Question Practice

Q1) Verge
 What is operating segment? Definition and Criteria. (According to IFRS
8…)
 Explain about aggregation (two or more operating segments can be
aggregated into a single operating segment…)

(Now read the question paragraph)

 Scenario connection.
 Here both the operating segments cannot be aggregated because they
have very different economic characteristics. (you may specify nature of
products, customers, prices etc.)

Q2) Corbel Co. (Sept/Dec 2020)

 Copy all the requirements first. Paste it to word processor. Split it.
 Read the requirement
 Split: Recognition of Intangible Assets, Measurement of Intangible
Assets.

a) Challenges while recognizing IA:

-Intangible assets are non-monetary assets without physical substance.
So, it is difficult to identify an intangible asset.
-The recognition of intangible assets is based on judgements. What is
perceived to be an intangible asset for one entity, might not be for
another entity.
-Most companies will have brand names through which they are
generating future benefits. But as per IAS 38, internally generated
intangible assets cannot be recognized even if they provide benefits to
the company.
Challenges while measuring IA:
-Intangible assets are not physical assets, so their useful life cannot be
reliably estimated.
-Since intangible assets do not have an active market, a reliable fair
value cannot be measured and hence revaluation model cannot be used
for many intangible assets.

b) i) Jengi Co brand name will be accounted for separately from

goodwill on acquisition:
As per IAS 38, an intangible asset is recognized when they are
identifiable, provides future economic benefits, controlled by the entity,
and the cost can be measured reliably.
Jengi Co.’s brand name is well known in the sector, retailing at premium
prices, which means this provides future economic benefits. Once the
registration of brand is completed, it will become identifiable, and will
be under the control of Corbel Co. Also, the cost can be reliably
measured. So Jengi brand will be accounted as a separate intangible
asset.

Whether it should be accounted for as a separate cash generating unit:

As per IAS 36, CGUs are the smallest identifiable group of assets for
whom independent cashflows can be measured and identified. Since
brand name alone cannot generate cashflows, this cannot be treated as
a CGU. Brand together with the other associated assets like
manufacturing facility, factory etc. should be clubbed together as CGU
and tested for impairment,

ii) How to account for intangible assets with an indefinite life:

Intangible assets with indefinite useful life cannot be amortized. Instead,
it should be tested for impairment either annually or when there is an
indication of impairment.
The useful life of an intangible asset will be indefinite if there is no
foreseeable limit to the period in which the asset will generate future
economic benefits.

Locust Perfume Brand:

Locust has been sold successfully for many years and has an established
market. Since the brand is used for many years and have an established
market, it can be used for many more years to come, and hence there is
no foreseeable limit, the useful life is indefinite.

Clara Perfume Brand:

The second perfume brand is a new perfume named after a famous
actor Clara who intends to promote the product. The sale of this brand
name will depend on the popularity of the actor and how long she
intends to promote it. There is a limit to the period in which these might
generate future benefits. Hence the useful life is definite.
iii) How to account for the proposed closure of the six stores, suggested
closure of the remaining stores:
As per IAS 37, restructuring is a programme, planned by the
management, which changes the scope of the business or the manner in
which the business is conducted. Corbel Co. plans to close 6 Italian
stores, which mostly changes the scope of the business and hence
constitutes restructuring.
A restructuring provision will be created when there is a formal plan and
this has been announced to those parties who are affected by the
restructuring. Since Corbel Co. approved and announced a plan to close
and sell all six Italian stores on 31st December 20X7, a restructuring
provision can be recognized for all direct costs arising as a result of
restructuring.

As per IFRS 5, a NCA can be classified as held for sale, if its carrying value
is recovered through a sale transaction and if they are available for
immediate sale in the present condition, the sale is probable, and will be
expected to be completed within 12 months. The six stores will close
after a liquidation sale which will last for three months, and hence is not
available for immediate sale and hence cannot be classified as NCA held
for sale.
A discontinued operation is a component of an entity which has either
been disposed off or is classified as held for sale and represents a major
line business or geographical area of operation. 6 Italian stores most
probably will be a separate geographical area of business and hence will
constitute a discontinued operation. The result of these should be
disclosed separately.

iv) Whether the primary store should be tested for impairment at 31 st

December 20X7:
An asset will be tested for impairment if the company is not able to
recover expected benefits from the asset. Even though the Paris store is
loss making, this is not a concern as the performance is consistent with
the expectations for such a new and expensive store and management
believes that the new store will have a positive effect on Corbel Co.’s
brand image. Thus, the store is functioning in line with the expectation
of the company and hence there is no need of an impairment test.

Whether the internet sales can be attributed to this store:

Any cashflow generated by the store directly can be attributed to that
store. The goods sold via the internet are sourced from either Corbel
Co.’s central distribution centre or individual stores and these are either
delivered to the customer’s home or collected by the customer from the
store supplying the goods.
Thus, the sales are not directly done by the primary store and cannot be
allocated to them. Instead, these should be allocated to those stores
from whom the products are transferred. Or else, internet sales should
be treated as a separate CGU.
 Q 59. Aron
a) Accounting Treatment of Convertible Bond
Convertible Bonds can be classified under ‘Compound Instruments’, where in,
they may have both equity (conversion of bonds into shares) and liability
(payments to be made when shares are redeemed) components.
According to IAS 32: Presentation and Measurement of Financial Instruments,
compound instruments should be accounted using ‘split accounting method’,
where the convertible bonds will be split into equity and liability components.

Liability Component:
Initial Measurement-
Liability component will be initially measured at the present value of cash
outflows discounted at a market rate of interest for a similar instrument
without conversion rights. In this case, the cashflows will be discounted at 9%,
as that is the interest rate given for bond without conversion option. Issue Cost
will have to be spilt in proportion and deducted from the opening balance of
the liability component to find the net opening balance.

Year-end Measurement:
Liability component will be measured in the year-end using Amortized Cost
Method. The liability component will be measured at amortized cost, meaning
that the interest is charged at effective rate of 9.38%. The cash payments will
reduce the liability.
The finance cost will be $8.581m, and the year-end measurement of the
liability component will be $94.06m.

Equity Component:
Initial Measurement-
Equity Component will be initially measured by calculating the difference
between cash proceeds and the opening balance of liability component. In this
case, the issue cost will also have to be reduced in the proportion to find the
net opening balance of the equity component.

