay Pacific Airlines (HKG) for €100 million.
Airbus has only one performance obligation—to
deliver airplanes to Cathay Pacific. If Airbus also
agreed to maintain the planes, a separate
performance obligation is recorded for this
promise.
Step 2: Identify the
separate performance
obligations in the
contract.
ILLUSTRATION 18.2
Five Steps of Revenue Recognition
Step 1: Identify the
contract with
customers.

250. LO 1
Transaction price is the amount of consideration
that a company expects to receive from a
customer in exchange for transferring a good or
service. In this case, the transaction price is
straightforward—it is €100 million.
ILLUSTRATION 18.2 Five Steps of Revenue Recognition
Step 3: Determine the
transaction
price.
In this case, Airbus has only one performance
obligation—to deliver airplanes to Cathay Pacific.
Step 4: Allocate the
transaction price to the
separate
performance
obligations.
Overview of the Five-Step Process

251. LO 1
Airbus recognizes revenue of €100 million for the
sale of the airplanes to Cathay Pacific when it
satisfies its performance obligation—the delivery of
the airplanes to Cathay Pacific.
ILLUSTRATION 18.2 Five Steps of Revenue Recognition
Step 5: Recognize
revenue when
each performance
obligation
is satisfied.
Overview of the Five-Step Process

252. LO 1
Extended Example of Five-Step Process
Identifying the Contract with Customers—Step 1
Assume that Tyler Angler orders a large cup of black coffee costing $3
from BEAN. Tyler gives $3 to a BEAN barista, who pours the coffee
into a large cup and gives it to Tyler.
Question:How much revenue should BEAN recognize on this
transaction?

253. LO 1
Extended Example of Five-Step Process
1. The contract has commercial substance: Tyler gives cash for the
coffee.
2. The parties have approved the contract: Tyler agrees to purchase
the coffee and BEAN agrees to sell it.
3. Identification of the rights of the parties is established: Tyler has the
right to the coffee and BEAN has the right to receive $3.
4. Payment terms are identified: Tyler agrees to pay $3 for the coffee.
5. It is probable that the consideration will be collected: BEAN has
received $3 before it delivered the coffee.
It appears that BEAN and Tyler have a valid contract with one another.
Step 1: Identify the contract with customers.

254. LO 1
Extended Example of Five-Step Process
BEAN has a performance obligation to provide a large cup of coffee
to Tyler.
BEAN has no other performance obligation for any other good or
service.
Step 2: Identify the separate performance obligations.
The price of the coffeeis $3, and no discounts or other adjustments
are available. Therefore, the transaction price is $3.
Step 3: Determine the transaction price.

255. LO 1
Extended Example of Five-Step Process
Given that BEAN has only one performance obligation, no allocation
is necessary.
Step 4: Allocate the transaction price to the separate
performance obligations.
BEAN satisfies its performance obligation when Tyler obtains control
of the coffee.
Step 5: Recognize revenue when each performance
obligation is satisfied.
BEAN should recognize $3 in revenue from this
transaction when Tyler receives the coffee.

256. LO 1
Extended Example of Five-Step Process
Identifying Separate Performance Obligations—Step 2
The following day, Tyler orders another large cup of coffee for $3 and
also purchases two bagels at a price of $5. The barista provides these
products and Tyler pays $8.
Question: How much revenue should BEAN recognize on the
purchase of these two items?

257. LO 1
Extended Example of Five-Step Process
A valid contract exists as it meets the five conditions necessary for a
contract to be enforceable as discussed in the previous example.
Step 1: Identify the contract with customers.
BEAN must determine whether the sale of the coffee and the sale of
the two bagels involve one or two performance obligations.
Step 2: Identify the separate performance obligations.

258. LO 1
Extended Example of Five-Step Process
Multiple performance obligations exist when the following two
conditions are satisfied:
1.BEAN must provide a distinct product or service.
2.BEAN’s products are distinct within the contract. If the performance
obligation is
►not highly dependent on,
►or interrelated with,
other promises in the contract, then each performance obligation
should be accounted for separately.
Step 2: Identify the separate performance obligations.
BEAN has two performance obligations.

259. LO 1
Extended Example of Five-Step Process
The transaction price is $8 ($3 + $5).
Step 3: Determine the transaction price.
BEAN has two performance obligations.
►Each obligation is distinct and not interrelated (and priced
separately); no allocation of the transaction price is necessary.
►The coffee sale is recorded at $3 and the sale of the bagels is
priced at $5.
Step 4: Allocate the transaction price to the separate
performance obligations.

260. LO 1
Extended Example of Five-Step Process
BEAN has satisfied both performance obligations when the coffee
and bagels are given to Tyler (control of the product has passed to
the customer).
Step 5: Recognize revenue when each performance
obligation is satisfied.
BEAN should recognize $8 ($3 + $5) of revenue
when Tyler receives the coffee and bagels.

261. LO 1
Extended Example of Five-Step Process
Determining the Transaction Price—Step 3
BEAN is interested in stimulating sales of its Smoke Jumper coffee
beans on Tuesdays, a slow business day for the store. Normally,
these beans sell for $10 for a 12-ounce bag, but BEAN decides to cut
the price by $1 when customers buy them on Tuesdays (the
discounted price is now $9 per bag). Tyler has come to the store on a
Tuesday, decides to purchase a bag of Smoke Jumper beans, and
pays BEAN $9.
Question: How much revenue should BEAN recognize on this
transaction?

262. LO 1
Extended Example of Five-Step Process
A valid contract exists as it meets the five conditions necessary for a
contract to be enforceable as discussed in the previous example.
Step 1: Identify the contract with customers.
BEAN has a performance obligation to provide a bag of Smoke
Jumper coffee beans to Tyler.
BEAN has no other performance obligation to provide a product or
service.
Step 2: Identify the separate performance obligations.

263. LO 1
The transaction for a bag of Smoke Jumper beans sold to Tyler is
$9, not $10.
Step 3: Determine the transaction price.
There is only one performance obligation, no allocation is necessary.
Step 4: Allocate the transaction price to the separate
performance obligations.
BEAN has satisfied both performance obligations.
Step 5: Recognize revenue when each performance
obligation is satisfied.
BEAN should recognize $9 of revenue when Tyler receives
the Smoke Jumper coffee beans.

264. LO 1
Extended Example of Five-Step Process
Allocating the Transaction Price to Separate
Performance Obligations—Step 4
Transaction price is allocated to the various performance obligations
based on their relative standalone selling prices.
BEAN offers customers a $2 discount on the purchase of a large cup
of coffee when they buy a bag of its premium Motor Moka beans
(which normally sell for $12) at the same time. As indicated earlier, a
large cup of coffee normally retails for $3 at BEAN.
Question: How much revenue should BEAN recognize on the
purchase of these two items?

265. LO 1
Extended Example of Five-Step Process
A valid contract exists as it meets the five conditions necessary for a
contract to be enforceable as discussed in the previous example.
Step 1: Identify the contract with customers.
The bag of Motor Moka beans and the large cup of coffee are distinct
from one another and are not highly dependent on or highly
interrelated with the other.
Step 2: Identify the separate performance obligations.

266. LO 1
Extended Example of Five-Step Process
The transaction price is $13 ($12 + $1).
Step 3: Determine the transaction price.
BEAN allocates the transaction price to the two performance
obligations based on their relative standalone selling prices as
follows.
Step 4: Allocate the transaction price to the separate
performance obligations.

267. LO 1
Extended Example of Five-Step Process
BEAN allocates the transaction price to the two performance
obligations based on their relative standalone selling prices as
follows.
Step 4: Allocate the transaction price to the separate
performance obligations.Standalone
Product Selling Price
Beans (one bag) $12 80%($12 ÷ $15)10.40$ ($13 × 80%)
Large cup of coffee 3 20% ($3 ÷ $15) 2.60 ($13 × 20%)
Total $15 100% 13.00$
Percentage Percentage
The total transaction price ($13) is allocated $10.40 to the bag of
Motor Moka beans and $2.60 to the large cup of coffee.

268. LO 1
Extended Example of Five-Step Process
BEAN has satisfied both performance obligations as control of the
bag of Motor Moka beans and the large cup of coffee has passed to
Tyler.
Step 5: Recognize revenue when each performance
obligation is satisfied.
BEAN should recognize revenue of $13, comprised of
revenue from the sale of the Motor Mokabeans at
$10.40 and the sale of the large cup of coffee at $2.60.

269. LO 1
Extended Example of Five-Step Process
BEAN satisfied its performance obligation(s) when Tyler obtained
control of the product(s).
Indicators that Tyler has obtained control are as follows:
a.BEAN has the right to payment for the coffee.
b.BEAN has transferred legal title to the coffee.
c.BEAN has transferred physical possession of the coffee.
d.Tyler has significant risks and rewards of ownership.
e.Tyler has accepted the asset.
Step 5: Recognize revenue when each performance
obligation is satisfied.

270. Contract:
Agreement between two or more parties that creates
enforceable rights or obligations.
Can be
►written,
►oral, or
►implied from customary business practice.
LO 2
The Five-Step
Process Revisited
Identifying the Contract with Customers—Step 1
LEARNING OBJECTIVE 2
Understand and apply the five-
step revenue recognition
process.

