International Accounting Lectures: 1) Introduction to Accounting: Equity

International Accounting lectures:

1) Introduction to accounting: Equity and Net income

A.Y. 2020-2021 Double degree Programme in Business and Economics University of Cagliari, Prague CULS & Bielefeld UAS Alessandro Mura [email protected]

The role and the users of Accounting

n Accounting is the language of business

n Accounting is a process of recording, organizing, summarizing, reporting and analysing financial information.

Financial accounting information is reported to stakeholders:

§ Owners (main and minority shareholders) § Potential investors § Managers § Creditors § Employess § Fiscal authorities § and other interested parties.

Each party is interested in the financial health of the company, though each party has its own expectations and its own objectives, sometime conflicting amongst each other.

. 1 The Basic Accounting Equation

ASSETS = LIABILITIES + EQUITY

ASSETS – LIABILITIES = EQUITY

Equity is also named Net Assets

IF ASSETS < LIABILITIES = NEGATIVE EQUITY

Assets

n An asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits (IASB definition)

n Non current assets: when an asset is expected to be realized (sold, consumed) beyond its normal operating cycle (12 months)

Property, Plant and Equipment

n Current assets: when an asset is expected to be realized (sold, consumed) in its normal operating cycle (12 months)

- Inventory - Accounts receivable - Cash at bank and in hand

2 Liabilities

n A liability is a present obligation of the entity to transfer an economic resource as a result of past events

n Economic resources that a company owes to others

n Examples of Liabilities

• Accounts Payable • Sales Tax Payable • Wages (Salaries) Payable

• Unearned Revenue (down payments received on work to be completed in the future)

• Mortgage Payable (for example mortgage on business property)

• Notes Payable (business financial obligations from signing a promissory note).

Equity

n Equity is the residual interest in the assets of the entity after deducting all its liabilities.

n the value of the owner investor in the company

n For sole proprietorschip and partnership – Equity is split into its ideal items: Capital and Withdrawl

n For corporations – Equity is split into its ideal items: Share Capital, Retained earnings

3 Equity

Statement of Financial Position (Balance sheet)

Assets (A) Liabilities (L)

Equity (E)

Picture of the wealth of the company at a specific moment in time

Net income Net income (or Earnings or Net profit) is equal to:

Revenues – Expenses

n Revenues (or Income) are increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims.

n Revenues represent wealth regenerated from the sale of products or the rendering of services to customers

n Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims.

n Expenses represent wealth consumed to get economic rescources

n If Expenses > Revenues = Net Loss

4 Net income

Income statement (Profit and Loss account)

Expenses (E) Revenues (R)

Net income (if R > E) Net Loss (if R< E)

The Income Statement reports the profitability of a business organization for a stated period of time.

”how equity increased or decreased as a result of business activities”. Net income, if not distributed, increases Retained Earnings and thus Equity

It is a Statement of Perfomance A Motion picture:

International Accounting

2) The accounting Cycle

A.Y. 2020-2021 Double degree Programme in Business and Economics University of Cagliari, Prague CULS & Bielefeld UAS Alessandro Mura [email protected]

5 The Accounting Cycle

1) Analyse Transactions

2) Prepare Journal Entries

3) Post Journal Entries

4) Prepare Unadjusted Trial Balance

Definition of “account”

n An account is a part of the accounting system used to classify and summarise the increases, decreases, and balances of each asset, liability, shareholders’ equity item, dividend, revenue, and expense.

DEBIT (LEFT SIDE) CREDIT (RIGHT SIDE)

Terminology: To debit an account means to enter an amount on the left side of the account. To credit an account means to enter an amount on the right side of an account. Account balance: difference between the debits and credits to the account Credit balance The balance in an account when the sum of the credits exceeds the sum of the debits Debit balance The balance in an account when the sum of the debits exceeds the sum of the credits.

6 General rules for Debits and Credits

n In financial accounting the labels “debit” and “credit” are conventional names.

n The meaning of debit and credit will change depending on the account type.

n Debit simply means left side; credit means right side.

n The rules of debit and credit are designed to enforce the balance of the accounting equation:

ASSETS = LIABILITIES + EQUITY

n The accounting system requires that each transaction is recorded by an entry that has equal debits and credits: this is called double-entry procedure, or duality.

= Increase = decrease

7 Recording changes in the Statement of financial position (balance sheet)

ASSETS LIABILITIES & EQUITY

DEBIT = Increase DEBIT = Decrease CREDIT = Decrease CREDIT = Increase

Recording changes in the Income Statement (Profit and Loss account) REVENUES EXPENSES

CREDIT = Increase DEBIT = Increase DEBIT = Decrease CREDIT = Decrease

Accounts Type

DEBIT ASSETS CREDIT

Increase Decrease

DEBIT LIABILITIES CREDIT

Decrease Increase

DEBIT EQUITY CREDIT

Decrease Increase

8 Accounts Type

DEBIT EXPENSES CREDIT

Increase Decrease

DEBIT REVENUES CREDIT

Decrease Increase

Main Accounting Records and Books

n A journal is a chronological record of business transactions.

n A journal entry is the recording of a business transaction in the journal. A journal entry shows all the effects of a business transaction as expressed in debit(s) and credit(s) and includes a description of the transaction.

n A ledger (general ledger) is the complete collection of all the accounts and transactions of a company.

n The chart of accounts is a listing of the titles and numbers of all the accounts in the ledger. The chart of accounts can be compared to a table of contents.

§ A trial balance is a listing of all accounts (in this order: asset, liability, equity, revenue, expense) with the ending account balance. It is called a trial balance because the information on the form must balance.

9 Journal entry rules

When a business transaction requires a journal entry, we must follow these rules:

The entry must have at least 2 accounts with 1 DEBIT amount and at least 1 CREDIT amount:

The DEBITS are listed first and then the CREDITS.

The DEBIT amounts will always equal the CREDIT amounts.

Each general journal entry records the date, the account title(s) to be debited and the corresponding amount(s) followed by the account title(s) to be credited and the corresponding amount(s), including a short description of the transaction.

Journal entries

On June 1, 20x8 a company borrows € 5,000 from its bank.

DATE Account Name Debit Credit

1/6/x8 Cash 5.000,00 Notes Payable 5.000,00 Description: Notes payable n… from Bank x

On June 2, 2018 the company repaid € 2,000 of the bank note.

DATE Account Name Debit Credit

2/6/x8 Notes Payable 2.000,00 Cash 2.000,00 Description: Partially repaid Notes payable n… from Bank x

10 T-accounts (Ledger) T-accounts are a visual aid for seeing the effect of the debit and credit on the two (or more) accounts

On June 1, 20x8 a company borrows € 5,000 from its bank.