Year-End Measurement-
Equity Component will not be re-measured. This means that the closing
balance of the equity component will be the same as the opening balance.
b) Shares in Smart
In this case, a derecognition happens. Aron held shares of Smart until
31st May 20X7, after which Smart was acquired by Given on 31st May
20X7. Aron exchanges its shares in Smart, which is disposal of shares,
with shares of Given, which is purchase of new shares. Here, to
recognize if it is a derecognition or not, a transfer of risk and reward
should happen. Here, since Aron disposed of all of its 3% holding in
Smart, it qualifies for derecognition.
The cumulative gain or loss that is received after measuring the asset to
fair value from the disposal will be reclassified to profit or loss account.
Since new shares have been received, the shares, if the intention is to
hold, will be initially measured at fair value. A profit on disposal of $0.5m
will be recorded in the statement of profit or loss. This is the difference
between the initial carrying amount of the shares in Given and the
carrying amount of the shares in the Smart that have been
derecognized. In addition, Aron may choose to make a transfer within
equity of the cumulative gain recognized upto the disposal date of
$400,000.

c) Winston Bonds
Financial assets are initially measured at fair value, so investment in the
bond will be recognized at $10m.
The entity’s business model involves both holding debt instruments to
collect their contractual cash flows and also selling the assets. As a debt
instrument, it would appear that the contractual terms of the asset
comprise the repayment of the principal and the interest on principal
amount outstanding. Therefore, the asset should be measured at fair
value through other comprehensive income.
 Q 58) Kayte
a) Definition:
IAS 16 defines property, plant and equipment as a tangible asset, that is mainly
held for production and supply of goods and services, or for administrative
purposes and should be held for a long number of period. Here, Kayte operates
in shipping. So, the vessels owned by them can be classified under IAS 16:
Property, Plant and Equipment.

Residual Value:
According to IAS 16, residual value is the amount that the entity will obtain
from the disposal of an asset, after deducting the estimated cost of disposal, if
the asset were already at the end of its useful life and in condition expected at
the end of its useful life.
Here, the vessels used by Kayte has an economic life of 30 years, whereas their
useful life is only 10 years. Kayte estimated the residual value of these vessels
at sale to be half the acquisition cost and estimated this value to be constant
during their useful life. This goes against the principles of IAS 16, where the
residual value should be reviewed annually and updated according to the
current market conditions, not based on assumptions that were made at the
time of acquisition. Kayte’s argument about taking residual value as half of the
acquisition cost is not justifiable, since broker valuations are available and are
considerably higher. If the broker valuations of the residual value is higher than
the carrying value of the asset, then such assets need not be depreciated
further.

Scrap Value and Overhaul Costs:

If the asset is used over its economic life, IAS 16 states that the scrap value
should be taken for depreciation calculation. Scrap value is the metal value or
the steel value of the asset at the end of its economic life. Kayte’s calculation
of the scrap value of the vessels kept for 30 years is based upon the steel value
of the vessel at the end of its economic life and is a correct treatment.
In IAS 16, overhaul cost is capitalized when incurred and should be depreciated
until the next overhaul. A provision cannot be created as per IAS 37, since
there is no present obligation. The vessels are required to undergo an engine
overhaul in dry dock every 10 years to restore their service potential, any
amount incurred here will be capitalized and depreciated until next overhaul
i.e. 10 years.

Any assets which no longer provides any future economic benefits should be
written off as an expense in the SOPL. Kayte has an engine which had to be
replaced after 8 years, and the carrying value of such engine should be written
off.
If an asset has different components with different cost and useful life, these
components should be depreciated separately, Since the funnel have a useful
life of 15 years, which is different from other components, funnel should be
depreciated over its life of 15 years separately.
Q 27) Fiskerton (b)
To recognize revenue over time, IFRS 15 states that it should satisfy one of the
three criteria that is given:
i) When the company delivers their performance, the customer
simultaneously receives and consumes it, but cannot postpone the
consumption. This is normally a feature of service, and this contract is
a sales contract for the construction of an asset. Therefore, this
criterion is not satisfied.

ii) As a result of the company’s performance, if an asset is created, the

control of the asset must belong to the customer. However, from the
scenario, there is no indication that the customer has control of the
asset during its construction. The customer takes possession at
delivery, which suggest they do not control the asset during
construction. This criterion is also not satisfied.

iii) The asset that is created, the company cannot take it for an
alternative use, but the company has the right to ask for payment for
the work completed till date. The scenario does not explicitly state
that the asset has no alternative use, but since the customer pays a
non-refundable deposit if they default, this may suggest an
enforceable right to payment for work completed to date. However,
more information is needed to confirm this.

Since none of the above criteria isn’t satisfied, the revenue earned from the
construction of this asset will have to be recognized at a point of time, and not
over the completion of work.
Q41) Leria
a.i) Whether the directors can classify the stadium as held for sale:
 YE: 31st October 20X5
 Sale happens after 13 months.
 Define what NCA held for sale (1)
 Conditions for Classification (0.5)
 12-month rule knowledge (1)
 Not beyond entity’s control, so not held for sale (0.5)

Here the year end is 31st October 20X5, but Leria Co. has entered into the
contract to sell the asset only on 30th November 20X6, which exceeds 12
months.
A non-current asset is classified as ‘held for sale’ when the principal amount
can be recovered principally through a sale transaction rather than through
continued use according to IFRS 5 ‘Assets Held for Sale’.
There are certain criteria to be satisfied in order to classify an asset as held for
sale. The criteria pertaining to the scenario includes:
1) The asset must be available for immediate sale in its present condition.
2) The asset should be sold within 12 months.
3) The sale should be probable.
If a sale does not take place within 12 months, the asset can be still classified
as held for sale, if the events or circumstances are beyond the company’s
control, or have sufficient evidence that the company is still committed to sale.
Here the company is committed to sell the asset only after 12 months
threshold (13 months), which means that it is a decision they have taken.
There is nothing beyond the entity’s control, which means that this asset
cannot be classified as held for sale.

ii) Leria Co’s accounting treatment of the crowd barrier improvements at 31 st

October 20X5:
 YE: 31st October 20X5
 Define provision
 Present obligation: no legal, no constructive
 Probable: No, Leria has plans to sell the asset
 No provision recognized
 $2 million treatment: wrong, no impairment
 Asset CV = 18+2
According to IAS 37, provision is defined as a liability of uncertain timing and
amount. To record a provision, there should be a present obligation, which
should be probable.
According to the scenario, Leria Co. does not have a current legal or a
constructive obligation. At the same time, the provision is not probable, as
Leria Co. has plans to sell the stadium by then. Therefore, a provision cannot
be recorded in such a case, as it does not satisfy the criteria required to
recognize a provision. Leria Co. may not decide to carry out the improvements,
especially as the stadium is going to be sold and then subsequently leased
back.