271. Accounting
Revenue cannot be recognized until a contract exists.
Company obtains rights to receive consideration and
assumes obligations to transfer goods or services.
Rights and performance obligations gives rise to an (net)
asset or (net) liability.
Company does not recognize contract assets or liabilities
until one or both parties perform under the contract.
LO 2
Contract with Customers—Step 1

272. Facts: On March 1, 2019, Margo Company enters into a contract to transfer a
product to Soon Yoon on July 31, 2019. The contract is structured such that
Soon Yoon is required to pay the full contract price of $5,000 on August 31,
2019.The cost of the goods transferred is $3,000. Margo delivers the product to
Soon Yoon on July 31, 2019.
LO 2
CONTRACTS AND RECOGNITION
Question: What journal entries should Margo Company make in regards to this
contract in 2019?
The journal entry to record the sale and related cost of goods sold is as follows.
July 31, 2019
Accounts Receivable 5,000
Sales Revenue 5,000
Cost of Goods Sold 3,000
Inventory 3,000
Contract with Customers—Step 1 ILLUSTRATION 18.3
Basic Revenue
Transaction

273. LO 2
CONTRACTS AND RECOGNITION
Cash 5,000
Accounts Receivable 5,000
Facts: On March 1, 2019, Margo Company enters into a contract to transfer a
product to Soon Yoon on July 31, 2019. The contract is structured such that
Soon Yoon is required to pay the full contract price of $5,000 on August 31,
2019.The cost of the goods transferred is $3,000. Margo delivers the product to
Soon Yoon on July 31, 2019.
Question: What journal entries should Margo Company make in regards to this
contract in 2019?
Margo makes the following entry to record the receipt of cash on August 31, 2019.
August 31, 2019
Contract with Customers—Step 1 ILLUSTRATION 18.3
Basic Revenue
Transaction

274. LO 2
A performance obligation is a promise to provide a distinct
product or service to a customer.
A product or service is distinct when a customer is able to
benefit from a good or service on its own or
together with other readily available resources.
The objective is to determine whether the nature of a
company’s promise is to transfer individual goods and services
to the customer or to transfer a combined item (or items) for
which individual goods or services are inputs.
Separate Performance Obligations—Step 2

275. AssumethatTataMotors(IND)sellsanautomobiletoMarquartAuto
Dealersatapricethatincludessixmonthsoftelematicsservicessuchas
navigationandremotediagnostics.Thesetelematicsservicesare
regularlysoldonastandalonebasisbyTataMotorsforamonthlyfee.
Afterthesix-monthperiod,theconsumercanrenewtheseservicesona
feebasiswithTataMotors.ThequestioniswhetherTataMotorssold
oneortwoproducts.
ILLUSTRATION
IfwelookatTataMotors’objective,itappearsthatitistoselltwogoods,
theautomobileandthetelematicservices.Botharedistinct(theycanbe
soldseparately)andarenotinterdependent.
LO 2
Separate Performance Obligations—Step 2

276. SoftTechInc.licensescustomer-relationshipsoftwaretoLopez
Company.Inadditiontoprovidingthesoftwareitself,SoftTechpromises
toprovideconsultingservicesbyextensivelycustomizingthesoftwareto
Lopez’sinformationtechnologyenvironment,foratotalconsiderationof
$600,000.Inthiscase,SoftTechisprovidingasignificantserviceby
integratingthegoodsandservices(thelicenseandtheconsulting
service)intoonecombineditemforwhichLopezhascontracted.In
addition,thesoftwareissignificantlycustomizedbySoftTechin
accordancewithspecificationsnegotiatedbyLopez.Dothesefacts
describeasingleorseparateperformanceobligation?
ILLUSTRATION
Thelicenseandtheconsultingservicesaredistinctbutinterdependent,
andthereforeshouldbeaccountedforasoneperformanceobligation.
LO 2
Separate Performance Obligations—Step 2

277. LO 2
Determining Transaction Price—Step 3
Transaction price
Amount of consideration that company expects to receive
from a customer.
In a contract is often easily determined because customer
agrees to pay a fixed amount.
Other contracts, companies must consider:
►Variable consideration
►Time value of money
►Non-cash consideration
►Consideration paid or payable to customers

278. LO 2
Determining Transaction Price—Step 3
Variable Consideration
Price dependent on future events.
►May include price increases, volume discounts,
rebates, credits, performance bonuses, or royalties.
Companies estimate amount of revenue to recognize.
►Expectedvalue
►Most likely amount

279. ILLUSTRATION 18.4 Estimating Variable Consideration
Expected Value: Probability-weighted amount in a range of possible
consideration amounts.
Most Likely Amount: The single most likely amount in a range of possible
consideration outcomes.
May be appropriate if a company has a large number of contracts with
similar characteristics.
Can be based on a limited number of discrete outcomes and probabilities.
May be appropriate if the contract has only two possible outcomes.
Determining Transaction Price—Step 3
LO 2

280. Facts: Peabody Construction Company enters into a contract with a
customer to build a warehouse for $100,000, with a performance bonus of
$50,000 that will be paid based on the timing of completion. The amount of
the performance bonus decreases by 10% per week for every week beyond
the agreed-upon completion date. The contract requirements are similar to
contracts that Peabody has performed previously, and management
believes that such experience is predictive for this contract. Management
estimates that there is a 60% probability that the contract will be completed
by the agreed-upon completion date, a 30% probability that it will be
completed 1 week late, and only a 10% probability that it will be completed 2
weeks late.
LO 2
Variable Consideration
ESTIMATING VARIABLE CONSIDERATION
Question:How should Peabody account for this revenue arrangement?
ILLUSTRATION 18.5
Transaction Price

281. Management has concluded that the probability-weighted method is the
most predictive approach:
LO 2
Variable Consideration
Question:How should Peabody account for this revenue arrangement?
On time:60% chance of $150,000 = $ 90,000
1 week late:30% chance of $145,000 = 43,500
2 weeks late:10% chance of $140,000 = 14,000
$147,500
Most likely outcome, if management believes they will meet the deadline
and receive the $50,000 bonus, the total transaction price would be?
$150,000 (the outcome with 60% probability)
ILLUSTRATION 18.5
Transaction Price

282. LO 2
Companies only allocate variable consideration if it is
reasonably assured that it will be entitled to the amount.
Companies only recognize variable consideration if
1.they have experience with similar contracts and are
able to estimate the cumulative amount of revenue,
and
2.based on experience, they do not expect a significant
reversal of revenue previously recognized.
If these criteria are not met, revenue recognition is
constrained.
Variable Consideration

283. LO 2
Determining Transaction Price—Step 3
Time Value of Money
When contract (sales transaction) involves a significant
financing component.
►Interest accrued on consideration to be paid over
time.
►Fair value determined either by measuring the
consideration received or by discounting the payment
using an imputed interest rate.
►Company reports as interest expense or interest
revenue.

284. Facts: On July 1, 2019, SEK Company sold goods to Grant Company for
R$900,000 in exchange for a 4-year, zero-interest-bearing note with a face
amount of R$1,416,163. The goods have a cost on SEK’s books of R$590,000.
LO 2
Time Value of Money
EXTENDED PAYMENT TERMS
Questions: (a) How much revenue should SEK Company record on July 1, 2019?
(b) How much revenue should it report related to this transaction on December
31, 2019?
Entry to record SEK’s sale to Grant Company on July 1, 2019, is as follows.
Notes Receivable 900,000
Sales Revenue 900,000
Cost of Goods Sold 590,000
Inventory 590,000
ILLUSTRATION 18.7
Transaction Price -
Extended Payment Terms

285. LO 2
Time Value of Money
EXTENDED PAYMENT TERMS
Questions: (a) How much revenue should SEK Company record on July 1, 2019?
(b) How much revenue should it report related to this transaction on December
31, 2019?
Entry to record interest revenue at the end of the year, December 31, 2019.
Notes Receivable 54,000
Interest Revenue (12% x ½ x R$900,000) 54,000
Companies are not required to reflect the time value of money if the time period
for payment is less than a year.
ILLUSTRATION 18.12
Transaction Price -
Extended Payment Terms
Facts: On July 1, 2019, SEK Company sold goods to Grant Company for
R$900,000 in exchange for a 4-year, zero-interest-bearing note with a face
amount of R$1,416,163. The goods have a cost on SEK’s books of R$590,000.

286. LO 2
Determining Transaction Price—Step 3
Non-Cash Consideration
Goods, services, or other non-cash consideration.
Companies sometimes receive contributions (e.g.,
donations and gifts).
Customers sometimes contribute goods or services, such
as equipment or labor, as consideration for goods
provided or services performed.
Companies generally recognize revenue on the basis of
the fair value of what is received.

287. LO 2
Determining Transaction Price—Step 3
Consideration Paid or Payable to Customers
May include discounts, volume rebates, coupons, free
products, or services.
In general, these elements reduce the consideration
received and the revenue to be recognized.

