International

GAAP®

2008Generally Accepted Accounting Practice under International Financial Reporting Standards

Mike Bonham Matthew Curtis Mike Davies Pieter Dekker Tim Denton Richard Moore Hedy Richards Gregory Wilkinson-Riddle Matt Williams Allister Wilson

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About this book  

This 2008 edition of International GAAP has increased in length by approximately 500 pages since the last edition, due to the fact that it has been revised and expanded substantially in order to: • deal with all new and amended authoritative pronouncements and exposure

drafts, including the new revised standards on business combinations and consolidated financial statements;

• update and expand the extracts from the published accounts of real companies from around the world;

• include an entirely new chapter on accounting for the Extractive Industries; and • provide insight and guidance in greater detail than ever before on the

interpretation and practical application of IFRS from a truly global perspective, based on the authors’ experience of dealing with day-to-day practical issues.

As a result, the book is now published in two volumes, comprising 39 Chapters, three indexes, and 90 pages of detailed contents. These are set out over the two volumes as follows:

Volume 1 • Complete set of Detailed Contents • Chapters 1 to 22 • Index of extracts from financial statements • Index of standards • Index

Volume 2 • Complete set of Detailed Contents • Chapters 23 to 39 • Index of extracts from financial statements • Index of standards • Index

Furthermore, for ease of use, the running header of each page of the book now includes a reference to the relevant chapter and section number. For example:

 

Foreword  

Philip Laskawy

Chairman of the Trustees International Accounting Standards Committee Foundation

The movement towards International Financial Reporting Standards (IFRSs) as the leading financial reporting framework for the global capital markets has gathered pace faster than most people expected. This is due to many different factors, including the adoption of and smooth transition to IFRSs in 2005 across Europe and in many other countries around the world. It is due also to the courage, vision and commitment shown not only by the members of the International Accounting Standards Board (IASB) under the outstanding leadership of the Board’s Chairman, Sir David Tweedie, but also by national governments, securities’ regulators, corporations, the auditing profession and others associated with the adoption.

Naturally, much work remains to be done. Several countries that are major participants in the global economy – such as Brazil, Canada, China, India, Japan and Korea – have announced recently their intention to converge their national standards with IFRSs. As a result, in my view, the single most important challenge now facing standard setters and regulators is to ensure that the application of IFRSs leads to a truly single set of standards used worldwide, and that ‘national variations’ in the interpretation and application of IFRS do not emerge. I have no doubt that calls will be made for even greater consistency and clarity in the application of IFRSs – both within individual industries and countries and across industries and national borders. Consequently, I believe that if country-specific variations of IFRSs develop, they will be a substantial hindrance to IFRSs becoming a truly global tool of financial communication.

Preventing any fragmentation in the application of IFRSs is particularly important in the light of the recent proposal by the SEC regarding the US GAAP reconciliation

requirements relating to foreign private issuers. In one of the most significant moves in support of global standards in recent times, the SEC issued in July 2007 a consultative document that proposes amendments to Form 20-F to accept – without reconciliation to US GAAP – financial statements prepared in accordance with the English language version of IFRS as published by the IASB. Furthermore, the SEC has recently published a Concept Release, asking whether US companies should be able to use IFRSs for their filings with the SEC.

It is important to note that in an effort to create a global system, the SEC is not proposing to change existing reconciliation requirements for foreign private issuers that file financial statements that are not in full compliance with IFRS as published by the IASB. This emphasises the need for jurisdictions to resist the temptation to develop local variations of IFRS in the promulgation, application and regulation of their financial reporting standards.

I warmly welcome the publication of this book, as I believe that it has an important part to play in the process of promoting consistent, comparable and high quality financial reporting under IFRSs. Because IFRSs are principles-based, there is an enormous need for a book such as this; a book that not only provides an analysis of the requirements of the standards and the principles that they expound, but also presents a unique explanation of how the standards should be interpreted and applied in practice. It addresses the main issues in International GAAP by explaining thoroughly the technical aspects of each standard, and providing a detailed analysis of possible solutions to the complex practical issues the application of each standard raises. All this is accompanied by worked examples, a comprehensive discussion of the possible alternative solutions available, and practical illustrations taken from the actual financial statements of companies that report under IFRSs.

October 2007 Philip Laskawy

 

Preface  

International accounting standards have come a long way since Henry Benson led the way to the creation, first, of the Accountants International Study Group in 1967 and, thereafter, of the International Accounting Standards Committee in 1973. Perhaps most remarkable is the pace at which the globalisation of accounting standards has moved: from the position only seven years ago where numerous disparate national systems existed, to the position today where IFRS has established itself as the globally accepted passport to capital raising in the world’s capital markets.

This represents a considerable achievement by all concerned: the European Union, whose leaders had the vision to set the agenda for a common financial reporting regime across the EU; the former Board of the International Accounting Standards Committee (IASC), who undertook the core standards programme that laid the groundwork for global acceptance of international standards; the many countries throughout the world whose standard-setters have contributed to the work of the IASC and the International Accounting Standards Board (IASB); the members of the IASB, who have worked assiduously over the past seven years under the unstinting leadership of Sir David Tweedie; and the large number of governments that have recognised the value of a common financial reporting regime, and adopted IFRS.

2007 has also seen the significant decision by the US Securities and Exchange Commission to accept from foreign private issuers financial statements prepared in accordance with IFRS as published by the IASB without reconciliation to US GAAP.

However, with the IASB’s undeniable success comes considerable responsibility. We believe that the IASB’s status as an independent private sector body should be defended vigorously; at the same time, however, given the importance of IFRS in the global capital markets, it is now more important than ever before that the accountability of the IASB to wider society is substantially improved. This implies that the IASB should be the subject of a significantly enhanced system of governance and oversight than is presently the case.

A further duty of the IASB is that it should take heed of the growing concern that is being expressed about certain aspects of the direction in which global financial reporting is moving. Important organisations such as The Corporate Reporting Users’ Forum and Columbia Business School’s Centre for Excellence in Accounting and Security Analysis are amongst the growing list of institutions that are questioning the IASB’s and FASB’s pursuit of the fair (exit) value-based balance sheet approach to performance measurement.

Accounting standards should result in corporate reports that are consistent with economic reality. However, in our view, the standard-setters’ exit value-based

balance sheet approach to performance measurement does not reflect the way in which many businesses operate, are managed or create value. We believe further that a balance sheet dominated approach that is based on exit values can result in information of limited relevance to economic decision making and does not necessarily provide a sound basis for the assessment of value creation. We therefore believe that the standard-setters should, as a matter of priority, explain and justify to their constituencies the position they hold on the conceptual superiority of the balance sheet approach, over the concept of income, as the primary measure of performance and value creation.

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We are deeply indebted to many of our colleagues within the global organisation of Ernst & Young for their selfless assistance and support in the publication of this book. It has been a truly international effort, with valuable contributions from Ernst & Young people around the globe.

Our thanks go particularly to those who reviewed and edited drafts, most notably: Richard Addison, Justine Belton, Tony Clifford, Michael Elliot, Daniel Feather, Charlie Feeney, Keith Gaebel, Sven Hayn, Mike Herbst, Rich Jones, Vincent de La Bachelerie, David Lindsell, Anne Lockwood, Alan Millings, John O’Grady, Eric Ohlund, Susan Oldmeadow-Hall, Ruth Picker, Chris Schibler, George Schleier, Eric Tarleton, Leo van der Tas, Lynda Tomkins, Dominique Thouvenin, Paul Wallek and Dmitry Weinstein. Within the International Financial Reporting Group itself, our thanks go to everyone who directly and indirectly contributed to the book’s creation: Marc Baumgartner, Denise Brand, Robin Chatterjee, Larissa Connor, Richard Crisp, Julie Dempers, Bernd Kremp, Robert Overend, Margaret Pankhurst, Tim Rogerson, Levent Serttas, Amir Shahar, Claire Taylor and Lawrence Wong. We also thank Jeremy Gugenheim for his assistance with the production technology throughout the period of writing.

As authors, however, we take responsibility for all the opinions expressed in the book, and the blame for all its faults.

London, Mike Bonham Richard Moore

November 2007 Matthew Curtis Hedy Richards

Mike Davies Gregory Wilkinson-Riddle

Pieter Dekker Matt Williams

Tim Denton Allister Wilson

  ix  

List of chapters  

VOLUME 1 1 The development of International GAAP................................................................ 1 2 The quest for a conceptual framework for financial reporting ............................. 87 3 Presentation of financial statements and accounting policies............................ 189 4 Non-current assets held for sale and discontinued operations........................... 259 5 First-time adoption ................................................................................................ 287 6 Consolidated and separate financial statements ................................................. 387 7 Business combinations and goodwill..................................................................... 461 8 Associates ................................................................................................................ 659 9 Joint ventures.......................................................................................................... 715 10 Foreign exchange.................................................................................................... 757 11 Hyperinflation......................................................................................................... 835 12 Intangible assets ..................................................................................................... 867 13 Property, plant and equipment ............................................................................. 951 14 Investment property .............................................................................................. 995 15 Impairment of fixed assets and goodwill ............................................................ 1033 16 Capitalisation of borrowing costs ........................................................................ 1109 17 Financial instruments: Introduction................................................................... 1131 18 Financial instruments: Recognition, derecognition and offset......................... 1231 19 Financial instruments: Financial liabilities and equity ..................................... 1327 20 Financial instruments: Measurement................................................................. 1411 21 Financial instruments: Hedge accounting ......................................................... 1477 22 Financial instruments: Disclosures..................................................................... 1595 Index of extracts from financial statements ........................................................index 1 Index of standards................................................................................................ index 7 Index....................................................................................................................index 55

The list of chapters in Volume 2 follows overleaf.

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VOLUME 2 23 Inventories ............................................................................................................ 1693 24 Construction contracts......................................................................................... 1711 25 Leases .................................................................................................................... 1735 26 Income taxes ......................................................................................................... 1819 27 Provisions, contingent liabilities and contingent assets.................................... 1919 28 Revenue recognition ............................................................................................ 2009 29 Transactions with governments: grants and service concession

arrangements......................................................................................................... 2121 30 Segment reporting................................................................................................ 2175 31 Share-based payment ........................................................................................... 2235 32 Employee benefits................................................................................................ 2403 33 Earnings per share ................................................................................................ 2495 34 Cash flow statements ........................................................................................... 2563 35 Related party disclosures ..................................................................................... 2605 36 Events after the balance sheet date.................................................................... 2633 37 Interim financial reporting................................................................................... 2649 38 Agriculture............................................................................................................. 2701 39 Extractive industries ............................................................................................ 2735 Index of extracts from financial statements ........................................................index 1 Index of standards................................................................................................ index 7 Index....................................................................................................................index 55

  xi  

Detailed contents  

VOLUME 1

CHAPTER 1 THE DEVELOPMENT OF INTERNATIONAL GAAP

1 THE EVOLUTION OF THE INTERNATIONAL ACCOUNTING STANDARDS BOARD ....................................................................................................................... 1 1.1 The Accountants International Study Group................................................. 3 1.2 The International Accounting Standards Committee (IASC)...................... 4

1.2.1 The IASC’s Standing Interpretations Committee (SIC) .................. 5 1.2.2 The IASC’s comparability/improvements project .............................. 6

1.3 The IASC/IOSCO agreement......................................................................... 6 1.4 The SEC Concept Release on International Accounting Standards ............ 8 1.5 The IOSCO Assessment Report on International Accounting

Standards ........................................................................................................ 10 1.6 The influence of the G4+1 Group of standard setters on

international accounting................................................................................ 11 2 THE RECONSTITUTION OF THE IASC.................................................................. 12

2.1 Shaping IASC for the future ......................................................................... 12 2.2 The new IASC structure ............................................................................... 13

2.2.1 The IASC Foundation (IASCF) ........................................................ 14 2.2.2 The IASC Foundation Constitution ................................................. 16 2.2.3 Trustees’ strategy to enhance the IASB’s governance

arrangements ...................................................................................... 18 2.2.4 The International Accounting Standards Board (IASB)................... 19 2.2.5 The IASB’s Due Process Handbook.................................................. 20 2.2.6 The Standards Advisory Council (SAC)............................................ 23 2.2.7 The International Financial Reporting Interpretations

Committee (IFRIC)........................................................................... 24 A The IFRIC’s system of due process ............................................. 25 B The Authority of IFRIC Interpretations...................................... 28

2.3 Enhancement the governance of the IASC Foundation.............................. 29 3 THE IASB’S TECHNICAL AGENDA AND GLOBAL CONVERGENCE ......................... 29

3.1 An initial agenda of twenty-five technical projects...................................... 29 3.2 The Improvements Project ........................................................................... 31 3.3 IFRS/US GAAP convergence ........................................................................ 32

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3.3.1 Convergence with US GAAP: The Norwalk Agreement.................. 32 3.3.2 US GAAP convergence and the SEC reconciliation

requirement for foreign private issuers: the 2009 ‘roadmap’ ........... 33 3.3.3 Memorandum of Understanding between the FASB and the

IASB .................................................................................................... 34 3.3.4 SEC proposal to accept IFRS financial statements without

reconciliation to US GAAP................................................................. 35 3.3.5 SEC Concept Release on allowing US issuers to prepare

financial statements in accordance with IFRS.................................. 36 3.4 The IASB’s current agenda ........................................................................... 38 3.5 The IASB’s ‘Annual Improvements Process’................................................ 42

4 FINANCIAL REPORTING IN COMPLIANCE WITH INTERNATIONAL FINANCIAL REPORTING STANDARDS ..................................................................... 42 4.1 Statement of compliance with IFRS ............................................................ 42 4.2 Fair presentation and compliance with IFRS............................................... 43 4.3 The fair presentation override ...................................................................... 44

5 THE MOVE TO IFRS IN THE EUROPEAN UNION .................................................. 48 5.1 Historical differences in European accounting ............................................ 48 5.2 Harmonisation achieved by the Fourth and Seventh Directives ................ 49 5.3 The European Commission’s 1995 Communication on international

harmonisation................................................................................................. 49 5.4 The European Commission’s Financial Services Action Plan ..................... 50 5.5 The European Commission’s Regulation on the application of IAS

in the European Union .................................................................................. 52 5.6 The EU endorsement mechanism................................................................ 53

5.6.1 The regulatory level of the endorsement mechanism: The Accounting Regulatory Committee ................................................... 54

5.6.2 The European Financial Reporting Advisory Group (EFRAG)............................................................................................. 55

5.6.3 Standards Advice Review Group........................................................ 58 5.7 Roundtable for the consistent application of IFRS in the EU.................... 58 5.8 Enforcement and regulation in an integrated European capital

market ......................................................................................................... 59 5.8.1 The Committee of European Securities Regulators (CESR).......... 60 5.8.2 CESR Standard No. 1......................................................................... 61 5.8.3 CESR Standard No. 2......................................................................... 62 5.8.4 CESR/SEC joint work plan ................................................................ 63

A Implementation of IFRS and US GAAP by internationally active issuers.................................................................................. 63

B Modernization of financial reporting and disclosure ................... 63 C Discussion of risk management practices .................................... 63

6 THE ADOPTION OF IFRS OUTSIDE THE EUROPEAN UNION ............................... 64 6.1 Australia ......................................................................................................... 64

Detailed contents – Volume 1  xiii 

6.2 Brazil ......................................................................................................... 65 6.3 Canada ......................................................................................................... 66 6.4 China and Hong Kong ................................................................................... 67

6.4.1 China................................................................................................... 67 6.4.2 Hong Kong .......................................................................................... 68

6.5 India ......................................................................................................... 69 6.6 Japan ......................................................................................................... 70 6.7 South Africa.................................................................................................... 71

7 WHAT CONSTITUTES INTERNATIONAL GAAP? ..................................................... 72 7.1 Generally Accepted Accounting Practice ..................................................... 72 7.2 Principles vs. Rules........................................................................................ 74 7.3 Practical interpretations of IFRS .................................................................. 76 7.4 Who ‘owns’ International GAAP?.................................................................. 77

8 CONCLUSION ......................................................................................................... 79

CHAPTER 2 THE QUEST FOR A CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

1 INTRODUCTION ..................................................................................................... 87 1.1 What is a conceptual framework?.................................................................. 88 1.2 Why is a conceptual framework necessary? .................................................. 88 1.3 Accounting and the globalisation of economic activity................................ 90

2 THE DEVELOPMENT OF A US CONCEPTUAL FRAMEWORK................................... 91 2.1 Accounting Research Studies........................................................................ 91 2.2 APB Statement No. 4 .................................................................................... 93 2.3 The Wheat and Trueblood Committees ...................................................... 93 2.4 The FASB conceptual framework................................................................. 94 2.5 The objectives of financial reporting............................................................ 95 2.6 The qualitative characteristics of accounting information .......................... 98

2.6.1 The decision-makers .......................................................................... 99 2.6.2 The cost/benefit constraint ............................................................... 99 2.6.3 Understandability............................................................................... 99 2.6.4 Relevance and reliability .................................................................. 100

A Relevance..................................................................................... 100 B Reliability..................................................................................... 101

2.6.5 Comparability ................................................................................... 102 2.6.6 Materiality ........................................................................................ 102 2.6.7 Conservatism .................................................................................... 102

2.7 The elements of financial statements ........................................................ 103 2.7.1 Assets ................................................................................................ 103

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2.7.2 Liabilities .......................................................................................... 104 2.7.3 Equity................................................................................................ 104 2.7.4 Investments by owners .................................................................... 104 2.7.5 Distributions to owners.................................................................... 105 2.7.6 Comprehensive income.................................................................... 105 2.7.7 Revenues, expenses, gains and losses.............................................. 105

2.8 Recognition and measurement ................................................................... 106 2.9 Using cash flow information in accounting measurements

(discounting)................................................................................................ 108 2.10 Concluding remarks on the FASB conceptual framework......................... 111

3 THE IASB’S CONCEPTUAL FRAMEWORK ............................................................. 113 3.1 Introduction ................................................................................................. 113 3.2 The contents of the IASB’s Framework ..................................................... 113

3.2.1 The objective and underlying assumptions of financial statements ........................................................................................ 114

3.2.2 The qualitative characteristics of financial statements.................. 116 A Understandability........................................................................ 116 B Relevance..................................................................................... 116 C Reliability..................................................................................... 117 D Comparability .............................................................................. 119

3.2.3 The elements of financial statements............................................. 119 A Assets ........................................................................................... 119 B Liabilities..................................................................................... 121 C Equity .......................................................................................... 121 D Income and expenses .................................................................. 121

3.2.4 Recognition of the elements of financial statements ..................... 122 3.2.5 Measurement of the elements of financial statements.................. 122 3.2.6 Concepts of capital and capital maintenance ................................. 123

3.3 Assessment of the IASB’s Framework ........................................................ 124 4 OTHER FRAMEWORK ENDEAVOURS ..................................................................... 124

4.1 The Corporate Report ................................................................................. 125 4.2 Financial reporting in times of high inflation............................................. 127

4.2.1 Current Purchasing Power accounting ............................................ 127 4.2.2 Value accounting............................................................................... 128

A Replacement cost accounting based on current entry values ........................................................................................... 128

B Present value accounting ............................................................ 129 C Continuously Contemporary Accounting (CoCoA)................... 130

4.2.3 Cash flow accounting........................................................................ 131 4.2.4 Current cost accounting (CCA)....................................................... 132

4.3 Canada: The Stamp Report ........................................................................ 134 4.4 Discussion document: ‘Making Corporate Reports Valuable’................... 135

Detailed contents – Volume 1  xv 

4.4.1 Background ....................................................................................... 135 4.4.2 The proposed information package ................................................. 136 4.4.3 Conclusion ........................................................................................ 137

4.5 The Solomons Report.................................................................................. 137 4.6 The UK’s conceptual framework ................................................................ 140 4.7 Conclusion.................................................................................................... 143

5 CONVERGENCE AND THE IASB-FASB FRAMEWORK PROJECT............................... 144 5.1 Introduction ................................................................................................. 144 5.2 IASB-FASB Discussion paper – Preliminary views on an improved

conceptual framework for financial reporting ............................................ 144 5.2.1 The objective of financial reporting ................................................ 145

A Stewardship ................................................................................. 146 B Users of financial reports ............................................................ 147 C Financial performance................................................................. 148

5.2.2 The qualitative characteristics of decision-useful financial reporting information ....................................................................... 148 A Faithful representation, verifiability and precision ................... 150 B Neutrality and conservatism....................................................... 152 C Understandability........................................................................ 153 D Substance over form.................................................................... 153

5.2.3 Current discussions .......................................................................... 154 A The revised definition of an asset, recognition and

derecognition............................................................................... 154 B Measurement............................................................................... 156

5.2.4 The status of the framework............................................................ 156 6 MEASUREMENT.................................................................................................... 158

6.1 Discussion paper: Measurement bases for financial accounting – measurement on initial recognition ............................................................ 159 6.1.1 The ‘cash-equivalent expectations attribute’ of assets and

liabilities............................................................................................ 160 6.1.2 Possible bases for measurement on initial recognition................... 161 6.1.3 Market vs. entity-specific measurement objectives ....................... 163 6.1.4 Value-affecting properties of assets and liabilities ......................... 165 6.1.5 Fair value........................................................................................... 165 6.1.6 Efficient market price ...................................................................... 167

6.2 The FASB Statement of Financial Accounting Standards No.157 – Fair Value Measurements............................................................................ 168

6.3 The IASB’s Discussion Paper: Fair value measurements.......................... 174 A Fair value-based information is the most useful........................ 175 B The fair value of a liability should be measured on the

basis of transferring that liability................................................ 175 C ‘Fair value’ is a useful term......................................................... 176

6.3.1 Constituents’ views of the fair value agenda................................... 177

xvi  International GAAP 

6.4 Measurement: current state........................................................................ 178 7 CONCLUSION ....................................................................................................... 181

CHAPTER 3 PRESENTATION OF FINANCIAL STATEMENTS AND ACCOUNTING POLICIES

1 INTRODUCTION ................................................................................................... 189 1.1 IAS 1 ....................................................................................................... 190

1.1.1 Background to IAS 1......................................................................... 190 1.1.2 Objective and scope of IAS 1 ........................................................... 191

1.2 IAS 8 ....................................................................................................... 192 1.2.1 Background to IAS 8......................................................................... 192 1.2.2 Objective and scope of IAS 8 ........................................................... 193

2 THE PURPOSE AND COMPOSITION OF FINANCIAL STATEMENTS ...................... 193 2.1 The purpose of financial statements .......................................................... 193 2.2 Frequency of reporting and period covered ............................................... 194 2.3 The components of financial statements ................................................... 194 2.4 Comparative information............................................................................. 196 2.5 Identification of the financial statements and accompanying

information................................................................................................... 197 2.5.1 Identification of financial statements ............................................. 197 2.5.2 Statement of compliance with IFRS ............................................... 198

3 THE STRUCTURE OF FINANCIAL STATEMENTS.................................................. 198 3.1 The balance sheet........................................................................................ 199

3.1.1 The distinction between current/non-current assets and liabilities............................................................................................ 199 A General......................................................................................... 199 B Classification of derivatives to which hedge accounting is

not applied................................................................................... 201 C Settlement of a liability by issuing of equity ............................. 202

3.1.2 Non-current assets and disposal groups held for sale ..................... 202 3.1.3 Current assets................................................................................... 203 3.1.4 Current liabilities ............................................................................. 204 3.1.5 Information required on the face of the balance sheet .................. 205 3.1.6 Information required either on the face of the balance sheet

or in the notes................................................................................... 207 3.1.7 Illustrative balance sheets................................................................ 208

3.2 The income statement ................................................................................ 209 3.2.1 Information required on the face of the income statement........... 209 3.2.2 Classification of expenses by nature or function ............................ 211

A Analysis of expenses by nature ................................................... 211 B Analysis of expenses by function ................................................ 213

Detailed contents – Volume 1  xvii 

3.2.3 Discontinued operations .................................................................. 214 3.2.4 Material, exceptional and extraordinary items................................ 214

A Exceptional or material items..................................................... 214 B Ordinary activities and extraordinary items............................... 215

3.3 The statement of changes in equity ........................................................... 216 3.4 The notes to the financial statements........................................................ 220

4 ACCOUNTING POLICIES....................................................................................... 221 4.1 General principles........................................................................................ 222

4.1.1 Fair presentation .............................................................................. 222 A Fair presentation and compliance with IFRS ............................ 222 B The fair presentation override.................................................... 223

4.1.2 Going concern................................................................................... 225 4.1.3 The accrual basis of accounting ....................................................... 226 4.1.4 Consistency....................................................................................... 226 4.1.5 Materiality, aggregation and offset .................................................. 227

A Materiality and aggregation ........................................................ 227 B Offset ........................................................................................... 228

4.1.6 Profit or loss for the period .............................................................. 229 4.2 The distinction between accounting policies and accounting

estimates ...................................................................................................... 230 4.3 The selection and application of accounting policies ................................ 230 4.4 Changes in accounting policies ................................................................... 232 4.5 Changes in accounting estimates................................................................ 235 4.6 Correction of errors...................................................................................... 236 4.7 Impracticability of restatement .................................................................. 239

4.7.1 Impracticability of restatement for a change in accounting policy. ................................................................................................ 241

4.7.2 Impracticability of restatement for a material error ....................... 242 5 DISCLOSURE REQUIREMENTS ............................................................................. 243

5.1 Disclosures relating to accounting policies ................................................ 243 5.1.1 Disclosure of accounting policies .................................................... 243

A Summary of significant accounting policies ............................... 243 B Judgements made in applying accounting policies.................... 244

5.1.2 Disclosure of changes in accounting policies .................................. 245 A Accounting policy changes pursuant to the initial

application of a standard or interpretation................................. 245 B Voluntary changes in accounting policy ..................................... 245 C Future impact of a new standard or interpretation ................... 246

5.2 Disclosure of estimation uncertainty and changes in estimates ............... 246 5.2.1 Key sources of estimation uncertainty ............................................ 246 5.2.2 Changes in accounting estimates .................................................... 249

5.3 Disclosure of prior period errors.................................................................. 249

xviii  International GAAP 

5.4 Disclosures about capital............................................................................. 249 5.5 Other disclosures ......................................................................................... 252

6 FUTURE DEVELOPMENTS .................................................................................... 252 6.1 The IASB’s joint project on financial statement presentation.................. 252 6.2 Financial statement presentation project Phase A .................................... 253

7 CONCLUSION ....................................................................................................... 254

CHAPTER 4 NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

1 INTRODUCTION ................................................................................................... 259 1.1 Background to IFRS 5 ................................................................................. 259 1.2 Objective and scope of IFRS 5.................................................................... 260 1.3 Effective date and transitional provisions .................................................. 260

1.3.1 Transitional arrangements for entities already reporting under IFRS ....................................................................................... 260

1.3.2 First-time adoption issues................................................................ 260 2 NON-CURRENT ASSETS (AND DISPOSAL GROUPS) HELD FOR SALE ................... 261

2.1 Classification of non-current assets (and disposal groups) held for sale ....................................................................................................... 261 2.1.1 The concept of a disposal group ...................................................... 261 2.1.2 Classification as held for sale ........................................................... 262

A Meaning of available for immediate sale .................................... 263 B Meaning of highly probable ........................................................ 264 C Abandonment .............................................................................. 267

2.1.3 Partial disposals of operations.......................................................... 267 2.2 Measurement of non-current assets (and disposal groups) held for

sale ....................................................................................................... 269 2.2.1 Scope of the measurement requirements ....................................... 269 2.2.2 Measurement of non-current assets and disposal groups held

for sale ............................................................................................... 270 A Measurement on initial classification as held for sale ............... 270 B Subsequent remeasurement ....................................................... 271

2.2.3 Impairments and reversals of impairment....................................... 272 2.2.4 Balance sheet presentation of non-current assets and

disposal groups held for sale............................................................. 274 2.2.5 Changes to a plan of sale .................................................................. 276