Also, the $2m spent on crowd barrier improvements to the stadium should not
be treated as an impairment of the asset’s carrying amount on 31 st October
20X5 as there is no reduction in value of the asset happening. Therefore the
$2m should be added back to the carrying amount of the stadium and a
corresponding credit made to profit or loss.

iii) Accounting Treatment for sale and Leaseback of the stadium at 30 th

November 20X6:
 YE: 30th November 20X6, CY: 31st October 20X5.
 CV of asset on 31st October 20X5 = $20m
 FV of the asset = $30m
 Lease Term – 10 years
 Lease Liability = $26m

31st October 20X5 – CV of the asset = $20m

DEPRECIATE FOR ONE YEAR (20*5%) = ($1m)
31st October 20X6 – CV of the asset = $19m
DEPRECIATE TILL 30TH NOV 20X6 (19*5%*1/12) = ($0.079m)
30th November 20X6 – CV of the asset = $18.921m

 Sale and Leaseback, first apply IFRS 15

 IFRS 15, Sale: i) Asset sold for MV ii) Market Sale of Lease Rental
 If not sale – Asset won’t be derecognized, financial liability recorded
 If sale apply IFRS 16 – Asset derecognized, Gain or Loss recorded to the
extend of rights transferred
 G/L = (FV-CV) x (FV – LL / FV)
 G/L = (30-18.92) x ((30-26)/30) = $1.70m
 ROU asset = CV * (LL/FV) = 18.92 * (26/30) = $16.39m
A sale and leaseback transaction occurs where an entity transfers an asset to
another entity and leases that asset back from the buyer/lessor. To identify if
the following asset can be considered as a sale and leaseback, it should be
assessed whether the transfer of asset meets IFRS 15: Revenue from Contract
with Customers requirements to determine when a performance obligation is
satisfied.

If the sale criteria are not satisfied, then it will be treated as a financing
transaction, where the buyer/lessor provides funds in exchange for future
payments, but the seller retains the control over the asset. A liability will be
recognized for the amount received when the asset was actually sold.

However, in case of Leria, it seems that a sale will occur on 30 th November

20X6, because of the binding sale commitment. If the fair value of the sale
consideration and the asset’s fair value are equal, and the lease payments are
at market rates, there is no need to adjust the sales proceeds under IFRS 16.

Leria Co. should follow IFRS 15 to account for the sale and then apply IFRS 16
to account for the lease. Leria Co. should account for the sale and leaseback as
follows:
- Derecognize the asset
- Recognize the sale at fair value
- Recognize only the gain/loss which relates to the rights transferred to the
buyer/lessor
- Recognize a right-of-use asset as a proportion of the previous carrying
amount of the underlying asset
- Recognize a lease liability

b. i) Amortization of intangible assets are acceptable policies in accordance

with IFRS standards:
 Define Intangible asset
 Useful life – definite? Amortize.
 Amortization based on revenue generation – knowledge
 Leria’s accounting treatment is correct.
 Industry’s accounting treatment is also right.

IAS 38 defines intangible asset as an identifiable, non-monetary asset with no

physical substance. As per IAS 38, the material cost of production which relates
to the content rights associated with the television programmes can be
recorded as an intangible asset by Leria as it provides the company with future
economic benefits.

Intangible assets with definite useful life can be amortized over its useful life.
According to IAS 38, there is a rule that assumes that amortization should not
be based normally on the revenue generated by using the asset. This
assumption can be overcome when it can be demonstrated that revenue and
the consumption of the economic benefits of the intangible assets are highly
correlated.

The intellectual property in the content rights is consumed as customers view

the television programme. The intellectual property included in the television
programme will generate cash flows through television channel subscriptions
and the estimated revenues for a television programme determine the amount
to be spent on producing the television programme. Also the budgeted cost of
production are based on the estimated future revenues for the television
programme. Revenue and consumption of the economic benefits of the
intangible asset seem highly correlated and therefore a revenue-based
amortization seem appropriate.

(The value of the content rights for the television program is used up as
customers watch it. The program earns money through subscriptions to the TV
channel, and the expected revenue from the program helps set the production
budget. In other words, the money planned for production is based on how
much revenue the program is expected to bring in. Because revenue is closely
linked to how much the program's economic value is consumed, using a
revenue-based method to calculate amortization makes sense here. Simple
explanation!)
Q33) Bohai
a. Whether the directors of Bohai were correct in not conducting an
impairment test at 31st December 20X8:
According to IAS 36, an impairment test will be conducted when there are
indications of impairment. At every year-end, the company should review
whether there is an indication of impairment.

Obsolescence, damage to the asset, adverse use of assets are internal

indications of impairment, whereas fall in market value, adverse changes in the
market, rise is market capital rates, carrying value of an entity’s net assets
greater than the market capitalization are external indicators of impairment.

Whenever, there is an indication of impairment, the CV of the asset and its

recoverable amount is computed and compared. If the recoverable amount is
less than CV, the impairment loss is charged to SOPL (adjusted to profit).

Bohai has a portfolio of global cruise brands and a fleet of 100 ships. Due to
recession, the company is planning to conduct an impairment test, which the
Board of Directors concluded is not required.

The price-to-book ratio, calculated by dividing the market price per share by
the carrying amount of the net assets per share was 0.3. This means that the
carrying value of the company’s net assets is greater than the market
capitalization of the company, which is an external indication of impairment.

Bohai’s ships were lying idle due to recession. There were not able to generate
revenues from these ships, which means that there is an adverse usage of the
asset and is an internal indication of impairment.

Bohai stated that there have not been any losses from the sale of ships which
were material in respect of 20X8 financial statements. However, there were
several cases where the loss relating to the disposal of the ship was 40% of the
carrying amount of the ship, which is a material amount and it points to the
fact that the value of the ships are in fact impaired.

Bohai has started negotiations with its creditors to defer payments of its debt
into 20X9 is also an indication that Bohai is facing difficulty in making
payments. This might be due to the adverse performance of the ships. This is
also an indication of impairment.
There has been an estimated 2% drop in the market value of the asset, which
definitely suggests an external impairment of asset.

All these factors point out to the fact that an impairment test should be done
for the company’s ships.

b. Whether it is acceptable for Bohai Co to recognize the additional deferred

tax asset of $5m in P/L rather than equity at 31st December 20X8:
 Deferred Tax in SOPL or OCI-
IAS 12: Income Tax states that deferred tax should be recorded in SOPL if the
transaction which leads to the creation of DT is recorded in SOPL. If the
transaction is recorded in OCI, the related DT should be recorded in OCI.