288. Facts:Sansung Company offers its customers a 3% volume discount if they
purchase at least ¥2 million of its product during the calendar year. On March 31,
2019, Sansung has made sales of ¥700,000 to Artic Co. In the previous 2 years,
Sansung sold over ¥3,000,000 to Artic in the period April 1 to December 31.
LO 2
Consideration Paid or Payable
VOLUME DISCOUNT
Questions: How much revenue should Sansung recognize for the first 3 months
of 2019?
Sansung makes the following entry on March 31, 2019.
Accounts Receivable 679,000
Sales Revenue 679,000
Sansung should reduce its revenue by ¥21,000 (¥700,000 x 3%)because it is
probable that it will provide this rebate.
ILLUSTRATION 18.8
Transaction Price –
Volume Discount

289. LO 2
Questions: How much revenue should Sansung recognize for the first 3 months
of 2019?
Assuming Sansung’s customer meets the discount threshold, Sansung makes
the following entry.
Cash 679,000
Accounts Receivable 679,000
If Sansung’s customer fails to meet the discount threshold, Sansung makes the
following entry upon payment.
Cash 700,000
Accounts Receivable 679,000
Sales Discounts Forfeited 21,000
Consideration Paid or Payable
ILLUSTRATION 18.8
Transaction Price –
Volume Discount

290. Allocating Transaction Price to Separate
Performance Obligations—Step 4
LO 2
Based on their relative fair values.
Best measure of fair value is what the company could
sell the good or service for on a standalone basis.
If not available, companies should use their best estimate
of what the good or service might sell for as a standalone
unit.

291. LO 2
Allocating Transaction Price to Separate
Performance Obligations—Step 4 ILLUSTRATION 18.9
Transaction Price—
Allocation

292. Facts:Handler Company is an established manufacturer of equipment
used in the construction industry. Handler’s products range from small to
large individual pieces of automated machinery to complex systems
containing numerous components. Unit selling prices range from
$600,000 to $4,000,000 and are quoted inclusive of installation and
training. The installation process does not involve changes to the
features of the equipment and does not require proprietary information
about the equipment in order for the installed equipment to perform to
specifications.
LO 2
Allocating Transaction Price
MULTIPLE PERFORMANCE OBLIGATIONS
ILLUSTRATION 18.12
Multiple Performance
Obligations—Product,
Installation, and Service
(continued)

293. Handler has the following arrangement with Chai Company.
• Chai purchases equipment from Handler for a price of $2,000,000 and
chooses Handler to do the installation. Handler charges the same
price for the equipment irrespective of whether it does the installation
or not. (Some companies do the installation themselves because they
either prefer their own employees to do the work or because of
relationships with other customers.) The installation service included
in the arrangement is estimated to have a standalone selling price of
$20,000.
LO 2
Allocating Transaction Price
MULTIPLE PERFORMANCE OBLIGATIONS
ILLUSTRATION 18.12
Multiple Performance
Obligations—Product,
Installation, and Service
(continued)

294. Handler has the following arrangement with Chai Company.
• The standalone selling price of the training sessions is estimated at
$50,000. Other companies can also perform these training services.
• Chai is obligated to pay Handler the $2,000,000 upon the delivery and
installation of the equipment.
• Handler delivers the equipment on September 1, 2019, and
completes the installation of the equipment on November 1, 2019
(transfer of control is complete). Training related to the equipment
starts once the installation is completed and lasts for 1 year. The
equipment has a useful life of 10 years.
LO 2
Allocating Transaction Price
MULTIPLE PERFORMANCE OBLIGATIONS
ILLUSTRATION 18.12
Multiple Performance
Obligations—Product,
Installation, and Service
(continued)

295. Handler’s primary objective is to sell equipment. The other services
(installation and training) can be performed by other parties if necessary.
As a result, the equipment, installation, and training are three separate
products or services. Each of these items has a standalone selling price
and is not interdependent.
LO 2
Allocating Transaction Price
Question: (a) What are the performance obligations for purposes of
accounting for the sale of the equipment?
ILLUSTRATION 18.12
Multiple Performance
Obligations—Product,
Installation, and Service
(continued)

296. The total revenue of $2,000,000 should be allocated to the three
components based on their relative standalone selling prices. In this
case, the standalone selling price of the equipment is $2,000,000, the
installation fee is $20,000, and the training is $50,000. The total
standalone selling price therefore is $2,070,000 ($2,000,000 + $20,000 +
$50,000). The allocation is as follows.
Equipment $1,932,367 [($2,000,000 ÷$2,070,000) ×$2,000,000]
Installation $19,324 [($20,000 ÷$2,070,000) ×$2,000,000]
Training $48,309 [($50,000 ÷$2,070,000) ×$2,000,000]
LO 2
Allocating Transaction Price
Question: (b) If there is more than one performance obligation, how
should the payment of $2,000,000 be allocated to various
components?
ILLUSTRATION 18.12
Multiple Performance
Obligations—Product,
Installation, and Service
(continued)

297. Handler makes the following entry on November 1, 2019, to record both
sales revenue and service revenue on the installation, as well as
unearned service revenue.
November 1, 2019
LO 2
Allocating Transaction Price
Question: (b) If there is more than one performance obligation, how
should the payment of $2,000,000 be allocated to various
components?
ILLUSTRATION 18.12
Multiple Performance
Obligations—Product,
Installation, and Service
(continued)
Cash 2,000,000
Service Revenue (installation) 19,324
Unearned Service Revenue 48,309
Sales Revenue 1,932,367

298. Assuming the cost of the equipment is $1,500,000, the entry to record
cost of goods sold is as follows.
November 1, 2019
LO 2
Allocating Transaction Price
Question: (b) If there is more than one performance obligation, how
should the payment of $2,000,000 be allocated to various
components?
ILLUSTRATION 18.12
Multiple Performance
Obligations—Product,
Installation, and Service
(continued)
Handler recognizes revenue from the sale of the equipment once the
installation is completed on November 1, 2019. In addition, it recognizes
revenue for the installation fee because these services have been
performed.
Cost of Goods Sold 1,500,000
Inventory 1,500,000

299. Handler recognizes the training revenues on a straight-line basis starting
on November 1, 2019, or $4,026 ($48,309 ÷12) per month for 1 year
(unless a more appropriate method such as the percentage-of-
completion method—discussed in the next section—is warranted). The
journal entry to recognize the training revenue for 2 months in 2019 is as
follows.
December 31, 2019
LO 2
Allocating Transaction Price
Question: (b) If there is more than one performance obligation, how
should the payment of $2,000,000 be allocated to various
components?
ILLUSTRATION 18-12
Multiple Performance
Obligations—Product,
Installation, and Service
(continued)
Unearned Service Revenue 8,052
Service Revenue (training) ($4,026 ×2) 8,052

300. Therefore, Handler recognizes revenue at December 31, 2019, in the
amount of $1,959,743 ($1,932,367 + $19,324 + $8,052). Handler makes
the following journal entry to recognize the remaining training revenue in
2020, assuming adjusting entries are made at year-end.
December 31, 2020
LO 2
Allocating Transaction Price
Question: (b) If there is more than one performance obligation, how
should the payment of $2,000,000 be allocated to various
components?
ILLUSTRATION 18-12
Multiple Performance
Obligations—Product,
Installation, and Service
Unearned Service Revenue 40,257
Service Revenue (training) ($48,309 − $8,052) 40,257

301. LO 2
Recognizing Revenue When (or as) Each
Performance Obligation Is Satisfied—Step 5
Company satisfies its performance obligation when the
customer obtains control of the good or service.
Change in Control Indicators
1.Company has a right to payment for asset.
2.Company has transferred legal title to asset.
3.Company has transferred physical possession of asset.
4.Customer has significant risks and rewards of ownership.
5.Customer has accepted the asset.

302. LO 2
Recognizing revenue from a performance obligation over
time
Measure progress toward completion
►Method for measuring progress should depict transfer
of control from company to customer.
►Most common are cost-to-cost and units-of-delivery
methods.
►Objective of methods is to measure extent of progress
in terms of costs, units, or value added.
Recognizing Revenue When (or as) Each
Performance Obligation Is Satisfied—Step 5

303. LO 2
Stepin Process
1.Identify the
contract with
customers.
Description
A contract is an
agreement that creates
enforceable rights or
obligations.
Implementation
A company applies the revenue
guidance to contracts.
ILLUSTRATION 18.15
Summary of the
Five-Step Revenue
Recognition Process
Recognizing Revenue When (or as) Each
Performance Obligation Is Satisfied—Step 5

304. LO 2
Stepin Process
2.Identify the
separate
performance
obligations in
the contract
Description
A performance obligation
is a promise in a contract
to provide a product or
service to a customer.
A performance obligation
exists if the customer can
benefit from the good or
service on its own or
together with other readily
available resources.
Implementation
A contract may be comprised of
multiple performance
obligations.
Accounting is based on
evaluation of whether the
product or service is distinct
within the contract.
If each of the goods or services
is distinct, but is interdependent
and interrelated, these goods
and services are combined and
reported as one performance
obligation.
ILLUSTRATION 18.15
Summary of the
Five-Step Revenue
Recognition Process
Recognizing Revenue When (or as) Each
Performance Obligation Is Satisfied—Step 5