3 DISCONTINUED OPERATIONS ............................................................................. 277 3.1 Definition of a discontinued operation....................................................... 277 3.2 Presentation of discontinued operations.................................................... 279 3.3 Trading between continuing and discontinued operations....................... 281

Detailed contents – Volume 1  xix 

4 COMPARATIVE INFORMATION ............................................................................. 282 4.1 Treatment of comparative information on initial classification as

held for sale .................................................................................................. 283 4.1.1 The income statement..................................................................... 283 4.1.2 The balance sheet ............................................................................ 283

4.2 Treatment of comparative information on the cessation of classification as held for sale........................................................................ 284 4.2.1 General requirements ...................................................................... 284 4.2.2 The treatment of associates and joint ventures.............................. 284

5 DISCLOSURE REQUIREMENTS ............................................................................. 284 6 CONCLUSION ....................................................................................................... 285

CHAPTER 5 FIRST-TIME ADOPTION

1 INTRODUCTION ................................................................................................... 287 1.1 Background................................................................................................... 287 1.2 Development of IFRS 1 .............................................................................. 287

1.2.1 SIC-8 ................................................................................................. 287 1.2.2 The need for IFRS 1 ........................................................................ 288 1.2.3 Amendments to IFRS 1 ................................................................... 289

2 REQUIREMENTS OF IFRS 1 ................................................................................. 289 2.1 Objective ...................................................................................................... 289 2.2 Scope and definitions .................................................................................. 290

2.2.1 What counts as first-time adoption?................................................ 290 2.2.2 When should IFRS 1 be applied?..................................................... 292 2.2.3 First-time adoption timeline ........................................................... 292 2.2.4 Fair value and deemed cost ............................................................. 294

2.3 Recognition and measurement principles .................................................. 294 2.3.1 Opening IFRS balance sheet and accounting policies ................... 294 2.3.2 Transitional provisions in other standards ...................................... 296 2.3.3 Departures from full retrospective application of IFRS................. 297

A Optional exemptions from the requirements of certain IFRS ............................................................................................. 297

B Exceptions to retrospective application of other IFRS............. 298 2.4 Business combinations exemption.............................................................. 299

2.4.1 Option to restate business combinations retrospectively .............. 299 2.4.2 Classification of business combinations .......................................... 301 2.4.3 Recognition and measurement of assets and liabilities.................. 302

A Derecognition of assets and liabilities........................................ 302 B Recognition of assets and liabilities ........................................... 302 C Subsequent measurement under IFRS not based on cost ........ 303 D Subsequent measurement on a cost basis under IFRS ............. 303

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E Measurement of items not recognised under previous GAAP............................................................................................ 304

F Summary of recognition and measurement requirements ........ 305 2.4.4 Restatement of goodwill .................................................................. 308

A Mandatory adjustments of goodwill ........................................... 308 B Prohibition of other adjustments of goodwill ............................ 309 C Derecognition of negative goodwill............................................ 310 D Goodwill previously deducted from equity................................ 311

2.4.5 Currency adjustments to goodwill................................................... 312 2.4.6 Previously unconsolidated subsidiaries ........................................... 313 2.4.7 Previously consolidated entities that are not subsidiaries ............. 314 2.4.8 Measurement of deferred taxation and minority interests ............ 314

2.5 ‘Fair value or revaluation as deemed cost’ exemption ............................... 315 2.5.1 Background ....................................................................................... 315 2.5.2 Scope of ‘fair value or revaluation as deemed cost’ exemption...... 316 2.5.3 Determining deemed cost ............................................................... 318

2.6 Financial instruments.................................................................................. 319 2.6.1 Exemption from the requirement to restate comparative

information ....................................................................................... 319 2.6.2 Designation of previously recognised financial instruments.......... 320

A Periods beginning before 1 January 2006................................... 320 B Periods beginning on or after 1 January 2006 and early

adopters ....................................................................................... 320 C Implementation guidance on other categories of financial

instruments.................................................................................. 321 2.6.3 Compound financial instruments .................................................... 322 2.6.4 Derecognition of financial assets and financial liabilities............... 323 2.6.5 Hedge accounting............................................................................. 323

A Prohibition on retrospective application.................................... 323 B Hedge accounting: opening IFRS balance sheet....................... 324 C Hedge accounting: subsequent treatment ................................ 329

2.6.6 Fair value measurement of financial instruments at initial recognition ........................................................................................ 330

2.6.7 Derivatives, embedded derivatives and transaction costs.............. 330 A Derivatives................................................................................... 330 B Embedded derivatives ................................................................ 330 C Transaction costs......................................................................... 331

2.7 Other exemptions........................................................................................ 331 2.7.1 Employee benefits............................................................................ 331

A Full actuarial valuations .............................................................. 332 B Actuarial assumptions ................................................................. 332 C Unrecognised past service costs ................................................. 333 D Exemption from presenting historical summary

information .................................................................................. 333 2.7.2 Cumulative translation differences ................................................. 333

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2.7.3 Share-based payment transactions .................................................. 334 A Meaning of ‘disclosed publicly’ .................................................. 335 B Restatement of costs recognised under previous GAAP?.......... 336

2.7.4 Insurance contracts .......................................................................... 336 2.7.5 Assets and liabilities of subsidiaries, associates and joint

ventures............................................................................................. 336 A Subsidiary becomes a first-time adopter later than its

parent ........................................................................................... 336 B Parent becomes a first-time adopter later than its

subsidiary ..................................................................................... 338 C Implementation guidance on accounting for assets and

liabilities of subsidiaries, associates and joint ventures............. 340 D Adoption of IFRS on different dates in separate and

consolidated financial statements .............................................. 340 2.7.6 Service concession arrangements..................................................... 340

2.8 Other exceptions to retrospective application of other IFRSs.................. 340 2.8.1 Estimates .......................................................................................... 341 2.8.2 Assets classified as held for sale and discontinued operations....... 344

2.9 Additional IFRS 1 implementation guidance............................................. 344 2.9.1 Property, plant and equipment........................................................ 344

A Depreciation method and rate.................................................... 344 B Use of fair value or revaluation as deemed cost ......................... 344 C Revaluation model....................................................................... 344 D Decommissioning provisions ...................................................... 345

2.9.2 Leases................................................................................................ 347 2.9.3 Subsidiaries and Special Purpose Entities ...................................... 348

A Future developments.................................................................. 348 2.9.4 Hyperinflation .................................................................................. 350 2.9.5 Intangible assets ............................................................................... 351 2.9.6 Revenue recognition......................................................................... 352 2.9.7 Borrowing costs................................................................................. 352 2.9.8 Comparative information under IFRS 6.......................................... 352

2.10 Presentation and disclosure ........................................................................ 353 2.10.1 Comparative information ................................................................. 353

A Exemption from the requirement to restate comparative information for IAS 32, IAS 39, IFRS 4 and IFRS 7 .................. 353

B Non-IFRS comparative information and historical summaries .................................................................................... 354

2.10.2 Explanation of transition to IFRS.................................................... 355 A Reconciliations ............................................................................ 357 B Designation of financial assets and financial liabilities ............. 368 C Use of fair value as deemed cost................................................. 369

2.10.3 Interim financial reports .................................................................. 370 2.11 Effective date............................................................................................... 372

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3 PRACTICAL ISSUES ............................................................................................... 372 3.1 First-time adoption by SEC registrants...................................................... 372 3.2 Income taxes ................................................................................................ 375

3.2.1 Previously revalued plant, property and equipment treated as deemed cost on transition ........................................................... 375

3.2.2 Share-based payment transactions subject to transitional provisions of IFRS 1 and IFRS 2...................................................... 376

3.3 Property, plant and equipment................................................................... 377 3.3.1 Parts approach .................................................................................. 377 3.3.2 Estimates of useful life and residual value...................................... 377

3.4 Functional currency ..................................................................................... 378 3.5 Currency adjustments to goodwill .............................................................. 378 3.6 Changes in IFRS accounting policies before first IFRS financial

statements.................................................................................................... 379 3.7 Disclosure of IFRS information in financial statements for periods

prior to an entity’s first IFRS reporting period .......................................... 379 3.7.1 CESR recommendation.................................................................... 379 3.7.2 IFRS guidance .................................................................................. 380

3.8 Transition to IFRS after 2005..................................................................... 381 4 CONCLUSION ....................................................................................................... 382

CHAPTER 6 CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS

1 THE CONCEPT OF A GROUP ................................................................................. 387 1.1 Background................................................................................................... 387 1.2 The objectives of consolidated financial statements................................. 388 1.3 What is a subsidiary? .................................................................................... 388 1.4 Consolidating partly owned subsidiaries .................................................... 389

1.4.1 The entity concept........................................................................... 389 1.4.2 The proprietary (parent entity) concept ........................................ 390 1.4.3 Comparison between the different concepts of a group ................ 391

A Intragroup transactions ............................................................... 392 B Loss-making subsidiaries ............................................................ 392

1.5 Other issues ................................................................................................. 393 2 DEVELOPMENT OF IAS 27 ................................................................................... 393 3 DEFINITION OF SUBSIDIARY ................................................................................ 394

3.1 Control ....................................................................................................... 394 3.1.1 Primary indicators of control............................................................ 394 3.1.2 Potential voting rights...................................................................... 395

A Interaction with IAS 28 and IAS 31 ........................................... 396

Detailed contents – Volume 1  xxiii 

B What rights are ‘currently exercisable’?...................................... 396 C Management intention and ability to exercise potential

ownership rights .......................................................................... 397 3.1.3 De facto control ................................................................................ 399

A IASB statement on de facto control ........................................... 399 B Implications of the IASB’s statement ........................................ 400

3.1.4 Investments held in a fiduciary capacity......................................... 401 3.2 Special Purpose Entities ............................................................................. 401

3.2.1 Definition of SPE ............................................................................. 401 3.2.2 Determining whether an entity is an SPE ...................................... 402 3.2.3 Practical interpretation issues ......................................................... 404

A Securitisation transactions .......................................................... 404 B Majority of the benefits and risks............................................... 404 C Benefits not necessarily financial ............................................... 405

3.3 Future developments .................................................................................. 407 4 REQUIREMENT TO PREPARE CONSOLIDATED FINANCIAL STATEMENTS.......... 407

4.1 Exemption from preparing consolidated financial statements.................. 407 4.1.1 Condition (a) – consent of minority shareholders .......................... 408 4.1.2 Condition (b) – securities not traded in a public market .............. 409 4.1.3 Condition (c) – no filing of financial statements for the

purpose of listing securities ............................................................. 409 4.1.4 Condition (d) – IFRS financial statements of parent’s parent

publicly available .............................................................................. 410 4.2 Entity no longer a parent at the balance sheet date .................................. 410 4.3 Interaction of IAS 27 and EU law ............................................................... 411 4.4 Combined financial statements .................................................................. 411

5 SCOPE OF CONSOLIDATED FINANCIAL STATEMENTS ........................................ 412 5.1 Venture capital organisations and similar entities ..................................... 412 5.2 Subsidiaries with dissimilar activities......................................................... 413 5.3 Subsidiaries subject to restrictions ............................................................. 413

6 CONSOLIDATION PROCEDURES .......................................................................... 414 6.1 Basic principles ............................................................................................ 414

6.1.1 Acquisition of a subsidiary that is not a business............................ 415 6.2 Proportion consolidated............................................................................... 415

6.2.1 Interaction with IAS 39.................................................................... 416 6.3 Intragroup eliminations ............................................................................... 416 6.4 Non-coterminous accounting periods......................................................... 417 6.5 Consistent accounting policies ................................................................... 418 6.6 Date of commencement and cessation of consolidation ........................... 419

A Future developments.................................................................. 419 6.6.1 Cumulative gains and losses reflected in equity............................. 420

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A Cumulative exchange gains and losses....................................... 420 B Other cumulative gains and losses previously recognised

in equity....................................................................................... 420 C Future developments.................................................................. 421

6.6.2 Group investment ceasing to be subsidiary .................................... 422 A Cumulative exchange differences on former subsidiaries ......... 422

6.6.3 Deemed disposals............................................................................. 423 6.6.4 Presentation of comparative information for a former

subsidiary .......................................................................................... 424 6.6.5 Demergers......................................................................................... 424

A Distribution at carrying amount ................................................. 425 B Distribution at fair value with gain recognised in equity.......... 425 C Distribution at fair value with gain recognised in profit or

loss................................................................................................ 425 D Conclusion ................................................................................... 425 E Future developments.................................................................. 425

6.7 Minority interests ........................................................................................ 426 6.7.1 Interaction with IAS 32.................................................................... 427 6.7.2 Loss-making subsidiaries ................................................................. 427

A Future developments.................................................................. 428 6.7.3 Cumulative preference shares held by minority interests ............. 429 6.7.4 Part disposals with no loss of control............................................... 429

A True disposals.............................................................................. 429 B Deemed disposals........................................................................ 431 C Future developments.................................................................. 432

7 SEPARATE FINANCIAL STATEMENTS ................................................................... 433 7.1 What are ‘separate financial statements’? .................................................. 433

7.1.1 Practical implications ....................................................................... 433 7.1.2 Publication requirements................................................................. 434

7.2 Requirements for separate financial statements........................................ 435 7.3 Cost method................................................................................................. 435

7.3.1 Cost of investment ........................................................................... 436 A Investments acquired for shares or other equity

instruments.................................................................................. 436 B Cost of subsidiary acquired in stages.......................................... 437 C Accounting in separate financial statements for the

formation of a new parent ........................................................... 437 7.3.2 ‘Pre-acquisition’ profits .................................................................... 437

A What are ‘profits’?........................................................................ 437 B Group reconstructions................................................................. 440

7.4 IAS 39 method ............................................................................................. 443 8 DISCLOSURE......................................................................................................... 443

8.1 Consolidated financial statements.............................................................. 443

Detailed contents – Volume 1  xxv 

8.2 Separate financial statements prepared by parent electing not to prepare consolidated financial statements ................................................. 443

8.3 Separate financial statements prepared by an entity other than a parent electing not to prepare consolidated financial statements ............ 445 8.3.1 Entities with no subsidiaries but exempt from applying

IAS 28 or IAS 31 ............................................................................... 446 9 TRANSITIONAL AND FIRST-TIME ADOPTION ISSUES.......................................... 446

9.1 Subsidiaries consolidated for the first time on first-time adoption .......... 447 9.2 Subsidiaries consolidated under previous GAAP ....................................... 448 9.3 Parents and subsidiaries and with different dates of adoption of

IFRS ....................................................................................................... 448 9.3.1 Subsidiary adopting IFRS after parent............................................ 448

A Subsidiaries preparing consolidation reporting packs under IFRS .................................................................................. 449

9.3.2 Parent adopting IFRS after its subsidiary ....................................... 449 9.3.3 Parent adopting IFRS at different dates in consolidated and

separate financial statements .......................................................... 450 9.3.4 Interaction with other requirements of IFRS 1.............................. 450

9.4 Separate financial statements – cost method............................................. 451 9.4.1 Future developments ....................................................................... 451

A Cost of investment...................................................................... 451 B Pre-acquisition distributions ...................................................... 452 C Impact of the proposed amendment.......................................... 452 D Response to the exposure draft .................................................. 453

10 FUTURE DEVELOPMENTS .................................................................................... 453 10.1 Business Combinations (Phase II) ............................................................. 453 10.2 Consolidation ............................................................................................... 454

10.2.1 Tentative decisions to date ............................................................. 454 10.2.2 Matters to be discussed ................................................................... 455

A ‘Autopilot’ SPEs .......................................................................... 455 B Recognition and derecognition................................................... 456 C Attribution of profits or losses in the context of potential

voting rights ................................................................................. 456 D Economic dependence................................................................ 457 E Disclosure .................................................................................... 457

10.2.3 Next steps......................................................................................... 457 10.3 Plans to sell the controlling interest in a subsidiary .................................. 457

CHAPTER 7 BUSINESS COMBINATIONS AND GOODWILL

1 INTRODUCTION ................................................................................................... 461 1.1 Background................................................................................................... 461 1.2 Development of an international standard................................................. 462

xxvi  International GAAP 

1.2.1 IAS 22 and related SIC Interpretations .......................................... 462 1.2.2 IASB’s project ................................................................................... 462 1.2.3 IFRS 3 ............................................................................................... 463

A Reasons for revising IAS 22......................................................... 463 B Main changes from IAS 22 .......................................................... 464

1.2.4 Future developments ....................................................................... 466 2 BUSINESS COMBINATIONS ................................................................................... 467

2.1 Objective of IFRS 3 ..................................................................................... 468 2.2 Scope of IFRS 3 ........................................................................................... 468

2.2.1 Identifying a business combination................................................. 468 2.2.2 Exclusions ......................................................................................... 470

2.3 Purchase method of accounting .................................................................. 470 2.3.1 Identifying the acquirer ................................................................... 472 2.3.2 Cost of a business combination ....................................................... 477

A Date of exchange......................................................................... 477 B Assets given and liabilities incurred or assumed by the

acquirer ........................................................................................ 478 C Equity instruments issued by the acquirer ................................ 480 D Costs directly attributable to the business combination .......... 481 E Adjustments to the cost of a business combination

contingent on future events (‘Contingent consideration’)....... 482 2.3.3 Allocating the cost to the assets acquired and liabilities and

contingent liabilities assumed ......................................................... 495 A Acquiree’s identifiable assets and liabilities .............................. 497 B Acquiree’s intangible assets ........................................................ 498 C Acquiree’s contingent liabilities ................................................. 510 D Determining the fair values of the acquiree’s identifiable

assets, liabilities and contingent liabilities ................................ 512 E Reassessment of the acquiree’s classification of assets,

liabilities, equity and relationships acquired in a business combination ................................................................................. 520

F Pre-existing relationships with an acquiree ............................... 523 2.3.4 Goodwill ............................................................................................ 525 2.3.5 Excess of acquirer’s interest in the net fair value of

acquiree’s identifiable assets, liabilities and contingent liabilities over cost............................................................................ 526

2.3.6 Subsequent adjustments to fair values............................................ 528 A Adjustments upon completion of initial accounting ................. 528 B Adjustments after the initial accounting is complete ............... 530 C Recognition of deferred tax assets after the initial

accounting is complete ............................................................... 532 2.3.7 Business combinations achieved in stages ...................................... 532

A Acquisitions of minority interests .............................................. 542 2.3.8 Reverse acquisitions ......................................................................... 546

A Cost of the business combination .............................................. 547

Detailed contents – Volume 1  xxvii 

B Preparation and presentation of consolidated financial statements ................................................................................... 549

C Minority interest ......................................................................... 551 D Earnings per share ....................................................................... 552 E Cash consideration ...................................................................... 554

2.3.9 Call and put options over minority interests .................................. 555 A Call options only.......................................................................... 556 B Put options only .......................................................................... 558 C Combination of call and put options .......................................... 569 D Call and put options entered into in relation to existing

minority interests ........................................................................ 569 2.3.10 Disclosure requirements relating to business combinations.......... 569

A Nature and financial effect of business combinations............... 570 B Effects of gains, losses, error corrections and other

adjustments recognised in the current period relating to business combinations ................................................................ 572

C Other necessary information....................................................... 572 2.4 Common control transactions and group reorganisations .......................... 573

2.4.1 Common control exemption ............................................................ 573 A Common control by an individual or group of individuals ........ 573 B Transitory control........................................................................ 575 C Accounting for business combinations involving entities

or businesses under common control ......................................... 577 2.4.2 Group reorganisations....................................................................... 585

A Introduction................................................................................. 585 B Setting up a new top holding company...................................... 586 C Inserting a new intermediate parent within an existing

group ............................................................................................ 590 D Transferring businesses outwith an existing group using a

Newco .......................................................................................... 592 3 GOODWILL ........................................................................................................... 594

3.1 Subsequent accounting for goodwill ........................................................... 595 3.2 Allocation of goodwill to cash-generating units.......................................... 595 3.3 Goodwill initially unallocated to cash-generating units............................. 596 3.4 Testing cash-generating units with goodwill for impairment ................... 597

3.4.1 Minority interest .............................................................................. 598 3.4.2 Timing of impairment tests............................................................. 601 3.4.3 Sequence of impairment tests ......................................................... 602 3.4.4 Carry-forward of a previous impairment test calculation ............... 602 3.4.5 Acquisition of minority interest....................................................... 603

3.5 Impairment loss for a cash-generating unit to which goodwill has been allocated .............................................................................................. 603

3.6 Reversing an impairment loss for goodwill ................................................. 603

xxviii  International GAAP 

3.7 Disposal of operation within a cash-generating unit to which goodwill has been allocated......................................................................... 604

3.8 Changes in composition of cash-generating units...................................... 605 3.9 The effect of IFRS 8 – Operating Segments – on the allocation of

goodwill ....................................................................................................... 606 3.10 Disclosure requirements relating to goodwill ............................................ 607

4 TRANSITIONAL ARRANGEMENTS AND FIRST-TIME ADOPTION ISSUES ............. 608 4.1 Transitional arrangements for entities already reporting under IFRS...... 608 4.2 First-time adoption issues........................................................................... 609

4.2.1 Option to restate business combinations retrospectively .............. 609 4.2.2 Classification of business combinations .......................................... 611 4.2.3 Recognition and measurement of assets and liabilities.................. 612

A Derecognition of assets and liabilities........................................ 612 B Recognition of assets and liabilities ........................................... 612 C Subsequent measurement under IFRS not based on cost ........ 613 D Subsequent measurement on a cost basis under IFRS ............. 613 E Measurement of items not recognised under previous

GAAP............................................................................................ 615 F Summary of recognition and measurement requirements ........ 615

4.2.4 Restatement of goodwill .................................................................. 618 A Mandatory adjustments of goodwill ........................................... 618 B Prohibition of other adjustments of goodwill ............................ 620 C Derecognition of negative goodwill............................................ 621 D Goodwill previously deducted from equity................................ 621

4.2.5 Previously unconsolidated subsidiaries ........................................... 622 5 FUTURE DEVELOPMENTS .................................................................................... 624

5.1 Summary of the expected revised IFRS 3.................................................. 625 5.1.1 Introduction...................................................................................... 625 5.1.2 Scope................................................................................................. 626 5.1.3 Identifying a business combination................................................. 627

A Definition of a business combination......................................... 627 B Definition of a business .............................................................. 627

5.1.4 The acquisition method................................................................... 628 5.1.5 Identifying the acquirer ................................................................... 629 5.1.6 Determining the acquisition date ................................................... 629 5.1.7 Recognising and measuring the identifiable assets acquired,

the liabilities assumed, and any non-controlling interest in the acquiree ...................................................................................... 629 A General principles ....................................................................... 629 B Classifying or designating identifiable assets acquired and

liabilities assumed ....................................................................... 630 C Recognising and measuring particular assets acquired and

liabilities assumed ....................................................................... 631

Detailed contents – Volume 1  xxix 

D Exceptions to the recognition and/or measurement principles ..................................................................................... 633

5.1.8 Recognising and measuring goodwill or a gain in a bargain purchase ............................................................................................ 636

5.1.9 Consideration transferred ................................................................ 637 A Contingent consideration ........................................................... 637 B Share-based payment awards exchanged for awards held

by the acquiree’s employees ....................................................... 639 C Acquisition-related costs............................................................. 640 D Business combinations achieved without the transfer of

consideration ............................................................................... 641 E Combinations involving mutual entities .................................... 642

5.1.10 Recognising and measuring non-controlling interests in acquiree............................................................................................. 643 A Option 1 – Measuring non-controlling interest at

acquisition-date fair value........................................................... 644 B Option 2 – Measuring non-controlling interest at the

proportionate share of the value of net identifiable assets acquired ....................................................................................... 644

C Impairment testing cash-generation units with goodwill and non-controlling interests...................................................... 646

5.1.11 Business combinations achieved in stages (‘step acquisitions’)..................................................................................... 646

5.1.12 Bargain purchase transactions.......................................................... 647 5.1.13 Assessing what is part of the exchange for the acquiree ................ 647

A Effective settlement of pre-existing relationships .................... 649 B Arrangements for contingent payments to employees .............. 649

5.1.14 Measurement period ........................................................................ 650 5.1.15 Disclosures........................................................................................ 651 5.1.16 Effective date and transition ........................................................... 652

6 CONCLUSION ....................................................................................................... 653

CHAPTER 8 ASSOCIATES

1 INTRODUCTION ................................................................................................... 659 1.1 The origins of equity accounting ................................................................ 659 1.2 Development of IAS 28 ............................................................................... 660 1.3 Other applicable IFRSs ............................................................................... 660

2 SCOPE OF IAS 28 .................................................................................................. 660 2.1 General ....................................................................................................... 660

2.1.1 Exemption for venture capital organisations and similar entities .............................................................................................. 661 A Application of IAS 39 to associates exempt from IAS 28 .......... 661

2.2 Definition of ‘associate’ and related terms................................................. 664

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2.2.1 Significant influence ........................................................................ 665 A Lack of significant influence ...................................................... 666 B Holdings of less than 20% of the voting power.......................... 666 C Holdings of more than 50% of the voting power ....................... 667 D Potential voting rights................................................................. 667 E Voting rights held in a fiduciary capacity ................................... 668 F Long-term restrictions over associate’s ability to transfer

funds to investor.......................................................................... 668 2.3 Requirement to apply the equity method.................................................. 668

2.3.1 Associates held for sale..................................................................... 670 2.4 Separate financial statements ..................................................................... 670

3 APPLICATION OF THE EQUITY METHOD............................................................. 671 3.1 Overview ...................................................................................................... 671 3.2 Similarities of equity accounting and consolidation .................................. 673

3.2.1 Differences between equity accounting and consolidation ........... 673 3.2.2 Piecemeal acquisition of an associate.............................................. 674

A Step increase in an existing associate......................................... 674 B Financial instrument becoming an associate ............................. 674 C Future developments.................................................................. 678

3.3 Share accounted for ..................................................................................... 679 3.3.1 Contingent voting rights .................................................................. 679 3.3.2 Where the reporting entity or the associate is a group................... 679 3.3.3 Cumulative preference shares held by parties other than the

investor.............................................................................................. 679 3.3.4 Several classes of equity ................................................................... 680

3.4 Transactions between the reporting entity and associates ....................... 681 3.4.1 Elimination of ‘upstream’ and ‘downstream’ transactions ............. 681

A Elimination of ‘downstream’ unrealised gains in excess of the investment ............................................................................ 683

B Transactions between associates and/or joint ventures ............ 684 3.4.2 Reciprocal interests .......................................................................... 684 3.4.3 Loans and borrowings between the reporting entity and

associates........................................................................................... 689 3.4.4 Cash flow statement......................................................................... 689 3.4.5 Contributions of non-monetary assets to an associate.................... 689

3.5 Non-coterminous accounting periods......................................................... 689 3.6 Consistent accounting policies ................................................................... 690 3.7 Loss-making associates................................................................................ 691 3.8 Date of commencement and cessation of equity accounting.................... 692

3.8.1 Cumulative exchange differences on associates ............................. 693 A Other cumulative gains and losses previously recognised

in equity....................................................................................... 693 B Future developments.................................................................. 694

Detailed contents – Volume 1  xxxi 

3.8.2 Deemed disposals............................................................................. 695 3.9 Income taxes ................................................................................................ 697 3.10 Distributions received in excess of the carrying amount........................... 697

4 IMPAIRMENT LOSSES ........................................................................................... 698 4.1 General ....................................................................................................... 698 4.2 Goodwill ....................................................................................................... 699 4.3 Allocation of impairment............................................................................. 701 4.4 Reversal of impairment................................................................................ 702

5 PRESENTATION AND DISCLOSURE ...................................................................... 703 5.1 Presentation ................................................................................................. 703

5.1.1 Balance sheet .................................................................................... 703 5.1.2 Income statement ............................................................................ 703

A Impairment of associates ............................................................ 705 5.1.3 Statement of changes in equity ....................................................... 705