DTA can be recognized if it is probable that there will be taxable profits in the
future which can be used to offset the tax payments using the DT.

As per IFRS 9: Financial Instruments, the impairment loss on financial assets

should be recorded in SOPL. So, the DT arising as a result of the same should
be recorded in SOPL itself.

As at 31st December 20X8, there was a change in ECL allowance. As a result,

Bohai Co increased the amount of DTA assessed as recoverable from $25m to
$30m and recognized the increase in DTA of $5m in P or L is a correct
treatment.

 Offsetting of Deferred Tax Asset and Deferred Tax Liability

IAS 12 notes that deferred tax asset and liabilities can be offset as long as:
i) The entity has a legally enforceable right to set off the current tax
asset and current tax liabilities.
ii) The deferred tax assets and liabilities relate to the tax levied by the
same tax authority.
Even though Yuyan Co is located within the same tax jurisdiction as Bohai Co,
the DTL of Yuyan Co and the DTA of Bohai Co is not related to the same entity.
So, the company might not have the intention to settle the current tax asset
and the current tax liability of Bohai and Yuyan simultaneously. Bohai Co has a
legally enforceable right to offset its own tax assets and liabilities but not that
of its subsidiaries.
As a result, the DTL of Yuyan of $10m and the DTA of Bohai of $30m cannot be
offset, instead should be shown separately.

c. Accounting for the lease and non-lease component of the cruise ship
agreements in accordance with IFRS 15/16:
IFRS 16: Lease states that if a contract contains a lease and a non-lease
component, these should be separated using the standalone price and
recorded separately.

In this case, IFRS 16 is applicable since the lessee have the right to use of the
ship for a specified number of years in exchange for a rental fee. This part is a
lease component and should be recorded as per IFRS 15 and any revenue will
be recorded when the performance obligation is satisfied.

The total amount should be split between lease component and non-lease
component on the basis of standalone selling price.

With respect to principal-agent relationship, any amount generated by

principal by providing service to customers can be recorded in full by the
principal. However, agents can only record the commission.

Bohai is providing engine maintenance and cleaning of the cruise ship. These
are billed at a price agreed on the date when the lease is signed. These are
services which are directly provided by Bohai which means Bohai acts as
principal and can record the full amount as revenue when the performance
obligation is satisfied.

For some operational items such as fuel and food supplies, the customer an
enter into direct purchase agreement with the third parties at each port but
the third parties bill Bohai Co directly as Bohai Co arranges the port facility. In
this specific case, Bohai Co then recharges the costs to the lessee based on the
lessee’s consumption of goods plus a management fee.

In this case, Bohai is not providing the service to the customer directly, as it is
the third party providing it. Bohai Co is only acting as an agent and cannot
record the full amount as revenue. Instead, the commission i.e the
management fee can only be recorded as revenue
 IAS 21: Forex Question Practise
Q8) Hummings

Hummings Co is the parent company of a multinational listed group of

companies. Hummings Co uses the dollar ($) as its functional currency.
Hummings Co acquired 80% of the equity shares of Crotchet Co on 1 January
20X4 and 100% of Quaver Co on the same date. The group’s current financial
year end is 31 December 20X4.

Crotchet Co: functional currency

The head office of Crotchet Co is located in a country which uses the dinar as
its main currency. However, its staff are located in a variety of other locations.
Consequently, half of their employees are paid in dinars and the other half are
paid in the currency of grommits. Crotchet Co has a high degree of autonomy
and is not reliant on finance from Hummings Co, nor do sales to Hummings Co
make up a significant proportion of their income. All of its sales and purchases
are invoiced in grommits and therefore Crotchet Co raises most of its finance
in grommits. Cash receipts are retained in both grommits and dinars. Crotchet
Co does not own a dollar ($) bank account. Crotchet Co is required by law to
pay tax on its profits in dinars.

Required: how the functional currency of Crotchet Co should be determined.

(5 marks)

Ans) Functional currency is the currency of the primary economic environment

in which the entity operates. In order to determine the functional currency of
Crochet Co, certain primary factors are to be considered. They include:

i) The currency which influences the selling price of goods and services
ii) The currency of the country whose regulations determine the selling
price of goods and services
iii) The currency that affects material, labour and other costs of
providing goods and services.

In case primary factors are inconclusive, secondary factors are to be

considered, like:

i) The currency where funds from financing activities are generated.

ii) The currency where profits from operating activities are retained.

In the scenario:
 - Half of the staff is paid in dinars, and the other half is paid in grommits,
which suggests a mix.
- All of the sales and purchases are involved in grommits.
- Crochet Co raises most of its finance in grommits
- Cash receipts are retained in both grommits and dinars.

Since grommits satisfy most of the criteria mentioned above, grommits is the
functional currency of Hummings Co.

Refined Answer by ChatGPT:

Functional currency is defined by IFRS 21 as the currency of the primary

economic environment in which an entity operates. To determine the
functional currency, primary factors must first be evaluated:

1. The currency that influences the selling price of goods and services.
2. The currency of the country whose regulations determine the selling
price of goods and services.
3. The currency that affects materials, labour, and other costs of providing
goods and services.

If the primary factors are inconclusive, secondary factors may also be

considered:

1. The currency in which financing activities are conducted.

2. The currency in which operating cash flows are retained.

Analysis of Crotchet Co:

 Primary Factors:
o All of Crotchet Co's sales and purchases are invoiced in grommits,
indicating that the pricing and competitive forces align with this
currency.
o Labour costs are mixed, with half paid in dinars and the other half
in grommits, but this does not outweigh the dominance of
grommits in sales and purchases.
o The influence of regulations in dinars appears minimal, as
Crotchet Co's pricing is market-driven in grommits.

 Secondary Factors:
o Financing is predominantly raised in grommits, further supporting
its significance.
 o Cash receipts are retained in both dinars and grommits, but this is
secondary to the operational factors.

Conclusion:
Based on the analysis, the functional currency of Crotchet Co is grommits, as it
dominates the primary economic environment through sales, purchases, and
financing activities.
 IFRS 8 : Operating Segment
Q1) ChatGPT
Harmony Co is a diversified company engaged in multiple lines of business:

 A retail division operating in North America.

 A manufacturing division selling goods globally.
 A digital services division providing subscription-based services
worldwide.

Management evaluates each division’s performance based on revenue,

operating profit, and the allocation of resources. However, the digital services
division accounts for only 7% of total revenue and 8% of total assets.

Requirement:
Explain whether the digital services division should be reported as a separate
operating segment under IFRS 8.