305. LO 2
Stepin Process
3.Determine the
transaction
price.
Description
Transaction price is the
amount of consideration
that a company expects to
receive from a customer
in exchange for
transferring goods and
services.
Implementation
In determining the transaction
price, companies must consider
the following factors:
1.variable consideration,
2.time value of money,
3.non-cash consideration, and
4.consideration paid or
payable to customer.
ILLUSTRATION 18.15
Summary of the
Five-Step Revenue
Recognition Process
Recognizing Revenue When (or as) Each
Performance Obligation Is Satisfied—Step 5

306. LO 2
Stepin Process
4.Allocate the
transaction
price to the
separate
performance
obligation.
Description
If more than one
performance obligation
exists, allocate the
transaction price based
on relative fair values.
Implementation
The best measure of fair value
is what the good service could
be sold for on a standalone
basis (standalone selling price).
Estimates of standalone selling
price can be based on
1.adjusted market
assessment,
2.expected cost-plus a margin
approach, or
3.a residual approach.
ILLUSTRATION 18.15
Summary of the
Five-Step Revenue
Recognition Process
Recognizing Revenue When (or as) Each
Performance Obligation Is Satisfied—Step 5

307. LO 2
Stepin Process
5.Recognize
revenue when
each
performance
obligation is
satisfied.
Description
A company satisfies its
performance obligation
when the customer
obtains control of the
good or service.
Implementation
Companies satisfy performance
obligations either at a point in
time or over a period of time.
Companies recognize revenue
over a period of time if one of
the following criteria is met:
1.customer receives and
consumes the benefits as
the seller performs,
2.customer controls the asset
as it is created, or
3.company does not have an
alternative use for the asset.
ILLUSTRATION 18.15
Summary of the
Five-Step Revenue
Recognition Process
Recognizing Revenue When (or as) Each
Performance Obligation Is Satisfied—Step 5

308. Accounting for Revenue
Recognition Issues
LO 3
Sales returns and allowances
Repurchase agreements
Bill and hold
Principal-agent relationships
Consignments
Warranties
Non-refundable upfront fees
LEARNING OBJECTIVE 3
Apply the five-step process to
major revenue recognition
issues.

309. Sales Returns and Allowances
LO 3
Right of return is granted for product for various
reasons (e.g., dissatisfaction with product).
Company returning the product receives any
combination of the following.
1.Full or partial refund of any consideration paid.
2.Credit that can be applied against amounts owed,
or that will be owed, to the seller.
3.Another product in exchange.

310. Illustration: Assume that on January 12, 2019, Venden NV sells 100
cameras for €100 each on account to Amaya SA. Venden allows
Amaya to return any unused cameras within 45 days of purchase. The
cost of each product is €60. Venden estimates that:
1.Three products will be returned.
2.The costs of recovering the products will be immaterial.
3.The returned products are expected to be resold at a profit.
LO 3
Credit Sales with Returns and Allowances
To record the sale of the cameras January 12, 2019.
Accounts Receivable 10,000
Sales Revenue (100 ×€100) 10,000
Cost of Goods Sold 6,000
Inventory (100 ×€60) 6,000

311. On January 24, Amaya returns two of the cameras. On January 31,
Venden prepares financial statements and determines that it is likely
that only one more camera will be returned. Venden makes the
following entries related to these transactions.
LO 3
To record the return of the cameras January 24, 2019.
Sales Returns and Allowances 200
Accounts Receivable (2 ×€100) 200
Returned Inventory 120
Cost of Goods Sold (2 ×€60) 120
Credit Sales with Returns and Allowances

312. Vendenoriginally estimated that the most likely outcome was that
three cameras would be returned. Venden believes the original
estimate is correct and makes the following adjusting entries to
account for expected returns at January 31, 2019.
LO 3
To record expected sales returns on January 31, 2019.
Sales Returns and Allowances 100
Allowance for Sales Returns and Allowances 100
To record the expected return of the one camera
Estimated Inventory Returns 60
Cost of Goods Sold (1 ×€60) 60
Credit Sales with Returns and Allowances

313. Venden’s income statement for the month of January.
LO 3
Credit Sales with Returns and Allowances
Venden’s statement of financial position as of January 31, 2019.
ILLUSTRATION 18.16
ILLUSTRATION 18.17

314. Illustration: Assume now that on January 12, 2019, Venden NV sells
100 cameras for €100 each for cash to Amaya SA. Venden allows
Amaya to return any unused cameras within 45 days of purchase. The
cost of each product is €60. Venden estimates that:
1.Three products will be returned.
2.The costs of recovering the products will be immaterial.
3.The returned products are expected to be resold at a profit.
LO 3
Cash Sales with Returns and Allowances
To record the sale of the cameras January 12, 2019.
Cash 10,000
Sales Revenue (100 ×€100) 10,000
Cost of Goods Sold 6,000
Inventory (100 ×€60) 6,000

315. Assuming that Venden did not pay cash at the time of the return of the
two cameras to Amaya on January 24, 2019, the entries to record the
return of the two cameras and related cost of goods sold are as
follows.
LO 3
To record the return of the cameras January 24, 2019.
Sales Returns and Allowances 200
Accounts Payable (2 ×€100) 200
Returned Inventory 120
Cost of Goods Sold (2 ×€60) 120
Credit Sales with Returns and Allowances

316. On January 31, 2019, Venden prepares financial statements. As
indicated earlier, Vendenestimates that the most likely outcome is that
one more camera will be returned. Venden therefore makes the
following adjusting entries.
LO 3
To record expected sales returns on January 31, 2019.
Sales Returns and Allowances 100
Accounts Payable (1 ×€100) 100
To record the expected return of the one camera
Estimated Inventory Returns 60
Cost of Goods Sold (1 ×€60) 60
Credit Sales with Returns and Allowances

317. Venden’s income statement for the month of January.
LO 3
Credit Sales with Returns and Allowances
Venden’s statement of financial position as of January 31, 2019.
ILLUSTRATION 18.18
ILLUSTRATION 18.19

318. Repurchase Agreements
LO 3
Allows company to transfer an asset to a customer but
have an unconditional (forward) obligation or
unconditional right (call option) to repurchase the asset
at a later date.
If the obligation or right to repurchase is for an amount
greater than or equal to selling price, then transaction
is a financing transaction.

319. Facts:Morgan Ltd., an equipment dealer, sells equipment on January 1,
2019, to Lane Company for £100,000. It agrees to repurchase this
equipment (an unconditional obligation) on December 31, 2020, for a price
of £121,000.
LO 3
REPURCHASE AGREEMENT
Question: How should Morgan Inc. record this transaction?
ILLUSTRATION 18.20
Recognition—Repurchase
AgreementRepurchase Agreements
Assuming an interest rate of 10% is imputed from the agreement, Morgan
makes the following entry to record the financingon January 1, 2019.
Cash 100,000
Liability to Lane Company 100,000

320. LO 3
ILLUSTRATION 18.22
Recognition—Repurchase
AgreementRepurchase Agreements
Morgan records interest on December 31, 2019, as follows.
Interest Expense 10,000
Liability to Lane Construction (£100,000 x 10%) 10,000
Question: How should Morgan record this transaction?
Morgan records interest and retirement of its liability to Lane on December
31, 2020, as follows.
Interest Expense 11,000
Liability to Lane Construction (£110,000 x 10%) 11,000
Liability to Lane Construction 121,000
Cash (£100,000 + £10,000 + £11,000) 121,000

321. Bill-and-Hold Arrangements
LO 3
Contract under which an entity bills a customer for a
product but the entity retains physical possession of
the product until a point in time in the future.
Result when buyer is not yet ready to take delivery but
does take title and accepts billing.

322. Facts:Butler A.Ş. sells ₺450,000 (cost ₺280,000) of fireplaces on March 1,
2019, to a local coffee shop, Baristo, which is planning to expand its
locations around the city. Under the agreement, Baristo asks Butler to retain
these fireplaces in its warehouses until the new coffee shops that will house
the fireplaces are ready. Title passes to Baristo at the time the agreement is
signed.
LO 3
BILL AND HOLD
Question: When should Butler recognize the revenue from this bill-
and-hold arrangement?
ILLUSTRATION 18.21
Recognition—Bill and Hold
Butler determines when it has satisfied its performance obligation to transfer
a product by evaluating when Baristo obtains control of that product.
Bill-and-Hold Arrangements

323. LO 3
Question: When should Butler recognize the revenue from this bill-
and-hold arrangement?
ILLUSTRATION 18.23
Recognition—Bill and Hold
For Baristo to have obtained control of a product in a bill-and-hold
arrangement, all of the following criteria should be met:
(a) The reason for the bill-and-hold arrangement must be substantive.
(b) The product must be identified separately as belonging to Baristo.
(c) The product currently must be ready for physical transfer to Baristo.
(d)Butler cannot have the ability to use the product or to direct it to another
customer.
In this case, it appears that the above criteria were met, and therefore
revenue recognition should be permitted at the time the contract is signed.
Bill-and-Hold Arrangements

324. LO 3
Question: When should Butler recognize the revenue from this bill-
and-hold arrangement?
ILLUSTRATION 18.23
Recognition—Bill and HoldBill-and-Hold Arrangements
March 1, 2019
Butler makes the following entries to record the bill-and-hold sale and
related cost of goods sold.
Accounts receivable 450,000
Sales Revenue 450,000
Cost of Goods Sold 280,000
Inventory 280,000

325. Principal-Agent Relationships
LO 3
Principal’sperformance obligation is to provide goods or
perform services for a customer.
Agent’sperformance obligation is to arrange for principal to
provide goods or services to a customer.
Examples:
►Preferred Travel Company (agent) facilitates the booking
of cruise excursions by finding customers for Regency
Cruise Company (principal).
►Priceline(USA) (agent) facilitates the sale of various
services such as car rentals at Hertz (USA) (principal).
Revenue for agent is amount of commission received.