The T-accounts look like this:

Cash (Asset account) Notes Payable (Liability account) Debit Credit Debit Credit

5,000.00 5,000.00

On June 2, 20x8 the company repaid € 2,000 of the bank note. Cash (Asset account) Notes Payable (liability account) Debit Credit Debit Credit

5,000.00 2,000.00 2,000.00 5,000.00

Account Classification Normal Balance ASSETS DEBIT CONTRA ASSSET CREDIT LIABILITY CREDIT CONTRA LIABILITY DEBIT OWNER’S EQUITY CREDIT SHAREHOLDERS’ EQUITY CREDIT OWNER’S DRAWING / DEBIT DIVIDENDS ACCOUNT REVENUES (OR INCOME) CREDIT EXPENSES DEBIT GAINS CREDIT LOSSES DEBIT

11 International Accounting

3) Completion of the accounting cycle

A.Y. 2020-2021 Double degree Programme in Business and Economics University of Cagliari, Prague CULS & Bielefeld UAS Alessandro Mura [email protected]

Completing the Accounting Cycle

1) Prepare Adjusting Journal Entries

2) Post Adjusting Journal Entries to the ledger

3) Prepare Adjusted Trial Balance

4) Prepare Financial Statements

5) Closing Entries

12 The accrual basis of accounting Under the accrual basis of accounting revenues are recognised when earned, regardless of when cash is received.

Expenses are recognized as incurred, whether or not cash has been paid out.

The matching principle requires that expenses be matched with revenues in the appropriate year. Revenue Recognition Revenues are recognised as earned: when goods are delivered and service are performed

Expenses should be recognized (recorded) as they are incurred to produce revenues. An expense is the outflow or using up of assets in the generation of revenue.

Nature and goal of adjusting entries (1)

The goal of adjusting entries is to comply with the accrual basis of accounting and with the relating matching principle

Each adjusting entry has a dual purpose:

(1) to make the income statement report the proper revenue or expense

(2) to make the balance sheet report the proper asset or liability.

Thus, every adjusting entry affects at least one income statement account and one balance sheet account (one debit and one credit)

Adjusting entries will never include cash

13 Nature and goal of adjusting entries (2)

n Adjusting entries will be made after the unadjusted trial balance and before the company prepares its financial statements

n Adjusting entries reflect unrecorded economic activity that has taken place but has not yet been recorded because it is either more convenient to wait until the end of the period to record the activity,

n or because no source document concerning that activity has yet come to the accountant’s attention.

n Additionally, periodic reporting and the matching principle necessitate the preparation of adjusting entries.

Class and type of adjusting entries

Adjusting entries fall into two broad classes:

1) accrued (meaning to grow or accumulate) items, which can be furher divided into:

accrued revenues accrued expenses

2) deferred (meaning to postpone or delay) items, which can be further divided into

unearned revenues prepaid expenes

n The adjusting entries for a given accounting period are entered in the general journal and posted to the appropriate ledger accounts (note: these are the same ledger accounts used to post the other journal entries

28 . 28

14 Logic of Adjusting Entries

Adjusting for accrued items - ACCRUALS

n Accrued Revenues are when a revenue has been earned (the company did the work or made a sale) but it has not been recorded in the books.

n Example:

n Igitur Limited rendered a transport service for a customer during last month of 20x8 for € 5,000. The customer has not been billed yet.

Debit Credit

31/12/x8 Accounts receivable 5,000.00 Service revenue 5,000.00 To accrue 1 month of transport services

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15 Adjusting for accrued items- ACCRUALS

Accrued Expenses are when an expense has been incurred but has not been entered into the books (an expense the company has not paid yet; no get or prepared the relating document)

n Example: Igitur Limited’s employees earned salary from 28th to 31st of December 20x8 (all working days) after the payday on the 27th of December. Salaries are € 500 per week (for 5 day workweek).

500 x 4/5= 400 Debit Credit

31/12/x8 Salaries expenses 400.00 Salaries payable 400.00 To accrue 4 day’s salaries not paid yet

. 31

Adjusting for deferred items - DEFERRALS

Unearned Revenues are amounts received before work has been performed and are recorded as a liability. Example: 1) Igitur Limited on December 7 received € 3,000 from a customer in payment for future transport services. The firm recorded the following journal entry: Debit Credit 7/12/x8 Cash 3,000.00 Unearned Revenue 3,000.00 To record the receipt n. 6 of cash in payment for future services.

2) Igitur Limited earned one-third of the € 3,000 services by December 31: Debit Credit 31/12/x8 Unearned Revenue 1,000.00 Service Revenue 1,000.00 To record transport service revenue for December 2018

16 Adjusting for deferred items - DEFERRALS

Prepaid expenses are expenses the company pays for in advance and are assets including things like rent, insurance, supplies, inventory, and other assets. Example: 1) Igitur Limited on the 1st Dec. purchased for 2,400.00 cash an insurance policy on its trucks for the 12 month period beginning December 1 : Debit Credit 1/12/x8 Prepaid insurance 2,400.00 Cash 2,400.00 Purchased one-year period truck insurance policy. 2) Igitur Limited records an adjusting entry for 1 month of insurance expence: Debit Credit 31/12/x8 Insurance expense 200.00 Prepaid insurance 200.00 To record insurance expense for December .

Adjusting for deferred items - DEFERRALS

Depreciable assets are tangible assets that provide services to a company over time (building, machinery, vehicles etc). Their life is limited (wear and tear from use, obsolescence).

For complying with the accrual basis of accounting their cost has to be shared amongst the years of their useful life: this is the depreciation process

Three factors are involved in computing this process:

Asset original (historical) cost

Estimated useful life

Depreciation formula

34 . 34

17 Adjusting for deferred items - DEFERRALS

1) Igitur Limited on the 1st January purchased for 100,000.00 on account: Debit Credit 1/1/x8 Machinery 100,000.00 Accounts Payable 100,000.00 To record the purchase of a machinery.

2) At year end the useful life of the machinery is estimated 4 years, end it is used the straight line depreciation formula: 100,000.00 / 4 = 25,000.00 Debit Credit 31/12/x8 Depreciation expense - Machinery 25,000.00 Accumulated Depreciation- Machinery 25.000,00 To record depreciation expense for 2018

Historical cost – Accumulated depreciation = Book value (or carrying value or carrying amonut) : 100,000.00 – 25,000.00 = 75,000.00

Adjusting for deferred items – Inventory

Companies may use two alternative accounting methods to track the inventory that is available:

The periodic inventory system The perpetual inventory system

Under the Periodic inventory system: a temporary account named “Purchases” records continuosly each purcahse that occurs. In contrast, inventory and the cost of goods sold are not updated continuosly, but only at the end of a given period (quarter, semester, year).

The Perpetual inventory system updates inventory accounts after each purchase or sale. Inventory ledger is updated after each transaction. Inventory quantities are updated continuously. The cost of goods sold is updated at each sale. No adjusting journal entries are required at year end.