5.2 Disclosures ................................................................................................... 705 5.2.1 Requirements of IAS 28 ................................................................... 705

A Summarised financial information of associates ........................ 708 5.2.2 IAS 37 – Provisions, Contingent Liabilities and Contingent

Assets ................................................................................................ 709 6 TRANSITIONAL AND FIRST-TIME ADOPTION ISSUES.......................................... 710

6.1 General ....................................................................................................... 710 6.1.1 Transition impairment review ......................................................... 710

6.2 Investor and associate with different dates of first-time adoption of IFRS ....................................................................................................... 711

7 CONCLUSION ....................................................................................................... 711

CHAPTER 9 JOINT VENTURES

1 INTRODUCTION ................................................................................................... 715 1.1 The nature of joint ventures ....................................................................... 715 1.2 Development of IAS 31 ............................................................................... 716 1.3 Other applicable IFRS................................................................................. 716

2 SCOPE OF IAS 31 .................................................................................................. 717 2.1 General ....................................................................................................... 717

2.1.1 Disclosures of venturers’ interests .................................................. 717 2.2 Definition of ‘joint venture’ and related terms.......................................... 717

2.2.1 ‘Venturer’ versus ‘investor’............................................................... 718 2.2.2 Joint control ...................................................................................... 718

A Contractual arrangement ............................................................ 718 B Legal and other restrictions on investee.................................... 719

xxxii  International GAAP 

C Potential voting rights................................................................. 719 2.3 Requirement to apply IAS 31 to jointly controlled entities ...................... 720 2.4 Separate financial statements ..................................................................... 721 2.5 ‘Pseudo’ joint ventures ................................................................................ 722

3 ACCOUNTING REQUIREMENTS............................................................................ 723 3.1 Jointly controlled operations ....................................................................... 723 3.2 Jointly controlled assets............................................................................... 724 3.3 Jointly controlled entities............................................................................ 726

3.3.1 Definition.......................................................................................... 726 3.3.2 Accounting treatment – summary ................................................... 728

A Difference between allowed treatments.................................... 728 B Consistency of treatment............................................................ 729

3.3.3 Proportionate consolidation ............................................................. 730 3.3.4 Equity method.................................................................................. 731 3.3.5 Jointly controlled entity previously accounted for under

IFRS 5 ............................................................................................... 733 3.3.6 Jointly controlled entity ceasing to be jointly controlled

entity ................................................................................................. 733 A Cumulative exchange differences on jointly controlled

entities ......................................................................................... 734 B Other cumulative gains and losses previously recognised

in equity....................................................................................... 735 C Future developments: Business Combinations Phase II .......... 735

3.3.7 Step acquisition of a joint venture................................................... 736 A Future developments.................................................................. 737

3.4 Transactions between a venturer and a joint venture ............................... 737 3.4.1 Background ....................................................................................... 737 3.4.2 IAS 31 requirements ........................................................................ 738 3.4.3 Non-monetary contributions to joint ventures ............................... 741

A ‘Commercial substance’ .............................................................. 741 B Applying SIC–13 in practice....................................................... 743

3.4.4 Loans and borrowings between the reporting entity and joint ventures............................................................................................. 747

3.5 Income Taxes............................................................................................... 748 3.6 Operators of joint ventures ......................................................................... 748

4 PRESENTATION AND DISCLOSURE ...................................................................... 749 4.1 Presentation ................................................................................................. 749

4.1.1 Jointly controlled operations and jointly controlled assets............. 749 4.1.2 Jointly controlled entities ................................................................ 749

4.2 Disclosure..................................................................................................... 749 4.2.1 Interests in joint ventures................................................................ 749 4.2.2 Accounting policy for jointly controlled entities............................. 750 4.2.3 Contingencies and commitments.................................................... 750

Detailed contents – Volume 1  xxxiii 

5 PRACTICAL ISSUES ............................................................................................... 751 5.1 Variable profit share..................................................................................... 751 5.2 Related party disclosures............................................................................. 751

6 TRANSITIONAL AND FIRST-TIME ADOPTION ISSUES.......................................... 752 6.1 General ....................................................................................................... 752

6.1.1 Transition impairment review ......................................................... 753 6.2 Venturer and joint venture with different dates of first-time

adoption of IFRS.......................................................................................... 753 7 FUTURE DEVELOPMENTS IN JOINT VENTURE ACCOUNTING............................. 753

CHAPTER 10 FOREIGN EXCHANGE

1 INTRODUCTION ................................................................................................... 757 1.1 Background................................................................................................... 757 1.2 Development of an international standard................................................. 758

1.2.1 IAS 21................................................................................................ 758 1.2.2 IAS 21 (Revised 2003) ..................................................................... 758 1.2.3 IAS 21 Amendment – Net Investment in a Foreign

Operation .......................................................................................... 759 1.2.4 SIC pronouncements ....................................................................... 759

2 REQUIREMENTS OF IAS 21 .................................................................................. 759 2.1 Objective of the standard............................................................................ 760 2.2 Scope ....................................................................................................... 760 2.3 Definitions of terms..................................................................................... 761 2.4 Summary of the approach required by the standard.................................. 761 2.5 Determination of an entity’s functional currency...................................... 762 2.6 Reporting foreign currency transactions in the functional currency

of an entity ................................................................................................... 764 2.6.1 Initial recognition ............................................................................. 764 2.6.2 Reporting at subsequent balance sheet dates................................. 765 2.6.3 Treatment of exchange differences................................................. 765

A Monetary items ........................................................................... 765 B Non-monetary items ................................................................... 767

2.6.4 Change in functional currency......................................................... 767 2.7 Use of a presentation currency other than the functional currency.......... 770

2.7.1 Translation to the presentation currency........................................ 770 A Functional currency is not that of a hyperinflationary

economy....................................................................................... 771 B Functional currency is that of a hyperinflationary

economy....................................................................................... 775 2.7.2 Translation of a foreign operation ................................................... 777

xxxiv  International GAAP 

A Exchange differences on intragroup balances............................ 777 B Non-coterminous period ends .................................................... 778 C Goodwill and fair value adjustments .......................................... 779

2.7.3 Disposal of a foreign operation ........................................................ 780 A Future developments.................................................................. 782

2.8 Tax effects of all exchange differences ...................................................... 782 2.9 Disclosure requirements ............................................................................. 782

2.9.1 Exchange differences ....................................................................... 782 2.9.2 Presentation and functional currency.............................................. 783 2.9.3 Convenience translations of financial statements or other

financial information ........................................................................ 783 3 PRACTICAL ISSUES ............................................................................................... 784

3.1 Determination of functional currency ........................................................ 784 3.1.1 General.............................................................................................. 784 3.1.2 Intermediate holding companies or finance subsidiaries ............... 784

3.2 Reporting foreign currency transactions in the functional currency of an entity ................................................................................................... 786 3.2.1 Date of transaction ........................................................................... 786 3.2.2 Use of average rate ........................................................................... 787 3.2.3 Dual rates or suspension of rates ..................................................... 788 3.2.4 Monetary or non-monetary? ............................................................. 789

A Deposits or progress payments ................................................... 790 B Investments in preference shares............................................... 791 C Foreign currency share capital .................................................... 791 D Deferred tax................................................................................. 792 E Post-employment benefit plans ................................................. 792

3.2.5 Treatment of exchange differences................................................. 794 3.2.6 Books and records not kept in functional currency ........................ 795

3.3 Translation to a different presentation currency ....................................... 796 3.3.1 Dual rates or suspension of rates ..................................................... 796 3.3.2 Calculation of average rate ............................................................... 796 3.3.3 Translation of equity items.............................................................. 799

A Share capital ................................................................................ 799 B Other equity balances resulting from transactions with

equity holders .............................................................................. 799 C Other equity balances resulting from income and

expenses being taken direct to equity ....................................... 800 3.3.4 Goodwill ............................................................................................ 800 3.3.5 Accounting for foreign operations where sub-groups exist............. 801 3.3.6 Disposal of a foreign operation ........................................................ 803

3.4 Intragroup transactions................................................................................ 808 3.4.1 Monetary items included as part of the net investment in a

foreign operation............................................................................... 808 A General......................................................................................... 808

Detailed contents – Volume 1  xxxv 

B Monetary item denominated in functional currency of either the reporting entity or the foreign operation.................. 810

C Monetary item denominated in functional currency that is not that of either the reporting entity or the foreign operation ...................................................................................... 811

D Monetary items transacted by other members of the group ............................................................................................ 815

E Monetary items becoming part of the net investment in a foreign operation ......................................................................... 820

F Monetary items ceasing to be part of the net investment in a foreign operation .................................................................. 822

3.4.2 Other intragroup transactions.......................................................... 825 A Dividends..................................................................................... 825 B Unrealised profits on intragroup transactions............................ 826

3.5 Introduction of the euro .............................................................................. 826 4 TRANSITIONAL ARRANGEMENTS AND FIRST-TIME ADOPTION ISSUES ............. 827

4.1 Transitional arrangements for entities already reporting under IFRS...... 827 4.2 First-time adoption issues........................................................................... 828

4.2.1 Cumulative translation differences ................................................. 828 4.2.2 Goodwill and fair value adjustments ............................................... 829 4.2.3 Other practical issues ....................................................................... 830

5 CONCLUSION ....................................................................................................... 831

CHAPTER 11 HYPERINFLATION

1 INTRODUCTION ................................................................................................... 835 1.1 Hyperinflationary economies ...................................................................... 836 1.2 Adjustment approaches ............................................................................... 836

2 REQUIREMENTS OF IAS 29 .................................................................................. 837 2.1 History ....................................................................................................... 837 2.2 Objective ...................................................................................................... 838 2.3 Scope ....................................................................................................... 839

2.3.1 Definition of hyperinflation............................................................. 840 2.4 The IAS 29 restatement process................................................................. 841

2.4.1 Selection of a general price index.................................................... 841 2.4.2 Analysis and restatement of balance sheet items ........................... 842

A Monetary or non-monetary ......................................................... 843 B Monetary items ........................................................................... 845 C Non-monetary items carried at current cost.............................. 845 D Non-monetary items carried at historical cost........................... 845 E Restatement of investees and subsidiaries ................................ 848 F Calculation of deferred taxation ................................................. 849

xxxvi  International GAAP 

G Restatement of equity ................................................................ 851 2.4.3 Restatement of the income statement............................................ 852 2.4.4 Calculation of the gain or loss on the net monetary position......... 854 2.4.5 Restatement of the cash flow statement ........................................ 855 2.4.6 Restatement of the corresponding figures ...................................... 856

2.5 Interim reporting ......................................................................................... 856 2.6 Economies becoming hyperinflationary...................................................... 856 2.7 Economies ceasing to be hyperinflationary ................................................ 857 2.8 Translation to a different presentation currency ....................................... 857 2.9 Disclosures ................................................................................................... 858

3 TRANSITIONAL ARRANGEMENTS AND FIRST-TIME ADOPTION ISSUES ............. 861 3.1 Transition..................................................................................................... 861 3.2 First-time adoption of IFRS........................................................................ 861

4 PRACTICAL PROBLEMS......................................................................................... 862 4.1 Selecting a general price index ................................................................... 862 4.2 General price index not available for all periods ........................................ 862 4.3 Inventories ................................................................................................... 863 4.4 Investees accounted for under the equity method.................................... 863 4.5 Restatement of interest and exchange differences.................................... 864

CHAPTER 12 INTANGIBLE ASSETS

1 INTRODUCTION ................................................................................................... 867 1.1 The incidence of intangible assets ............................................................. 867 1.2 Background to accounting for intangible assets ......................................... 868

1.2.1 Development of IAS 9, IAS 22, IAS 38 and SIC-32........................ 868 1.2.2 IFRS 3 and IAS 38 (as revised in 2004) .......................................... 868

2 THE REQUIREMENTS OF IAS 38.......................................................................... 869 2.1 Scope and definitions .................................................................................. 869

2.1.1 Scope................................................................................................. 869 2.1.2 What is an intangible asset? ............................................................. 871

A Identifiability............................................................................... 871 B Control ......................................................................................... 873 C Future economic benefits ........................................................... 874

2.1.3 Tangible and intangible assets ........................................................ 874 2.2 Recognition and measurement ................................................................... 875

2.2.1 Recognition....................................................................................... 875 2.2.2 Measurement.................................................................................... 876 2.2.3 Subsequent expenditure.................................................................. 876

2.3 Specific recognition and measurement requirements ............................... 876

Detailed contents – Volume 1  xxxvii 

2.3.1 Separate acquisition ......................................................................... 876 A Recognition.................................................................................. 876 B Components of cost .................................................................... 877 C Costs to be expensed .................................................................. 878 D Incidental operations .................................................................. 878

2.3.2 Acquisition as part of a business combination ................................ 879 A Recognition of intangible assets acquired in a business

combination ................................................................................. 880 B IFRS 3 examples of intangible assets acquired in a

business combination .................................................................. 881 C Measuring fair value of intangible assets acquired in a

business combination .................................................................. 882 D Customer relationship intangible assets acquired in a

business combination .................................................................. 884 E In-process research and development........................................ 885

2.3.3 Acquisition by way of government grant ......................................... 886 2.3.4 Exchanges of assets .......................................................................... 887

A Measurement of assets exchanged ............................................. 887 B Commercial substance ................................................................ 888

2.3.5 Internally generated goodwill .......................................................... 888 2.3.6 Internally generated intangible assets............................................. 889

A Research phase ............................................................................ 890 B Development phase .................................................................... 890 C Internally generated brands, mastheads, publishing titles

and customer lists........................................................................ 895 D Website costs ............................................................................... 895

2.3.7 Cost of an internally generated intangible asset............................. 897 A Establishing the time from which costs can be capitalised....... 898 B Determining the costs eligible for capitalisation....................... 899

2.3.8 Recognition of an expense ............................................................... 899 A Catalogues and other advertising costs ...................................... 900

2.4 Measurement after initial recognition........................................................ 901 2.4.1 Cost model........................................................................................ 902 2.4.2 Revaluation model............................................................................ 902

A Active market .............................................................................. 903 B Frequency of revaluations........................................................... 903 C Accounting for revaluations ........................................................ 904 D No active market ......................................................................... 906

2.5 Assessing the useful life of an intangible asset .......................................... 906 2.5.1 Useful life of contractual or other legal rights ................................ 910

2.6 Intangible assets with a finite useful life.................................................... 911 2.6.1 Amortisation period and method ..................................................... 911 2.6.2 Review of amortisation period and amortisation method............... 912 2.6.3 Residual value................................................................................... 912

2.7 Intangible assets with an indefinite useful life .......................................... 913

xxxviii  International GAAP 

2.8 Impairment losses........................................................................................ 913 2.9 Retirements and disposals........................................................................... 914 2.10 Disclosure..................................................................................................... 915

2.10.1 General disclosures........................................................................... 915 2.10.2 Balance sheet presentation .............................................................. 918 2.10.3 Income statement presentation ...................................................... 919 2.10.4 Additional disclosures under the revaluation model....................... 919 2.10.5 Research and development expenditure......................................... 920

3 PRACTICAL ISSUES ............................................................................................... 920 3.1 Regulatory assets ......................................................................................... 920

3.1.1 SFAS 71 – Accounting for the effects of certain types of regulation .......................................................................................... 921

3.2 Research and development in the pharmaceutical industry ..................... 921 3.3 Emission rights............................................................................................. 923

3.3.1 Development of IFRIC 3................................................................. 923 3.3.2 Accounting for emission rights by participants in cap and

trade schemes ................................................................................... 924 A IFRIC 3........................................................................................ 924 B Application of the IAS 8 hierarchy of authoritative

guidance....................................................................................... 925 3.3.3 Accounting for emission rights by brokers and traders................... 932 3.3.4 Accounting for green certificates or renewable energy

certificates ........................................................................................ 932 3.4 Television and programme rights ............................................................... 934

3.4.1 Classification of programme rights .................................................. 934 3.4.2 Recognition of programme rights .................................................... 935 3.4.3 Amortisation of programme rights ................................................... 936

3.5 Measurement of intangible assets acquired in a business combination.................................................................................................. 939 3.5.1 Identifying intangible assets............................................................ 939 3.5.2 Valuing the intangible assets ........................................................... 940

4 TRANSITION AND FIRST-TIME ADOPTION.......................................................... 942 4.1 Transitional arrangements for entities already reporting under IFRS...... 942

4.1.1 Early adoption of IFRS 3.................................................................. 942 4.1.2 Exchanges of similar assets .............................................................. 942

4.2 First-time adoption...................................................................................... 943 4.2.1 Retrospective application of IAS 38 ................................................ 943 4.2.2 Using fair value or revaluation as deemed cost ............................... 944

5 CONCLUSION ....................................................................................................... 945

Detailed contents – Volume 1  xxxix 

CHAPTER 13 PROPERTY, PLANT AND EQUIPMENT

1 INTRODUCTION ................................................................................................... 951 2 THE REQUIREMENTS OF IAS 16 ........................................................................... 952

2.1 Introduction ................................................................................................. 952 2.2 Scope, definition and recognition ............................................................... 952

2.2.1 Definitions ........................................................................................ 953 2.2.2 Recognition....................................................................................... 954

2.3 Measurement at recognition ....................................................................... 958 2.3.1 Elements of cost and cost measurement......................................... 958

A ‘Directly attributable’ costs ........................................................ 959 B Borrowing costs............................................................................ 960 C Administration and other general overheads ............................. 960 D Cessation of capitalisation .......................................................... 960 E Incidental and non-incidental income ....................................... 960 F Proceeds from selling items produced while bringing the

asset to the location and condition intended by management ................................................................................ 961

G Other forms of income ................................................................ 961 H Self-built assets ........................................................................... 962 I Deferred payment ....................................................................... 962 J Land and buildings to be redeveloped....................................... 962 K Tooling contributions when the supplier owns the tooling

equipment ................................................................................... 963 2.3.2 Accounting for changes in decommissioning and restoration

costs................................................................................................... 964 2.3.3 Exchanges of assets .......................................................................... 965 2.3.4 Assets held under finance leases ..................................................... 967 2.3.5 Assets acquired with the assistance of government grants ............ 968

2.4 Measurement after recognition................................................................... 968 2.4.1 Revaluation model............................................................................ 968

A Accounting for valuation surpluses and deficits ........................ 969 B Adopting a policy of revaluation ................................................. 970 C Assets held under finance leases ................................................ 970

2.4.2 Depreciation ..................................................................................... 971 A Depreciable amount, useful life and residual values ................. 971 B Depreciation charge .................................................................... 972 C Useful lives .................................................................................. 972 D When depreciation starts ............................................................ 974 E Depreciation methods................................................................. 974

2.5 Impairment .................................................................................................. 975 2.5.1 Compensation for impairment......................................................... 975

2.6 Derecognition and disposal ......................................................................... 975

xl  International GAAP 

2.6.1 IFRS 5 – Non-current assets held for sale and discontinued operations.......................................................................................... 976

2.6.2 Sale of assets held for rental ............................................................ 976 2.7 IAS 16 disclosure requirements .................................................................. 977

2.7.1 General disclosures........................................................................... 977 2.7.2 Additional disclosures for revalued assets ....................................... 980 2.7.3 Other disclosures.............................................................................. 982

2.8 Practical issues ............................................................................................. 982 2.8.1 Accounting for parts of assets .......................................................... 982 2.8.2 Useful life ......................................................................................... 983 2.8.3 The meaning of fair value ................................................................ 983

A Fair value or market value........................................................... 983 B Other methods of calculating fair value ..................................... 984

2.8.4 Reversals of downward valuations ................................................... 986 2.8.5 Depreciation of infrastructure assets .............................................. 987 2.8.6 Depreciation methods...................................................................... 988

A Double declining balance............................................................ 988 B Sum of the digits ......................................................................... 988 C Unit of production method......................................................... 989

2.8.7 Tangible or intangible assets – the issue of new technology costs................................................................................................... 989

2.8.8 Amounts charged under operating leases during the construction of an asset.................................................................... 990

3 TRANSITIONAL PROVISIONS AND FIRST-TIME ADOPTION OF IAS 16................ 990 3.1 First-time adoption of IAS 16 ..................................................................... 990 3.2 First-time adoption of IFRIC 1................................................................... 991

4 CONCLUSION ....................................................................................................... 992

CHAPTER 14 INVESTMENT PROPERTY

1 INTRODUCTION ................................................................................................... 995 2 DEFINITIONS AND SCOPE .................................................................................... 996

2.1 Property interests held under operating leases.......................................... 997 2.2 Identifying investment property................................................................. 997

2.2.1 Land .................................................................................................. 997 2.2.2 Buildings leased to others ................................................................ 998 2.2.3 Property held for trading or being constructed for resale............... 998 2.2.4 Owner occupation............................................................................. 998 2.2.5 Property in the course of construction and redevelopment........... 999 2.2.6 Properties with dual uses ............................................................... 1001 2.2.7 Provision of services ....................................................................... 1001 2.2.8 Group of assets leased out under a single operating lease ........... 1002

Detailed contents – Volume 1  xli 

2.3 Recognition ................................................................................................ 1004 2.4 Initial measurement .................................................................................. 1004 2.5 Initial measurement of property held under finance or operating

leases ..................................................................................................... 1005 2.6 Initial measurement of assets acquired in exchange transactions .......... 1006

3 MEASUREMENT AFTER INITIAL RECOGNITION................................................ 1006 3.1 Measurement by insurers and similar entities ......................................... 1007 3.2 The fair value model.................................................................................. 1007

A Transaction costs incurred by the purchaser ........................... 1007 B Determining fair value .............................................................. 1008 C The fair value discussion paper ................................................ 1010

3.2.1 Assets and liabilities subsumed within fair value ......................... 1010 3.2.2 Prepaid or accrued operating lease income................................... 1010 3.2.3 The fair value of properties held under a lease............................. 1011

A Methods currently available...................................................... 1011 Method 1: Adjusting by the valuer’s assessment of the

present value of the lease obligations....................................... 1012 Method 2: Adjusting by the finance lease obligation

recognised in the financial statements..................................... 1013 B Future changes .......................................................................... 1014

3.3 Inability to determine fair value ............................................................... 1014 3.4 The cost model .......................................................................................... 1015 3.5 IFRS 5 and investment properties measured at fair value ...................... 1017

4 TRANSFER OF ASSETS INTO OR FROM INVESTMENT PROPERTY ...................... 1018 4.1 Transfers of investment property held under operating leases............... 1020

5 DISPOSAL OF INVESTMENT PROPERTY.............................................................. 1020 5.1 Replacement of parts of investment property ......................................... 1022 5.2 Compensation from third parties.............................................................. 1023

6 THE DISCLOSURE REQUIREMENTS OF IAS 40 .................................................. 1023 6.1 Introduction ............................................................................................... 1023 6.2 Disclosures under both fair value and cost models .................................. 1023 6.3 Additional disclosures for the fair value model ........................................ 1027

6.3.1 Presentation of changes in fair value in the income statement........................................................................................ 1028

6.3.2 Extra disclosures where fair value cannot be determined reliably............................................................................................. 1029

6.4 Additional disclosures for the cost model................................................. 1029 7 FIRST-TIME ADOPTION...................................................................................... 1030 8 FUTURE DEVELOPMENTS .................................................................................. 1030

8.1 Measurement of investment property under construction ..................... 1030

xlii  International GAAP 

8.2 Revenue ..................................................................................................... 1031 9 CONCLUSION ..................................................................................................... 1031

CHAPTER 15 IMPAIRMENT OF FIXED ASSETS AND GOODWILL

1 INTRODUCTION ................................................................................................. 1033 2 THE THEORY BEHIND THE IMPAIRMENT REVIEW ............................................ 1034 3 THE REQUIREMENTS OF IAS 36........................................................................ 1035

3.1 Scope and definitions ................................................................................ 1035 3.2 When an impairment test is required ....................................................... 1038 3.3 The impairment test ................................................................................. 1041

3.3.1 Fair value less costs to sell ............................................................. 1043 3.3.2 Determining value in use (VIU).................................................... 1044

Step 1 Dividing the entity into cash-generating units (CGUs) ...................................................................................... 1045

Step 2 Identifying the carrying amount of CGU assets ............ 1049 Step 3 Estimating the future pre-tax cash flows of the

CGU under review .................................................................... 1052 Step 4 Identifying an appropriate discount rate and

discounting the future cash flows............................................. 1055 Step 5 Comparing carrying value with VIU and recognising

impairment losses...................................................................... 1059 3.3.3 Recognition of impairment losses.................................................. 1060

A Impairment losses on individual assets .................................... 1060 B Impairment losses and CGUs................................................... 1061

3.4 Impairment of intangible assets with an indefinite life and goodwill..... 1064 3.4.1 Impairment of intangible assets with an indefinite useful life .... 1064

A Measuring the recoverable amount of an intangible asset with an indefinite useful life .................................................... 1065

3.4.2 Impairment of goodwill .................................................................. 1066 A Timing of the goodwill impairment test and testing of

CGUs ......................................................................................... 1067 3.5 The reversal of impairment losses ............................................................ 1068

A Reversals of impairments – revalued assets ............................. 1070 B Reversals of impairments – cash-generating units .................. 1071

4 DISCLOSURES REQUIRED BY IAS 36 .................................................................. 1071 4.1 Introduction ............................................................................................... 1071 4.2 IAS 36 disclosures ...................................................................................... 1071

4.2.1 Disclosures required for impairment adjustments ....................... 1071 A Material impairments................................................................ 1072

4.2.2 Annual impairment disclosures required for goodwill and intangible assets with an indefinite useful life. ............................ 1073

Detailed contents – Volume 1  xliii 

5 PRACTICAL ISSUES ............................................................................................. 1082 5.1 Discount rates and the weighted average cost of capital......................... 1082

5.1.1 Pre-and post-tax discount rates ..................................................... 1083 5.1.2 Determining pre-tax rates taking account of tax losses ............... 1088 5.1.3 Entity-specific WACCs and different project risks within the

entity ............................................................................................... 1088 5.1.4 Entity-specific WACCs and capital structure ............................... 1089 5.1.5 Use of discount rates other than the WACC ................................ 1090

5.2 Impairment of assets and goodwill recognised on acquisition ................ 1091 5.2.1 Testing goodwill ‘created’ by deferred tax for impairment ......... 1091 5.2.2 Assets whose fair value reflects tax benefits ................................. 1093 5.2.3 Deferred tax assets and losses of acquired businesses ................. 1094

5.3 Future capital expenditure ....................................................................... 1094 5.4 Use of fair value less costs to sell for the purposes of impairment

testing ..................................................................................................... 1096 5.5 Testing for impairment: group issues....................................................... 1098

5.5.1 Associates, joint ventures and testing goodwill for impairment ..................................................................................... 1098

5.5.2 Testing investments in subsidiaries for impairment in separate financial statements ........................................................ 1099 A Group reorganisations ............................................................... 1100 B Transfer pricing ......................................................................... 1102

5.5.3 Acquisitions of minority interests of a subsidiary and subsequent goodwill impairment tests ......................................... 1102

5.5.4 Acquisitions by subsidiaries and determining the level at which the group tests goodwill for impairment ............................ 1103

6 EFFECTIVE DATE, TRANSITIONAL PROVISIONS AND FIRST-TIME ADOPTION........................................................................................................... 1104 6.1 Transitional provisions and effective date ............................................... 1104 6.2 First-time adoption.................................................................................... 1104

7 CONCLUSION ..................................................................................................... 1106

CHAPTER 16 CAPITALISATION OF BORROWING COSTS

1 INTRODUCTION ................................................................................................. 1109 2 THE REQUIREMENTS OF IAS 23........................................................................ 1110

2.1 Scope and definitions ................................................................................ 1110 2.1.1 Scope............................................................................................... 1110 2.1.2 Qualifying assets............................................................................. 1110 2.1.3 Borrowing costs............................................................................... 1112