Ans) an operating segment can be reported only when it satisfies one of the
three criteria: i) segmental revenue should be more than 10% of the total
revenue ii) segmental results should be more than 10% of the total profits or
losses, which ever is higher iii) segmental assets should be more than 10% of
the total assets. In this scenario, the digital services division accounts for only
7% of the revenue and 8% of the total assets, which means that this division
cannot be reported as a separate operating segment.

Refined Answer:

According to IFRS 8: Operating Segments, a segment must meet at least one of

the following quantitative thresholds to be reported as a separate operating
segment:

1. Its revenue is 10% or more of the combined revenue of all operating

segments.
2. Its reported profit or loss (absolute value) is 10% or more of the greater
of:
o Total combined profit of all profitable segments, or
o Total combined loss of all loss-making segments.
3. Its assets are 10% or more of the combined assets of all operating
segments.

In this scenario:
  The digital services division accounts for only 7% of total
revenue and 8% of total assets, which do not meet the quantitative
thresholds.

Conclusion:
As a result, the digital services division cannot be reported as a separate
operating segment under quantitative criteria. However, IFRS 8 allows
segments to be reported if management deems the information useful, or the
segment could be disclosed under "Other Segments" or aggregated with
others, depending on its materiality.

Q2) Crescendo Co operates in the following sectors:

1. Consumer electronics.
2. Home appliances.
3. Office furniture.

The company prepares its financial statements under IFRS and reports
segment information to its Chief Operating Decision Maker (CODM). Each
segment meets the quantitative thresholds, but the CODM suggests combining
home appliances and office furniture due to similarities in customer base,
production processes, and economic characteristics.

Requirement:
Determine whether the two segments can be aggregated under IFRS 8. Justify
your answer.

Ans) According to IFRS 8 Operating Segments, two or more segments can be

aggregated or combined together, if it has similar economic characteristics,
like: i) the nature of products or services ii) similar distribution processes iii)
similar class of customers iv) similar production processes v) if applicable, the
nature of regulatory environment. In this scenario, since home appliances and
office furniture have similar customer base, production process and economic
characteristics, both the operating segments can be aggregated according to
IFRS 8.

Refined Answer:

According to IFRS 8: Operating Segments, two or more operating segments

can be aggregated if they meet the following criteria:
 1. They have similar economic characteristics (e.g., similar margins or
growth trends).
2. They share similarities in:
o Nature of products or services.
o Distribution processes.
o Class of customers.
o Production processes.
o Regulatory environment (if applicable).

In this scenario:
Home appliances and office furniture have:

 A similar customer base.

 Comparable production processes.
 Shared economic characteristics.

Based on these factors, the segments meet the criteria for aggregation under
IFRS 8. The Chief Operating Decision Maker (CODM) has the responsibility to
evaluate and justify this aggregation.

Conclusion:
Both segments can be aggregated. However, the entity must disclose the
aggregation criteria and rationale in the financial statements, ensuring
transparency for users.

Q3) Dario Co has four divisions (A, B, C and D). Divisions A and B produce and
sell to third parties. Division A produces , generating 60% of Dario Co’s total
revenue. Division B produces allergy testing kits and sells them to pharmacy
wholesalers, generating 20% of Dario Co’s total revenue.

Division B’s long‐term average gross profit margin is significantly higher than
division A’s. Divisions C and D undertake research and development. Division C
does not provide any research and development services to third parties and
only conducts activities for divisions A and B. Division C does not generate
revenue from any internal or external source. It is purely a cost centre
operating from division D’s premises.

Division D performs contract investigation activities for other laboratories and

pharmaceutical companies. The external revenues of this division represent
20% of Dario Co’s total revenues.
The operating results for divisions A, B, and D are regularly reviewed by the
CEO. These results include separate divisional operating profit or loss
statements, from which operational decisions are made. The costings and
budgets for division C are also reviewed by the CEO.

There are four divisional heads who are directly accountable to the CEO and
these heads regularly discuss the operating activities including the research
and development activities, financial results, forecasts and plans for their
division.

The CEO is the chief operating decision maker.

Explain, in accordance with the principles of IFRS 8 Operating Segments,

whether divisions A, B, C and D should be treated as separate reportable
segments. Your explanation should cover:

 the definition of an operating segment

 the aggregation of operating segments, and
 the identification of reportable segments. (8 marks)

Ans) Definition of Operating Segments-

An operating segment is a component of entity:
i) which is engaged in business activities for which expenses are incurred and
revenues are generated
ii) the operating results are regularly reviewed by the chief operating decision
maker, who takes decisions for the resource allocation of the segments and
assesses their performance
iii) for which discrete financial information is available.

In this scenario:
Division A: Division A generates 60% of Dario’s total revenue, the operating
results are regularly reviewed by the CEO, and their financial statements are
available too. Division A meets the definition of an operating segment.
Division B: Division B produces testing kits which is a business activity,
generates 20% of Dario’s total revenue, the operating results are regularly
reviewed by the CEO and the financial statements are available too. Division B
meets the definition of an operating segment.
Division C: Division C does not generate any revenues, and is purely a cost
centre. Even though the CEO reviews the costing and budgets of Division C, it
does not generates any revenue. Division C does not meet the definition of an
operating segment.
Division D: Division D generates revenues that represent 20% of Dario’s total
revenues. The CEO regularly reviews the operating results and the financial
statements are discreetly available too. Division D meets the definition of an
operating segment.

Aggregation of Operating Segments-

Operating segments can be aggregated when they have similar economic
characteristics, like:
- Similar products and services
- Similar production processes
- Similar class of customers
- Similar distribution methods

In this scenario,
Although Division A and B sells similar products, the production process for
vaccines and allergy testing kits might be different. Also the type of customers
for these products are very different, being governments compared to
pharmaceutical wholesalers. Division A and B reports significantly different
long-term average gross margins, which suggest that they might not have
similar economic characteristics.
Therefore it would be inappropriate to aggregate Divisions A and B into
operating segments for reporting purposes.

Identification of Reportable Segments-

An operating segment can be reported, if they satisfy any one of the following
criteria:
- The segment revenue should be more than 10% of the total revenue
(segment + external)
- The segment results should be more than 10% of the total segments profits
or losses (in absolute terms) whichever is higher.
- The segment’s assets should be more than 10% of the combined assets of all
segments.