18 The perdiodic inventory system 1) Igitur Plc on the 1st of January 20x8 has an opening inventory of € 1,000 (1,000 units of merchandise at the cost of 1 € per unit). The relatedT account is as follows: Merchandise Inventory 1,000.00

2) On the 1st of May 2018 Igitur plc purchases on account 3,000 units of merchandise at € 1.00 per unit . Debit Credit 1/5/x8 Purchases 3,000.00 Accounts payable 3,000.00 To record the invoice n… for the purchase of merchandise on account.

3) On the 1st of August Igitur plc sells on credit 1,000 units of merchandise at the price of € 1.50 per unit : Debit Credit 1/8/x8 Accounts receivable 1,500.00 Sales 1,500.00 To record the invoice n…. for the sale of merchandise on account

The perdiodic inventory system 1) On the 1st of October Igitur plc sells on credit account 1,500 units of merchandise at the price of € 1.50 per unit: Debit Credit 1/10/x8 Accounts receivable 2,250.00 Sales 2,250.00 To record the invoice n… for the sale of merchandise on account. At the end of the period (31/12/20x8) as the temporary account “Purchases” completes its role of giving information on the purchases of the year, it is is zeroed out by transferring its balance to the ”Inventory” account” Debit Credit 31/12/x8 Merchandise Inventory 3,000.00 Purchases 3,000.00 To zero out the “purchases” account After posting these journal entries to the general ledger, the T accounts of Inventories, Purcases and Sales are: Purchases Merchandise Inventory Sales 3,000.00 3.000,00 1.000,00 1,500.00 3.000,00 2,250.00

19 The perdiodic inventory system At this point an Adjusting journal entry is required to comply with the accrual basis: § to expense the Cost of Goods sold (and match it with the Sales of the year) § to capitalise the cost of the ending inventory as an asset (& defer it to the next year)

Beginning inventory + Purchases during the period - Ending inventory = Cost of Goods sold € 1,000 + € 3,000 - € 1,500 = 2,500

Beginning inventory + Purchases during the period - Cost of Goods sold = Ending Inventory € 1,000 + € 3,000 - € 2,500 = 1,500

Debit Credit 31/12/x8 Cost of goods sold 2,500.00 Merchandise inventory 2,500.00 To expense the cost of goods sold The ending balance of these accounts is now Cost of Goods sold Sales Merchandise Inventory 2,500.00 1,500.00 1.000,00 2,500.00 2,500.00 2,250.00 3.000,00 3,750.00 1.500,00

The perdiodic inventory system Balances in the revenue and expense accounts (temporary accounts) are zeroed out by tranfserring their balances to the Income Summary account

Debit Credit 31/12/x8 Income summary ………. …….. ………… Cost of goods sold 2,500.00 …….. ………… To close all expense accounts

Debit Credit 31/12/x8 Sales 3,750.00 …….. ………… …….. …………. Income summary ………… To close all revenue accounts

20 The perpetual inventory system 1) Igitur Plc on the 1st of January 20x8 has an opening inventory of € 1,000 (1,000 units of merchandise at the cost of 1 € per unit). The related T account is as follows: Merchandise Inventory 1,000.00

2) On the 1st of May 20x8 Igitur plc purchases on account 3,000 units of merchandise at € 1.00 per unit . Debit Credit 1/5/x8 Merchandise Inventory 3,000.00 Accounts payable 3,000.00 To record the invoice n… for the purchase of merchandise on account.

The perpetual inventory system The cost of goods sold is updated after each sale (1,000 units at the cost of € 1.00 per unit) : Debit Credit 1/8/x8 Cost of Goods Sold 1,000.00 Merchandise Inventory 1,000.00 To expense the cost of goods sold.

1) On the 1st of October Igitur plc sells on credit account 1,500 units of merchandise at the price of € 1.50 per unit: Debit Credit 1/10/18 Accounts receivable 2,250.00 Sales 2,250.00 To record the invoice n... for the sale of merchandise The cost of goods sold is (1,500 units at the cost of € 1.00 per unit) :

1/8/18 Cost of Goods Sold 1,500.00 Merchandise Inventory 1,500.00 To expense the cost of goods sold.

21 The perpetual inventory system At this point no Adjusting journal entry is required to comply with the accrual basis: § as the balance of Cost of Goods sold account is already updated (and matches with the Sales of the year) § as the balance of the Merchandise Inventory account already expresses the ending inventory

Cost of Goods sold Sales Merchandise Inventory 1,000,00 1,500.00 1.000,00 1,000.00 1,500.00 2,250.00 3.000,00 1,500.00 2,500.00 3,750.00 1.500,00

The perpetual inventory system Closing entries are exactly the same as under the periodic inventory system

Debit Credit 31/12/18 Income summary ………. …….. ………… Cost of goods sold 2,500.00 …….. ………… To close all expense accounts

Debit Credit 31/12/18 Sales 3,750.00 …….. ………… …….. …………. Income summary ………… To close all revenue accounts

22 Preparing an adjsuted trial balance The adjusted trial balance is a listing of all accounts with the ending balances updated with the balances of the adjusting entries. Preparing Financial Statements The financial statements are prepared after the adjusted trial balance. Amongst them, three are central: Income Statement: Calculates net income or loss of a company by showing revenues – expenses. If revenues are greater than expenses, you have net income. If revenues are less than expenses, you have net loss.

Statement of Retained Earnings: Calculates an ending balance in the retained earnings account using net income or loss calculated on the income statement. This statement takes the beginning balance in retained earnings + net income (or – net loss) – dividends to get the ending retained earnings balance. The ending retained earnings balance is reported on the statement of financial position. Statement of financial position (Balance Sheet): Proves the accounting equation of Assets = Liabilities + Equity and uses ending retained earnings calculated on the statement of retained earnings in equity.

Closing entries: Permanent (real) & temporary (nominal) accounts

Asset, liability, and most owner/shareholder equity accounts are referred to as ”Permanent accounts" (or "real accounts").

Permanent accounts are not closed at the end of the accounting year; their balances are automatically carried forward to the next accounting year.

"Temporary accounts" (or "nominal accounts") include all of the revenue accounts, expense accounts, the owner drawing account, and the income summary account. Generally speaking, the balances in temporary accounts increase throughout the accounting year and are "zeroed out" and closed at the end of the accounting year.

23 Closing entries: Permanent (real) & temporary (nominal) accounts (2)

Balances in the revenue and expense accounts are zeroed out by closing/transferring/clearing their balances to the Income Summary account.

The net amount in Income Summary is then closed/transferred/cleared to an owner equity account, such as Retained Earnings if the company is a corporation.

The dividend account is a temporary account and it is closed directly to the retained earnings account without going through an income summary account.

In a proprietorship the owner drawing account is a temporary account and it is closed directly to the owner capital account without going through an income summary account.

The IASB and IAS/IFRS The International Accounting Standard Board (IASB) is a Standard Setter based in London, which replaced the former International Accounting Standard Committee (IASC) in 2001.