2.2 Accounting policies.................................................................................... 1112 2.2.1 Borrowing costs treated as an expense .......................................... 1112

xliv  International GAAP 

2.2.2 Capitalisation of borrowing costs................................................... 1112 2.2.3 Consistency of application of a capitalisation policy .................... 1112

2.3 Capitalisation of borrowing costs .............................................................. 1113 2.3.1 Directly attributable borrowing costs............................................ 1113 2.3.2 Capitalisation rate .......................................................................... 1113 2.3.3 Impairment and capitalisation of borrowing costs ........................ 1114 2.3.4 Capitalisation of borrowing costs in hyperinflationary

economies ....................................................................................... 1115 2.4 Commencement, suspension and cessation of capitalisation.................. 1115

2.4.1 Commencement of capitalisation.................................................. 1115 2.4.2 Suspension of capitalisation........................................................... 1116 2.4.3 Cessation of capitalisation ............................................................. 1116

2.5 Disclosure requirements of IAS 23 ........................................................... 1116 3 PRACTICAL ISSUES ............................................................................................. 1117

3.1 Borrowing costs .......................................................................................... 1117 3.1.1 Exchange differences as a borrowing cost ..................................... 1118 3.1.2 Other finance costs......................................................................... 1118

A Derivative financial instruments .............................................. 1119 B Gains and losses on derecognition of borrowings .................... 1122 C Gains or losses on termination of derivative financial

instruments................................................................................ 1122 D Dividends payable on shares classified as financial

liabilities .................................................................................... 1123 E Unwinding discounts on provisions classified as finance

costs in the income statement.................................................. 1123 3.2 Borrowings and capitalisation rate ............................................................ 1124 3.3 Accrued costs ............................................................................................. 1125 3.4 Assets carried in the balance sheet below cost......................................... 1126 3.5 Group financial statements ....................................................................... 1126

3.5.1 Borrowings in one company and development in another............ 1126 3.5.2 Qualifying assets held by joint ventures........................................ 1126

3.6 Change of accounting policy ..................................................................... 1127 4 TRANSITION AND FIRST-TIME ADOPTION........................................................ 1127

4.1 Effective date and transition to IAS 23 (revised 2007) ........................... 1127 4.2 First-time adoption.................................................................................... 1127

5 CONCLUSION ..................................................................................................... 1128

Detailed contents – Volume 1  xlv 

CHAPTER 17 FINANCIAL INSTRUMENTS: INTRODUCTION

1 INTRODUCTION ................................................................................................. 1131 1.1 Accounting for financial instruments – the challenge ............................. 1131 1.2 Publication of the original IAS 32 ............................................................. 1132 1.3 Evolution of a ‘full fair value’ accounting model...................................... 1132 1.4 Publication of the original IAS 39 ............................................................. 1133 1.5 IASB ‘improvements’ project and EU adoption....................................... 1134 1.6 Conclusion.................................................................................................. 1137 1.7 How financial instruments are dealt with in Chapters 17 to 22 ............. 1137

2 WHAT IS A FINANCIAL INSTRUMENT? ............................................................... 1139 2.1 Definitions ................................................................................................. 1139 2.2 Applying the definitions............................................................................ 1140

2.2.1 The need for a contract.................................................................. 1140 2.2.2 Simple examples............................................................................. 1141 2.2.3 Contingent rights and obligations ................................................. 1142 2.2.4 Leases.............................................................................................. 1143 2.2.5 Non-financial assets and liabilities and contracts thereon........... 1143 2.2.6 Equity instruments......................................................................... 1144 2.2.7 Derivative financial instruments ................................................... 1144

3 SCOPE ................................................................................................................. 1146 3.1 Subsidiaries, associates, joint ventures and similar investments ............ 1146 3.2 Leases ..................................................................................................... 1147 3.3 Insurance contracts.................................................................................... 1148

3.3.1 Weather derivatives ........................................................................ 1148 3.3.2 Contracts with discretionary participation features ..................... 1149

3.4 Financial guarantee contracts.................................................................... 1149 3.4.1 Definition........................................................................................ 1150

A Reimbursement for loss incurred ............................................. 1150 B Debt instrument ....................................................................... 1150 C Form and existence of contract ................................................ 1151

3.4.2 Issuers of financial guarantee contracts......................................... 1152 3.4.3 Holders of financial guarantee contracts ....................................... 1153 3.4.4 Financial guarantee contracts between entities under

common control .............................................................................. 1153 3.5 Loan commitments.................................................................................... 1153 3.6 Equity instruments.................................................................................... 1156 3.7 Business combinations............................................................................... 1156

3.7.1 Contingent consideration in a business combination................... 1156 3.7.2 Contracts between an acquirer and a vendor in a business

combination .................................................................................... 1157

xlvi  International GAAP 

3.8 Employee benefit plans and share-based payment.................................. 1161 3.9 Contracts to buy or sell commodities and other non-financial items ..... 1162

3.9.1 Contracts that may be settled net................................................. 1163 3.9.2 Normal sales and purchases (or own use contracts) ..................... 1163

A Net settlement of similar contracts ......................................... 1164 B Commodity broker-traders and similar entities....................... 1165 C Written options that can be settled net................................... 1166 D Electricity and similar ‘end-user’ contracts ............................. 1166 E Other contracts containing volume flexibility ......................... 1168 F Disclosure of normal sale and purchase contracts ................... 1168

3.10 Reimbursement rights in respect of provisions........................................ 1168 3.11 Disposal groups classified as held for sale and discontinued

operations................................................................................................... 1169 4 DERIVATIVES ...................................................................................................... 1169

4.1 Changes in value in response to changes in underlying........................... 1170 4.1.1 Notional amounts ........................................................................... 1170 4.1.2 Underlying variables....................................................................... 1170 4.1.3 Non-financial variables specific to one party to the contract....... 1171

4.2 Initial net investment................................................................................ 1172 4.3 Future settlement ..................................................................................... 1174 4.4 Common examples of derivatives ............................................................. 1175 4.5 In-substance derivatives............................................................................ 1176 4.6 Regular way contracts ................................................................................ 1177

5 EMBEDDED DERIVATIVES................................................................................... 1177 5.1 The meaning of ‘closely related’ ............................................................... 1179

5.1.1 Financial instrument hosts ............................................................ 1179 A Foreign currency monetary items............................................. 1179 B Interest rate indices .................................................................. 1179 C Term extension and similar call, put and prepayment

options in debt instruments ..................................................... 1180 D Interest rate floors and caps...................................................... 1182 E Inflation linked debt ................................................................. 1182 F Commodity and equity linked interest and principal

payments.................................................................................... 1183 G Credit linked notes ................................................................... 1183 H Convertible and exchangeable debt instruments.................... 1183 I Puttable instruments ................................................................ 1184 J Callable equity instruments ..................................................... 1185

5.1.2 Contracts for the sale of goods or services .................................... 1186 A Foreign currency derivatives..................................................... 1186 B Inputs, ingredients, substitutes and other proxy pricing

mechanisms ............................................................................... 1190 C Inflation linked features ........................................................... 1191

Detailed contents – Volume 1  xlvii 

D Floors and caps .......................................................................... 1191 E Fund performance fees ............................................................. 1191

5.1.3 Leases.............................................................................................. 1192 A Foreign currency derivatives..................................................... 1192 B Inflation linked features ........................................................... 1192 C Contingent rentals based on related sales ............................... 1192 D Contingent rentals based on variable interest rates ................ 1192

5.1.4 Insurance contracts ........................................................................ 1192 5.2 Identifying the terms of embedded derivatives and host contracts ....... 1193

5.2.1 Embedded non-option derivatives ................................................ 1193 5.2.2 Embedded option-based derivative............................................... 1194 5.2.3 Nature of a financial instrument host ........................................... 1194

5.3 Multiple embedded derivatives................................................................ 1195 5.4 Reassessment of embedded derivatives ................................................... 1196

5.4.1 IFRIC 9 ........................................................................................... 1196 5.4.2 Acquisition of contracts.................................................................. 1197 5.4.3 Business combinations ................................................................... 1197 5.4.4 Remeasurement issues arising from reassessment ....................... 1197

5.5 Non-financial variables specific to one party to the contract .................. 1198 6 LINKED AND SEPARATE TRANSACTIONS AND ‘SYNTHETIC’

INSTRUMENTS.................................................................................................... 1200 7 CLASSIFICATION OF FINANCIAL INSTRUMENTS............................................... 1202

7.1 Assets and liabilities at fair value through profit or loss .......................... 1203 7.1.1 Assets and liabilities held for trading ............................................ 1203 7.1.2 Instruments designated at fair value through profit or loss ......... 1204

A The original fair value option.................................................... 1204 B The fair value option amendments .......................................... 1205

7.2 Held-to-maturity investments .................................................................. 1211 7.2.1 Instruments that may be classified as held-to-maturity............... 1212 7.2.2 Positive intention and ability to hold to maturity ........................ 1213 7.2.3 The tainting provisions .................................................................. 1214

7.3 Loans and receivables................................................................................ 1217 7.4 Available-for-sale assets ............................................................................. 1218 7.5 Reclassifications......................................................................................... 1219 7.6 Classification of financial instruments in a business combination.......... 1220

8 EFFECTIVE DATES, TRANSITIONAL PROVISIONS AND FIRST-TIME ADOPTION........................................................................................................... 1220 8.1 Effective dates ........................................................................................... 1220 8.2 Transitional provisions .............................................................................. 1221 8.3 First-time adoption.................................................................................... 1222

8.3.1 Derivatives and embedded derivatives ......................................... 1222

xlviii  International GAAP 

8.3.2 Other financial assets and financial liabilities at fair value through profit or loss ...................................................................... 1222

8.3.3 Held-to-maturity investments....................................................... 1223 8.3.4 Loans and receivables..................................................................... 1223 8.3.5 Available-for-sale assets.................................................................. 1223

9 FUTURE DEVELOPMENTS .................................................................................. 1224

CHAPTER 18 FINANCIAL INSTRUMENTS: RECOGNITION, DERECOGNITION AND OFFSET

1 INTRODUCTION ................................................................................................. 1231 1.1 Background................................................................................................. 1231 1.2 Off-balance sheet finance.......................................................................... 1232

2 DEVELOPMENT OF IFRS ................................................................................... 1233 2.1 General ..................................................................................................... 1233

2.1.1 Derecognition of assets – a mixed accounting model................... 1234 2.2 Definitions ................................................................................................. 1235

3 RECOGNITION.................................................................................................... 1236 3.1 General ..................................................................................................... 1236

3.1.1 Receivables and payables ............................................................... 1236 3.1.2 Firm commitments......................................................................... 1237 3.1.3 Forward contracts ........................................................................... 1238 3.1.4 Option contracts............................................................................. 1238 3.1.5 Planned future transactions ........................................................... 1238 3.1.6 Treatment by transferee of transfers of financial assets not

qualifying for derecognition by transferor ..................................... 1239 3.2 ‘Regular way’ transactions ......................................................................... 1239

3.2.1 Trade date accounting ................................................................... 1240 3.2.2 Settlement date accounting........................................................... 1240

A Current market practice – ‘due date’ accounting.................... 1241 3.2.3 Illustrative examples ...................................................................... 1241

A Exchanges of non-cash financial assets .................................... 1245 4 DERECOGNITION – FINANCIAL ASSETS............................................................. 1246

4.1 Summary..................................................................................................... 1246 4.1.1 Background ..................................................................................... 1246 4.1.2 Decision tree................................................................................... 1248 4.1.3 Importance of applying tests in sequence..................................... 1250

4.2 Are the derecognition principles applied to all or part of an asset? ........ 1251 4.2.1 Credit enhancement through transferor’s waiver of right to

future cash flows............................................................................. 1252 4.2.2 Derecognition of groups of financial assets................................... 1253

Detailed contents – Volume 1  xlix 

A The IASB’s view and the IFRIC’s tentative conclusions........ 1254 B What are ‘similar assets’?........................................................... 1255

4.2.3 Transfer of asset (or part of asset) for only part of its life............ 1256 4.2.4 ‘Financial asset’ includes whole or part of a financial asset

in 4.3 to 4.8 below .......................................................................... 1256 4.3 Have the contractual rights to cash flows from the asset expired? ......... 1257 4.4 Has the entity ‘transferred’ the asset?...................................................... 1257

4.4.1 Transfers of contractual rights to receive cash flows.................... 1258 A Meaning of ‘transfers the contractual rights to receive the

cash flows’ .................................................................................. 1258 B Transfers subject to conditions ................................................ 1261

4.4.2 Retention of rights to receive cash flows subject to obligation to pay over to others (pass-through arrangement) ...... 1262

4.4.3 Securitisations ................................................................................ 1263 A Recourse to originator ............................................................... 1265 B Short-term loan facilities .......................................................... 1265 C Insurance protection ................................................................. 1265 D Treatment of collection proceeds ............................................ 1266 E Transfer of a group of assets not all of which are

derecognised.............................................................................. 1267 4.4.4 ‘Empty’ SPEs.................................................................................. 1268 4.4.5 Client money .................................................................................. 1268

4.5 Has the entity transferred or retained substantially all the risks and rewards of ownership?................................................................................ 1269 4.5.1 Transfers resulting in transfer of substantially all risks and

rewards ............................................................................................ 1270 4.5.2 Transfers resulting in retention of substantially all risks and

rewards ............................................................................................ 1270 4.5.3 Transfers resulting in neither transfer nor retention of

substantially all risks and rewards.................................................. 1271 4.6 Has the entity retained control of the asset? ........................................... 1271

4.6.1 Transferee’s ‘practical ability’ to sell the asset............................. 1272 4.7 Practical application of the derecognition criteria ................................... 1272

4.7.1 Repurchase agreements (‘repos’) and securities lending............. 1273 A Agreements to return the same asset....................................... 1273 B Agreements with right to return the same or substantially

the same asset............................................................................ 1273 C Agreements with right of substitution ..................................... 1274 D Net cash-settled forward repurchase ....................................... 1274 E Agreement to repurchase at fair value...................................... 1274 F Right of first refusal to repurchase at fair value....................... 1274 G Wash sale.................................................................................... 1275

4.7.2 Transfers subject to put and call options ...................................... 1275 A Deeply in the money put and call options ............................... 1275 B Deeply out of the money put and call options......................... 1275

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C Options that are neither deeply out of the money nor deeply in the money.................................................................. 1275

D Option to put or call at fair value ............................................. 1277 E Net cash-settled options........................................................... 1277 F Removal of accounts provision.................................................. 1277 G Clean-up call options ................................................................ 1277 H Same (or nearly the same) price put and call options ............. 1277 I Changes in probability of exercise of options after initial

transfer of asset.......................................................................... 1278 4.7.3 Subordinated retained interests and credit guarantees ............... 1280 4.7.4 Total return swaps.......................................................................... 1280 4.7.5 Interest rate swaps ......................................................................... 1280 4.7.6 Factoring of trade receivables ........................................................ 1281

4.8 Accounting treatment................................................................................ 1281 4.8.1 Transfers that qualify for derecognition........................................ 1282

A Transferred asset part of larger asset ....................................... 1283 B Servicing assets and liabilities .................................................. 1285

4.8.2 Transfers that do not qualify for derecognition through retention of risks and rewards........................................................ 1287

4.8.3 Transfers with continuing involvement – summary ..................... 1292 A Guarantees................................................................................. 1292 B Options ...................................................................................... 1293 C Associated liability..................................................................... 1293 D Subsequent measurement of assets and liabilities .................. 1293 E Continuing involvement in part only of a larger asset............. 1294

4.8.4 Transfers with continuing involvement – accounting examples ......................................................................................... 1294 A Transfers with guarantees......................................................... 1294 B Transfers of assets measured at amortised cost....................... 1296 C Transfers of assets measured at fair value................................ 1298 D Continuing involvement in part only of a financial asset ........ 1304

4.8.5 Miscellaneous provisions................................................................ 1307 A Offset ......................................................................................... 1307 B Collateral.................................................................................... 1307 C Rights or obligations over transferred assets that continue

to be recognised......................................................................... 1308 4.9 Reassessing derecognition......................................................................... 1308

4.9.1 Reassessment of consolidation of SPEs......................................... 1308 5 DERECOGNITION – FINANCIAL LIABILITIES..................................................... 1309

5.1 Extinguishment of debt ............................................................................ 1309 5.1.1 What constitutes ‘part’ of a liability?............................................. 1310 5.1.2 Legal release by creditor ................................................................ 1310 5.1.3 ‘In-substance defeasance’ arrangements....................................... 1311

Detailed contents – Volume 1  li 

5.1.4 Extinguishment in exchange for transfer of assets not meeting the derecognition criteria ................................................ 1311

5.2 Exchange or modification of debt by original lender ............................... 1312 5.2.1 Costs and fees................................................................................. 1314 5.2.2 Illustrative examples ...................................................................... 1314 5.2.3 Settlement of financial liability with issue of new equity

instrument ...................................................................................... 1317 5.3 Gains and losses on extinguishment of debt ............................................ 1317 5.4 Derivatives that can be financial assets or financial liabilities ................ 1318

6 OFFSET ............................................................................................................... 1318 6.1 Legal framework ........................................................................................ 1319 6.2 Right and intention to settle net .............................................................. 1319 6.3 Simultaneous settlement .......................................................................... 1320 6.4 Situations where offset is not normally appropriate ................................ 1320

6.4.1 Synthetic instruments.................................................................... 1320 6.4.2 Other ............................................................................................... 1321

6.5 Master netting agreements ....................................................................... 1321 7 TRANSITIONAL AND FIRST-TIME ADOPTION ISSUES........................................ 1322

7.1 Transitional issues – derecognition of assets ........................................... 1322 7.2 First-time adoption issues......................................................................... 1322

7.2.1 Comparative information ............................................................... 1322 7.2.2 Recognition and derecognition ...................................................... 1323

A Multiple transfers under same arrangement............................ 1323 B Transfers to SPEs...................................................................... 1323

CHAPTER 19 FINANCIAL INSTRUMENTS: FINANCIAL LIABILITIES AND EQUITY

1 INTRODUCTION ................................................................................................. 1327 1.1 Background................................................................................................. 1327 1.2 Development of IFRS on classification of liabilities and equity ............. 1328 1.3 Possible future developments................................................................... 1329

2 OBJECTIVE, SCOPE AND DEFINITIONS .............................................................. 1330 2.1 Objective .................................................................................................... 1330 2.2 Scope ..................................................................................................... 1330 2.3 Definitions ................................................................................................. 1330

3 LIABILITIES AND EQUITY ................................................................................... 1332 3.1 General provisions of IAS 32 ..................................................................... 1332

3.1.1 Examples of equity instruments.................................................... 1333 3.1.2 Comparison with IFRS 2 – Share-based Payment........................ 1335

lii  International GAAP 

3.2 Contractual obligation to deliver cash or other financial assets .............. 1335 3.2.1 Preference shares and similar instruments ................................... 1338

A Instruments redeemable mandatorily or at the holder’s option ......................................................................................... 1338

B Instruments redeemable at the issuer’s option or not redeemable ................................................................................ 1339

C Instruments with a ‘dividend blocker’ clause .......................... 1340 D Perpetual instruments with a ‘step-up’ clause ........................ 1341 E Relative subordination .............................................................. 1342 F Economic compulsion ............................................................... 1343 G ‘Linked’ instruments ................................................................ 1344 H ‘Change of control’, ‘taxation change’ and ‘regulatory

change’ clauses .......................................................................... 1345 I Hedging of instruments classified as equity ............................ 1345

3.2.2 Puttable instruments and limited-life entities............................. 1345 A The issue ................................................................................... 1345 B IFRIC 2...................................................................................... 1347 C Possible future developments .................................................. 1348

3.2.3 Perpetual debt ................................................................................ 1350 3.3 Contracts settled by delivery of the entity’s own equity

instruments ................................................................................................ 1350 3.3.1 Contracts accounted for as equity instruments ............................ 1351

A What is a ‘fixed amount’ of cash (or other financial assets)?....................................................................................... 1352

B Instrument issued by foreign subsidiary convertible into equity of parent ......................................................................... 1353

C Number of equity instruments issued adjusted for capital restructuring .............................................................................. 1355

3.3.2 Contracts accounted for as financial assets or financial liabilities.......................................................................................... 1356 A Variable number of equity instruments ................................... 1356 B Contracts based on the price of the entity’s equity

instruments................................................................................ 1356 C Fixed number of equity instruments for variable

consideration ............................................................................. 1356 D Fixed number of equity instruments with variable value ....... 1357 E Fixed amount of cash determined by reference to share

price ........................................................................................... 1357 F Net-settled contracts over own equity..................................... 1357

3.3.3 Gross-settled contracts for the purchase of the entity’s own equity instruments ......................................................................... 1357 A Contracts to purchase own equity during ‘close’ or

‘prohibited’ periods ................................................................... 1359 B Contracts to acquire minority interests ................................... 1359

3.3.4 Gross-settled contracts for the sale or issue of the entity’s own equity instruments ................................................................. 1360

Detailed contents – Volume 1  liii 

3.4 Contingent settlement provisions ............................................................ 1361 3.4.1 Terms that are ‘not genuine’ ......................................................... 1362 3.4.2 Liabilities that arise only on liquidation ....................................... 1363 3.4.3 Liabilities that arise only on a change of control .......................... 1363 3.4.4 Some typical contingent settlement provisions............................ 1364

3.5 Derivative financial instruments with settlement options...................... 1365 3.6 Consolidated financial statements............................................................ 1365 3.7 Single entity financial statements ............................................................ 1366

4 COMPOUND FINANCIAL INSTRUMENTS ........................................................... 1367 4.1 Background................................................................................................. 1367

4.1.1 Treatment by holder and issuer contrasted .................................. 1368 4.2 The components of a compound instrument........................................... 1368

4.2.1 Determining the components of a financial instrument .............. 1368 4.2.2 Separated (i.e. not closely-related) embedded derivatives.......... 1371

4.3 Initial recognition ...................................................................................... 1372 A Temporary differences arising from split accounting.............. 1375

4.3.1 Accounting for the equity component........................................... 1375 4.4 Conversion, early repurchase and modification........................................ 1376

4.4.1 Conversion at maturity................................................................... 1376 A Embedded derivatives .............................................................. 1376

4.4.2 Conversion before maturity ........................................................... 1377 A ‘Fixed stated principal’ of a bond ............................................. 1377 B Accounting treatment ............................................................... 1377

4.4.3 Early repurchase ............................................................................. 1378 4.4.4 Modification.................................................................................... 1380 4.4.5 Settlement of financial liability with new equity instrument...... 1382

4.5 Issuer cash settlement options ................................................................. 1383 4.6 Other issues ............................................................................................... 1384

5 INTEREST, DIVIDENDS, GAINS AND LOSSES ...................................................... 1385 5.1 Transaction costs of equity transactions .................................................. 1386

6 TREASURY SHARES.............................................................................................. 1387 6.1 Entities ‘controlled’ by the entity............................................................. 1388 6.2 Comparison with IFRS 2 – Share-based payment ........................................ 1388

7 CONTRACTS OVER OWN EQUITY INSTRUMENTS .............................................. 1389 7.1 Forward contracts ...................................................................................... 1389

7.1.1 Forward purchase ........................................................................... 1389 7.1.2 Forward sale .................................................................................... 1392 7.1.3 ‘Back-to-back’ forward contracts ................................................... 1394

7.2 Call options ................................................................................................ 1395 7.2.1 Purchased call option ..................................................................... 1395

liv  International GAAP 

7.2.2 Written call option.......................................................................... 1398 7.3 Put options................................................................................................. 1400

7.3.1 Purchased put option ..................................................................... 1400 7.3.2 Written put option ......................................................................... 1403

7.4 Dissenting opinion..................................................................................... 1406 8 TRANSITIONAL AND FIRST-TIME ADOPTION PROVISIONS ............................... 1407

CHAPTER 20 FINANCIAL INSTRUMENTS: MEASUREMENT

1 INTRODUCTION ................................................................................................. 1411 2 INITIAL MEASUREMENT..................................................................................... 1413

2.1 General requirements................................................................................ 1413 2.2 Initial fair value.......................................................................................... 1413

2.2.1 Interest-free and low-interest loans .............................................. 1413 2.2.2 Short-term receivables and payables ............................................. 1416 2.2.3 Equity instruments reclassified as liabilities following

modification of contractual terms.................................................. 1416 2.2.4 Financial guarantee contracts and off-market loan

commitments.................................................................................. 1417 2.2.5 ‘Day 1’ profits ................................................................................. 1417

2.3 Transaction costs ....................................................................................... 1418 2.4 Bid-ask spreads .......................................................................................... 1419 2.5 Embedded derivatives and financial instrument hosts............................ 1420 2.6 Regular way transactions ........................................................................... 1420 2.7 Assets and liabilities arising from loan commitments.............................. 1420

3 SUBSEQUENT MEASUREMENT AND RECOGNITION OF GAINS AND LOSSES ..... 1422 3.1 Financial assets and financial liabilities at fair value through profit

or loss ..................................................................................................... 1423 3.2 Held-to-maturity investments .................................................................. 1423 3.3 Loans and receivables................................................................................ 1424 3.4 Available-for-sale assets ............................................................................. 1424 3.5 Other financial liabilities........................................................................... 1426 3.6 Reclassifications......................................................................................... 1426 3.7 Financial guarantees and commitments to provide a loan at a

below-market interest rate........................................................................ 1427 3.8 Other exceptions ....................................................................................... 1427

3.8.1 Hedging relationships .................................................................... 1427 3.8.2 Regular way transactions ................................................................ 1428 3.8.3 Liabilities arising from ‘failed derecognition’ transactions .......... 1428

4 FAIR VALUE MEASUREMENT CONSIDERATIONS................................................ 1428

Detailed contents – Volume 1  lv 

4.1 Quoted prices in an active market ............................................................ 1429 4.2 Valuation techniques where there is no active market............................ 1432 4.3 Inputs to valuation techniques ................................................................. 1434 4.4 Unquoted equity instruments and related derivatives............................ 1435 4.5 Demand deposits and similar liabilities.................................................... 1436 4.6 Negative assets and liabilities ................................................................... 1437 4.7 ‘Day 1’ profits............................................................................................. 1437 4.8 Own credit risk .......................................................................................... 1439

5 AMORTISED COST AND THE EFFECTIVE INTEREST METHOD.......................... 1441 5.1 Fixed interest, fixed term instruments .................................................... 1443 5.2 Prepayment, call and similar options........................................................ 1444

5.2.1 Revisions to estimated cash flows ................................................. 1444 5.2.2 Interaction with the requirements for embedded derivatives..... 1446

5.3 Floating rate instruments.......................................................................... 1448 5.4 Perpetual debt instruments ...................................................................... 1450 5.5 Acquisition of impaired debt instruments................................................ 1451 5.6 Other, more complex, instruments........................................................... 1451

6 IMPAIRMENT ...................................................................................................... 1452 6.1 Impairment reviews................................................................................... 1453 6.2 Financial assets carried at amortised cost................................................. 1455

6.2.1 Individual and collective assessments........................................... 1455 6.2.2 Measurement – general requirements .......................................... 1456 6.2.3 Measurement – detailed requirements ......................................... 1459 6.2.4 Impairment of assets subject to hedges ........................................ 1461 6.2.5 Reversal of impairment losses........................................................ 1462

6.3 Available-for-sale assets measured at fair value........................................ 1462 6.3.1 Recognition of impairment ............................................................ 1462 6.3.2 Reversals of impairment................................................................. 1462 6.3.3 Further declines in the fair value of impaired equity

instruments..................................................................................... 1463 6.3.4 Timing of impairment tests and interaction with interim

reporting.......................................................................................... 1464 6.4 Financial assets carried at cost .................................................................. 1465 6.5 Interest income after impairment recognition......................................... 1465

7 FOREIGN CURRENCIES....................................................................................... 1465 7.1 Foreign currency instruments ................................................................... 1465 7.2 Foreign entities.......................................................................................... 1468