In this scenario, Division A (generates 60% of total revenue), Division B

(generates 20% of total revenue) and Division D (represents 20% of total
revenue) satisfies the 10% revenue criteria, which means that Division A, B and
D are reportable segments.
 IFRS 16 : Lease Questions
Q) On 1 January 20X1 Kappan’s E learn entered into a contract to lease a car
for three years. The lessor agrees to maintain the car during the three year
period. The total contract cost is $180,000. Kappan’s must pay $60,000 each
year with the payments commencing on 31 December 20X1. Kappan’s
accounts for non-lease components separately from leases. If contracted
separately it has been determined that the standalone price for the lease of
the car is $160,000 and the standalone price for the maintenance services is
$40,000. Kappan’s can borrow at a rate of 5% a year. Explain how the above
will be accounted for by Kappans in the year ended 31 December 20X1.

Ans) Recognition Criteria:

Kappans entered into a contract to lease a car for 3 years, which suggest that
this is a not short term lease, as this lease exceeds 12 months. This means that
Kappans will recognise a ‘right -of-use asset’ and a ‘lease liability’ in the
statement of financial position.

Segregation of Lease Components:

The contract includes both a lease component (for the car) and a non-lease
component (maintenance), which Kappans accounts for separately.

Statement of Financial Position:

Kappans will recognise a Right-of-Use Asset of $ and a lease liability of $ in the
financial statements. The lease liability will be further spilt into current liability
(which is the difference between current year lease liability and next year lease
liability) of $ and non-current liability (which is the balance) of $ .

Statement of Profit or Loss:

Kappans will recognise a depreciation charge of $ and an interest payment of $
in the statement of profit or loss.

IAS 40 – Investment Property

Q) Conseil, an investment property company, has been constructing a new cinema.
At 31 December 20X8, the cinema was nearing completion, and the costs capitalised
to date were:

$m

Materials, labour and subcontractors 14.8

Other directly attributable overheads 2.5

Interest on borrowings 1.3

The amount of borrowings outstanding at 31 December 20X8 in respect of this
project was $18 million and the annual interest rate was 9.5%.
During the three months to 31 March 20X9, in which the cinema was completed, the
following additional costs were incurred:

$m

Materials, labour and subcontractors 1.7

Other directly attributable overheads 0.3

Conseil adopts the IAS 40 fair value model; however, it was not able to measure the
fair value of the property reliably during the construction period and so measured it at
cost pending completion.
On 31 March 20X9, Conseil obtained a professional appraisal of the cinema's fair
value; the valuer's report put this at $24 million. The valuation fee for this appraisal
was $0.1 million; this has not been included in the above amounts for costs incurred
during the three months.
The cinema was taken by a national multiplex chain on an operating lease as at 1
April 20X9, and was immediately welcoming capacity crowds. In a complete
valuation of Conseil's investment properties at 31 December 20X9, the fair value of
the cinema was measured at $28 million.
Required:
Discuss the measurement of the cinema complex in the year ended 31
December 20X9.

Ans) Initial Measurement :

According to IAS 40, investment property will be measured at cost. Cost includes
purchase price and directly attributable costs. An investment property is a qualifying
asset within the scope of IAS 23 Borrowing Cost and therefore eligible borrowing
costs should also be recognized as part of the cost of the asset.

The total costs capitalized at 31.12.20X8 are $18.6 million. (14.8 + 2.5 + 1.3).
Although Counseil adopted IAS 40 fair value model, since fair value couldn’t be
measured reliably, they resorted to using the cost model itself, as the standard
allows to do so. Whilst the cost model is applied, it cannot be depreciated, since the
asset is not ready for its intended use.
Construction continues into 20X9 and therefore further costs, until the cinema is
complete increases the initial measurement. Directly attributable cost during these
three months are $2m. Borrowing costs on the specific loan to be capitalized are
$0.43m (18m x 3/12 x 9.5%). Any borrowing costs incurred after the completion of
the cinema will be recognized as finance cost in profit or loss.

Initial Measurement of the cinema :

Cost b/f on 01.01.20X9 18.6

Cost up to 31.03.20X9 (1.7 + 0.3 + 0.43) 2.43

Total (18.6 + 2.43) 21.03

On completion, the property must be measured at fair value, which is now estimated
at $24m. The increase of $2.97m will be shown as gain in SOPL.

Dr. Investment Property 2.97

Cr. Profit or Loss (Gain) 2.97

(Being increase from cost to FV)

The professional valuation fee does not bring future economic benefits to the entity,
so this will not be recognized as an asset, rather it will be shown as an expense in
SOPL. No depreciation will be charged as per IAS 40 Fair Value Model.

Subsequent Measurement :

On 31.12.20X9, the fair value of the cinema was measured at $28m, which leads to
a further gain, this will be adjusted accordingly in SOPL.

Dr. Investment Property 4

Cr. Profit or Loss (Gain) 4

(Being the increase in FV on subsequent measurement)

Q2) Conrad has owned an office building for a number of years, operating its sales,
marketing and finance departments from the property. The Board decided at a
meeting on 1 June 20X1 to promote flexible homeworking and as a result does not
need the office building. At this meeting the Board decided to rent the property out
under operating leases. It already holds other properties that it rents out and it
measured these at fair value. An office removal company emptied the last of
Conrad’s office furniture from the property on 1 August 20X1 and Conrad instructed
commercial property agents to market the property to prospective tenants on 31
August 20X1. On 1 June the property was held at depreciated cost of $450,000 and
had a useful life of 15 years left. At this date it was determined to have a fair value of
$820,000, which was unchanged throughout August. At 31 December 20X1 the
property had a fair value of $890,000.
Required:
Discuss how Conrad should account for the property in the financial
statements for the year ended 31 December 20X1.

Ans) The property is initially accounted for using IAS 16: Property, Plant and
Equipment, as they operated their sales, marketing and finance department from that
property, which shows that they conducted their production and supply of goods and
services (meets the definition of IAS 16). But on 01.06.X1, the Board held a meeting
and decided to rent out the property under operating leases as they have decided to
promote flexible homeworking and do not need the office building anymore. This
shows a change in use of the asset.

The Conrad Board decided to vacate the property and rent it out on 01.06.X1. IAS 40
is clear that a transfer to the investment property classification only takes place when
a property meets the definition of investment property and there is evidence of a
change in use. There is no evidence of change in use as of 01.06.X1, which means
the property still remains occupied and does not meet the definition of investment
property since it is used by Conrad for administrative purposes.

The transfer date of the asset was on 01.08.X1, which means from this point, the
asset will be now recognized under IAS 40: Investment Property, as the office
furniture was moved by an office removal company on this date. This shows that the
property is now ready for commercial/rental purposes and to earn capital
appreciation.