The IASB adopted all current International Accounting Standards ( IAS) and currently issues International Financial Reporting Standards (IFRS)

The body of IASs and IFRSs is collecively known as IAS/IFRS or simply IFRS that are now wide-spread world-wide

The EU adopted IFRS for listed companies from 2005 onward

The other G20 countries are gradually moving towards the use of IFRS (including Russia, Brazil, Japan, South Africa

www.ifrs.org/use-around-the-world/use-of-ifrs-standards-by-jurisdiction/

24 US GAAP The Financial Accounting Standard Board (FASB), is the US standard setter and issues Financial Accounting Standards (FASs) also collectively known as US Generally Accepted Accounting Principles (GAAP)

US GAAP are enforced by the Security Exchange Commission (SEC), the US Stock Exchange watchdog

Given the importance of US markets, US GAAPs have been influencial internationally

An ambitious convergence project is in place between IASB and FASB to make US GAAP and IFRS fully compatible: the so called convergence project

A joint project to share a common Framework (started in 2004) was suspended in 2012

The future of this project is uncertain

Standard setting and enforcement in the European Union 50

n Major aim of EU has been to create a single financial market that requires access by investors to financial reports prepared according to common accounting standards

n The initial steps were the issue of accounting directives– the Fourth Directive, the Seventh Directive, and the Eight Directive.

n The directives were required to be adopted by each EU country into their national laws

n The existing directives were subsumed in 2013 in a new Accounting Directive with particular attention to Small-Medium Enterprises and Micro Enterprises

25 Standard setting and enforcement in the European Union 51

n Yet great differences still remain amongst EU countries and almost each country has its own Standard Setter

n In Germany Deutsches Rechnungslegungs Standards Committee (DRSC)

n In Italy Organismo Italiano di Contabilità (OIC)

International Accounting

4) Efforts to reduce international accounting differences and the leading role of the IASB and IAS/IFRS A.Y. 2020-2021 Double degree Programme in Business and Economics University of Cagliari & Bielefeld UAS Alessandro Mura [email protected]

See Part 3, Chapter 6 of Financial Accounting and Reporting Elliot and Elliot: Regulatory framework – an attempt to achieve uniformity

26 Reasons for differences in Financial Reporting If several accountants are given a set of transactions from which to prepare financial statements, they will not produce identical statements.

For many reasons:

§ Accounting rules may differ amongst countries and also within countries

§ Rules for company groups may differ from individual companies

§ No set of rules covers every eventuality or is prescriptive of each detail

§ Within the same set of rules, companies are allowed alternative accounting treatments

§ Thus, room for professional judgement is always present

The IASB and IAS/IFRS The International Accounting Standard Board (IASB) is a Standard Setter based in London, which replaced the former International Accounting Standard Committee (IASC) in 2001.

The IASB adopted all current International Accounting Standards ( IAS) and currently issues International Financial Reporting Standards (IFRS)

The body of IASs and IFRSs is collecively known as IAS/IFRS or simply IFRS that are now wide-spread world-wide

The EU adopted IFRS for listed companies from 2005 onward

The other G20 countries are gradually moving towards the use of IFRS (including Russia, Brazil, Japan, South Africa

www.ifrs.org/use-around-the-world/use-of-ifrs-standards-by-jurisdiction/

27 US GAAP The Financial Accounting Standard Board (FASB), is the US standard setter and issues Financial Accounting Standards (FASs) also collectively known as US Generally Accepted Accounting Principles (GAAP)

US GAAP are enforced by the Security Exchange Commission (SEC), the US Stock Exchange watchdog

Given the importance of US markets, US GAAPs have been influencial internationally

An ambitious convergence project is in place between IASB and FASB to make US GAAP and IFRS fully compatible: the so called convergence project

A joint project to share a common Framework (started in 2004) was suspended in 2012

The future of this project is uncertain

Standard setting and enforcement in the European Union 56

n Major aim of EU has been to create a single financial market that requires access by investors to financial reports prepared according to common accounting standards

n The initial steps were the issue of accounting directives– the Fourth Directive, the Seventh Directive, and the Eight Directive.

n The directives were required to be adopted by each EU country into their national laws

n The existing directives were subsumed in 2013 in a new Accounting Directive with particular attention to Small-Medium Enterprises and Micro Enterprises

28 Standard setting and enforcement in the European Union 57

n Yet great differences still remain amongst EU countries and almost each country has its own Standard Setter

n In Germany Deutsches Rechnungslegungs Standards Committee (DRSC)

n In Italy Organismo Italiano di Contabilità (OIC)

International Accounting

5) The IASB’s new Conceptual Framework for Financial Reporting

A.Y. 2020-2021 Double degree Programme in Business and Economics University of Cagliari, Prague CULS & Bielefeld UAS Alessandro Mura [email protected]

See Part 3, Chapter 7 of Financial Accounting and Reporting Elliot and Elliot: Concepts – Evolution of an international conceptual framework

29 The new Framework (issued in March 2018) 59

n Purpose of the Framework

n Objective and qualitative characteristics

n The reporting entity

n Elements of financial statements and recognition

n Derecognition

n Measurement

n Profit or loss and other comprehensive income

Purpose of the Conceptual Framework

q Assist the IASB to develop IFRS standards based on consistent concepts

q Assist preparers to develop consistent accounting policies when no Standard applies to a particular transaction or other event, or when a Standard allows a choice of accounting policy

q assist all parties to understand and interpret the Standards.

The Conceptual Framework is not a Standard

Nothing in the Conceptual Framework overrides any Standard or any requirement in a Standard.

30 Objective of financial reporting

Provide financial information useful to users in making decisions

Users’ decisions involve decisions about

voting and influencing buying, holding or selling providing or settling loans management

To make these decisions, users assess

prospects for future net cash inflows to the management’s stewardship of the entity’s entity economic resources

To make both these assessments, users need information about both

economic resources, claims and changes in how efficiently and effectively management those resources and claims has discharged its responsibilities

Qualitative characteristics

Fundamental qualitative characteristics

Relevance Faithful representation

• Information is relevant if it is • Information must faithfully capable of making a difference to represent the substance of what it the decisions made by users purports to represent

Enhancing characteristics

Comparability Verifiability Timeliness Understandability

Cost constraint

31 Clarifying aspects of faithful representation

• Exercise of caution under conditions of uncertainty • Does not allow for overstatement or understatement of Prudence assets, liabilities, income or expenses • Supports neutrality

• Arises when monetary amounts cannot be observed directly Measurement and need to be estimated • Does not prevent information from being useful uncertainty • If very high, may affect whether a sufficiently faithful representation can be achieved

• Economic substance of the underlying economic Substance over phenomenon is normally the same as the legal form form • If not, need to represent the substance to provide faithful representation