8 EFFECTIVE DATES, TRANSITIONAL PROVISIONS AND FIRST-TIME ADOPTION........................................................................................................... 1468 8.1 Effective dates ........................................................................................... 1468

lvi  International GAAP 

8.2 Transitional provisions .............................................................................. 1469 8.3 First-time adoption.................................................................................... 1469

8.3.1 Assets and liabilities measured at amortised cost......................... 1470 8.3.2 Loan impairments .......................................................................... 1470 8.3.3 Derivatives and other instruments classified at fair value

through profit or loss ...................................................................... 1470 8.3.4 Embedded derivatives.................................................................... 1471 8.3.5 Transition adjustments: available-for-sale assets ......................... 1471 8.3.6 Transition adjustments: other instruments .................................. 1472

9 FUTURE DEVELOPMENTS .................................................................................. 1472

CHAPTER 21 FINANCIAL INSTRUMENTS: HEDGE ACCOUNTING

1 INTRODUCTION ................................................................................................. 1477 1.1 Background................................................................................................. 1477 1.2 What is hedge accounting? ........................................................................ 1478 1.3 Development of hedge accounting standards .......................................... 1479

2 HEDGING INSTRUMENTS AND HEDGED ITEMS................................................ 1481 2.1 Hedging instruments................................................................................. 1481

2.1.1 Derivative financial instruments ................................................... 1481 A Options and collars.................................................................... 1482 B Credit break clauses .................................................................. 1484

2.1.2 Cash instruments............................................................................ 1484 2.1.3 Combinations of instruments ........................................................ 1485 2.1.4 Portions and proportions of hedging instruments ........................ 1486

A Time and interest elements of options and forwards.............. 1487 B Proportions of instruments ....................................................... 1487 C Cash instruments ...................................................................... 1487 D Notional decomposition............................................................ 1487 E Restructuring of derivatives...................................................... 1488

2.1.5 Reduction of risk ............................................................................ 1488 2.1.6 Hedging different risks with one instrument ............................... 1489 2.1.7 Own equity instruments ................................................................ 1491 2.1.8 Pension scheme assets ................................................................... 1491

2.2 Hedged items............................................................................................. 1491 2.2.1 Financial items: portions and proportions..................................... 1492

A Portions of interest rate risk ..................................................... 1492 B Foreign currency risk associated with publicly quoted

shares.......................................................................................... 1494 C IFRIC and IASB deliberations.................................................. 1494

2.2.2 Non-financial items: portions ........................................................ 1496 2.2.3 Groups of items as hedged items................................................... 1499 2.2.4 Hedges of general business risk..................................................... 1500

Detailed contents – Volume 1  lvii 

2.2.5 Held-to-maturity investments....................................................... 1500 2.2.6 Derivatives ...................................................................................... 1501 2.2.7 Own equity instruments ................................................................ 1501 2.2.8 Recognised core deposit intangibles ............................................. 1502

2.3 Internal hedges and other group accounting issues ................................. 1502 2.3.1 Internal hedging instruments ........................................................ 1502 2.3.2 Offsetting internal hedging instruments ...................................... 1505

A Interest rate risk........................................................................ 1505 B Foreign exchange risk................................................................ 1506

2.3.3 Offsetting external hedging instruments...................................... 1514 2.3.4 Internal hedged items .................................................................... 1516

A Intragroup monetary items ....................................................... 1516 B Forecast intragroup transactions .............................................. 1516

2.3.5 Hedged item and hedging instrument held by different group entities.................................................................................. 1518

3 TYPES OF HEDGING RELATIONSHIPS ................................................................ 1518 3.1 Fair value hedges ....................................................................................... 1518 3.2 Cash flow hedges ....................................................................................... 1519 3.3 Hedges of foreign currency monetary items ............................................ 1520 3.4 Hedges of firm commitments ................................................................... 1520 3.5 All-in-one hedges ....................................................................................... 1521 3.6 Hedges of net investments in foreign operations .................................... 1522

3.6.1 Presentation currency approach..................................................... 1522 3.6.2 Functional currency approach........................................................ 1524 3.6.3 IFRIC deliberations ....................................................................... 1527 3.6.4 Summary ......................................................................................... 1528

4 ACCOUNTING FOR EFFECTIVE HEDGES ............................................................ 1528 4.1 Fair value hedges ....................................................................................... 1529

4.1.1 Ongoing fair value hedge accounting ............................................ 1529 4.1.2 Dealing with adjustments to the hedged item ............................. 1531 4.1.3 Discontinuing fair value hedge accounting ................................... 1533

4.2 Cash flow hedges ....................................................................................... 1534 4.2.1 Ongoing cash flow hedge accounting ............................................ 1534 4.2.2 Recycling gains and losses from equity ......................................... 1536 4.2.3 Discontinuing cash flow hedge accounting................................... 1540 4.2.4 Acquisitions and disposals.............................................................. 1541

4.3 Accounting for hedges of a net investment in a foreign operation.......... 1542 5 QUALIFYING CONDITIONS FOR HEDGE ACCOUNTING ..................................... 1542

5.1 Documentation and designation............................................................... 1543 5.1.1 Business combinations ................................................................... 1543 5.1.2 Dynamic hedging strategies........................................................... 1544

lviii  International GAAP 

5.2 Forecast transactions ................................................................................. 1545 5.3 Assessing hedge effectiveness................................................................... 1547

5.3.1 Basic requirements ......................................................................... 1548 5.3.2 The ‘dollar-offset’ method............................................................. 1550 5.3.3 Dollar-offset: comparison of spot rate and forward rate

methods .......................................................................................... 1557 5.3.4 Law of small numbers .................................................................... 1562 5.3.5 Hedging using instruments with a non-zero fair value................. 1563 5.3.6 Regression analysis and other statistical methods ........................ 1563

A Basic concepts of regression...................................................... 1563 B Summary .................................................................................... 1567

5.3.7 ‘Almost fully offset’ and under-hedging ........................................ 1567 5.3.8 ‘Short-cut method’ ......................................................................... 1568 5.3.9 ’Critical terms match’ approach..................................................... 1568 5.3.10 Interest accruals and ‘clean’ vs. ‘dirty’ values ............................... 1571 5.3.11 Effectiveness of options ................................................................. 1572 5.3.12 Net investment hedges.................................................................. 1573

A Non-derivative liabilities used as the hedging instrument ..... 1573 B Derivatives used as the hedging instrument ........................... 1574 C Combinations of derivative and non-derivative

instruments used as the hedging instrument .......................... 1576 D Unrecognised assets .................................................................. 1576 E Individual or separate financial statements ............................. 1576

6 PORTFOLIO (OR MACRO) HEDGING .................................................................. 1577 7 EFFECTIVE DATES, TRANSITIONAL PROVISIONS AND FIRST-TIME

ADOPTION........................................................................................................... 1578 7.1 Effective dates ........................................................................................... 1578 7.2 Transitional provisions .............................................................................. 1579 7.3 First-time adoption.................................................................................... 1579

7.3.1 Cumulative translation differences and related hedges ............... 1579 7.3.2 Hedge accounting: prohibition on retrospective application....... 1580 7.3.3 Hedge accounting: opening IFRS balance sheet .......................... 1581

A Measurement of derivatives and elimination of deferred gains and losses.......................................................................... 1581

B Hedge relationships reflected in the opening IFRS balance sheet ............................................................................. 1583

C Reflecting cash flow hedges in the opening IFRS balance sheet........................................................................................... 1584

D Reflecting fair value hedges in the opening IFRS balance sheet........................................................................................... 1585

7.3.4 Hedge accounting: subsequent treatment.................................... 1586 7.3.5 Hedge accounting: examples ......................................................... 1587

8 FUTURE DEVELOPMENTS .................................................................................. 1589

Detailed contents – Volume 1  lix 

CHAPTER 22 FINANCIAL INSTRUMENTS: DISCLOSURES

1 INTRODUCTION ................................................................................................. 1595 1.1 IAS 32 ..................................................................................................... 1595 1.2 IFRS 7 ..................................................................................................... 1596

2 IAS 32 ................................................................................................................. 1597 2.1 General matters ......................................................................................... 1597

2.1.1 Scope............................................................................................... 1597 2.1.2 Risks arising from financial instruments ....................................... 1597 2.1.3 Format, location and degree of aggregation .................................. 1598

2.2 Narrative disclosures ................................................................................. 1599 2.2.1 Risk management policies ............................................................. 1599 2.2.2 Hedging Activities.......................................................................... 1599 2.2.3 Accounting policies ........................................................................ 1599 2.2.4 Terms and conditions..................................................................... 1600

2.3 Principal numerical disclosures................................................................. 1608 2.3.1 Interest rate risk disclosures .......................................................... 1608 2.3.2 Credit risk ....................................................................................... 1610 2.3.3 Fair values ....................................................................................... 1612

A General disclosure requirements.............................................. 1613 B Exceptions ................................................................................. 1614

2.3.4 Income, expenses, gains and losses ............................................... 1615 2.4 Other disclosures ....................................................................................... 1616

2.4.1 Derecognition ................................................................................. 1616 2.4.2 Defaults and breaches .................................................................... 1617 2.4.3 Reclassifications.............................................................................. 1617 2.4.4 Financial instruments at fair value through profit or loss............. 1617

A Balance sheet and income statement....................................... 1617 B Financial liabilities designated at fair value through profit

or loss ......................................................................................... 1618 C Loans and receivables designated at fair value through

profit or loss ............................................................................... 1620 2.4.5 Collateral......................................................................................... 1620

3 IFRS 7................................................................................................................. 1621 3.1 Scope ..................................................................................................... 1622

3.1.1 Entities required to comply with IFRS 7...................................... 1622 3.1.2 Financial instruments within the scope of IFRS 7 ....................... 1622

3.2 Structuring the disclosures........................................................................ 1622 3.2.1 Level of detail................................................................................. 1623 3.2.2 Materiality ...................................................................................... 1623 3.2.3 Classes of financial instrument...................................................... 1624 3.2.4 Reconciliation to balance sheet ..................................................... 1624

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3.3 Significance of financial instruments for an entity’s financial position and performance .......................................................................... 1624 3.3.1 Accounting policies ........................................................................ 1624 3.3.2 Income, expenses, gains and losses ............................................... 1626

A Gains and losses by measurement category ............................. 1626 B Interest income and expense.................................................... 1626 C Fee income and expense........................................................... 1627 D Impairment losses ..................................................................... 1627

3.3.3 Hedge accounting........................................................................... 1627 3.3.4 Balance sheet .................................................................................. 1632

A Categories of financial assets and financial liabilities.............. 1632 B Financial liabilities designated at fair value through profit

or loss ......................................................................................... 1633 C Loans and receivables designated at fair value through

profit or loss ............................................................................... 1635 D Reclassification.......................................................................... 1636 E Derecognition............................................................................ 1636 F Collateral.................................................................................... 1637 G Allowance account for credit losses .......................................... 1638 H Compound financial instruments with multiple

embedded derivatives ............................................................... 1640 I Defaults and breaches of loans payable.................................... 1640

3.3.5 Fair values ....................................................................................... 1640 A General disclosure requirements.............................................. 1641 B Day 1 profits .............................................................................. 1642 C Exceptions ................................................................................. 1644

3.4 Nature and extent of risks arising from financial instruments................ 1645 3.4.1 Qualitative disclosures ................................................................... 1647 3.4.2 Quantitative disclosures................................................................. 1649

A General matters ......................................................................... 1649 B Credit risk.................................................................................. 1650 C Liquidity risk ............................................................................. 1657 D Market risk ................................................................................ 1661 E Concentrations of risk ............................................................... 1673 F Operational risk ......................................................................... 1674 G Capital disclosures..................................................................... 1674

4 PRESENTATION ON THE FACE OF THE FINANCIAL STATEMENTS AND RELATED DISCLOSURES ..................................................................................... 1675 4.1 Income statement...................................................................................... 1675

4.1.1 Presentation on the face of the income statement....................... 1675 4.1.2 Further analysis of gains and losses recognised in the income

statement........................................................................................ 1676 4.1.3 Offsetting and hedges .................................................................... 1678 4.1.4 Embedded derivatives.................................................................... 1679 4.1.5 Entities whose share capital is not equity..................................... 1679

Detailed contents – Volume 1  lxi 

4.2 Statement of changes in equity ................................................................ 1680 4.3 Balance sheet ............................................................................................. 1681

4.3.1 Assets and liabilities ....................................................................... 1681 4.3.2 The distinction between current and non-current assets and

liabilities.......................................................................................... 1683 A Derivatives................................................................................. 1683 B Convertible loans....................................................................... 1683

4.3.3 Equity.............................................................................................. 1684 4.3.4 Entities whose share capital is not equity..................................... 1684

4.4 Cash flow statement.................................................................................. 1686 5 EFFECTIVE DATE, TRANSITIONAL PROVISIONS AND FIRST-TIME

ADOPTION........................................................................................................... 1687 5.1 Effective date............................................................................................. 1687 5.2 Transitional provisions .............................................................................. 1687 5.3 First-time adoption.................................................................................... 1687

6 FUTURE DEVELOPMENTS .................................................................................. 1687 The detailed table of contents of Volume 2 follows overleaf.

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VOLUME 2

CHAPTER 23 INVENTORIES

1 INTRODUCTION ................................................................................................. 1693 1.1 Objectives of inventory measurement...................................................... 1693 1.2 Cost flow assumptions............................................................................... 1694

1.2.1 Specific identification/actual cost ................................................. 1694 1.2.2 FIFO (first-in, first-out) ................................................................ 1694 1.2.3 Weighted average ........................................................................... 1694 1.2.4 LIFO (last-in, first-out) ................................................................. 1695

2 THE REQUIREMENTS OF IAS 2 .......................................................................... 1695 2.1 Scope and definitions ................................................................................ 1695 2.2 Measurement ............................................................................................. 1696

2.2.1 What may be included in cost........................................................ 1697 2.2.2 Cost measurement methods .......................................................... 1698 2.2.3 Net realisable value ........................................................................ 1699

2.3 Recognition in the income statement ...................................................... 1700 2.4 Disclosure requirements of IAS 2 ............................................................. 1700

3 PRACTICAL ISSUES ............................................................................................. 1702 3.1 Constituents of cost .................................................................................. 1702

3.1.1 Distribution and storage costs ....................................................... 1703 3.1.2 General and administrative overheads .......................................... 1703 3.1.3 Allocation of overheads................................................................... 1704

3.2 Net realisable value ................................................................................... 1704 3.3 The valuation of high volumes of similar items of inventory .................. 1705 3.4 Manufacturer dealer transactions and goods on consignment................. 1705 3.5 Core inventories......................................................................................... 1706 3.6 Real estate inventory ................................................................................. 1706 3.7 Property demolition costs ......................................................................... 1707 3.8 Revaluation effects on inventory valuations............................................. 1708

4 CONCLUSION ..................................................................................................... 1708

CHAPTER 24 CONSTRUCTION CONTRACTS

1 INTRODUCTION ................................................................................................. 1711 1.1 Scope and definitions of IAS 11................................................................ 1711 1.2 Combination and segmentation of contracts............................................ 1712

2 CONTRACT REVENUE, COSTS AND EXPENSES................................................... 1713

Detailed contents – Volume 2  lxiii 

2.1 Contract revenue ....................................................................................... 1713 2.2 Contract costs ............................................................................................ 1714

2.2.1 Borrowing costs............................................................................... 1715 2.3 The recognition of contract revenue and expenses ................................. 1716

2.3.1 Types of construction contract...................................................... 1717 A Fixed price contracts................................................................. 1717 B Cost plus contracts.................................................................... 1717

2.3.2 The stage of completion method .................................................. 1717 2.3.3 Changes in estimates ..................................................................... 1720 2.3.4 The determination of contract revenue and expenses................. 1720 2.3.5 Inability to estimate the outcome of a contract reliably .............. 1721 2.3.6 Loss-making contracts.................................................................... 1722 2.3.7 Contract inefficiencies ................................................................... 1722

3 DISCLOSURE REQUIREMENTS OF IAS 11 .......................................................... 1723 4 PRACTICAL ISSUES ............................................................................................. 1727

4.1 Whether an arrangement is a construction contract and IFRIC D 21 – Real Estate Sales ........................................................................................ 1727 4.1.1 Scope of IAS 11 and features of a construction contract.............. 1728

4.2 Combining and segmenting of contracts: future developments and the convergence project ............................................................................ 1729

4.3 Options for the construction of an additional asset ................................. 1730 4.4 Service concession agreements ................................................................. 1731

5 FIRST-TIME ADOPTION...................................................................................... 1731 6 CONCLUSION ..................................................................................................... 1732

CHAPTER 25 LEASES

1 INTRODUCTION ................................................................................................. 1735 1.1 Background: the development of IAS 17.................................................. 1736 1.2 The search for a new approach to lease accounting ................................. 1736

2 SCOPE AND CLASSIFICATION OF LEASES........................................................... 1738 2.1 Scope of IAS 17.......................................................................................... 1738

2.1.1 Leases and licences – IAS 17 and arrangements over intangible assets ............................................................................. 1738

2.2 What are leases? ......................................................................................... 1740 2.2.1 Determining whether an arrangement contains a lease ............... 1740

A How to determine whether an arrangement is, or contains, a lease ......................................................................... 1742

B Identification of an asset........................................................... 1742 C Parts of assets and the unit of account..................................... 1743 D The arrangement conveys a right to use the item................... 1743

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E Analysing the arrangements...................................................... 1744 F Fixed or current market prices and control of the asset ......... 1746 G When to assess the arrangements............................................. 1747 H Separation of leases from other payments within the

arrangement............................................................................... 1748 I Disclosure requirements ........................................................... 1749 J Effective date and transitional arrangements .......................... 1750

2.2.2 Transactions that are not, in substance, leases............................. 1750 2.3 Lease classification .................................................................................... 1754

2.3.1 Finance and operating leases ......................................................... 1754 2.3.2 Determining the substance of transactions .................................. 1755 2.3.3 Changes to lease provisions ........................................................... 1757 2.3.4 Leases of land and buildings.......................................................... 1758 2.3.5 Leases and investment properties................................................. 1762 2.3.6 Buying and selling long leases of land ........................................... 1762

3 ACCOUNTING FOR FINANCE AND OPERATING LEASES..................................... 1763 3.1 Finance leases – summary of accounting by lessees and lessors ............. 1763

3.1.1 Inception and commencement of the lease.................................. 1764 3.1.2 Fair value......................................................................................... 1765 3.1.3 Minimum lease payments .............................................................. 1765 3.1.4 Lease term and non-cancellable period ........................................ 1766 3.1.5 Interest rate implicit in the lease and incremental borrowing

rate .................................................................................................. 1766 3.1.6 Residual value................................................................................. 1766 3.1.7 Contingent rents ............................................................................ 1767

A Contingent rents and operating leases..................................... 1767 3.1.8 Initial direct costs........................................................................... 1767 3.1.9 Calculation of the implicit interest rate and present value of

minimum lease payments .............................................................. 1767 3.2 Accounting by lessees – finance leases ..................................................... 1768

3.2.1 Initial recognition ........................................................................... 1768 3.2.2 Allocation of finance costs.............................................................. 1769 3.2.3 Recording the liability.................................................................... 1770 3.2.4 Accounting for the leased asset ..................................................... 1771

3.3 Accounting by lessors – finance leases...................................................... 1772 3.3.1 The lessor’s net investment in the lease ...................................... 1772 3.3.2 Allocation of finance income.......................................................... 1773 3.3.3 Residual values ............................................................................... 1774 3.3.4 Disposals by lessors of assets held under finance leases .............. 1774 3.3.5 Manufacturer or dealer lessors....................................................... 1775 3.3.6 Lessor accounting – net investment or net cash investment? ..... 1775

3.4 Operating leases......................................................................................... 1776 3.4.1 Operating leases in the accounts of lessees .................................. 1776

A Leases that include payments for services............................... 1777

Detailed contents – Volume 2  lxv 

B Straight-line recognition over the lease term .......................... 1777 C Notional or actual interest paid to lessors................................ 1777

3.4.2 Lease incentives – accounting by lessees...................................... 1778 3.4.3 Onerous contracts........................................................................... 1780 3.4.4 Operating leases in the accounts of lessors ................................... 1780 3.4.5 Lease incentives – accounting by lessors ...................................... 1781

3.5 Sale and leaseback transactions ................................................................ 1782 3.5.1 Sale and finance leaseback............................................................. 1782 3.5.2 Operating leaseback ....................................................................... 1783

3.6 Leases as financial instruments ................................................................ 1785 3.6.1 Derecognition of lease receivables by lessors................................ 1786 3.6.2 Impairment of lease receivables .................................................... 1787 3.6.3 Derecognition of lease payables..................................................... 1787 3.6.4 Embedded derivatives and contingent rentals ............................. 1787

3.7 Service concessions and similar arrangements ......................................... 1788 3.8 Disclosures required by IAS 17 ................................................................. 1788

3.8.1 Disclosures relating to financial assets and liabilities................... 1788 3.8.2 Disclosure by lessees: finance leases ............................................. 1789 3.8.3 Disclosure by lessees: operating leases ......................................... 1790 3.8.4 Disclosure by lessors: finance leases.............................................. 1793 3.8.5 Disclosure by lessors: operating leases .......................................... 1794

4 PRACTICAL ISSUES ............................................................................................. 1795 4.1 Lease classification .................................................................................... 1795

4.1.1 The residual value of an asset........................................................ 1795 A Residual value guarantees by the lessee .................................. 1796 B Residual value guarantors ......................................................... 1797

4.1.2 Rental rebates................................................................................. 1797 4.2 Modifying the terms of leases ................................................................... 1797

4.2.1 Determining whether there is a different classification............... 1798 4.2.2 Accounting for reclassified leases .................................................. 1801 4.2.3 Accounting for modifications to finance leases............................. 1802 4.2.4 Tax and interest variation clauses and similar modifications....... 1804

4.3 Derecognition of finance leases and termination payments.................... 1805 4.3.1 Finance leases – lessee................................................................... 1805 4.3.2 Finance leases – lessor.................................................................... 1806

4.4 Payments made in connection with the termination of operating leases ..................................................................................................... 1806

4.5 Sub-leases and back-to-back leases........................................................... 1808 4.5.1 Introduction.................................................................................... 1808 4.5.2 The original lessor and the ultimate lessee .................................. 1809 4.5.3 The intermediate party.................................................................. 1809

4.6 Sale and leaseback arrangements including repurchase agreements and options................................................................................................. 1811

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4.6.1 Sale and leaseback arrangements with put and call options ........ 1812 5 EFFECTIVE DATE, TRANSITIONAL PROVISIONS AND FIRST-TIME

ADOPTION........................................................................................................... 1814 5.1 Effective date and transitional provisions ................................................ 1814 5.2 First-time adoption.................................................................................... 1814

6 CONCLUSION ..................................................................................................... 1814

CHAPTER 26 INCOME TAXES

1 INTRODUCTION ................................................................................................. 1819 1.1 The nature of taxation............................................................................... 1819 1.2 Allocation between periods ....................................................................... 1819 1.3 Timing and temporary differences contrasted......................................... 1820

1.3.1 Timing differences ......................................................................... 1820 1.3.2 Temporary differences ................................................................... 1822

A The ‘temporary difference’ approach....................................... 1822 B Conceptual basis of the temporary difference approach ......... 1825

1.4 The flow-through method......................................................................... 1826 1.5 The development of IAS 12 ...................................................................... 1827

2 OBJECTIVE AND SCOPE OF IAS 12 ..................................................................... 1828 2.1 Objective .................................................................................................... 1828 2.2 Scope ..................................................................................................... 1829

2.2.1 What is an ‘income tax’?................................................................. 1829 A Investment tax credits .............................................................. 1830

2.2.2 Interest and penalties .................................................................... 1831 2.3 Discontinued operations – interaction with IFRS 5 ................................ 1832

3 DEFINITIONS ..................................................................................................... 1832 3.1 General definitions .................................................................................... 1832 3.2 Definitions of ‘temporary difference’ and ‘tax base’................................ 1833

3.2.1 Tax base .......................................................................................... 1834 A Tax base of assets ...................................................................... 1834 B Tax base of liabilities ................................................................ 1835 C Tax base of items not recognised as assets or liabilities in

financial statements .................................................................. 1836 D Equity items with a tax base..................................................... 1837 E Items whose tax base is not immediately apparent................. 1837 F Items with more than one tax base .......................................... 1837 G Temporary differences in consolidated financial

statements ................................................................................. 1838 3.3 Examples of temporary differences .......................................................... 1838

3.3.1 Taxable temporary differences ...................................................... 1838

Detailed contents – Volume 2  lxvii 

A Transactions that affect the income statement ...................... 1838 B Transactions that affect the balance sheet .............................. 1838 C Revaluations .............................................................................. 1839 D Business combinations and consolidation ................................ 1839 E Hyperinflation ........................................................................... 1840

3.3.2 Deductible temporary differences................................................. 1840 A Transactions that affect the income statement ...................... 1840 B Fair value adjustments and revaluations .................................. 1841 C Business combinations and consolidation ................................ 1841

3.3.3 Assets and liabilities with no temporary difference (because tax base equals carrying amount)................................................... 1841

4 RECOGNITION OF TAX ASSETS AND LIABILITIES .............................................. 1841 4.1 Current tax................................................................................................. 1841 4.2 Deferred Tax.............................................................................................. 1842

4.2.1 The basic principles ....................................................................... 1842 A Taxable temporary differences (Deferred tax liabilities) ....... 1842 B Deductible temporary differences (Deferred tax assets) ....... 1842

4.2.2 The ‘initial recognition exemption’............................................... 1842 A Initial recognition of goodwill................................................... 1843 B Initial recognition of assets and liabilities................................ 1844 C Practical problems arising from the exemption ....................... 1846 D Possible future developments .................................................. 1849

4.2.3 Restrictions on recognition of deferred tax assets ........................ 1849 A Future deductible temporary differences ignored .................. 1850 B Tax planning opportunities ...................................................... 1850 C Unused tax losses and unused tax credits................................ 1851 D Re-assessment of deferred tax assets ....................................... 1852

4.2.4 Assets carried at fair value.............................................................. 1853 A Revaluations of non-deductible assets ..................................... 1853

4.2.5 Initial recognition of compound financial instruments ................ 1854 4.2.6 Subsidiaries, branches, associates and joint ventures................... 1855

A Taxable temporary differences ................................................. 1857 B Deductible temporary differences ........................................... 1859 C Measurement and presentation................................................ 1860 D Anticipated intragroup dividends in future periods ................ 1861 E Temporary differences arising from differences between

functional currency and tax currency ....................................... 1861 F Unpaid intragroup interest, royalties, management

charges etc. ................................................................................ 1861 G Other overseas income taxed only on remittance.................... 1862

4.2.7 Partially deductible and ‘super-deductible’ assets ....................... 1862 4.2.8 Uncertain tax positions .................................................................. 1866 4.2.9 Consolidated tax returns and group relief for losses..................... 1866 4.2.10 Deferred taxable gains ................................................................... 1867

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5 MEASUREMENT.................................................................................................. 1868 5.1 Legislation at the balance sheet date ....................................................... 1868 5.2 Income taxed at non-standard tax rates ................................................... 1868 5.3 Expected manner of recovery of assets or settlement of liabilities......... 1869

5.3.1 Determining the expected manner of recovery of assets ............. 1871 A Change in intended manner of recovery of an asset or

settlement of a liability ............................................................. 1873 B Possible future developments .................................................. 1873

5.3.2 Non-depreciable assets .................................................................. 1873 A Revalued assets (SIC-21) ......................................................... 1873 B Investment properties accounted for at fair value................... 1873 C Non-amortised intangible assets .............................................. 1874