326. Consignments
LO 3
Manufacturers (or wholesalers) deliver goods but retain
title to the goodsuntil they are sold.
Consignor(manufacturer or wholesaler) ships
merchandise to the consignee(dealer), who is to act as
an agent for the consignor in selling the merchandise.
Consignormakes a profit on the sale.
►Carries merchandise as inventory.
Consigneemakes a commission on the sale.

327. LO 3
ILLUSTRATION 18.23
Recognition—Sales on
ConsignmentConsignments

328. LO 3
ILLUSTRATION 18.23

329. LO 3
ILLUSTRATION 18.23

330. LO 3
ILLUSTRATION 18.23

331. LO 3
ILLUSTRATION 18.25
Recognition—Sales on
ConsignmentConsignments

332. Warranties
LO 3
Two types of warrantiesto customers:
1.Product meets agreed-upon specifications in contract at
time product is sold.
a.Warranty is included in sales price (assurance-type
warranty).
2.Not included in sales price of product (service-type
warranty).
a.Recorded as a separate performance obligation.

333. Facts:MaverickCompanysold1,000RollomaticsonOctober1,2019,at
totalpriceof$6,000,000,withawarrantyguaranteethattheproductwas
freeofdefects.ThecostoftheRollomaticsis$4,000,000.Thetermofthis
assurancewarrantyis2years,withanestimatedcostof$80,000.In
addition,Mavericksoldextendedwarrantiesrelatedto400Rollomaticsfor3
yearsbeyondthe2-yearperiodfor$18,000.OnNovember22,2019,
Maverickincurredlaborcostsof$3,000andpartcostsof$25,000relatedto
theassurancewarranties.Maverickpreparesfinancialstatementson
December31,2019.Itestimatesthatitsfutureassurancewarrantycostswill
total$44,000atDecember31,2019.
WARRANTIES
Question:WhatarethejournalentriesthatMaverickCompanyshould
makeshouldmakein2019relatedtothesaleoftheRollomaticsandthe
assuranceandextendedwarranties?
ILLUSTRATION 18.26
Performance Obligations
and WarrantiesWarranties
LO 3

334. October 1, 2019
To record the sale of the Rollomatics and the related extended warranties:
Cash ($6,000,000 + $18,000) 6,018,000
Sales Revenue 6,000,000
Unearned Warranty Revenue 18,000
To record the cost of goods sold and reduce the inventory of Rollomatics:
Cost of Goods Sold 4,000,000
Inventory 4,000,000
Warranties
LO 3
Question:WhatarethejournalentriesthatMaverickCompanyshould
makeshouldmakein2019relatedtothesaleoftheRollomaticsandthe
assuranceandextendedwarranties?
ILLUSTRATION 18.24
Recognition—Performance
Obligations and Warranties

335. November 22, 2019
To record the warranty costs incurred:
Warranty Expense 28,000
Salaries and Wages Payable 3,000
Inventory (parts) 25,000
December 31, 2019
To record the adjusting entry related to its assurance warranty at year end:
Warranty Expense 44,000
WarrantyLiability 44,000
ILLUSTRATION 18.24
Recognition—Performance
Obligations and WarrantiesWarranties
LO 3
Question:WhatarethejournalentriesthatMaverickCompanyshould
makeshouldmakein2019relatedtothesaleoftheRollomaticsandthe
assuranceandextendedwarranties?

336. Non-Refundable Upfront Fees
LO 3
Payments from customers before
►Delivery of a product.
►Performance of a service.
Generally relate to initiation, activation, or setup of a
good or service to be provided or performed in the future.
Most cases, upfront payments are nonrefundable.
►Examples include:
Membership fee in a health club.
Activation fees for phone, Internet, or cable.

337. Presentation
Presentation and Disclosure
LO 4
Contract Assets and Liabilities
Contract assets are of two types:
1.Unconditional rights to receive consideration
because company has satisfied its performance
obligation.
2.Conditionalrightsto receive consideration because
company has satisfied one performance obligation
but must satisfyanother performance obligation
before it can bill the customer.
LEARNING OBJECTIVE 4
Describe presentation and
disclosure regarding
revenue.

338. Facts:OnJanuary1,2019,FinnASAentersintoacontracttotransfer
ProductAandProductBtoObermineOverstockfor€100,000.Thecontract
specifiesthatpaymentofProductAwillnotoccuruntilProductBisalso
delivered.Inotherwords,paymentwillnotoccuruntilbothProductAand
ProductBaretransferredtoObermine.Finndeterminesthatstandalone
sellingpricesare€30,000forProductAand€70,000forProductB.Finn
deliversProductAtoObermineonFebruary1,2019.OnMarch1,2019,
FinndeliversProductBtoObermine.
LO 4
CONTRACT ASSET
Question: What journal entries should Finn Company make in regards
to this contract in 2019?
ILLUSTRATION 18.27
Contract Asset Recognition
and PresentationPresentation

339. Contract Asset 30,000
Sales Revenue 30,000
Question: What journal entries should Finn Company make in regards
to this contract in 2019?
On February 1, 2019, Finn records the following entry:
On February 1, Finn does not record an accounts receivable because it does
not have an unconditional right to receive the €100,000 unless it also
transfers Product B to Obermine. When Finn transfers Product B on March
1, 2019, it makes the following entry.
LO 4
ILLUSTRATION 18.27
Contract Asset Recognition
and Presentation
Accounts Receivable 100,000
Contract Asset 30,000
Sales Revenue 70,000
Presentation

340. Facts:OnMarch1,2019,HenlyCompanyentersintoacontracttotransfera
producttoPropelInc.onJuly31,2019.ItisagreedthatPropelwillpaythe
fullpriceof$10,000inadvanceonApril1,2019.Thecontractisnon-
cancelable.Propel,however,doesnotpayuntilApril15,2019,andHenly
deliverstheproductonJuly31,2019.Thecostoftheproductis$7,500.
LO 4
CONTRACT LIABILITY
Question: What journal entries are required in 2019?
ILLUSTRATION 18.28
Contract Liability Recognition
and Presentation
No entry is required on March 1, 2019:
►Neither party has performed on the contract.
►Neither party has an unconditional right as of March 1, 2019.
Presentation

341. LO 4
Question: What journal entries are required in 2019?
Cash 10,000
Unearned Sales Revenue 10,000
On receiving the cash on April 15, 2019, Henly records the following entry.
Unearned Sales Revenue 10,000
Sales Revenue 10,000
On satisfying the performance obligation on July 31, 2019, Henly records the
following entry to record the sale.
ILLUSTRATION 18.28
Contract Liability Recognition
and Presentation
Cost of Good Sold 7,500
Inventory 7,500
In addition, Henly records cost of goods sold as follows.
Presentation

342. Contract Modifications
Change in contract terms while it is ongoing.
Companies determine
►whether a new contract (and performance
obligations) results or
►whether it is a modification of the existing contract.
LO 4
Presentation

343. Separate Performance Obligation
Account for as a new contract if bothof the following
conditions are satisfied:
►Promised goods or services are distinct (i.e.,
company sells them separately and they are not
interdependent with other goods and services), and
►The company has the right to receive an amount of
consideration that reflects the standalone selling
priceof the promised goods or services.
LO 4
Contract Modifications

344. For example, Crandall Co. has a contract to sell 100 products to a
customer for $10,000 ($100 per product) at various points in time
over a six-month period. After 60 products have been delivered,
Crandall modifies the contract by promising to deliver 20 more
products for an additional $1,900, or $95 per product (which is the
standalone selling price of the products at the time of the contract
modification). Crandall regularly sells the products separately.
Given a new contract, Crandall recognizes an additional:
LO 4
Separate Performance Obligation
Original contract [(100 units -60 units) x $100] = $4,000
New product (20 units x $95) = 1,900
Total revenue $5,900

345. Prospective Modification
Company should
►account for effect of change in period of change as
well as future periods if change affects both.
►not change previously reported results.
LO 4
Contract Modifications

346. Products not delivered under original contract
($100 x $40) = $4,000
Products to be delivered under contract
modification ($95 x 20) = 1,900
Total remaining revenue $5,900
Revenue per remaining unit ($5,900 ÷60) = $98.33
For Crandall, the amount recognized as revenue for each of the
remaining products would be a blended price of $98.33, computed
as follows.
LO 4
Prospective Modification

347. Under the prospective approach, a blended price ($98.33) is used
for sales in the periods after the modification.
LO 4
Prospective Modification
ILLUSTRATION 18.30
Comparison of Contract Modification Approaches

348. LO 4
Costs to Fulfill a Contract
Companies divide fulfillment costs (contract acquisition
costs) into two categories:
1.Those that give rise to an asset.
2.Those that are expensed as incurred.
Presentation

349. LO 4
Collectibility
Credit risk that a customer will be unable to pay in
accordance with the contract.
►Whether a company will get paid is not a consideration
in determining revenue recognition.
►Amount recognized as revenue is not adjusted for
customer credit risk.
Presentation

350. Disclosure
LO 4
Companies disclose qualitative and quantitative information
about the following:
Contracts with customers.
Significant judgments.
Assets recognized from costs incurred to fulfill a contract.