Reporting entity and Financial Statements

• an entity that is required, or chooses, to prepare financial Reporting entity statements • not necessarily a legal entity—could be a portion of an entity or comprise more than one entity

Financial a particular form of financial reports that provide information about the reporting entity’s assets, liabilities, equity, income and statements expenses

Consolidated Unconsolidated Combined financial financial statements financial statements statements

provide information about provide information about provide information about assets, liabilities, equity, assets, liabilities, equity, assets, liabilities, equity, income and expenses of income and expenses of income and expenses of two both the parent and its the parent only or more entities that are not subsidiaries as a single all linked by a parent- reporting entity subsidiary relationship

32 Elements of financial statements— assets, liabilities and equity

n Relate to financial position

A present economic resource controlled by the entity as a result of Asset past events • An economic resource is a right that has the potential to produce economic benefits

A present obligation of the entity to transfer an economic resource as a result of past events Liability • An obligation is a duty or responsibility that the entity has no practical ability to avoid

The residual interest in the assets of the entity after deducting all its liabilities Equity • Financial Instruments with Characteristics of Equity research project further explores how to distinguish liabilities from equity

Elements of financial statements— income and expenses

n Relate to financial performance

Increases in assets, or decreases in liabilities, that result in Income increases in equity, other than those relating to contributions from holders of equity claims

Decreases in assets, or increases in liabilities, that result in Expenses decreases in equity, other than those relating to distributions to holders of equity claims

Information about income and expenses is just as important as information about assets and liabilities

33 Source: Framework for Financial Reporting (IASB-2018) 67

Recognition

Recognition criteria

Relevance Faithful representation

Whether recognition of an item results in Whether recognition of an item results in relevant information may be affected by, a faithful representation may be affected for example: by, for example: • low probability of a flow of economic • measurement uncertainty benefits • recognition inconsistency • existence uncertainty • presentation and disclosure of resulting income, expenses and changes in equity

Cost constraint

34 Example 1 Product warranties

n A manufacturer gives warranties at the time of sale to purchasers of its product. Under the terms of the contract for sale the manufacturer undertakes to make good, by repair or replacement, manufacturing defects that become apparent within three years from the date of sale.

n The manufacturer has sold a batch of products.

n No defects have yet been reported to it.

Does the entity have a liability?

Example 1 Product warranties

Criterion Met? Potential to require transfer of an economic resource ü No practical ability to avoid ü As a result of past events ü ò Does the entity have a liability? ü

35 Example 2 Contaminated land constructive obligation

n An entity in the oil industry causes contamination and operates in a country where there is no environmental legislation. However, the entity has a widely published environmental policy in which it undertakes to clean up all contamination that it causes. The entity has a record of honouring this published policy.

Does the entity have a liability?

Example 2 Contaminated land constructive obligation

Criterion Met? Potential to require transfer of an economic resource ü Depends No practical ability to avoid (but likely to be ü) As a result of past events ü ò Depends Does the entity have a liability? (but likely to be ü)

36 Example 3 Purchase option

n An entity has entered into a contract that gives it an option to purchase a commodity for a fixed price of € 10,000. The entity can exercise the option at any time in the next year. The current price of the commodity is € 9,000.

n The entity paid € 100 for the option.

n The option cannot be traded.

Does the entity have an asset?

Example 3 Purchase option

Criterion Met? Right ü Potential to produce economic benefits ü Controlled by the entity ü As a result of past events ü ò Does the entity have an asset? ü

37 Derecognition

Aims to faithfully represent both:

Any assets and liabilities retained The change in the entity’s assets after the transaction that led to the and liabilities as a result of that derecognition transaction

Derecognition normally occurs

for an asset for a liability when the entity loses control of all or part or when the entity no longer has a present the recognised asset obligation for all or part of the recognised liability

Measurement The new framework proposes a mixed measurement approach

Historical cost Current value

Amortised cost Fair value Value in use Fulfilment value Current cost

Derived from transaction or Updated to reflect conditions other event that gave rise to on the measurement date the asset or liability

Information about changes in Information about margins prices and other factors

38 Current value

the price that would be received to sell an asset, or paid to Fair value: transfer a liability, in an orderly transaction between market participants at the measurement date.

the present value of the cash flows, or other economic benefits, Value in use: that an entity expects to derive from the use of an asset and from its ultimate disposal.

the present value of the cash, or other economic resources, Fulfilment value: that an entity expects to be obliged to transfer as it fulfils a liability

The current cost of an asset is the cost of an equivalent asset at the measurement date, comprising the consideration that would be paid at the measurement date plus the transaction costs that Current cost: would be incurred at that date. The current cost of a liability is the consideration that would be received for an equivalent liability at the measurement date minus the transaction costs that would be incurred at that date.

Selecting a measurement basis

Information in both the statement of financial position and the statement(s) of financial performance

Relevance Faithful representation

Characteristics of the asset Measurement inconsistency or liability (‘accounting mismatch’)

Contribution to future cash Measurement uncertainty flows

Enhancing qualitative characteristics and cost constraint

39 Consideration of cost constraint, verifiability and comparability Historical cost Fair value

Cost constraint Often less costly to Can be costly to measure and verifiability measure & easier to verify and difficult to verify BUT BUT •Estimating consumption •Not if observable market and impairment can be prices exist difficult

Comparability Can reduce comparability: Enhances comparability: •often results in identical •Identical assets or assets and liabilities being liabilities measured at fair measured at different value will, in principle, be amounts because of when measured at the same they were acquired or amount by entities that incurred have access to the same markets

Profit or loss and OCI

Statement of profit • Primary source of information about or loss performance • Default location for income and expenses

Other • Exceptional circumstances • Only changes in current values of assets and comprehensive liabilities income • In principle, OCI items are recycled

Classification into profit or loss and OCI and recycling

Relevance Faithful representation

Only the Board can take decisions on OCI and recycling

40 International Accounting

6) IAS 1 Presentation of Financial Statements

A.Y. 2020-2021 Double degree Programme in Business and Economics University of Cagliari, Prague CULS & Bielefeld UAS Alessandro Mura [email protected]

See Part 2, Chapter 3 of Financial Accounting and Reporting Elliot and Elliot: Preparation of Financial Statements

IAS 1: Objective

Objective of Financial Statements

To provide information of an entity about its

Financial Position Financial Perfomance Cash Flows

information that assists users:

in making economic decisions

in predicting the entity's future cash flows

41 IAS 1: Components

Components of Financial Statements

Statement of Statement of Statement of Statement of Financial Profit or Loss Changes in Cash Flows Position and Other Equity (Balance sheet) Comprehensive Income (OCI)

Notes (including accounting principles and other explanatory notes)

An entity may use titles for the statements other than those stated above

IAS 1: General Features

Going Concern

Fair presentaion and compliance Accrual Basis

Financial Statements: Consistency General features Materiality & Aggregation

Comparative Offsetting information Freqeuncy of reporting

42 IAS 1: General Features

Fair presentation In accordance with the Framework and in application and compliance: of IFRSs

financial statements are normally prepared assuming Going Concern the entity is a going concern and will continue in operation for the foreseeable future

An entity prepares its financial statements, except for Accrual Basis cash flow information, using the accrual basis of accounting.