From 01.06.X1 to 01.08.X1, the asset was recognized using IAS 16. On 01.08.X1,
the value of the asset, after depreciation was $445,000 (450,000-(450,000/15*2/12)).
On the date of transfer, the fair value of the asset was $820,000, which means there
is a revaluation gain of $375,000 (820,000-445,000), which will be transferred to
Other Comprehensive Income.

Since Conrad adopted IAS 40 fair value model, no depreciation is charged on the
property from the transfer date to the reporting date. On 31.12.X1, the property is
again revalued at $890,000, which means the increase of $70,000 (890,000-
820,000) will be recorded as gain in Statement of Profit of Loss.

Q3) Tweedie operates in the leisure sector and holds a number of properties on a
long-term basis throughout the world. The management has identified an opportunity
to acquire a controlling shareholding in another company that will allow it to access
new markets and intends to issue new shares to raise the necessary funds.
In order to increase market confidence and ensure that the issue is successful,
Tweedie’s finance department has been instructed to adopt accounting policies that
maximise retained earnings and specifically to recognise all gains in its owned
properties in profit or loss and all losses in other comprehensive income. The
Finance Director has justified this by reference to a recent comprehensive IFRS
refresher course that she attended at which the importance of achieving fair
presentation was discussed. She feels that the overall trend in property prices is
upwards and therefore the suggested approach will result in fair presentation.
Required:
Discuss the suggested accounting treatment, referring to ethical
considerations.

Ans) It is not known what kind of properties that Tweedie owns, whether it is owner-
occupied, or an investment property.

If it is owner-occupied, the relevant standard is IAS 16, which permits measurement

of assets within a specific class at fair value using revaluation model. In this case,
any increase in fair value is recognised in OCI, and any decrease in fair value is
shown as a loss in SOPL.

If it is an investment property, the relevant standard is IAS 40, which permits the
measurement of assets based on cost or fair value model. Where the fair value
model is selected, properties are remeasured to fair value at the reporting date, and
any increase or decrease in fair value will be recorded as gain or loss in SOPL
respectively.

The suggested accounting treatment does not accurately reflect the requirements of
IFRS Accounting Standards correctly. It appears that the finance director is
motivated by the wish to increase market confidence in the company ahead of share
issue by maximising retained earnings. As a result, she has behaved unethically.

She should be aware of the fact that IAS 1 clarifies that this is presumed to be
achieved when the requirements of IFRS Accounting Standards are adhered to. The
finance director is bound by the Code of Ethics and should adhere to the
fundamental principles within it. This type of manipulation contravenes the principles
of objectivity, integrity and professional competence.

If pressured to comply with unethical policies, the finance director should document
concerns, escalate the issue internally and if necessary, seek professional advice
from ACCA.

Q. Gustoso
Gustoso Co (Gustoso) is a company which produces a range of luxury food
products. It prepares its financial statements in accordance with IFRS Accounting
Standards. Its financial year end is 31 December 20X7.
A new accountant has recently started work at Gustoso. She noticed that the
provisions balance as at 31 December 20X7 is significantly higher than in the prior
year. She made enquiries of the finance director, who explained that the increase
was due to substantial changes in food safety and hygiene laws which become
effective during 20X8. As a result, Gustoso must retrain a large proportion of its
workforce. This retraining has yet to occur, so a provision has been recognised for
the estimated cost of $2 million. The finance director then told the accountant that
such enquiries were pointless and that timewasting would not be looked at
favourably when deciding on future pay rises and bonuses. The new accountant is
aware that a director’s bonus scheme has recently been introduced in an attempt to
boost company profits. Directors will be entitled to a bonus if Gustoso's profits in the
year ended 31 December 20X8 exceed those in the year ended 31 December 20X7.
The new accountant and the finance director are both ACCA members.
Required: Discuss the ethical issues arising and recommend any actions that
the new accountant should take. Professional skills marks will be awarded for the
relevance of the ethical principles and actions identified.

A. According to IAS 37: Provisions, Contingent Liabilities and Contingent Assets, a

provision is a liability of uncertain timing or amount and will be recognized in the
financial statements, only if it satisfies the following criteria:
- The provision should have a present legal or a contractual obligation arising out of
a past event.
- There will be a probable outflow of economic resources for the settlement of
obligation
- The obligation can be reliably measured.
Applying this to the scenario, it can be seen that Gustoso’s financial director has
created a provision for an event that is happening in the future, which is a change in
the food safety and hygiene laws coming into effect only from 20X8. There is no
present obligation arising out of a past event. In such a case, the accountant should
de-recognize the provision of $2m, and the expense shown in the SOPL should be
removed.

Ethical Implications:
- The finance director’s decision to recognize a $2m provision lacks integrity and
objectivity. This was deliberately done so as to show a lower profit margin in 20X7,
and transferring this amount to next year would show a higher profit margin in 20X8,
which may lead to the director being eligible for a bonus. This constitutes a clear
self-interest threat.
- The finance director has also failed to correctly apply the principles of IAS 37, as
the legal obligation to retrain the workforce arises in 20X8 when the new laws have
become effective. The company has no present obligation at 31st December 20X7,
as the new laws are not in force. The provision is therefore a material misstatement
of the financial statements and the finance director has shown a lack of due care and
professional competence in its preparations.
- The finance director’s behaviour towards the accountant also seems highly
unprofessional and has a tone of intimidation, where the director intimidated the
accountant regarding the future pay rises and bonuses. This is a sign of intimidation
threat by the finance director.
- It is important that the accountant should ignore the threats of the director regarding
the pay rises and bonuses. If the director refuses to comply with accounting
standards, then it would be appropriate to discuss the matter with the audit
committee or the Chairman of the Board, as they are responsible for the governance
and oversight of the company’s financial reporting. The accountant may also seek
the professional help and advice from ACCA directly. Legal advice should be
considered if necessary. The accountant should keep a record of the conversations
and actions. Resignation should be considered if matters are not satisfactorily
resolved.

Q. Fernanda Co is a group which constructs industrial properties. In September

20X7, a section of the roof in a building constructed by Fernanda Co partially
collapsed, injuring 10 people. Production, which was taking place inside the building,
had to be stopped. However, no legal action had been brought against Fernanda Co
as at 31 December 20X7, as accident investigators were still trying to find out the
reason for the collapse. The investigators were assessing the responsibilities of the
various parties involved, with the report expected in February 20X8. The extent of
the damage and the details of any compensation payments to be made had not as
yet been determined. Fernanda Co felt that given the current stage of the
investigation into the accident, there was no requirement to record any liability in the
consolidated financial statements as at 31 December 20X7, especially as Fernanda
Co felt that any compensation payable would be covered by insurance.
Required: Discuss the acceptability of Fernanda Co’s decision not to record any
liability for the roof collapse in the consolidated financial statements for the year
ending 31 December 20X7.