5.3.3 ‘Single asset’ entities...................................................................... 1874 5.3.4 Different tax rates applicable to retained and distributed

profits .............................................................................................. 1875 5.4 Discounting................................................................................................ 1876 5.5 Unrealised intragroup profits and losses in consolidated financial

statements.................................................................................................. 1876 5.5.1 Intragroup transfers of goodwill and intangible assets ................. 1877

5.6 Tax-planning strategies ............................................................................. 1879 6 ALLOCATION OF TAX CHARGE OR CREDIT........................................................ 1879

6.1 Items credited or charged directly to equity............................................ 1880 6.1.1 SORIE or SOCE?............................................................................ 1880 6.1.2 Revalued assets............................................................................... 1881 6.1.3 Retrospective restatements or applications .................................. 1882 6.1.4 Dividends........................................................................................ 1882

A Incoming dividends................................................................... 1883 6.1.5 ‘Recycled’ gains and losses............................................................. 1883 6.1.6 Gain/loss in income statement and loss/gain in equity offset

for tax purposes............................................................................... 1884 6.1.7 Tax relief for defined benefit pension plans where actuarial

gains and losses are recognised in equity ...................................... 1886 6.2 Business combinations............................................................................... 1887

A Apparent immediate impairment of goodwill created by deferred tax................................................................................ 1888

6.2.1 First-time adoption of IFRS .......................................................... 1888 6.2.2 Deferred tax assets ......................................................................... 1889

A Assets of the acquirer ................................................................ 1889 B Assets of the acquiree ............................................................... 1889 C Treatment of ‘grandfathered’ business combinations............. 1890 D Possible future developments .................................................. 1891

6.2.3 Deferred tax liabilities of acquired entities .................................. 1891 6.2.4 Tax relief for acquisition costs....................................................... 1892

6.3 Share-based payment transactions............................................................ 1892

Detailed contents – Volume 2  lxix 

6.3.1 Allocation of tax relief between the income statement and equity .............................................................................................. 1893

6.3.2 Allocation when more than one award is outstanding .................. 1895 6.3.3 Staggered exercise of awards.......................................................... 1896 6.3.4 Share-based payment transactions subject to transitional

provisions of IFRS 1 and IFRS 2.................................................... 1899 6.4 Change in tax status of entity or shareholders ......................................... 1900 6.5 Previous revaluation of PPE treated as deemed cost on transition......... 1900

7 PRESENTATION .................................................................................................. 1901 7.1 Balance sheet ............................................................................................. 1901

7.1.1 Offset .............................................................................................. 1901 A Current Tax ............................................................................... 1901 B Deferred Tax ............................................................................. 1902

7.2 Income statement...................................................................................... 1903 8 DISCLOSURE....................................................................................................... 1903

8.1 Components of tax expense ...................................................................... 1903 8.2 Other disclosures ....................................................................................... 1903

8.2.1 Tax (or tax rate) reconciliation...................................................... 1905 8.2.2 Temporary differences relating to subsidiaries, associates,

branches and joint ventures ........................................................... 1906 8.3 Reason for recognition of certain tax assets ............................................. 1906 8.4 Dividends ................................................................................................... 1907 8.5 Example of disclosures .............................................................................. 1908

9 TRANSITIONAL ARRANGEMENTS AND FIRST-TIME ADOPTION ISSUES ........... 1911 10 SHORT-TERM CONVERGENCE PROJECT............................................................ 1912

10.1 Definition of temporary difference........................................................... 1912 10.2 Exceptions to the temporary difference approach................................... 1913

10.2.1 ‘Initial recognition exemption’ ...................................................... 1913 10.2.2 Investments in subsidiaries, branches and associates and

interests in joint ventures .............................................................. 1915 10.2.3 Intragroup transactions .................................................................. 1915 10.2.4 Foreign non-monetary assets and liabilities.................................. 1915

10.3 Measurement ............................................................................................. 1916 10.4 Deferred tax assets .................................................................................... 1916 10.5 Allocation of tax charges and credits to equity......................................... 1916 10.6 Balance sheet classification of assets and liabilities................................. 1916 10.7 Uncertain tax positions.............................................................................. 1916

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CHAPTER 27 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

1 INTRODUCTION ................................................................................................. 1919 1.1 Background................................................................................................. 1919 1.2 Development of IFRS ............................................................................... 1921

1.2.1 IAS 10.............................................................................................. 1921 1.2.2 IAS 37.............................................................................................. 1921 1.2.3 IFRIC Interpretations.................................................................... 1922

A IFRIC 1...................................................................................... 1922 B IFRIC 3...................................................................................... 1922 C IFRIC 5...................................................................................... 1922 D IFRIC 6...................................................................................... 1922

1.2.4 Future developments ..................................................................... 1923 2 OBJECTIVE AND SCOPE OF IAS 37 ..................................................................... 1924

2.1 Objective .................................................................................................... 1924 2.2 Scope ..................................................................................................... 1924

2.2.1 Exemptions..................................................................................... 1924 A Executory contracts, except where the contract is onerous.... 1924 B Provisions, contingent liabilities or contingent assets

covered by another standard..................................................... 1924 2.2.2 Provisions and other liabilities....................................................... 1925 2.2.3 Provisions and contingent liabilities.............................................. 1927

3 RECOGNITION.................................................................................................... 1928 3.1 Provisions ................................................................................................... 1928

3.1.1 ‘An entity has a present obligation (legal or constructive) as a result of a past event’ ..................................................................... 1928

3.1.2 ‘It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation’........ 1930

3.1.3 ‘A reliable estimate can be made of the amount of the obligation’ ....................................................................................... 1930

3.2 Contingencies ............................................................................................ 1930 3.2.1 Contingent liabilities ..................................................................... 1931 3.2.2 Contingent assets ........................................................................... 1933 3.2.3 Summary ......................................................................................... 1934

3.3 Recognising an asset when recognising a provision ................................. 1934 4 MEASUREMENT.................................................................................................. 1935

4.1 Best estimate of provision ......................................................................... 1935 4.2 Discounting to present value .................................................................... 1937

4.2.1 Real v. nominal rate........................................................................ 1937 4.2.2 Adjusting for risk ............................................................................ 1938 4.2.3 Pre-tax discount rate ...................................................................... 1939

Detailed contents – Volume 2  lxxi 

4.2.4 Unwinding of the discount ............................................................ 1939 4.2.5 Change in interest rates ................................................................. 1942

4.3 Future events............................................................................................. 1942 4.4 Recoveries from third parties .................................................................... 1943 4.5 Gains on disposals of related assets .......................................................... 1944 4.6 Changes and uses of provisions ................................................................. 1944

5 APPLICATION OF THE RECOGNITION AND MEASUREMENT RULES ................. 1945 5.1 Restructuring provisions............................................................................ 1945

5.1.1 Definition........................................................................................ 1945 5.1.2 Recognition..................................................................................... 1946 5.1.3 Costs that can be recognised within a restructuring provision .... 1949

5.2 Operating losses......................................................................................... 1950 5.3 Onerous contracts ...................................................................................... 1951 5.4 Other types of provisions .......................................................................... 1956

5.4.1 Environmental provisions............................................................... 1956 5.4.2 Decommissioning provisions.......................................................... 1960

A IFRIC 1...................................................................................... 1964 B IFRIC 5...................................................................................... 1965

5.4.3 Emission rights and green certificates........................................... 1969 A Emission rights .......................................................................... 1969 B Green certificates ...................................................................... 1971

5.4.4 EU Directive on ‘Waste Electrical and Electronic Equipment’ ..................................................................................... 1972 A IFRIC 6...................................................................................... 1972

5.4.5 Repairs and maintenance ............................................................... 1974 5.4.6 Dilapidation and other provisions relating to leased assets ......... 1975 5.4.7 Warranty provisions ........................................................................ 1977 5.4.8 Litigation and other legal claims ................................................... 1978 5.4.9 Refunds policy ................................................................................ 1979 5.4.10 Staff training costs.......................................................................... 1979 5.4.11 Self insurance.................................................................................. 1980 5.4.12 Regulatory liabilities....................................................................... 1980

6 DISCLOSURE REQUIREMENTS ........................................................................... 1982 6.1 Provisions ................................................................................................... 1982 6.2 Contingent liabilities................................................................................. 1985 6.3 Contingent assets ...................................................................................... 1986 6.4 Exemption from disclosure when seriously prejudicial ........................... 1986

7 TRANSITIONAL ARRANGEMENTS AND FIRST-TIME ADOPTION ISSUES ........... 1986 7.1 Transitional arrangements for entities already reporting under IFRS.... 1986 7.2 First-time adoption issues......................................................................... 1987

8 FUTURE DEVELOPMENTS .................................................................................. 1988

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8.1 Overview of the proposals to amend IAS 37 and IAS 19 ......................... 1989 8.1.1 Scope and terminology ................................................................... 1989 8.1.2 Contingent liabilities ..................................................................... 1990 8.1.3 Recognition..................................................................................... 1990

A Redeliberations following round-table discussions.................. 1991 8.1.4 Measurement.................................................................................. 1992 8.1.5 Constructive obligations ................................................................ 1993 8.1.6 Onerous contracts........................................................................... 1993 8.1.7 Restructuring provisions ................................................................ 1994 8.1.8 Contingent assets ........................................................................... 1994 8.1.9 Reimbursements............................................................................. 1994 8.1.10 Proposed changes to IAS 19........................................................... 1995

8.2 Explanation of the principal changes resulting from the proposals ........ 1995 8.2.1 ‘Stand ready’ obligations ................................................................ 1995

A Redeliberations following round-table discussions.................. 1997 8.2.2 Constructive obligations ................................................................ 1999

A Redeliberations following round-table discussions.................. 2000 8.2.3 Contingent assets ........................................................................... 2001 8.2.4 Liabilities for restructuring costs................................................... 2001 8.2.5 Effective date and transition ......................................................... 2002

8.3 Ernst & Young’s concerns about the proposals ........................................ 2002 8.3.1 Recognition criteria for non-financial liabilities............................ 2002 8.3.2 Conditional versus unconditional non-financial liabilities ........... 2003 8.3.3 Reliability of measurement............................................................ 2004

9 CONCLUSION ..................................................................................................... 2004

CHAPTER 28 REVENUE RECOGNITION

1 THE NATURE OF REVENUE ................................................................................ 2009 2 THE TIMING OF REVENUE RECOGNITION ........................................................ 2012

2.1 The critical event approach....................................................................... 2013 2.1.1 The recognition of revenue at the completion of production...... 2013 2.1.2 The recognition of revenue at the time of sale............................. 2014 2.1.3 The recognition of revenue subsequent to delivery..................... 2015

2.2 The accretion approach ............................................................................. 2017 2.2.1 The use by others of entity resources ........................................... 2017 2.2.2 Long-term contracts....................................................................... 2017 2.2.3 The rendering of services............................................................... 2017 2.2.4 Natural growth and ‘biological transformation’............................. 2017

2.3 The revenue allocation approach .............................................................. 2019 3 THE REQUIREMENTS OF IAS 18........................................................................ 2020

3.1 Scope ..................................................................................................... 2020

Detailed contents – Volume 2  lxxiii 

3.2 The distinction between income, revenue and gains .............................. 2021 3.3 The link between the Framework and IAS 18 .......................................... 2024 3.4 Income and distributable profits .............................................................. 2024 3.5 Measurement of revenue........................................................................... 2024 3.6 Identification of the transaction ............................................................... 2025 3.7 The sale of goods ....................................................................................... 2027 3.8 The rendering of services .......................................................................... 2031 3.9 Exchanges of goods and services............................................................... 2033 3.10 Exchanges of property plant and equipment ........................................... 2034 3.11 Barter transactions involving advertising services.................................... 2035 3.12 Interest, royalties and dividends............................................................... 2036 3.13 Uncollectible revenue ............................................................................... 2037 3.14 Disclosure................................................................................................... 2038 3.15 What should be shown in the income statement within revenue? ......... 2038

3.15.1 The disclosure of share of the profit or loss of associates and joint ventures accounted for using the equity method ................ 2039

3.15.2 Interest and other finance income ................................................ 2040 3.15.3 Gains on disposal of property, plant and equipment.................... 2045 3.15.4 Example of income statement presentation of revenue............... 2045

4 REVENUE RECOGNITION UNDER US GAAP...................................................... 2046 4.1 Applicability of US literature .................................................................... 2046 4.2 The general approach to revenue recognition under US GAAP.............. 2046 4.3 US literature .............................................................................................. 2047

5 THE IASB/FASB JOINT REVENUE RECOGNITION PROJECT............................... 2048 5.1 Project background .................................................................................... 2048 5.2 Overview of the revenue recognition model being developed jointly

by the FASB and IASB............................................................................... 2049 5.3 The way forward ........................................................................................ 2050

6 SUMMARY OF BROAD APPROACHES TO REVENUE RECOGNITION ..................... 2051 7 PRACTICAL ISSUES ............................................................................................. 2053

7.1 ‘Bill and hold’ sales .................................................................................... 2053 7.2 Goods shipped subject to conditions........................................................ 2053 7.3 Layaway sales ............................................................................................. 2054 7.4 Payments in advance ................................................................................. 2054 7.5 Sale and repurchase agreements ............................................................... 2056 7.6 Instalment sales ......................................................................................... 2056 7.7 Receipt of initial fees................................................................................. 2056

7.7.1 Franchise fees ................................................................................. 2057 A Supplies of equipment and other tangible assets.................... 2058

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B Supplies of initial and subsequent services ............................. 2058 C Continuing Franchise Fees....................................................... 2058 D Agency Transactions ................................................................. 2059 E Summary .................................................................................... 2059

7.7.2 Advance royalty/licence receipts.................................................... 2059 7.7.3 Financial service fees...................................................................... 2061

A Fees that are an integral part of the effective interest rate of a financial instrument ........................................................... 2061

B Fees earned as services are provided........................................ 2062 C Fees that are earned on the execution of a significant act...... 2063

7.7.4 Initial fees received by a fund manager......................................... 2065 7.7.5 Credit card fees .............................................................................. 2067 7.7.6 Entrance and membership fees ..................................................... 2067

7.8 Subscriptions to publications .................................................................... 2068 7.9 Installation fees.......................................................................................... 2068 7.10 Advertising revenue ................................................................................... 2069 7.11 Insurance agency commissions.................................................................. 2069 7.12 Software revenue recognition.................................................................... 2069

7.12.1 The basic principles of SOP 97–2 ................................................. 2070 7.12.2 Accounting for arrangements which require significant

production, modification or customisation of software ................ 2071 7.12.3 Accounting for software arrangements with multiple

elements.......................................................................................... 2073 7.12.4 Determining fair value based on vendor-specific objective

evidence .......................................................................................... 2074 7.12.5 Upgrades, enhancements and post-contract customer

support (PCS) ................................................................................ 2075 7.12.6 Evaluation of whether a fee is fixed or determinable and

arrangements that include extended payment terms................... 2076 7.12.7 Rights to return or exchange software........................................... 2076 7.12.8 Services ........................................................................................... 2077

7.13 Revenue recognition issues in the telecommunications sector............... 2077 7.13.1 Recording revenue for multiple service elements ........................ 2078 7.13.2 Whether to record revenue gross or net ........................................ 2078 7.13.3 Connection and up-front fees........................................................ 2079 7.13.4 Multiple deliverables (‘bundled offers’) ....................................... 2081

A Handsets .................................................................................... 2082 B ‘Free’ services ............................................................................ 2084

7.13.5 The distribution channel ............................................................... 2085 7.13.6 Other ‘gross versus net’ issues ....................................................... 2086

A Third party content providers .................................................. 2086 B Number portability ................................................................... 2088

7.13.7 Accounting for roll-over minutes ................................................... 2089 7.13.8 Accounting for the sale of pre-paid calling cards by

telecommunications operators ....................................................... 2090

Detailed contents – Volume 2  lxxv 

7.13.9 Illustration of comprehensive revenue recognition accounting policy disclosures of a telecommunications operator ........................................................................................... 2091

7.14 Excise taxes and goods and services taxes: Recognition of gross versus net revenues ................................................................................... 2093

7.15 Sales incentives.......................................................................................... 2096 7.16 Film exhibition and television broadcast rights ....................................... 2098 7.17 The disposal of property, plant and equipment....................................... 2099

7.17.1 The general principle ..................................................................... 2099 7.17.2 Sale of assets held for rental .......................................................... 2101 7.17.3 Pre-completion contracts ............................................................... 2102

7.18 Regulatory liabilities .................................................................................. 2105 7.19 Customer loyalty programmes................................................................... 2106

7.19.1 Development of IFRIC 13............................................................. 2106 7.19.2 The scope of IFRIC 13 .................................................................. 2110 7.19.3 The requirements of IFRIC 13 ..................................................... 2110 7.19.4 Measuring the fair value of award credits ..................................... 2114 7.19.5 Effective date and transition ......................................................... 2115

7.20 Sale and leaseback transactions ................................................................ 2115 8 CONCLUSION ..................................................................................................... 2115

CHAPTER 29 TRANSACTIONS WITH GOVERNMENTS: GRANTS AND SERVICE CONCESSION ARRANGEMENTS

1 INTRODUCTION ................................................................................................. 2121 2 GOVERNMENT GRANTS...................................................................................... 2122

2.1 Requirements of IAS 20 ............................................................................ 2122 2.1.1 Nature of government grants and government assistance ........... 2123

A Government assistance ............................................................. 2123 B Government grants.................................................................... 2123

2.2 Scope ..................................................................................................... 2124 2.3 Accounting for government grants............................................................ 2125

2.3.1 Recognition..................................................................................... 2125 2.3.2 Matching grants against related costs ........................................... 2126

A Income approach and capital approach .................................... 2126 B Application of the income approach......................................... 2126

2.4 Presentation of grants................................................................................ 2128 2.4.1 Presentation of grants related to assets......................................... 2128

A Assets not being depreciated.................................................... 2129 B Cash flows.................................................................................. 2129

2.4.2 Presentation of grants related to income ...................................... 2129 2.5 Repayment of government grants ............................................................. 2130

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2.6 Government assistance.............................................................................. 2130 2.7 Disclosures ................................................................................................. 2131

2.7.1 General............................................................................................ 2131 2.7.2 Government assistance .................................................................. 2131

3 PRACTICAL ISSUES ............................................................................................. 2132 3.1 Achieving the most appropriate matching................................................ 2132

3.1.1 Should the grant be split into its elements? ................................. 2133 3.1.2 What was the purpose of the grant? .............................................. 2133 3.1.3 What is the period to be benefited by the grant? ......................... 2133 3.1.4 Is a grant related to long-term assets or income?.......................... 2133

4 TRANSITION AND FIRST-TIME ADOPTION........................................................ 2134 5 THE FUTURE REVISION OF IAS 20..................................................................... 2134 6 SERVICE CONCESSION ARRANGEMENTS............................................................ 2135

6.1 Introduction ............................................................................................... 2135 6.2 The IFRIC’s proposed approach to accounting for service

concessions................................................................................................. 2137 6.3 Scope of the project................................................................................... 2138

6.3.1 Public-to-private service concession arrangements within scope................................................................................................ 2139

6.3.2 Inter-relationship with other accounting standards ..................... 2141 6.3.3 The control model.......................................................................... 2142

A Regulation of services................................................................ 2142 B Control of the residual interest ................................................ 2143

6.3.4 The ‘control model’ and other IFRSs............................................ 2144 6.3.5 Assets within scope ........................................................................ 2145

A Partially regulated assets........................................................... 2145 6.4 Accounting for the infrastructure asset: choosing between the

financial asset and intangible asset models .............................................. 2146 6.4.1 Consideration for services provided and the choice between

the two models ............................................................................... 2146 6.4.2 The financial asset model .............................................................. 2149 6.4.3 The intangible asset model............................................................ 2152

A Amortisation .............................................................................. 2155 B Impairment................................................................................ 2156

6.4.4 Revenue recognition implications of the two models .................. 2156 6.4.5 ‘Bifurcation’ – single arrangements that contain both

financial and intangible assets ....................................................... 2157 6.5 Expenditure during the operations phase of the concession

agreement................................................................................................... 2157 6.5.1 Additional construction services.................................................... 2158

A Subsequent construction services that are part of the initial infrastructure asset ......................................................... 2158

Detailed contents – Volume 2  lxxvii 

B Subsequent construction services that comprise a new infrastructure asset.................................................................... 2159

6.5.2 Accounting for the operations phase ............................................. 2159 6.6 Items provided to the operator by the grantor......................................... 2163 6.7 Effective date and transitional arrangements .......................................... 2163 6.8 Accounting practice ................................................................................... 2163

7 CURRENT DISCLOSURE REQUIREMENTS: SIC–29............................................ 2169 8 CONCLUSION ..................................................................................................... 2171

CHAPTER 30 SEGMENT REPORTING

1 INTRODUCTION ................................................................................................. 2175 1.1 IAS 14 ..................................................................................................... 2175 1.2 IFRS 8 ..................................................................................................... 2175

2 THE REQUIREMENTS OF IAS 14........................................................................ 2176 2.1 Objective and scope................................................................................... 2176

2.1.1 Objective......................................................................................... 2176 2.1.2 Scope............................................................................................... 2176 2.1.3 First-time adoption ........................................................................ 2177 2.1.4 General approach............................................................................ 2177

2.2 Definitions ................................................................................................. 2177 2.2.1 Definitions from other standards................................................... 2177 2.2.2 Business, geographical and reportable segments .......................... 2178

A Business segment ...................................................................... 2178 B Geographical segment............................................................... 2179 C Determining the composition of a business or

geographical segment................................................................ 2179 D Reportable segment .................................................................. 2180

2.2.3 Segment revenue, expense, result, assets, liabilities and accounting policies ......................................................................... 2180 A Segment revenue....................................................................... 2180 B Segment expense ...................................................................... 2180 C Segment result .......................................................................... 2181 D Segment assets .......................................................................... 2181 E Segment liabilities..................................................................... 2181 F What is meant by ‘directly attributable to a segment’?........... 2182 G Segment accounting policies .................................................... 2182

2.3 Identifying externally reportable segments ............................................. 2182 2.3.1 Primary and secondary segment reporting formats....................... 2184 2.3.2 Combining internally reported operating segments..................... 2184 2.3.3 Reportable segments...................................................................... 2185 2.3.4 Vertically integrated activities ....................................................... 2187

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2.3.5 Unallocated internally reported operating segments ................... 2187 2.3.6 Restatement of segments reported in comparative periods......... 2188

2.4 Measurement ............................................................................................. 2189 2.4.1 Segment accounting policies ......................................................... 2189 2.4.2 Consolidation adjustments and inter-segment revenue............... 2191 2.4.3 Shared assets................................................................................... 2192

2.5 Information to be disclosed about reportable segments.......................... 2192 2.5.1 Primary segment information ........................................................ 2192

A Mandatory primary segment disclosures.................................. 2192 B Equity accounted investments ................................................. 2195 C Reconciliation to the financial statements .............................. 2197 D Voluntary primary segment disclosures.................................... 2198

2.5.2 Secondary segment information .................................................... 2200 A Where the primary format is business segments ..................... 2200 B Where the primary format is geographical segments............... 2202

2.5.3 Other disclosure matters................................................................ 2204 3 PROBLEM AREAS ................................................................................................. 2205

3.1 Disclosure of commercially sensitive information ................................... 2205 3.2 Identifying the primary segment format .................................................. 2205

3.2.1 Equal emphasis and the matrix presentation................................ 2206 3.2.2 Neither business nor geographical segments are reported

internally ......................................................................................... 2206 3.2.3 Only business or geographical segments are reported

internally ......................................................................................... 2207 3.3 Identifying reportable segments when information is not provided

to top management.................................................................................... 2207 3.3.1 Looking beyond the information reported to top

management ................................................................................... 2207 3.3.2 Identifying externally reportable segments .................................. 2209

3.4 Measuring the segment assets and liabilities of a subsidiary .................. 2209 4 IFRS 8 – OPERATING SEGMENTS ...................................................................... 2210

4.1 The main features of IFRS 8 compared to IAS 14................................... 2211 4.1.1 Identification of segments ............................................................. 2211 4.1.2 Measurement of segment information .......................................... 2211 4.1.3 Disclosure ....................................................................................... 2212

4.2 Objective and scope................................................................................... 2212 4.2.1 Objective......................................................................................... 2212 4.2.2 Scope............................................................................................... 2213 4.2.3 First-time adoption ........................................................................ 2214

4.3 Definitions ................................................................................................. 2214 4.3.1 Operating segments ....................................................................... 2214

A Identifying a single set of operating segments ........................ 2214 B ‘Chief operating decision maker’ and ‘segment manager’....... 2215

Detailed contents – Volume 2  lxxix 

4.3.2 Segment revenue, expense, result, assets and liabilities.............. 2215 4.4 Identifying externally reportable segments ............................................. 2216

4.4.1 Combining internally reported operating segments..................... 2217 4.4.2 Operating segments which are reportable because of their

size................................................................................................... 2217 4.4.3 Combining two or more small operating segments....................... 2218 4.4.4 Unallocated internally reported operating segments ................... 2218 4.4.5 A ‘practical limit’ for the number of reported operating

segments ......................................................................................... 2218 4.4.6 Restatement of segments reported in comparative periods......... 2218

4.5 Measurement ............................................................................................. 2219 4.6 Information to be disclosed about reportable segments.......................... 2219

4.6.1 General information about reportable segments .......................... 2220 4.6.2 Information about profit or loss and assets and liabilities ............ 2221 4.6.3 Explanation of the measurements used in segment reporting .... 2222 4.6.4 Reconciliations................................................................................ 2223 4.6.5 Restatement of previously reported information.......................... 2225

4.7 Entity-wide disclosures ............................................................................. 2225 4.7.1 Information about products and services ...................................... 2226 4.7.2 Information about geographical areas............................................ 2226 4.7.3 Information about major customers............................................... 2227

A Customers known to be under common control...................... 2227 5 CONCLUSION ..................................................................................................... 2229

CHAPTER 31 SHARE-BASED PAYMENT

1 INTRODUCTION ................................................................................................. 2235 1.1 Background................................................................................................. 2235 1.2 Development of IFRS 2 ............................................................................ 2236

2 THE OBJECTIVE AND SCOPE OF IFRS 2 .............................................................. 2237 2.1 Objective .................................................................................................... 2237 2.2 Scope ..................................................................................................... 2238

2.2.1 Definitions ...................................................................................... 2238 2.2.2 Transactions within the scope of IFRS 2...................................... 2238

A Transactions by shareholders and other group entities........... 2239 B Transactions with employee benefit trusts and similar

vehicles ...................................................................................... 2240 C Transactions where identifiable consideration received

appears less than consideration given (IFRIC 8) .................... 2240 2.2.3 Transactions not within the scope of IFRS 2 ............................... 2241

A Transactions that are clearly not payments for goods and services....................................................................................... 2242

B Transactions with shareholders as a whole .............................. 2242

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C Business combinations .............................................................. 2242 D Transactions in the scope of IAS 32 and IAS 39...................... 2243 E Transactions in financial assets not in the scope of IAS 32

and IAS 39.................................................................................. 2243 F ‘All employee’ share plans......................................................... 2243

2.2.4 Some practical applications of the scope requirements ............... 2244 A Remuneration in non-equity shares ......................................... 2244 B Employment taxes relating to share-based payment

transactions................................................................................ 2244 C Cash bonus dependent on share price performance................ 2246 D Cash-settled share-based payment transactions settled by

shareholder ................................................................................ 2246 2.3 Overall approach of IFRS 2 ....................................................................... 2248

2.3.1 Classification differences between IFRS 2 and IAS 32/IAS 39.... 2248 3 GENERAL RECOGNITION PRINCIPLES............................................................... 2249

3.1 ‘Vest’ and related terms............................................................................. 2250 3.1.1 Vesting conditions .......................................................................... 2250

A Conditions which are neither service conditions nor performance conditions............................................................. 2250