The presentation and classification of items shall be Consistency retained from one period to the next unless there is a change in circumstances or a requirement of a new IFRS

IAS 1: General Features

Each material class of similar items must be presented Materiality & separately. Aggregation Dissimilar items may be aggregated only if they are individually immaterial.

Offsetting Assets and liabilities, and income and expenses, may not be offset unless required or permitted by an IFRS.

Comparative to be disclosed in respect of the previous period for all amounts reported in the financial statements and information in the notes

Frequency of At least annualy reporting

43 IAS 1: Identification of Financial Statements They must be clearly distinguished from other information in a published document Whether it is a group or an Name of the individual reporting entity Igitur Group company

Statement of Financial Position Date of the financial as at 31 December 2018 period (in Thousands EUR) Presentation currency 2018 2017 & Level of rounding Property, Plant and Equipment ..….. ….… Intangible assets ...…. ……. ……………. …………….

IAS 1: Statement of Financial Position Line items: minimum Assets content Liabilities

Property, Plant and Equipment Trade and other Payables Investment Property Provisions

Intangible Assets Financial Liabilities

Financial Assets Current income tax assets & liabilities Investments by equity methods Deferred tax assets & liabilities Biological Assets Assets & Liabilities IFRS 5 Inventory Equity

Trade and other receivable Non-controlling interests, Cash and Cash equivalents presented within equity Issued capital and reserves attributable to owners of the parent

Additional line items, headings and subtotals may be needed to fairly present the entity’s financial position 88

44 IAS 1: Current non-current classification

Separation of current and non-current assets and General rule liabilities is based on the normal course of the operating cycle, unless presentation based on liquidity provides information that is reliable

The operating cycle is the length of time between the Operating Cycle purchase of inventory and the cash collected from the sale of inventory

In either case, if an asset (liability) category combines amounts to be received (settled) after 12 months with amounts to be received (settled) within 12 months, note disclosure is required to separate the longer-term amounts from the 12-month amounts

Current & non-current Assets and Liabilities Currents assets are those:

n expected to be realised in the entity's normal operating cycle; n held primarily for the purpose of trading;

n expected to be realised within 12 months after the reporting period n cash and cash equivalents (unless restricted).

n All other assets are non-current.

Currents liabilities are those:

n expected to be settled within the entity's normal operating cycle n held for purpose of trading

n due to be settled within 12 months n for which the entity does not have an unconditional right to defer settlement beyond 12 months. n Other liabilities are non-current.

Deferred tax assets & deferred tax liabilities are never presented as Current

45 Format of Statement of Financial Position

n IAS 1 does not prescribe a specific format

n Assets can be presented current then non-current, or vice versa.

n Liabilities and Equity can be presented current then non-current then equity, or vice versa.

n A net asset presentation (assets minus liabilities) is also allowed.

n The long-term financing approach used in UK and elsewhere is also acceptable:

Fixed assets + Current assets - Short term Payables = Long-term Debt plus Equity

IAS 1: Statement of profit or loss and OCI

profit or loss: "the total of income less expenses, excluding the components of other comprehensive income"

+ ONLY THIS PROFIT IS DISTRIBUTABLE TO SHAREHOLDERS

items of income and expense (including Other comprehensive reclassification adjustments) that are not income recognised in profit or loss as required or permitted by other IFRSs" = change in equity during a period resulting from Comprehensive income for transactions and other events, other than those the period changes resulting from transactions with owners in their capacity as owners"

46 IAS 1: Statement of profit or loss and OCI

Line items minimum Profit or Loss content Revenue Tax expense

Finance Cost Post tax profit or loss /IFRS 5

Share of the profit or loss of associates Profit or Loss or joint ventures by equity method Parent

Other Comprehensive income (OCI)

Each component of OCI classified by NCI nature and grouped between those items that will or will not be reclassified Total comprehensive income to profit and loss in subsequent periods

Share of OCI by associates or joint ventures by equity method

IAS 1: Statement of profit or loss and OCI

Choice in presentation

•a single statement of profit or loss and other comprehensive income, with profit or loss and other comprehensive income presented in two sections, • two statements: • a separate statement of profit or loss • a statement of comprehensive income, immediately following the statement of profit or loss and beginning with profit or loss

Choice in presentation for profit and loss section

Expenses recognised in profit or loss should be analysed either by nature (raw materials, staffing costs, depreciation, etc.) or by function (cost of sales, selling, administrative, etc). If an entity categorises by function, then additional information on the nature of expenses – at a minimum depreciation, amortisation and employee benefits expense – must be disclosed in the notes.

47 IAS 1: Statement of profit or loss and OCI

Classifying expenses by nature/function

IAS 1: Statement of Changes in Equity

Parent

Total comprehensive income

Non controlling Interest

Effect of retrospective application and restatement

Profit or Loss

Movement of each component of Equity OCI

Owners

48 IAS 1: Notes

General information + compliance with IFRS

Accounting policies and judgement

Source of estimation uncertainty

Capital

Dividend

International Accounting

6) IAS 2 Inventories

A.Y. 2020-2021 Double degree Programme in Business and Economics University of Cagliari & Bielefeld UAS Alessandro Mura [email protected]

See Part 5, Chapter 20 of Financial Accounting and Reporting - Elliot and Elliot: Inventories

49 IAS 2: Objective & scope

IAS 2 prescribes the accounting treatment for inventories Inventories include: assets held for sale in the ordinary course of business (finished goods) assets in the production process for sale in the ordinary course of business (work in process) materials and supplies that are consumed in production (raw materials)

IAS 2 does not apply to:

work in process under construction contracts (IAS 11)

Financial instruments (IAS 39)

Biological assets of agricultural activities(IAS 41)

Inventory types in manufacturing entities

Finished Inventory whose production process is completed and is goods ready for sale

Work in progress Inventory that is partly completed

Raw Source products that are required to manufacture the good materials for sale Finished Consummables Immaterial items that are required in the production process.

Inventory types in merchandise entities

Goods for sale

Consummables

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50 IAS 2: Fundamental principle

Inventories are required to be stated at the

lower of

Net realisable value Cost NVR

Cost incurred in bringing inventory to its present conditions and location Selling price Less: Cost to complete Cost of selling

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IAS 2: Measurement of inventories Cost should include all:

§ costs of purchase (including irrecovarable taxes, transport, and handling) net of trade discounts received

§ costs of conversion (including fixed and variable manufacturing overheads) § Other costs incurred in brigning the inventories to their present location and condition

Cost should not include:

§ abnormal waste § storage costs § administrative overheads unrelated to production § selling costs § foreign exchange differences arising directly on the recent acquisition

§ interest cost when inventories are purchased with deferred settlement terms.