351. Disclosure
LO 4
Companies provide a range of disclosures:
Disaggregation of revenue.
Reconciliation of contract balances.
Remaining performance obligations.
Cost to obtain or fulfill contracts.
Other qualitative disclosures.
►Significant judgments and changes in them.
►Minimum revenue not subject to variable consideration
constraint.

352. Revenue Recognition Over Time
Under certain circumstances companies recognize revenue
over time.
The most notable context in which revenue may be
recognized over time is long-term construction contract
accounting.
APPENDIX 18A Long-Term Construction Contracts
LEARNING OBJECTIVE 5
Apply the percentage-of-completion method for long-term contracts.
LO 5

353. Long-term contracts frequently provide that seller (builder)
may bill purchaser at intervals.
►Examples:
Development of military and commercial aircraft
Weapons-delivery systems
Space exploration hardware
LO 5
Revenue Recognition Over Time

354. A company satisfies a performance obligation and recognizes
revenue over time if at least one of the following three criteria is
met:
1.Customer simultaneously receives and consumes the
benefits of the seller’s performance as the seller performs.
2.Company’s performance creates or enhances an asset (for
example, work in process) that the customer controls as the
asset is created or enhanced; or
3.Company’s performance does not create an asset with an
alternative use. In addition to this alternative use element, at
least one of the following criteria must be met:
LO 5
Revenue Recognition Over Time

355. In addition to this alternative use element, at least oneof the
following criteria must be met:
a.Another company would not need to substantially re-perform
the work the company has completed to date if that other
company were to fulfill the remaining obligation to the
customer.
b.The company has a right to payment for its performance
completed to date, andit expects to fulfill the contract as
promised.
LO 5
Revenue Recognition Over Time

356. If criterion 1, 2 or 3 is met, then a company recognizes
revenue over time if it can reasonably estimate its progress
toward satisfaction of the performance obligations.
Company recognizes revenues and gross profits each
period based upon the progress of the construction—
referred to as the percentage-of-completion method.
If criteria are not met, the company recognizes revenues
and gross profit when the contract is completed, referred
to as the cost-recovery (zero-profit) method.
LO 5
Revenue Recognition Over Time

357. Measuring the Progress Toward Completion
Most popular input measure used to determine the progress
toward completion is the cost-to-cost basis.
LO 5
Percentage-of-Completion Method
Revenue Recognition Over Time

358. LO 5
Revenue to be Recognized on Cost-to-Cost Basis
ILLUSTRATION 18A.1
ILLUSTRATION 18A.2
ILLUSTRATION 18A.3
Percentage-of-Completion Method

359. Illustration:Hardhat Construction Company has a contract to
construct a £4,500,000 bridge at an estimated cost of
£4,000,000. The contract is to start in July 2019, and the bridge
is to be completed in October 2021. The following data pertain to
the construction period.
LO 5
Percentage-of-Completion Method
2019 2020 2021

360. ILLUSTRATION 18A.4
Application of Percentage-of-
Completion Method, Cost-to-
Cost Basis LO 5
Percentage-of-Completion Method
2019 2020 2021
2019 2020 2021

361. ILLUSTRATION 18A.5
LO 5
2019 2020 2021
Percentage-of-Completion Method
2019 2020 2021

362. Illustration:Percentage-of-Completion Revenue, Costs, and
Gross Profit by Year
ILLUSTRATION 18A.6
LO 5
2019
2020
2021
Percentage-of-Completion Method

363. ILLUSTRATION 18A.7
ILLUSTRATION 18A.6
LO 5
Percentage-of-
Completion
Method
2019
2020
2021
2019 2020 2021

364. Illustration:Content of Construction in Process Account—
Percentage-of-Completion Method
ILLUSTRATION 18A.8
LO 5
Percentage-of-Completion Method

365. Financial Statement Presentation—Percentage-of-
Completion
ILLUSTRATION 18A.9
Computation of Unbilled Contract Price at 12/31/19
LO 5
Percentage-of-Completion Method

366. Financial Statement Presentation—Percentage-of-
Completion (2019)
ILLUSTRATION 18A.10
Percentage-of-Completion Method

367. Financial Statement Presentation—Percentage-of-
Completion (2020)
ILLUSTRATION 18A.11
Percentage-of-Completion Method

368. Financial Statement Presentation—Percentage-of-
Completion (2021)
ILLUSTRATION 18A.12
Percentage-of-Completion Method
LO 5

369. This method recognizes revenue only to the extent of costs
incurred that are expected to be recoverable.
Only after all costs are incurred is gross profit recognized.
Cost-Recovery (Zero-Profit) Method
APPENDIX 18A Long-Term Construction Contracts
LEARNING OBJECTIVE 6
Apply the cost-recovery method for long-term contracts.
LO 6

370. LO 6
Illustration: Hardhat Construction would report the following
revenues and costs for 2019–2021.
ILLUSTRATION 18A.14
Cost-Recovery (Zero-Profit) Method
2019
2020
2021

371. LO 6
ILLUSTRATION 18A.14
Cost-Recovery Method Revenue,
Costs, and Gross Profit by Year
ILLUSTRATION 18A.15
Journal Entries—Cost-Recovery Method
2019 2020 2021

372. LO 6
ILLUSTRATION 18A.16
Comparison of Gross Profit Recognized under Different Methods
ILLUSTRATION 18A.14
Cost-Recovery Method Revenue,
Costs, and Gross Profit by Year

373. LO 6
ILLUSTRATION 18A.17
Financial Statement Presentation—Cost-Recovery Method

374. 1.Loss in Current Period on a Profitable Contract
►Percentage-of-completion method only, the estimated
cost increase requires a current-period adjustment of
excess gross profit recognized in prior periods.
2.Loss on an Unprofitable Contract
►Under both percentage-of-completion and cost-recovery
methods, the company must recognize in the current
period the entire expected contract loss.
Long-Term Contract Losses
APPENDIX 18A Long-Term Construction Contracts
LEARNING OBJECTIVE 7
Identify the proper accounting for losses on long-term contracts.
LO 7

375. Prepare the journal entries to record revenue and expense for 2018, 2019, and
2020 assuming the estimated cost to complete at the end of 2019 was
$215,436.2018 2019 2020
Contract price $675,000 $675,000 $675,000
Cost incurred current year 150,000 287,400 215,436
Estimated cost to complete
in future years 450,000 215,436 0
Billings to customer current year 135,000 360,000 180,000
Cash receipts from customer
Current year 112,500 262,500 300,000
Loss in Current Period
LO 7
Long-Term Contract Losses

376. 2014 2015 2016
Costs incurred to date 150,000$ 437,400$ 652,836$
Estimated cost to complete 450,000 215,436
Est. total contract costs 600,000 652,836 652,836
Est. percentage complete 25.0% 67.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 452,250 675,000
Rev. recognized prior year (168,750) (452,250)
Rev. recognized currently 168,750 283,500 222,750
Costs incurred currently (150,000) (287,400) (215,436)
Gross profit recognized 18,750$ (3,900)$ 7,314$ LO 7
2018 2019 2020
Loss in Current Period

377. Construction in Process 18,750 7,314
Construction Expenses 150,000 215,436
Revenue from LT Contracts 168,750 222,750
Construction in Process 3,900
Construction Expenses 287,400
Revenue from LT Contracts 283,500
20202018 2019 LO 7
Loss in Current Period

378. Prepare the journal entries for 2018, 2019, and 2020 assuming the estimated
cost to complete at the end of 2019 was $246,038 instead of $170,100.
Casper Construction Co. 2018 2019 2020
Contract price $675,000 $675,000 $675,000
Cost incurred current year 150,000 287,400 246,038
Estimated cost to complete
in future years 450,000 246,038 0
Billings to customer current year135,000 360,000 180,000
Cash receipts from customer
Current year 112,500 262,500 300,000
LO 7
Loss on Unprofitable Contract
Long-Term Contract Losses

379. 2014 2015 2016
Costs incurred to date 150,000$ 437,400$ 683,438$
Estimated cost to complete 450,000 246,038
Est. total contract costs 600,000 683,438 683,438
Est. percentage complete 25.0% 64.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 432,000 675,000
Rev. recognized prior year (168,750) (432,000)
Rev. recognized currently 168,750 263,250 243,000
Costs incurred currently (150,000) (290,438) (243,000)
Gross profit recognized 18,750$ (27,188)$ -$ $675,000 –683,438 = (8,438) cumulative loss
LO 7
Loss on Unprofitable Contract
2018 2019 2020