A. According to IAS 37: Provisions, Contingent Liabilities and Contingent Assets, a

provision is a liability of uncertain timing and amount, and is recognized in the
financial statements only if it satisfies the following criteria:
- the provision should have a present (legal or contractual) obligation as a result of
past events.
- there is a probable outflow of economic resources for the settlement of obligation
- a reliable estimate of the obligation can be made
If these conditions are not met, a provision will not be recorded.
In this scenario, although the roof collapsed and injured 10 people, no legal action
was taken against Fernanda Co., as accident investigators were still trying to find the
reason for the collapse, which means that there was no present obligation. Since the
extent of damage and details of any compensation payments were not made, outflow
of economic resource is not probable, rather remote, and a reliable estimate has not
been made either. This means that a provision will not be recognized in the financial
statements, which means Fernanda Co. was right in not recording any liability on 31 st
December 20X7.
Since the investigation is still undergoing to determine the reliable estimate, a
contingent liability can be recorded as disclosure in the notes.

Q. Farham has a production facility which started to show signs of subsidence since
January 20X8. It is probable that Farham will have to undertake a major repair
sometime during 20X9 to correct the problem. Farham does have an insurance
policy but it is unlikely to cover subsidence. The chief operating officer (COO)
refuses to disclose the issue at 30 June 20X8 since no repair costs have yet been
undertaken although she is aware that this is contrary to international accounting
standards. The COO does not think that the subsidence is an indicator of
impairment. She argues that no provision for the repair to the factory should be
made because there is no legal or constructive obligation to repair the factory.
Farham has a revaluation policy for property, plant and equipment and there is a
balance on the revaluation surplus of $10 million in the financial statements for the
year ended 30 June 20X8. None of this balance relates to the production facility but
the COO is of the opinion that this surplus can be used for any future loss arising
from the subsidence of the production facility.
Required: Discuss the accounting treatment which Farham should adopt to address
this issue.

A. According to IAS 16, an asset will be tested for impairment when the carrying
value of the asset exceeds the recoverable amount (lower of fair value less cost to
sell and value-in-use). Before an asset is tested for impairment, the asset should
show some indication of impairment. Here, the production facility of Farham started
to show some signs of subsidence, which indicates that this is an internal indication
of impairment, and that the asset should be tested for impairment as well, but the
COO is wrong to think that subsidence was not a sign of impairment.

For performing the impairment test, the recoverable amount of the facility should be
calculated, which is the lower of the fair value and the value in use of the asset.
Here, the facility can be treated as a ‘cash generating unit’ and the impairment loss
calculated should be shown as an expense in the Statement of Profit or Loss.

The COO is right in arguing that no provision is required for repairs to factory,
because there is no legal or constructive obligation to do so. Although Farham has a
revaluation policy regarding PPE, and has a balance of $10m, this balance cannot
be used to net off the impairment loss that arises, because the production facility
does not come under the same class of assets as PPE, and the balance on the
revaluation surplus does not relate to production facility, which means that the
COO’s opinion of ‘using the surplus to net off any future loss’ is wrong.

The COO is deliberately trying to overstate the profit by not recording any expenses
related to impairment in the current financial year.

Q. At 30 June 20X8 Farham had a plan to sell its 80% subsidiary Newall. This plan
has been approved by the board and reported in the media. It is expected that
Oldcastle, an entity which currently owns the other 20% of Newall, will acquire the
80% equity interest. The sale is expected to be complete by December 20X8. Newall
is expected to have substantial trading losses in the period up to the sale. The
accountant of Farham wishes to show Newall as held for sale in the consolidated
financial statements and to create a restructuring provision to include the expected
costs of disposal and future trading losses. The COO does not wish Newall to be
disclosed as held for sale nor to provide for the expected losses. The COO is
concerned as to how this may affect the sales price and would almost certainly mean
bonus targets would not be met. The COO has argued that they have a duty to
secure a high sales price to maximise the return for shareholders of Farham. She
has also implied that the accountant may lose his job if he were to put such a
provision in the financial statements. The expected costs from the sale are as
follows:
$m
Future trading losses 30
Various legal costs of sale 2
Redundancy costs for Newall employees 5
Impairment losses on owned assets 8
Included within the future trading losses is an early termination penalty of $6 million
for a leased asset which is deemed surplus to requirements.
Required: Discuss the accounting treatment which Farham should adopt to address
this issue.

Q. Genpower is a company involved in the electricity generating industry. It operates

some nuclear power stations for which environmental clean-up costs can be a large
item of expenditure. The company operates in some countries where environmental
costs have to be incurred as they are written into the licensing agreement, and in
other countries where they are not a legal requirement. The details of a recent
contract Genpower entered into are:
A new nuclear power station has been built at a cost of $200 million and was brought
into commission on 1 October 20X7. The licence to produce electricity at this station
is for 10 years. This is also the estimated economic life of the power station. The
terms of the licence require the power station to be demolished at the end of the
licence. It also requires that the spent nuclear fuel rods (a waste product) have to be
buried deep in the ground and the area sealed such that no contamination can be
detected. Genpower will also have to pay for the cost of cleaning up any
contamination leaks that may occur from the water-cooling system that surrounds
the fuel rods when they are in use.
Genpower estimates that the cost of the demolition of the power station and the fuel
rod sealing operation will be $180 million in ten years’ time. The present value of
these costs at an appropriate discount rate is $120 million. From past experience
there is a 30% chance of a contaminating water leak occurring in any 12-month
period. The cost of cleaning up a leak varies between $20 million and $40 million
depending on the level of the contamination.
Extracts from Genpower’s draft financial statements to 30 September 20X8 relating
to the contract after applying the company’s normal accounting policy for this type of
power station are:

Statement of profit or loss $m

Depreciation (power station)

(10% × $200 million) 20

Provision for demolition and

sealing costs (10% × $180
million) 18

Provision for cleaning up

contamination due to water leak

(30% × an average of $30 million) 9

47

Statement of financial position

Property, plant and equipment

Power station at cost 200

Depreciation (20)

180

Non-current liabilities
Provision for environmental costs
($18 + $9 million) 27
Note: No contamination from water leakage occurred in the year to 30
September 20X8.
Genpower is concerned that its current policy does not comply with IAS
37 Provisions, Contingent Liabilities and Contingent Assets and has asked for
your advice.
Required: Comment on the acceptability of Genpower’s current accounting
policy, and redraft the extracts of the financial statements in line with the
requirements of IAS 37.