3.1.2 Vesting period................................................................................. 2252 4 EQUITY-SETTLED TRANSACTIONS.................................................................... 2253

4.1 Cost of awards – overview ......................................................................... 2254 4.1.1 The credit entry ............................................................................. 2256

A Awards made by partly-owned subsidiaries.............................. 2256 4.2 Transactions with employees.................................................................... 2256

4.2.1 Who is an ‘employee’? .................................................................... 2257 4.2.2 Basis of measurement..................................................................... 2257

A Grant date.................................................................................. 2257 4.3 Transactions with non-employees ............................................................ 2258 4.4 Determining the fair value of equity instruments ................................... 2258 4.5 Transactions in which services are received – allocation of expense...... 2259 4.6 Vesting conditions other than market conditions .................................... 2260

4.6.1 Summary of accounting treatment ................................................ 2260 4.6.2 Equity instruments vesting in instalments (‘graded’ vesting)..... 2262 4.6.3 Transactions with variable vesting periods ................................... 2263 4.6.4 Transactions with variable number of equity instruments

awarded ........................................................................................... 2265 4.6.5 Transactions with variable exercise price ..................................... 2266

4.7 Market conditions...................................................................................... 2267 4.7.1 What is a ‘market condition’?......................................................... 2267 4.7.2 Summary of accounting treatment ................................................ 2268 4.7.3 Transactions with market conditions and known vesting

periods............................................................................................. 2271

Detailed contents – Volume 2  lxxxi 

4.7.4 Transactions with variable vesting periods due to market conditions........................................................................................ 2272

4.7.5 Transactions with independent market and non-market conditions........................................................................................ 2273

4.7.6 Transactions with hybrid market and non-market conditions..... 2275 4.8 Reload features .......................................................................................... 2275 4.9 Accounting after vesting............................................................................ 2275 4.10 Modification, cancellation and settlement............................................... 2276

4.10.1 Background ..................................................................................... 2276 A Possible future developments .................................................. 2277

4.10.2 Valuation requirements.................................................................. 2278 4.10.3 Modification.................................................................................... 2279

A Modifications that increase the value of an award .................. 2279 B Modifications that decrease the value of an award.................. 2282 C Modifications with altered vesting period ............................... 2283

4.10.4 Cancellation and settlement.......................................................... 2284 A Distinction between cancellation and forfeiture..................... 2285 B Distinction between cancellation and modification................ 2286 C The required accounting treatment......................................... 2286 D Replacement options ................................................................ 2287 E Share splits and consolidations ................................................. 2291

5 DETERMINING THE FAIR VALUE OF EQUITY INSTRUMENTS............................ 2292 5.1 Introduction ............................................................................................... 2292 5.2 Options ..................................................................................................... 2293

5.2.1 Call options – overview .................................................................. 2293 5.2.2 Call options – valuation.................................................................. 2293 5.2.3 Factors specific to employee share options................................... 2295

A Non-transferability .................................................................... 2296 B Continued employment requirement ...................................... 2296 C Vesting conditions ..................................................................... 2296 D Periods during which exercise is restricted ............................. 2296 E Limited ability to hedge option values .................................... 2296 F Dilution effects ......................................................................... 2297

5.3 Selection of an option-pricing model........................................................ 2297 5.3.1 The Black-Scholes-Merton formula .............................................. 2298 5.3.2 The binomial model ....................................................................... 2300 5.3.3 Monte Carlo Simulation................................................................. 2304 5.3.4 Adapting option-pricing models for share-based payment

transactions ..................................................................................... 2306 A Non-transferability .................................................................... 2306 B Treatment of vesting conditions .............................................. 2306

5.3.5 Selecting appropriate assumptions for option-pricing models..... 2307 A Expected term of the option .................................................... 2308 B Exercise and termination behaviour......................................... 2311

lxxxii  International GAAP 

C Expected volatility of share price ............................................. 2313 D Expected dividends................................................................... 2316 E Risk-free interest rate ............................................................... 2317

5.3.6 Capital structure effects and dilution ........................................... 2318 5.4 Other awards requiring the use of option valuation models.................... 2319

5.4.1 Shares .............................................................................................. 2319 5.4.2 Non-recourse loans......................................................................... 2320 5.4.3 Share appreciation rights (SARs)................................................... 2320 5.4.4 Performance rights ......................................................................... 2320

5.5 Awards whose fair value cannot be measured reliably ............................. 2320 5.5.1 Intrinsic value method – the basic accounting treatment............ 2320 5.5.2 Modification, cancellation and settlement ................................... 2322

5.6 Awards with reload features ...................................................................... 2323 6 CASH-SETTLED TRANSACTIONS........................................................................ 2323

6.1 Scope of requirements............................................................................... 2323 6.2 Required accounting.................................................................................. 2324

6.2.1 Basic accounting treatment ........................................................... 2324 6.2.2 Application of the accounting treatment ...................................... 2325

A Determining the vesting period ............................................... 2326 B Periodic allocation of cost ......................................................... 2326 C Vesting conditions ..................................................................... 2326 D Market conditions ..................................................................... 2327 E Modification, cancellation and settlement .............................. 2327

6.3 What constitutes a cash-settled award?.................................................... 2327 6.3.1 Market purchases of own equity used to satisfy awards............... 2328 6.3.2 Market purchases of own equity following equity-settlement

of award ........................................................................................... 2329 6.3.3 Broker settlement........................................................................... 2330 6.3.4 Sale of shares to meet tax liabilities .............................................. 2331

A Liabilities of the employee ....................................................... 2331 B Employment tax liabilities of the employer............................. 2331

7 TRANSACTIONS WITH CASH ALTERNATIVES..................................................... 2331 7.1 Transactions where the counterparty has choice of settlement ............. 2332

7.1.1 Transactions in which the fair value is measured directly ........... 2332 7.1.2 Other transactions .......................................................................... 2332 7.1.3 Accounting treatment .................................................................... 2333

A During vesting period ............................................................... 2333 B Settlement................................................................................. 2335

7.1.4 Transactions with cash-settlement alternative for employee introduced after grant date ............................................................ 2335

7.1.5 ‘Backstop’ cash settlement rights.................................................. 2337 7.1.6 Convertible bonds issued to acquire goods or services................. 2337

7.2 Transactions where the entity has choice of settlement......................... 2337

Detailed contents – Volume 2  lxxxiii 

7.2.1 Transactions treated as cash-settled ............................................. 2338 A Economic compulsion for cash settlement .............................. 2338

7.2.2 Transactions treated as equity-settled.......................................... 2339 7.2.3 Change in classification of award after grant date ........................ 2340

7.3 Awards requiring cash settlement in specific circumstances .................. 2340 7.3.1 Analysis 1 – Treat as cash-settled if contingency is outside

entity’s control................................................................................ 2340 7.3.2 Analysis 2 – Treat as cash-settled if contingency is outside

entity’s control and probable ......................................................... 2341 7.3.3 Awards requiring cash settlement on a change of control ............ 2342

7.4 Cash settlement alternative not based on share price............................. 2343 8 DISCLOSURES..................................................................................................... 2343

8.1 Nature and extent of share-based payment arrangements...................... 2343 8.2 Valuation of share-based payment arrangements..................................... 2344 8.3 Impact of share-based transactions on financial statements ................... 2345 8.4 Example of IFRS 2 disclosures.................................................................. 2346

9 TAX DEDUCTIONS.............................................................................................. 2350 10 OTHER PRACTICAL ISSUES................................................................................. 2351

10.1 Replacement options issued in a business combination or acquisition of a minority interest .............................................................. 2351 10.1.1 Business combination..................................................................... 2351

A Financial statements of the acquired entity ............................ 2353 10.1.2 Acquisition of minority interest..................................................... 2353 10.1.3 Possible future developments........................................................ 2355

A Replacement awards which the acquiror is obliged to make........................................................................................... 2355

B Replacement awards which the acquiror is not obliged to make........................................................................................... 2357

10.2 Determination of grant date ..................................................................... 2357 10.2.1 Communication of awards to employees....................................... 2357 10.2.2 Exercise price dependent on share price ...................................... 2358 10.2.3 Exercise price paid in shares.......................................................... 2359 10.2.4 Awards subject to modification by entity after original grant

date.................................................................................................. 2359 A Significant equity restructuring or transactions ...................... 2359 B Interpretation of general terms ................................................ 2360 C ‘Good leaver’ clauses ................................................................. 2360 D Discretion to make further awards ........................................... 2361

10.3 Matching share awards .............................................................................. 2361 10.4 Limited recourse loans .............................................................................. 2367 10.5 Employee benefit trusts (‘EBTs’) and similar entities ........................... 2368

10.5.1 Background ..................................................................................... 2368

lxxxiv  International GAAP 

10.5.2 Accounting for EBTs ...................................................................... 2370 10.5.3 Illustrative examples ...................................................................... 2371 10.5.4 Separate financial statements........................................................ 2373

10.6 Awards entitled to dividend during the vesting period ........................... 2375 10.7 Awards exercisable on flotation (or change of control, trade sale

etc.) ..................................................................................................... 2377 10.7.1 Grant date ....................................................................................... 2378 10.7.2 Vesting period................................................................................. 2378 10.7.3 Awards requiring achievement of a minimum price ..................... 2378 10.7.4 Awards ‘purchased for fair value’ ................................................... 2379

10.8 Awards with a foreign currency strike price ............................................. 2380 10.9 ‘Hedging’ share-based payment transactions........................................... 2381

11 GROUP SHARE SCHEMES .................................................................................... 2381 11.1 Typical features of a group share scheme................................................. 2381 11.2 Accounting treatment – issues.................................................................. 2382

11.2.1 IFRIC 11 – Group and Treasury Share Transactions................... 2382 A Grant by subsidiary of award settled in equity of the

parent ......................................................................................... 2383 B Transactions not covered by IFRIC 11 .................................... 2384

11.3 Awards satisfied by market purchase of shares ........................................ 2386 11.3.1 Consolidated financial statements ................................................ 2386 11.3.2 Parent.............................................................................................. 2387

A EBT treated as separate entity................................................. 2387 B EBT treated as extension of the parent................................... 2388 C Parent company as employing company................................... 2388

11.3.3 Employing subsidiary ..................................................................... 2389 11.4 Awards satisfied by fresh issue of shares................................................... 2390

11.4.1 Consolidated financial statements ................................................ 2390 11.4.2 Parent.............................................................................................. 2391

A EBT treated as separate entity................................................. 2391 B EBT treated as extension of parent ......................................... 2392 C Parent as employer .................................................................... 2392

11.4.3 Employing subsidiary ..................................................................... 2394 11.5 Employee transferring between group entities........................................ 2394

12 TRANSITIONAL AND FIRST-TIME ADOPTION ISSUES........................................ 2395 12.1 Accounting requirements .......................................................................... 2395

12.1.1 Equity-settled transactions............................................................ 2395 A Existing IFRS reporters (i.e. entities not applying

IFRS 1) ...................................................................................... 2395 B Equity-settled transactions – first-time adopters of IFRS...... 2397

12.1.2 Cash-settled transactions............................................................... 2398 A Existing IFRS users................................................................... 2398

Detailed contents – Volume 2  lxxxv 

B First-time adopters.................................................................... 2398 12.1.3 Transactions where the counterparty has a choice of

settlement method – all preparers ................................................ 2399 12.2 Disclosure................................................................................................... 2399

CHAPTER 32 EMPLOYEE BENEFITS

1 INTRODUCTION ................................................................................................. 2403 2 OBJECTIVE AND SCOPE OF IAS 19 ..................................................................... 2405

2.1 Objective .................................................................................................... 2405 2.2 Scope ..................................................................................................... 2405

3 PENSIONS AND OTHER POST-EMPLOYMENT BENEFITS – DEFINED CONTRIBUTION AND DEFINED BENEFIT PLANS ............................................... 2408 3.1 The distinction between defined contribution plans and defined

benefit plans .............................................................................................. 2408 3.2 Insured benefits......................................................................................... 2409 3.3 Multi-employer plans ................................................................................ 2411

3.3.1 Multi-employer plans other than those sharing risks between entities under common control...................................................... 2411 A The treatment of multi-employer plans .................................. 2411 B What to do when ‘sufficient information’ becomes

available ..................................................................................... 2413 3.3.2 Multi-employer plans sharing risks between entities under

common control .............................................................................. 2413 A Periods beginning before 1 January 2006................................. 2414 B Periods beginning on or after 1 January 2006 .......................... 2414

3.4 State plans.................................................................................................. 2416 3.5 Plans that would be defined contribution plans but for the

existence of a minimum return guarantee................................................ 2417 3.6 Death-in-service benefits .......................................................................... 2418

4 DEFINED CONTRIBUTION PLANS...................................................................... 2420 4.1 Accounting requirements .......................................................................... 2420

5 DEFINED BENEFIT PLANS.................................................................................. 2421 5.1 General ..................................................................................................... 2421 5.2 Valuation of the plan surplus or deficit..................................................... 2422

5.2.1 Plan assets....................................................................................... 2422 A Definition of plan assets ........................................................... 2422 B Measurement of plan assets...................................................... 2423 C Contributions to defined benefit funds ................................... 2424

5.2.2 Plan liabilities ................................................................................. 2425 A Legal and constructive obligations ........................................... 2425

lxxxvi  International GAAP 

B Actuarial methodology............................................................... 2426 C Attributing benefit to years of service...................................... 2427 D Actuarial assumptions ............................................................... 2430 E Discount rate ............................................................................. 2432 F Frequency of valuations ............................................................ 2435

5.3 Balance sheet treatment of defined benefit plans................................... 2436 5.3.1 Measurement of the plan surplus or deficit.................................. 2436

A Actuarial gains and losses .......................................................... 2436 B Restriction of assets to their recoverable amounts.................. 2438 C Restriction of the recognition of profits (losses) solely as a

result of actuarial losses (gains)................................................ 2445 D Business combinations .............................................................. 2447

5.3.2 Presentation of balance sheet amounts......................................... 2448 5.4 Income statement treatment of defined benefit plans ........................... 2450

5.4.1 Current service cost ....................................................................... 2451 5.4.2 Interest cost.................................................................................... 2451 5.4.3 Expected return on plan assets (and any reimbursement

rights).............................................................................................. 2452 5.4.4 Actuarial gains and losses ............................................................... 2454 5.4.5 Settlements and curtailments ....................................................... 2454 5.4.6 Past service costs ............................................................................ 2457 5.4.7 Impending amendment regarding curtailments and past-

service costs .................................................................................... 2459 6 OTHER EMPLOYEE BENEFITS ............................................................................ 2459

6.1 Short-term employee benefits .................................................................. 2459 6.1.1 General recognition criteria for short-term employee

benefits ........................................................................................... 2460 6.1.2 Short-term compensated absences................................................ 2460

A Accumulating absences ............................................................. 2460 B Non-accumulating absences ..................................................... 2461

6.1.3 Profit sharing and bonus plans....................................................... 2461 A Present legal or constructive obligation ................................... 2461 B Reliable estimate of provision .................................................. 2462

6.2 Long-term employee benefits other than post-employment benefits ..................................................................................................... 2463 6.2.1 Meaning of other long-term employee benefits ........................... 2463 6.2.2 Recognition and measurement ...................................................... 2463

A Annually determined bonuses with a loyalty period greater than one year................................................................. 2464

B Long-term disability benefit..................................................... 2465 6.3 Termination benefits................................................................................. 2465

6.3.1 Recognition..................................................................................... 2465 6.3.2 Measurement.................................................................................. 2467

7 DISCLOSURE REQUIREMENTS ........................................................................... 2467

Detailed contents – Volume 2  lxxxvii 

7.1 Defined contribution plans ....................................................................... 2467 7.2 Defined benefit plans................................................................................ 2467

7.2.1 Periods beginning before 1 January 2006 ...................................... 2468 7.2.2 Periods beginning on or after 1 January 2006 ............................... 2474

7.3 Short-term employee benefits .................................................................. 2485 7.4 Long-term employee benefits................................................................... 2485 7.5 Termination benefits................................................................................. 2486

8 TRANSITIONAL ARRANGEMENTS AND FIRST-TIME ADOPTION ISSUES ........... 2486 8.1 General ..................................................................................................... 2486 8.2 Transitional arrangements for entities not subject to IFRS 1................. 2486 8.3 First-time adoption issues......................................................................... 2487 8.4 Revisions to IAS 19 made in December 2004 .......................................... 2488

9 POSSIBLE FUTURE DEVELOPMENTS.................................................................. 2489 9.1 The long-term intentions of the IASB ..................................................... 2489 9.2 Short-term projects.................................................................................... 2490

9.2.1 The IASB’s proposals ..................................................................... 2490 A Termination benefits ................................................................ 2490 B Annual improvements ............................................................... 2491

9.2.2 IFRIC’s work programme............................................................... 2491 10 CONCLUSION ..................................................................................................... 2491

CHAPTER 33 EARNINGS PER SHARE

1 INTRODUCTION ................................................................................................. 2495 2 OBJECTIVE AND SCOPE OF IAS 33 ..................................................................... 2496

2.1 Objective .................................................................................................... 2496 2.2 Scope ..................................................................................................... 2497

3 THE BASIC EPS................................................................................................... 2497 3.1 Earnings ..................................................................................................... 2498 3.2 Number of shares....................................................................................... 2498

4 CHANGES IN OUTSTANDING ORDINARY SHARES .............................................. 2502 4.1 Weighted average number of shares ......................................................... 2502 4.2 Purchase and redemption of own shares .................................................. 2503 4.3 Changes in ordinary shares without corresponding changes in

resources..................................................................................................... 2503 4.3.1 Capitalisation, bonus issue, share split and share

consolidation................................................................................... 2504 A Capitalisation, bonus issues and share splits ........................... 2504 B Stock dividends ......................................................................... 2505

lxxxviii  International GAAP 

C Share consolidations.................................................................. 2505 4.3.2 Share consolidation with a special dividend ................................. 2505 4.3.3 Rights issue..................................................................................... 2507 4.3.4 B share schemes.............................................................................. 2509 4.3.5 Put warrants priced above market value ....................................... 2510

4.4 Options exercised during the year ............................................................ 2512 4.5 Post balance sheet changes in capital....................................................... 2513 4.6 Issue to acquire another business ............................................................. 2513

4.6.1 Acquisitions .................................................................................... 2513 4.6.2 Reverse acquisitions ....................................................................... 2513 4.6.3 Establishment of a new parent undertaking ................................. 2514

4.7 Adjustments to EPS in historical summaries ........................................... 2515 5 MATTERS AFFECTING THE NUMERATOR.......................................................... 2515

5.1 Earnings ..................................................................................................... 2515 5.2 Preference dividends................................................................................. 2515 5.3 Retrospective adjustments........................................................................ 2517 5.4 Participating equity instruments and two class shares ............................ 2517 5.5 Other bases ................................................................................................ 2519 5.6 Possible future developments in accounting for changes in a parent

entity’s ownership interest in a non-wholly owned subsidiary................ 2519 6 DILUTED EARNINGS PER SHARE........................................................................ 2520

6.1 The need for diluted EPS ......................................................................... 2520 6.2 Calculation of diluted EPS........................................................................ 2521

6.2.1 Diluted earnings ............................................................................. 2522 6.2.2 Diluted number of shares .............................................................. 2523

6.3 Dilutive potential ordinary shares............................................................. 2524 6.3.1 Dilution judged by effect on profits from continuing

operations........................................................................................ 2524 6.3.2 Dilution judged by the cumulative impact of potential shares.... 2525

6.4 Particular types of dilutive instruments ................................................... 2527 6.4.1 Convertible instruments ................................................................ 2527

A Convertible debt ....................................................................... 2528 B Convertible preference shares .................................................. 2530 C Participating equity instruments and two class shares

with conversion rights ............................................................... 2531 6.4.2 Options, warrants and their equivalents ....................................... 2531

A The numerator .......................................................................... 2531 B Written call options................................................................... 2534 C Written put options and forward purchase agreements .......... 2537 D Options over convertible instruments...................................... 2537 E Settlement of option exercise price with debt or other

instruments of the entity.......................................................... 2537

Detailed contents – Volume 2  lxxxix 

F Specified application of option proceeds ................................. 2538 6.4.3 Purchased options and warrants .................................................... 2538 6.4.4 Partly paid shares............................................................................ 2539 6.4.5 Share based payments .................................................................... 2540 6.4.6 Contingently issuable shares ......................................................... 2542

A Earnings-based contingencies................................................... 2542 B Share-price-based contingencies .............................................. 2546 C Other contingencies.................................................................. 2546

6.4.7 Potential ordinary shares of investees ........................................... 2546 6.4.8 Contingently issuable potential ordinary shares ........................... 2549

7 PRESENTATION, RESTATEMENT AND DISCLOSURE ......................................... 2549 7.1 Presentation ............................................................................................... 2549 7.2 Restatement............................................................................................... 2550 7.3 Disclosure................................................................................................... 2551

8 CONCLUSION ..................................................................................................... 2552 9 APPENDIX ........................................................................................................... 2553

CHAPTER 34 CASH FLOW STATEMENTS

1 INTRODUCTION ................................................................................................. 2563 2 THE REQUIREMENTS OF IAS 7 .......................................................................... 2564

2.1 Objective and scope................................................................................... 2564 2.1.1 Objective......................................................................................... 2564 2.1.2 Scope............................................................................................... 2565 2.1.3 First-time adoption ........................................................................ 2565

2.2 Cash and cash equivalents......................................................................... 2566 2.2.1 Definitions ...................................................................................... 2566 2.2.2 Components of cash and cash equivalents.................................... 2566

A Cash and cash equivalents in the cash flow statement ........... 2566 B Bank overdrafts.......................................................................... 2568 C Policy for determining the components of cash and cash

equivalents................................................................................. 2568 D Reconciliation with items reported in the balance sheet........ 2569

2.2.3 Restrictions on the use of cash and cash equivalents ................... 2570 2.3 Presentation of the cash flow statement .................................................. 2571

2.3.1 Reporting cash flows from operating activities ............................. 2572 A The direct method .................................................................... 2573 B The indirect method................................................................. 2574

2.3.2 Cash flows from investing activities .............................................. 2576 2.3.3 Cash flows from financing activities .............................................. 2577 2.3.4 Allocating items to operating, investing and financing

activities.......................................................................................... 2577

xc  International GAAP 

A Interest and dividends .............................................................. 2578 B Taxes on income ....................................................................... 2580 C VAT and other non-income taxes............................................. 2580 D Factoring of trade receivables................................................... 2580 E Treasury shares.......................................................................... 2581

2.3.5 Exceptional and other material cash flows.................................... 2581 2.4 Groups ..................................................................................................... 2582

2.4.1 Preparation of the group cash flow statement .............................. 2582 2.4.2 Acquisitions and disposals.............................................................. 2583

A Deferred and other non-cash consideration............................. 2584 B Contingent consideration ......................................................... 2585 C Settlement of amounts owed by the acquired entity .............. 2585 D Settlement of intra-group balances on a demerger.................. 2585

2.4.3 Cash flows in subsidiaries, associates and joint ventures ............. 2585 A Investments in subsidiaries, associates and joint ventures ..... 2585 B Transactions with minority shareholders ................................. 2586

2.5 Measurement of movements presented in the cash flow statement...... 2587 2.5.1 Gross or net presentation of cash flows......................................... 2587 2.5.2 Foreign currency cash flows ........................................................... 2588

A Entities applying the direct method ........................................ 2588 B Entities applying the indirect method..................................... 2588 C Hedging transactions ................................................................ 2590

2.5.3 Non-cash transactions and transactions on deferred terms.......... 2590 A Asset purchases on deferred terms........................................... 2591 B Asset disposals on deferred terms ............................................ 2591

2.6 Voluntary disclosures ................................................................................. 2591 2.6.1 Cash flows to increase and maintain operating capacity .............. 2592 2.6.2 Segment cash flow disclosures....................................................... 2592

3 REQUIREMENTS OF OTHER STANDARDS........................................................... 2594 3.1 Cash flows of discontinued operations ..................................................... 2594 3.2 Cash flows arising from insurance contracts............................................. 2595 3.3 Cash flows arising from the exploration of mineral resources ................. 2595

4 FINANCIAL INSTITUTIONS ................................................................................ 2595 4.1 Presentation of the cash flow statement .................................................. 2596

4.1.1 Operating cash flows for financial institutions.............................. 2596 4.1.2 Reporting cash flows on a net basis ............................................... 2596 4.1.3 Reporting operating cash flows using the indirect method.......... 2597

5 FUTURE DEVELOPMENTS .................................................................................. 2598 5.1 Proposed amendments to IAS 27.............................................................. 2598 5.2 Project on financial statement presentation ............................................ 2599

6 CONCLUSION ..................................................................................................... 2600

Detailed contents – Volume 2  xci 

CHAPTER 35 RELATED PARTY DISCLOSURES

1 INTRODUCTION ................................................................................................. 2605 1.1 The related party issue.............................................................................. 2605 1.2 Possible solutions....................................................................................... 2606

1.2.1 Remeasurement of transactions at fair values............................... 2606 1.2.2 Disclosure of transactions .............................................................. 2606

2 REQUIREMENTS OF IAS 24 ................................................................................ 2606 2.1 Objective of the standard.......................................................................... 2606 2.2 Scope ..................................................................................................... 2607 2.3 Identification of related parties ................................................................ 2607

2.3.1 Parties that control, are controlled by, or are under common control with, the entity .................................................................. 2607

2.3.2 Parties that have significant influence over the entity................. 2608 2.3.3 Parties that have joint control over the entity .............................. 2609 2.3.4 Associates ........................................................................................ 2610 2.3.5 Joint ventures ................................................................................. 2611 2.3.6 Key management personnel........................................................... 2611 2.3.7 Close family members .................................................................... 2613 2.3.8 Entities controlled, jointly controlled or significantly

influenced by certain individuals................................................... 2614 2.3.9 Post-employment benefit plans..................................................... 2618 2.3.10 Parties presumed not to be related parties ................................... 2618

2.4 Disclosure of controlling relationships ..................................................... 2619 2.5 Disclosure of related party transactions ................................................... 2620

2.5.1 Disclosable transactions ................................................................. 2620 A Key management personnel compensation.............................. 2620 B Other transactions..................................................................... 2621

2.5.2 Materiality ...................................................................................... 2621 2.5.3 Aggregation of items of a similar nature........................................ 2622 2.5.4 Disclosures required in respect of key management

personnel compensation................................................................. 2622 A Short-term employee benefits.................................................. 2623 B Post-employment benefits........................................................ 2624 C Other long-term benefits .......................................................... 2624 D Termination benefits ................................................................ 2624 E Share-based payment ................................................................ 2625 F Groups........................................................................................ 2625

2.5.5 Other disclosures required in respect of related party transactions ..................................................................................... 2625

3 FUTURE DEVELOPMENTS................................................................................... 2630 4 CONCLUSION ..................................................................................................... 2631

xcii  International GAAP 

CHAPTER 36 EVENTS AFTER THE BALANCE SHEET DATE

1 INTRODUCTION ................................................................................................. 2633 2 REQUIREMENTS OF IAS 10 ................................................................................ 2634

2.1 Objective, scope and definitions............................................................... 2634 2.1.1 Adjusting events ............................................................................. 2636 2.1.2 Non-adjusting events ..................................................................... 2637

2.2 The treatment of adjusting events ........................................................... 2639 2.2.1 Events requiring adjustment to the amounts recognised, or

disclosures made, in the financial statements .............................. 2639 2.2.2 Events indicating that the going concern basis is not

appropriate...................................................................................... 2639 2.3 The treatment of non-adjusting events.................................................... 2640 2.4 Other disclosure requirements ................................................................. 2642

3 PRACTICAL ISSUES ............................................................................................. 2643 3.1 The valuation of inventory realised after the balance sheet date ........... 2643 3.2 Construction contracts .............................................................................. 2644 3.3 Insolvency of a debtor................................................................................ 2644 3.4 Tenant insolvency in respect of investment property held at fair

value ..................................................................................................... 2645 4 FIRST-TIME ADOPTION ISSUES.......................................................................... 2645 5 CONCLUSION ..................................................................................................... 2647