380. Construction in Process 18,750 -
Construction Expenses 150,000 243,000
Revenue from LT Contracts 168,750 243,000
Construction Expenses 290,438
Construction in Process 27,188
Revenue from LT Contracts 263,250
20202018 2019 LO 7
Loss on Unprofitable Contract

381. Loss on LT Contracts 8,438
Construction in Process 8,438
20202018 2019 For the Cost-Recoverymethod, companies would recognize the
following loss :
LO 7
Loss on Unprofitable Contract

382. Chapter Seven
IAS 8
ACCOUNTING POLICIES,
CHANGES IN ACCOUNTING
ESTIMATES AND ERRORS
1

383. 2
Itprescribesthecriteriafor:
•Howtoselectandapplyouraccountingpolicies;
•Howtoaccountforthechangesinaccountingpolicies;
•Howtoaccountforchangesinaccountingestimates;
•Howtocorrecterrorsmadeinthepreviousreportingperiods;
and
•Howtodisclosethechanges.
OBJECTIVES OF IAS 8

384. 3
OBJECTIVES OF IAS 8

385. Meaning
Accountingpoliciesarethespecificprinciples,bases,guidelines,
conventions,rules,practices,andsimilarnormsappliedbyanentity
inpreparingandpresentingfinancialstatements.
Example:
ValuationofinventoryusingFIFO,AverageCostorothersuitable
basisasper[IAS2]
ValuationofPPEusingcostmodelorrevaluationmodel[IAS16]
Classification,presentationandmeasurementoffinancialassets
andliabilitiesundercategoriesspecified[IAS32/IAS39/IFRS9]
4
MEANING OF ACCOUNTING POLICIES

386. Accounting Policies
HOW
TO
REPORT?
WHEN
TO
REPORT?
WHERE
TO
REPORT?
Objective of Financial Reporting
[Conceptual Framework]
Useful Information
For Decisions Making
WHAT
TO
REPORT?
The Means
Recognition
Measurement
Presentation
Disclosure
The End
MEANING OF ACCOUNTING POLICIES

387. IAS8HIERARCHY
IAS8establishesthehierarchythatfirmsmustfollowwhendealing
withanaccountingissue(transactionoritem).TheIFRS
ACCOUNTINGPOLICYHIERARCHYis:
1.Applyspecificallyrelevantstandards(IASs,IFRSs,
Interpretations).
Ifthereisnoapplicablestandard(useIAS8):
1.RefertootherIASBstandards(analogy).
2.RefertotheIASBFrameworkforguidance(conceptualFW).
3.Considerthemostrecentpronouncementsofotherstandard-
settingbodies(FASB),practices….
6
SELECTION OF ACCOUNTING POLICIES

388. 7
1
st
. Apply specifically relevant standards
(IASs, IFRSs, Interpretations)
2
nd
. Refer to other IASB standards.
3
rd
. Refer to the IASB Framework
for guidance.
4
th
. Consider the most recent pronouncements of
other standard-setting bodies.
IAS 8 Hierarchy: TheIFRS Accounting Policy Hierarchy is:
SELECTION OF ACCOUNTING POLICIES

389. This material is the property of Department of Accounting and Finance, CoBE, AAU.
Permission must be obtained from the Department prior to reproduction
CHANGES IN ACCOUNTING POLICIES
Meaning

390. Why/WhentoChange?
MANDATORY:WhenitisrequiredbyanotherIFRS.
ThiswillbethecasewhennewIFRSisissuedandyouHAVETO
applyitmandatorily.
VOLUNTARY:Whennewaccountingpolicyprovidesbetter,more
faithfulandrelevantinformation.
Changefromcosttorevaluationmodel.
9
CHANGES IN ACCOUNTING POLICIES

391. Accounting Treatment (Rule)-Retrospective Method –
Restatement & cumulative effect adjustment.
Exemptions from Retrospective Treatment
Change in accounting policy is immaterial [Materiality]
Change in accounting policy is impracticable [Cost & Undue Effort]
Requirement by transitional guidance of new accounting policy
(mandatory in the guidance)
Application of a new accounting policy to a transaction different
in substance to those undertaken previously.
Application of a new accounting policy for transactions that did
not occur previously or were immaterial.
CHANGES IN ACCOUNTING POLICIES

392. 11
Application of a new accounting policy to a transaction
different in substance to those undertaken previously.
PPE
COST
METHOD
PPE
REVALUATION
METHOD
Retrospective
Treatment
Prospective
Treatment
IP
FAIR VALUE
METHOD
CHANGES IN ACCOUNTING POLICIES

393. 12
Disclosures
Followingmustbedisclosedinthefinancialstatementsofthe
accountingperiodinwhichachangeinaccountingpolicyis
implemented:
−TitleofIFRS
−Natureofchangeinaccountingpolicy
−Reasonsforchangeinaccountingpolicy
−Amountofadjustmentsincurrentandpriorperiodpresented
−Whereretrospectiveapplicationisimpracticable,theconditionsthat
causedtheimpracticality
CHANGES IN ACCOUNTING POLICIES

394. 13
Example:
AnentityuntilnowhasvaluedinventoryusingLIFOmethod.However,
followingchangestoIAS2Inventories,theuseofLIFOmethodhasbeen
disallowed.Therefore,managementofthecompanyintendstouseFIFO
methodforthevaluationofthecompany'sstock.Followingareextracts
oftheentity'smostrecentfinancialstatementsbeforetheapplicationof
FIFOmethod.
1. Statement of Financial Position as at 31 December 20X2
20X2 20X1
Current Assets
Cash and Bank xx xx
Short Term Investments xx xx
Inventory 10 12
CHANGES IN ACCOUNTING POLICIES

395. 14
2.IncomeStatementfortheyearended31December20X2
20X2 20X1
CostofSales
OpeningInventory 12 8
Purchases 48 44
ClosingInventory (10) (12)
50 40
3.StatementofChangesinEquityfortheyearended31December20X2
20X2 20X1
RetainedEarnings
OpeningReserves 40 30
NetProfit 30 20
Dividend (10) (10)
ClosingReserves 60 40
CHANGES IN ACCOUNTING POLICIES

396. 15
ManagementestimatesthatthevalueofitsinventoryusingFIFO
methodwouldbeasfollows:
20X2 20X1 20X0
Inventory 12 13 10
Managementfurtherbelievesthatthevaluationofinventoryusing
FIFOmethodforperiodspriorto20X0wouldproducematerially
similarresults.
Thefinancialstatementextractsoftheentitywouldappearas
followsaftertheretrospectiveapplicationofthechangein
accountingpolicy.
CHANGES IN ACCOUNTING POLICIES

397. 16
LIFO FIFO
1. SOFP at 31 Dec. 20X2
20X2 20X1 20X2 20X1
Current Assets
Cash and Bank xx xx xx xx
Short Term Investments xx xx xx xx
Inventory 10 12 12 13
2. SOPL for the year ended 31 Dec. 20X2
20X2 20X1 20X2 20X1
Cost of Sales
Opening Inventory 12 8 13 10
Purchases 48 44 48 44
Closing Inventory (10) (12) (12) (13)
50 40 49 41
3. SOCE for the year ended 31 Dec. 20X2
20X2 20X1 20X2 20X1
Retained Earnings
Opening Reserves 40 30 41.00 32.00
Net Profit 30 20 31.00 19.00
Dividend (10) (10) (10) (10)
Closing Reserves 60 40 62.00 41.00

398. Cumulative Prior Period Adjustment
Inventory 2.00
Retained Earnings/Reserves 2.00
CHANGES IN ACCOUNTING POLICIES

399. MEANING OF ACCOUNTING ESTIMATES
18
Meaning
An item of financial statements that cannot be measured precisely
[subjective judgments] due to Uncertaintiesinherent in the business.

400. 19
Meaning
A change in either some amountof an asset or a liability, or
pattern of its consumptionin both current and future
reporting periods that result from changes in the circumstances
in which the estimate was based.
As a result of a new information
As a result of new development
More experience
CHANGES IN ACCOUNTING ESTIMATES

401. Examples:
−Depreciationratesandusefullivesofassets
−Provisionsforwarrantyrepairs
−Impairmentofnon-currentassets
−Patternofeconomicbenefitsexpectedtobereceivedfromnon-
currentassetsforcalculatingdepreciation
−Impairmentofreceivables(baddebtprovisions)
20
CHANGES IN ACCOUNTING ESTIMATES

402. 21
Changesinaccountingpolicyvs.accountingestimate
Accountingpolicyisaprincipleorrule,orameasurementbasis,
Accountingestimateistheamountdeterminedbasedonselected
basisorsomepatternoffutureconsumptionoftheasset.
Forexample:
•ChoiceofFairvaluevs.Historicalcostisachoiceinaccounting
policy(remember,measurementbasis),
•Butupdatingsomeprovisionbasedonfairvaluechangeisa
changeinaccountingestimate.
CHANGES IN ACCOUNTING ESTIMATES

403. 22
AccountingTreatment(Rule)
Changeinaccountingestimatesareaccountedprospectively,either:
Inthecurrentreportingperiod(e.g.baddebtestimate)or;
Inboththecurrentandfuturereportingperiods,ifthechange
affectsboth(forexample,changeinusefullivesaffects
depreciationchargesinboththecurrentandthefuture
reportingperiods).
“Prospectively”meansthatcomparativesandequityNOTrestated.
Financialstatementsinthepreviousreportingperiodsnotrestatedand
simplyadjustcalculationsinthecurrentandfuturereportingperiods.
CHANGES IN ACCOUNTING ESTIMATES

404. 23
Past
F/S
Future
F/S
Current
F/S
Prospective Method
CHANGES IN ACCOUNTING ESTIMATES
WhyProspective:Prospectiveapplicationofchangesinestimates
preventsfrequentrevisionsinpriorperiodcomparativefigures
whichmightcauseunnecessarycomplicationsinrespectof
financialstatementbalances.
Whenitishardtodifferentiatebetweenachangeinaccounting
policyandachangeinaccountingestimate,thechangeis
accountedforprospectivelyasanestimate.