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51 IAS 2: Write-down to Net Realisable Value

Net realisable value (NVR) is equal to:

the estimated selling price in the ordinary course of business

minus

the estimated cost of completion and the estimated costs necessary to make the sale

§ Any write-down to NRV should be recognised as an expense in the period in which the write-down occurs.

§ Any reversal should be recognised in the income statement in the period in which the reversal occurs

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IAS 2: Example IBIDEM plc paid € 3 per unit for the raw materials of its products. To complete each incurred € 2 per unit in direct labour. Production overheads for the year based on normal output of 12,000 units was € 72,000. Due to industrial action only 10,000 unit were produced and 1,000 units were in inventory at the end of the year. As a result of the industrial action some units were badly stored and became damaged. It’s estimated that 200 of the units will now only be sold for € 12 each after minor repairs of € 2 each. What figure for closing inventory would be shown in the Statement of Financial Position? NVR: Cost: Damaged goods: Direct cost: raw materials) € 3 Selling price: € 12 Labour cost € 2 (less) Cost to complete (€ 2) Overheads (72,000/12,000) € 6 NRV € 10 Undamaged goods: Total cost per unit € 11 Selling price: € 12 NRV € 12 Undamaged goods: Damaged goods: 800 x 11 = € 8,800 200 x 10 = € 2,000 Closing inventory: € 10,800.00

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52 IAS 2: Measurement of inventories

For inventory items that are not interchangeable, specific costs are attributed to the specific individual items of inventory

For inventory items that are interchangeable IAS 2 allows these formulas:

the first (oldest) inventories acquired are assumed to be § FIFO formula (First in – First out) – used first: inventory on hand at any time is assumed to consist of the most recently acquired items. § weighted average cost formula.

§ The LIFO formula (Last in-First out) is no longer allowed (since 2002).

The same cost formula should be used for all inventories with similar characteristics as to their nature and use to the entity.

For groups of inventories that have different characteristics, different cost formulas may be justified.

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IAS 2: Disclosure

Required disclosure in the notes:

§ accounting policy for inventories

§ carrying amount, generally classified as merchandise, supplies, materials, work in progress, and finished goods. The classifications depend on what is appropriate for the entity § carrying amount of any inventories carried at fair value less costs to sell

§ amount of any write-down of inventories recognised as an expense in the period § amount of any reversal of a write-down to NRV and the circumstances that led to such reversal § carrying amount of inventories pledged as security for liabilities cost of inventories recognised as expense (cost of goods sold). § See Basf’ and Ferrarri’s financial statements.

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53 International Accounting

7) IAS 16 Property, Plant and Equipment (PPE)

A.Y. 2020-2021 Double degree Programme in Business and Economics University of Cagliari, Prague CULS & Bielefeld UAS Alessandro Mura [email protected]

See Part 5, Chapter 17 of Financial Accounting and Reporting - Elliot and Elliot: Property, Plant and Equipment

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IAS 16: Objective & scope IAS 16 prescribes the accounting treatment for Property, Plant & Equipment (PPE)

PPE include tangible assets that are: a) held by an entity for use in the production or supply of goods and services, for rental to others, or for administrative purpose

b) expected to be used for more than one period PPE will normally be included in the non-current assets section of the Statement of Financial Position IAS 16 does not apply to:

assets classified as held for sale in accordance with IFRS 5 Biological assets of agricultural activities (IAS 41) exploration and evaluation assets related to mineral resources (IFRS 6) mineral rights and mineral reserves such as oil, natural gas and similar non- regenerative resources

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54 IAS 16: Recognition criteria

Recognition of PPE

Future economic benefits Cost reliably measurable

Criteria to be met for both:

Initial costs to acquire or Subsequent costs to add to, replace construct an item of PPE part of, or service an item of PPE

Not necessary to own PPE to recognise them, but to have control over the assets: the entity will receive rewards and carry the risks associated with the asset

A present economic resource controlled by the entity as a result of past events Remember Asset’s • An economic resource is a right that has the potential to definition produce economic benefits

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IAS 16: Initial measurement

An item of PPE should be initially recognised at cost

The cost of an item of PPE is made up of:

Purchase price including irrecoverable taxes and after deducting trade discount

Directly attributable costs to bringing the asset to the location and condition necessary for it to operate according to its intended use: site preparation, handling, delivering, installation intended by the managemnt + Removal costs: estimated costs of dismantling and removing the asset and restoring the site where a present obligation exists (Provisions at present value)

Example of removal costs: A company estimates future costs of € 300,000 (present value) for removing a machinery that has been anchored at the moment of installation:

Machinery 300,000 Dismantling Provisions 300,000

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55 IAS 16: Initial measurement

The cost of an item of PPE does not include:

Costs that are incidental to the construction (e.g. errors)

General overhead costs Initial losses before an asset reaches its intended uses

If payment is deferred interest at market rate must be recognised +

If asset acquired in exchange of other non-monetary assets Fair value

Subsequent expenditure on PPE can be capitalised only if it improves the assets beyond its originally assessed standard of perforrmance (faster production, higher quality product, etc)

Repair and maintenance that simply restore the PPE’ original level of efficiency cannot be capitalised

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IAS 16: Initial measurement

Borrowing costs

Borrowing costs that are directly attributable to the acquisition, construction or production of a “qualifying asset” should be included in the cost of that asset: they should be capitalised (IAS 23 Borrowing costs)

A “qualifying asset” is one that necessarily takes a substantial period of time to get ready for its intended use + I

In any case, capitalisation of borrowing costs ceases when assets are ready for use

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56 IAS 16: Initial measurement (Example) Estis plc purchases a machine that had a list price of € 100,000, but was offered a trade discount of 10%. Estis pls also incurred the following charges in getting the asset ready for its intended use: € Shipping and handling charges 3,500 Pre-production testing 12,000 Site preparation costs 17,000 General overheads 4,500

Included in the preparation costs is € 3,000 as a result of Estis providing incorrect requirement for the asset.

Compute the initial cost of the machine to be recorded according to IAS 16

90% of list price (100,000): 90,000 Shipping and handling charges 3,500 Pre-production testing 12,000 Site preparation cost (17,000-3,000) 14,000 Initial cost € 119,500

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IAS 16: PPE

Subsequent measurement of PPE

Cost model Revaluation model

Cost Fair value

_ _

Accumulated depreciation Subsequent Accumulated

depreciation

_ _

Accumulated Impairment loss Subsequent Accumulated impairment loss

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57 IAS 16: Revaluation model Revaluations should be carried out regularly, so that the carrying amount of an asset does not differ materially from its fair value at the balance sheet date.