CHAPTER 37 INTERIM FINANCIAL REPORTING

1 INTRODUCTION ................................................................................................. 2649 2 REQUIREMENTS OF IAS 34 ................................................................................ 2651

2.1 Objective and scope................................................................................... 2651 2.1.1 Objective......................................................................................... 2651 2.1.2 Scope............................................................................................... 2651

2.2 Content of an interim financial report prepared under IAS 34............... 2652 2.2.1 Definitions ...................................................................................... 2652 2.2.2 Components, form and content of an interim financial report .... 2652

A Complete set of financial statements ...................................... 2653 B Condensed financial statements .............................................. 2653 C Requirements for both complete and condensed interim

financial information ................................................................. 2654 2.2.3 Selected explanatory notes ............................................................ 2654

A Disclosure of accounting policies ............................................. 2656 B Comments on seasonality ......................................................... 2659

Detailed contents – Volume 2  xciii 

C Disclosure of unusual amounts................................................. 2659 D Changes in the composition of the entity................................ 2660

2.2.4 Segment information in condensed interim financial statements ...................................................................................... 2660 A Entities complying with IAS 14................................................ 2660 B Entities applying IFRS 8........................................................... 2660

2.2.5 Disclosure of compliance with IFRS ............................................. 2661 2.2.6 Periods for which interim financial statements are required

to be presented............................................................................... 2663 A Other comparative information ................................................ 2667 B Length of interim reporting period .......................................... 2667

2.2.7 Materiality ...................................................................................... 2668 2.3 Disclosure in annual financial statements................................................ 2668 2.4 Recognition and measurement ................................................................. 2669

2.4.1 Same accounting policies as in annual financial statements ........ 2670 A Measurement on a year-to-date basis....................................... 2670 B Changes in accounting policies................................................. 2671

2.4.2 Seasonal businesses ........................................................................ 2672 A Revenues received seasonally, cyclically, or occasionally ........ 2673 B Costs incurred unevenly during the financial year .................. 2673

2.5 Examples of application of recognition and measurement principles .... 2674 2.5.1 Property, plant and equipment and intangible assets .................. 2674

A Depreciation and amortisation ................................................. 2674 B Impairment of assets ................................................................. 2675 C Intangible assets........................................................................ 2675 D Capitalisation of borrowing costs.............................................. 2675

2.5.2 Reversal of impairment losses recognised in a previous interim period................................................................................. 2676

2.5.3 Employee benefits.......................................................................... 2677 A Employer payroll taxes and insurance contributions............... 2677 B Year-end bonuses....................................................................... 2677 C Pensions ..................................................................................... 2677 D Vacations, holidays, and other short-term compensated

absences ..................................................................................... 2678 2.5.4 Inventories and cost of sales .......................................................... 2678

A Inventories................................................................................. 2678 B Contractual or anticipated purchase price changes................. 2678 C Interim period manufacturing cost variances .......................... 2679

2.5.5 Taxation .......................................................................................... 2679 A Measuring interim income tax expense ................................... 2679 B Changes in the effective tax rate during the year ................... 2681 C Difference in financial reporting year and tax year ................. 2684 D Tax loss and tax credit carrybacks and carryforwards .............. 2684 E Tax credits................................................................................. 2687

2.5.6 Foreign currency translation .......................................................... 2688

xciv  International GAAP 

A Foreign currency translation gains and losses .......................... 2688 B Interim financial reporting in hyperinflationary

economies .................................................................................. 2688 2.5.7 Provisions, contingencies and accruals for other costs ................. 2689

A Provisions................................................................................... 2689 B Other planned but irregularly occurring costs ......................... 2689 C Major planned periodic maintenance or overhaul ................... 2690 D Contingent lease payments ...................................................... 2690

2.6 Use of estimates......................................................................................... 2690 2.7 Restatement of previously reported interim periods............................... 2692

3 TRANSITIONAL RULES AND FIRST-TIME ADOPTION ........................................ 2693 3.1 First-time presentation of interim reports complying with IAS 34 ........ 2693 3.2 Additional disclosures for first-time adopters of IFRS ............................ 2693

4 CONCLUSION ..................................................................................................... 2696

CHAPTER 38 AGRICULTURE

1 INTRODUCTION ................................................................................................. 2701 1.1 Background and need for a standard......................................................... 2701 1.2 The use of fair values................................................................................. 2703

2 REQUIREMENTS OF IAS 41 ................................................................................ 2705 2.1 Definitions ................................................................................................. 2705

2.1.1 Agriculture-related definitions ...................................................... 2705 2.1.2 General definitions......................................................................... 2706

2.2 Scope ..................................................................................................... 2707 2.3 Recognition and measurement ................................................................. 2708

2.3.1 Recognition..................................................................................... 2708 2.3.2 Measurement.................................................................................. 2708

A Biological assets ......................................................................... 2708 B Agricultural produce.................................................................. 2708 C Point-of-sale costs ..................................................................... 2709 D Determining fair value .............................................................. 2709 E Forward sales contracts ............................................................. 2712 F Biological assets attached to land ............................................. 2713 G Subsequent expenditure........................................................... 2714

2.3.3 Gains and losses.............................................................................. 2714 2.3.4 Inability to measure fair value reliably .......................................... 2715

2.4 Government grants .................................................................................... 2716 2.5 Disclosure................................................................................................... 2716

2.5.1 General............................................................................................ 2716 A Balance sheet............................................................................. 2716

Detailed contents – Volume 2  xcv 

B Income statement ..................................................................... 2720 C Groups of biological assets ........................................................ 2721 D Other.......................................................................................... 2722

2.5.2 Additional disclosures if fair value cannot be measured reliably............................................................................................. 2724

2.5.3 Government grants......................................................................... 2727 3 TRANSITIONAL RULES AND FIRST-TIME ADOPTION ........................................ 2727 4 PRACTICAL ISSUES.............................................................................................. 2728

4.1 Determining fair values in the absence of a market price ....................... 2728 4.2 Adopting the cost option for valuations.................................................... 2729 4.3 Obligation to replant a biological asset after harvest ............................... 2730 4.4 Leased assets ............................................................................................. 2730

5 CONCLUSION ..................................................................................................... 2731

CHAPTER 39 EXTRACTIVE INDUSTRIES

1 INTRODUCTION ................................................................................................. 2735 1.1 Nature of the extractive industries........................................................... 2735 1.2 Phases in extractive activities ................................................................... 2738

1.2.1 Upstream and downstream activities ............................................ 2738 1.2.2 Phases in upstream activities......................................................... 2738

1.3 Definition of terms .................................................................................... 2740 1.4 Development of IFRS guidance................................................................ 2740

1.4.1 Development of IFRS 6 ................................................................. 2741 1.4.2 Extractive activities research project............................................. 2742

2 MINERAL RESERVES AND RESOURCES ............................................................... 2743 2.1 Significance of reserves estimation to financial reporting under

IFRS ..................................................................................................... 2743 2.2 Reserve estimation and reporting ............................................................. 2744

2.2.1 Petroleum reserve estimation and reporting................................. 2744 A Standard-setting organisations ................................................. 2744 B Petroleum Resources Management System (SPE-PRMS)..... 2745

2.2.2 Mining resource and reserve reporting.......................................... 2749 A Standard-setting organisations ................................................. 2749 B CRIRSCO International Reporting Template ........................ 2750

2.2.3 International harmonisation of reserve reporting ......................... 2752 A IASB Extractive Activities Research Project............................ 2752 B Convergence with the United States....................................... 2753

2.3 Disclosure of mineral reserves and resources ........................................... 2754 2.3.1 Disclosure of proven, probable and possible reserves................... 2754

A Oil and gas industry................................................................... 2756

xcvi  International GAAP 

B Mining industry ......................................................................... 2761 2.3.2 Disclosure of the value of reserves ................................................ 2764

A Extractive activities research project ....................................... 2764 B FAS 69 disclosure of standardised measure of oil and gas....... 2766

3 IFRS 6 – EXPLORATION FOR AND EVALUATION OF MINERAL RESOURCES.... 2769 3.1 Objective and scope................................................................................... 2769

3.1.1 Scope exclusions in other standards relating to the extractive industries ........................................................................................ 2770

3.2 Recognition of exploration and evaluation assets .................................... 2771 3.2.1 Temporary exemption from IAS 8................................................. 2771 3.2.2 Changes in accounting policies...................................................... 2774

3.3 Measurement of exploration and evaluation assets ................................. 2774 3.3.1 Measurement at recognition.......................................................... 2774 3.3.2 Elements of cost of exploration and evaluation assets ................. 2775 3.3.3 Measurement after recognition ..................................................... 2776

3.4 Presentation ............................................................................................... 2776 3.4.1 Classification of E&E assets .......................................................... 2776 3.4.2 Reclassification of E&E assets....................................................... 2777

3.5 Impairment ................................................................................................ 2777 3.5.1 Recognition and measurement of impairment ............................. 2777

A Impairment testing ‘triggers’.................................................... 2777 B Specifying the level at which E&E assets are assessed for

impairment ................................................................................ 2778 C Order of impairment testing..................................................... 2778

3.5.2 Reversal of impairment losses........................................................ 2779 3.6 Disclosure................................................................................................... 2779 3.7 Effective date, transitional provisions and first-time adopters ............... 2781

4 PRACTICAL ISSUES IN THE EXTRACTIVE INDUSTRIES...................................... 2781 4.1 Guidance under national accounting standards ....................................... 2781

4.1.1 Other standard-setting bodies ....................................................... 2782 4.2 Unit of account .......................................................................................... 2783

4.2.1 What is the unit of account? .......................................................... 2783 4.2.2 Unit of account in the extractive industries ................................. 2788

4.3 Investments in the extractive industries.................................................. 2789 4.3.1 Investments in subsidiaries ........................................................... 2789 4.3.2 Investments in joint ventures........................................................ 2789

A Jointly controlled operations..................................................... 2790 B Jointly controlled assets and undivided interests.................... 2791 C Jointly controlled entities ......................................................... 2792 D Future developments: Short-term improvements................... 2794

4.3.3 Investments in associates............................................................... 2797 4.3.4 Investments in financial assets ...................................................... 2797

Detailed contents – Volume 2  xcvii 

4.3.5 Investments in undivided interests............................................... 2797 4.3.6 Operators of joint ventures ............................................................ 2798

A Reimbursements of costs .......................................................... 2798 B Direct legal liability................................................................... 2798

4.4 Acquisitions................................................................................................ 2799 4.4.1 Business combinations versus asset acquisitions .......................... 2799

A Definition of a ‘business’ .......................................................... 2799 B Asset purchase transactions ...................................................... 2801 C Differences between asset purchase transactions and

business combinations .............................................................. 2801 4.4.2 Business combinations ................................................................... 2801

A Goodwill in business combinations .......................................... 2801 B Impairment of assets and goodwill recognised on

acquisition.................................................................................. 2802 C Value beyond proved and probable reserves (VBPP) .............. 2803

4.5 Depreciation, depletion and amortisation (DD&A)................................ 2804 4.5.1 Requirements under IFRS............................................................. 2804

A Property, plant and equipment ................................................ 2804 B Intangible assets........................................................................ 2804 C Mineral reserves ........................................................................ 2805 D Unit of account.......................................................................... 2805 E Practical issues........................................................................... 2805

4.5.2 Straight-line method ...................................................................... 2806 4.5.3 Unit-of-production method ........................................................... 2807

A Unit-of-production formula ...................................................... 2809 B Reserves base............................................................................. 2810 C Unit of measure ......................................................................... 2814 D Joint and by-products................................................................ 2815

4.6 Impairment of assets ................................................................................. 2817 4.6.1 Impairment indicators.................................................................... 2817 4.6.2 Future capital expenditure ............................................................ 2819 4.6.3 Identifying cash-generating units.................................................. 2819

A Markets for intermediate products .......................................... 2819 B External users of processing assets........................................... 2820 C Shared infrastructure................................................................. 2820 D Fields or mines operated on a portfolio basis........................... 2820

4.6.4 Projections of cash flows ................................................................ 2821 4.6.5 Mineral reserves and resources ...................................................... 2821 4.6.6 Risk-adjusted discount rates.......................................................... 2822

4.7 Events after the balance sheet date.......................................................... 2822 4.7.1 Reserves proven after the balance sheet date............................... 2822 4.7.2 Application of the purchase method ............................................. 2823

4.8 Decommissioning ...................................................................................... 2824 4.8.1 Recognition and measurement issues ........................................... 2824

xcviii  International GAAP 

A Initial recognition...................................................................... 2824 B Measurement of the liability .................................................... 2825

4.8.2 Accounting for changes in decommissioning and restoration costs................................................................................................. 2825

4.8.3 Treatment of exchange differences............................................... 2827 4.8.4 Deferred tax on decommissioning obligations.............................. 2828

4.9 Revenue recognition.................................................................................. 2829 4.9.1 Revenue in the development phase: Incidental revenue............. 2829 4.9.2 Revenue in the development phase: Integral to development.... 2830

4.10 Long-term contracts and leases ................................................................ 2830 4.10.1 Embedded leases............................................................................ 2830 4.10.2 Take-or-pay contracts .................................................................... 2831

A Makeup product and undertake ............................................... 2834 4.11 Taxation ..................................................................................................... 2834

4.11.1 Determining the nature of the taxation........................................ 2834 4.11.2 Excise duties, production taxes and severance taxes ................... 2835

A Production-based taxation ........................................................ 2836 B Petroleum revenue tax.............................................................. 2837

4.11.3 Grossing up of notional quantities withheld................................. 2838 4.12 Financial instruments................................................................................ 2839

4.12.1 Normal purchase and sales exemption.......................................... 2839 A Requirements of IAS 32 and IAS 39......................................... 2839 B Application of the normal purchase or sale exemption in

the extractive industries ........................................................... 2840 4.12.2 Embedded derivatives.................................................................... 2841

A Separating embedded derivatives ............................................ 2841 B Foreign currency embedded derivatives .................................. 2842 C Provisionally priced contracts ................................................... 2842 D Long-term supply contracts...................................................... 2842 E Development of gas markets .................................................... 2843

4.12.3 Volume flexibility in supply contracts........................................... 2844 5 PRACTICAL ISSUES IN THE OIL AND GAS INDUSTRY ......................................... 2845

5.1 Legal rights to explore for, develop and produce mineral properties ..... 2845 5.1.1 Mineral leases and concession agreements ................................... 2846

A Concessionary agreements (concessions) ................................ 2847 5.1.2 Production sharing contracts ......................................................... 2848 5.1.3 Pure-service contracts .................................................................... 2851 5.1.4 Risk service contracts ..................................................................... 2851 5.1.5 Joint operating agreements............................................................ 2852

5.2 Different types of royalty interests........................................................... 2853 5.2.1 Working interest and basic royalties.............................................. 2853 5.2.2 Overriding royalties ........................................................................ 2853 5.2.3 Production payment royalties ........................................................ 2853

Detailed contents – Volume 2  xcix 

5.2.4 Net profits interests ....................................................................... 2854 5.3 Risk-sharing arrangements ........................................................................ 2854

5.3.1 Carried interests ............................................................................. 2854 A Types of carried interest arrangements ................................... 2854 B Carried interest arrangements in the E&E phase ................... 2856 C Financing-type carried interest arrangements in the

development phase ................................................................... 2857 D Purchase/sale-type carried interest arrangements in the

development phase ................................................................... 2857 E Government as the carried party .............................................. 2860

5.3.2 Farm-ins and farm-outs .................................................................. 2860 A Farm-in arrangements in the E&E phase ................................ 2860 B Farm-in arrangements outside the E&E phase ....................... 2861

5.3.3 Asset swaps ..................................................................................... 2863 A E&E assets................................................................................. 2863 B PP&E, intangible assets and investment property.................. 2864 C Exchanges of E&E assets for other types of assets ................. 2865

5.3.4 Unitisations and redeterminations ................................................ 2865 A Unitisations ............................................................................... 2865 B Redeterminations...................................................................... 2867

5.4 Exploration and evaluation costs............................................................... 2872 5.4.1 Successful efforts method.............................................................. 2872 5.4.2 Full cost method............................................................................. 2874 5.4.3 Area-of-interest method................................................................. 2875

5.5 Capitalisation of costs................................................................................ 2877 5.5.1 Major maintenance and turnarounds............................................. 2877 5.5.2 Well workovers and recompletions ................................................ 2879

5.6 Revenue recognition.................................................................................. 2879 5.6.1 Royalties.......................................................................................... 2879 5.6.2 Overlift and underlift ..................................................................... 2880

A Sales method ............................................................................. 2880 B Entitlements method................................................................ 2881 C Overlift and underlift in practice ............................................. 2882 D Facility imbalances.................................................................... 2883

5.6.3 Trading activities............................................................................ 2883 5.6.4 Inventories ...................................................................................... 2884

A Pipeline fill and cushion gas ..................................................... 2884 B Exchanges of inventories .......................................................... 2885 C Carried at fair value ................................................................... 2886 D Recognition................................................................................ 2887

6 PRACTICAL ISSUES IN THE MINING INDUSTRY ................................................. 2887 6.1 Functional currency of mining companies................................................ 2887

6.1.1 Determining the functional currency............................................ 2887 6.1.2 Changes in functional currency ..................................................... 2889

c  International GAAP 

6.2 Stripping costs and overburden ................................................................ 2890 6.2.1 Expensing of production stripping costs as incurred.................... 2890 6.2.2 Capitalising stripping costs as cost of inventory: EITF 04-6 ....... 2891 6.2.3 Deferral of stripping costs to match future production................ 2892

A Specific identification approach ............................................... 2892 B Average strip ratio approach...................................................... 2892

6.2.4 Presentation of deferred stripping costs ....................................... 2894 6.3 Revenue recognition.................................................................................. 2894

6.3.1 Provisionally priced contracts ........................................................ 2894 6.3.2 The recognition of revenue at the completion of production...... 2896

6.4 Impairment of assets ................................................................................. 2897 6.4.1 Low mine profitability near end of life ......................................... 2897

6.5 Inventories ................................................................................................. 2898 6.5.1 Recognition..................................................................................... 2898 6.5.2 Stockpiles of low grade ore ............................................................ 2899 6.5.3 Sale of by-products and joint products.......................................... 2901

A By-products................................................................................ 2901 B Joint products ............................................................................ 2902

6.6 Tolling arrangements................................................................................. 2903 7 GLOSSARY ........................................................................................................... 2904

  ci  

Abbreviations  

The following abbreviations are used in this book:

Professional and regulatory bodies:

AASB Australian Accounting Standards Board

AICPA American Institute of Certified Public Accountants

APB Accounting Principles Board (of the AICPA, predecessor of the FASB)

ARC Accounting Regulatory Committee of representatives of EU Member States

ASB Accounting Standards Board in the UK

ASC Accounting Standards Committee (the predecessor of the ASB)

CESR Committee of European Securities Regulators, an independent committee whose members comprise senior representatives from EU securities regulators

CICA Canadian Institute of Chartered Accountants

EC European Commission

EFRAG European Financial Reporting Advisory Group

EITF Emerging Issues Task Force in the US

EU European Union

FAF Financial Accounting Foundation

FASB Financial Accounting Standards Board in the US

G4+1 The (now disbanded) group of four plus 1, actually with six members, that comprised an informal ‘think tank’ of staff from the standard setters from Australia, Canada, New Zealand, UK, and USA, plus the IASC

IASB International Accounting Standards Board

IASC International Accounting Standards Committee. The former Board of the IASC was the predecessor of the IASB

IASCF International Accounting Standards Committee Foundation

ICAEW Institute of Chartered Accountants in England and Wales

ICAS Institute of Chartered Accountants of Scotland

IFRIC International Financial Reporting Interpretations Committee of the IASB

IGC Implementation Guidance Committee on IAS 39 (now disbanded)

cii  International GAAP 

IOSCO International Organisation of Securities Commissions

JWG Joint Working Group of Standard-setters that comprised representatives from the IASC, the FASB, and eight other international bodies. The purpose of the (now disbanded) group was to develop an integrated and harmonised standard on financial instruments – a task they were unable to complete

SAC Standards Advisory Council, which provides advice to the IASB on a wide range of issues

SEC Securities and Exchange Commission (the US securities regulator)

SIC Standing Interpretations Committee of the IASC (replaced by IFRIC)

Accounting related terms:

ADS American Depositary Shares

AFS Available-for-sale investment

ARB Accounting Research Bulletins (issued by the AICPA)

ARS Accounting Research Studies (issued by the APB)

CGU Cash Generating Unit

CIS Comprehensive Income Statement, as developed by the G4+1 group of accounting standard-setters, and published in June 1999 in the ASB Discussion Paper Reporting Financial Performance: Proposals for Change

CU Currency Unit

CULS Convertible Unsecured Loan Stock

E Exposure Draft (of an IAS)

EBIT Earnings Before Interest and Taxes

EBITDA Earnings Before Interest, Taxes, Depreciation and Amortisation

ED Exposure Draft

EPS Earnings per Share

FAS Financial Accounting Standards (issued by the FASB)

FC Foreign currency

FIFO First-In, First-Out basis of valuation

FRS Financial Reporting Standard (issued by the ASB)

FTA First-time Adoption

GAAP Generally accepted accounting practice (as it applies under IFRS), or generally accepted accounting principles (as it applies to the US)

HTM Held-to-maturity investment

IAS International Accounting Standard (issued by the former board of the IASC)

Abbreviations  ciii 

IFAC International Federation of Accountants

IFRS International Financial Reporting Standard (issued by the IASB)

IPO Initial Public Offering

IPR&D In-process Research and Development

IRR Internal Rate of Return

JV Joint Venture

LC Local Currency

LIBOR London Inter Bank Offered Rate

LIFO Last-In, First-Out basis of valuation

NBV Net Book Value

NRV Net Realisable Value

PP&E Property, Plant and Equipment

R&D Research and development

SFAC Statement of Financial Accounting Concepts (issued by the FASB as part of its conceptual framework project)

SFAS Statement of Financial Accounting Standards (issued by the FASB)

SPE Special Purpose Entity

TSR Total Shareholder Return

VIU Value In Use

WACC Weighted Average Cost of Capital

References to IFRSs, IASs, Interpretations and supporting documentation:

AG Application Guidance

AV Alternative View

B, BCZ Basis for Conclusions on IASs

BC Basis for Conclusions on IFRSs and IASs

DO Dissenting Opinion

IE Illustrative Examples on IFRSs and IASs

IG Implementation Guidance

IN Introduction to IFRSs and IASs

  cv  

Authoritative literature  

The content of this book takes into account all accounting standards and other relevant rules issued up to 31 October 2007. Consequently, it covers the IASB’s Framework for the Preparation and Presentation of Financial Statements and authoritative literature listed below.

Unless otherwise indicated therein, all references in footnotes to the extant pronouncements below are to the versions of those pronouncements as included in the Bound Volume of International Financial Reporting Standards as at 1 January 2007 published by the IASB (ISBN 978-1-905590-26-1). † The standards and interpretations marked with a dagger have been withdrawn or superseded. IASB Framework Framework for the Preparation and Presentation of Financial Statements International Financial Reporting Standards IFRS 1 First-time Adoption of International Financial Reporting Standards IFRS 2 Share-based Payment IFRS 3 Business Combinations IFRS 4 Insurance Contracts IFRS 5 Non-current Assets Held for Sale and Discontinued Operations IFRS 6 Exploration for and Evaluation of Mineral Resources IFRS 7 Financial Instruments: Disclosures IFRS 8 Operating Segments International Accounting Standards IAS 1 Presentation of Financial Statements IAS 2 Inventories IAS 7 Cash Flow Statements IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors IAS 10 Events After the Balance Sheet Date IAS 11 Construction Contracts IAS 12 Income Taxes IAS 14 Segment Reporting IAS 16 Property, Plant and Equipment IAS 17 Leases IAS 18 Revenue IAS 19 Employee Benefits IAS 20 Accounting for Government Grants and Disclosure of Government Assistance

cvi  International GAAP 

IAS 21 The Effects of Changes in Foreign Exchange Rates IAS 23 Borrowing Costs IAS 24 Related Party Disclosures IAS 26 Accounting and Reporting by Retirement Benefit Plans IAS 27 Consolidated and Separate Financial Statements IAS 28 Investments in Associates IAS 29 Financial Reporting in Hyperinflationary Economies † IAS 30 Disclosures in the Financial Statements of Banks and Similar Financial Institutions IAS 31 Interests in Joint Ventures IAS 32 Financial Instruments: Presentation IAS 33 Earnings per Share IAS 34 Interim Financial Reporting IAS 36 Impairment of Assets IAS 37 Provisions, Contingent Liabilities and Contingent Assets IAS 38 Intangible Assets IAS 39 Financial Instruments: Recognition and Measurement IAS 40 Investment Property IAS 41 Agriculture International Financial Reporting Interpretations Committee Interpretations IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities IFRIC 2 Members’ Shares in Co-operative Entities and Similar Instruments † IFRIC 3 Emission Rights IFRIC 4 Determining whether an Arrangement contains a Lease IFRIC 5 Rights to Interests arising from Decommissioning, Restoration and Environmental

Rehabilitation Funds IFRIC 6 Liabilities arising from Participation in a Specific Market – Waste Electrical and

Electronic Equipment IFRIC 7 Applying the Restatement Approach under IAS 29 – Financial Reporting in

Hyperinflationary Economies IFRIC 8 Scope of IFRS 2 IFRIC 9 Reassessment of Embedded Derivatives IFRIC 10 Interim Financial Reporting and Impairment IFRIC 11 IFRS 2 – Group and Treasury Share Transactions IFRIC 12 Service Concession Arrangements IFRIC 13 Customer Loyalty Programmes IFRIC 14 IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements

and their Interaction Standing Interpretations Committee Interpretations SIC-7 Introduction of the Euro SIC-10 Government Assistance – No Specific Relation to Operating Activities SIC-12 Consolidation – Special Purpose Entities SIC-13 Jointly Controlled Entities – Non-Monetary Contributions by Venturers

Authoritative literature  cvii 

SIC-15 Operating Leases – Incentives SIC-21 Income Taxes – Recovery of Revalued Non-Depreciable Assets SIC-25 Income Taxes – Changes in the Tax Status of an Enterprise or its Shareholders SIC-27 Evaluating the Substance of Transactions Involving the Legal Form of a Lease SIC-29 Service Concession Arrangements: Disclosures SIC-31 Revenue – Barter Transactions Involving Advertising Services SIC-32 Intangible Assets – Web Site Costs Other IASB publications IFRS 3

(Revised) Near-final draft of the revised IFRS 3, published June 2007.

IASB Exposure Drafts ED 9 Joint Arrangements Amendments to IAS 32 Financial Instruments: Presentation and

IAS 1 Presentation of Financial Statements – Financial Instruments Puttable at Fair Value and Obligations Arising on Liquidation

Amendments to IFRS 2 Share-based Payment – Vesting Conditions and Cancellations

Amendments to IFRS 3 Business Combinations Amendments to IAS 27 Consolidated and Separate Financial Statements Amendments to IAS 37 Provisions, Contingent Liabilities and Contingent

assets and IAS 19 Employee Benefits Amendments to IFRS 1 First-time Adoption of International Financial

Reporting Standards – Cost of an Investment in a Subsidiary Proposed IFRS for Small and Medium-sized Entities Amendments to IAS 24 Related Party Transactions – State-controlled Entities

and the Definition of a Related Party. Amendments to IAS 39 Financial Instruments Recognition and Measurement

– Exposures Qualifying for Hedge Accounting Proposed Improvements to International Financial Reporting Standards IFRIC Exposure Drafts IFRIC D21 Real Estate Sales IFRIC D22 Hedges of a Net Investment in a Foreign Operation