405. Disclosures
the nature of the change;
the effect on the current periods financial
statements; and
the effect in future periods if this is practicable.
CHANGES IN ACCOUNTING ESTIMATES

406. 25
Example
−Anentityhasdepreciatedamachineoveritsexpectedusefullifeof
5years.Noresidualvalueisexpectedattheendofthemachine's
usefullife.ThecostofmachinewasBr100,000andannual
depreciationchargewasthereforeBr20,000.
−Threeyearslater,theremainingusefullifeofthemachinewas
estimatedtobeonly1year.
−Theentityshouldaccountforthechangeinestimateprospectively
byallocatingthenetcarryingamountoftheassetoverits
remainingusefullife.Noadjustmentisrequiredtorestatethe
depreciationchargeinpreviousaccountingperiods.
CHANGES IN ACCOUNTING ESTIMATES

407. 26
Depreciation
Expense
Accumulated
Depreciation
Working
Year1 20,000 20,000 (100,000/5)
Year2 20,000 40,000 (80,000/4)
Year3 30,000 70,000 (60,000/2)
Year4 30,000 100,000 (30,000/1)
Depreciation expense for the machine would therefore be as follows:
Althoughexpectedusefullifeofthemachinehasreducedatthe
endofthirdyear,depreciationexpenserecordedinpreviousyears
isnotaffected.Instead,thedepreciationexpenseisincreased
accordinglyinyears3and4.
CHANGES IN ACCOUNTING ESTIMATES

408. CORRECTION OF PRIOR PERIOD ERRORS
27
Meaning
Omissionsfrom,andmisstatementsin,theentity’sFSforoneormore
priorperiodsarisingfromafailuretouse,ormisuseof,reliable
informationthat:
wasavailablewhenFSforthoseperiodswereauthorisedfor
issue;and
couldreasonablybeexpectedtohavebeenobtainedandtaken
intoaccountinthepreparationandpresentationofthoseFS.

409. 28
Example:
−Misapplicationofaccountingpolicies:e.g.notrecognizingsaleupon
transferofgoodstoacustomer.
−Fraud:e.g.overstatingsalesrevenuebyissuingfakeinvoicesbefore
thereportingdate
−Misunderstanding/misinterpretationsoffacts,orfailuretonotice,
informationatthetimeofpreparationoffinancialstatements:
e.g.notwritingoffareceivablewhohadbeenannouncedasinsolvent
beforetheauthorizationoffinancialstatements.
−Arithmetical/mathematicalmistakes
−Oversights:Omissionoftransactionsandeventsfromthefinancial
statements
CORRECTION OF PRIOR PERIOD ERRORS

410. 29
AccountingErrorsdiscoveredafterthereportingdatebutbeforethe
authorizationoffinancialstatementsareadjustingeventsafterthe
reportingdateasperIAS10andmustthereforebecorrectedinthe
currentperiodpriortotheissuanceoffinancialstatements.
CORRECTION OF PRIOR PERIOD ERRORS
Error
Accounting Treatment (Rule)

411. 30
Example:
Anentitynotedin20X6thatin20X5ithadomittedtorecorda
depreciationexpenseonanassetamountingtoBr.60.Itsaccounts,
beforethecorrectionoferrors,lookedlikethis:
Current PeriodEarliest Period
20X6 20X5
Gross profit 600 690
Distribution costs (60) (60)
Administrative expenses (180) (180)
Depreciation (60) Nil
Profit from operations 300 450
Income tax (60) (90)
Net profit 240 360
CORRECTION OF PRIOR PERIOD ERRORS

412. 31
Entity’sretainedearningsforthetwoyearsbeforethecorrectionof
errorsare:
20X6 20X5
Retained earnings c/fwd 690 450
Retained earnings b/fwd 450 90
IAS8(revised)statesthatthecorrectionofanerrorthatrelatesto
priorperiodsshouldbeshownasanadjustmenttotheopening
balanceofretainedearnings.
In the 20X6 accounts (ignoring all tax implications):
CorrectingEntry
Retainedearnings[b/fwd] 60
Accumulateddepreciation 60
CORRECTION OF PRIOR PERIOD ERRORS

413. 32
i.e.thiswillhavenoimpactonthecurrentyearincomestatement
butisshownasapriorperiodadjustmentinthestatementof
changesinequity:
20X6
Retained earnings b/fwd as reported previously 450
Prior period adjustment to correct error (60)
Retained earnings, beginning, as restated 390
Net profit 240
Retained earnings c/fwd 630
CORRECTION OF PRIOR PERIOD ERRORS

414. 33
20X6 20X5
(restated)
Gross profit 600 690
Distribution costs (60) (60)
Administrative expenses (180) (180)
Depreciation (60) (60)
Profit from operations 300 390
Income tax (60) (90)
Net profit 240 300
Comparative information should be restated unless it is impracticable’
to do so. The statement of profit or loss will be presented thus:
CORRECTION OF PRIOR PERIOD ERRORS

415. 34
Statement of Financial Position as at 31 December 20X6
20X6 20X5
Non Current Assets
Cost xxx xxx
Accumulated Depreciation (60+x) (60)
xxx xxx
Thestatementoffinancialpositionstatementextractsofthe
companywouldappearasfollowsaftertheretrospectivecorrection
ofthepriorperiodaccountingerror.
CORRECTION OF PRIOR PERIOD ERRORS

416. 35
The statement of changes in equity will also need
comparators:
20X6 20X5
(Restated)
Retained earnings b/fwd as reported previously450 90
Prior period adjustment to correct error (60) Nil
Retained earnings, beginning, as restated 390 90
Net profit 240 300
Retained earnings c/fwd 630 390
CORRECTION OF PRIOR PERIOD ERRORS

417. Disclosures
•the nature of the prior period error;
•the amount of the correction for each period presented;
•the amount of the correction at the start of the earlier
prior period presented; and
•if retrospective correction is not practicable, a description
of how and when the error was corrected.
CORRECTION OF PRIOR PERIOD ERRORS

418. 37
A.Previously, ABC LTD accounted for its non-current assets using the
historical cost basis. In the current period, however, ABC LTD has
adopted the revaluation model of IAS 16 to account for its non-
current assets.
B.ABC LTD previously had a policy of calculating depreciation on
equipment using the straight line method @ 10%. However, In
light of significant losses recognized on recent disposals the
management has decided to depreciate equipment by using the
reducing balance method @ 20% which shall more accurately
reflect the wear and tear of equipment.
I.Identify whether the following constitute a change in accounting
policy, a revision in accounting estimate or a correction of prior-
period error.
Cases For Discussions

419. 38
C.ABC LTD has a policy of valuing inventory using the FIFO method.
The value of inventory brought forward in the current period (i.e.
last year's closing inventory balance) has been changed because it
had erroneously been valued using the LIFO method last year.
D.ABC LTD has a past practice of recognizing sales revenue at the
time of dispatch of goods to the retailers. In the current period,
however, sales revenue has not been recognized by ABC LTD until
the goods sold to retailers have been re-sold to the end-consumers.
Management believes the new recognition rule more accurately
reflects the economic substance of the sales and returns
arrangement with retailers.
Cases For Discussions

420. 39
E.In estimating the employee benefits obligations of ABC LTD at the
previous year end, the actuary failed to take into account ABC
LTD's plan to discontinue operations in one of its geographic
segments. Management had announced its plan three years ago.
Recently, the actuary furnished revised estimates of ABC PLC's
liability with respect to employee benefits of the current and prior
periods taking into account the plans for discontinuation.
Financial statements of this year have been amended accordingly.
Cases For Discussions

421. 40
A.Change in Accounting Policy: Basis of measurement of the elements
of financial statements (e.g. historical cost, fair value, etc.) represent
accounting policies. Any change in the basis of measurement
therefore constitutes a change in accounting policy.
B.Revision of Accounting Estimate: Change in the depreciation method
merely reflects a shift in the management's expectation of the
pattern of periodic consumption of equipment and therefore
represents a revision in accounting estimate.
Cases For Discussions

422. 41
C.Correction of Prior-Period Error: Misapplication of an accounting
policy represents an accounting error.
D.Change in Accounting Policy: Variation in rules and practices used in
the preparation of financial statements represents a change in
accounting policy.
E.Correction of Prior-Period Error: Failing to consider material
information while developing estimates that was already available at
that time constitutes an accounting error.
Cases For Discussions