If an item is revalued, the entire class of assets to which that asset belongs should be revalued. If Carrying amount

increases: decreases

Credit to equity: Credit to income: Debit to expenses: Debit to equity: Revaluation If reverses if exceeds If reverses reserve previous decrease previous increase previous increase in profit or loss in revaluation in revaluation reserve reserve

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IAS 16: Revaluation model (example 1) Land Year 1 Initial cost 1,000 Year 2: fair value 1,100 (+100) Year 5: fair value 950 (-150) Year 8: fair value 1,030 (+ 80)

Year 1 Debit Credit Land 1,000 Cash 1,000 Year 2 Land 100 Revaluation reserve 100 Year 5 Revaluation reserve 100 Revaluation Loss 50 Land 150 Year 8 Land 80 Revaluation Gain 50 Revaluation reserve 30

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58 IAS 16: Revaluation model (example 2) Plant: Initial cost 1,000 Useful life 10 Years At the end of year 4 Accumulated depreciation 400 (1,000 x 40%) Fair value 1,260 Revaluation = fair value – book value Revaluation 1,260 – 600 = 660

31/12/Y4 Debit Credit Accumulated depreciation 400 Plant 400 31/12/Y4 Plant 660 Revaluation reserve 660

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IAS 16: Depreciation = allocation of depreciable amount over its useful life on a systematic basis

Depreciable amount Useful life Systematic basis

How much How long In what manner

Cost Period N. of units Depreciation method

Minus

Residual value

Straight-line Diminishing N. of units balance

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59 IAS 16: Depreciation a) The period of time over which an asset is expected to be Useful life used by an entity b) The number of production or similar units expected to be obtained from the asset by an entity

How is it Not necessarily the life expectancy of an asset. determined? Economic life normally lower than the working life because of obsolescence: assets become less economically and technologically efficient when old

Residual Amount an entity expects to obtain for an asset at the end of its value useful life less Expected costs of disposal Often not considered as the estimate is not reliable or not material Residual value and useful life should be reviewed at least at each financial year-end if expectations dffer, any change is accounted for prospectively

119

IAS 16: Depreciation

Component the various components of an asset to be identified and approach depreciated separately if they have differing patterns of benefits and are significant relative to the total cost of the item.

Depreciation a) Straight line (most popular): �� − �� methods �� ℎ�� = ��

b) Diminishing balance (depreciation is calculated annually n = years of on the carrying value (book value, or net written-down value) useful life % = 1 − ! (�� /��)

. c) N. of units. % = .

The depreciation method used should reflect the pattern in which the asset's economic benefits are consumed by the entity

120

60 IAS 16: Depreciation

Straight line Diminishing balance Difference (38%) € € € Cost 11,000 11,000 Depreciation year 1 2,000 4,180 2,180 Carrying value 9,000 6,820 Depreciation for year 2 2,000 2,592 592 Carrying value 7,000 4,228 Depreciation for year 3 2,000 1,606 (394) Carrying value 5,000 2,622 Depreciation for year 4 2,000 996 (1,004) Carrying value 3,000 1,626 Depreciation for year 5 2,000 618 (1,382) Residual value 1,000 1,008

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IAS 16: Depreciation § Depreciation starts when the asset is ready for its intended use, and not from when it starts to be used. § Any change in estimate is applied prospectively by applying the new estimate to the carrying value of the PPE at the date of change

Example: Change in useful life Oportebat bought a machine for € 25 million on 1 January 2015 and depreciated over its useful life of 10 years. On 31/12/2017 the remaining useful life was estimated as 5 years. Calculate the amount to be shown in the financial statements for the year-ended 2018.

Solution: Initial cost € 25 m Accumulate depreciation ( € 25 m /10x3) (€ 7,5 m) Carrying value at 31/12/2017 € 17,5 m Depreciation for year 2018 (17,5/5) = € 3,5 m SPL Carrying value at 31/12/2018= € 14 m SFP

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61 IAS 16: Depreciation

Example: Change in method A vehicle was purchased for € 40,000 on 1 January 2013 when its useful life was estimated to be 10 years with the residual value of € 5,000. The depreciation policy of 20% reducing balance was selected. On 1st January 2018 the directors decided that to give a fair presentation a depreciation policy of straight line over the useful economic life should be followed. There has been not change in the estimated useful economic life of the asset as a result Calculate the depreciation charge to be shown in the financial statements for the year ended 31/12/2018.

Solution: Diminishing Balance Change of Method Initial Cost 40,000.00 Straight-line formula Depreciation 2013 8,000.00 Carrying value = (13,710.20) Carrying value 31/21/13 32.000.00 Depreciation 2014 6,400.00 Residual value = € 5,000 Carrying value 31/21/14 25,600.00 Remaining life = 5 years Depreciation 2015 5,120.00 Carrying value 31/21/15 20,480.00 Depreciation 2016 4,096.00 Depreciation charge for year ended 31/12/18 = (13,710.20-5,000.00)/5 = Carrying value 31/21/16 16,384.00 Depreciation 2017 3,276.80 € 1,621.44 Carrying value 31/21/17 13,107.20

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IAS 16: Derecognition

Derecognition of PPE

On disposal No future economic benefits

Gain or Loss

= Net disposal proceeds – Carrying amount

124

62 IAS 16: Derecognition (example) Atque plc sells for 25,000 € in cash a machine whose initial cost was € 100,000, after having reached € 70,000 of accumulated depreciation.

Net disposal proceeds = 25,000 Carrying value = 30,000 Loss on disposal of asset = 5,000

…….. Debit Credit Accumulated depreciation 70,000.00 Machine 70,000,00 …….. Cash 25,000.00 Loss on asset disposal 5,000.00 Machine 30,000.00

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IAS 16: Disclosure in the notes

For each class of property, plant, and equipment, disclose: § basis for measuring carrying amount § depreciation method(s) used § useful lives or depreciation rates § gross carrying amount and accumulated depreciation and impairment losses § reconciliation of the carrying amount at the beginning and the end of the period, showing:

• additions • disposals • acquisitions through business combinations • revaluation increases or decreases • impairment losses • reversals of impairment losses • depreciation • net foreign exchange differences on translation • other movements

126

63 IAS 16: Disclosure in the notes

For each class of property, plant, and equipment, disclose:

§ basis for measuring carrying amount § depreciation method(s) used § useful lives or depreciation rates § gross carrying amount and accumulated depreciation and impairment losses § reconciliation of the carrying amount at the beginning and the end of the period, showing:

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IAS 16: Disclosure

Required disclosure in the notes:

If property, plant, and equipment is stated at revalued amounts, certain additional disclosures are required:

•the effective date of the revaluation

• whether an independent valuer was involved

• for each revalued class of property, the carrying amount that would have been recognised had the assets been carried under the cost model

• the revaluation surplus, including changes during the period and any restrictions on the distribution of the balance to shareholders

•See Basf’s and Ferrari’s Financial Statements.

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